Fair Value Measurement

Fair value measurement refers to the process of determining the value of an asset or liability
based on its exchange price in the market. It involves estimating the price at which an asset
could be sold or a liability transferred between knowledgeable, willing parties in an orderly
transaction.
The measurement and disclosure requirements of this IFRS do not apply to the
following:
a) Share-based payment transactions within the scope of IFRS 2 Share-based Payment;
b) Leasing transactions accounted for in accordance with IFRS 16 Leases; and
c) Measurements that have some similarities to fair value but are not fair value, such as
net realizable value in IAS 2 Inventories or value in use in IAS 36 Impairment of
Assets.
The definition of fair value in IFRS13 is as follows:
“...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”
Elements of the definition
Current exit price
 The exit price is defined as: “...The price that would be received to sell an asset or
paid to transfer a 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-arm’s length sales
Market participants
 Must be independent from each other (not related parties)
 Must be knowledgeable about the asset or liability
 Must have the ability to enter into the transaction
 Must be willing to transact and not be forced or compelled
Who would transact for the item?
 Market participants are buyers and sellers in the principal (or most advantageous)
market who are:
 Independent:- ABLE TO ENTER INTO TRANSACTION.
 Knowledgeable: WILLING; - to enter into transaction.
  Market participants’ act is their economic best interest.
 Maximise the value of the asset.
 Minimise the value of the liability.
To measure fair value determine
 All characteristics of the asset and liability being measured (exclude things that are
not characteristics of the asset or liability:
 For non-financial asset the valuation premise and the highest and best use:
 The principal ( or most advantageous) market
Characteristic of an asset or liability
Fair value measurement is for particular asset or liability.
All characteristics that market participants would take into account when pricing an asset or
liability.
Eg
Location of the asset.
Condition of the asset.
Restrictions on sale or use of the asset.
Is the asset or liability a stand-alone asset or it is a group of assets?
Where would the transaction taken place
FV measurement assumes that the transaction takes place in either: the principal market or
the most advantageous market
 Principal market
The market with the greatest volume and level of activity
 Most advantageous market
The market that would maximise the amount received/paid after deducting transaction and
transport costs
Transaction and transport costs
Transaction Cost: the costs to sell asset/transfer the liability that are directly attributable to
the disposal of asset or the transfer of the liability.
They are characteristic of the transaction not of the asset or liability.
We use when we determine fair value measurement most advantageous market but not
in principal market.
 Transport costs are the costs incurred to transport an asset from its current location to
its principal market.
 However, the price used to measure FV is NOT adjusted for transaction costs
Transport costs are deducted to calculate the fair value
Assets and Liabilities for which Fair Value Measurement is allowed:
i. Financial Instruments: Fair value measurement is generally allowed for various
financial instruments, including:
 Marketable securities (e.g., stocks, bonds, mutual funds)
 Derivatives (e.g., options, futures, swaps)
 Financial liabilities measured at fair value through profit or loss
ii. Investment Property: IFRS requires investment property to be measured at fair
value, with changes in fair value recognized in profit or loss. Investment property
refers to property held to earn rental income or for capital appreciation.
iii. Biological Assets: Biological assets, such as living animals or plants, are measured at
fair value. Changes in fair value are recognized in profit or loss. This applies to
agricultural produce at the point of harvest as well.
iv. Deferred Compensation Plans: Certain deferred compensation plans, such as
employee share-based payment arrangements, may be measured at fair value. Fair
value measurement is used to determine the cost of employee services received in
exchange for equity instruments granted.
Assets and Liabilities for which Fair Value Measurement is Not Allowed or Limited:
i. Property, Plant, and Equipment (PPE): Generally, fair value measurement is not
allowed for property, plant, and equipment. Instead, PPE is typically measured at
cost less accumulated depreciation and impairment.
ii. Intangible Assets: Similar to PPE, fair value measurement is not typically allowed
for intangible assets. Intangible assets, such as patents, trademarks, and copyrights,
are usually measured at cost less accumulated amortization and impairment.
iii. Inventories: Fair value measurement is generally not allowed for inventories.
Inventories are typically measured at the lower of cost or net realizable value.
iv. Deferred Tax Assets and Liabilities: Fair value measurement is not allowed for
deferred tax assets and liabilities. These are measured using the tax rates and laws
applicable to the respective jurisdictions.
v. Provisions: Fair value measurement is generally not allowed for provisions.
Provisions are measured at the best estimate of the expenditure required to settle
the obligation.
vi. Operating Leases: Under IFRS 16, operating leases are accounted for differently,
and fair value measurement is not typically allowed for lease assets and lease
 liabilities. Instead, lessees recognize a right-of-use asset and a lease liability
measured at the present value of lease payments.
Fair Value Hierarchy:
IFRS establishes a fair value hierarchy that categorizes inputs used in fair value
measurements into three levels: Level 1, Level 2, and Level 3.
 Level 1 input is quoted prices in active markets for identical assets or liabilities,
providing the most reliable evidence of fair value.
 Level 2 inputs are observable market data other than quoted prices for identical assets
or liabilities, such as market comparable or pricing models.
 Level 3 inputs are unobservable inputs, requiring significant management judgment,
and are used when observable data is not available. These inputs are based on the
entity's own assumptions.
Impairments
Definitions
 In accounting, impairment describes a permanent reduction in the value of a company's
asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the
total profit, cash flow, or other benefit expected to be generated by that specific asset is
periodically compared with its current book value. If it is determined that the book value of
the asset exceeds the future cash flow or benefit of the asset, the difference between the two
is written off and the value of the asset declines on the company's balance sheet.

 The impairment of a fixed asset can be described as an abrupt (sudden) decrease in fair
value due to physical damage, changes in existing laws creating a permanent decrease,
increased competition, poor management, obsolescence of technology, etc. In the case of a
fixed-asset impairment, the company needs to decrease its book value in the balance sheet
and recognize a loss in the income statement. Impairment can occur as the result of an
unusual or one-time event, such as a change in legal or economic conditions, change in
consumer demands, or damage that impacts an asset.
 Assets should be tested for impairment regularly to prevent overstatement on the balance
sheet.
 Impairment exists when an asset's fair value is less than its carrying value on the balance
sheet.
 If impairment is confirmed as a result of testing, an impairment loss should be recorded.
 An impairment loss records an expense in the current period which appears on the income

statement and simultaneously reduces the value of the impaired asset on the balance sheet.
Differences between depreciation and impairment as per IFRS (International Financial
Reporting Standards):
Depreciation:
I. Definition: Depreciation is the systematic allocation of the cost of an asset over its
useful life. It represents the recognition of the consumption of an asset's economic
benefits over time.
II. Purpose: The primary purpose of depreciation is to match the cost of an asset to the
periods in which it contributes to generating revenue. It helps in spreading the cost of
an asset over its estimated useful life.
III. Scope: Depreciation applies to tangible assets with a limited useful life, such as
property, plant, and equipment (PPE). It does not apply to intangible assets or
financial instruments.
IV. Calculation: Depreciation is calculated using various methods, such as straight-line
depreciation, reducing balance method, or units-of-production method. The method
used should reflect the pattern of consumption of the asset's economic benefits.
V. Recognition: Depreciation is recognized as an expense in the income statement and is
allocated to the relevant period's financial results. It reduces the carrying amount of
the asset on the balance sheet.
VI. Reversal: Under IFRS, depreciation is generally not reversed unless there is a change
in the useful life or residual value of the asset. Any changes are treated as a change in
accounting estimate and are applied prospectively.
Impairment:
I. Definition: Impairment refers to a significant or prolonged decline in the value of an
asset below its carrying amount. It indicates that the asset's future economic benefits
are not expected to be fully realized.
II. Purpose: The purpose of impairment is to recognize a loss in value when the carrying
amount of an asset exceeds its recoverable amount. Impairment ensures that the asset
is stated at its recoverable amount in the financial statements.
III. Scope: Impairment applies to various assets, including tangible assets (e.g., PPE),
intangible assets (e.g., goodwill, patents), and financial assets (e.g., loans, equity
investments). It does not apply to current assets such as inventory or trade receivables.
IV. Calculation: Impairment is determined by comparing an asset's carrying amount with
its recoverable amount. The recoverable amount is the higher of an asset's fair value
less costs to sell or its value in use.
V. Recognition: If an asset's carrying amount exceeds its recoverable amount, it is
considered impaired. The impairment loss is recognized as an expense in the income
statement, reducing the carrying amount of the asset on the balance sheet.
VI. Reversal: Under IFRS, an impairment loss can be reversed if there is a change in the
estimates used to determine the recoverable amount. The reversal is limited to the
original impairment loss amount, ensuring the carrying amount does not exceed what
it would have been without the impairment.