#TaxmannPPT | Ind AS 113 – Fair Value Measurement

Ind AS 113 Fair Value Measurement

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Ind AS 113 Fair Value Measurement

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Ind AS 113 Fair Value Measurement

Agenda ► ► ► ► ► ► ► ► ► ► ► ► ► ►

Objective Scope Definition Unit of account Valuation premise Characteristic of asset/liability Transportation costs treatment Highest and Best use Principal market and most advantageous market Liquidity Orderly and dis-orderly transactions Valuation techniques Fair value hierarchy Disclosures

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Ind AS 113 Fair Value Measurement

Objective

►

To determine Fair Value

►

To set out single source of guidance and improved consistency for measuring Fair Value

►

To require disclosures with respect to fair value measurements

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Ind AS 113 Fair Value Measurement

Scope

►

Applies when another Ind AS requires or permits: ►

Fair value measurement (asset or liability, both financial and non-financial) or;

►

disclosures about fair value measurements

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Ind AS 113 Fair Value Measurement

Other Ind AS requiring Fair Value ►

►

Business combinations (Ind AS 103) ► Assets acquired and liabilities assumed ► Contingent consideration ► Non-controlling interests in an acquiree ► Previously held interest Financial instruments: Recognition and measurement (Ind AS 109) ► Assets/liabilities eligible for FV option ► Derivatives ► Hybrid financial instruments ► Financial guarantee contracts Page 7

Ind AS 113 Fair Value Measurement

Other Ind AS requiring Fair Value Contd. ► ► ► ► ► ► ► ► ► ► ►

Employee benefits- post-employment benefit obligations (Ind AS 19) Intangible assets- revaluation model (Ind AS 38) Investments in associates and JV held by mutual funds and similar entities (Ind AS 28) PP&E—revaluation model and exchange of assets (Ind AS 16) NCA held for sale & discontinued operations (Ind AS 105) Investment property (Ind AS 40) Biological assets- Agriculture (Ind AS 41) Impairment of assets- (Ind AS 36) Revenue (Ind AS 115) CFS & SFS- investments in subsy by investment entities (Ind AS 27) Government Grants- Non-monetary government grants (Ind AS 20)

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Ind AS 113 Fair Value Measurement

Scope exclusions ►

►

Excludes both measurement and disclosures: ►

Ind AS 102 Share-based Payment

►

Ind AS 116 Leases

►

Similar terms (such as ‘net realisable value’ in Ind AS 2 Inventory or ‘value in use’ in Ind AS 36 Impairment of Assets)

Excludes disclosures only: ►

Employee benefit plan assets under Ind AS19 Employee Benefits

►

Recoverable amount (based on fair value less costs of disposal) under Ind AS 36 Impairment of Assets

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Ind AS 113 Fair Value Measurement

Definition - Fair value The price ► that would be received to sell an asset or ► paid to transfer a liability ► in

an orderly transaction

► between ► at

market participants

the measurement date.

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Ind AS 113 Fair Value Measurement

Definition - Understanding ►

Fair value is the Exit price

►

It is an orderly transaction i.e. based on marketing activities that are usual and customary for transactions and are not distress/ liquidation/ forced sale.

►

It is based on perspective of market participants who are knowledgeable, independent, able and willing to do transaction i.e. it is not entity specific

►

It is the current value of the asset or liability at the measurement date and not its potential value at some future date.

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Ind AS 113 Fair Value Measurement

Definition - Understanding Perspective of market participants means ►

An entity shall measure the fair value of an asset or a liability using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their best economic interest.

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Ind AS 113 Fair Value Measurement

Determining the Fair Value

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Ind AS 113 Fair Value Measurement

Steps in application of Ind AS 113

Identify unit of account ► Assess valuation premise ► Identify the market for basis of valuation ► Apply the appropriate valuation technique(s) ► Determine Fair Value ► Do appropriate disclosures ►

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Ind AS 113 Fair Value Measurement

Unit of account ►

►

►

Defines what is being measured and recognised for financial reporting purposes (level of aggregation or disaggregation) for presentation and disclosure purposes Is generally determined in accordance with the Ind AS that requires or permits the fair value measurement in the first place Requires to measure FV basis on (P*Q) for asset or liability Page 15

Ind AS 113 Fair Value Measurement

Unit of account - examples ►

Stand alone asset or liability ► ► ►

►

Share in Public Co. A derivative Instrument An outstanding loan

Group of related asset and/or liabilities ► ► ►

Portfolio of receivables Portfolio of deposits A cash generating unit

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Ind AS 113 Fair Value Measurement

Unit of account: question An entity holds a large position in a company that is traded in an active market. If the entity sells its entire holding in a single transaction, the market’s normal daily trading volume would not be sufficient to absorb the quantity held. That single transaction would affect the quoted price and result in the entity receiving a lower selling price.

Should the entity adjust the fair value of that asset to reflect this? ►

►

Since there is an active market, the fair value of the asset or liability should continue to be measured as the product of the quoted price and the quantity held (P x Q).

The same applies to a liability or a position comprising a large number of identical assets or liabilities, such as a holding of financial instruments, that are traded in an active market.

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Ind AS 113 Fair Value Measurement

Valuation premise ►

►

It is a valuation concept that addresses how a non-financial asset derives its maximum value to market participants, either on stand-alone basis or through its use in combination with other assets and liabilities.

Asset or liability measured at fair value might be: ► A stand-alone asset or liability ► A group of assets, a group of liabilities or a group of assets and liabilities i.e. CGU assessment Page 18

Ind AS 113 Fair Value Measurement

Valuation premise Contd. ►

For example, a customised machinery purchased along with few other assets as part of operating line which are incidental to use the said machinery in manufacturing. Although the unit of account for the machinery is stand alone asset (i.e. it is accounted and presented for financial reporting purpose at individual asset level in accordance with Ind AS 16) but determination of fair value of the machinery may be derived from its use with those other assets in operating line.

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Ind AS 113 Fair Value Measurement

Characteristics of the asset or liability ►

►

Characteristics of asset or liability are considered if market participants would consider those characteristics when pricing the asset or liability at the measurement date.

Examples: Condition and location of the asset ► Restrictions on the sale or use of the asset Note: Entity-specific restrictions do not affect fair value however asset-specific restrictions do affect fair value. ►

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Ind AS 113 Fair Value Measurement

Example: restriction on the sale of an equity instrument An entity holds an equity instrument (i.e., financial asset) for which sale is contractually restricted for a specified period by limiting its transfer or sale to qualifying investors.

1. Is this restriction a characteristic of the instrument?

2. How should fair value be measured?

1.

2.

Yes, the restriction is a characteristic of the instrument and would therefore be transferred to market participants.

Fair value should be measured based on the quoted price for an otherwise identical unrestricted equity instrument of the same issuer that trades in a public market, adjusted to reflect the effect of the restriction. The adjustment would reflect the amount market participants would demand, due to risk relating to the inability to access public market for the specified period.

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Ind AS 113 Fair Value Measurement

Transportation costs to deduct or not in FV measurement? ►

►

Generally not, but yes, if and only if, the location is a characteristic of the asset or liability being measured, the FV measurement should incorporate transportation costs.

For example, suppose a Tea producing entity intends to sell its Tea by using a futures contract on the Mysore commodity exchange. The contract calls for physical delivery to the Mysore Railway Yard; therefore, because the location of the Tea is an attribute of the contract, the company should deduct the cost of physically transporting the Tea to the sale location in the calculation of FV. Page 22

Ind AS 113 Fair Value Measurement

Highest and best use for non-financial assets ►

►

► ►

Fair value considers a market participant’s ability to generate economic benefits by using the asset in its highest and best use.

Highest and best use considers a use that is: ► Physically possible ► Legally permissible ► Financially feasible Current use is presumed to be highest and best use.

Highest and best use is always considered when measuring fair value, even if the entity intends a different use.

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Ind AS 113 Fair Value Measurement

Highest and best use for non-financial assets (cont.)

Can be either:

On a stand-alone basis ► In combination with other assets and/or liabilities ►

► ►

►

Assumed the complementary assets/liabilities are available to market participants Complementary liabilities include liabilities that fund working capital, but exclude liabilities to fund assets outside the relevant group Assumptions must be consistent for all assets and/or liabilities of the relevant group

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Ind AS 113 Fair Value Measurement

Example: highest and best use Land acquired in a business combination is currently developed for industrial use as a site for a manufacturing facility. Nearby sites were recently developed for residential high-rise. It was determined that the land could be used to develop residential high-rise.

How is highest and best used determined? ►

►

In this case, the highest and best use is determined from the higher of: a) The value of the land used in the manufacturing operation b) The value of the land as a vacant site for residential use Note that transformation costs (e.g., costs to demolish the manufacturing facility) would be considered in the value of land as a vacant site.

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Ind AS 113 Fair Value Measurement

Principal market and most advantageous market ►

►

Principal market ► Market with greatest volume and level of activity for the asset or liability ► Entity must have access to the market at measurement date ► Rebuttable presumption that principal market is market in which entity normally transacts Most advantageous market (absent a principal market) ► Market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction and transport costs Page 26

Ind AS 113 Fair Value Measurement

Example ►

Suppose a Entity A, a producer of medicine X had market both in India and US. Price for the medicine is higher in US market than in India. However, Govt. restriction allows only 25% of the output to be exported.

►

Here, though the most advantageous market is the export market, as it gives the higher benefits to the producers, the domestic market is the principal market as it can handle all of the volume that producers have to sell.

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Ind AS 113 Fair Value Measurement

Principal market and most advantageous market – key points ►

►

►

Ind AS 113 does not permit the use of a price in the most advantageous market if a principal market price is available.

It is not necessary to perform an exhaustive search of all possible markets to identify the principal market or the most advantageous market. All information that is reasonably available should be considered and the basis for conclusions should be documented.

Where entity transacts in various markets it should document which particular market price is used and process followed to determine the appropriate market.

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Ind AS 113 Fair Value Measurement

Transaction costs Incremental, Direct and Essential costs i.e. Would not be incurred if no decision to sell Page 29

CONSIDERED in determining most advantageous market

Ind AS 113 Fair Value Measurement

NOT considered in Fair Value measurement

Example Particulars

Market A

Annual volume

Market B

Market C

30,000

12,000

6,000

Transactions per month

30

12

10

Price

50

48

53

Transport cost

(3)

(3)

(4)

Quoted value

47

45

49

Transaction costs

(1)

(2)

(1)

Net proceeds

46

43

48

Principal market Fair value Most advantageous market (if no principal market) Fair value Page 30

Ind AS 113 Fair Value Measurement

Market A 47 Market C 49

Liquidity ►

Ind AS 113 requires liquidity considerations to be incorporated into the valuation. ► This may be demanding and require inputs from valuation experts.

►

Liquidity is a new Ind AS concept for non-financial assets. ► Further discussion may be necessary at the IASB level on how to build liquidity into valuation of non-financial instruments.

►

You should consider the processes and procedures required to ensure liquidity risk is built into fair value measurement for non-financial assets.

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Ind AS 113 Fair Value Measurement

Example: liquidity Investor X holds a 10% investment in private company Y, classified as an FVTOCI investment under Ind AS 109. It values Y using a market multiple of recent earnings of comparable listed entity Z. Should this valuation be adjusted for: 1. Illiquidity of Y’s shares, as compared to Z? 2. The lower price X is likely to get if X sold the entire 10% investment in a single transaction, rather than if it sold its shares in Y in smaller batches?

1.

2.

X should adjust for Y’s illiquidity because this is a characteristic of Y’s shares. Y’s shares are not listed; Z’s are listed.

However, X should not adjust the valuation for the likely outcome that if it sold all of the 10% investment in a single transaction, it might receive a lower price.

This is because the unit of account in Ind AS 109 is deemed to be a single instrument. Therefore, fair value must reflect the fair value of each share in Y.

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Ind AS 113 Fair Value Measurement

Orderly and disorderly transaction ► ►

►

►

Exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary Ind AS 113 assumes: ► An orderly transaction at measurement date ► That the transaction involves market participants that are willing and motivated to transact, but not forced or compelled Unlike an orderly transaction, in a distressed transaction: ► Market participants are compelled to transact ► There is little or no exposure to the market Circumstances that may indicate a transaction is not orderly: ► Inadequate exposure to the market ► Marketed to a single market participant ► Seller in or near bankruptcy or forced regulatory or legal requirements ► Transaction price is an outlier Page 33

Ind AS 113 Fair Value Measurement

Orderly and disorderly transaction (cont.) ►

A significant decrease in volume and activity within a market does not mean that all transactions are not orderly. ► Further analysis needed to assess their relevance

►

Less weight should be placed on transactions without sufficient information to conclude whether the transaction is orderly, compared with other transactions that are known to be orderly.

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Ind AS 113 Fair Value Measurement

Example: orderly and disorderly transactions A private investor pays 25 million to purchase a rare painting at a public auction. The seller had advertised the sale of the rare painting for six months prior to the event. A total of 15 individuals placed bids on the rare painting during the public art auction. All bidders were provided with the same information and ability to view the rare painting prior to the public art auction.

Is this an orderly transaction, despite the supply and demand imbalance for the rare painting? ► What if the rare painting was marketed solely to one buyer (e.g., a particular museum)? ►

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Ind AS 113 Fair Value Measurement

Solution: orderly and disorderly transactions A private investor pays 25 million to purchase a rare painting at a public auction. The seller had advertised the sale of the rare painting for six months prior to the event. A total of 15 individuals placed bids on the rare painting during the public art auction. All bidders were provided with the same information and ability to view the rare painting prior to the public art auction. ►

Yes this is an orderly transaction.

►

Then it might not be an orderly transaction as painting was not made available in market for market participants.

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Ind AS 113 Fair Value Measurement

Active and inactive market ►

►

The determination of whether a market is active or inactive affects the extent of judgement that management can apply. ► Example:► Few recent transactions ► Price quotations are not developed using current information The same factors used to determine if a market is inactive can be used to assess whether there has been a significant decrease in activity. This is based on: ► The weight of the available evidence ► The relevance of observed transactions or quoted prices Page 37

Ind AS 113 Fair Value Measurement

Valuation techniques ► ►

Objective – Estimate the Price Ind AS 113 describes three valuation techniques ► ► ►

►

Use valuation techniques that: ► ► ► ►

►

Income approach (discounted future cash flows) Cost approach (current replacement cost) Market approach (price and other relevant information) Are appropriate in the circumstances Have sufficient available data Maximise use of relevant observable inputs Minimise use of unobservable inputs

One or several valuation techniques might be used ►

If a range of values are indicated, select the point within that range most representative of fair value

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Ind AS 113 Fair Value Measurement

Valuation techniques (cont.)

MARKET APPROACH ► It uses prices and other relevant information generated by market transactions involving identical or comparable (that is, similar) assets, liabilities, or a group of assets and liabilities. ►

Often used for real estate when comparable transactions and prices are available.

►

It may also be used as a secondary approach to evaluate and support the conclusions derived using other approach.

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Ind AS 113 Fair Value Measurement

Valuation techniques (cont.)

COST APPROACH ► Reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost). ►

It assumes that the FV would not exceed what it would cost a market participant to acquire or construct a substitute asset of comparable utility after adjusting for physical, functional and economical obsolescence.

►

Typically used for plant, property and equipment.

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Ind AS 113 Fair Value Measurement

Valuation techniques (cont.)

INCOME APPROACH ► Converts future amounts (e.g. cash flows or income and expenses) to a single current (i.e. discounted) amount. The FV is determined on the basis of the value indicated by current market expectations about those future amounts. ► E.g.: Discounted Cash Flow ► Steps in application of DCF: ► estimating future cash flows for a certain discrete projection period; ► estimating the terminal value, if appropriate; and ► discounting those amounts to present value at a rate of return that considers the relative risk of the cash flows and the time value of money. ► Typically used to measure the value of liabilities, intangible assets, businesses and financial instruments (not traded in an active market).

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Ind AS 113 Fair Value Measurement

Valuation techniques (cont.) ► ► ►

► ►

If transaction price equals fair value at initial recognition, calibrate valuation technique to this price at initial recognition Apply valuation techniques consistently Change in valuation technique needed if: ► New markets develop ► New information becomes available ► Information previously used is no longer available ► Valuation techniques improve ► Market conditions change Change in valuation technique = change in estimate Evaluate whether changes to valuation techniques are appropriately disclosed (Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors has limited application) Page 42

Ind AS 113 Fair Value Measurement

Fair value hierarchy Level 1 Definition Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date Example

Quoted prices for an equity security that trades on the London Stock Exchange

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Level 2

Level 3

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly

Unobservable inputs to valuation techniques

Interest rates and yield curves observable at commonly quoted intervals, implied volatilities and credit spreads

Growth rate applied to historical cash flows used to value a business or NCI in an entity that is not publicly listed

Ind AS 113 Fair Value Measurement

Fair value hierarchy (cont.) ► ► ►

Valuation must be based on the quoted price of an identical asset or liability traded in an active market (if available).

Valuation techniques must maximise use of relevant observable inputs and minimise unobservable inputs.

Multiple inputs might be categorised in different levels of the hierarchy. ► The overall fair value measurement is categorised in the hierarchy at the lowest level input that is significant to entire measurement. ► This requires judgement. ► Adjustments to arrive at measurements based on fair value are NOT considered when determining the level in the hierarchy (e.g., fair value less cost to sell).

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Ind AS 113 Fair Value Measurement

Disclosures

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Ind AS 113 Fair Value Measurement

Disclosure principles ►

► ►

Disclose information that helps users assess the following: ► For assets and liabilities measured at fair value on a recurring or non-recurring basis after initial recognition, valuation techniques and inputs used to develop those measurements ► For recurring fair value measurements using significant unobservable inputs (Level 3), the effect of measurements on P/L or OCI for the period Fair value disclosures are required separately for each class of assets and liabilities.

Quantitative disclosures are presented in a tabular format unless another format is more appropriate.

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Ind AS 113 Fair Value Measurement

Fair value hierarchy and disclosures Non-recurring Recurring fair fair value value measurement measurement (after initial recognition)

Fair value at end of reporting period Reasons for measurement at fair value Level in fair value hierarchy Amounts of transfers between Level 1 and Level 2, reasons for transfers and policy for determining when transfers occurred If highest and best use differs from current use, that fact, and why being used that way Page 47

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Fair value disclosure (for items not measured at fair value)

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Ind AS 113 Fair Value Measurement

Fair value hierarchy and disclosures (cont.)

Non-recurring fair value measurement (after initial recognition)

Fair value disclosure (for items not measured at fair value)

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Recurring fair value measurement

For Level 2 and 3, a description of valuation technique(s) and inputs used For Level 2 and 3, any changes in valuation technique(s), and reasons for change For Level 3, quantitative information about significant unobservable inputs For Level 3, description of valuation processes Page 48

Ind AS 113 Fair Value Measurement

Extra disclosures for Recurring Level 3 measurement ►

Reconciliation between opening to closing balances showing separately: ► Total gains or losses recognised in P&L, and which line item(s) ► Unrealised gains or losses relating to assets and liabilities held at balance sheet date and which line item(s) ► Total gains or losses recognised in OCI and which line item(s) ► Purchases, sales, issues and settlements (each separately) ► Amounts of transfers in/out of Level 3 (each separately) ► Reasons for transfers in/out of Level 3 ► Accounting policy for determining when transfers occurred

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Ind AS 113 Fair Value Measurement

Extra disclosures for Recurring Level 3 measurement (cont.) ►

►

►

A narrative description of sensitivity to changes in unobservable inputs, if a change in those inputs to a different amount might result in a significantly higher or lower fair value If there are interrelationships between those inputs and other unobservable inputs used, describe those interrelationships and how they might magnify or mitigate effect of changes in unobservable inputs ► At a minimum, qualify the unobservable inputs For financial assets and financial liabilities, disclose if changing one or more of the unobservable inputs would change fair value significantly Page 50

Ind AS 113 Fair Value Measurement

Thank you

Presented by: CA Abhinay Gupta