Relevant Standard

♦ HKFRS 13
Intermediate Accounting 2  Fair Value Measurement
2021/22 Semester 1

Topic 1
Fair Value Measurement
Globalisation of Accounting Regulation

Fair Value Measurement Definitions

♦ Scope ♦ Fair value

 Applicable to all HKFRSs where a fair value
measurement is required except:
• Measurements similar to, but not the same as, fair
value:
– Net realisable value (HKAS 2)
– Value in use (HKAS 36)
• Share-based payment transactions (HKFRS 2)
• Leases transactions (IFRS 16)
 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
♦ Exit price
 The price that would be received to sell an asset or paid to
transfer a liability.
♦ Entry price
 The price paid to acquire an asset or received to assume a
liability in an exchange transaction.
♦ Bid price
 The price at which an asset can be sold to the market
♦ Ask (offer) price
 The price at which an asset can be bought from the market

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Definitions
♦ 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
♦ Principal market
 The market with the greatest volume and level of activity
for the asset or liability
♦ Most advantageous market
 The market that maximises the amount that would be
received to sell the asset or minimises the amount that
would be paid to transfer the liability, after taking into
account transaction costs and transport costs
5  Sometimes, a group of assets or liabilities
Identifying Principal Market
♦ Identification process
 Exhaustive search - unnecessary
 Consider all information that is reasonably
available
♦ Presumption
 The market in which an entity normally enters
into transactions to sell the asset or to transfer
the liability
♦ Identifying the most advantageous market
 The same consideration
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Measurement of Fair Value
♦ Market based measurement
 Not entity-specific measurement
 Reflecting market conditions at the measurement date
 Using the assumptions that market participants would use
when pricing the asset (liability)
 Considering any relevant characteristics of the asset
(liability):
• Location and condition of the asset
• Restrictions, if any, on the sale or use of the asset
♦ Fair value measurement rules
 Price in the principal market
 Failing the above, price in the most advantageous market
♦ Unit of account
 Usually, individual asset or liability
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Transport Costs and Transaction Costs
♦ Transport costs
 Adjusted for (i.e. to be deducted)
 Because location is a characteristic of asset
♦ Transaction costs
 Not adjusted for (i.e. NOT to be deducted)
 Because they are not a feature of the asset or
liability
 But to be considered in determining the most
advantageous market
Example 1 Valuation Approaches and Techniques

An entity holds an asset which could be sold in one of two

markets. 1. Market approach
Market A Market B  Using prices and other relevant information from market
$ $
transactions involving identical or similar assets and
liabilities
Sale price 650 625
2. Income approach
Transport cost (50) (50)
 Converting future amounts (eg cash flows or profits) to a
600 575 single current amount (ie discounting)
Transaction cost (75) (25) 3. Cost approach
Net amount received 525 550  The amount required to replace the service capacity of
an asset (current replacement cost)
What is the fair value of the asset if ♦ Valuation techniques
a) Market A is the principal market?  Use appropriate valuation techniques in the
b) Principal market cannot not be identified? circumstances and for which sufficient information is
available to measure fair value
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Inputs to Valuation Techniques Fair Value Hierarchy for Disclosure

♦ General requirement Definition Example

 A valuation technique should be used to maximise Level 1 Quoted prices in active markets • Share price quoted
for identical assets or liabilities on the Hong Kong
the use of relevant observable inputs and minimise
that the entity can access at the Exchange
the use of unobservable inputs measurement date
♦ Quoted price in an active market Level 2 Inputs other than quoted prices • Quoted price of a
 The most reliable evidence of fair value included within Level 1 that are similar asset to the
observable for the asset or one being valued.
 Must be used to measure fair value whenever liability, either directly or • Quoted interest
available indirectly rate
Level 3 Unobservable inputs for • Cash flow
the asset or liability projections

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Fair Value of Non-financial Assets Example 2

♦ Measurement rule X Limited acquired a plot of land developed for industrial

use as a factory. A factory with similar facilities and
 Non-financial assets to be value at its highest and
access has recently been sold for $50 million.
best use
Similar sites nearby have recently been developed for
♦ Highest and best use residential use as sites for high-rise apartment buildings.
 Market participants would seek to maximise the X Limited determines that the land could be developed as
value of an asset a site for residential use at a cost of $10 million (to cover
 Such use should be: demolition of the factory and legal costs associated with
the change of use). The plot of land would then be worth
• Physically possible;
$62million.
• Legally permissible; and
• Financially feasible.
Determine the fair value of the land.
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Example 2 Fair Value of Financial Assets

The highest and best use of the land would be determined ♦ Quoted financial assets
by comparing the following:
 A price within the bid-ask range
$ million
 May use the mid-price
♦ Value of the land as currently developed 50
 HKFRS 13 does NOT require the use of bid price
♦ Value of the land as a vacant site for
for asset
residential use ($62 million – $10 million) 52
♦ Unquoted equity investments
Conclusion  A number of valuation techniques available
The fair value of the land is $52 million.  Normally some unobservable inputs are used to
derive the fair value
 Therefore, classified as Level 3 measurement
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Fair Value of Liabilities Example 3

♦ Assumptions On 1 July 2020, Parrot Ltd issued $100,000 5%

 The liability is transferred at the measurement date to a debentures and redeemable 4 years later at par. These
market participant were bought by a wide variety of investors.
 The market participant is then obliged to fulfill the
obligation
What is the fair value of debentures in the book of Parrot
 The obligation is not settled or extinguished at the Ltd as at 30 June 2021 if
measurement date
a) these securities were trading in an active market at
♦ Non-performance risk $990 per $1,000 debentures at 30 June 2021?
 The risk that an entity will not fulfill an obligation
b) these securities were not traded in an active market
 Non-performance risk includes the entity’s own credit
and the interest rate for similar liabilities at 30 June
risk
2021 is 6%?
 The fair value of a liability reflects the effect of non-
performance risk
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Example 3 Example 4
The fair value should reflect the price that would be paid by Parrot
Ltd to transfer the liability to market participants at the measurement
date under current market conditions.
A and B individually enter into legal obligations to each
pay $200,000 to X in seven years in exchange for some
goods.
a) Quoted market price should be used as it is most reliable.
A has a very good credit rating and can borrow at 4%. B’s
credit rating is lower and it can borrow at 8%. The
Fair value of the debentures should be $99,000
exchange of goods is not traded in an active market.
($100,000 x 990/1,000).

What is the fair value of the legal obligation that A and that
b) A valuation method should be employed to determine the fair
B must record in their own financial statements?
value, which is the PV of all future interest and principal payments
discounted at 6%
$100,000 x 5% x PVF-OA3,6% + $100,000 x PVF3,6%
= $97,327
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Example 4 Disclosures

♦ Valuation techniques and inputs used to develop fair value

♦ Liability in A’s financial statement measurements
 Approximately $152,000 ($200,000 x 1/1.047), ♦ The fair value measurement at the end of the reporting period
♦ The level of the fair value hierarchy within which the fair value
being the present value of $200,000 in seven measurements are categorised in their entirety (Level 1, 2 or 3)
years at 4% ♦ For fair value measurements categorised within Level 3
 Quantitative information about the significant unobservable inputs
♦ Liability in B’s financial statement used
 Approximately $166,600 ($200,000 x 1/1.087),  Description of the valuation processes used
 Reconciliation from opening to closing balances, disclosing
being the present value of $200,000 in seven • Total gains or losses recognised in profit or loss
years at 8% • Total gains or losses recognised in other comprehensive income
• Purchases, sales, issues and settlements;
♦ These two values are different, even though the • Transfers into or out of Level 3
amount and period are the same, because of the  Description of the sensitivity to changes in unobservable inputs
different risk profiles of the two companies. ♦ Reason for a non-financial asset being used in a manner that
differs from its highest and best use when this is the case
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Disclosure Example Disclosure Example

$m
Trading equity securities
Non-trading equity securities
Corporate securities
Investment properties
Total recurring FV measurement
FV measurements at the end of the
reporting period using Valuation processes for level 3 fair values
Level 1 inputs Level 2 inputs Level 3 inputs
♦ The company engages qualified valuers to determine the fair value
31 Dec 2020 of the group’s financial instruments that are in level 3 of the fair
45 45 - - value hierarchy every 6 months. The fair value of investment
32 - - 32 property is determined at the end of each reporting period.
♦ The following table sets out the amount of total gains or losses for
9 9 - -
the period included in profit or loss in relation to assets measured
6 - - 6 on a recurring basis using level 3 of the fair value hierarchy:
92 54 - 38

Land held for sale (note) 4.5 - 4.5 - Non-trading Investment Total
equity Properties
Total non-recurring FV 4.5 - 4.5 - securities
measurement Recognised gains and losses recognised ($1.2m) $0.8m ($0.4m)
in Statement of Profit or Loss
Note:
The company has measured land held for sale at fair value on a non-recurring
basis as a result of its classification as held for sale.
Disclosure Example Globalisation of Accounting Regulation

Valuation techniques ♦ Driving force

The following valuation techniques are used for different  Globalisaton of capital markets
levels of inputs:
 One set of accounting regulation facilitates cross-
Level 1: Equity and corporate Quoted share prices
securities country investment
Level 2: Land held for sale Sale comparison approach: sale prices of comparable
land in similar location are adjusted for differences in
♦ Major players
key attributes such as land size. The valuation model
is based on price per square metre.
 IOSCO
Level 3: Non-trading equity Discounted cash flow method. Key unobservable
(International Organization of Securities Commissions)
securities inputs are: weighted average cost of capital, revenue
growth rate, discount for lack of marketability and
 IASB (previously IASC)
control premium.  SEC
Investment
properties
Income approach based on estimated rental values.
Key unobservable inputs are discount rate, expected
 FASB
vacancy rate and rental growth rate.
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International Accounting / Financial Development of the IASB and IFRSs

Reporting Standards
 1973: IASC founded by accountancy bodies from 9 countries
♦ IASs and IFRSs  Up to 1980’s: main activity – codifying best practice through issue of
IASs
 Authoritative statements of how particular types  Developed countries continued to use domestic GAAP
of transaction and other events should be  1989: publication of conceptual framework and initial discussions with
reflected in financial statements IOSCO
 Compliance with accounting standards  1993+: adoption of IASs by number of continental European companies
necessary to enable financial statements to for consolidated financial statements
“show a true and fair view”  1998: laws to permit use of IASs in some European countries
 2000: IOSCO endorses IASs
 Issued by International Accounting Standards  2001: Reformed Board – IASB formed
Board (IASB) – the standard-setting body of the  2002: EU requires IASs for listed companies by 2005
IFRS Foundation  2005: Hong Kong adopted IFRSs
 Standards based on IASB’s “Conceptual  2000s: Other major countries start adopting/converging with IFRSs
Framework” – which is principles-based 27
 2018: 166 jurisdictions adopted IFRSs
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Convergence of IFRS and US GAAP
 2002: “Norwalk Agreement” with US FASB for convergence of US FAS
and IFRS
 2006: Roadmap/MoU of convergence with US FASB announced –
projects to be completed by June 2011
 2007: SEC remove requirement for IFRS accounts reconciliation (Form
20-F) with US GAAP
 2007: SEC roadmap for adoption of IFRS by US companies by 2014
 2009: G20 heads call for re-doubling of efforts to complete convergence
in global accounting standards
 2011: Major FASB/IFRS convergence projects not all completed;
change in Chair of IASB; review of objectives
 2013: No decision yet by SEC whether to adopt IFRS
 2014: The SEC stepped backward from its previous roadmap and
is questioning whether a single set of global accounting standards can
be achievable. FASB is no longer committed to convergence projects
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Consequences of Global IFRS Adoption
♦ Benefits
 Common financial accounting and reporting methods
 Increased transparency in reporting
 Principles rather than rules based
 Wider pool of investors -> lower cost of capital
 Increase in cross-border M&A activity
♦ Criticisms
 Increased use of fair values has lead to increased volatility in
earnings
 Length and complexity of many IFRSs
 Alternative accounting treatments permitted by some IFRSs
 Enforcement effectiveness may vary across countries
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