CH 4. NCA - Fair value measurement (IFRS-13)

Question 1

What is the Purpose of Fair value measurement (IFRS-13)?

&

When is it applied and what are the exceptions?

Answer 1

To provide a single source of guidance for fair value measurement, to all IFRS’s

Rather than it being spread throughout several reporting standards. e.g

• • IAS16 - PPE
• • IFRS 3 - BUSINESS COMBINATIONS

The only exceptions are:-

• - Share-based payments IFRS 2
• - Leases IFRS 16
• - Measurements that are similar to, but not the same as, fair value, eg:
  
  • Net realisable value of inventories (IAS 2)
  • Value in use (IAS 36)

Question 2

What is the definition of Fair value?

and

What is the main aim of IFRS 13?

Answer 2

• Fair value: The price that would be received to sell an asset or paid to transfer a liability in an:-
  
  • Orderly transaction: the transaction occurs “at arm’s length”, has real commercial substance and not forced into a transaction.
• Between
  
  • Market participants are knowledgeable, third parties. who when pricing an asset or a liability, they would take into account: Condition, location and restrictions on the use of the asset or liability.
• At the measurement date.

The main aim: - To estimate the price that would be transferred in a transaction with a market participant, whatever approach is taken to determine the fair value.

IFRS 13 notes that there are various approaches to determining the fair value of
an asset or liability:

• Market approaches (valuations based on recent sales prices)
• Cost approaches (valuations based on replacement cost)
• Income approaches (valuations based on financial forecasts).

Whatever approach is taken, the aim is always the same,

Question 3

How do you measure the fair value of a transaction?

What is the Hierarchy of F.V inputs?

Answer 3

Fair value is a market-based measure, not an entity-specific one.

The aim is to maximise the use of relevant observable inputs (Quotes) and minimise the use of unobservable inputs.

• Observable inputs are defined as “inputs that are developed using market data”
• Unobservable inputs are inputs used in fair value accounting for which there is no market information available,

There is a Hierarchy for the level of inputs:

• Level 1: Quoted prices for identical assets in active markets.
• Level 2: Observable prices that are not level 1 inputs identical assets. e.g
  
  • – Quoted prices for similar assets in active markets​
  • – Quoted prices for identical assets in less active markets
  • – Observable inputs that are not prices (such as interest rates).
• Level 3: Unobservable inputs for the asset or liability, eg discounting estimates of future cash flows
  
  • ​A significant adjustment to a level 2 input would lead to it being
    categorised as a level 3 input.

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.

IFRS 13 says that fair value should be measured by reference to the:

- principal market,

if there isn’t one, then the

- most advantageous market.

Question 4

How is the active market determined?

and

How is the fair value measurements affect by the Principle and most advantageous market?

Answer 4

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.

IFRS 13 says that fair value should be measured by reference to the principal market, if there isn’t one, then the most advantageous market.

• - PRINCIPAL MARKET - is the market with the greatest activity for the asset or liability. The market in which an entity normally transacts is presumed to be the principal market
• Note–> The entity must be able to access the market at the measurement date.
• - The MOST ADVANTAGEOUS MARKET. This is assessed by comparing the highest Net amount receivable from the different markets: -
  
  • Selling Price
  • Less the Transaction costs
  • Less the Transportation costs
  • = Net Amount receivable or payable.

But the fair value of the asset is always calculated:- Selling Price - Transport costs = F.V

^{This is because transaction costs are characteristic of the market rather than the asset.}

Question 5

How do you measure the Fair value of non-financial assets?

and

How do you determine the highest and best use of the non-financial asset?

Answer 5

Non-Financial assets -

F.V measurement is the value of the asset in its highest and best use.

Current use of a non-financial asset can be assumed to be the highest and best use

UNLESS evidence exists otherwise, you should consider if other uses are:

• Physically possible (Value of asset, less costs to get the asset ready)
• Legally permissible (legally allowed, but does not need to be legally approved.)
• Financially feasible (does it make financial sense)

Question 6

How do you measure the Fair value of a Liability?

Answer 6

The measurement of the fair value of a liability assumes that the liability remains outstanding and would be required to fulfil the obligation.

The fair value of liability also reflects the effect of non-performance risk.

E.g

+ The expected value of cash flows

+ the adjustment for inflation

+ Risk premium

* discounted to current market value

= Fair Value (present value of expected cash flow adjusted for market risk)

Question 7

Summarise the steps on how to apply IFRS 13?

Answer 7

STEP 1 A Financial asset or Non-Financial asset?

• Financial Asset - Skip to Step 3
• Non- Financial Assets - move on to step 2

STEP 2 - USE THE HIGHEST AND BEST USE OF ASSET

STEP 3, SEE WICH HIERARCHY TO USE FOR THE 3 LEVEL TEST

STEP 4- LEVEL 1 OBSERVABLE PRICES, Use principal market, if not available then the most advantageous

STEP 5 - LEVEL 2 - OBSERVABLE PRICE OF SIMILAR ASSETS

STEP 6 - LEVEL 3 - DISCOUNTED CASH FLOWS