AF301 ACCOUNTING THEORY AND APPLICATIONS

Topic : Fair Value Measurement

You will have learned from an earlier session in this course that the IASB is currently working
on a project to develop a new Conceptual Framework to employ as a frame of reference in
construction entities external financial reports. One of the issues that the IASB is still working
on is the principle of measurement. The following bases for measurement are currently under
consideration,(a) Historical cost
(b) Modified historical cost (for depreciation and impairment,- that is a downward
adjustment to a carrying amount where it is necessary to ensure that no asset is
reported at an amount that exceeds that obtainable from using or selling it.)
(c) Current entry price (the cost to replace an item)
(d) Current exit price (the sum obtainable if an asset is sold, or the sum paid out if a
liability is discharged)
(e) Fair value as defined in IFRS 13.
(f) Present value
(g) Value to the entity (the lower of replacement cost as compared with the higher of
present value and net realizable value)
The IASBs current thinking is that each of these bases may be the most appropriate form of
measurement to employ for at least one line item typically found reported in an entitys statement
of financial position. Application of fair value accounting in financial reporting is therefore likely
to be selective.
In times past the IASB and its forerunner the IASC have used the term fair value rather loosely.
Where accounting standards have used the term fair value the standard setter has intended it to
mean different things in different standards, so at one time or another items (c),(d).(f) and (g)
have all been understood as fair values. In 2010 the IASB issued IFRS 13 Fair Value
Measurement. The IASB required adoption of IFRS 13 for reporting periods beginning on or
after 1st January 2013. From that date preparers of financial reports are to understand the term
fair value and determine fair value measures and make disclosures as required IFRS 13 in
almost all cases where the term is used in the IASBs suite of accounting standards. The IASBs
objectives in developing IFRS 13 are as follows,a) To define fair value measurement

b) To establish a framework for measuring fair value that is to be applied (with some minor
exceptions) in all contexts.
c) To establish disclosure requirements in relation to fair value.
IFRS 13 does not specify that any asset or liability must be measured at fair value. It specifies
how fair value is to be measured where such a valuation may be, or must be, reported to comply
with any other Standard.
Fair Value Defined:IFRS 13 Fair Value Management defines fair value as,- 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.
This will impact on the reporting required under the following statements for reporting periods
commencing on or after 1st January 2013, where the term fair value has been used but defined
differently.
IAS 16: Property Plant and Equipment
IAS 32: Financial Instruments Presentation
IAS 38: Intangible Assets
IAS 39: Financial Instruments : Recognition and Measurement
IAS 40: Investment Property
IFRS 4: Insurance Contracts
IFRS 5: Non-current assets held for sale and discontinued operations.
The following standards make reference to market based valuations in financial reporting,
without offering a definition of fair value.
IAS36 Impairment of Assets
IAS41 Agriculture
IFRS6 Exploration for the Evaluation of Mineral Resources
IFRS7 Financial Instrument Disclosures
IFRS9 Financial Instruments
The IFRS 13 definition will apply to all these Standards.
However the definition does not apply in the following cases,IAS17 Leases
IAS19 Employee Benefits
IAS26 Accounting for Reporting by Retirement Benefit Plans
IFRS2 Share Based Payments
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Measurement of net realiasable value (IAS2) and value in use (IAS36) are not affected.
How does application of fair value accounting impact on equity?
IFRS 13 does not in itself require any account to be reported at fair value. In some of the
standards listed above reporting fair values is required, in other it is an option. However use of
fair values in financial reporting raises the issue as to how the value changes from the original
costs recorded in the ledger system will impact on how equity is reported in the financial
statements. Should any value change be considered part of the operating profit measure, a part of
the other comprehensive income measure, or should it be taken to the statement of changes in
equity? While IFRS 13 has provided a rationalisation of our understanding of fair value, it has
not rationalised how we report the impact of reported value changes on equity. For example
IFRS 9 Financial Instruments requires the following,

Such assets held solely in order to collect contractual cash flows, - report at amortised cost..
Such assets held in order to collect contractual cash and possibly to sell at some unspecified
future date,- report at fair value through other comprehensive income
All other financial assets are to be reported at fair value through profit or loss.

How do we find the fair value for any asset or liability?

As fair value is a market based measurement it is necessary to consider which market an entity
should refer to in taking a measurement. The appropriate market is deemed to be the principal
market the entity operates in, and if there is no principal market, the market that is the most
advantageous for the entity to operate in. Note that an entity, which is more likely to buy than to
sell in the market seeks the market it is best to make purchases in, but will report the net selling
price in that market. In making a decision as to which market is most advantageous to operate in,
both transaction costs and transportation costs are obviously relevant. Consider the following
example,Example 1
Asset XYZ is sold in two different active markets.
In market A, the price that would be received is $27; transaction costs are $4 and the costs to
transport Asset XYZ to Market A are $2
In market B, the price that would be received is $26; transaction costs are $1 and the costs to
transport Asset XYZ to Market B are $3
Required:
(a) Which is the most advantageous market?
(b) What will the reported fair value be for asset XYZ?
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Acknowledgement: Adapted from IASB (2013) IFRS 13 Fair Value Measurement, Illustrative
Examples
But, suppose there is only an imperfect market for an asset.
Example 2
When you start work you may decide that you want to get your own car. Few of us can afford to
buy a brand new vehicle. How will you determine the fair value for a second hand car? (IAS 16
allows but does not require non current assets to be reported at fair value).
Or suppose that there is no market for an asset at all.
Example 3
How would you determine the fair value of shares in the following companies operating in Fiji?

Fijian Holdings Limited

Kontiki Growth Fund
Asian Paints Ltd
Basic Industries
New World Ltd

(IFRS 9 requires investments, other than investments in subsidiary and associate companies to be
reported at fair value)
It is worth noting that George Benson an American academic has estimated, in the context of the
American economy, that only 1% of fair values that could be determined purely on quoted
prices.
Now consider example 4
Example 4
Twinkle Toes Ltd conducts a business that makes womens shoes. It operates a factory in a
suburb of Nadi. The company owns both the factory and the land on which the factory stands.
The land was acquired in 2001 for $200000 and the factory was built in that year at a cost of
$520000. Both assets are recorded at a cost, with the factory having a carrying amount at 31 st
December 2012 of $260000.
In recent years there has been a property boom on the outskirts of Nadi, with residential house
prices doubling such that the average price of a house is approximately $500000. A recent
valuation of the land on which the factory stands as performed by a property valuation group and
based on recent sales of land in the area has the land at a value of $1000000. The land is now
considered prime residential property given its closeness to Denarau and its suitability for
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building executive apartments. It would cost $100000 to demolish the factory to make way for
these apartments to be built. The directors of Twinkle Toes Ltd want to report both the factory
and the land at fair value.
How would you go about determining the fair values?
Acknowledgement: This example has been adapted from material appearing in Leo K., J.
Hoggett and J. Sweeting (2012) Company Accounting 9th edition. Wiley.
And finally consider example 5
Example 5
On 1st January 2013 Swift Expansion Ltd issues a fixed interest security at a unit par value of
$1000, raising $2 million, with a coupon rate of 6%, maturing on 31 st December 2022.. Fiji
Finance Ltd purchased 200 units at issue date. On 31st December 2013 Swift Expansion Ltd is
considering issuing another fixed interest security that will also mature on 31 st December 2022.
Examining conditions prevailing in the market, it concludes that it will have to offer a coupon
rate of 8% per annum if it is to attract investors to purchase units of the security at its par value.
Required:
(a) Determine the fair value of the securities issued by Swift Expansion Ltd as at 31 st
December 2013 applying the provisions of IFRS 13.
(b) Construct the journal entries Swift Expansion Ltd and Fiji Finance Ltd will have made on
1st January and at 31st December 2013 in relation to the sale and purchase of this security.

Appendix: Illustrative Example of Disclosure Required by IFRS 13

Table 1: Disclosure requirements complying with paragraphs 93(a) and (b) of IFRS 13
Fair value measurements at the end of the
reporting period using

Description
Recurring fair value
measurements
Trading equity securities
Real estate industry
Oil gas industry
Other
Total trading equity securities
Other equity securities
Financial services industry
Healthcare industry
Energy industry
Private equity fund investments
Other equity securities
Total other equity securities
Non-recurring fair value
measurements
Assets held for sale

31/12/X9
$000

Quoted prices
in active
Significant
markets for other
identical
observable
assets
inputs
(Level 1)
(Level 2)
$000
$000

93
45
15
153

70
45
15
130

150
163
32
25
15
385

150
110

Significant
unobservable
inputs
(Level 3)
$000

Total
gains
(losses)

23

23

53
32
25

15
275

110

26

(15)

Table 2: Disclosure requirements complying with paragraph 93(d) of IFRS 13

Quantitative information about fair value measurements using
significant unobservable inputs (Level 3)
Fair value
at

Valuation

Unobservable

Range
(weighted

Description
Other equity
securities:

31/12/X9

technique(s)

input

average)

Healthcare industry

530

Discounted cash
flow

weighted average cost of capital

7%-16%
(12.1%)

long-term revenue growth rate

long-term pre-tax operating
margin

2%-5% (4.2%)
3%-20%
(10.3%)

discount for lack of marketability

control premium

5%-20% (17%)
10%-30%
(20%)

EBITDA multiple

10-13 (11.3)

revenue multiple

1.5-2.0 (1.7)

discount for lack of marketability

5%-20% (17%)

control premium

10%-30%
(20%)

$000

Market comparable
companies

Equity securities

Debt securities

Opening balance
Transfers into Level 3
Transfers out of Level 3
Total gains or losses for the period
Included in profit or loss
Included in other comprehensive

Private equity fund

20

Residential mortgage
backed securities
105
60(a)(b)
(5)(b)(c)

Total
125
60
(5)

(23)

(18)

income
Purchases, issues, sales and
settlements
Purchases
Issues
Sales
Settlements
Closing balance
Change in unrealised gains or losses
for the period included in profit
or loss for assets held at the end of
the reporting period

(12)

(12)

25

125

150

(23)

(18)

Table 3; Fair value measurements using significant unobservable inputs (Level 3)

complying with paragraph 93 (e) of IFRS 13 in $millions

a) Transferred from Level 2 to Level 3 because of lack of observable market data, resulting
from a decrease in market activity for the securities.
b) The entitys policy is to recognize transfers into and transfers out of Level 3 as of the date
of the event or change in circumstances that caused the transfer.
c) Transferred from Level 3 to Level 2 because observable market data became available for
the securities.
Acknowledgement: These illustrative disclosures have been adapted from IASB (2013) IFRS
13 Fair Value Measurement: Illustrative Examples

Reading:
International Accounting Standards Board (2012) IFRS 13 Fair Value Measurement (available
on the IASBs website)
Leo K, J Hoggett and J Sweeting (2012) Company Accounting 9th edition. Chapter 5. Wiley