IFRS 13: Fair Value Measurement – Part 2

 

In our previous blog– IFRS 13: Fair Value Measurement- Part 1, we discussed on the definition of fair value and key aspects of which management requires to consider while determining fair value under IFRS 13. Fair value is an exit price, thus while measuring fair value one should consider the price of such asset or a liability on the basis of its units (standalone or within group like CGU) and its characteristics, price in a principal market or most advantageous market, price in hypothetical transaction between market participants & the price to take exit from that asset or a liability or group. We have discussed these concepts with the help of suitable examples.

 

In this blog, we will further discuss the few more concepts required for fair value measurement viz. factors to consider for a non-financial asset, valuation techniques and hierarchy of information to be used while determining FV. We know that fair value is not an entity specific measure but is market participants’ perception. All these concepts ensure that an exit price is based on market participants’ assumptions and entity-specific factors are not considered while measuring fair value.

 

Considerations for non-financial asset (PPE, investment property etc.)

Generally, financial assets do not have alternative use because they have specific contractual terms and can have a different use only if the contractual terms of the instruments are changed. However, non- financial assets viz. PPE, investment property etc. do not have specific contractual use and can be used for multiple purposes.

 

Fair value is a market-based measurement, it is measured using the assumptions that market participants would use when pricing the asset. For e.g., an entity’s intention to hold an intangible asset or to use it defensively to protect its exiting intangible asset or otherwise is not relevant when measuring the fair value of that asset. Thus, fair valuation in the case of such non-financial assets often requires looking for the highest and best use by its market participants and that will be the reference point to evaluate fair value of such non-financial assets.

Fair value shall always be based on the market participant’s perspective and never be entity specific. The concept of highest and best use makes the non-financial asset separate from any specific entity who would like to use such asset in their own specific purposes which may or may not be its best use.

If market or other factors do not suggest different use by market participants that maximises assets value, then fair value should be based on the asset’s current use.

Example 1

 

An entity XYZ bought some land which is intended to be used for business purposes. However, the entity now wants to sell this piece of land at its fair value. One has to evaluate all possible uses of this land before determining its fair value. The land could be used to make a commercial place, which could be more in value as compared to when it is used for business purposes. The commercial place value would be considered its highest and best use if the same is allowed in its near locations and condition.

 

Example 2 – Potential use as Highest and Best Use

ABC Ltd owns a property, which comprises land with an old warehouse on it. It has been determined that the land could be redeveloped into a leisure park. The land’s market value would be higher if redeveloped than the market value under its current use. ABC Ltd is unclear about whether the investment property’s fair value should be based on the market value of the property (land and warehouse) under its current use, or the land’s potential market value if the leisure park redevelopment occurred.

 

The property’s fair value should be based on the land’s market value for its potential use. The ‘highest and best use’ is the most appropriate model for fair value. Under this approach, the property’s existing-use value is not the only basis considered. Fair value is the highest value, determined from market evidence, by considering any other use that is physically possible, legally permissible and financially feasible.

Valuation techniques – approaches for arriving at the price

An entity shall use valuation techniques that are:

·        appropriate in the circumstances and

·        for which sufficient data are available to measure fair value,

·        maximising the use of relevant observable inputs and minimising the use of unobservable inputs

Three main approaches for measuring fair value are:

NOTES –

·        It is worth noting that in case of availability of quoted prices which are being used in an active market, there is no need to consider any other valuation approach further.

·        The standard requires and allows using one or combination of more than one approach to measure any fair value.

·        Selecting an appropriate approach is matter of judgment and based on the available inputs related to the asset / liability.

Fair value hierarchy

Valuation techniques used to measure fair value shall maximize the use of relevant observable inputs and minimize the use of unobservable inputs.

Observable Inputs: Inputs that are developed using market data, such as publicly available information about actual events or transactions, and that reflect the assumptions that market participants would use when pricing the asset or liability.

Unobservable Inputs: Inputs for which market data are not available and that are developed using the best information available about the assumptions that market participants would use when pricing the asset or liability.

Example 3

If a market participant would take into account the effect of a restriction on the sale of an asset when estimating the price for the asset, an entity would adjust the quoted price to reflect the effect of that restriction. If that quoted price is a Level 2 input and the adjustment is an unobservable input that is significant to the entire measurement, the measurement would be categorised within Level 3 of the fair value hierarchy.

 

Example 4

An entity is holding investment which is quoted in BSE, India and NYSE, USA. However, significant activities are being done at BSE only. The fair value of the investment would be referenced to the quoted price at BSE India, which is Level 1 fair value – direct quoted price with no adjustments.

Example 5

Receive-fixed, pay-variable interest rate swap based on a yield curve denominated in a foreign currency. It requires rate for 11 years can be established using extrapolation or some other techniques which is based on 10 years’ available rates of swap. The fair value of 11 years so derived would-be Level 2 fair value.

 

Example 6 – Cash-generating unit

A Level 3 input would be a financial forecast (e.g. of cash flows or profit or loss) developed using the entity’s own data, if there is no reasonably available information that indicates usage of different assumptions by market participants.

We hope this blog helps you to understand the important concepts to arrive at the price which is considered to be a market-based measure i.e. FV by considering the highest and best use for non-financial assets, applying appropriate approach for valuation and using fair value hierarchy.

Thank you for reading! For more simplified insights on IFRS, fair value measurement, and other accounting standards, follow our blog and stay updated.

Other IFRS-related blogs: