International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  are not related parties, the standard does allow the price in a related party transaction

  to be used as an input in a fair value measurement provided the entity has evidence the

  transaction was entered into at market terms. [IFRS 13.BC57].

  Market participants in the principal (or most advantageous) market should have sufficient

  knowledge about the asset or liability for which they are transacting. The appropriate

  level of knowledge does not necessarily need to come from publicly available information,

  but could be obtained in the course of a normal due diligence process.

  When determining potential market participants, certain characteristics should be

  considered. These include the legal capability and the operating and financial capacity

  to purchase the asset or assume the liability. Market participants must have both the

  willingness and the ability to transact for the item being measured. For example, when

  measuring the fair value less costs of disposal of a cash-generating unit (CGU), as part of

  testing the CGU for impairment in accordance with IAS 36, the market participants

  considered in the analysis should be in both a financial and operating position to

  purchase the CGU.

  7.2

  Market participant assumptions

  IFRS 13 specifies that fair value is not the value specific to one entity, but rather is meant

  to be a market-based measurement. If market participants would consider adjustments

  for the inherent risk of the asset or liability, or consider the risk in the valuation

  technique used to measure fair value, then such risk adjustments should be considered

  in the fair value assumptions. For example, when measuring the fair value of certain

  financial instruments, market participants may include adjustments for liquidity,

  uncertainty and/or non-performance risk.

  Fair value is not the value specific to the reporting entity and it is not the specific value to

  one market participant whose risk assessment or specific synergies may differ from other

  market participants. The reporting entity should consider those factors that market

  participants, in general, would consider. Fair value should not be measured based on a

  single market participant’s assumptions or their specific intent or use of the asset or liability.

  To illustrate, assume a single market participant, Market Participant A, is willing to pay a

  higher price for an asset than the remaining market participants, due to specific synergies

  that only Market Participant A could achieve. In such a situation, fair value would not be

  the price that Market Participant A would be willing to pay for the asset. Instead, fair value

  would be the price that typical market participants would pay for the asset.

  The underlying assumptions used in a fair value measurement are driven by the

  characteristics of the market participants that would transact for the item being

  measured and the factors those market participants would consider when pricing the

  asset or liability. Importantly, IFRS 13 notes that fair value should be based on

  assumptions that market participants acting in their ‘economic best interest’ would use

  when pricing an asset or liability. [IFRS 13.22]. That is, market participants are assumed to

  transact in a manner that is consistent with the objective of maximising the value of their

  business, their net assets or profits. In certain instances, this may result in market

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  participants considering premiums or discounts (e.g. control premiums or discounts for

  lack of marketability) when determining the price at which they would transact for a

  particular asset or liability (see 15.2 below for additional discussion on the consideration

  of premiums and discounts in a fair value measurement).

  In situations where market observable data is not available, the reporting entity can use

  its own data as a basis for its assumptions. However, adjustments should be made to the

  entity’s own data if readily available market data indicates that market participant

  assumptions would differ from the assumptions specific to that reporting entity (see 19

  below for further discussion regarding Level 3 inputs).

  The intended use and risk assumptions for an asset or asset group may differ among

  market participants transacting in the principal market for the asset. For example, the

  principal market in which the reporting entity would transact may contain both strategic

  and financial buyers. Both types of buyers would be considered in determining the

  characteristics of market participants; however, the fair value measurement of an asset

  may differ among these two types of market participants. The following example from

  the standard illustrates this point. [IFRS 13.IE3-6].

  Example 14.8: Asset group

  An entity acquires assets and assumes liabilities in a business combination. One of the groups of assets

  acquired comprises Assets A, B and C. Asset C is billing software integral to the business developed by the

  acquired entity for its own use in conjunction with Assets A and B (i.e. the related assets). The entity measures

  the fair value of each of the assets individually, consistently with the specified unit of account for the assets.

  The entity determines that the highest and best use of the assets is their current use and that each asset would

  provide maximum value to market participants principally through its use in combination with other assets

  or with other assets and liabilities (i.e. its complementary assets and the associated liabilities). There is no

  evidence to suggest that the current use of the assets is not their highest and best use.

  In this situation, the entity would sell the assets in the market in which it initially acquired the assets (i.e. the

  entry and exit markets from the perspective of the entity are the same). Market participant buyers with whom

  the entity would enter into a transaction in that market have characteristics that are generally representative

  of both strategic buyers (such as competitors) and financial buyers (such as private equity or venture capital

  firms that do not have complementary investments) and include those buyers that initially bid for the assets.

  Although market participant buyers might be broadly classified as strategic or financial buyers, in many cases

  there will be differences among the market participant buyers within each of those groups, reflecting, for

  example, different uses for an asset and different operating strategies.

  As discussed below, differences between the indicated fair values of the individual assets relate principally

  to the use of the assets by those market participants within different asset groups:

  (a) Strategic buyer asset group – The entity determines that strategic buyers have related assets that would

  enhance the value of the group within which the assets would be used (i.e. market participant synergies).

  Those assets include a substitute asset for Asset C (the billing software), which would be used for only

  a limited transition period and could not be sold on its own at the end of that period. Because strategic

  buyers have substitute assets, Asset C would not be used for its full remaining economic life. The

  indicated fair values of Assets A, B and C within the strategic buyer asset group (reflecting the synergies

  resulting from the use of the assets within that group) are CU 360, CU 260 and CU 30, respectively. T
he

  indicated fair value of the assets as a group within the strategic buyer asset group is CU 650.

  (b) Financial buyer asset group – The entity determines that financial buyers do not have related or substitute

  assets that would enhance the value of the group within which the assets would be used. Because

  financial buyers do not have substitute assets, Asset C (i.e. the billing software) would be used for its

  full remaining economic life. The indicated fair values of Assets A, B and C within the financial buyer

  asset group are CU 300, CU 200 and CU 100, respectively. The indicated fair value of the assets as a

  group within the financial buyer asset group is CU 600.

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  The fair values of Assets A, B and C would be determined on the basis of the use of the assets as a group

  within the strategic buyer group (CU 360, CU 260 and CU 30). Although the use of the assets within the

  strategic buyer group does not maximise the fair value of each of the assets individually, it maximises the fair

  value of the assets as a group (CU 650).

  The example above illustrates that the principal (or most advantageous) market for an

  asset group may include different types of market participants (e.g. strategic and

  financial buyers), who would make different assumptions in pricing the assets.

  When there are two or more different types of market participants that would transact

  for the asset, or the asset group, separate fair value estimates of the assets should

  generally be performed for each type of market participant in order to identify which

  type of market participant (and the appropriate related assumptions) should be

  considered in the fair value measurement.

  In each of these analyses, the intended use of the asset and any resulting market

  participant synergies are considered. These include synergies among the assets in the

  asset grouping and synergies in combination with other assets held by (or available to)

  market participants generally. The selection of the appropriate market participants is

  based on the type of market participants that generate the maximum value for the asset

  group, in aggregate.

  This is illustrated in Example 14.8. Fair value would be measured by reference to

  assumptions made by the Strategic Buyer because the fair value of the group of assets

  (CU 650) exceeds that of the Financial Buyer (CU 600). Consequently, the fair value of

  the individual assets within the asset grouping would be estimated based on the

  indicated values related to the market participants with the highest overall value for the

  asset grouping. In other words, once the assets are appropriately grouped based on their

  valuation premise, they should be valued using a consistent set of assumptions (i.e. the

  assumptions for the same type of market participants and the same related use). As

  shown in the example, this is true even though the fair value measurement of a specific

  asset, Asset C in the example, is deemed to be higher for the Financial Buyer.

  Example 14.8 above also highlights the interdependence between the key concepts

  within the IFRS 13 fair value framework. Understanding the interrelationships between

  market participants, exit market and the concepts of valuation premise and highest and

  best use is important when measuring the fair value of non-financial assets (the concepts

  of ‘valuation premise’ and ‘highest and best use’ are discussed at 10 below).

  In the example, the indicated value for the assets as a group is determined based on the

  valuation premise (i.e. their use in combination with other assets) and market participant

  assumptions that would maximise the value of the asset group as a whole (i.e.

  assumptions consistent with strategic buyers). The valuation premise for Assets A, B and

  C is based on their use in combination with each other (or with other related assets and

  liabilities held by or available to market participants), consistent with the highest and

  best use of these assets.

  The example also highlights the distinction between the unit of account (i.e. what is

  being measured and presented for financial reporting purposes) and the valuation

  premise, which forms the basis of how assets are grouped for valuation purposes (i.e. as

  a group or on a stand-alone basis). The unit of account may be the individual assets

  (i.e. Asset A, separate from Asset B and Asset C), but the valuation premise is the asset

  Fair value measurement 973

  group comprised of Assets A, B and C. Therefore, the indicated value of the assets in

  combination (CU 650) must be attributed to the assets based on their unit of account,

  resulting in the fair value measurement to be used for financial reporting purposes.

  8 THE

  TRANSACTION

  As at the measurement date, the transaction to sell an asset or transfer a liability is, by

  definition, a hypothetical transaction for the particular asset or liability being measured

  at fair value. If the asset had actually been sold or the liability actually transferred as at

  the measurement date, there would be no asset or liability for the reporting entity to

  measure at fair value.

  IFRS 13 assumes this hypothetical transaction will take place in the principal (or most

  advantageous) market (see 6 above) and will:

  • be orderly in nature;

  • take place between market participants that are independent of each other, but

  knowledgeable about the asset or liability (see 7 above for additional discussion on

  market participants);

  • take place under current market conditions; and

  • occur on the measurement date. [IFRS 13.15].

  These assumptions are critical in ensuring that the estimated exit price in the

  hypothetical transaction is consistent with the objective of a fair value measurement.

  For example, the concept of an orderly transaction is intended to distinguish a fair value

  measurement from the exit price in a distressed sale or forced liquidation. Unlike a

  forced liquidation, an orderly transaction assumes that the asset or liability is exposed

  to the market prior to the measurement date for a period that is usual and customary to

  allow for information dissemination and marketing. That is, the hypothetical transaction

  assumes that market participants have sufficient knowledge and awareness of the asset

  or liability, including that which would be obtained through customary due diligence

  even if, in actuality, this process may not have begun yet (or may never occur at all, if

  the entity does not sell the asset or transfer the liability).

  The hypothetical transaction between market participants does not consider whether

  management actually intends to sell the asset or transfer the liability at the measurement

  date; nor does it consider the reporting entity’s ability to enter into the transaction on

  the measurement date. [IFRS 13.20]. To illustrate, consider a hypothetical transaction to

  sell a security that, due to a restriction, cannot be sold as at the measurement date.

  Although the restriction may affect the measurement of fair value, it does not preclude

  the entity from assuming a hypothetical transaction to sell the security (see 5 above for

  further discussion on restrictions).

  An orderly transaction assumes there will be adequate market exposure, so that market

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sp; participants would be sufficiently knowledgeable about the asset or liability. This does

  not mean the hypothetical exchange takes place at some point in the future. A fair value

  measurement considers market conditions as they exist at the measurement date and is

  intended to represent the current value of the asset or liability, not the potential value

  of the asset or liability at some future date. The transaction is therefore assumed to take

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  14

  place on the measurement date and the entity assumes that the marketing activities and

  due diligence activities have already been performed. For example, assume an entity is

  required to re-measure an asset to fair value at its reporting date of 31 December 2018.

  The customary marketing activities and due diligence procedures required for the asset

  to be sold take six months. The asset’s fair value should not be based on the price the

  entity expects to receive for the asset in June 2019. Instead, it must be determined based

  on the price that would be received if the asset were sold on 31 December 2018,

  assuming adequate market exposure had already taken place.

  Although a fair value measurement contemplates a price in an assumed transaction,

  pricing information from actual transactions for identical or similar assets and liabilities

  is considered in measuring fair value. IFRS 13 establishes a fair value hierarchy

  (discussed at 16 below) to prioritise the inputs used to measure fair value, based on the

  relative observability of those inputs. The standard requires that valuation techniques

  maximise the use of observable inputs and minimise the use of unobservable inputs. As

  such, even in situations where the market for a particular asset is deemed to be inactive

  (e.g. due to liquidity issues), relevant prices or inputs from this market should still be

  considered in the measurement of fair value. It would not be appropriate for an entity

  to default solely to a model’s value based on unobservable inputs (a Level 3

  measurement), when Level 2 information is available. Judgement is required in assessing

  the relevance of observable market data to determine the priority of inputs under the

  fair value hierarchy, particularly in situations where there has been a significant