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Financial Accounting IV 2015

Fair value measurement

FAIR VALUE MEASUREMENT


Reference:
1. IFRS 13 Fair value measurement
Topics covered:
1. Introduction
2. Objective and scope
3. Definitions
4. Measurement of fair value
4.1. Definition of fair value
4.1.1. The asset or liability
4.1.2. The transaction
4.1.3. Market participants
4.1.4. The price
4.2. Application to non-financial assets
4.2.1. Highest and best use for non-financial assets
4.2.2. Valuation premise for non-financial assets
4.3. Application to liabilities and an entitys own equity instruments
4.3.1. General principles
4.3.2. Non-performance risk
4.3.3. Restriction preventing the transfer of a liability or an entitys own equity
instrument
4.3.4. Financial liability with a demand feature
4.4. Application to financial assets and financial liabilities with offsetting positions
in market risks or counterparty risk
4.4.1. Exposure to market risks
4.4.2. Exposure to credit risk of a particular company
4.5. Fair value at initial recognition
4.6. Valuation techniques
4.7. Fair value hierarchy
5. Disclosure
6. Examples

1. Introduction
Prior to IFRS 13 being issued, the manner in which the fair value of assets, liabilities
and an entitys own equity instruments was measured varied between the different
standards. Some standards gave limited guidance and others were very detailed with
the result that the treatment in practice has varied, which has reduced comparability
among entities. IFRS 13 remedies this situation by defining fair value, setting out a
framework for measuring fair value and requiring disclosures about the fair value
measurement.

2. Objective and scope


IFRS 13 p.1 states that the purpose of the statement.
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Financial Accounting IV 2015


Fair value measurement

The scope of IFRS 13 p.5-8 (i.e. whats included & whats excluded).
3. Definitions
Refer to IFRS 13 appendix A.

4. Measurement of fair value:


The basis of the measurement of fair value is market-based rather than dependent
on the specific entitys intentions, which are not relevant when measuring fair value.
Consideration of the fair value will be based on the assumptions that a market
participant would use to price the asset or liability and will include assumptions about
risk under current market conditions.
4.1

Definition of fair value:

Definition: refer to IFRS 13 p.9, IFRS 13 p.B2


Paragraph B2 requires an entity to determine all of the following in a fair value
measurement approach (IFRS13 p.B2):
4.1.1 The asset or liability
Refer to IFRS 13 p.11- 14 and illustrative examples 8 and 9. deals with the
effect of restrictions on the sale or use of an asset.
4.1.2
The transaction
Refer to IFRS 13 p.15
A fair value measurement assumes that the transaction takes place either:
IFRS 13 p.17
What guidance should be considered in terms of p.18-21 in identifying the
principal or advantageous market?
4.1.3 Market participants
Refer to IFRS 13 p.22-23:
4.1.4 The price
Refer to IFRS 13 p.24
What costs should be included and which costs should be excluded? (p.2526)

4.2 Application to non-financial assets:


4.2.1 Highest and best use
Refer to IFRS 13 p.27
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Financial Accounting IV 2015


Fair value measurement

In terms of p.28 what is considered to be the highest and best use?


Refer to IFRS 13 p.29-30 and illustrative example 3 for further guidance on
determining highest and best use.
4.2.2 Valuation premise (basis) refer IFRS 13 p.31-34
Highest and best use of an asset achieved through its use in combination with
other assets as a group or in combination with other assets and liabilities (refer
illustrative examples 2-5 & 9)

Highest and best use is achieved on a stand-alone basis, refer to para B3 for a
description of the application of this concept.
4.3 Application to liabilities and an entitys own equity instruments
4.3.1 General principles
Refer to IFRS 13 p.34-41, illustrative examples 10-13.
4.3.2 Non-performance risk
Refer to IFRS 13 p.42-44, illustrative examples 10-13.
Restriction preventing the transfer of a liability or an entitys own
equity instrument
Refer to IFRS 13 p.45-46, illustrative examples 11 & 13.
4.3.3

4.3.4 Financial liability with a demand feature


Refer to IFRS 13 p.47.

4.4 Application to financial assets and financial liabilities with offsetting


positions in market risks or counterparty credit risk
Refer to IFRS 13 p.48-52.
4.4.1 Exposure to market risks
Refer to IFRS 13 p.53-55
4.4.2 Exposure to credit risk of a particular company
Refer to IFRS 13 p.56

4.5 Fair value at initial recognition


Refer to IFRS 13 p.57-60. Refer to p. B4 for situations where the transaction price
differs from the fair value at initial recognition.

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Financial Accounting IV 2015


Fair value measurement

4.6 Valuation techniques


Refer to IFRS 13 p.61-66.

4.7 Fair value hierarchy:


IFRS 13 has provided a fair value hierarchy to increase consistency and
comparability in fair value measurements and disclosures. This hierarchy
categorises the inputs used in valuation techniques that measure fair value, into
three levels (IFRS 13 p.72-73).
Level 1 inputs:
Refer to p.76-80
Level 2 inputs:
Refer to p.81-85

Level 3 inputs:
Refer to p.86-90

5. Disclosure
IFRS 13 p.91 requires an entity to disclose information that helps users of its
financial statements to assess both:
for assets and liabilities that are measured at fair value on a recurring or nonrecurring basis in the statement of financial position after initial recognition:
o the valuation technique; and
o the inputs used to develop those measurements.
for recurring fair value measurements using significant unobservable inputs
(level 3), the effect of the measurements on profit or loss or other comprehensive
income for the period.
Refer to IFRS 13 p.92 99 and the illustrative examples for further detailed
disclosure.

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Financial Accounting IV 2015


Fair value measurement

Example
Question:
Zlotnik Limited (Zlotnik) is a company listed on the JSE Securities Exchange. The
company requires advice regarding the measurement and disclosure of the following
items in its group annual financial statements:
1.

Shortly before the financial year end, the company purchased a patent for
New-Way crushing machinery which has been developed by two
university engineering professors. An amount of R25 million was paid for
this intellectual property in a deal negotiated at arms-length with the
sellers. The Zlotnik directors estimate that the net present value of the
profits the company would have lost if the patent were exploited by a third
party, amount to R45 million, as the products to which the patent relates
would create direct competition with Zlotnik thereby reducing the profits of
the company. Zlotnik will not use the patent the acquisition was simply to
prevent anyone else using it. There will be no income streams flowing
directly from these assets, and thus the valuers appointed by the Zlotnik
group have valued the patent at R nil. The accountant has accordingly
impaired the patents to R nil in the financial statements.

2.

A subsidiary of Zlotnik, Plotnik Planes (Pty) Limited owns a Spitfire aircraft,


which is a collectors item. It is housed at a hanger in Lanseria Airport in
South Africa. The main market for such specialised collectors items is in
London. The historic aircraft dealer in London has valued the Spitfire at
1 million, if sold in London. To ship the Spitfire to London will cost
approximately R500 000. For financial statement purposes, the aircraft is
revalued annually. The accountant has valued the Spitfire at R13m (as the
exchange rate at year-end was R13 : 1) and the plane is still in South
Africa.

3.

A subsidiary of Zlotnik, Karbunkle Recyclers (Pty) Limited recycles old


computers. As at the year end, it had inventory on hand which had an
original cost of R100 million.
Costs associated with restoring the
computers and retrieving the saleable parts amounted to R10 million. To
sell this inventory, commission of R10 million will be payable. Based on the
selling prices generally being achieved by the company, the stock is
expected to ultimately be sold for about R130 million. The accountant has
valued the stock at R120 million in the financial statements, which he
believes is in compliance with IFRS 13.

4.

Zlotnik issued R100 million debentures two year ago which are redeemable
in three years time. The debentures have always been classified as
financial liabilities at fair value through profit or loss. In terms of the
debenture trust deed, the debenture holders are entitled to demand
immediate payment if the debt : equity ratio of Zlotnik per the year-end
balance sheet is over 50 %. At year-end, the ratio was 51 %. The
consultants appointed by Zlotnik have valued the debentures at R50 million
based on the current estimated realisable value of the debentures.
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Financial Accounting IV 2015


Fair value measurement

You are required to:


Explain how each of the items referred to above should be measured for financial
statement purposes in accordance with IFRS.
HW/lt
11.09.2012
Solution:
1.
1.1
1.2

2.
2.1

2.2

3.
3.1
3.2
3.3

4.
4.1
4.2

New-way patent
This should be included in the financial statements at R25 million, as that is
the fair value determined in an arms-length transaction.
IFRS 13 requires that this amount be reflected and not the value specific to
Zlotnik.
Spitfire
In terms of IFRS 13, an asset should be valued in its principal market and it
is appropriate to take into account transport costs to transport the asset to
the market.
Thus, the value is R12.5 million (1m x 13 = R13m R500 000
transportation costs).

Computer stock
These should be valued at R110 million, being the cost to the company
plus the costs of conversion, in terms of IAS 2.
It is not necessary to deduct the selling costs, in terms of IAS 2.
IFRS 13 does not apply to inventory.

Debentures
These should be included in the group financial statements at their full face
value of R100 million.
IFRS 13 requires that where liabilities have a demand feature, these be
included at that amount (despite the fact that these may carry a different
market value).

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