FAIR VALUE ACCOUNTING

Learning Outcomes:

 Understand the key characteristics of the

term ‘fair value’
 Understand the key concepts used in fair
value framework
 Explain the steps in determining the fair
value of non-financial assets
 Understand how to measure the fair
value of liabilities & an entity’s own
equity instruments

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 Assets 2
Classification, recognition and measurement

PP&E Intangible
Inv
Inventory Property
Assets
Etc Financial
Defined Biological
Benefit assets
ASSET TYPE MEASUREMENT AT
INITIAL
RECOGNITION
IFRS 9 Financial Fair value
Instruments
IAS 16 Property, Purchase costs + construction
Plant and costs + costs to bring to the
Equipment location and condition
necessary to be capable of
operating in the manner
intended by management.
IAS 38 Intangible Purchase costs +
Assets development costs + costs to
bring to the location and
condition necessary to be
capable of operating as
intended by management
IAS 40 Cost including transaction
Investment costs
Property
IAS 41 Agriculture Fair value less costs to sell
© 2010 IFRS Foundation.
30 Cannon Street | London
EC4M 6XH | UK.
www.iasb.org
MODEL BASED BASIS OF
ON FAIR VALUE IMPAIRMENT
TEST
For specified financial
assets and for particular
business models: fair
value
Accounting policy Compare carrying
choice: revaluation amount to recoverable
model amount.
Recoverable amount is
greater of value in use
and fair value less
Accounting policy
disposal costs (IAS 36)
choice: revaluation
model
Accounting policy
choice: fair value
Fair value less costs to
sell
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 Previous definition of fair value (FV)
The old definition of fair value
The amount for which an
asset could be
exchanged, or a liability
settled, between
knowledgeable, willing
parties in an arm’s length
?
transaction.
Its weaknesses
It did not specify whether an
entity is buying or selling the
asset.
It was unclear about what
settling meant because it did
not refer to the creditor.
It was unclear about whether it
was market-based.
It did not state explicitly when
the exchange or settlement
takes place.
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 MFRS 13
The need for a MFRS 13:

 Sets out in a single framework for measuring FV to

reduce complexity and improve consistency in
application

 Clarify the definition of FV and related guidance

 Enhance disclosures about FV to asses the extent to

which FV is used – the inputs used to derive FV

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 Fair Value
Definition: MFRS 13

“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.”

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 Cont.
Explanation on definition:

 Would
 Transaction may be hypothetical

 When there is no observable market to provide

pricing information, a fair value measurement shall
assume that a transaction takes place at that date

 “Exit price” - expectations about the future cash inflows

and outflows associated with the asset or liability from
the perspective of market participants at the
measurement date.

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 Cont.
Illustration: Exit Price vs Entry Price

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 Cont.
 Orderly Transaction
 A 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 or liabilities;

 it is not a forced transaction (e.g. a forced liquidation

or distress sale)

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 Cont.
 Market
 The transaction takes place either:

 in the principal market; or

 in the absence of a principal market, in the most
advantageous market.

 But the entity must have access to the market

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 Cont.
 The principal market:

 the market with the greatest volume and level of

activity for the asset or liability
 need not to make exhaustive search for the principal
market.
 It is assumed that the principal market is the market
the company usually enters unless evidence to the
contrary exist.

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 Cont.
 The most advantageous market:

 The market that maximizes the amount that would be

received to sell the asset or transfer the liability after
considering transaction cost and transport cost

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 Cont.
Illustration 1:

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 Cont.
Illustration 2:

Asset XYZ is sold in two different active markets.

In market A, the price that would be received is RM27;
transaction costs are RM2 and the costs to transport the
asset to Market A are RM3.
In market B, the price that would be received is RM26;
transaction costs are RM2 and the costs to transport the
asset to market B are RM1.

Find the fair value of asset XYZ.

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 Cont.
Solution

The fair value of the asset is measured using the price in

the most advantageous market. The most advantageous
market is the one that maximizes the amount that would be
received to sell the asset after considering transaction cost
and transport cost.

In market A, the net amount received by the entity is RM22

(RM27-RM2-RM3)

In market B, the net amount received by the entity is $23,

(RM26-RM2-RM1)

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 Cont.
Solution

Market B is the most advantageous market. The fair value

of the asset is RM25, being the amount received net of
transport cost.

Although transaction costs are used to determine the most

advantageous market, they are not used in the calculation
of fair value.

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 Cont.
 Market Participants

 Need not identify specific market participants

 Assumptions that market participants would use in
pricing the asset/liability.
 Characteristics:
 They are independent of each other,
 They are knowledgeable, having reasonable
understanding about the asset/liability and using all
available information
 They are able to enter into a transaction
 They are willing to enter into a transaction

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 Cont.
Acceptable Valuation Techniques

 Market Approach
A valuation technique that uses prices and other
relevant information generated by market transactions
involving identical or similar assets or liabilities.

 Income Approach
valuation technique the converts future amounts to a
single present (discounted ) amount. e.g. Present value;
Option Pricing

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 Cont.
 Cost Approach
A valuation technique that reflects the amount that
would be required currently to replace the service
capacity of an asset (Current Replacement Cost)

Choice of technique

MFRS does not propose a hierarchy of valuation

technique. Some valuation techniques are better in
some circumstances than others. Judgment is required
in selecting the appropriate technique.

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 Cont.
Inputs to Valuation

Observable inputs:
Those values that can be obtained independently from
available market data, possibly with some adjustment for the
specific asset, which would be used by market participants
when valuing an asset or liability.

Unobservable inputs:
Based on information that is not available to the market but
must be inferred or estimated based on the best information
available.

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 Cont.
Fair Value Hierarchy:

Level 1 Inputs:
Quoted prices (unadjusted) in active markets for identical
assets or liabilities.

Level 2 Inputs:
Inputs other than quoted prices included within Level 1 that
are observable.
Include:
o Quoted prices for similar assets/liabilities in active markets
o Quoted prices for identical or similar assets/liabilities in
markets that are not active
o Inputs other than market prices that are observable such
as interest rates and credit risks
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 Cont.
Fair Value Hierarchy:

Level 3 Inputs:
Inputs that are not based on observable market data
(unobservable inputs).

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 Cont.
Fair Value of Non-Financial Assets:

 Must reflect the use of a non-financial asset by market

participants that maximises the value of the asset:

o physically possible – look at the physical characteristics.

o legally permissible – considering any legal restrictions

(e.g. zoning regulations on the use of property. The
asset need not to be legal but it must not be legally
prohibited).

o financially feasible – use of the asset must result to

appropriate return from the asset.
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 Cont.
Illustration:

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 Cont.
Fair Value of Non-Financial Assets:

 Highest and best use is usually (but not always) the

current use.
o Stand-alone valuation premise – the price to
market participants who would use the asset on
stand alone basis.

o In-combination valuation premise – the price where

the market participants obtain maximum value
through using the asset in combination with other
assets & liabilities.

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