FAIR VALUE

MEASUREMENT
IFRS – 13
Tutor: Rashid Hussain ACCA
Why IFRS 13?
■ The objectives of IFRS 13 are:
– to define fair value;
– to set out in a single IFRS a framework for measuring fair value;
and
– to require disclosures about fair value measurements.
■ Fair value is a market-based measurement, not an entity-specific
measurement. It means that an entity:
■ shall look at how the market participants would look at the asset or
liability under measurement
■ shall not take own approach (e.g. use) into account.
The definition of fair value
■ Fair value is defined as 'the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date' (IFRS 13, para 9).
■ Fair value measurements are based on an asset or a liability's unit of
account, which is specified by each IFRS where a fair value
measurement is required. For most assets and liabilities, the unit of
account is the individual asset or liability, but in some instances may
be a group of assets or liabilities (IFRS 13: para. 13).
Definition: Unit of account
■ Unit of account: The level at which an asset or a liability is
aggregated or disaggregated in an IFRS for recognition purposes.
■ The unit of account for the asset or liability must be determined in
accordance with the IFRS that requires or permits the fair value
measurement.
■ An entity must use the assumptions that market participants would
use when pricing the asset or liability under current market conditions
when measuring fair value. The fair value must take into account all
characteristics that a market participant would consider relevant to
the value. These characteristics might include:
■ the condition and location of the asset; and restrictions, if
any, on the sale or use of the asset.
Example
Fair value
■ A premium or discount on a large holding of the same shares
(because the market's normal daily trading volume is not sufficient to
absorb the quantity held by the entity) is not considered when
measuring fair value: the quoted price per share in an active market is
used.
■ However, a control premium is considered when measuring the fair
value of a controlling interest, because the unit of account is the
controlling interest. Similarly, any non-controlling interest discount is
considered where measuring a non-controlling interest.
Market participants
Definition: Market participants
■ Market participants: Buyers and sellers in the principal (or most
advantageous) market for the asset or liability. Market participants
have all of the following characteristics:
– They are independent of each other;
– They are knowledgeable, having a reasonable understanding
about the asset or liability and the transaction using all available
information, including information that might be obtained through
due diligence efforts that are usual and customary.
– They are able to enter into a transaction for the asset or liability.
– They are willing to enter into a transaction for the asset or
liability, i.e. they are motivated but not forced or otherwise
compelled to do so.
Scope of IFRS 13
■ IFRS 13 applies to any situation where IFRS requires or permits fair
value measurements or disclosures about fair value measurements
(and other measurements based on fair value such as fair value less
costs to sell) with the following exceptions.
■ IFRS 13 does not apply to:
– share based payment transactions within the scope of IFRS 2; or
– measurements such as net realisable value (IAS 2 Inventories) or
value in use (IAS 36 Impairment of Assets) which have some
similarities to fair value but are not fair value.
■ The IFRS 13 disclosure requirements do not apply to the following:
– plan assets measured at fair value (IAS 19: Employee benefits);
– retirement benefit plan investments measured at fair value (IAS
26: Accounting and reporting by retirement benefit plans); and
– assets for which recoverable amount is fair value less costs of
disposal in accordance with IAS 36.
Measuring fair value
■ Sometimes it might be possible to use observable market transactions
to fair value an asset or a liability (e.g. a share might be quoted on a
stock exchange). For other assets and liabilities this may not be
possible.
■ However, in each case the objective is the same, being to estimate
the price at which an orderly transaction to sell the asset (or transfer
a liability) would take place between market participants at the
measurement date under current market conditions.
Three Levels
■ Level 1 inputs
– Quoted prices (unadjusted) in active markets for identical assets or
liabilities that the entity can access at the measurement date (IFRS 13:
para. 76).

■ Level 2 inputs
– Inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly (ie prices) or indirectly
(ie derived from prices). For example quoted prices for similar assets in
active markets or for identical or similar assets in non-active markets or
use of quoted interest rates for valuation purposes (IFRS 13: para. 81–82).

■ Level 3 inputs
– Unobservable inputs for the asset or liability, eg discounting estimates of
future cash flows (IFRS 13: para. 86). Level 3 inputs are only used where
relevant observable inputs are not available or where the entity Scrape
determines that transaction price or quoted price does not represent fair Value
value.
Definition: Active market
■ A market in which transactions for the asset or liability take place with
sufficient frequency and volume to provide pricing information on an
ongoing basis. If there is no such active market (e.g. for the sale of an
unquoted business or surplus machinery) then a valuation technique
would be necessary.
■ If an active market exists then it will provide information that can be
used for fair value measurement.
■ A quoted price in an active market provides the most reliable
evidence of fair value and must be used to measure fair value
whenever available.
■ It would be unusual to find an active market for the sale of non-
financial assets so some other sort of valuation technique would
usually be used to determine their fair value.
Inputs to determine fair
value
■ IFRS 13 gives the following examples of inputs used to determine fair
value:
Asset Example
Level 1 Equity shares in a listed Unadjusted quoted prices in
entity an active market.
Level 2 Building held and used Price per square metre for
the building from observable
market data, such as
observed transactions for
similar buildings in similar
locations.
Level 3 Cash-generating unit Profit or cash flow forecast
using own data.
Test you understanding 1 –
Baklava
■ Baklava has an investment property that is measured at fair value.
This property is rented out on short-term leases.
■ The directors wish to fair value the property by estimating the present
value of the net cash flows that the property will generate for Baklava.
They argue that this best reflects the way in which the building will
generate economic benefits for Baklava.
■ The building is unique, although there have been many sales of
similar buildings in the local area.
■ Required:
– Discuss whether the valuation technique suggested by the
directors complies with International Financial Reporting
Standards.
Solution
■ The directors’ estimate of the future net cash flows that the building
will generate is a level 3 input. IFRS 13 gives lowest priority to level 3
inputs. These should not be used if a level 1 or level 2 input exists.
■ Observable data about the recent sales prices of similar properties is
a level 2 input. The fair value of the building should therefore be
based on these prices, with adjustments made as necessary to reflect
the specific location and condition of Baklava’s building.
Markets
■ The price received when an asset is sold (or paid when a liability is transferred)
may differ depending on the specific market where the transaction occurs.
■ Principal market
– IFRS 13 says that fair value should be measured by reference to the principal
market.(Where you are selling most of your product)
– The principal market is the market with the greatest activity for the
asset or liability being measured.
– The entity must be able to access the principal market at the measurement
date. This means that the principal market for the same asset can differ
between entities.
■ Most advantageous market(That maximize your benefits)
– If there is no principal market, then fair value is measured by reference to
prices in the most advantageous market.
– The most advantageous market is the one that maximises the net
amount received from selling an asset (or minimises the amount paid
to transfer a liability).
– Transaction costs (such as legal and broker fees) will play a role in deciding
which market is most advantageous. However, fair value is not adjusted for
transaction costs because they are a characteristic of the market, rather than
the asset.
Example - Principal market v most
advantageous market
■ An asset is sold in two different active markets at the following prices per item:

European market North American

market
$ $
Selling price 53 54
Transport costs to (3) (6)
market
50 48
Transaction costs (3) (2)
■ The principal market (the one with the greatest volume and level of activity) is the
47 46
North American market. The company normally trades in the European market,
but it can access both markets. The fair value of the asset is therefore $48 per
item, ie the price after taking into account transport costs in the principal market
for the asset.
■ If, however, neither market were the principal market, the fair value would be
measured using the price in the most advantageous market. The most
advantageous market is the European market after considering both transaction
and transport costs ($47 in European market v $46 in the North American market)
and so the fair value measure would be $50 per item (as fair value is measured
before transaction costs).
Test your understanding 2 –
Markets
■ An asset is sold in two different active markets at different prices. An
entity enters into transactions in both markets and can access the
price in those markets for the asset at the measurement date as
follows:
Market 1 Market 2
$ $
Price 26 25
Transaction costs (3) (1)
Transport costs (2) (2)
Net price received 21 22

■ What is the fair value of the asset if:

a) market 1 is the principal market for the asset?
b) no principal market can be determined?
Solution
a) If Market 1 is the principal market then the fair value would be
measured using the price that would be received in that market less
transport costs. The fair value would therefore be $24 ($26 – $2).
Transaction costs are ignored as they are not a characteristic of the
asset.
b) If neither market is the principal market for the asset then the fair
value would be measured in the most advantageous market. The
most advantageous market is the market that maximises the net
amount received from the sale.
■ The net amount received in Market 2 ($22) is higher than the net
amount received in Market 1 ($21). Market 2 is therefore the most
advantageous market. This results in a fair value measurement of $23
($25 – $2). IFRS 13 specifies that transaction costs play a role when
determining which market is most advantageous but that they are not
factored into the fair value measurement itself.
What is a non-financial
asset?
■ Financial assets include:
– Contractual rights to receive cash (such as receivables)
– Investments in equity shares.
■ Non-financial assets include:
– Property, plant and equipment
– Intangible assets.
The fair value of a non-
financial asset
■ IFRS 13 says that the fair value of a non-financial asset should be
based on its highest and best use.
■ The highest and best use of an asset is the use that a market
participant would adopt in order to maximise its value.
■ The current use of a non-financial asset can be assumed to be the
highest and best use, unless evidence exists to the contrary.
■ The highest and best use should take into account uses that are:
– Physically possible
– Legally permissible
– Financially feasible.
■ IFRS 13 says a use can be legally permissible even if it is not legally
approved.
Test you understanding 3 – Five Quarters

■ Five Quarters has purchased 100% of the ordinary shares of Three

Halves and is trying to determine the fair value of the net assets at
the acquisition date.
■ Three Halves owns land that is currently developed for industrial use.
The fair value of the land if used in a manufacturing operation is $5
million.
■ Many nearby plots of land have been developed for residential use (as
high-rise apartment buildings). The land owned by Three Halves does
not have planning permission for residential use, although permission
has been granted for similar plots of land. The fair value of Three
Halves’ land as a vacant site for residential development is $6 million.
However, transformation costs of $0.3 million would need to be
incurred to get the land into this condition.
■ Required: How should the fair value of the land be determined?
Solution
■ Land is a non-financial asset. IFRS 13 says that the fair value of a
nonfinancial asset should be based on its highest and best use. This is
presumed to be its current use, unless evidence exists to the contrary.
■ The current use of the asset would suggest a fair value of $5 million.
■ However, there is evidence that market participants would be
interested in developing the land for residential use.
■ Residential use of the land is not legally prohibited. Similar plots of
land have been granted planning permission, so it is likely that this
particular plot of land will also be granted planning permission.
■ If used for residential purposes, the fair value of the land would be
$5.7 million ($6m – $0.3m).
■ It would seem that the land’s highest and best use is for residential
development. Its fair value is therefore $5.7 million.
Example - Highest and best
use
■ An entity acquires control of another entity which owns land. The land is
currently used as a factory site. The local government zoning rules also
now permit construction of residential properties in this area, subject to
planning permission being granted. Apartment buildings have recently
been constructed in the area with the support of the local government.
Market values are as follows:
$m

– Value in its current use 20

– Value as a development site (including uncertainty
30
over whether planning permission would be granted)
– Demolition costs to convert the land to a vacant site 2
■ The fair value of the land is $28m ($30m – $2m) as this is its highest and
best use because market participants would take into account the site's
development potential when pricing the land.
Example: Highest and best
use
■ X Limited acquired a plot of land developed for industrial use as a
factory. A factory with similar facilities and access has recently been
sold for $50 million. Similar sites nearby have recently been
developed for residential use as sites for high-rise apartment
buildings.
■ X Limited determines that the land could be developed as a site for
residential use at a cost of $10 million (to cover demolition of the
factory and legal costs associated with the change of use). The plot of
land would then be worth $62 million.
■ The highest and best use of the land would be determined by
comparing the following:
$ million
Value of the land as currently developed 50
Value of the land as a vacant site for residential use 52
($62 million – $10 million)