•Chapter 2
•Fair value measurement
• Prepared by
• MOHAMMED A.
List of Applicable IFRS
Topic List Standards
Financial Instruments IFRS 9
Property, Plant and Equipment IAS 16
Investment Property IAS 40
Intangible Assets IAS 38
Agriculture IAS 41
Business combination IFRS 3
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The objective of IFRS 13
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The objective of IFRS 13
IFRS 13 establishes how to measure fair value. It does not
prescribe:
what should be measured at fair value;
when to measure fair value (i.e. the measurement date); or
how (or whether) to account for any subsequent changes in
fair value (e.g. in profit or loss or in other comprehensive
income).
Apply IFRS 13:
When another IFRS requires or permits fair value
measurements or disclosures about fair value measurements
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• The NEW definition of fair value in IFRS 13 is as follows:
Definition
“...the price thatofwould
fair value
be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date.”
• The exit price is defined as:
“...The price that would be received to sell an asset or paid to
transfer a liability”
• The exit price is based on the perspective of the holder
• The exit price is based on expectations about future cash flows
generated by the asset subsequent to its sale
• These cash flows may be generated from use of the asset by the
acquiring entity or its sale by the acquiring entity
• Similarly, an entity might intend to hold a liability until
settlement – its fair value is based on expected cash outflows by
Who would transact for the item?
• Market participants are buyers and sellers in the principal
(or most advantageous) market who are:
• independent from each other (not related parties)
• knowledgeable about the asset or liability
• have the ability to enter into the transaction
• willing to transact and not be forced or compelled
• Market participants act in their economic best interest
Maximise the value of the asset
Minimise the value of the liability
Orderly transactions
• Excludes sales made under liquidation or “fire sale” conditions
• Orderly implies a ‘period for marketing’ that is customary for such an
asset prior to the transaction date
• Excludes non-arms length sales
• Fair value: market participant perspective application guidance:
how to measure fair value
• To measure fair value determine:
all characteristics of the asset or liability being measured (exclude
things that are not characteristics of the asset or liability);
for non-financial assets, the valuation premise & the highest and best
use;
the principal (or most advantageous) market;
the appropriate valuation technique/s and inputs that market
participants would use when pricing the asset or liability and the level
of the fair value hierarchy within which the inputs are categorised 7
• characteristic of an asset or liability
• Fair value measurement is for a particular asset or liability
it captures all characteristics of the asset or liability
being measured that market participants would take into
account when pricing the item
–Location
–age and remaining economic life
–Condition
–restrictions on use or sale that are a characteristic of
the item
• it excludes things that are not characteristics of the asset
or liability
transactions costs
restrictions on use or sale that are not a characteristic
of the item
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Transaction and transport costs
Description Included in fair
value?
Transaction The costs to sell the asset No (Although they are
or transfer the liability that considered in the
costs are directly attributable to assessment of which market
the disposal of the asset or is most advantageous)
the transfer of the liability They are a characteristic of
the transaction, not of the
asset or liability
Transport The costs that would be Yes Transport changes a
incurred to transport an characteristic of the asset
costs asset from its current (its location)
location to its exit market Transport costs are
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deducted to calculate the
fair value
Elements of the definition – Example
5.1
• An entity sells asset XYZ in • IF we sold the asset, net
markets, including Market B proceeds would be $23
• In Market B • Compare this amount to
• Price = $26 other markets
• Transaction Costs = $2 • If $23 is the highest amount,
• Transport costs = $1 Market B is the principal
• How do we determine the market
principal (ie the most (you must consider both
advantageous) market? costs)
• What is the Fair Value? • Fair value is $25
• FV is adjusted for transport
costs only
Fair value: which market? test your understanding:
transaction costs
Example: FV Company has an asset that is sold in two different
markets, Market A and Market B, with similar volumes of activities,
but with different prices. FV Company enters into transactions in both
markets and can access the price in those markets for the asset at the
measurement date. There is no principal market for the asset.
Information from both markets is presented as follows.
Market A Market B
Price Br. 30 Br.28
Transport costs (5)
(4)
Br. 25 Br.24
Transaction costs (3) (1)
Net amount received Br. 22 Br.23
• How should FV Company measure the fair value of the asset? Or how
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much is the fair value of the asset?
Where would the transaction take place?
Fair value is the price in the …
Or, if no principal market, the
Principal market
most advantageous market
The market with the greatest volume The market that maximises the amount
and level of activity for the asset or that would minimises be received to
liability sell the asset and the amount that
would be paid to transfer the liability
• In most cases, these markets will be the same
arbitrage opportunities will be competed away
• The entity must have access to the principal (or most
advantageous) market
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Fair value: which market?
Determining the principal market
The following three markets exist for Sugar Corporation’s fleet of vehicles.
The corporation has the ability to transact in all three markets (and has
historically done so). As at the measurement date, the corporation has 100
vehicles (same make, model and mileage) that it needs to measure at fair
value. Volumes and prices in the respective markets are as follows:
Market price The corporation's volume for the Total market-based
asset in the market volume for the asset
(based on history
and/or intent)
A 490,000 60% 15%
B 500,000 25% 75%
C 550,000 15% 10%
Which of the market is the principal market for the corporation's Vehicle?
• IFRS 13 applies to:
• Non-financial assets; and
Application
• Liabilities of AASB
and equity 13
• Four step process to make a fair value measurement:
• Step 1 - Determine the asset or liability that is the subject of the
measurement
• Step 2 - Determine the valuation premise that is appropriate *
• Step 3 - Determine the principal or most advantageous market
• Step 4 - Determine the appropriate valuation technique
• This step involves considering characteristics that market
participants would take into account when pricing an asset or
liability.
• Relevant questions to consider include:
• What is the location of the asset?
• What is the condition of the asset?
• Are there any restrictions on sale or use of the asset?
• Is the asset or liability a stand-alone asset or it is a group of
assets?
How do we arrive at a market-based measurement?
Is there a quoted price in an active market for an identical asset or liability?
Yes No
Replicate a market price through a valuation
Use this quoted price to
technique* (using observable+ and
measure fair value (Level 1) unobservable inputs: Levels 2 and 3)
No significant Use of significant
Must use without adjustment unobservable unobservable
(Level 3) inputs‡ = (Level 3) inputs‡ =
* Valuation techniques include the Level 2 measurement Level 3 measurement
market approach, income approach and
cost approach.
+ Maximise the use of relevant observable inputs and minimise the use of unobservable inputs.
Observable inputs include market data (prices and
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other information that is publicly available).
‡ Unobservable inputs include the entity’s own data (budgets, forecasts), which must be adjusted if
market participants would use different assumptions.
Fair Value: Hierarchy
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Fair value: non-financial asset
Valuation premise
A non-financial asset either:
provides maximum value through its use in combination with
other assets and liabilities as a group
– is its value influenced by it being ‘operated’ with other assets?
– an example: equipment used in production facility
– market participants are assumed to hold complementary assets
provides maximum value through its use on a stand-alone basis
– is its value independent of its use with other assets?
– an example: a vehicle or an investment property
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Does not apply to financial instruments or liabilities
Highest and best use
The fair value of non financial asset should reflect the
highest and best use from market participant
perspective.
HBU: the use of a non-financial asset by market
participants that maximises the value of the asset:
– physically possible
– legally permissible
– financially feasible
CURRENT USE is presumed to be the HIGHEST AND BEST USE
unless market or other factors suggest otherwise
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Example : highest and best use
Land acquired in a business combination is currently developed for
industrial use as a site for a manufacturing facility. Nearby sites were
recently developed for residential high-rise flats. It was determined
that the land could be used to develop residential high-rise flats.
How is highest and best used determined?
In this case, the highest and best use is determined from the higher
of:
a) The value of the land used in the manufacturing operation
b) The value of the land as a vacant site for residential use
Note that transformation costs (e.g., costs to demolish the
manufacturing facility) would be considered in the value of
land as a vacant site.
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InStep
combination valuation
2: Determine the premise
valuation
FV is determined under this premise when market
premise that is appropriate
participants would obtain maximum benefit
principally through using the asset in combination
with other assets and liabilities as a group.
The asset will be sold as an individual asset, not as
a group, but the asset will be used by the market
participant in conjunction with other assets.
Stand-alone valuation premise
FV is determined under this premise when market
participants would obtain maximum benefit
principally through using the asset on a stand-
alone basis.
FV of a non-financial asset-Highest and Best Use : test your
understanding
For example, at Sene 30 you are valuing your factories land use right.
● Land rights with a similar factory of the same age, same condition and same
square area as yours are sold for Br. 7 million of which the value of the factory is
4 million. At the same date a ‘bare land’ homogeneous(identical) with your
factory’s plot of land are sold for alternate use for Br. 5 million. what is the
highest and best use of your land right?
Choose one
A. Br. 3 million
B. Br. 5 million
C. Br. 4 million
D. Br. 7 million
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example 2
On 31 December 2000 two of the plots adjoining your plot were sold (ie sale
of the land rights and the buildings, if any, constructed thereon):
Plot 901 sold for Br. 30 million: land rights with a similar factory of the
same age, same condition and same floor area as yours.
Plot 899 sold for Br. 10 million because it is undeveloped (yet to be built
on).
On 31 December 2000 what is the fair value of your land rights (ie excluding
the factory building)?
Choose 1 of:
1) Br. 0; 2) Br. 10 million; 3) Br. 20 million; 4) Br. 30 million; 5) Br. 70
million; 6) Br. 80 million; 7) Br. 100; million; or 8) another amount
On 31 December 2000 what is the fair value of your factory building (ie
excluding the land rights)?
Choose 1 of:
1) Br. 0; 2) Br. 10 million; 3) Br. 20 million; 4) Br. 30 million; 5) Br. 70
million; 6) Br. 80 million; 7) Br. 100; million; or 8) another amount
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Valuation
Step 4:techniques
Determine the appropriate
• The objective of the valuation technique selected is to
valuation technique
estimate the price at which an orderly transactions would
take place between market participants under current market
conditions.
• Three possible valuation techniques exist:
• Market approach – uses prices and other relevant information
generated by market transactions involving identical or comparable
assets, liabilities or groups of assets and liabilities (e.g. a business)
• Cost approach – often referred to as current replacement cost – it
reflects the amount currently required to replace the service
capacity of the asset
• Income approach – converts future amounts (e.g. cash flows or
income and expenses) to a single current (e.g. discounted) amount.
FV measurement is based on values indicated by current market
expectations about those future amounts
Disclosure
As the disclosures are really extensive, here,
the examples of the minimum requirements
are listed:
• Fair value measurement at the end of the reporting
period;
• The reasons for measurement (for nonrecurring)
• The level in which they are categorized in the fair
value hierarchy,
• Description of valuation techniques and inputs used;
• And many others
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