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N Appendix I: Fair value

measurement

While the fair value concept is an integral element of IFRS, it cannot be

ignored in preparing consolidated financial statements. There are several transactions in groups where fair value is an important element. Fair value issues arise
always on the acquisition of subsidiaries and their disposals. Depending on the
carrying assets of group companies, these issues may also arise in preparing
regular consolidated financial statements. As fair value measurement affects the
preparation of consolidated financial statements at various opportunities, this
appendix will explain some relevant concepts, methods and tasks necessary to
prepare the statements.1
1.History
The treatment of fair values and their measurement has been discussed for
several years. This is because definitions and elements of fair value are spread
across several IFRS, are sometimes not consistent or do not meet the desired
objective. Often, additional guidance on how to apply fair value measurements is
missing. As a consequence, the IASB and the FASB jointly have developed common requirements for measuring fair value and disclosing fair value information.
The results of these activities are published in IFRS 13 Fair Value Measurement.
IFRS 13.C1 requires the application of this standard for periods beginning on or
after 1 January 2013, even if earlier application is permitted. As the application of this
standard is relatively recent, two cases require attention as fair values may have different definitions:
IFRS 13 adopted
If IFRS 13 is adopted, all measurement issues of fair values follow the
definition as outlined in IFRS 13.9: This IFRS 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 appendix explains only selected aspects of fair value measurement and valuation techniques
important for groups. Valuation techniques and methods are described only in general. It is recommended to make use of other literature, particularly valuation literature, for a full scope of
fair value measurement and the application and handling of appropriate valuation techniques
including the details required by each method.
Principles of Group Accounting under IFRS. Andreas Krimpmann.
2015 John Wiley & Sons, Ltd. Published 2015 by John Wiley& Sons, Ltd.

751

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IFRS 13 not yet adopted

If not yet adopted, a transition to IFRS 13 is required. IFRS 13.C2
requires a prospective transition, so a retrospective adjustment is not necess
ary simplifying the transition. The transition also changes the definition
of fair value. Older IFRS have different definitions, e.g. IFRS 5.A: The
amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arms length transaction.

2.Definition
IFRS 13.9 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. Due to this definition, the price determined is an
exit price (assuming a sale). Even if this definition is very comprehensive, several
facts and circumstances have to be determined in assuming the fair value:
Assets that are subject to a fair value measurement
Subject to fair value measurements are all assets and liabilities that
require a recording at fair values. IFRS 13.5 addresses the application if
any standard requires a fair value measurement. Accordingly, some items
are exempt from an application.
Item

Covered by standard

Scope Exemptions Comment

Intangible assets

IAS 38

Yes

Only if revaluation
model is applied

Property, plant
& equipment
Asset measurement: value
in use
Asset measurement: fair
value less cost of disposal
Financial assets
Investment property
Agricultural assets
Mineral resources

IAS 16

Yes

IAS 36

No

IAS 36

Yes

Only if revaluation
model is applied
Similarity to fair value
given but not fair value
Disclosures not
required

IFRS 9
IAS 40
IAS 41
IFRS 6

Yes
Yes
Yes
Yes

Inventories
Share-based payments
Leasing
Pensions: plan assets
Retirement benefit plan
investments
Business combinations

IAS 2
IFRS 2
IAS 17
IAS 19
IAS 26

No
No
No
Yes
Yes

IFRS 3

Yes

Financial liabilities
Provisions, liabilities

IFRS 9
IAS 37

Yes
No

Yes

Only if revaluation
model is applied
Disclosures not required
Yes
Yes

Disclosures not required

Disclosures not required
Applies to purchase
price allocation

Tab. N1 List of assets subject to fair value measurement

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Depending on the nature of assets and liabilities, a fair value

measurement occurs on a recurring basis or if specified circumstances
or events exist. This requires a consideration of the characteristics of the
assets and liabilities, particularly any restrictions and uses.
The fair value measurement can be applied to individual assets and
liabilities as well as to a group of them.
A determination of fair value is not limited to specific types of asset.
An application is required for financial as well as non-financial assets. Nonfinancial assets are all those assets that are not measured in accordance
with IAS 39 or IFRS 9. A common feature of those assets is often a missing
active market.
The principal market of that asset and its participants
The principal market is the market where trading of assets frequently
occurs with sufficient volume to determine pricing information on an ongoing
basis. If there is no principal market, the most advantageous market has to
be determined. If there are several markets with different prices, the principal
market has to be applied. Both the principal and the most advantageous
markets are active markets. Access to the market must exist.
Market participants have to be unrelated parties dealing at arms length
principle for their own economic interest.
The price
The price is a fair value that has been achieved for the sale of an asset in
an orderly transaction. The price considers the fair value of the asset only.
Therefore, no transactions costs are included. An adjustment might be
necessary to have the asset available for the market. IFRS 13.24 mentions
transportation costs as one example for those adjustments.
Appropriate valuation techniques
In the absence of an active market, valuation techniques have to be
applied to determine an active market. This assumes that an estimation of
a fair value can be derived from the asset and its use.
3.Measurement
The measurement of assets and liabilities covers the whole lifecycle and therefore has to consider the initial as well as subsequent measurements. Therefore,
fair value measurement requirements apply at different stages.
Initial recognition
Usually, it is assumed that the price paid to acquire an asset or a group
of assets or assume liabilities is based on an arms-length transaction so
that the price reflects the fair value of the asset.2 Nevertheless, there are
situations where an asset is obtained at a price different than its fair value.
2

The price paid is also called the entry price.

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To adjust the initial price asset to its fair value, day one gains or losses
arise. Reasons for those dissenting prices are:

Transactions between related parties;

Transaction executed under duress;
Transaction covers a group of items;
Transactions in different markets and not in the principal market.

Subsequent measurement
Measuring the fair value of an asset in subsequent periods assume an
exit price, so a price that can be achieved on an active market. The full set
of fair value tools can be applied.
Regardless of which method is applied to determine the fair value of an asset
or liability, IFRS 13.72 defines a fair value hierarchy that has to be applied. This
hierarchy is a guideline regarding which inputs are most suitable when valuation
techniques are used. The intention of this hierarchy is to increase consistency and
comparability.
Level Rationale
1) Quoted prices in active
markets

2) Other observable inputs:

2a) Quoted prices for similar
assets and liabilities in
active markets
2b) Quoted prices for
identical or similar
assets and liabilities in
non-active markets
2c) Inputs other than
quoted prices for assets
and liabilities
2d) Market-corroborated
inputs
3) Unobservable other
inputs

Comment
Quoted prices are always unadjusted prices. An adjustment is
only appropriate if
Large amounts of similar assets and liabilities are held but
the quoted price is not readily accessible.
Quoted price does not equal fair value (e.g. due to timing
issues, the fair value measurement date does not equal the
acquisition date or significant events have changed the fair
value).
Observed identical assets and liabilities are subject to
adjustments.
Active markets trade assets frequently and in a certain volume.
This is primarily the principal market and only in the absence
of this market the most advantageous market.
Only if level 1 inputs are not available, level 2 has to be applied.
Similar assets and liabilities are not defined any further by
IFRS 13. Identifying such items requires not only judgement
but also an understanding of the terms and other factors that
affect the fair value and an identification and assessment of
any differences in the terms compared to the asset subject to
measurement.
Similar to quoted prices, adjustments to quoted prices for iden
tical or similar assets may be necessary to reflect the behaviour
of the asset subject to measurement. Typical examples are risk
alignments, conditions and locations.

Level 3 inputs are only appropriate if any market relationship

is missing. Therefore, internal inputs based on the groups own
data are used. If again evidence is given that other market
participants use other data, appropriate adjustments are considered to reflect at least some market aspects.

Tab. N2 Fair value hierarchy

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The order of the fair value hierarchy ensures that observable inputs have to
be preferably applied as they are market related (external) and therefore provide
more assurance than internal ones.
If assets cannot be reliably measured by using similar assets in active markets,
the application of valuation techniques, as outlined in IAS 13.61, is an appropriate method in deriving fair value. Valuation techniques vary depending on the
nature of the underlying asset to be measured. IFRS 13.62 provides three valu
ation approaches that can be used:
Market approach;
Cost approach;
Income approach.
Various valuation techniques are available for each approach.
3.1. Market approach
This approach uses market data to derive fair value for the asset under review.
Market data can be derived from transactions with similar or comparable assets.
Data can also be derived from current or similar markets. Due to the various
market data and the application on the asset to be valued, several methods are
available.
Analogy methods
Analogy methods observe transactions with similar assets in active
markets and try to derive a value for the asset subject to valuation from
these transactions. The challenge in applying analogy methods is to find
active markets and similar assets. Active markets are markets where the
group operates in. Similar assets mean that these assets have to have the
same characteristic and service capacity as the original asset. If observed
assets deviate from the original asset appropriate adjustments are necessary.
Analogy methods apply to assets that are traded in markets. Typical
examples of markets and assets are merger & acquisition transactions
of companies or markets for new or used machines. Analogy methods
regularly fail for self-constructed assets or assets with specific purposes.
To get better confidence, peer groups (a set of similar transactions) are
often used.
Multiples
Similarly to analogy, this method determines the value of an asset
through observation. The value of the comparable asset is transferred
to standardized values relative to key statistics to cal
cu
la
te valuation
multiples. These multiples are applied to the asset subject to estimate its
value. Multiples must have a relationship with the market. They are often
based on earnings, cash flows or other market measures like enterprise
values or price-earnings ratios. Like analogy methods, multiples face the
same challenges in identifying assets and markets.

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Matrix pricing
This is a mathematical method where the value of an asset is derived
against several benchmarks or quoted prices in the market. So a multiple
reference is used to determine the fair value. Matrix pricing is a common
method used for financial instruments (so assets and liabilities).
Direct market prices
The assets value can be taken directly from the market. Direct prices
interfere with the size of the market. Also, the volume of an assets trade
in the market, compared to the volume of the asset subject to valuation,
has to be considered. This is important in the case of assumed bulk sales
of the asset: such transactions have the ability to change the observed
market price. Direct market prices are often applied to financial assets and
liabilities, such as securities.
3.2. Cost approach
This approach focuses on the asset itself and reflects the amount required
to replace the asset in its current condition. Replacing an asset can occur in two
ways: either by replacing the asset through a substitute (a product that is available in the market) or by rebuilding the asset. Appropriate valuation methods are
available for both ways.
Replacement costs
The replacement cost method assumes that the asset can be replaced
by a substitute, so an asset with the same characteristics as the original
one. The substitute has to have the same service capacity as the original
asset. Replacement costs might be adjusted by obsolescence if necessary.
Obsolescence comprises physical deterioration, technological and econ
omic obsolescence.
Reproduction costs
The reproduction cost method assumes that the asset in its current
condition is built up right from scratch. Any improvements to the product
due to new standards, production processes and similar issues are not
considered. The method uses historical costs that are indexed to adjust
historical costs to current conditions. This adjustment has to consider all
costs incurred: labour costs, materials as well as an appropriate overhead
portion.
3.3.Income approach
This approach is based on the ability of an asset to generate future cash flows or
profits. The amount determined reflects the market expectation of the fair value of
these future cash flows. Applying the income approach demands an application
of discounted cash flow models and consequently an estimation of discount rates
(e.g. by using weighted average costs of capital based on capital asset pricing models), planning data of future cash flows the asset will generate, market parameters

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like inflation and market growth rates and tax effects. In particular, planning data
is important as this data reflects the underlying business. Therefore, management
accounting is involved in preparing the data by considering pricing and volume
of products and services, cost structures related to the asset and the product portfolio, so the mix of products and services expected to be sold or delivered.
As future cash flows depend on the underlying assets and its character, a set
of measurement methods is available:
Option pricing models
These models are mathematical methods which determine the fair
value of an equity option by considering various market metrics. The
most known models are the Black-Scholes model and the binominal
model proposed by Cox, Ross and Rubinstein. Option pricing models are
applicable for financial assets.
Direct cash flows
These methods apply only if an asset has the ability to generate
measureable cash flows. These cash flows might be subject to adjustments
as appropriate before discounting to determine the value of the asset.
Incremental cash flows (ICF)
The incremental cash flow method compares the cash flows of the
company carrying the asset with a fictitious company with similar cash
flows but without the asset. The difference between both cash flows
represents the cash flow attributable to the asset.
Incremental cash flows are popular not only for determining the value
of an asset but also for determining the consequences of management
decisions, the profitability of projects and investments. The method usually
ignores any sunk cost and overhead costs but considers opportunity costs,
side effects and changes in net-working capital.
Comparative income differential method (CIDM)
Similar to incremental cash flows, this method estimates the income
differential of an asset between its utilization and its absence. Applying
this method requires appropriate knowledge about the assets and its use
and utilization. The more complex an asset is the more effects require
attention. Typical effects are cost savings, interactions with other assets
and revenue impacts.
Multi-period excess earnings method (MEEM)
This method estimates the fair value based on expected future
economic earnings that is generated by a business unit or a group of assets.
The method is the preferred choice if cash flows generated by an asset
cannot be reliably directly measured. To determine the fair value of an
asset, charges for all other assets involved are deducted from cash flows of
the business unit or group of assets. The residual cash flow then represents
the cash flow assigned to the asset which will be discounted to arrive at the
value of the asset.

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Relief from royalty method (RFR)

The relief from royalty method is a measurement method based on
savings of license payments to third parties. RFR is usually applied to
intangible assets that are legally protected. It assumes that these protected
intangible assets (e.g. patents, trademarks or similar rights) could be
licensed in an arms-length transaction from an unrelated party at a royalty
rate that represents market conditions. The fees to be paid to ensure access
and use to these rights are the basis. The associated cash flows will be
discounted to arrive at the fair value of the asset.
The challenge of this method is the determination of the appropriate
royalty rate to be paid. Therefore, actual licensing agreements of the same
or similar assets are the best references to be used. Either single agreements
or a pool of agreements act as a benchmark. This requires a database
research for identifying actual licensing agreements that match the assets
subject to valuation. Appropriate adjustments to the royalty rate are
necessary to align the licensing agreement to the asset if a perfect fit is not
given. Typical reasons for adjustments are industry specific application,
technology, remaining useful lives, exclusivity of the asset and other
aspects.
4. Measurement techniques for selected assets and
liabilities
The following table provides an overview of measurement techniques that are
available for or can be applied to selected assets and liabilities.
Item

Primary
category

Alternate
category

Applicable
measurement
methods

Comments

Assembled workforce

Cost

Income

Multi-periodexcess-earnings
method

One charge of
the model

Capitalized intangible
assets
Copyrights
Customer relationships,
non-contractual

Cost
Income
Income

Market
Market

Distribution networks
Franchise rights
In process research &
development
Inventory
Management
information software
Non-compete agreements
Orders

Cost
Income
Cost

Income
Market

Income
Cost
Income
Income

Discount due to
ageing!
Multi-periodexcess-earnings
method

Market
CIDM

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Item

Primary
category

Alternate
category

Other rights
Patents

Income
Income

Market
Market

Product software
Self-constructed and
used non-current assets
(fixed assets)
(Tax amortization
benefits)

Income
Cost

Market

Trademarks, trade names

and brands

Income

Applicable
measurement
methods

759

Comments

Relief from royalty method

Replacement
costs, Indexing

Income
Market

Multi-periodOne charge of
excess-earnings the model
method
Relief from royalty method,
Incremental cash
flow method

Tab. N3 Measurement methods for selected assets and liabilities