Implementing IFRS 13 Fair Value Measurement

Transcription

1 Implementing IFRS 13 Fair Value Measurement 18 April 2013 Association des Directeurs de Comptabilité & de Gestion (APDC)

2 Speakers

3 Yann Magnan Managing Director, Valuation Advisory Services Yann Magnan, Managing Director, is the leader of the Paris, France office of Duff & Phelps SAS. He is part of the Financial Advisory Practice and the leader for Valuation Advisory Services across Europe. Before joining Duff & Phelps, Yann began his career at E&Y Audit France and then moved to E&Y Valuation & Business Modeling France. As a member and then co-leader at E&Y V&BM Paris, Yann was involved in numerous international transaction and valuation projects, including business valuations, financial modeling, but also intangible assets valuations such as trademarks, brands, customer relationships, telecom licenses and technologies. His other experiences include tax valuations, transaction opinions and arbitration valuation. Yann was appointed E&Y V&BM Southwest Europe Leader beginning Duff & Phelps SAS Paris yann.magnan@duffandphelps.com Yann s recent engagements are: several Purchase Price Allocations in the Aerospace and Defense industry, several Purchase Price Allocations in the Technology and Telecom industries, valuation of a leading French film studio in connection with potential IPO, valuation of a cartoon studio for tax purposes, impairment testing at a leading French media conglomerate, including valuation of the French and US studios and their catalogue, valuation of leading French internet companies, valuation of transportation contracts for a global leader in the transportation business, Purchase Price Allocations at incumbent telecom company on Spanish, UK, and Luxemburg assets; PPP models reviews in the Utility industry for French Utility leader; valuation and Purchase Price Allocation for leader in the energy industry; independent business valuation for a major infrastructure investment fund; Purchase Price allocation on a leader of generic healthcare industry based in Eastern Europe; Purchase Price Allocation on photovoltaic acquisition for a French leader in the oil industry. Yann has given numerous lectures on valuation, especially related to valuations, in France and abroad. He is also a visiting professor at HEC Paris. Yann graduated from Ecole Centrale Paris with an MSc in Engineering. He is a member of Société Française des Evaluateurs. Duff & Phelps - Private & Confidential 3

4 Hilary S. Eastman, CFA Director, Office of Professional Practice Hilary Eastman is a director in Duff & Phelps Office of Professional Practice, where she provides firm-wide technical guidance on a variety of valuation, financial reporting and tax reporting issues. Hilary recently re-joined Duff & Phelps after spending nearly 7 years at the International Accounting Standards Board (IASB). Hilary is based in the London office, promoting the firm's IFRS education efforts and marketing initiatives, as well dealing with IFRS implementation issues. At the IASB Hilary led the joint IASB-FASB fair value measurement project that led to the issuance of IFRS 13 Fair Value Measurement and ASU Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. Hilary presented complex fair value measurement topics to the IASB and the FASB for their consideration in developing converged guidance. She has also been involved in the development of the IFRS Foundation's educational material on fair value measurement, the project to revise IFRS 3 Business Combinations in 2008, and the IASB s Expert Advisory Panel on measuring fair value when markets have become inactive. Duff & Phelps Ltd. London, United Kingdom Hilary.Eastman@duffandphelps.com Hilary became the IASB s Senior Manager, Investor Liaison upon the completion of IFRS 13. In that role she worked with the investor community to ensure that they understood the implications of the IASB s work on their analysis of financial statements. She also worked to ensure that the IASB understood the information needs of investors and analysts. In addition, she managed the IASB s investor group, the Capital Markets Advisory Committee. In her role at the IASB, Hilary regularly presented at conferences globally, including in the United States, Europe and Asia, both for the IFRS Foundation and for third parties, on the topics of fair value measurement, financial instruments and the IASB s investor outreach activities. Before joining the IASB, Hilary was part of Duff & Phelps Valuation Advisory Services business unit, focusing on clients valuation needs, primarily for financial reporting or tax purposes. She spent over six years providing valuation and tax services to clients in Europe, the United States and Australasia, many of which were multinational. Hilary has conducted numerous business and asset valuations for a variety of purposes, including purchase price allocations, goodwill impairment testing and mergers and acquisitions. She has been involved in multiple valuation assignments for a wide range of industries, including pharmaceutical, information technology and industrial manufacturing. Hilary received her bachelor s and master s degrees in finance from San Diego State University. She is also a CFA charterholder and a member of CFA Institute and CFA Society of the UK, and is a member of the CFA Society of the UK s Financial Reporting and Analysis Committee. Duff & Phelps 18 April

5 Agenda Section General Fair Value Measurement Principles 1 Practical Implications when Applying: IFRS 3 Business Combinations 2 IAS 36 Impairment of Assets 3 IAS 40 Investment Property 4 IAS 39 Financial Instruments: Recognition and Measurement 5 IFRS 10 Consolidated Financial Statements 6 Fair Value Disclosures 7 Differences Between IFRS 13 and US GAAP s ASC Topic Duff & Phelps 18 April

6 IFRS 13 Will Affect Some Companies More than Others Will be most relevant for companies with: M&A activity (fair value of acquired assets and assumed liabilities) Revalued assets (eg PP&E, land, investment properties) Impairments of assets when recoverable amount is based on fair value less costs of disposal Financial assets and liabilities Some of the biggest changes are for disclosures: Disclosure by three-level hierarchy Qualitative sensitivity analysis Quantitative disclosure for Level 3 inputs In general, the new (and more explicit) measurement guidance will require more support for the assumptions made 6

7 Section 1 General Fair Value Measurement Principles

8 From 1 January 2013, IFRS 13 Applies to all Fair Values in IFRSs (with a few exceptions) The standard applies to:* IFRSs that require or permit fair value measurements IFRSs that require or permit disclosures about fair values Fair value less costs to sell and fair value less costs of disposal Disclosures for subsequent fair value measurements The standard does not apply to: Share-based payments Leases Measurements similar to fair value (such as net realisable value for inventories, value in use for impairment testing and the measurement of provisions and contingent liabilities) Goodwill and other impairment disclosures Retirement benefits and employee benefits disclosures * In the first year of application, comparative periods do not need to be restated. Duff & Phelps 18 April

9 Fair Value Defined Now Identical to US GAAP The amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm s length transaction. Is the entity buying or selling the asset? What is meant by settling the liability? Market-based or entityspecific? When does the exchange or settlement take place? The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The entity is selling the asset The entity is transferring the liability It is clearly marketbased The sale or transfer takes place on a specific date Exit Price Concept: Clear market-based, sale-focused objective Highest and Best Use / Valuation Premise Now Explicit: Current use versus alternative uses Liabilities / Own Equity: Fair value of corresponding asset if there is one Bid-ask Spread: No longer only bid for assets and ask for liabilities Three-level Hierarchy of Inputs: Prioritises use of relevant observable market data New Disclosures: Particularly for Level 3 models using unobservable inputs 9

10 The Unit of Account in other IFRSs Determines What is Valued The IFRS that requires or permits the fair value measurement specifies the asset or liability to be valued (the unit of account ). For example: Standard What Unit of account IFRS 3 Business Combinations Identifiable assets acquired The individual asset IAS 36 Impairment of Assets Cash-generating unit The individual CGU IAS 40 Investment Property IAS 39 Financial Instruments: Recognition and Measurement Investment property building Financial asset The individual building, comprising the building and the associated lease contracts The individual financial asset IFRS 10 Consolidated Financial Statements Investment in a subsidiary Tentative IASB decision: Investment as a whole, not the individual instruments making up the investment 10

11 The Exit Transaction Takes Place in the Principal Market Yes Is there a market that has the greatest volume and level of activity for the asset or liability? No That is the principal market and its price must be used: Price 50 Transport costs 3 Fair Value 47 Price 51 Transport costs 5 Transaction costs 2 Net proceeds 44 Market A Which market maximises the amount that would be received to sell the asset and minimises the amount that would be paid to transfer the liability? Market B Price 50 Transport costs 3 Transaction costs 4 Net proceeds 43 Market A is the most advantageous market and its price must be used: Price 51 Transport costs 5 Fair Value 46 Market B is not the most advantageous market 11

12 Market Participants Transact in the Principal Market Independent of each other Knowledgeable and sufficiently informed about the asset or liability and the transaction Market participants Able to enter into a transaction for the asset or liability Willing to enter into a transaction for the asset or liability (not forced) Market participants act in their economic best interest in a transaction for the unit of account Identifying characteristics of market participants who would transact for the asset or liability is fundamental to the determination of fair value 12

13 Fair Value Reflects the Highest and Best use of an Asset The use of an asset by market participants that would maximise the value of the asset that is: Physically possible Legally permissible Financially feasible Highest and best use is usually (but not always) the current use by the entity An asset either provides maximum value through its use: In combination with other assets and liabilities as a group; or On a stand-alone basis Highest and best use does not apply to financial instruments or liabilities 13

14 Example Assessing Highest and Best Use A building is used as a factory but is in a newly residential area. Other industrial and commercial buildings have been converted into residential use in the area Based on expected future cash flows from use as a factory, the company estimates a value of EUR 20m. However, the building could be sold for conversion to residential property for EUR 21m, incurring transaction costs of EUR 1.5m. Prior to sale, the building would require repairs costing EUR 0.5m to return site to safe for human dwelling What is the fair value of the building? 1. EUR 19m 2. EUR 19.5m 3. EUR 20.5m 4. EUR 21m Duff & Phelps 14

15 Example continued Assessing Highest and Best Use 3. EUR 20.5m Highest and best use is the highest value achieved through either current or alternative use The value is calculated net of repair cost but do not include transaction costs Duff & Phelps 15

16 The Valuation Technique used Depends on the Availability of Data and its Ability to Reflect the Economic Characteristics Valuation technique Description Example Market Approach Income Approach Cost Approach Uses prices and other relevant information generated by market transactions involving identical or comparable (ie similar) assets, liabilities or a group of assets and liabilities, such as a business Convert future amounts (eg cash flows or income and expenses) to a single current (ie discounted) amount using current market expectations about those future amounts Reflects the amount that would be required currently to replace the service capacity of an asset Market comparable method Can be used only if observable market prices for the same or similar assets and liabilities are available Discounted cash flow method Can be used only if there are directly identifiable cash flows Current replacement cost or current reproduction cost Used for assets that do not have observable market prices and are not income producing 16

17 The Three-Level Fair Value Hierarchy Indicates the Relative Level of Subjectivity of the Measurement Level 1 Level 2 Level 3 Quoted prices in in active markets for identical assets and assets liabilities and liabilities Must be be used used without without adjustment whenever available Market approach Market approach Inputs other than quoted Inputs other than quoted quoted prices included prices included within prices included within within Level 1 Level that are 1 that are Level that are observable for for the the asset asset observable for the asset or liability or liability Market approach, income approach, cost approach Inputs for other than asset or quoted liability that prices are included not within observable Level (but 1 that still must are observable be consistent for with the asset or assumptions liability market participants would make) Market approach, income approach, cost approach Must maximise relevant observable inputs (Levels 1 and 2), minimise unobservable inputs (Level 3) The level in the fair value hierarchy of the fair value measurement in its entirety depends on the lowest level input that is significant to the measurement 17

18 Example Fair Value Hierarchy How would you categorise the measurement of the units in the following investment funds? Unit 1 A unit in an investment fund is quoted in an active market. However the underlying investments are in unquoted equities that would be categorised within Level 3 in the fair value hierarchy Unit 2 A unit in a non-quoted investment fund which only invests in financial assets quoted in active markets. No adjustments are made to the quoted prices when arriving at the value of the fund Unit 1 Unit 2 1. Level 1 Level 1 2. Level 1 Level 2 3. Level 2 Level 1 4. Level 3 Level 2 Duff & Phelps 18

19 Example continued Fair value hierarchy 2. Level 1 and Level 2 Unit 1 Level 1 This is because the fund s units are quoted in an active market. Unit 2 Level 2 Although the fund s investments are quoted, the fund s own units are not quoted However the fund s units may be appraised indirectly, using the quoted fund s investments Duff & Phelps 19

20 The Fair Value of a Liability Generally equals the Fair Value of the Corresponding Asset Yes Is there an observable market price to transfer the liability? No Fair value = observable market price of liability e.g. derivative Yes Does somebody hold the corresponding asset? No Fair value = observable market price of asset Fair value = fair value of the corresponding asset e.g. financial debt Fair value = another valuation technique e.g. decommissioning obligation Yes No Fair value = another valuation technique Is there an observable market price for the liability traded as an asset? This diagram also applies to an entity s own equity instruments Adapted from IASB Fair Value measurement webcast on 23 May 2011 Duff & Phelps 18 April

21 The Transaction Price is Often Presumed to equal Fair Value The recognition of day 1 gains or losses is determined by other IFRSs Potential differences between transaction price and fair value Transactions between related parties Seller under duress Example Need to verify whether transaction was at arm s length If seller is experiencing financial difficulties, need to verify whether price paid or received reflects an orderly transaction Different unit of account Buy asset in one form, modify it and sell it in another form Buy group of assets, recognise a separate individual asset (eg business combination) Over or under payment relative to fair value (eg bargain purchase in business combination; may be entity-specific) Different markets Retail versus dealer market Bid-ask spread differences Calibration to observable market data is required Duff & Phelps 18 April

22 Section 2 Application to IFRS 3 Business Combinations

23 Assets Acquired and Liabilities Assumed are Measured at their Acquisition-date Fair Values What is the same? Requirement to prioritise observable market prices Focus on using market participant assumptions Emphasis on use of asset by market participants (highest and best use) What has changed? Exit price focus for the asset or liability Reference to principal (or most advantageous) market Incorporating non-performance risk into the measurement of liabilities assumed Disclosures about business combinations are covered by IFRS 3, not IFRS 13 23

24 Changes for the Fair Value of Consideration Transferred, Assets Acquired and Liabilities Assumed Asset or liability What to be aware of when applying IFRS 13 Intangible assets Inventories PP&E (including investment property) Non-financial liabilities (e.g. decommissioning obligation, contingent liabilities and contingent consideration) Financial assets, financial liabilities, preexisting interest in a step acquisition and non-controlling interest Characteristics of market participants and assessing how they would use the asset Unit of account and determining principal market Relationship between valuation premise and assessment of economic obsolescence Incorporate compensation market participants would demand for taking on the obligation Consider effect of non-performance risk (including credit risk) Should be the same as fair value of corresponding asset if there is one See changes to IAS 39 24

25 Example What if an Asset s Current Use is not its Highest and Best Use? Entity A acquires land in a business combination (or is using the revaluation model in IAS 16) The land is currently being used as a site for a factory Nearby sites have recently been developed for residential use as sites for high-rise apartment buildings Entity A determines that its land could be developed as a site for residential use because there is evidence that market participants would take into account the potential to do so when pricing the land The highest and best use of the land would be determined by comparing: the value of the land as currently used as a site for a factory (valuation premise for all assets in the group is to be used in combination with other assets), with the value of the land as a vacant site for residential use assuming the factory is demolished (valuation premise for all assets in the group is to be used on a standalone basis) 25

26 Example continued What if an Asset s Current Use is not its Highest and Best Use? The valuation premise says that all assets within the asset group must be valued on a consistent basis All are used in combination with other assets or all are used on a standalone basis For the highest and best use not to be the current use, two things must happen: The costs to convert the land to its alternative use must not be prohibitive (ie ensure that financial feasibility criterion is met) The increase in value of the land in its alternative use must overshadow the sum of the decrease in standalone values of the other assets within the group If those things happen, are the other assets within the group (eg the factory) impaired? 26

27 Section 3 Application to IAS 36 Impairment of Assets

28 An Asset is Impaired if its Carrying Amount is More Than its Recoverable Amount Carrying Amount Comparison Recoverable Amount Higher of Fair Value less Costs of Disposal (FVLCD) Value in Use (VIU) What is the same? Priority for observable prices when available Fair value reflects current market conditions CGU concept is consistent with valuation premise concept for asset groupings What has changed? There is no longer a requirement to use bid prices Fair value reflects an orderly transaction regardless of the entity s situation Explicit reference to the asset s highest and best use Disclosures about impaired assets are covered by IAS 36, not IFRS 13 28

29 Section 4 Application to IAS 40 Investment Property

30 An Entity May Remeasure its Investment Properties at Fair Value What is the same? Focus on market participant assumptions Focus on current market conditions Emphasis on orderly and arm s length transaction Priority given to observable market prices, but other inputs may be used Fair value reflects rental income from current leases What has changed? Explicit reference to highest and best use and valuation premise, and those assumptions will need to be supported Be careful not to double-count items that are other assets or liabilities, not the investment property asset IFRS 13 did not change reliability threshold 30

31 Section 5 Application to IAS 39 Financial Instruments: Recognition and Measurement

32 Financial Instruments are Measured at Fair Value Initially and, in Some Cases, Subsequently What is the same? Focus on exit price Emphasis on market participant assumptions Focus on current market conditions Priority on observable market prices Measurement on a net basis if there are offsetting market risks Incorporating non-performance risk Fair value at initial recognition is normally the same as transaction price Day 1 gains or losses prohibited unless model uses only observable market data Calibrate to observable market data Transaction costs not part of fair value No block discounts What has changed? Principal market focus, not most advantageous active market No longer bid for assets and ask for liabilities Additional guidance on measuring fair value when markets have become inactive Additional disclosures now required Disclosures about the fair value of financial instruments are now in IFRS 13, not IFRS 7 32

33 Financial Instruments can be Valued on a Net Basis if Risk- Managed on a Net Basis Previous guidance allowed net measurement for offsetting market risks, but not explicitly about counterparty credit risk Market risk: Risk(s) must be substantially the same Duration of instruments leading to exposure to market risk must be substantially the same Counterparty credit risk: Must have arrangement to mitigate credit risk in place Reflects both credit valuation adjustments (CVA) and debit valuation adjustments (DVA) Net measurement does not apply to presentation (value must be allocated to individual instrument unit of account) IASB will be discussing interaction between portfolio exception and other measurement requirements in IFRS 13 (including how to treat instruments with Level 1 inputs and block discounts) 33

34 The Valuation Technique and Inputs must Reflect the Characteristics of the Asset or Liability Sometimes a premium or discount must be applied to reflect those characteristics: Any premium or discount applied must be consistent with characteristics of asset or liability and the unit of account Need to be careful not to double-count or omit value (eg do not adjust for control if the price already reflects its value) Yes Is there Level 1 input available for the asset or liability? No It must be used without adjustment FV = Level 1 price x quantity held Yes Would market participants incorporate a premium or discount in a transaction for the asset or liability? No Fair value reflects a premium or discount Fair value does not reflect a premium or discount No block discounts (they are a characteristic of the holding, not of the asset itself) 34

35 Fair Value of Unquoted Equity Instruments IFRS 9 removed cost exemption that was in IAS 39 An entity was precluded from measuring an unquoted equity instrument at fair value if its fair value was not reliably measurable IASB concluded that unquoted equity instruments can be measured reliably However, there were concerns about:» What approaches were appropriate and acceptable under IFRS» What to do if limited information is available, such as sometimes in emerging markets Material focuses on IFRS 9 but much of it is applicable for IAS 39 and IFRS 10 35

36 Main valuation approaches for unquoted equity 4 approaches described Market approach Income approach Cost approach (not developed) Adjusted net asset approach Identical or similar instrument Discounted Cash Flows Guideline companies and transactions Dividend Discount Models 36

37 Choosing a valuation technique Valuation techniques used should use least subjective adjustments (i.e. maximise observable market data) However, IFRS 13 acknowledges that one or several valuation techniques may be more appropriate depending on facts and circumstances Choice of valuation method depends on: Information availability Market conditions Investment horizon Stage of the life cycle Industry Existence of market references Availability of cash flow projections Etc. Bullish markets Bearish markets Flight to quality Etc. Finite-life assets Short-term investment Etc. Start-up Power plants Etc. Specific valuation references used for certain industries (e.g. specific multiples) 37

38 Calibrating valuation techniques Fair value reflects market conditions at the measurement date At initial recognition: Calibrate the valuation technique to the transaction price using available (and relevant) market data Examples of calibration at initial recognition: Set DCF result equal to transaction price Set results from the market approach equal to transaction price (ie calibrating both multiples and any premium/discount applied) In subsequent periods: Assess how changes in market conditions affect observable and unobservable inputs to determine whether the fair value has changed 38

39 Section 6 Application to IFRS 10 Consolidated Financial Statements

40 From 1 January 2014, Investment Entities Must Measure their Subsidiaries at Fair Value Fundamental change to consolidation rules in IFRSs Investment entity subsidiaries (controlled investments) no longer consolidated Users told IASB that fair value information is more useful Resulting measurement questions: Is the unit of account the investment in the subsidiary or the individual instruments comprising that investment? If the unit of account is the investment, how to reconcile the requirement in IFRS 13 to use Level 1 inputs whenever available? Investment entities are subject to disclosures in IFRS 13 40

41 The Unit of Account is not Always Clear For example: Standard What Unit of account IAS 27 Separate Financial Statements IAS 28 Investments in Associates IFRS 10 Consolidated Financial Statements Investment in a subsidiary Investment in an associate (for venture capital and similar investors) Investment in an investment entity subsidiary The investment as a whole or the individual financial assets per IAS 39 and IFRS 9? The investment as a whole or the individual financial assets per IAS 39 and IFRS 9? The investment as a whole or the individual financial assets per IAS 39 and IFRS 9? Does IAS 39/IFRS 9 or the standard initially requiring the fair value measurement determine the unit of account? Duff & Phelps 18 April

42 Example Fair Value of Debt When Valuing a Controlling Equity Interest Assume Entity A has a controlling equity interest in Entity B Assume the terms of Entity B s debt (e.g. bank debt) require that it be repaid at par upon a change in control (i.e. it has a change in control provision ) The following values have been determined for Entity B: Enterprise Value $150 Debt par value 100 Debt fair value 95 If Equity Value = Enterprise Value Debt Value: Is the fair value of a controlling interest in the equity $50 or $55? In other words, does the value of the debt assume that the change in control provision has been triggered and that it is repaid on the valuation date? 42

43 Example continued Fair Value of Debt When Valuing a Controlling Equity Interest View A View B Fair value of equity Value of debt Rationale $50 Par value Assumes the change in control provision has been triggered: Fair value is an exit price and an exit (sale) of a controlling interest in the equity would trigger the change in control provision at the measurement date. A market participant buyer of the equity instruments would not pay $55 to acquire them if it would only receive $50 to sell its interest on the measurement date. $55 Fair value Assumes the change in control provision has not been triggered: Although fair value is an exit price, it reflects the sale of an asset or transfer (not settlement) of a liability with the characteristics that exist on the measurement date. One of the characteristics of the debt is that it has a change in control provision that has not been triggered because an actual change in control has not yet happened. The fair value of the debt reflects the existence of the change in control provision and market participant expectations about the likelihood and timing of an actual change in control. Economically, why would the equity holder sell the equity and repay the debt today for $100 if they could wait until the debt matures and repay the debt at that time for $100, which is worth $95 today? 43

44 Section 7 Fair Value Disclosures

45 More Consistent and Transparent Information About Fair Values What is the same? Financial instruments Three-level hierarchy Transfers between levels Level 3 reconciliation Quantitative sensitivity analysis Key inputs used in valuation Non-financial assets and liabilities Methods and assumptions used Use of market prices vs models Reconciliations of beginning and ending balances What has changed? Three-level hierarchy for all fair values Guidance for disaggregation by class Qualitative sensitivity analysis Explicit quantitative disclosure for Level 3 inputs Valuation processes IAS 16 and IAS 40 already required disclosure of use of independent valuer Whether highest and best use is not current use, and why Information about fair values disclosed but not recognised Accounting policy for using portfolio exception Existence of third-party guarantees 45

46 Section 8 Differences between IFRS 13 and US GAAP s ASC Topic 820

47 Differences between IFRS 13 and US GAAP s ASC Topic 820 Difference Investment Interests in Investment Companies Reason for Difference IFRSs do not articulate whether or not the use of NAV is appropriate in estimating the fair value of an interest in an investment company Some different disclosures in ASC Topic 820 about use of NAV practical expedient Deposit Liabilities Guidance in IFRS 13, not ASC Topic 820 Disclosures Wording and Style IFRSs generally do not allow net presentation for derivatives, so the amounts disclosed in Level 3 may differ IFRS 13 requires a quantitative sensitivity analysis for Level 3 financial instruments ASC Topic 820 has some different disclosure requirements for nonpublic entities. IFRS for SMEs, not IFRS 13, addresses disclosures for similar entities. Spelling and grammar differences between North American and British English 47

48 Any questions?