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The accountant's role in the bankruptcy valuation process.

Creditors, debtors, lawyers and accountants involved in the bankruptcy and reorganization process often rely upon appraisers. Appraisers are relied upon for a number of traditional asset, property and business interest valuation purposes. However, many accountants who rely upon appraisals may not be adequately familiar with the valuation process. In such instances, these accountants may give inappropriate instructions to the appraiser. They may misinterpret the quantitative valuation opinion or the written work product prepared by the appraiser. Or, they may simply underutilize the experience and expertise of the appraiser. That is, they may fail to take advantage of the full set of analytical skills and judgments professional appraisers can contribute to the bankruptcy and reorganization process.

This article will discuss some of the factors that parties in interest (i.e., appraisal clients) and their accountants should consider as part of the bankruptcy and reorganization valuation process. This article will outline some of the valuation issues specific to the bankruptcy appraisal process that accountants should be familiar with.

These issues are particularly relevant since business interests are often the largest asset in many corporate bankruptcies and reorganizations. And, debtors, creditors and their accountants often rely upon appraisals in property management, development, investment, financing and liquidation decisions. In fact, appraisals prepared during the bankruptcy process directly affect the disposition of many distressed properties.

Factors Specific to the Bankruptcy Appraisal


There are a number of factors distinguishing the bankruptcy appraisal process. These factors should be considered by the appraisal client (i.e., the party actually retaining the appraiser) and by their accountants. One factor is the unusually high degree of third party reliance placed upon the appraisal.

In many other circumstances, the appraiser and the client agree on the definition of the appraisal assignment. The appraiser prepares the analysis, concludes a valuation opinion and issues an appraisal report. The client then relies upon the appraisal report for various transactional or management information purposes. In these instances, the client has direct access to the appraiser. The client can challenge data, assumptions and premises upon which the appraiser relied. The appraiser is available to elaborate on and clarify the analyses and conclusions presented in the report.

In many bankruptcy and restructuring circumstances, the user of the appraisal report is not the appraiser's direct client. Rather, a number of third parties not directly related to the appraisal process - including accountants - may rely upon the appraisal work product in their financing, investment, management and judicial decisions. For example, creditors, debtors, investors, courts and others may rely, in part, upon the bankruptcy appraisal. These third parties may not have direct access to the appraiser. They may not be fully informed regarding the appraisal assignment. They may not be fully informed regarding the business interests subject to appraisal. And, therefore, they may misinterpret the valuation conclusions or the appraisal work product.

Foundation for the Appraisal

Clients, accountants and appraisers should both be cognizant of this degree of third party reliance with respect to bankruptcy appraisals. Because of this third party reliance, it is particularly important the appraisal client completely and accurately define the foundation for the appraisal (e.g, purpose and objective, definition of value, premise of value, etc.). It is equally the responsibility of the appraiser to develop a clear understanding of it before undertaking the assignment. All elements should be clearly delineated in the client engagement letter.

Transactional versus

Notational Appraisal

Another significant factor regarding bankruptcy appraisals is they are transactional - versus notational - in purpose. All appraisals are quantitative analyses based upon qualitative judgments. Notational appraisals are prepared for accounting or management information purposes only. A property sale transaction will not be consummated based upon the appraisal analysis or conclusion. An example of a notational appraisal may be the periodic valuation of a portfolio of real properties. The valuation may be performed to measure the appreciation or depreciation in the portfolio of properties (perhaps compared to a general real estate market index), however, no actual purchase or sale of a property is planned.

On the other hand, transactional appraisals are performed in anticipation of an actual property purchase or sale transaction. These appraisals may be used to establish a transaction price, to negotiate a transaction price, to obtain transactional financing, etc. In any event, an actual property transaction will be consummated based, in part, upon the appraisal. Due to their transactional nature, these appraisals usually involve greater documentation and substantiation than do notational appraisals. Clients, accountants and appraisers should understand the difference between transactional and notational appraisals when considering the bankruptcy valuation process.

Foundation of the

Bankruptcy Appraisal

There are several elements to the foundation of all appraisals used in the bankruptcy and reorganization process. These elements should be delineated in writing between the appraisal client and the appraiser. These elements should be specifically articulated in the valuation opinion report. And, these elements should be thoroughly understood by accountants and others before the appraisal is relied upon for investment, financing or other purposes.

The elements of the foundation of a bankruptcy appraisal include: * the objective of the appraisal * the purpose of the appraisal * the definition of value * the premise of value * the description of the property

subject to appraisal * the valuation date

Each of these foundation elements will be described briefly below.

Objective of the Appraisal

The objective of the appraisal clearly and concisely states the appraisal assignment. The objective of the appraisal will briefly identify the business interest subject to appraisal, the definition of value used in the appraisal and the "as of" valuation date. The objective of a bankruptcy appraisal may be more complex (and more difficult to accomplish) than appraisals performed for other purposes; nonetheless, the appraisal objective should still be stated in a simple declarative sentence. An example of an appraisal objective follows: "The objective of this appraisal is to determine the fair market value of the net assets of The Sleepwell Hotel Corporation, as of December 31, 1990."

Although it is in declarative form, the appraisal objective states the questions that the valuation conclusions answers. The individual components of the statement of appraisal objective will be described briefly below.

Purpose of the Appraisal

The purpose of the appraisal describes the intended use for the valuation conclusion and appraisal work product. The purpose of the appraisal indicates who is going to rely upon the appraisal and in what decision making context will the reliance be made. The purpose statement should also indicate (and limit, if appropriate) the degree of the appraiser's responsibility for any decision making based upon the results of the valuation. An example of the statement of appraisal purpose follows: "The purpose of this appraisal is to provide an independent valuation opinion that will be considered by the debtor in possession in his decision as to the appropriate sale price for the net assets of The Sleepwell Hotel Corporation." If there are multiple purposes for the appraisal, then each one should be listed in simple declarative form.

Accountants and other third party users should pay particularly close attention to the stated purpose of the appraisal upon which they are relying. If the stated purpose is different than the user's intended purpose, then the appraisal probably should not be relied upon. While the appraisal may accurately achieve its stated objective, it may incorporate a definition of value, a premise of value and an appraisal subject that is inconsistent with another appraisal purpose.

Definition of Value

The definition of value should be mentioned in the appraisal objective and then described in greater detail in a separate statement. To avoid confusion, professional appraisers do not refer to the word "value" alone, since "value" is imprecise and may lead to the erroneous conclusion that a property has only one value. The selection of the appropriate definition of value is an important part of the appraisal process. The definition of value should be agreed upon between the client and the appraiser before the assignment is undertaken. Indeed, the selection of the definition of value for a subject property will have a material impact on the valuation conclusion.

There are numerous alternative definitions of value. Some of the more common definitions of value include: * market value * fair value * use value * acquisition value * investment value * insurable value * assessed value * owner value

Each of these alternative types of property value may have application to the bankruptcy and reorganization process. Each of these alternative types of value have a specific and different definition. Accountants who are not familiar with each alternative definition should exercise caution before relying upon the appraisal work product.

Premise of Value

There are also several alternative premises of value that may apply in the bankruptcy valuation process. A premise of value is the overall conceptual framework through which the appraiser applies quantitative analysis and qualitative judgment to conclude on (or more) of the defined values listed above. As mentioned above, an appraisal may result in materially different valuation conclusions for the same property - depending upon which definition of value is applied. Likewise, an appraisal may result in materially different valuation conclusions for the same property - using the same definition of value - depending upon which premise of value is applied.

The four most common alternative premises of value are briefly explained, as follows:

Value in use, as Part of a going concern - this premise contemplates the contributory value of a property, as part of a mass assemblage of tangible and intangible assets, to an income producing business enterprise (e.g., a fully functioning franchised hotel).

Value in place, as part of an assemblage of assets - this premise contemplates the property is fully functional, is part of an assemblage of assets ready for use, but is not currently engaged in the production of income (e.g., a franchised hotel that is temporarily closed).

Value in exchange, in an orderly disposition - this premise contemplates the property will be sold, in its current assembled condition, with normal exposure to its appropriate secondary market, but without the contributory value of any associated intangible assets (e.g., a functional hotel but without a franchise, management or workforce that is sold in a normal willing buyer, willing seller environment).

Value in exchange, in a forced liquidation - this premise contemplates the property is sold piecemeal, in an auction environment, with an artificially abbreviated exposure to its secondary market (e.g., a functional hotel without any personal property or intangible assets is auctioned to the highest bidder).

Obviously, these alternative premises of value will affect the appraisal conclusion. In addition, these alternative premises of value each have direct application within a bankruptcy and reorganization environment within a bankruptcy and reorganization environment. In such an instance, the parties in interest may be keenly interested in the market value of our illustrative hotel under all four alternative premises of value.

Certainly, accountants and other users of appraisals should be aware of, and understand the subtle difference between, the alternative definitions of value and premises of value used in a particular appraisal. Definitions and premises appropriate to one decision making process may not be appropriate to another. Likewise, appraisers should unambiguously explain the definition and premise of value used in appraisals that may be relied upon in a bankruptcy environment.

Description of the Property

The description of the property subject to appraisal should, of course, be presented in the statement of appraisal objective. Also, the subject property should be more thoroughly described in the valuation opinion report.

Obviously, users need to know exactly what asset, property or business interest is the subject of the valuation. For example, with regard to The Sleepwell Hotel mentioned above, the appraisal user needs to know whether the valuation conclusion relates to the equity in the hotel corporation, the total assets in the hotel corporation, the net assets in the hotel corporation or the fee simple interest in the hotel property itself. Each of these business interests would be valid appraisal subjects for a bankruptcy appraisal. It is the responsibility of the appraiser to adequately describe the property subject to appraisal.

Typically, the description of the property will include a legal description, a common description and description of the actual condition of the property. In the case of real property, a legal description is made by reference to public maps, plats or other recorded information which exactly defines the boundaries and limits of the property by metes and bounds, government surveys or subdivision plat. A common description of the same property may include the name of the property and a standard street address, such as for example: The Sleepwell Hotel, located at the northwest corner of the Elm Street and Second Avenue intersection.

The description of the property should also include the actual physical characteristics (including evidence of deterioration and obsolescence) of the subject. This description of the actual condition of the property is important as it should explicitly confirm that the property is appraised in an "as is, where is" condition. If the property is appraised in any other condition than "as is, where is" (such as as improved" or "as completed"), then this hypothetical condition should be clearly revealed. And, any differences (including both valuation and physical differences) between this hypothetical condition of the property and the actual condition of the property should be clearly described.

Valuation Date

The last item that should be included in the appraisal objective is the valuation "as of" date. With regard to distressed properties, particularly with regard to business interests in a bankruptcy environment, the valuation date is an important factor to the user of the appraisal. Distressed property values may change materially in a relatively short timeframe. This is especially true if the distressed property is not adequately maintained or if the appropriate secondary market is becoming saturated with similarly distressed properties. Also, the values of properties subject to a reorganization environment may change fairly quickly. The impact of the reorganization may have a positive or a negative effect on the value of the subject business interest.

Therefore, it is incumbent upon the accountant to carefully note the valuation date. Appraisals not current may not accurately reflect current market conditions and may not be sufficiently reliable for investment or other decision making purposes. As mentioned above, this is particularly important due to the transactional nature of appraisals used in the bankruptcy process.

Traditional Bankruptcy

Appraisal Services

Appraisals of assets, properties and business interests are a routine part of the bankruptcy process. Appraisals are relied upon for such uses as: debtor-in-possession financing, restructurings, reorganization financing, out-of-court reorganizations and turnarounds. First, we will discuss several different types of traditional appraisal services. Second, we will explore the different types (or definitions) of property that may be subject to a traditional appraisal.

The authoritative text Appraisal Principles and Procedures(1) distinguishes between the terms appraisal, valuation, cost estimation and earnings forecast. Although these terms are often interchanged in a casual discussion of the appraisal process, the distinctions between these terms will augment our understanding of traditional appraisal services.

A valuation is the determination of the current market value, at a specified date, of the specified property rights encompassed in the ownership of the subject. A valuation involves the consideration of the appropriate secondary market and the reasonable types of buyers and sellers for the subject. A valuation normally is made by reference to actual transactional data involving properties of comparable character to the subject.

A cost estimation is an estimate of the amount of money that would be required, at a specified date, to construct, produce, replace, recreate or reproduce the subject. A cost estimation is made without regard to the ownership of the subject. A cost estimation normally is made by reference to an analysis of the utility, functionality, purpose and application of the subject.

An earnings forecast is an estimate of the prospective economic returns that may be derived from the ownership of the subject. An earnings forecast involves a projection of one or more measures of future economic benefits associated with the subject. An earnings forecast normally encompasses the analysis of the risk (or degree of uncertainty) of the projection of future economic benefits.

An appraisal is the stated result of a valuation, a cost estimation or an earnings forecast. Normally, an appraisal is based upon a synthesis of the conclusions of two or more of the procedures of a valuation, a cost estimation and an earnings forecast. According to Appraisal Principles and Procedures: "the word |appraisal' is thus a general term which includes valuation, cost estimation and earnings forecast..."(2) Accordingly, "it is correct to speak of an appraised value, an appraised cost, and an appraised earning power."(3)

In a bankruptcy environment, it is a common error to think of an appraisal as encompassing real estate (i.e., land and land improvements) only. However, and particularly in a bankruptcy environment, professional appraisers categorize all of the world into two categories of property with two options per category. These categories are: 1. Real and personal property. 2. Tangible and intangible property.

Accordingly, every asset, property, or business interest is defined by one of the following four cells in a two category by two option grid: tangible real property, intangible real property, tangible personal property, and intangible personal property.

Tangible real property is called real estate. In fact, the authoritative text, The Appraisal of Real Estate offers the following definition: "Real estate is the physical land and appurtenances including structures affixed thereto."(4) So, by definition, real estate is tangible and immobile. Examples of tangible real estate include land, buildings, pavement and infrastructures.

Intangible real property includes the interests, benefits and rights inherent in the ownership and/or use of physical real estate. Intangible real property represents a partial interest in the complete bundle of rights related to real estate ownership. Examples of intangible real property include leasehold interests, easements, air rights, land rights and water rights.

Tangible personal property is all other physical property not permanently part of or affixed to real estate. So, tangible personal property includes all physical assets that are movable. Therefore, personal property includes all of the rights of legal ownership not related to the rights of real estate ownership. Examples of tangible personal property include machinery and equipment, merchandise inventory, works of art, books, jewelry, yachts and automobiles.

Intangible personal property includes the interests, benefits and rights inherent in the ownership of and/or use of the physical personal property. Leases or other assignments of rights to use tangible personal property are called chattels personal. Intangible personal property represents a partial interest in the complete bundle of rights related to tangible personal property. Examples of intangible personal property include franchise agreements, trademarks and trade names, management agreements and contracts plus a trained and assembled workforce.

In a bankruptcy environment, it is important to properly classify all appraisal subjects into the right categories for several reasons (each of which affect a property's value): 1. Different categories of assets are

subject to differing ad valorem

property tax treatment 2. Different categories of assets are

subject to differing accounting

and income tax treatment 3. Different categories of assets may

be subject to differing security or

collateral debt agreements 4. Different categories of assets may

be subject to differing insurance

protection 5. Different categories of assets may

be subject to differing sale, transfer,

or liquidation restrictions 6. Different categories of assets

transfer in their own secondary

markets and should be appraised

with consideration to their respective


Accordingly, in the traditional bankruptcy valuation process, the appraiser will first categorize the subject property according to its real versus personal characteristics and to tangible versus intangible characteristics.

Second, the appraiser will perform a valuation, a cost estimation and/or an earnings forecast. Based upon a synthesis of the results of two or more of these procedures, the appraiser will conclude the specified value of the subject business interest as of a specified date. That valuation conclusion, then, is "the appraisal" of the subject business interest.

Nontraditional Bankruptcy

Appraisal Services

In addition to the traditional appraisal services listed above, professional appraisers have experience and expertise that may serve debtors, creditors and their accountants with a wide range of insolvency and troubled debt analyses. The skills and judgment of professional appraisers serve the needs of various parties in interest in areas such as the following: * restructuring strategies for recovery

of business value * creation of troubled business

workout plans * assessment of troubled business

workout plan feasibility * identification of asset or business

spinoff opportunities * valuation of asset or business

spinoff opportunities * valuation of adequate protection

plans * valuation of claims for purchase

or sale * fraudulent conveyance analyses * reorganization, recapitalization

and restructuring analyses

Professional appraisers can often assist business owners and their accountants both before and after they reach reorganization status. Appropriately experienced appraisers can serve the informational, analytical and assessment needs of debtors in possession, of secured and unsecured creditors, and even of their accountants. These analyses are designed to identify - and maximize - all of the elements of business value (both tangible and intangible), to the benefit of all parties in interest to the reorganization.

These types of appraisal assignments are often called evaluations (as opposed to valuations) in the appraisal literature. The Appraisal of Real Estate states:

"In evaluation assignments, current market activity and evidence provide the basis for a conclusion other than a specified value conclusion. For both valuation and evaluation assignments, the conclusion is derived by appropriate data analysis in conformity with standards of professional practice."(5)

Appraisal Process in the

Bankruptcy Environment

Of course, most appraisal procedures remain unchanged whether or not the property (or the property's owner) is involved in a bankruptcy proceeding. This discussion will relate exclusively to those procedures that require special attention during the bankruptcy-related real estate appraisal process.

The first step in the bankruptcy appraisal process is to specifically identify and categorize all of the assets encompassed by - and associated with - the subject business. This involves the categorization of real versus personal properties and tangible versus intangible properties described above. While this step is relevant to all appraisals, it is particularly important to appraisals performed in a bankruptcy environment. While all of these property categories may be included in the appraisal subject, the different categories of property may be sold separately (and within their own respective secondary markets) in an actual market transaction involving the subject. A bundle of assets - and a bundle of property rights - are often sold collectively in a non-bankruptcy transaction; in a bankruptcy environment, the bundle of assets - and the bundle of property rights - may be sold separately. These separate transactions may be part of an overall plan of reorganization. Or, these separate transactions may simply be the strategy that maximizes the total value of the subject - a common goal for the business owner and the other parties in interest to the bankruptcy.

The second step in the bankruptcy appraisal process is to specify the definition of value and premise of value appropriate to the appraisal assignment. Obviously, the definition and premise of value should be described in every appraisal. However, in a bankruptcy appraisal, there may be several widely used descriptions for the same definition and premise of value. These different descriptions may have a material impact on both the valuation conclusion and on the utility of the appraisal to the parties in interest.

For example, most appraisal users believe they have a fundamental understanding of the term "market value." This term is loosely defined in every appraisal that concludes a "market value." However, in a bankruptcy environment, the following subtle ambiguities in the definition of "market value" can materially impact the stated valuation conclusion: 1. Value on an all-cash basis or value

with non-cash-equivalent financing

terms 2. Value of specified property rights

versus fee simple estate 3. Value as the most probable price

or as the highest price 4. Value in an equilibrium market

versus value in a depressed market

Each of these subtle concepts regarding a bankruptcy "market value" will be discussed briefly.

Normally, market value is quantified on a cash equivalency basis. However, many distressed businesses or businesses sold out of bankruptcy are sold with financing terms. Certainly, financing terms that are not equivalent to cash affect the value of the property. However, if such financing terms are the norm for distressed properties or properties sold out of bankruptcy, then;including the affect of these terms is appropriate to market value. These financing terms reflect the normal activity of the collective market for such properties - i.e., market value.

In theory, the market value of real estate is derived from the appraisal of some specified rights in the subject property, not in the valuation of the physical tract of real estate. Normally, the specified rights that are encompassed in market value is the fee simple estate. However, this may not be the bundle of rights that exist with a property in bankruptcy. In such instances, the specified rights that are transferable in the subject property are the as-leased estate, the as-mortgaged estate or some other interest in the real estate. These are the specified rights, then, that should be encompassed in market value.

Market value, in most appraisals, connotes the actions of numerous willing buyers, of numerous willing sellers, and of enough product to satisfy market supply and demand. Under these conditions, it is possible to estimate a mean or median price or some other mathematical expectation of the most likely transaction price. In a bankruptcy environment, however, appraisal users are not concerned with the most probable price that the subject property may sell for. Rather, business owners, investors and their advisors are concerned with the highest price that the property will sell for, under a set of specific conditions. This highest price, then, is the market value for the subject property (because the property seller will seek, and hold out for, this highest price).

Conceptually, market value is the price a property would sell for when supply and demand are in balance. This condition assumes market equilibrium. The market for distressed businesses or businesses in bankruptcy is not always in equilibrium. More often than not, there is a much greater supply of these businesses than there is demand for these businesses interests. This disequilibrium of product supply and demand directly affects the expected transaction price of each business that is offered for sale in this environment. Business owners, investors and their advisors are concerned with the price that the subject business will fetch in the market in which it is offered, albeit a disequilibrium market. This price, then, represents the market value of the subject business.

Likewise, the description of the premise of value should be both specific and appropriate to a bankruptcy appraisal. Obviously, a premise of value in use, as part of a going concern would not be a meaningful premise if the business is not a going concern business. In a bankruptcy environment, business owners, investors and their accountants are only concerned with the premise of value that is representative of the most likely disposition of the business.

Valuation Approaches in the

Bankruptcy Environment

In any environment, the three traditional approaches to value are the starting point for any appraisal. However, in a bankruptcy environment, there are several specific factors that should be considered by the appraiser with regard to the application of the cost approach, the market approach, and the income approach. These factors will be described briefly.

The cost approach implicitly assumes that a willing buyer can earn a fair return on the cost investment in the property. (This is true whether cost investment is defined as depreciated replacement cost, depreciated reproduction cost, or any similar measure.) But, this assumption is not always valid in the case of a property in a bankruptcy environment. Especially in such an environment, the appraiser should carefully identify and quantify all elements of functional obsolescence and economic (or external) obsolescence that relate to the subject property. The functional obsolescence of the property may be one reason the property is in bankruptcy. Almost by definition, property in bankruptcy is not generating an adequate rate of return to the property owner. Therefore, substantial amounts of economic obsolescence may exist.

In quantifying the obsolescence factors to apply in the cost approach, the appraiser should distinguish between those factors that are intrinsic to (or directly related to) the business interest itself and those factors that are associated with the current ownership or management of the property. For example, a hotel chain or a retain chain may have filed for bankruptcy. There may be many causes for this filing, including inefficient or ineffective business management. However, the owned properties of these failed businesses may be intrinsically sound. Unless the location, use, design or specifications of the property contributed to the business failure, the cost approach value of the real estate should not be penalized due to bankruptcy of the property owner. Therefore, appraisers should consider the reasons for and causes of the bankruptcy in order to determine the effect, if any, on the subject property value.

The market approach implicitly assumes that there are willing buyers and a willing seller for the subject property. This approach also assumes that all market participants have unrestricted access to relevant data regarding the subject property. And, the use of this approach assumes that appraisers can obtain adequate reliable data regarding arm's length transactions of comparable properties. In a bankruptcy appraisal, these conditions do not always exist.

First, the appraiser will consider the likely types of buyers for the subject property. This consideration of likely buyer motivations will help the appraiser focus on the dynamics of the subject distressed property within its bankruptcy environment.

Second, the appraiser will select criteria for the selection of, and analysis of, sales transactions of comparable properties. These criteria should consider the bankruptcy status of the subject property. Presumably, the most comparable properties were in a similar status during their exposure to the market.

Third, the appraiser will obtain, confirm and "purify" comparable property transactional data. This purification process may include adjustments after an analysis of each comparable transaction. These adjustments may relate to special financing terms and conditions, the purchase price allocation between all assets, the granting of a noncompetition agreement as part of the sale, the granting of seller or third party guarantees, the granting of third party business concessions and any special transaction conditions imposed by the bankruptcy court or the creditors committee to approve the comparable transaction.

The appraiser should be aware of all of the special transactional conditions and make appropriate adjustments in the comparable data before selecting valuation multiples. As part of this data purification process, the appraiser will assess the dynamics of the relevant market for the subject property. For example, the appraiser will decide whether cash equivalency analyses are appropriate - or whether special financing terms represent the "normal" market for the subject property.

The income approach implicitly assumes that a stream of predictable income can be associated with a subject property. This approach assumes that a capitalization rate, based upon stakeholders' required rates of return, can be quantified and associated with the property's income stream. In a bankruptcy environment, both of these assumptions deserve examination.

The first challenge in the bankruptcy appraisal is quantifying the subject property's income stream. A distressed property may not be generating any income at all. A property in bankruptcy may be generating negative income (defined as almost any measure of economic performance). Certainly,the appraiser will have to assess how much income (if any) is being generated by the subject property. In addition, the appraiser will have to assess how much income (if any) will be generated by a typical willing buyer of the subject property. This latter assessment is intended to filter out any decremental income effects associated with a current inefficient or ineffective property owner. This latter assessment may also filter out the incremental costs (and decrement to value) associated with the bankruptcy filing itself (e.g., legal, accounting, administrative, etc. costs).

Clearly, the appraiser will analyze where the subject property is in its respective business cycle before making an income estimate. Given this analysis of the business cycle and the bankruptcy environment in which the property operates, the appraiser will decide how long the reasonable projection period may be for a yield capitalization. Given these conditions, the appraiser will decide what is the appropriate measure of normalized income (i.e., what's "normal" for the subject property?) for a direct capitalization analysis.

The second challenge in the bankruptcy appraisal is quantifying the appropriate capitalization or discount rate. In addition to considering what type of buyer would invest in the subject property, the appraiser will consider what type of financier will lend against the purchase of the property. This consideration of likely lender motivations will help the appraiser focus on the dynamics of the financing market and the expected costs of capital for the subject property.

In addition to the traditional calculation of the costs of debt and equity capital, the appraiser will consider and will quantify - the risk premia that stakeholders (both debt and equity investors) will require for investing in a distressed property or a property in bankruptcy. The data for this analysis will be derived from comparable property transactional analysis and from current investor expectations for similarly situated properties.

Valuation Synthesis

In a bankruptcy appraisal, as in an appraisal for any other purpose, the appraiser will perform a synthesis of the results of the valuation approaches and prepare a final valuation conclusion. This synthesis will be influenced by the quantity and quality of data available for each approach and by the appraiser's confidence (based upon experience and judgment) in the quantitative and qualitative analyses.

Nonetheless, appraisers realize that both the analyses and the conclusions of bankruptcy appraisals must be more practical and less theoretical than appraisals performed for other purposes. Unlike notational values, the transactional values presented in a bankruptcy appraisal may be verified very quickly - if the property is placed on the market and actually sold. In a bankruptcy environment, business owners, investors and their accountants are not so much interested in what a willing buyer would be to a willing seller for a business like the subject; they are interested in the expected current selling price for the particular business in its particular market.


Professional appraisers can assist parties in interest with a variety of traditional valuation services related to the bankruptcy and reorganization process. In addition, many professional appraisers have skills and expertise to assist business owners and their accountants with a wide array of insolvency and troubled property assessment and analytical services.

This article has discussed some of the special factors that affect the appraisal process in a bankruptcy environment. We presented some of the special factors that appraisers will consider in the application of traditional valuation approaches to a property in bankruptcy.

This article also discussed the foundation elements of a bankruptcy appraisal. Due to space constraints, we have not considered the valuation approaches and methodologies to use with regard to various types of assets, properties or business interests. We have also not considered the appropriate qualifications for professional appraisers or the appropriate contents of a valuation opinion report. Accordingly, accountants should exercise due judgment and prudence in evaluating these aspects of the bankruptcy property appraisal.


(1) x

(2) Ibid, page 3.

(3) Ibid, page 3.

(4) X

(5) Ibid, page 12.

Robert F. Reilly, MBA, CPA, CMA, CME, ASA, CREA, ATA, is the president and managing director of Willamette Management Associates, a firm specializing in valuation consulting, security analysis and financial advisory services, in Chicago, Illinois. He has published more than 200 articles on valuation related topics.
COPYRIGHT 1992 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Reilly, Robert F.
Publication:The National Public Accountant
Date:Jun 1, 1992
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