Fair value measurement

Prepared by: Michael Wells

Date: June 13-17, 2016
Addis Ababa
Aims

» Understand conceptual underpinnings for fair value

measurement
» Understand how fair value is measured for:
» non-financial assets
» financial assets
» financial liabilities
» Understand the judgements in measuring the fair value of an
item

2
Conceptual underpinnings
 Conceptual underpinnings
4
» Measurement is the process of determining monetary amounts at which elements
are recognised and carried (paragraph 4.54 of IASB Conceptual Framework)
» To a large extent financial reports are based on estimates, judgements and models
rather than exact depictions
» The Conceptual Framework establishes the concepts that underlie those estimates,
judgements and models (paragraph 4.54 of IASB Conceptual Framework)
» objective/s of general purpose financial information; qualitative characteristics
» cost constraint

» Conceptual Frameworks are weak on measurement: list measurement conventions

» Impairment ‘concept’: an asset should not be measured at an amount greater than
the entity expects to recover from its sale or use

© Michael JC Wells 4
Many measurements for assets
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IFRS IFRS for Impairment
SMEs necessary?
Historical cost ✔ ✔ ✔
Modified historical cost ✔ ✔ ✔
Fair value ✔ ✔ ✘
Fair value less costs to sell ✔ ✔ ✘
an impairment
Value in use ✔ ✔ measurement
often an impairment
Net realisable value ✔ ✔ measurement
Other measurements ✔ ✔ ✔
5
Mixed measurement model
source of measurement bases indicated: IFRS
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Assets IFRS measure Equity IFRS measure
Unimpaired land (PPE) & Historical cost (HC) or fair value (FV) Residual What does it mean?
indefinite life intangibles (choice) (assets minus liabilities)

Other PPE, intangibles and Modified (M)HC or modified FV Liabilities IFRS measure
bearer plants (choice)

Investment property MHC or FV (choice) Bank loan Amortised cost (AC)

Biological assets FV less costs to sell Trade payable AC
Investments in associates Equity method Derivatives and others FV
when FV option is used

Other financial instruments MHC or FV (depends on cash flow Provisions Amount to settle or
characteristics and business model) transfer today

Inventories Lower of HC and net realisable Defined benefit Projected unit credit
value; exceptions FV and NRV employee benefits method

TOTAL What does it mean? TOTAL What does it mean?

6
 Trying to develop measurement concepts
IASB thinking on when to prescribe which measurement?
7
» Consideration of the objective of financial reporting, the qualitative
characteristics and the cost constraint is likely to result in different
measurement bases for different items (paragraph 6.3 of IASB exposure
Draft ED/2015/3 Conceptual Framework for Financial Reporting)
» The selection of a measurement (paragraph 6.35 of IASB Discussion Paper
DP/2013/1 A Review of the Conceptual Framework for Financial Reporting)
» for a particular asset should depend on how that asset contributes to future cash flows
» for a particular liability should depend on how the entity will settle or fulfil that liability
» the number of different measurements used should be the smallest number necessary
to provide relevant information

© Michael JC Wells 7
 Characteristics of fair value
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» a market value (not entity-specific value)
» an exit value
» reflects all changes that market participants factor into pricing at
the measurement date
» a clear measurement objective
» requires judgement to measure (especially Level 3
measurements)
» determine the appropriate valuation technique/s and inputs that market
participants would use when pricing the asset or liability
© Michael JC Wells 8
 What the IASB says about fair value
source: paragraphs 6.28 to 6.32 of IASB ED/2015/3
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» Has predictive value and confirmatory value (provides relevant information)
» fair value reflects expectations about the amount, timing and uncertainties of the cash
flows (reflecting market participants’ expectations).
» Provides comparable information (between entities and within an entity)
» market participant perspective, identical assets (absent estimation error) measured at
the same amount irrespective of when and for what purpose they are acquired
» Level 1 measurement is easily understood, low cost and verifiable
» Does not necessarily reflect the entity’s business model
» for example, when the business model is not to sell the asset or not to transfer the
liability
» Level 3 measurement can be costly, complex and subjective.

© Michael JC Wells 9
 What Lynn Turner and Walter Schuetz said
source: http://accountingonion.com/2014/08/time-for-the-sec-to-step-up-to-the-plate.html
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» (August 2014) Excerpts from a dialogue between former US SEC
commissioner Lynn Turner and Walter Schuetze former SEC Chief
Accountant
» Lynn Turner—“Walter, I not only agree that banks should be required to
disclose the fair value of their loans based on an independent valuation, but
they also account for those loans in the balance sheet using those values.”
» Walter Schuetze’s response—“I do not disagree. But, my proposal will, for
now, be easier to sell. And, investors will be happy with my proposal. Even
if the data are not on the face of the basic financial statements, once the
investors find the data, even if the data are on page XXX, they will luxuriate
in the data.”
© Michael JC Wells 10
Single measurement basis: fair value
would this provide relevant (decision-useful) information?
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Assets $ Equity $
Residual (assets minus liabilities) Does this XXX
CGU 1: fair value of individual assets XXX mean fair value of the company?

Synergies between assets in CGU1 XXX

Liabilities $
Fair value of CGU 1 XXX Fair value of bank loan XXX
… CGU 2; CGU 3; CGU 4 etc XXX Fair value of trade payables XXX
Synergies between CGUs XXX Fair value of derivatives XXX
Fair value of the collection of CGUs XXX Fair value of provisions XXX
Fair value of corporate assets XXX Fair value of tax obligations XXX
Fair value of investment property, Fair value of defined benefit employee
trade receivables, inventories etc XXX obligations XXX
Cash XXX Fair value of lease obligations XXX
Fair value of total assets XXX Fair value of total liabilities XXX
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Fair value: non-financial asset
 Fair value: an asset
the concept
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» The fair value of an asset is:
» the price that would be received to sell an asset (exit price)
» in an orderly transaction (not a forced sale)
» between market participants (market-based view)
» at the measurement date (current price) (IFRS 13 Fair Value Measurement)
» The market value of an asset is:
» the amount for which the asset could be exchanged between knowledgeable,
willing parties in an arm’s length transaction
» (IFRS for SMEs and paragraph 7.24 of IPSASB’s Conceptual Framework)
» Market participant perspective: consequently, the entity’s intention to hold
an asset is not relevant when measuring fair value.
© Michael JC Wells 13
 Fair value model
relating the concept of fair value to the objective of financial reporting
14
» Information about an entity’s financial performance in a period,
reflected by changes in economic resources is useful in
assessing the entity’s past and future ability to generate net
cash inflows (see paragraph OB18 of the IASB Conceptual
Framework)

© Michael JC Wells 14
 Fair value
measurement objective
15
» Objective of fair value measurement: estimate the price at
which an orderly transaction to sell and asset or to transfer a
liability would take place between market participants at the
measurement date under current market conditions (paragraph
B2 of IFRS 13)
» the objective provides focus to fair value measurement

© Michael JC Wells 15
 Fair value
market participants
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» Characteristics of market participants (ie buyers and sellers in
principal market (or most advantageous market)):
» independent
» knowledgeable
» diligent
» use all available information
» willing to transact for the asset or liability
» able to transact for the asset or liability
» Assumption: market participants act in their economic best interest

© Michael JC Wells 16
 Fair value: market participant perspective
application guidance: how to measure fair value
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» 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)
© Michael JC Wells 17
Fair value hierarchy
application guidance: Levels 1, 2 and 3
18
Is there a quoted price in an active market for an identical asset or liability?

Yes No

Use this quoted price to

Replicate a market price through a valuation
measure fair value
technique (maximise use of observable inputs)
(Level 1 measurement)

No use of significant Use of significant

unobservable inputs unobservable inputs
(Level 2 measurement) (Level 3 measurement)
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 Fair value of a non-financial asset
application guidance: valuation premise
19
If non-financial asset provides maximum value through its use in
combination with other assets:
» market participants are assumed to hold complementary assets
» 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

© Michael JC Wells 19
 Fair value of a non-financial asset
application guidance: highest and best use
20
» Fair value measurement logically assumes that a market
participant would put a non-financial asset to its highest and
best use because that maximises the value of the asset.
» The highest and best use must be
» physically possible
» legally permissible
» financially feasible

© Michael JC Wells 20
 Fair value of a non-financial asset
test your understanding: example 1
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» Your factory is built on Plot 900 in a recently developed industrial
development zone on the outskirts of Addis Ababa where the land that
is divided into one hundred two acre plots that before their further
development were essentially homogenous. Factories, like yours, are
the highest and best use for the land rights.
» On 31 December 2000 two of the plots adjoining your plot were sold (ie
sale of the land rights and the buildings, if any, constructed thereon):
» Plot 901 sold for $30 million: land rights with a similar factory of the same age,
same condition and same floor area as yours.
» Plot 899 sold for $10 million because it is undeveloped (yet to be built on).

© Michael JC Wells 21
 Fair value of a non-financial asset
test your understanding: example 1
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On 31 December 2000 what is the fair value of your land rights (ie
excluding the factory building)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80
million; 7) $100; million; or 8) another amount
On 31 December 2000 what is the fair value of your factory building
(ie excluding the land rights)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80
million; 7) $100; million; or 8) another amount
© Michael JC Wells 22
 Fair value of a non-financial asset
test your understanding: example 2
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» The facts are the same as Example 1, except that in this
example (fifteen years later), on 31 December 2015:
» high-rise commercial development is now the highest and best use
for your land rights because the rapidly expanding financial district of
Addis Ababa has grown to the boundary of plots 899, 900 and 901.
» Consequently, on 31 December 2015 Plots 899 and 901 each sold for
$100 million.

© Michael JC Wells 23
 Fair value of a non-financial asset
test your understanding: example 2
24
On 31 December 2015 what is the fair value of your land rights (ie excluding the
factory building)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80 million; 7) $100;
million; or 8) another amount
On 31 December 2015 what is the fair value of your factory building (ie excluding
the land rights)?
» Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70 million; 6) $80 million; 7) $100;
million; or 8) another amount
Does your estimate of the fair value of your factory building (ie excluding the land
rights) depend on which model you use for your land rights (cost model or
revaluation
© Michael model)?
JC Wells 24
 Fair value of a non-financial asset
what do you think? example 3
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» In Examples 1 and 2 fair value was determined with reference to the sale of
similar assets at the measurement date (31 December 2000 and 2015).
» The facts are the same as in Example 2, except that there have been no
recent sales of similar assets (ie Plots 899 and 901 are unsold).
» How could the fair value of the factory building on Plot 900 be measured at
31 December 2015?
» What judgements would be made in measuring such a Level 3 fair value?
» Can such a Level 3 fair value measurement be faithfully represented?
» Is such a Level 3 fair value measure verifiable?

© Michael JC Wells 25
 Fair value: market participants’ view point
application guidance: characteristic of an asset or liability
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» 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
» 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
» restrictions on use or sale that are not a characteristic of the item

© Michael JC Wells 26
 Fair value: market participants’ view point
application guidance: which market?
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Most advantageous market only when cannot identify principal market.
» Principal market has the greatest volume and level of activity for the asset
or liability
» Most advantageous market
» maximises the amount that would be received to sell an asset
» minimises the amount that would be paid to transfer the liability
» after taking into account transactions costs and transport costs.
» Other considerations:
» absent evidence to the contrary use the market the reporting entity usually accesses
» reporting entity must have access to the market at the measurement date

© Michael JC Wells 27
 Fair value: which market?
test your understanding: transaction costs
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You have access to two active markets to sell an asset:
» Market (M)1: price = $100; transaction costs = $10
» M2: price = $95; transaction costs = $3.
What is the fair value of the asset? Choose one of:
1) $100 if M1 is the principal market, otherwise $95;
2) $90 if M1 is the principal market, otherwise $92;
3) $95 because the most advantageous market (M2) must be the
principal market;
4) $92 because the most advantageous market (M2) must be the
principal market.
© Michael JC Wells 28
 Fair value: which market?
test your understanding: transport costs
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You have access to two active markets to sell an asset:
» Market (M)1: price = $100; transport costs = $10
» M2: price = $95; transport costs = $3.
What is the fair value of the asset? Choose one of:
1) $100 if M1 is the principal market; otherwise $95
2) $90 if M1 is the principal market; otherwise $92
3) $95 because the most advantageous market (M2) must be the
principal market
4) $92 because the most advantageous market (M2) must be the
principal market
© Michael JC Wells 29
 Fair value: restriction on use
test your understanding
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» 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 $950,000 on 30 October 2015 (Plot B); and
» for $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.
© Michael JC Wells 30
 Fair value: restriction on use
test your understanding
31
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:
$100,000,000
» Scenario 2: market participants believe there is no prospect of the zoning laws
changing: $1,000,000
What is the fair value of the land use rights to Plot A at 31 December 2015?
Choose one of:
1) $950,000; 2) $1,000,000; 3) $30,000,000; 4) $100,000,000; or
5) another amount.
© Michael JC Wells 31
 Fair value: location
test your understanding
32
» You recently won a tender to explore for gold in the Northern
Greenstone Belt of Ethiopia.
» On 30 November 2015 you:
» buy a mineral exploration rig for $20 million in the US
» incur buying agent commission of $2 million
» pay $1 million for the rig to be transported safely from the US to your
exploration site
» The seller of the drill incurs $2 million selling costs.
» The market at which you purchased the rig is your principal market
(should you choose to sell the rig).
© Michael JC Wells 32
 Fair value: location
test your understanding
33
What is the fair value of the rig at 31 December 2015?
Choose one of:
1) $25 million
2) $23 million
3) $22 million
4) $21 million
5) $20 million
6) $19 million
7) $17 million

© Michael JC Wells 33
Fair value: financial assets
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).
» Specific guidance for financial liabilities with demand features – the fair
value of such liabilities cannot be less than the amount payable on
demand, discounted from the first date that the amount could be required
to be paid (see paragraph 47 of IFRS 13).

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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)

36
Fair value: restriction on sale of a financial asset
test your understanding: example 1

Entity A pledges 100,000 BP plc shares that it owns as collateral in a

borrowing arrangement.
» Consequently, Entity A cannot sell its BP shares until it settles the borrowing.
» BP plc shares are issued without such a restriction and trade on both the
London Stock Exchange and the New York Stock Exchange.
Is the restriction relevant to measuring the fair value of the BP shares held by
Entity A? Choose one of:
» 1) Yes
» 2) No
» 3) It depends (specify)

37
Fair value: restriction on sale of a financial asset
test your understanding: example 2

» Entity B acquires 100,000 MTN Zakhele shares the sale of which is

restricted as follows:
» the share cannot be traded for the next three years
» for a further three-year period the shares can be sold only to those that
qualify as being previously disadvantaged in accordance with MTN Zakhele’s
South African broad-based black economic empowerment (BEE) scheme.
» thereafter trading in the share is unrestricted.
» Assume MTN Zakhele has no liabilities and its only assets are its
MTN shares (which are unrestricted and trade actively on the
Johannesburg Stock Exchange).

38
Fair value: restriction on sale of a financial asset
test your understanding: example 2

» Are the restrictions relevant to measuring the fair value of the

MTN Zakhele shares held by Entity B? Choose one of:
1) Yes, only the initial three-year prohibition of trading
2) Yes, only the subsequent three-year restriction of trading to qualifying
BEE participants
3) Yes, both 1) and 2) above
4) It depends (specify)

39
Fair value: restriction on sale of a financial asset
test your understanding: example 2 extended

» MTN Zakhele uses the dividends it receives from the MTN shares it holds to meet its
operating costs and interest on its loans. Any surplus cash is applied to reducing its
loan liabilities.
» When measuring the fair value of a MTN Zakhele shares what adjustments from the
price of an MTN share would Entity B’s management make? Decreases for (choose
one of):
1) liabilities funded by each MTN Zakhele share
2) liquidity restriction 1: initial three-year prohibition of trading
3) liquidity restriction 2: subsequent three-year restriction of trading to qualifying BEE participants
4) operating costs of MTN Zakhele to be met from dividends on its MTN shares
5) liquidity expectation: dividends received by MTN Zakhele from its MTN shares will be used to
reduce liabilities
6) all of the above

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Fair value: low-interest loan asset
test your understanding

Entity C advances an ‘interest-free’ loan of $121,000 to a related

party on 1 January 2016.
» The loan is repayable on 31 December 2017 at $121,000.
» The annual market interest rate that would otherwise have
applied to the related party borrowing would have been 10%.
However, this estimate is not based solely on observable
market data.

41
Fair value: low-interest loan asset
test your understanding

At 1 January 2016 the fair value of the loan is?

Choose one of:
1) $0
2) $21,000
3) $100,000 (ie the present value of $121,000);
4) $121,000 (the cash flow)

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Fair value: bid-ask spread
application guidance

» Bid prices apply to long positions and ask prices apply to short
positions (paragraph 70 of IFRS 13). However,
» IFRS 13 does not preclude the use of mid-market pricing or other
pricing conventions that are used by market participants as a practical
expedient for fair value measurement within a bid-ask spread
(paragraph 71 of IFRS 13)
» The entity uses the price within the bid-ask spread that is most
representative of fair value in the circumstances (paragraph 70 of IFRS
13)

43
Fair value: bid-ask spread
test your understanding: example 1

Entity D holds a security which at 31 December 2015 has:

» bid price $990
» ask price $1,010
Could Entity D measure the fair value of the security it holds at? Choose
one of:
1) $990 (bid price)
2) $1,000 (mid-market price)
3) $1,010 (ask price)
4) $990 or $1,000
5) $990 or $1,010
6) any of $990, $1,000 or $1,010
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Fair value: bid-ask spread
test your understanding: example 2

» Entity D also holds a security which at 31 December 2015 has:

» bid price $180
» ask price $220
» Could Entity D measure the fair value of the security it holds at? Choose
one of:
1) $180 (bid price)
2) $200 (mid-market price)
3) $220 (ask price)
4) $180 or $220
5) $180 or $200
6) any of 1), 2) or 3)
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Fair value: a large holding

» Use ‘unit of account’ specified in underlying Standard (see paragraph 14 of IFRS

13)
» individual share in accordance with IAS 39/IFRS 9
» ED/2014/4 Measuring the Fair Value of Investments in Subsidiaries, Joint Ventures and
Associates indicates the unit of account is investment as a whole
» However, if Level 1 input available, it must be used for measuring fair value (see
paragraphs 22, 69, 77 and 80 of IFRS 13)
» the principle: measure fair value using the assumptions that market participants would use
when pricing the item when acting in their economic best interest
» take into account characteristics of the item that market participants would take into account in transacting
» a rule: when a Level 1 measurement is available for an identical financial instrument
(including a position comprising of a number of identical assets or liabilities), fair value =
quoted price x quantity held even if the market’s normal daily trading volume is not sufficient
to absorb the quantity held by the entity (paragraph 80)
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Fair value: a large holding
test your understanding

Entity E holds 10% of the (1 million shares) share capital in Entity Z

» Entity Z’s shares trade actively in a deep and liquid market
» at 31 December 2015 trading in Entity Z shares closes at $10 per share
» Entity E believes that it would be able to sell its 10% stake in Entity Z in
a single transaction for $950,000 at 31 December 2015
At 31 December 2015 is the fair value of Entity E’s 10% holding in Entity
Z (Choose one of):
1) $950,000 (ie reflecting an adjustment for liquidity);
2) $1,000,000 (ie without reflecting an adjustment for liquidity); or
3) it depends on an assessment of all facts and circumstances?

47
Fair value: a large holding
test your understanding

Entity E also holds 10% of the (1 million shares) share capital in Entity Y
whose shares do not trade publicly (a private company)
» At 31 December 2015 management estimate the fair value of the 10%
stake in Entity Y at:
» $1,000,000 (without adjusting for liquidity) using multiples for comparable
companies whose shares do trade actively in deep and liquid markets; and
» $910,000 after adjusting for liquidity.
At 31 December 2015 is the fair value of Entity E’s 10% holding in Entity Y
(Choose one of):
1) $910,000 (ie reflecting management’s estimate of an adjustment for liquidity); or
2) $1,000,000 (ie without reflecting an adjustment for liquidity)?

48
Fair value: a controlling holding
test your understanding

Entity E also holds 55% of the (1 million shares) share capital in Entity
X (its subsidiary)
» Entity X’s shares trade actively in a deep and liquid market
» at 31 December 2015 trading in Entity X shares closes at $10 per share
» At 31 December 2015 must the fair value of Entity E’s 55% holding in
Entity X (Choose one of):
1) reflect the control premium irrespective of whether this is consistent with the
market perspective;
2) reflect the control premium only if consistent with the market perspective; or
3) be measured at $5,500,000 (ie without reflecting a control premium)?

49
Fair value: a controlling holding
test your understanding

Entity E also holds 55% of the (1 million shares) share capital in Entity
W (its subsidiary)
» Entity W’s shares do not trade publicly (a private company)
At 31 December 2015 must the fair value of Entity E’s 55% holding in
Entity W for presentation in its separate financial statements (Choose
one of):
1) reflect the control premium irrespective of whether this is consistent with the
market perspective;
2) reflect the control premium only if consistent with the market perspective; or
3) be measured without reflecting a control premium?

50
Fair value: significantly decreased trading volume
test your understanding

» Entity E also holds 1% of the share capital in Entity V.

» At 31 December 2015 the quoted price on the stock exchange is $200 per
Entity V share.
» Trading volume on 31 December 2015 is similar to the average daily
trading volume since July 2015.
» From 1 June to 31 July 2015 trading on the stock exchange was
suspended and the government took several steps to support the market.
» Due to financial and political instability, the share price and trading activity
have declined sharply since July 2015, with historical lows in November
2015.

51
Fair value: significantly decreased trading volume
test your understanding

At 31 December 2015 is the market in Entity V shares active (ie

is the quoted price a Level 1 input)? Choose one of:
1) Yes;
2) No; or
3) it depends on whether the transactions on 31 December were
orderly.

52
Fair value: infrequent trading
test your understanding

» Entity E also holds 1% of the share capital in Entity T.

» Although Entity T’s shares are quoted on the stock exchange
they trade very infrequently. The most recent trade occurred on
31 October 2015 at $200 per Entity T share.
» Entity E’s management believe that at 31 December 2015 the
fair value of its Entity T shares is about $300 per share.
» On 31 January 2016, before Entity T approved its 2015 financial
statements for issue, a small number of Entity E shares traded
at $220 per share.
53
Fair value: infrequent trading
test your understanding

Is the price of the trade on 31 October 2015 in the market ($200)

indicative of the fair value of an Entity T share at 31 December
2015? Choose one of:
1) Yes ($200 is fair value at 31 December 2015);
2) No (ignore the trade in determining fair value at 31 December); or
3) the weight placed on the trade on 31 October depends on whether the
transaction on 31 October was orderly and on the extent of changes in
Entity T’s circumstances since that trade.

54
Fair value: groups of financial assets and financial liabilities with
offsetting positions

Group managed on basis of net exposure to particular

market risk or credit risk to particular counterparty in

No
accordance with documented risk management or
investment strategy?
Yes Measurement
Provide information to on a net basis

No
key management personnel on that basis? is prohibited!
Yes

Measured at fair value

No
in the statement of financial position?
Yes

Measurement on a net basis is permitted

55
Fair value: groups of financial assets and financial liabilities with offsetting positions
test your understanding

At 31 December 2015 Entity F has, in a particular market risk that are not
categorised within Level 1 of the fair value hierarchy:
» a long position of 100 individual financial assets; and
» a short position of 95 individual financial liabilities the financial
instruments within the portfolio are identical
» Entity F uses bid prices to measure asset positions and ask prices to
measure liability positions
» bid price is $99; mid price is $100; ask price is $101
» assume there is no discount/premium that results from the size of the
net risk exposure

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Fair value: groups of financial assets and financial liabilities with offsetting positions
test your understanding

Entity F presents the instruments in its statement of financial

position at their fair value/s of (choose one of):
1) financial assets $9,900 (ie 100 instruments x $99) and financial liabilities
$9,595 (ie 95 instruments x $101)
2) $305 financial asset ($9,900 long position less $9,595 short position)
3) $495 financial asset [ie (100 long position less 95 short position) x $99]
4) $505 financial asset [ie (100 long position less 95 short position) x $101]
5) it depends: 3) above if Entity F applies the portfolio measurement
exception; and 1) above if it does not.

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Fair value: liability
 Fair value: a liability
the concept
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» 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)

© Michael JC Wells 59
Fair value: liability decision tree
application guidance: liabilities
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Yes Is there an observable market No

price to transfer the instrument?

Fair value = Does somebody hold the
observable market corresponding asset?
price of instrument Yes No

Fair value = Fair value = fair value of the Fair value = another
observable market corresponding asset valuation technique
price of asset
Yes Is there an observable market
No
price for the instrument traded
as an asset?
Fair value = another
valuation technique Level 2 or 3
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