IFRS 13 Fair Value Measurement. IFRS Advanced Application 2013

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1 IFRS 13 Fair Value Measurement IFRS Advanced Application 2013

2 Agenda Key considerations Unit of account Principal/most advantageous market Market participants Highest and best use Price Disclosure 2

3 Definition of fair value The price received to sell an asset or paid to transfer a liability in an orderly transaction in the principal market (or most advantageous market) between market participants at the measurement date 3

4 Key considerations Step 1: What is the unit of account? Step 2: Is there more than one market for the item? Step 3: Who are the other market participants? How would they use the asset/liability? Step 4: What is the current use of the asset? Is there a better alternative use for the asset? Step 5: Calculate the price Step 6: Fair value disclosures 4

5 Unit of account

6 Definition: Unit of Account The level at which an asset or a liability is aggregated or disaggregated in IFRS for recognition purposes based on the particular IFRS standard 6

7 Individual vs groups Group immaterial items and individually insignificant (eg a process plant) Stand alone value of specialised asset vs combination with other assets Inseparable third party credit enhancement Identified intangible asset in a business combination vs group of complementary intangible assets 7

Example Individual vs group of assets Y Ltd has investment property comprising furnished building If Y Ltd uses the investment property as a group of assets (each floor is rented as a

8 Example Individual vs group of assets Y Ltd has investment property comprising furnished building If Y Ltd uses the investment property as a group of assets (each floor is rented as a single asset) the unit of account is each floor If Y Ltd uses the investment property as individual assets (the building is rented as a whole) the unit of account is the individual asset 8

Investments in subsidiary, JV and associate

9 Investments in subsidiary, JV and associate (separate financial statements) Which standard? IAS 27 IAS 39 / IFRS 9 Unit of account is entire investment? Unit of account is generally individual financial instrument In what circumstances is unit of account not individual financial instrument? 9

Financial instruments Example 1: Unit of account X Ltd is the majority shareholder (65%) of A Ltd holding 400 000 shares Previously X Ltd purchased the shares for US$12 million in 2009 X Ltd believes

10 Financial instruments Example 1: Unit of account X Ltd is the majority shareholder (65%) of A Ltd holding shares Previously X Ltd purchased the shares for US$12 million in 2009 X Ltd believes that it would be able to sell its shareholding for a total of US$20 million at 31 December 2013 One individual share has been valued at US$40 at 31 December 2013 X Ltd carries its investment in subsidiary at fair value in its separate financial statements 10

11 Example 1: What is the fair value? million million million 11 11

12 Example 1: What is the fair value? Solution million 12 12

13 Financial instruments Example 2: Unit of account Assume X Ltd carries the investment at cost (US$12 million) in its separate financial statements At 31 December 2014 the share price is US$20 per share (US$8 million for entire investment ) X Ltd plans to sell the entire investment during 2015, therefore it is classified as held for sale A number of interested buyers would pay US$11 million for the 65% shareholding Transaction costs of US$ would be incurred by X Ltd to sell the investment 13

14 Example 2: What is the fair value? million 2. 8 million million million 14

15 Example 2: What is the fair value? Solution million million 15

16 Principal/most advantageous market

Principal/most advantageous markets Principal market Highest volume and level of trading activity No Most advantageous market Consider BOTH transaction costs and transport costs In absence

17 Principal/most advantageous markets Principal market Highest volume and level of trading activity No Most advantageous market Consider BOTH transaction costs and transport costs In absence of evidence to the contrary, use market that the entity usually transacts in Audit teams should evaluate management s assessment of principal market and assess reasonableness of conclusions 17

18 Example 3: Principal market Company P holds inventory (maize) that is traded in three different markets as follows: Company P Buys and sells in Market A Market B Market C Volume (annual) Trades per month Price Transport costs (3) (3) (4) Possible fair value Transaction costs (1) (2) (1) Net Proceeds

19 Example 3(a) Which market is the principal market? 1. Market A 2. Market B 3. Market C 19

20 Example 3(a) Solution 1. Market A 2. Market B 3. Market C 20

21 Example 3(b) Which market is the most advantageous market? 1. Market A 2. Market B 3. Market C 21

22 Example 3(b) Solution 3. Market C 22

23 Example 3(c) What is the fair value of the maize?

24 Example 3(c) Solution

25 Market participants

26 Definition: Market participant Buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics: 26

Measuring fair value Use assumptions market participants would use when pricing assets and liabilities Assume they act in their economic best interests Take into

27 Measuring fair value Use assumptions market participants would use when pricing assets and liabilities Assume they act in their economic best interests Take into account the characteristics of an asset or liability that market participants would consider: Condition and location of asset Restrictions on the sale or use of the asset 27

28 Example 4 Market participants A leasing company may have several aircraft recorded as fixed assets. The aircraft are carried at fair value The aircraft are leased to third parties under operating leases In the market in which the leasing company operates, the third party operating leases related to an aircraft would typically not be acquired by the buyers in the market 28

29 Example 4 (cont.) Should the operating leases be taken into account in determining the fair value of the aircraft by the leasing company? 1. Yes 2. No 29

30 Example 4 Solution Should the operating leases be taken into account in determining the fair value of the aircraft by the leasing company? 2. No 30

31 Highest and best use

32 Definition: Highest and best use The use of a non-financial asset by market participants that would maximise the value of the asset or group of assets and liabilities (eg a business) within which the asset would be used 32

33 Requirements for determining highest and best use Non-financial asset Physically possible Legally permissible Financially feasible Assume current use is highest and best use if no evidence to the contrary Audit teams should consider whether evidence that current use is different from highest and best use and reasonableness of management s conclusions 33

34 Example 5 Highest and best use Luxury hotel in Victoria Falls that generates rental income Independent property valuation experts have valued this hotel at US$65 million X Ltd has signed an agreement with a local bank whereby it cannot make certain modifications to the hotel, reducing the value of the hotel to US$55 million The proximity of the hotel suggests that it could be converted into a super-factory Conversion modifications of US$10 million would need to be made to the hotel The modified building could then be sold for US$73 million 34

35 Example 5: What is the fair value of the property? million million million million 35 35

36 Example 5: Solution million 36 36

37 Fair value of investment property Pre IFRS 13 Exclude future capital expenditure (IAS 40.51) Per IFRS 13 Include the capital expenditure for future improvements in determining fair value of investment property if market participants would consider Audit teams should evaluate management s assessment of effect of IFRS 13 if future capital expenditure was not considered in the past 37

38 Price

39 Price: Bid-ask spread Most representative Use price within the bid-ask spread most representative of the fair value Mid-market prices Not prohibited to use mid-market or similar pricing convention, as long as it is a reasonable approximation of an exit price Asset & Liability IFRS 13 permits entities to continue using bid prices for asset positions and ask prices for liability positions, but does not require it Audit teams should critically assess the reasonableness of the conclusions and consider whether the most representative price for fair value is used 39

Price: Transaction price vs fair value Transaction price normally is the fair value unless: The transaction is between related parties The transaction takes place

account for the asset or liability measured at fair value The market in which the transaction takes place is different from the principal market (or most

40 Price: Transaction price vs fair value Transaction price normally is the fair value unless: The transaction is between related parties The transaction takes place under duress or the seller is forced to accept the price in the transaction The unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value The market in which the transaction takes place is different from the principal market (or most advantageous market) Entities should consider factors specific to the transaction in order to determine whether the fair value at initial recognition equals transaction price 40

Example 6 Fair value vs transaction price Future contracts to purchase 20,000 tons of oil in December 2013 X Ltd purchased these contracts from a third party for US$1 million Price includes

41 Example 6 Fair value vs transaction price Future contracts to purchase 20,000 tons of oil in December 2013 X Ltd purchased these contracts from a third party for US$1 million Price includes transaction costs of US$ X Ltd would be able to sell these contracts for US$1.2 million on the market X Ltd would have to incur transaction costs of US$ to sell the contracts 41

42 Example 6 What is the fair value at original recognition?

43 Example 6 Solution What is the fair value at original recognition?

44 Price: Valuation technique Using valuation techniques When a quoted price for an identical asset or liability in an active market is not available Maximise the use of observable inputs Minimise the use of unobservable inputs Fair value hierarchy Level 1 Unadjusted quoted prices for identical instruments in active market Level 2 Quoted prices for similar instruments in active market Quoted prices for similar/identical instruments in non active market Observable inputs and insignificant unobservable inputs Level 3 Significant unobservable inputs 44

45 Price: Orderly transactions Calculating fair value based on recent transaction Determine if transaction is orderly No little if any weight given to transaction price Yes transaction price is considered Not known to be orderly transaction price considered but with less weight placed on it compared to orderly transactions 45

46 Price: Circumstances where a transaction is not orderly Inadequate exposure to market to allow usual and customary marketing activities Asset/liability marketed to single market participant Seller is near bankruptcy or receivership Transaction price is outlier 46

47 Disclosure

48 New disclosure requirements Fair value hierarchy for non-financial assets and liabilities measured at fair value and for fair value measurements used only for disclosure purposes Quantitative information about unobservable inputs used for fair value measurements, sensitivity to these inputs (narrative for non-financial assets and liabilities and quantitative for financial assets and financial liabilities), and interrelationships between them Description of valuation processes for Level 3 fair value measurements Non-financial assets whose highest and best use differs from their current use Audit teams should consider the new disclosure requirements when evaluating whether the entity s disclosures are of sufficient quality and detail 48

49 Thank You The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks of KPMG International.

FINANCIAL REPORTING WORKSHOP IFRS 13- Fair Value Measurement Presentation by: CPA Stephen Obock November Uphold public interest

FINANCIAL REPORTING WORKSHOP IFRS 13- Fair Value Measurement Presentation by: CPA Stephen Obock November 2017 Uphold public interest 1 Agenda 1.Introduction 2.Scope of IFRS 13 3.Definition of Fair Value