115. The adjusted net asset method involves deriving the fair value of a business by reference to the fair value of its assets and liabilities. This method is likely to be appropriate for a business whose value derives mainly from the holding of assets rather than from deploying those assets as part of a broader business. Examples of such businesses are property-holding companies and investment companies.
116. This method might also be appropriate for a business that is not making an adequate return on assets or that is making only marginal levels of profits because it is in the very early stages of its development (eg an entity that has virtually no financial history, no developed product or a small amount of invested cash).
117. The adjusted net asset method requires an investor to measure the fair value of the individual assets and liabilities recognised in an investee‘s statement of financial position as well as the fair value of any unrecognised assets and liabilities at the measurement date. The resulting fair values of the recognised and unrecognised assets and liabilities should therefore represent the fair value of the investee‘s equity capital. Depending on the measurement method that the investee has used to
24 The discount rate considered in this formula has been presented with only one decimal point. The enterprise value has been computed with a discount rate of 8.9142%.
measure its assets and liabilities, and depending on whether they are recognised in the statement of financial position, the assets and liabilities that are most commonly subject to adjustments are as follows (the list is not exhaustive):
intangible assets (recognised and unrecognised);
property, plant and equipment (eg land and buildings);
receivables, intercompany balances;
financial assets not measured at fair value; and
unrecognised contingent liabilities.
118. Because the adjusted net asset method results in the valuation of a controlling interest, an investor must consider the need for applying a minority interest discount when measuring the fair value of a non-controlling equity interest if the investor has concluded that there is a benefit associated with control. An investor must additionally consider the existence of other factors that might result in the need for an adjustment such as:
lack of liquidity (see paragraphs 60–63);
significant time elapsing between the reporting date and the measurement date. Adjustments would consider the effect of additional investments in assets, subsequent changes in the fair value of the investee‘s underlying assets, incurring additional liabilities, market changes or other economic condition changes; and
any other facts and circumstances. For example, an investor measuring the fair value of an unquoted interest in a fund must consider whether, for example, potential performance fees have been recognised appropriately in the fund‘s net asset value. The investor must also consider any features of the fund agreement that might affect distributions, but that are not captured in the net asset value.
119. Example 24 illustrates the application of the adjusted net asset method.
Example 24—Adjusted net asset method
An investor has a 10 per cent non-controlling equity interest in Entity X, a private company. There is no controlling shareholder for Entity X, which is an outsourcing services provider for its shareholders, including the investor. Entity X‘s sales depend on its shareholders‘ business activities and, as a result, Entity X does not have its own growth strategy. Entity X additionally has a very low profit margin and it does not have comparable public company peers.
The investor needs to measure the fair value of its non-controlling equity interest in Entity X as of 31 December 20X1 (ie the measurement date). The investor has Entity X‘s latest statement of financial position, which is dated 30 September 20X1. The following are the adjustments performed by the investor to the latest statement of financial position of Entity X:
- Entity X‘s major asset is an office building that was acquired when Entity X was founded 25 years ago. The fair value of the building was measured by a valuation specialist at CU2,500 at the measurement date. This value compares to a book value of CU1,000.
- During the three-month period from 30 September 20X1 to the measurement date, the fair value of Entity X‘s investments in public companies changed from CU500 to CU600.
- The investor observes that Entity X measures its current assets and current liabilities at fair value.
The volume of operations of Entity X is so flat that the investor estimates that the amounts of the current assets and current liabilities shown in Entity X‘s statement of financial position as of 30 September 20X1 are most representative of their fair value at the measurement date, with the exception of an amount of CU50 included in Entity X‘s trade receivables that became unrecoverable after 30 September 20X1.
- On the basis of Entity X‘s business model and profitability, the investor estimates that unrecognised intangible assets would not be material.
- The investor does not expect that Entity X‘s cash flows for the quarter ended 31 December 20X1 are material.
- The investor does not expect any major sales of assets from Entity X. As a result, it concludes that there are no material tax adjustments that need to be considered when valuing Entity X.
The adjustments described above are reflected in the adjusted statement of financial position shown below.
Before considering any adjustments (eg discount for the lack of liquidity, minority interest discount), the indicated fair value of the investor‘s 10 per cent non-controlling equity interest in Entity X is CU405 (10% x CU4,050 = CU405). For the purpose of this example, it has been assumed that the discount for the lack of liquidity amounts to CU40 and that the minority interest discount amounts to CU80.
On the basis of the facts and circumstances described above, the investor concludes that the price that is most representative of fair value for its 10 per cent non-controlling equity interest in Entity X is CU285 (CU405 – CU40 – CU80 = CU285) at the measurement date.(*)
(*): The process shown above is not the only possible method that an investor could apply to measure the fair value of its non-controlling equity interest. As a result, the adjustments above should not be considered to be a comprehensive list of all applicable adjustments. The necessary adjustments will depend on the specific facts and circumstances. In addition, the amounts of the adjustments above are not supported by detailed calculations. They have been included for illustrative purposes only.