Fair Value Measurement: Prepared By: Michael Wells Date: June 13-17, 2016 Addis Ababa
Fair Value Measurement: Prepared By: Michael Wells Date: June 13-17, 2016 Addis Ababa
Fair Value Measurement: Prepared By: Michael Wells Date: June 13-17, 2016 Addis Ababa
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Conceptual underpinnings
Conceptual underpinnings
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» Measurement is the process of determining monetary amounts at which elements
are recognised and carried (paragraph 4.54 of IASB Conceptual Framework)
» To a large extent financial reports are based on estimates, judgements and models
rather than exact depictions
» The Conceptual Framework establishes the concepts that underlie those estimates,
judgements and models (paragraph 4.54 of IASB Conceptual Framework)
» objective/s of general purpose financial information; qualitative characteristics
» cost constraint
© Michael JC Wells 4
Many measurements for assets
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IFRS IFRS for Impairment
SMEs necessary?
Historical cost ✔ ✔ ✔
Modified historical cost ✔ ✔ ✔
Fair value ✔ ✔ ✘
Fair value less costs to sell ✔ ✔ ✘
an impairment
Value in use ✔ ✔ measurement
often an impairment
Net realisable value ✔ ✔ measurement
Other measurements ✔ ✔ ✔
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Mixed measurement model
source of measurement bases indicated: IFRS
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Assets IFRS measure Equity IFRS measure
Unimpaired land (PPE) & Historical cost (HC) or fair value (FV) Residual What does it mean?
indefinite life intangibles (choice) (assets minus liabilities)
Other PPE, intangibles and Modified (M)HC or modified FV Liabilities IFRS measure
bearer plants (choice)
Other financial instruments MHC or FV (depends on cash flow Provisions Amount to settle or
characteristics and business model) transfer today
Inventories Lower of HC and net realisable Defined benefit Projected unit credit
value; exceptions FV and NRV employee benefits method
© Michael JC Wells 7
Characteristics of fair value
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» a market value (not entity-specific value)
» an exit value
» reflects all changes that market participants factor into pricing at
the measurement date
» a clear measurement objective
» requires judgement to measure (especially Level 3
measurements)
» determine the appropriate valuation technique/s and inputs that market
participants would use when pricing the asset or liability
© Michael JC Wells 8
What the IASB says about fair value
source: paragraphs 6.28 to 6.32 of IASB ED/2015/3
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» Has predictive value and confirmatory value (provides relevant information)
» fair value reflects expectations about the amount, timing and uncertainties of the cash
flows (reflecting market participants’ expectations).
» Provides comparable information (between entities and within an entity)
» market participant perspective, identical assets (absent estimation error) measured at
the same amount irrespective of when and for what purpose they are acquired
» Level 1 measurement is easily understood, low cost and verifiable
» Does not necessarily reflect the entity’s business model
» for example, when the business model is not to sell the asset or not to transfer the
liability
» Level 3 measurement can be costly, complex and subjective.
© Michael JC Wells 9
What Lynn Turner and Walter Schuetz said
source: http://accountingonion.com/2014/08/time-for-the-sec-to-step-up-to-the-plate.html
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» (August 2014) Excerpts from a dialogue between former US SEC
commissioner Lynn Turner and Walter Schuetze former SEC Chief
Accountant
» Lynn Turner—“Walter, I not only agree that banks should be required to
disclose the fair value of their loans based on an independent valuation, but
they also account for those loans in the balance sheet using those values.”
» Walter Schuetze’s response—“I do not disagree. But, my proposal will, for
now, be easier to sell. And, investors will be happy with my proposal. Even
if the data are not on the face of the basic financial statements, once the
investors find the data, even if the data are on page XXX, they will luxuriate
in the data.”
© Michael JC Wells 10
Single measurement basis: fair value
would this provide relevant (decision-useful) information?
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Assets $ Equity $
Residual (assets minus liabilities) Does this XXX
CGU 1: fair value of individual assets XXX mean fair value of the company?
© Michael JC Wells 14
Fair value
measurement objective
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» Objective of fair value measurement: estimate the price at
which an orderly transaction to sell and asset or to transfer a
liability would take place between market participants at the
measurement date under current market conditions (paragraph
B2 of IFRS 13)
» the objective provides focus to fair value measurement
© Michael JC Wells 15
Fair value
market participants
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» Characteristics of market participants (ie buyers and sellers in
principal market (or most advantageous market)):
» independent
» knowledgeable
» diligent
» use all available information
» willing to transact for the asset or liability
» able to transact for the asset or liability
» Assumption: market participants act in their economic best interest
© Michael JC Wells 16
Fair value: market participant perspective
application guidance: how to measure fair value
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» 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 and 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.
» (see paragraph B2 of IFRS 13)
© Michael JC Wells 17
Fair value hierarchy
application guidance: Levels 1, 2 and 3
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Is there a quoted price in an active market for an identical asset or liability?
Yes No
© Michael JC Wells 19
Fair value of a non-financial asset
application guidance: highest and best use
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» Fair value measurement logically assumes that a market
participant would put a non-financial asset to its highest and
best use because that maximises the value of the asset.
» The highest and best use must be
» physically possible
» legally permissible
» financially feasible
© Michael JC Wells 20
Fair value of a non-financial asset
test your understanding: example 1
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» Your factory is built on Plot 900 in a recently developed industrial
development zone on the outskirts of Addis Ababa where the land that
is divided into one hundred two acre plots that before their further
development were essentially homogenous. Factories, like yours, are
the highest and best use for the land rights.
» 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 $30 million: land rights with a similar factory of the same age,
same condition and same floor area as yours.
» Plot 899 sold for $10 million because it is undeveloped (yet to be built on).
© Michael JC Wells 21
Fair value of a non-financial asset
test your understanding: example 1
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On 31 December 2000 what is the fair value of your land rights (ie
excluding the factory building)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80
million; 7) $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) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80
million; 7) $100; million; or 8) another amount
© Michael JC Wells 22
Fair value of a non-financial asset
test your understanding: example 2
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» The facts are the same as Example 1, except that in this
example (fifteen years later), on 31 December 2015:
» high-rise commercial development is now the highest and best use
for your land rights because the rapidly expanding financial district of
Addis Ababa has grown to the boundary of plots 899, 900 and 901.
» Consequently, on 31 December 2015 Plots 899 and 901 each sold for
$100 million.
© Michael JC Wells 23
Fair value of a non-financial asset
test your understanding: example 2
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On 31 December 2015 what is the fair value of your land rights (ie excluding the
factory building)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80 million; 7) $100;
million; or 8) another amount
On 31 December 2015 what is the fair value of your factory building (ie excluding
the land rights)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80 million; 7) $100;
million; or 8) another amount
Does your estimate of the fair value of your factory building (ie excluding the land
rights) depend on which model you use for your land rights (cost model or
revaluation
© Michael model)?
JC Wells 24
Fair value of a non-financial asset
what do you think? example 3
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» In Examples 1 and 2 fair value was determined with reference to the sale of
similar assets at the measurement date (31 December 2000 and 2015).
» The facts are the same as in Example 2, except that there have been no
recent sales of similar assets (ie Plots 899 and 901 are unsold).
» How could the fair value of the factory building on Plot 900 be measured at
31 December 2015?
» What judgements would be made in measuring such a Level 3 fair value?
» Can such a Level 3 fair value measurement be faithfully represented?
» Is such a Level 3 fair value measure verifiable?
© Michael JC Wells 25
Fair value: market participants’ view point
application guidance: characteristic of an asset or liability
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» 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
» 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
© Michael JC Wells 26
Fair value: market participants’ view point
application guidance: which market?
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Most advantageous market only when cannot identify principal market.
» Principal market has the greatest volume and level of activity for the asset
or liability
» Most advantageous market
» maximises the amount that would be received to sell an asset
» minimises the amount that would be paid to transfer the liability
» after taking into account transactions costs and transport costs.
» Other considerations:
» absent evidence to the contrary use the market the reporting entity usually accesses
» reporting entity must have access to the market at the measurement date
© Michael JC Wells 27
Fair value: which market?
test your understanding: transaction costs
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You have access to two active markets to sell an asset:
» Market (M)1: price = $100; transaction costs = $10
» M2: price = $95; transaction costs = $3.
What is the fair value of the asset? Choose one of:
1) $100 if M1 is the principal market, otherwise $95;
2) $90 if M1 is the principal market, otherwise $92;
3) $95 because the most advantageous market (M2) must be the
principal market;
4) $92 because the most advantageous market (M2) must be the
principal market.
© Michael JC Wells 28
Fair value: which market?
test your understanding: transport costs
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You have access to two active markets to sell an asset:
» Market (M)1: price = $100; transport costs = $10
» M2: price = $95; transport costs = $3.
What is the fair value of the asset? Choose one of:
1) $100 if M1 is the principal market; otherwise $95
2) $90 if M1 is the principal market; otherwise $92
3) $95 because the most advantageous market (M2) must be the
principal market
4) $92 because the most advantageous market (M2) must be the
principal market
© Michael JC Wells 29
Fair value: restriction on use
test your understanding
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» You own land use rights to Plot A that is zoned ‘green belt’—which
prohibits the construction of buildings on that land.
» Similar neighbouring plots’ with the same land use rights and subject to the
same restrictions sold recently:
» for $950,000 on 30 October 2015 (Plot B); and
» for $30,000,000 on 31 December 2015 (Plot C).
» The difference in the selling price of Plots B and C is attributable primarily
to the press leaked confidential government dossier setting out the
government’s plans for proposing an amendment to the law to allow for
the construction of high-rise buildings on some (but unspecified which)
green belt land.
© Michael JC Wells 30
Fair value: restriction on use
test your understanding
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You employ a reputable property valuation expert to value the land use
rights to Plot A at 31 December 2015 under each of the following
hypothetical scenarios:
» Scenario 1: the land is rezoned allowing for the construction of a high-rise building:
$100,000,000
» Scenario 2: market participants believe there is no prospect of the zoning laws
changing: $1,000,000
What is the fair value of the land use rights to Plot A at 31 December 2015?
Choose one of:
1) $950,000; 2) $1,000,000; 3) $30,000,000; 4) $100,000,000; or
5) another amount.
© Michael JC Wells 31
Fair value: location
test your understanding
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» You recently won a tender to explore for gold in the Northern
Greenstone Belt of Ethiopia.
» On 30 November 2015 you:
» buy a mineral exploration rig for $20 million in the US
» incur buying agent commission of $2 million
» pay $1 million for the rig to be transported safely from the US to your
exploration site
» The seller of the drill incurs $2 million selling costs.
» The market at which you purchased the rig is your principal market
(should you choose to sell the rig).
© Michael JC Wells 32
Fair value: location
test your understanding
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What is the fair value of the rig at 31 December 2015?
Choose one of:
1) $25 million
2) $23 million
3) $22 million
4) $21 million
5) $20 million
6) $19 million
7) $17 million
© Michael JC Wells 33
Fair value: financial assets
Specific requirements for financial instruments
» The ‘highest and best use’ concept does not apply to financial instruments
» The unit of account for financial instruments in the scope of IAS 39 and
IFRS 9 is typically the individual financial instrument
» an exception, if certain conditions are met, IFRS 13 permits an entity to measure
the fair value of a group of financial assets and financial liabilities with offsetting
risk positions on the basis of its net exposure (the portfolio measurement
exception) (see paragraphs 48 and 49 of IFRS 13).
» Specific guidance for financial liabilities with demand features – the fair
value of such liabilities cannot be less than the amount payable on
demand, discounted from the first date that the amount could be required
to be paid (see paragraph 47 of IFRS 13).
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Measuring fair values of financial instruments
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Fair value: restriction on sale of a financial asset
test your understanding: example 1
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Fair value: restriction on sale of a financial asset
test your understanding: example 2
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Fair value: restriction on sale of a financial asset
test your understanding: example 2
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Fair value: restriction on sale of a financial asset
test your understanding: example 2 extended
» MTN Zakhele uses the dividends it receives from the MTN shares it holds to meet its
operating costs and interest on its loans. Any surplus cash is applied to reducing its
loan liabilities.
» When measuring the fair value of a MTN Zakhele shares what adjustments from the
price of an MTN share would Entity B’s management make? Decreases for (choose
one of):
1) liabilities funded by each MTN Zakhele share
2) liquidity restriction 1: initial three-year prohibition of trading
3) liquidity restriction 2: subsequent three-year restriction of trading to qualifying BEE participants
4) operating costs of MTN Zakhele to be met from dividends on its MTN shares
5) liquidity expectation: dividends received by MTN Zakhele from its MTN shares will be used to
reduce liabilities
6) all of the above
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Fair value: low-interest loan asset
test your understanding
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Fair value: low-interest loan asset
test your understanding
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Fair value: bid-ask spread
application guidance
» Bid prices apply to long positions and ask prices apply to short
positions (paragraph 70 of IFRS 13). However,
» IFRS 13 does not preclude the use of mid-market pricing or other
pricing conventions that are used by market participants as a practical
expedient for fair value measurement within a bid-ask spread
(paragraph 71 of IFRS 13)
» The entity uses the price within the bid-ask spread that is most
representative of fair value in the circumstances (paragraph 70 of IFRS
13)
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Fair value: bid-ask spread
test your understanding: example 1
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Fair value: a large holding
test your understanding
Entity E also holds 10% of the (1 million shares) share capital in Entity Y
whose shares do not trade publicly (a private company)
» At 31 December 2015 management estimate the fair value of the 10%
stake in Entity Y at:
» $1,000,000 (without adjusting for liquidity) using multiples for comparable
companies whose shares do trade actively in deep and liquid markets; and
» $910,000 after adjusting for liquidity.
At 31 December 2015 is the fair value of Entity E’s 10% holding in Entity Y
(Choose one of):
1) $910,000 (ie reflecting management’s estimate of an adjustment for liquidity); or
2) $1,000,000 (ie without reflecting an adjustment for liquidity)?
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Fair value: a controlling holding
test your understanding
Entity E also holds 55% of the (1 million shares) share capital in Entity
X (its subsidiary)
» Entity X’s shares trade actively in a deep and liquid market
» at 31 December 2015 trading in Entity X shares closes at $10 per share
» At 31 December 2015 must the fair value of Entity E’s 55% holding in
Entity X (Choose one of):
1) reflect the control premium irrespective of whether this is consistent with the
market perspective;
2) reflect the control premium only if consistent with the market perspective; or
3) be measured at $5,500,000 (ie without reflecting a control premium)?
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Fair value: a controlling holding
test your understanding
Entity E also holds 55% of the (1 million shares) share capital in Entity
W (its subsidiary)
» Entity W’s shares do not trade publicly (a private company)
At 31 December 2015 must the fair value of Entity E’s 55% holding in
Entity W for presentation in its separate financial statements (Choose
one of):
1) reflect the control premium irrespective of whether this is consistent with the
market perspective;
2) reflect the control premium only if consistent with the market perspective; or
3) be measured without reflecting a control premium?
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Fair value: significantly decreased trading volume
test your understanding
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Fair value: significantly decreased trading volume
test your understanding
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Fair value: infrequent trading
test your understanding
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Fair value: groups of financial assets and financial liabilities with
offsetting positions
No
accordance with documented risk management or
investment strategy?
Yes Measurement
Provide information to on a net basis
No
key management personnel on that basis? is prohibited!
Yes
No
in the statement of financial position?
Yes
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Fair value: groups of financial assets and financial liabilities with offsetting positions
test your understanding
At 31 December 2015 Entity F has, in a particular market risk that are not
categorised within Level 1 of the fair value hierarchy:
» a long position of 100 individual financial assets; and
» a short position of 95 individual financial liabilities the financial
instruments within the portfolio are identical
» Entity F uses bid prices to measure asset positions and ask prices to
measure liability positions
» bid price is $99; mid price is $100; ask price is $101
» assume there is no discount/premium that results from the size of the
net risk exposure
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Fair value: groups of financial assets and financial liabilities with offsetting positions
test your understanding
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Fair value: liability
Fair value: a liability
the concept
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» The fair value of a liability is
» the price that would be paid to transfer a liability (exit price)
» in an orderly transaction (not a forced sale)
» between market participants (market-based view)
» at the measurement date (current price). (IFRS 13 Appendix A)
» Market participant perspective: consequently, the entity’s intention to settle
or otherwise fulfil a liability is not relevant when measuring fair value.
» The market value of a liability is:
» the amount for which the liability could be settled between knowledgeable, willing
parties in an arm’s length transaction
» (IFRS for SMEs and IPSASB’s Conceptual Framework)
© Michael JC Wells 59
Fair value: liability decision tree
application guidance: liabilities
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Yes Is there an observable market No
Fair value = Fair value = fair value of the Fair value = another
observable market corresponding asset valuation technique
price of asset
Yes Is there an observable market
No
price for the instrument traded
as an asset?
Fair value = another
valuation technique Level 2 or 3
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