Solutions to GAAP: Graded Questions Fair value measurement
Solution 25.6
Fair value per IFRS 13 Fair value measurement is based on the notion of an exit price,
namely how much the asset could be sold for.
In this regard, it would be incorrect to leave the jet measured at its cost of C160 000, being
the amount that it would initially have been measured at. This is because Chokwa has chosen
to adopt the revaluation model to measure the jet, and thus leaving the jet measured at cost
would mean it was measured at an entry price (i.e. the cost to acquire the asset) instead of an
exit price (i.e. the selling price of the asset).
In measuring the exit price, the possible markets where the sale of the jet would take place
needs to be established. The key details of the three available markets are given below:
Three available markets: Northern Africa East Asia Western Europe
Selling price (given) C192 000 C160 000 C320 000
Chokwa’s 5% premium selling price C201 600 C168 000 C336 000
(C192 000 x 105%) (C160 000 x 105%) (C320 000 x 105%)
Future selling price after expected N/A (1) C240 000 N/A (1)
‘price correction’ (C160 000 x 150%)
Transaction costs C19 200 C16 000 C32 000
(C192 000 x 10%) (C160 000 x 10%) (C320 000 x 10%)
Market entry fee (given) C32 000 C32 000 C32 000
Transaction costs (given) C32 000 C16 000 C16 000
Average number of sales per annum 100 100 80
Comments:
(1) The price correction of 50% only relates to the East Asia market, as it is the result of the
Chinese government announcement. Thus, it would not be appropriate to apply the price
correction to the other two markets.
Principal market:
The principal market is defined as the market with the greatest volume and level of activity for
the asset. The Northern African and East Asian markets offer the greatest number of sales per
annum (both markets averaging one hundred sales per annum compared to the Western
European market). Since the Northern African and East Asian markets offer the same number
of sales per annum, either of these markets could potentially be the principal market.
However, for the principal market to exist, the other criteria of IFRS 13 need to be met. Since
the East Asian market is being subdued by Chinese requests to stop purchasing the jet, their
prices represent more of a liquidation transaction than an arm’s length transaction. Since the
East Asian market price represents a forced price, it is thus not representative of an orderly
transaction. Thus, the prices in the East Asian market do not meet the definition of ‘fair
value’.
Since the East Asian market does not meet all necessary criteria, the principal market is the
Northern African market.
© Service & Kolitz, 2020 Chapter 25: Page 7
Solutions to GAAP: Graded Questions Fair value measurement
Solution 25.6 continued…
Most advantageous market:
The most advantageous market is the market that maximises the selling price of an asset after
taking into account the transaction costs and transportation costs that market participants
would take into account. The determination of the most advantageous market, shown below,
shows that Western Europe is the most advantageous market as it maximises these net
proceeds at C240 000.
Northern Africa East Asia Western Europe
Selling price C192 000 C160 000 C320 000
Less transportation costs C32 000 C16 000 C16 000
Less transaction costs C19 200 C16 000 C32 000
(C192 000 x 10%) (C160 000 x 10%) (C320 000 x 10%)
Less market entry fee C32 000 C32 000 C32 000
Net proceeds C108 800 C96 000 C240 000
Fair value measurement:
As explained above, the C160 000 cost of the jet to Chokwa is an entry price and is therefore
not appropriate for an IFRS 13 fair value. Instead, an exit price must be determined.
The exit price of the jet is measured based on current market conditions in the principal
market, or if a principal market does not exist, then in the most advantageous market.
Since a principal market exists (the Northern African market), the measurement of the fair
value must be made based on exit prices in terms of this principal market (i.e. not in terms of
the most advantageous market). This is regardless of the fact that a higher amount would be
achieved in the Western European market.
Chokwa’s ability to increase the jet’s selling price is not used when measuring the fair value
because the 5% increase represents a characteristic of Chokwa and not of the asset being sold.
In other words, it is an entity-specific characteristic rather than a market characteristic.
The expected future selling price, (i.e. the prices that are based on the expectation that prices
will increase due to the East Asian market being artificially depressed or effectively ‘closed
down’), is not used for the measurement of the fair value because it is based on a hypothetical
future market reaction and not current market conditions.
Thus, the current selling price of C192 000 in the principal market (the Northern African
market) is to be used in the measurement of fair value because it is representative of market
conditions at measurement date.
For the sale to take place, the jet will be transported to North Africa at a cost of C32 000. This
cost is a transport cost that the market participants (i.e. those who would buy in the principal
market), would take into account in valuing the jet and would thus be taken into account when
measuring the fair value.
The transaction cost, being 10% of the selling price, is excluded from the fair value
measurement as it is a characteristic of how the asset is sold and not of the asset being sold.
Conclusion:
The fair value is therefore C160 000, being the C192 000 selling price in North Africa (i.e.
the principal market) less the C32 000 transport costs (C192 000 – C32 000 = C160 000).
© Service & Kolitz, 2020 Chapter 25: Page 8
