Fair Value Measurement Case Studies CS

Case Studies:
Fair Value
Measurement
Executive IFRS Workshop for

Regulators
Diplomatic Academy of Vienna, 4 June 2013
KPMG International Standards Group

Case study 1: Restriction on sale of financial asset
Restriction on sale of equity instrument (financial asset)

Quoted price in active market for shares that is not subject to
restriction is available
■ Fact pattern:
– Entity A enters into a borrowing arrangement.
– In accordance with the arrangement, an equity security that A holds as
an investment is pledged as a collateral.
– A is restricted from selling the security pledged during the period the
borrowing is outstanding.
Question:
Should the restriction be considered when measuring the fair value of the
security?
© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

Case Study: Fair Value Measurement 1
All rights reserved. Internal use only.
Case study 1 solution: Restriction on sale of financial asset
Is the restriction a characteristic of the financial asset (IFRS 13.11)?

■ transferability
■ imposed on holder by regulations
■ part of contractual terms of financial asset
■ attached to financial asset through purchase contract or other commitment?
Yes No
Adjustment for restriction required Adjustment for restriction prohibited
Level 1 input for financial asset without Holder of restricted financial asset
restriction is not level 1 input for financial considered to have access to principal
asset with restriction market at measurement date
Solution:
The restriction is entity-specific and should not be considered in measuring
the fair value of the security

Case study 2: Day 1 gain
Bank B enters into an interest rate swap (IRS) contract with a corporate
client for no initial cash consideration.
B has access to the wholesale market which is the principal market for this
instrument.
B estimates the fair value of the IRS in the wholesale market at the
transaction date using a valuation technique. The fair value using the
valuation technique is CU 10 (an asset).
Scenario 1:
■ All the inputs used in the valuation technique are observable
Scenario 2:
■ The valuation technique uses inputs that are not observable
Question:
What is the fair value of the IRS? Should Bank B recognise a “day 1” gain?

Case study 2 solution: Day 1 gain (1/2)
May indicate that

Transaction is between related parties transaction price and
fair value are different
(IFRS 13.B4).
IFRS 13 does not
Transaction is forced prescribe rules for
recognition of gains
Unit of account represented by the transaction is or losses at initial
different from unit of account used for measuring recognition – look to
fair value IFRS that
permits/requires the
The market in which transaction takes place is fair value
different from the market in which the entity measurement (e.g.
would sell the asset or transfer the liability IAS 39/IFRS 9)

Case study 2 solution: Day 1 gain (2/2)
Scenario 1:
■ The fair value is CU 10 (based on the valuation technique)
■ Bank B recognises day 1 gain of CU 10
Scenario 2:
■ The fair value is CU 10 (based on the valuation technique)
■ Bank B does not recognise a day 1 gain (the carrying amount of the IRS
on initial recognition is adjusted to defer the difference between the fair
value measurement and the transaction price)
Fair value represents the price in the principal market. However, under
IAS 39/IFRS 9, if the fair value at initial recognition differs from the
transaction price but is not evidenced by a valuation technique that
uses only data from observable markets, any “day 1” gain is deferred
(IAS 39.AG76, IFRS 9.B5.1.2A)

Case study 3: Low interest loan
■ Entity G makes an interest-free loan of CU 100 to a related party at

1/1/X3
■ The loan is repayable after 3 years at CU 100
■ Entity G estimates that the annual interest rate that the related party
would have been required to pay to an unrelated party (e.g. a bank) for a
loan with similar terms is 5%. However, this estimate is not based solely
on observable market data.
Question:
What is the fair value of loan at 1/1/X3? Should G recognise a “day 1” loss?

Case study 3 solution: Low interest loan
The fair value/transaction price of the loan is CU 86 (100/1.05³). G

expenses the remainder of 14.
Fair value at initial recognition usually = transaction price = fair value of
consideration given. But if part of the consideration relates to something
other than the financial instrument, measure the FV of the financial
instrument.
The fair value of a loan that carries no interest can be measured as the
present value of all future cash flow receipts discounted using the prevailing
market rate of interest for a similar instrument with a similar credit rating.
Any additional amount lent is an expense or a reduction in income unless it
qualifies for recognition as some other type of asset (IAS 39.AG64).

Case study 4: Principal and most advantageous markets
Entity D owns an asset. It has access to two different active markets

to sell the asset
Market A Market B
Price 99 96
Transaction costs 6 2
Net amount received 93 94
Scenario 1:
■ Market A is the principal market as it is the market with the greatest
volume and level of activity for the asset
Scenario 2:
■ There is no principal market
Question:
What is the fair value of the asset in each scenario?

Case study 4 solution: Principal and most advantageous
markets
Scenario 1:
■ The fair value is 99 (the price in market A which is the principal market)
Scenario 2:
■ The most advantageous market is market B
■ The fair value is 96 (the price in market B)
In measuring fair value, the price is not adjusted for transaction costs
(IFRS 13.25). However, transaction costs are taken into account in
determining the most advantageous market (IFRS 13.A)

Case study 5: The most representative price within a bid-
ask spread
Entity L holds 2 securities; X and Y which have bid and ask prices as
follow:
Security Bid Price Ask price Mid-market

price
X 99.9 100.1 100

Y 90 110 100
Question:
Can L use mid-market prices for measuring the fair values of the securities?

Case study 5 solution: The most representative price within
a bid-ask spread
■ The entity uses the price within the bid-ask spread that is most
representative of fair value in the circumstances (IFRS 13.70).
■ IFRS 13 does not preclude the use of mid-market pricing or other pricing
conventions that are used by market participants as a practical expedient
for fair value measurement within a bid-ask spread (IFRS 13.71).
For security X, the mid-market price of 100 may be used as it seems to

provide a reasonable approximation of the exit price
For security Y, due to the wide bid-ask spread, the mid-market price of
100 may not provide a reasonable approximation of the exit price and
therefore would not be used

Case study 6: Premiums and discounts
■ Entity M holds:
– 5% of the shares of entity Z; and
– 80% of the shares of entity W which give M control over W.
■ Z and W shares do not have a quoted price. Fair values for these shares
are initially estimated using multiples for comparable public companies.
Questions:
1. Should the fair value of Z shares be adjusted for the effect of lack of
liquidity?
2. Should the fair value of the investment in W be adjusted to include a
control premium?

Case study 6 solution: Premiums and discounts
■ The fair value of Z shares should be adjusted for the effect of lack of
liquidity if market participants would take this into account when
measuring the fair value (IFRS 13.69)
– May be required if initial estimate of fair value is based on
comparables for public companies (ie. quoted/liquid shares).
■ The fair value of W should be adjusted for a control premium if:
– it is not inconsistent with the asset’s unit of account (IFRS 13.14, 69);
and
– market participants would include such a premium when measuring
the fair value (IFRS 13.69).
The issue of how to determine the unit of account

is currently under discussion by the IASB

Case study 7: Large holding
Fact pattern:
■ Entity B holds 8% (i.e. 1.5 million shares) of the share capital in Entity Q.
■ Daily trading volume is 1% of outstanding shares.
■ The quoted price for one share in Q is CU 10 at the measurement date.
■ B assumes that it would be able to sell its 8% stake in one transaction for
CU 13.5 million at the measurement date.
Question:
What is the fair value of B’s 8% interest in Q at the measurement date if Q’s
shares are traded in an active market?

Case study 7 solution: Large holding
CU
The FV of A’s 8% interest in Q is CU 15 million 15 million
■ Unit of valuation and unit of account is individual share in
accordance with IFRS 13.14 and IAS 39/IFRS 9.
■ If Level 1 input available, it should be used for FV measurement (IFRS
13.69, 77, 80): 1.5 million shares × CU 10 = CU 15 million.
■ Discount of CU 1.5 million is a blockage factor that is:
– a characteristic of the entity’s holding;
– inconsistent with the unit of account;
– not a characteristic of the individual share; and
– conceptually similar to transaction costs.
Follow up question:
Would the answer be different if the market for Q’s shares was not active?
Case study 8: Fair value measurement of a portfolio of
assets and liabilities
■ Bank C has a long position of 100 individual financial assets and a short
position of 95 individual financial liabilities in a particular market risk.
■ The financial instruments within the portfolio are identical.
■ Bid price is CU 99; mid price is CU 100; ask price is CU 101.
■ C uses bid prices to measure asset positions and ask prices to measure
liability positions.
■ The individual financial instruments are not categorised within level 1 of
the fair value hierarchy.
■ Assume there is no discount/premium that results from the size of the net
risk exposure.
Question:
What is the sum of the fair values of the assets and liabilities assuming:
A. Bank C applies the portfolio exception; or
B. Bank C does not apply the portfolio exception.
Case study 8 solution: Fair value measurement of a
portfolio of assets and liabilities (1/2)
If C applies the portfolio exception, the sum of the fair values is CU

495 and can be measured as follows:
Quantity held Price Fair value
95 100 9,500
Financial assets
5 99 495
Financial (95) 100 (9,500)

liabilities
Net long position 5 99 495

Case study 8 solution: Fair value measurement of a
portfolio of assets and liabilities (2/2)
Without the application of the portfolio exception, the sum of the fair
values is CU 305 and is measured as follows:
Quantity held Price Fair value
Financial assets 100 99 9,900
Financial (95) 101 (9,595)

liabilities
Net long position 5 305

Case study 9: Adjustment for DVA
■ Entity H entered into an interest rate swap (IRS) contract with a bank in
2011.
■ Under IAS 39, H has not adjusted the fair value of the IRS for its own
credit risk (DVA adjustment).
■ H applies IFRS 13 from 1 January 2013.
■ The value of the IRS on 1 January 2013, excluding DVA, is CU 100 (an
asset)
■ H believes that an adjustment to the fair value for its own credit risk is not
required under IFRS 13 because:
– it would be misleading since H intends to settle the IRS with the bank; and
– the IRS is currently classified as an asset, so the effect of H’s own credit risk is not
relevant for the valuation.
Question:
Should the fair value of the IRS be adjusted for H’s own credit risk?
Case study 9 solution: Adjustment for DVA
H’s own credit risk should be considered when measuring the fair
value of the IRS if market participants would do so when valuing the
instrument
■ Under IFRS 13, the fair value of a liability reflects the effect of ‘non
performance risk’ which includes an entity’s own credit risk (IFRS 13.42).
■ Since fair value under IFRS 13 is an ‘exit price’, H’s intention to settle
should not affect the measurement (IFRS 13.9).
■ The effect of the entity’s own credit risk may be relevant for measuring
the fair value of an instrument that might change from being an asset to a
liability (even when the current position of the instrument is an asset) –
since a market participant may consider this risk and the potential credit
exposure to H that might arise when determining the price of the asset.
[Similarly, counterparty credit risk may be relevant to measuring a liability
that might change to being an asset.]

Case study 10: Decrease in volume or level of activity (1/2)
■ Entity C holds 4% of the share capital in Entity F.

■ Quoted price on stock exchange is CU 200 at measurement date
(31/12/20X2).
■ During Q2-20X2, trading was suspended for 8 weeks and during 20X2
the government took several steps to support the market.
■ Due to financial and political instability, the share price and trading
activity have declined sharply since Q2-20X2, with historical lows in Q4-
20X2.
■ Trading volume on measurement date is similar to the average quarterly
trading volume.

Case study 10: Decrease in volume or level of activity (2/2)
Question:
Is C allowed to use a price, other than the quoted price, to measure the FV
of a share in F at the measurement date?

Case study 10 solution: Decrease in volume or level of
activity
■ Is market active (i.e. is the quoted price a Level 1 input (IFRS 13.76))?
■ In an active market, transactions for the asset or liability take place with
sufficient frequency and volume to provide pricing
information on an ongoing basis (IFRS 13.A).
■ There may be a significant decrease in volume or
level of activity for the shares in F (IFRS 13.B37).
■ Significant decrease in volume or level of activity ≠ inactive market
■ Based on fact pattern presented  sufficient evidence to consider the
market active.
■ Even if market is inactive, quoted price may still
represent best evidence of FV as the transactions can still be orderly
(IFRS 13.B43).

Case study 11: Not using the transaction price when
measuring fair value (1/2)
■ Entity K holds a debt security for which there has been a significant
decrease in the level of activity in the market such that there were only a
few transactions in recent months.
■ K concludes that the market for the security is no longer an active
market.
■ The last transaction in the market took place at 23/12/X3 at a price of CU
60. The debt security’s principal amount is CU 100.
■ K states that:
– due to the lack of activity and the illiquidity of the market, the price in
the market does not represent fair value;
– the current low market price results from irrational trends caused by
wider economic concerns that are not specific to the security;
– it will hold the security until the market price increases or until maturity.

Case study 11: Not using the transaction price when
measuring fair value (2/2)
■ Accordingly, K values the security at 31/12/X3 at CU 90 using an income

approach that is based on its analysis of expected cash flows and what it
considers a reasonable rate of return of 6%.
Question:
Can K ignore the last transaction price of CU 60 and use its own valuation
technique when measuring the fair value of the security?

Case study 11 solution: Not using the transaction price
when measuring fair value (1/2)
FV represents price of an orderly transaction. It is not appropriate to

conclude that all transactions in the market are not orderly – need to
evaluate the circumstances of transactions (IFRS 13.B44):
■ if evidence indicates orderly – take transaction price into account
■ if insufficient evidence – also take into account but less weight
■ if evidence indicates not orderly – little, if any, weight

Case study 11 solution: Not using the transaction price
when measuring fair value (2/2)
FV should reflect market participants’ (not K’s) assumptions about expected

cash flows and discount rates, including the risk premium a market
participant would demand. Therefore, K’s intention to hold the asset is not
relevant (IFRS 13.22).
Multiple valuation techniques may be appropriate – but weighting should
reflect objective of determining the point that is most representative of
current market conditions (IFRS 13.63).
Need to consider time between last transaction and measurement date
(IFRS 13.B44(b)).
Based on the information presented, K cannot ignore the transaction

price of CU 60. Also, K’s alternative valuation technique is not
calibrated to a market participant perspective.

Questions and feedback
Please send your feedback on today’s
session to:
Chris Spall
Seconded Partner in KPMG’s
International Standards Group
chris.spall@kpmgifrg.com
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such information without appropriate professional advice after a thorough examination of the particular situation.
KPMG International Standards Group is part of KPMG IFRG Limited.
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Case Studies:

Executive IFRS Workshop for

Diplomatic Academy of Vienna, 4 June 2013

KPMG International Standards Group

Restriction on sale of equity instrument (financial asset)

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

Is the restriction a characteristic of the financial asset (IFRS 13.11)?

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

May indicate that

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

■ Entity G makes an interest-free loan of CU 100 to a related party at

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

The fair value/transaction price of the loan is CU 86 (100/1.05³). G

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

Entity D owns an asset. It has access to two different active markets

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

Security Bid Price Ask price Mid-market

X 99.9 100.1 100

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

For security X, the mid-market price of 100 may be used as it seems to

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

The issue of how to determine the unit of account

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

If C applies the portfolio exception, the sum of the fair values is CU

Quantity held Price Fair value

Financial (95) 100 (9,500)

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

Quantity held Price Fair value

Financial assets 100 99 9,900

Financial (95) 101 (9,595)

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

■ Entity C holds 4% of the share capital in Entity F.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

■ Accordingly, K values the security at 31/12/X3 at CU 90 using an income

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

FV represents price of an orderly transaction. It is not appropriate to

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

FV should reflect market participants’ (not K’s) assumptions about expected

Based on the information presented, K cannot ignore the transaction

© 2013 KPMG IFRG Limited, a UK registered company limited by guarantee.

KPMG International Standards Group is part of KPMG IFRG Limited.

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