Week 1| Fair Value measurement Flashcards
What are the main objectives of AASB/IFRS 13? Discuss why such a standard was considered necessary
The main objectives are:
- to define fair value
- to establish a framework for measuring fair value
- to require disclosures about fair value measurement (AASB 13, para 1)
In response to various accounting scandals and corporate collapses, the International Accounting Standards Board (IASB) issued IFRS 13 Fair Value Measurement in 2011 to provide a more regulated and consistent approach to how companies determine the fair values of their assets and liabilities. The standard also requires companies to disclose more details about their fair value measurements.
What are the key elements of the definition of ‘fair value’? Explain the effects of inclusion of each element in the definition
(Key elements:
Current exit price (2 marks for explaining asset and liability)
Orderly transaction (1 mark for AASB def, 1 for orderly transaction def, 1 mark for two factors indicating a transaction is not orderly)
Between market participants (1 mark for AASB def, 3 marks for characteristics of market participants)
i) Current exit price: to sell an asset or paid to transfer a liability
CEP is based on the perspective of the entity that holds the asset or owes the liability.
For asset, exit price is the expected future cash inflows generated from the acquiring entity from the use of the asset or from selling of the asset
For a liability, the exit price is the expected future cash outflows for the settlement of the liability or the price to transfer the liability to a market participant
ii) In an orderly transaction
AASB 13 defines an ordelry transaction as “ transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets liabilities; it is not a forced transaction.
An orderly transaction is where both parties to the transaction are considered to be at arm’s length. That is, the goods are sold at their full market value, and not at a ‘sale’ or ‘discounted’ price.
Factors that would indicate a transaction is not orderly include:
- the seller is in or near bankruptcy
the seller was forced to settle to meet regulatory or legal requirements
iii) Between market participants
AASB defines market participants as buyers and sellers in the principal (or most advantageous) market for the asset of liability
The market participants must be:
- independent of each other
- knowledgeable - have a reasonable understanding of the asset or liability and the transaction using all available information
- able and willing to enter into a transaction for the asset or liability (i.e. they are not forced to enter into the transaction)
Does the measurement of fair value take into account transport costs and transaction costs? Explain
(2 marks for explaining what transport ad transaction costs are)
( 1 mark for why one of them is included and the other one isn’t)
Transaction costs are incremental direct costs to sell an asset or transfer a liability
Transport costs are costs necessarily incurred to transfer an asset to its most advantageous market
The measurement of fair value requires both costs to be taken into consideration in the determination of the most advantageous market. However, only transport costs are used in calculation of fair value.
This is because transaction costs are entity specific, transport costs are not, they relate to the characteristic of the asset itself
How does measurement of fair value of liability differ from that of an asset? What are the key steps in determining a fair value measure?
(1 mark for fair value def
4 marks for asset valuation
1 mark for liability valuation)
The fair value measurement of a liability is the amount paid to transfer a liability to another market participant It assumes that liability remains outstanding, the transferee will now be required to fulfil the obligation, and the liability is not considered to be settled at measurement date.
When considering fair value of asset, the entity must determine
- The particular asset that is the subject of the measurement (consistent with its unit of account)
- For a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest ad best use)
- The principal (or most advantageous market) for the asset
- The valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use in pricing the asset and the level of the fair value hierarchy within which the inputs are categorised
When considering fair value of a liability, the entity must determine the same steps as for an asset except for step 2. That is, no valuation premise (in combination or stand alone) is required for liabilities
Explain the difference between the current use of an asset and the highest and best
use of that asset.
The current use of the asset is how the reporting entity is currently using an asset
The highest and best use is based on how market participants will use the asset
An example of where the 2 may differ is where land is currently used as a site for a factory, but the land could be used for residential purposes. The current use is industrial while the highest and best use could be either industrial or residential
Explain the difference between the in-combination valuation premise and the stand alone valuation premise
(1 mark for in-combo def
1 mark for standalone def and 1 mark for highest and best value)
In-combination valuation premise: A basis used to determine the fair value of an asset that provides maximum value to market participants principally through its used in combination with other assets and liabilities as a group (as installed or otherwise configured for use)
Stand-alone valuation premise:
A basis used to determine the fair value of an asset that provides maximum value to market participants principally on a stand-alone basis
The highest and best use of an asset established the valuation premise used to measure the fair value of that asset
What valuation techniques are available to measure fair value?
Th market approach: prices generated by market transaction
The cost approach: prices based on amounts required to replace the service capacity of an asset
The income approach: prices generated by considering future cash flows or future income and expenses
Discuss the differences between the various levels in the fair value hierarchy. Do you agree that the outcomes at all three levels should be described as ‘fair values’?
(1 mark for fair value hierarchy def
3 marks for the input levels specification
1 mark for how they are used in disclosure)
The fair value hierarchy is a hierarchy of inputs into the fair value measurement. The inputs are the assumptions that market participants make when using a valuation technique in pricing an asset or liability
The inputs are classified as observable or unobservable. The fair value hierarchy gives the highest priority to observable inputs and the lowest to unobservable inputs
The hierarchy does not prioritise the valuation techniques, just inputs to those techniques
The fair value hierarchy prioritises inputs into 3 levels
Level 1, 2 and 3 see the answer to RQ 14 for info on these levels
The hierarchy is also used in the disclosure process as a fair value measure is classified in its entirety based on the lowest level input that is significant to the entire measurement
Discuss the use of entity-specific information in the generation of fair value
measurements under AASB 13/IFRS 13.
Information that is specific to an entity is required to be ignored when considering the fair value of an asset.
This is because the fair value is measured on observations of market participants
and not with any particular entity. An example of an entity-specific factor would be blockage – discounts on sale of items in blocks or bulk quantities. Assuming all criteria for fair value measurement are met, if a buyer purchases one item, the value of the asset would be its ‘highest and best use’.
However, when an entity is offered a discount for purchasing multiple items of the same product, the discounted price per item is lower than its highest or best use. The offering of discounts for bulk purchases in the market place is therefore ignored when determining fair value.
Another example of an entity-specific factor is the way in which a particular acquirer would use the asset if they were to purchase it. The fair value must be determined based on the potential uses, and not specific uses, by market participants.
