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IFRS 13- FAIR VALUE MEASUREMENT

Introduction
IASB has adopted a fair value method to measure assets and liabilities in its IFRS accounting
standards because the historic cost convention was not consistent with the underlying qualitative
characteristic of relevance. The issue was that there was no definition of what fair value actually
was, until IFRS 13 was created. IFRS 13 does not apply to share based payment transactions
within the scope of IFRS 2. Measurements such as net realisable value (IAS 2 Inventories) or value
in use (IAS 36 Impairment of Assets) have some similarities to fair value but are not fair value and
are outside of the scope of IFRS 13.
IFRS 13 states how to recognise fair value and not when to measure fair value.
Fair value – 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 is also
known as the exit price.
Measurement Date: this is the date that transactions took place between market participants.
This definition emphasises that fair value is a market-based measurement, not an entity-
specific measurement i.e. it takes market conditions into consideration. In other words, if two
entities hold identical assets these assets (all other things being equal) should have the same fair
value and this is not affected by how each entity uses the asset or how each entity intends to use
the asset in the future.
An entity must use the assumptions that market participants would use when pricing the asset or
liability under current market conditions when measuring fair value.
In measuring fair value, the entity must determine the following:
Asset or Liability subject to fair value measurement which must be determined consistently
with its unit of account.
There is the need to determine whether there is the valuation of assets or liabilities on their stand-
alone values or a group of assets and liabilities. Unit of account is the level at which an asset or
liability is aggregated or disaggregated. IFRS 13 also requires that the characteristics of an asset
or liability when setting the fair value mainly the condition and location of the asset and the
restriction on the sale of the asset or the transfer of the liability.
For a non-financial asset, the valuation premise is the highest and best use of the asset.
In determining the highest and best use of an asset, the entity needs to take into consideration the
physical possibility of the use of the asset (location or size), legal permissibility and financial
feasibility.
For a financial liability or entity’s own financial instruments, the general principle is that the entity
should assume transfer and not settlement of liability/own equity instrument.
To get the value to use for liability/own equity instrument use the quoted price, if not, the entity
has to value the liability/own equity instrument using the corresponding value of a financial asset
held by another entity, and if this isn’t the case, the entity has to use a valuation technique to
determine the fair value.
IFRS 13 states that the fair value of an asset or liability at initial recognition is the exit price. In
most cases, the entry price (transaction price) is equal to the exit price. However, there are
instances where the transaction price will not be equal to the exit price:
i. The transaction is between related parties
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Principal Market: This is where the greatest volume and level of activity for an asset takes place
in an orderly transaction. Under this market, the fair value of an asset is the amount that will be
received from the sale of the asset less its transport cost. Transactions costs are ignored as they are
not a characteristics of the asset.
Transaction Costs: these are the costs incurred in acquiring an asset or in settling a liability e.g.
agent fee, commission, brokers fee and charges, legal fees, etc.
Most Advantageous Market: this is the market that maximizes the net amount that will be
received to sell an asset. That is the selling price of an asset less its transaction costs and transport
costs. Although the transaction cost is taken into consideration in determining the most
advantageous market, it will still be ignored in determining the fair value of the asset.
IFRS 13 states that when determining the fair value, an entity should use the assumptions a market
participant would use when pricing the asset or liability and they must in their best economic
interest.
Market Participants are independent buyers and sellers who are well informed, willing and able
to enter into business transactions. The following are their characteristics:
i. They must be independent of each other and means they are not related parties in accordance
with 1AS 24.
ii. They must be knowledgeable
iii. They must be able to enter into transactions for the asset or liability
iv. They must be willing to enter into the transaction and not forced.
Prices must be based on the orderly transactions and this occurs when two key components are
present:
a) There is adequate market exposure in order to provide market participants the ability to obtain
knowledge and awareness of the asset or liability necessary for the exchange.
b) Market participants are willing and motivated to carry out the activity and not forced to do so.

➢ Valuation techniques.
The objective of using a valuation technique is to estimate the price at which an orderly transaction
to sell the asset (or to transfer the liability) would take place between market participants at the
measurement date under current market conditions.

IFRS 13 requires that one of three valuation techniques must be used and the appropriate
techniques must maximise the use of relevant observable inputs and minimise the use of
unobservable inputs.
• market approach – uses prices and other relevant information from market transactions involving
identical or similar assets and liabilities. There could be the use of market multiples such as
EBITDA or Revenue or the use of matrix pricing which is a mathematical approach used
principally to value some type of financial instruments.
• cost approach – the amount required to replace the service capacity of an asset (also known as
the current replacement cost). This is used often for non-financial assets. In using this approach,
obsolescence of the asset into consideration because the price to sell the asset depends on the price
someone is willing to buy the asset.
• income approach – converts future amounts (cash flows, profits) to single current (discounted)
amount. The fair value measurement includes current market expectations of those future amounts.
E.g. present value techniques, option pricing models, multi-period excess earnings method.
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An entity must use a valuation technique that is appropriate in the circumstances and for which
sufficient data is available to measure fair value, maximising the use of relevant observable inputs
and minimising the use of unobservable inputs.
A valuation technique should be used to maximise the use of relevant observable inputs and
minimise the use of unobservable inputs.

Quoted price in an active market provides the most reliable evidence of fair value and must be
used to measure fair value whenever available.

Bid /Offer prices

For some assets (liabilities) markets quote prices that differ depending on whether the asset is
being sold to or bought from the market.

The price at which an asset can be sold to the market is called the bid price (it is the amount the
market bids for the asset). IFRS 13 adopts a hierarchical approach to measuring fair value, whilst
giving consideration to the principal market, being the largest market in which an asset/liability is
traded. It also considers the highest and best use of an asset.

The price within the bid-ask spread that is most representative of fair value in the circumstances
must be used to measure fair value. Previously, bid price had to be used for financial assets and
ask price for financial liabilities but this is no longer the case.

Level 1 inputs
Level 1 inputs are quoted prices (unadjusted for some risk premium or discounts) in active markets
(frequency and volume) for identical assets or liabilities that the entity can access at the
measurement date.
A quoted market price in an active market provides the most reliable evidence of fair value and is
used without adjustment to measure fair value whenever available, with limited exceptions.

Level 2 inputs
Level 2 inputs are inputs other than quoted market prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly.
Level 2 inputs include:
 quoted prices for similar assets or liabilities in active markets
 quoted prices for identical or similar assets or liabilities in markets that are not active
 inputs other than quoted prices that are observable for the asset or liability, for example
interest rates and yield curves observable at commonly quoted intervals
Level 3 inputs
Level 3 inputs are unobservable inputs for the asset or liability and covers the scenarios whereby
there is little, if any, market activity.
An entity develops unobservable inputs using the best information available in the circumstances,
which might include the entity's own data, taking into account all information about market
participant assumptions that is reasonably available.
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PRACTICE QUESTIONS

QUESTION 1
a. Mehran, a public limited company, has just acquired a company, which comprises a farming
and mining business. Mehran wishes advice on how to fair value some of the assets acquired. One
such asset is a piece of land, which is currently used for farming. The fair value of the land if used
for farming is $5 million. If the land is used for farming purposes, a tax credit currently arises
annually, which is based upon the lower of 15% of the fair market value of land or $500,000 at the
current tax rate. The current tax rate in the jurisdiction is 20%. Mehran has determined that market
participants would consider that the land could have an alternative use for residential purposes.
The fair value of the land for residential purposes before associated costs is thought to be $7·4
million. In order to transform the land from farming to residential use, there would be legal costs
of $200,000, a viability analysis cost of $300,000 and costs of demolition of the farm buildings of
$100,000. Additionally, permission for residential use has not been formally given by the legal
authority and because of this, market participants have indicated that the fair value of the land,
after the above costs, would be discounted by 20% because of the risk of not obtaining planning
permission. In addition, Mehran has acquired the brand name associated with the produce from
the farm. Mehran has decided to discontinue the brand on the assumption that it will gain increased
revenues from its own brands. Mehran has determined that if it ceases to use the brand, then the
indirect benefits will be $20 million. If it continues to use the brand, then the direct benefit will be
$17 million.

b. Mehran wishes to fair value the inventory of the entity acquired. There are three different
markets for the produce, which are mainly vegetables. The first is the local domestic market where
Mehran can sell direct to retailers of the produce. The second domestic market is one where
Mehran sells directly to manufacturers of canned vegetables. There are no restrictions on the sale
of produce in either of the domestic markets other than the demand of the retailers and
manufacturers. The final market is the export market but the government limits the amount of
produce which can be exported. Mehran needs a licence from the government to export its produce.
Farmers tend to sell all of the produce that they can in the export market and, when they do not
have any further authorisation to export, they sell the remaining produce in the two domestic
markets. It is difficult to obtain information on the volume of trade in the domestic market where
the produce is sold locally direct to retailers but Mehran feels that the market is at least as large as
the domestic market – direct to manufacturers. The volumes of sales quoted below have been taken
from trade journals.
Domestic market – Domestic market – Export market
direct to retailers direct to manufacturers
Volume – annual Unknown 20,000 tonnes 10,000 tonnes
Mehran – sales per month 10 tonnes 4 tonnes 60 tonnes
Price per tonne $1,000 $800 $1,200
Transport costs per tonne $50 $70 $100
Selling agents’ fees per tonne – $4 $6
c. Mehran owns a non-controlling equity interest in Erham, a private company, and wishes to fair
value it as at its financial year end of 31 March 2016. Mehran acquired the ordinary share interest
in Erham on 1 April 2014. During the current financial year, Erham has issued further equity
capital through the issue of preferred shares to a venture capital fund. As a result of the preferred
share issue, the venture capital fund now holds a controlling interest in Erham. The terms of the
preferred shares, including the voting rights, are similar to those of the ordinary shares, except that
the preferred shares have a cumulative fixed dividend entitlement for a period of four years and
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the preferred shares rank ahead of the ordinary shares upon the liquidation of Erham. The
transaction price for the preferred shares was $15 per share. Mehran wishes to know the factors
which should be taken into account in measuring the fair value of their holding in the ordinary
shares of Erham at 31 March 2016 using a market-based approach.

QUESTION 2
a. Prior to the advent of IFRS 13, many standards such as IAS 16, IAS 38, IAS 40 and IAS 39
among others require the use of fair value. These various requirements have been harmonised with
the introduction of IFRS 13 Fair Value Measurement.
Required: Define fair value in accordance with IFRS 13.

b. One of the companies formally operating in Nigeria that had recently relocated its operation to
Ghana as a result of the challenging business environment in Nigeria has access to both Lagos and
Accra market for its product. The product sells at slightly different prices (in naira) in the two
active markets. An entity enters into transactions in both markets and can access the price in those
markets for the product at the measurement date as follows:

Lagos Market (N’000) Accra Market (N’000)

Sale price 260 250
Transaction cost (30) (10)
Transport cost (20) (20)
Net price received 210 220

Required
i. Briefly explain the principal market of an asset in accordance with IFRS 13 and determine
what fair value would be used to measure the sale of the above product if the Lagos market
were the principal market?
ii. How is fair value determined in the absence of a principal market and what fair value would
be used to measure the sale of the above product if no principal market could be identified?

c. Megida Plc, a public limited liability company, has just acquired some hectares of land in Abuja
earmarked by government for economic empowerment program of citizens given the harsh
economic environment in Nigeria and so is only meant for commercial purposes. The fair value of
the land if used for commercial purpose is N100million. If the land is used for commercial purpose
it is expected that it will result in reducing unemployment. This will attract a tax credit annually,
which is based upon the lower of 15% of the fair market value of the land or N10,000,000 at the
current tax rate. The current tax rate as fixed by the government is 20%. Megida Plc has determined
that given the nature of Abuja’s land, market participants would consider that it could have an
alternative use for residential purposes. The fair value of the land Megida Plc has just acquired for
residential purposes before associated costs is estimated to be N148 million. In order to transform
the land from its commercial purposes to residential use, there is estimated legal costs of
N4,000,000, a project viability analysis cost of N6,000,000 and costs of demolition of the
commercial buildings of N2,000,000. In addition, permission for residential use has not been
formally given by Abuja Municipal Authority. This has created uncertainty in the minds of market
participants. Consequently, the market participants have indicated that the fair value of the land,
after the above costs, would be discounted by 20% because of the risk of not obtaining the planning
permission from Abuja Municipal Authority.

Required: Discuss the way in which Megida Plc should compute the fair value of the Abuja
land with reference to the principles of IFRS 13 Fair Value Measurement.
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QUESTION 3
Brainfield has an asset that can be sold in two different active markets at different process. It enters
into transactions in both markets and obtains the following prices at the measurement date:
i. The selling price of the asset was #40m in Market A and #38m in Market B.
ii. The legal fees incurred were #2m and #1.8m in Market A and B respectively.
iii. The valuation fees were #3.5m and #1m respectively.
iv. The costs of delivering the assets to the market were #4m and #3m.

Determine:
a. Market A is the principal market
b. Neither Market is a principal market.

QUESTION 4
a. Yanong owns several farms and also owns a division which sells agricultural vehicles. It is
considering selling this agricultural retail division and wishes to measure the fair value of the
inventory of vehicles for the purpose of the sale. Three markets currently exist for the vehicles.
Yanong has transacted regularly in all three markets. At 30 April 2015, Yanong wishes to find the
fair value of 150 new vehicles, which are identical. The current volume and prices in the three
markets are as follows:

Market Sales price per vehicle Volume sales in market Volume sold (Yanong)
Europe 40,000 150,000 6,000
Asia 38,000 750,000 2,500
Africa 34,000 100,000 1,500
Transaction cost per vehicle Transport cost to market per vehicle
500 400
400 700
300 600
Yanong wishes to value the vehicles at $39,100 per vehicle as these are the highest net proceeds
per vehicle and Europe is the largest market for Yanong’s product.

Required: Yanong would like advice as to whether this valuation would be acceptable under
IFRS 13 Fair Value Measurement.

b. Yanong uses the revaluation model for its non-current assets. Yanong has several plots of
farmland which are unproductive. The company feels that the land would have more value if it
were used for residential purposes. There are several potential purchasers for the land but planning
permission has not yet been granted for use of the land for residential purposes. However,
preliminary enquiries with the regulatory authorities seem to indicate that planning permission
may be granted. Additionally, the government has recently indicated that more agricultural land
should be used for residential purposes. Yanong has also been approached to sell the land for
commercial development at a higher price than that for residential purposes.
Required: Yanong would like advice on how to measure the fair value of the land in its
financial statements.

c. Luploid Co acquired 80% of the five million equity shares ($1 each) of Colyson Co on 1 July
20X4 for cash of $90 million. The fair value of the non‐controlling interest (NCI) at acquisition
was $22 million. The fair value of the identifiable net assets at acquisition was $65 million,
excluding the following asset. Colyson Co purchased a factory site several years prior to the date
of acquisition. Land and property prices in the area had increased significantly in the years
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immediately prior to 1 July 20X4. Nearby sites had been acquired and converted into residential
use. It is felt that, should the Colyson Co site also be converted into residential use, the factory site
would have a market value of $24 million. $1 million of costs are estimated to be required to
demolish the factory and to obtain planning permission for the conversion. Colyson Co was not
intending to convert the site at the acquisition date and had not sought planning permission at that
date. The depreciated replacement cost of the factory at 1 July 20X4 has been correctly calculated
as $17.4 million.

Required: How the fair value of the factory site should be determined at 1 July 20X4 and
why the depreciated replacement cost of $17.4 million is unlikely to be a reasonable estimate
of fair value.