IFRS 13 Fair Value Measurement 2015

Financial Accounting IV 2015 Fair value measurement

Fair value measurement: of 6

© School of Accountancy, University of the Witwatersrand, 2013

FAIR VALUE MEASUREMENT Reference:

1. IFRS 13 Fair value measurement Topics covered: 1. Introduction 2. Objective and scope 3. Definitions 4. Measurement of fair value

4.1. Definition of fair value 4.1.1. The asset or liability 4.1.2. The transaction 4.1.3. Market participants 4.1.4. The price

4.2. Application to non-financial assets 4.2.1. Highest and best use for non-financial assets 4.2.2. Valuation premise for non-financial assets

4.3. Application to liabilities and an entity’s own equity instruments 4.3.1. General principles 4.3.2. Non-performance risk 4.3.3. Restriction preventing the transfer of a liability or an entity’s own equity

instrument 4.3.4. Financial liability with a demand feature

4.4. Application to financial assets and financial liabilities with offsetting positions in market risks or counterparty risk

4.4.1. Exposure to market risks 4.4.2. Exposure to credit risk of a particular company

4.5. Fair value at initial recognition 4.6. Valuation techniques 4.7. Fair value hierarchy

5. Disclosure 6. Examples

1. Introduction Prior to IFRS 13 being issued, the manner in which the fair value of assets, liabilities and an entity’s own equity instruments was measured varied between the different standards. Some standards gave limited guidance and others were very detailed with the result that the treatment in practice has varied, which has reduced comparability among entities. IFRS 13 remedies this situation by defining fair value, setting out a framework for measuring fair value and requiring disclosures about the fair value measurement.

2. Objective and scope IFRS 13 p.1 states that the purpose of the statement.




The scope of IFRS 13 p.5-8 (i.e. what’s included & what’s excluded). 3. Definitions Refer to IFRS 13 appendix A. 4. Measurement of fair value:

The basis of the measurement of fair value is market-based rather than dependent on the specific entity’s intentions, which are not relevant when measuring fair value. Consideration of the fair value will be based on the assumptions that a market participant would use to price the asset or liability and will include assumptions about risk under current market conditions. 4.1 Definition of fair value: Definition: refer to IFRS 13 p.9, IFRS 13 p.B2 Paragraph B2 requires an entity to determine all of the following in a fair value measurement approach (IFRS13 p.B2):

4.1.1 The asset or liability Refer to IFRS 13 p.11- 14 and illustrative examples 8 and 9. deals with the effect of restrictions on the sale or use of an asset.

4.1.2 The transaction Refer to IFRS 13 p.15 A fair value measurement assumes that the transaction takes place either: IFRS 13 p.17 What guidance should be considered in terms of p.18-21 in identifying the principal or advantageous market? 4.1.3 Market participants Refer to IFRS 13 p.22-23: 4.1.4 The price Refer to IFRS 13 p.24 What costs should be included and which costs should be excluded? (p.25-26)

4.2 Application to non-financial assets:

4.2.1 Highest and best use Refer to IFRS 13 p.27




In terms of p.28 what is considered to be the highest and best use? Refer to IFRS 13 p.29-30 and illustrative example 3 for further guidance on determining highest and best use.

4.2.2 Valuation premise (basis) refer IFRS 13 p.31-34 Highest and best use of an asset achieved through its use in combination with other assets as a group or in combination with other assets and liabilities (refer illustrative examples 2-5 & 9) Highest and best use is achieved on a stand-alone basis, refer to para B3 for a description of the application of this concept.

4.3 Application to liabilities and an entity’s own equity instruments

4.3.1 General principles Refer to IFRS 13 p.34-41, illustrative examples 10-13.

4.3.2 Non-performance risk

Refer to IFRS 13 p.42-44, illustrative examples 10-13. 4.3.3 Restriction preventing the transfer of a liability or an entity’s own

equity instrument Refer to IFRS 13 p.45-46, illustrative examples 11 & 13.

4.3.4 Financial liability with a demand feature

Refer to IFRS 13 p.47. 4.4 Application to financial assets and financial liabilities with offsetting

positions in market risks or counterparty credit risk

Refer to IFRS 13 p.48-52.

4.4.1 Exposure to market risks Refer to IFRS 13 p.53-55

4.4.2 Exposure to credit risk of a particular company Refer to IFRS 13 p.56

4.5 Fair value at initial recognition Refer to IFRS 13 p.57-60. Refer to p. B4 for situations where the transaction price differs from the fair value at initial recognition.




4.6 Valuation techniques Refer to IFRS 13 p.61-66. 4.7 Fair value hierarchy: IFRS 13 has provided a fair value hierarchy to increase consistency and comparability in fair value measurements and disclosures. This hierarchy categorises the inputs used in valuation techniques that measure fair value, into three levels (IFRS 13 p.72-73). Level 1 inputs: Refer to p.76-80

Level 2 inputs: Refer to p.81-85

Level 3 inputs: Refer to p.86-90

5. Disclosure

IFRS 13 p.91 requires an entity to disclose information that helps users of its financial statements to assess both:

for assets and liabilities that are measured at fair value on a recurring or non-recurring basis in the statement of financial position after initial recognition:

o the valuation technique; and o the inputs used to develop those measurements.

for recurring fair value measurements using significant unobservable inputs (level 3), the effect of the measurements on profit or loss or other comprehensive income for the period.

Refer to IFRS 13 p.92 – 99 and the illustrative examples for further detailed disclosure.




Example Question: Zlotnik Limited (“Zlotnik”) is a company listed on the JSE Securities Exchange. The company requires advice regarding the measurement and disclosure of the following items in its group annual financial statements:

1. Shortly before the financial year end, the company purchased a patent for ‘New-Way’ crushing machinery which has been developed by two university engineering professors. An amount of R25 million was paid for this intellectual property in a deal negotiated at arm’s-length with the sellers. The Zlotnik directors estimate that the net present value of the profits the company would have lost if the patent were exploited by a third party, amount to R45 million, as the products to which the patent relates would create direct competition with Zlotnik – thereby reducing the profits of the company. Zlotnik will not use the patent – the acquisition was simply to prevent anyone else using it. There will be no income streams flowing directly from these assets, and thus the valuers appointed by the Zlotnik group have valued the patent at R nil. The accountant has accordingly impaired the patents to R nil in the financial statements.

2. A subsidiary of Zlotnik, Plotnik Planes (Pty) Limited owns a Spitfire aircraft, which is a collector’s item. It is housed at a hanger in Lanseria Airport in South Africa. The main market for such specialised collector’s items is in London. The historic aircraft dealer in London has valued the Spitfire at £1 million, if sold in London. To ship the Spitfire to London will cost approximately R500 000. For financial statement purposes, the aircraft is revalued annually. The accountant has valued the Spitfire at R13m (as the exchange rate at year-end was R13 : £1) and the plane is still in South Africa.

3. A subsidiary of Zlotnik, Karbunkle Recyclers (Pty) Limited recycles old computers. As at the year end, it had inventory on hand which had an original cost of R100 million. Costs associated with restoring the computers and retrieving the saleable parts amounted to R10 million. To sell this inventory, commission of R10 million will be payable. Based on the selling prices generally being achieved by the company, the stock is expected to ultimately be sold for about R130 million. The accountant has valued the stock at R120 million in the financial statements, which he believes is in compliance with IFRS 13.

4. Zlotnik issued R100 million debentures two year ago which are redeemable in three years’ time. The debentures have always been classified as “financial liabilities at fair value through profit or loss”. In terms of the debenture trust deed, the debenture holders are entitled to demand immediate payment if the debt : equity ratio of Zlotnik per the year-end balance sheet is over 50 %. At year-end, the ratio was 51 %. The consultants appointed by Zlotnik have valued the debentures at R50 million based on the current estimated realisable value of the debentures.




You are required to: Explain how each of the items referred to above should be measured for financial statement purposes in accordance with IFRS. HW/lt 11.09.2012

Solution: 1. ‘New-way’ patent 1.1 This should be included in the financial statements at R25 million, as that is

the fair value determined in an arm’s-length transaction. 1.2 IFRS 13 requires that this amount be reflected and not the value specific to

Zlotnik.

2. Spitfire 2.1 In terms of IFRS 13, an asset should be valued in its principal market and it

is appropriate to take into account transport costs to transport the asset to the market.

2.2 Thus, the value is R12.5 million (£1m x 13 = R13m – R500 000 transportation costs).

3. Computer stock 3.1 These should be valued at R110 million, being the cost to the company

plus the costs of conversion, in terms of IAS 2. 3.2 It is not necessary to deduct the selling costs, in terms of IAS 2. 3.3 IFRS 13 does not apply to inventory.

4. Debentures 4.1 These should be included in the group financial statements at their full face

value of R100 million. 4.2 IFRS 13 requires that where liabilities have a demand feature, these be

included at that amount (despite the fact that these may carry a different market value).

IFRS 13 Fair Value Measurement 2015

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