CHAPTER TWO

FAIR VALUE MEASUREMENT(IFRS 13)

1
Arba Minch University, Department of Accounting and Finance
 Learning Objectives

At the completion of studying this chapter, you will be able to:

Understand conceptual underpinnings for fair value measurement
Understand how fair value is measured for:

 non-financial assets

 financial assets

 financial liabilities
Understand the judgments in measuring the fair value of an item

identify the disclosure requirements of IFRS 13

distinguish between fair value measurement under US GAAP and IFRS

2
List of Applicable IFRS
Topic List Standards
Financial Instruments IFRS 9
Property, Plant and Equipment IAS 16
Investment Property IAS 40
Intangible Assets IAS 38
Agriculture IAS 41
Business combination IFRS 3

3
The objective of IFRS 13

4
 THE SCOPE OF IFRS 13
Excluded from the scope
Disclosures in IFRS 13 not required for
•IFRS 2 (Share based payment)
•IFRS 16(leases)
• IAS 2 (net realisable value)
• IAS 36 (value in use)
• Plan assets (IAS 19)
• Retirement benefit plan investments
(IAS 26)
• Assets for which recoverable amount is fair
value less cost of disposal (IAS 36)
5
6
Who would transact for the item?

 Market participants are buyers and sellers in the principal (or most advantageous)
market who are:

Independent Knowledgeable

Able to enter into a Willing to enter into a

transaction transaction

 Market participants act in their economic best interest

 Maximise the value of the asset
 Minimise the value of the liability
7
Fair value: market participant perspective
application guidance: how to measure fair value
 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)

8
Fair value: market participants’ view point
application guidance: characteristic of an asset or
liability
 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
– age and remaining economic life

– 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

9
Transaction and transport costs
Description
Transaction The costs to sell the asset or
costs transfer the liability that are
directly attributable to the
disposal of the asset or the
transfer of the liability
Transport costs The costs that would be
incurred to transport an asset
from its current location to its
exit market
10
Included in fair value?
No (Although they are considered
in the assessment of which
market is most advantageous)
They are a characteristic of the
transaction, not of the asset or
liability
Yes Transport changes a
characteristic of the asset
(its location)
Fair value: which market?
test your understanding: transaction costs
Example: GLORY Company has an asset that is sold in two different markets, Market A
and Market B, with similar volumes of activities, but with different prices. GLORY
Company enters into transactions in both markets and can access the price in those
markets for the asset at the measurement date. There is no principal market for the
asset. Information from both markets is presented as follows.
Market A Market B
Price Br. 30 Br.28
Transport costs (5) (4)
Br. 25 Br.24
Transaction costs (3) (1)
Net amount received Br. 22 Br.23
 1. Which market is the most advantageous ? 2. how much is the fair value of the
asset? 11
Where would the transaction take place?
Fair value is the price in the …
Or, if no principal market, the
Principal market
most advantageous market
The market with the greatest volume and The market that maximises the amount that
level of activity for the asset or liability would be received to sell the asset and/ or
minimizes the amount that would be paid
to transfer the liability

 In most cases, these markets will be the same

 arbitrage opportunities will be competed away
 The entity must have access to the principal (or most advantageous) market

12
Fair value: which market?
Determining the principal market
 The following three markets exist for Sugar Corporation’s fleet of vehicles. The
corporation has the ability to transact in all three markets (and has historically done
so). As at the measurement date, the corporation has 100 vehicles (same make,
model and mileage) that it needs to measure at fair value. Volumes and prices in the
respective markets are as follows:

Market price The corporation's volume for Total market-

the asset in the market based
(based on history volume for the
and/or intent) asset
A 490,000 60% 15%
B 500,000 25% 75%
C 550,000 15% 10%

Which of the market is the principal market for the corporation's Vehicle?
How do we arrive at a market-based measurement?
Is there a quoted price in an active market for an identical asset or liability?

Yes No
Replicate a market price through a valuation
Use this quoted price to measure fair
technique* (using observable+ and unobservable
value (Level 1) inputs: Levels 2 and 3)

Must use without adjustment Use of significant

No significant unobservable
unobservable
(Level 3) inputs‡ =
(Level 3) inputs‡ =
* Valuation techniques include the market Level 2 measurement
approach, income approach and cost Level 3 measurement
approach.
+ Maximise the use of relevant observable inputs and minimise the use of unobservable inputs. Observable
inputs include market data (prices and other information that is publicly available).

‡ Unobservable inputs include the entity’s own data (budgets,

14
forecasts), which must be adjusted if market
participants would use different assumptions.
Fair Value: Hierarchy

15
Fair value: Valuation Techniques

16
Valuation techniques
When determining fair value, an entity shall use valuation techniques:
 Appropriate in the circumstances
 For which sufficient data are available to measure fair value
 Maximizing the use of relevant observable inputs
 Minimizing the use of unobservable inputs.

17
 Fair value: non-financial asset

Highest and best use

 Fair value assumes a non-financial asset is used by market participants at
its highest and best use
 the use of a non-financial asset by market participants that maximises
the value of the asset
– physically possible

– legally permissible

– financially feasible

18
Highest and best use continued
 Highest and best use is determined from the perspective of market participants,
even if the entity intends a different use.
 However, an entity’s current use of a non-financial asset is presumed to be its
highest and best use unless market or other factors suggest that a different use by
market participants would maximize the value of the asset.
 Highest and best use is usually (but not always) the current use
 if for competitive reasons an entity does not intend to use the asset at its highest
and best use, the fair value of the asset should still be measured assuming its
highest and best use by market participants (defensive value)
 Does not apply to financial instruments or liabilities

19
Valuation premise
 A non-financial asset either:
 provides maximum value through its use in combination with other assets and
liabilities as a group
– is its value influenced by it being ‘operated’ with other assets?

– an example: equipment used in production facility

– market participants are assumed to hold complementary assets

 provides maximum value through its use on a stand-alone basis

– is its value independent of its use with other assets?

– an example: a vehicle or an investment property

 Does not apply to financial instruments or liabilities

20
Valuation premise continued

 Example: a manufacturer has unique work in progress inventory which market

participants would convert into finished goods. To measure the fair value of the
unique work in progress the manufacturer assumes that market participants have
the machinery necessary to convert the unique work in progress inventory into
finished goods
 this assumption applies even when the necessary equipment is bespoke and
unique to the entity holding the inventory

21
Example : highest and best use
Land acquired in a business combination is currently developed for industrial use as a
site for a manufacturing facility. Nearby sites were recently developed for residential
high-rise flats. It was determined that the land could be used to develop residential
high-rise flats.
How is highest and best used determined?

 In this case, the highest and best use is determined from the higher of:
a) The value of the land used in the manufacturing operation
b) The value of the land as a vacant site for residential use
 Note that transformation costs (e.g., costs to demolish the manufacturing facility)
would be considered in the value of land as a vacant site.
FV of a non-financial asset-Highest and Best Use :
test your understanding
For example, at Sene 30 you are valuing your factories land use right.
● Land rights with a similar factory of the same age, same condition and same square

area as yours are sold for Br. 7 million of which the value of the factory is 4 million. At
the same date a ‘bare land’ homogeneous(identical) with your factory’s plot of land are
sold for alternate use for Br. 5 million. what is the highest and best use of your land
right?
Choose one
A. Br. 3 million

B. Br. 5 million
C. Br. 4 million

D. Br. 7 million
23
Fair value: restriction on use
test your understanding
Example: A donor of land specifies that the land must be used by the corporation for
cultivation of sugar cane. Upon review of relevant documentation, the corporation
determines that the donor’s restriction would not transfer to market participants if the
corporation sold the asset (i.e. the restriction on the use of the land is specific to the
association). Furthermore, the corporation is not restricted from selling the land.
Without the restriction on the use of the land, the land could be used as a site for coffee
plantation. In addition, the land is subject to an easement (a legal right that enables a
utility to run power lines across the land).
 Under these circumstances, what is the effect of the restriction and the easement on
the fair value measurement of the land?

24
 Fair value: restriction on use
test your understanding
 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 Br. 950,000 on 30 October 2015 (Plot B); and
 for Br. 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.

25
Fair value: restriction on use
test your understanding
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: Br. 100,000,000 D
 Scenario 2: market participants believe there is no prospect of the zoning laws
changing: Br. 1,000,000 B
What is the fair value of the land use rights to Plot A at 31 December 2015? Choose
one of:
1) Br. 950,000; 2) Br. 1,000,000; 3) Br. 30,000,000; 4) Br. 100,000,000; or 5) another
amount.

26
Fair value: location
test your understanding
On Sene 1, 2008 your firm buys a machinery for ¥ 90 million in china to increase its
productivity. Additionally the firm paid ¥ 10 million agent commission and ¥ 5 million
to transport the machine from China to its production site. The seller of the machine
incurred ¥ 6million selling costs. Assuming that the market at which the firm purchased
the machine is its principal market (should the firm choose to sell the machine).
What is the fair value of the machine at Sene 30, 2008 (in ¥)?
Choose one:
A. 75 million
B. 80 million
C. 85 million
D. 74 million

E. 69 million
27
Exercise
1. Company X holds an asset that is traded in three different markets. It usually
buys and sells in market C. information about the three markets are:
Market A Market B Market C
Volume (annual) 30,000 12,000 6,000
Trades per month 30 12 10
Price 50 48 53
Transportation cost (3) (3) (4)
Possible fair value 47 45 49
Transaction cost (1) (2) (2)
Net proceed 46 43 47

a. What is the principal market?

b. What is the fair value of the asset?
c. What is the most advantageous market?
28
 Fair value: financial asset

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).

29
Measuring fair values of financial instruments
 Generally measure fair value using:
 market approach (for example, quoted market prices and market multiples for
comparable assets); and/or
 income approach (for example, present value techniques and option-pricing models)

 Generally do not use the cost approach

 Considerations that affect the fair value of financial instruments include:
 the time value of money
 non-performance / credit risk
 liquidity risk

 Effect of risk: (i) variable expectations of future cash flows, (ii) price for bearing this
uncertainty (see paragraphs B15 to B17 of IFRS 13)

30
Fair value: liabilities
 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)

31
 Fair value: liability decision tree
application guidance: liabilities
Is there an observable market price No
Yes to transfer the instrument?
Does somebody hold the
Fair value = corresponding asset?
observable market Yes
price of instrument No

Fair value = fair value of the Fair value = another

corresponding asset valuation technique

Is there an observable market

Level 2 or 3
Yes
price for the instrument No

Fair value = traded as an asset?

Fair value = another
observable market valuation technique
price of asset 32
Disclosure
IFRS 13 requires extensive disclosure of sufficient information to asses:
 Valuation techniques and inputs used to develop fair value measurement for both
recurring and nonrecurring measurements;
 The effect of measurements on profit or loss or other comprehensive income for
recurring fair value measurements using significant Level 3 inputs.
 Recurring fair value measurements are those presented in the statement of financial
position at the end of each reporting period (for example, financial instruments).
 Nonrecurring fair value measurements are those presented in the statement of
financial position in particular circumstances (for example, an asset held for sale in line
with IFRS 5).
.
33
Disclosure

As the disclosures are really extensive, here, the examples of

the minimum requirements are listed:
 Fair value measurement at the end of the reporting period;
 The reasons for measurement (for nonrecurring)
 The level in which they are categorized in the fair value hierarchy,
 Description of valuation techniques and inputs used;
 And many others

34
Questions or comments?

35