Michael B. Lehner, CPA/ABV, CFE, ASA
732-412-3825
MLehner@zbtcpa.com
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Hunting for buried treasure — or traps – Hidden assets and liabilities may affect business value

Hidden assets

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Hidden assets and liabilities may affect value

To determine what a business is truly worth, appraisers must consider many aspects of its operations — from management, to products, to the health of its industry. They also need to look beyond the balance sheet, seeking any hidden assets or liabilities that may affect value and bringing them to light.

Whether in divorce matters or other kinds of litigation, appraisers often need to search for unusual, nonrecurring events in a company’s financial statements. Such searches can provide a clearer picture of the company’s normal operations and help ensure the numbers better reflect reality.

Unearth hidden assets

An appraiser starts with the line that reports total net worth on a company’s balance sheet. That’s the upfront part of the equation. From there, the appraiser hunts for unrecorded liabilities or contra assets, such as those with a negative credit balance. Here are several areas to examine:

Uncollectible receivables. Customer and factory receivables — those related to warranties and incentives — make up a significant portion of many companies’ total receivables. Holding items on the books that are overaged, and that the business is unlikely to collect, misrepresents its overall financial picture.

Management should review accounts receivable regularly to determine which accounts they probably won’t collect, and then adjust the allowance accordingly. The result after the adjustments is the net realizable value of the receivables.

Inventories. Of course, inventories make up an important part of many companies’ net worth. The prevalent use of the last-in, first-out (LIFO) method for valuing inventories could result in undervaluation if proper adjustments aren’t made. Thus, it’s usually proper to adjust inventory in accordance with the first-in, first-out (FIFO) method.

Fixed assets. For book purposes, companies may record depreciation on fixed assets (such as furniture, fixtures, tools and equipment) in several ways. Net book value, for instance, will usually differ drastically from the actual fair market value. This difference would alter the business’s net worth. The appraiser compares the net book value of a company’s fixed assets with their fair market value.

 

Fine-tune the value

After a valuator makes a preliminary estimate of a company’s value, he or she considers additional fine-tuning. Before finalizing the conclusion, the valuator assesses exactly what the preliminary value estimate includes. If anything is missing, the valuator makes a last-minute alteration.

Common last-minute alterations include changes to:

  • Excess/deficit working capital (compared with the company’s operational needs),
  • Contingent or unrecorded assets and liabilities,
  • Nonoperating assets, and
  • Real estate (if most industry participants rent their facilities).

When making last-minute adjustments, a valuator also adjusts the earnings for any income or expenses these assets or liabilities generate, including any tax benefits or consequences.

Dig up the truth

Digging up hidden assets and liabilities will likely lead to a fairer presentation of a business’s true value. To make the appropriate adjustments, an appraiser needs to perform detailed analysis and have a good overview of the company’s current and future operations.

Sidebar: Detecting fraud

In marital dissolution cases, valuators may have to watch out (and adjust) for spouses trying to dissipate their businesses’ values. For instance, the moneyed spouse may attempt to hide business assets, delay revenue recognition or overstate expenses.

A lower bottom line benefits a moneyed spouse in two ways. First, to the extent that a company’s value is based on its earnings, reduced income lowers value. Therefore, low profits increase a moneyed spouse’s share of the marital estate’s remaining assets. Some moneyed spouses will even hide physical assets or use fraudulent accounting tactics to lower profits reported before their divorce.

Of course, the nonmoneyed spouse has less experience and knowledge of the business, and such a charge may be baseless. But to determine whether the claim is justified or is completely without merit, valuation — and forensic accounting — expertise is essential.

Michael Lehner


This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations.