Fair Value Measurement under IndAS 113

Apurva Parikh (CA aspirant) (30 Points)

08 December 2015  

Fair Value Measurement as per Indian Accounting Standard (IndAS)

Introduction to Fair Value

Every industry witnesses ground-breaking changes, in Financial reporting one such is advent of IndAS. New to Indian soil, IndAS are Indian moulded version of IFRS. Fair value as we will study today has derived its form from IFRS 13: Fair Value Measurements.

Let us understand Fair value with one small example;

Mr. A takes a loan of Rs. 100 @ 5%, when market rate was 10%. He recorded it at Rs. 100, but this is not Fair value of the loan. Loan shall be adjusted to the tune of 5% to be brought down to it Fair value.

Brief aspects of Governing pronouncement, IndAS 113

IndAS 113 provides that assets and liabilities shall be recorded at Fair value at measurement date and provides means and principles of measurement, recognition and disclosures. This IndAS would be crucial one because it provides framework for all other IndAS which requires Fair value measurement or disclosure.

Scope of IndAS 113: Fair Value Measurement

IndAS 113 applies when any IndAS requires or permits Fair value measurement or disclosures, except for;

i. Share based payment transactions under IndAS 102
ii. Leasing transactions under IndAS 17
iii. Measurements having similarities with Fair Value but are not Fair value Eg: NRV, Value in use, etc.

Definition of Fair Value as per IndAS 113

Let us understand meaning of a few words used in definition:

The Market (Principal or the most advantageous market):

The principal market is the market with greatest volume and level of activity for sale or transfer of Asset and Liabilities.

o  The most advantageous market is the market where entity would fetch maximum amount for sale of asset and minimizes the amount for transfer of liability, considering transaction costs in respective market.

Eg: Bharti Airtel is listed on both NSE and BSE. On closure of 3/12/2015 following data is available:

Particulars

NSE

BSE

Closing price

319.55

319.70

Volume

3,973,225

570,224

Market type

Principal Market

Most Advantageous Market

Fair Value

Rs. 319.55

Market participants:

They are buyers and sellers in the principal market who are;

- Independent or not related parties
- Knowledgeable
- Able to transact
- Willing to transact

Price and Orderly transaction:

o  An orderly transaction is one which assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for sale or transfer of such A&L and doesn't consider a forced transaction.

o  The price would be the amount that could be received on sale or transfer of asset but excludes transaction cost as same is not an attribute.

Note:

Price determination under most advantageous market:

As for above said Bharti Airtel's Securities: (Not considering NSE as principal market for the sake of this example)

Particulars

NSE

BSE

Price

319.55

319.70

Transaction cost (Min. Brokerage charges)

20

18.5

Net Price

299.55

301.20

Most advantageous market

No

Yes

Asset or Liabilities: (Hereinafter referred as "A&L" )

o  Such attributes of A&L should be considered which will be considered by market participants Eg:

- Location of A&L
- Condition of A&L, etc.

How Fair value is to be computed or assessed:

Following principle points are laid down for assessing Fair Value, which are as follows;

Example: Measuring Fair Value of a liability using present value technique.

Company

TATA Motors Ltd.

Instrument

Debentures

Coupon Rate

10%

Date of issue

1/04/2013

Tenure

10 years

Credit rating as issue

CRISIL A

Measurement Date

31/04/2015

Credit rating

CRISIL BBB

Market Expected rate due to demotion

10.5%

Valuation technique employed

Present Value

Inputs Considered

- CRISIL BBB rating
- Remaining tenure of 8 years
- Principal amount of Rs. 100 Crores
- Revised minimum return of 10.5% and credit spread

Present value of its obligation as an asset for market on 31/03/15 (Fair Value)

Rs. 98.857 Crores

Hierarchy of Fair Value:

IndAS 113 incorporates a three level hierarchy for inputs used in valuation for measurement of Fair value. The hierarchy gives the highest priority to quoted prices and lowest to unobservable inputs.

Categories of Inputs:

Level 1 Inputs: Quoted prices

i. Level 1 inputs are quoted prices in active market for identical A&L.
ii. The entity can access principal market at the measurement date.
iii. The quoted price shall be used without adjustment except:

o Alternative pricing method is used for a large number of similar A&L for which quoted prices are available but not readily accessible.

o When a quoted price in active market doesn't represent fair value or requires adjustment.

Level 2 Inputs: Other than quoted market prices within Level 1

i. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the A&L, either directly or indirectly.

ii. Level 2 inputs include;

o Quoted price for similar A&L in active markets
Quoted prices for similar or identical A&L in markets that are not active markets

Inputs other than quoted market prices that are observable like;

i. Interest rates and yield curves (Bonds, debenture instruments)
ii. Implied volatilities (Options)
iii. Credit spreads[1], etc.

Market corroborated inputs

Examples of level 2 Inputs:

Arrangement

Level 2 Input

Receive-fixed, pay-variable interest rate swop based on the Mumbai Interbank Offered rate (MIBOR) swap rate

MIBOR swap rate

Finished goods inventory at a retail outlet

Price requiring least adjustment: Retail price to customer or wholesale price

Buildings held and used

Per square meter of comparable building in similar location

Cash generating units

Multiple for revenue or earnings

Eg. P/E ratio

Level 3 Inputs: Unobservable Inputs

a. Level 3 inputs are unobservable inputs for the A&L
b. Are used only when observable inputs are not available
c. Such inputs shall be developed with best information available, includes entity level estimates, but shall be adjusted if reasonable information is made available.

Arrangement

Level 3 Inputs

Three-year option on exchange-traded shares

Historical volatility

Decommissioning liability assumed in business combination

Expected future cash outflows obligations, discounted into current estimate.

Cash generating unit

Entity's own developed financial forecast

Fair value at Initial Recognition:

Difference between on-going Transaction price and Fair Value :

Measurement For

Transaction price

Fair Value

Assets

Price paid to acquire

Price that would be received to sell the asset

Liabilities

Amount received to assume the liability

Amount that would be paid to settle or transfer the liability

Where transaction price is different the entity shall recognize profit or loss unless that IndAS specifies otherwise.

There may be situation where transaction price differs from Fair value such as;

o Where transaction is carried out;

- With related parties
- Under duress or forced transaction

Unit of account represented by transaction price is different from that under fair value Eg: Transaction price includes transaction cost.

o Market in which transaction takes place is other than principal market

Measurement criteria:

A&L type

Measurement criteria

Special consideration

Non-Financial asset

For Usage: Highest and best use

For Selling: Price to be fetched by market participants

Highest and best use considers considerations such as;

- Physical
- Legal
- Financial

Liabilities and equity instruments held as assets

Fair value of identical items held as asset by market participant

 

Liabilities and equity instruments not held as assets

Fair value using a valuation technique from perspective of market participant that owes the liability or has issued the claim on equity

 

Financial liability with a demand feature

Not less than amount repayable on demand discounted from first date that the amount could be repaid.

 

Valuation Technique:

- Use of valuation technique which maximises use of observable inputs and minimises use of unobservable inputs.
- Multiple techniques may be required.

Disclosures:

An entity shall disclose such information that helps the users of its financial statements assess both of the following:

o Valuation technique and inputs used to measure fair value.

o  Effect of recurring fair value measurement using significant unobservable inputs (Level III) on profit or loss or other comprehensive income for the period.

Illustrative Disclosure: (Extracts from Oxford instruments, UK and Paladin energy, Australia)

 

 

Inputs used in valuation

a. The fair value of interest rate swaps is based on broker quotes.

b. The fair value of forward exchange contracts is their market price at the Consolidated Statement of Financial Position date, being the present value of the forward price.

 

Technique used

c. The fair value of the unlisted securities is determined using valuation techniques. Such techniques include using recent arm's length market transactions, net asset values and by an external valuer using the Black-Scholes model

Measurement date

d.  The identifiable assets acquired and the liabilities assumed are measured at their acquisition date fair values

Disclosure of quantitative details of significant Unobservable inputs

Disclosure of Transfer in and out of levels of fair value hierarchy

Reconciliation for Level 3 fair value movements

b

2010 2009
US$M US$M
Opening balance 3.9 4.5
Other comprehensive income/(loss) 0.4 (0.6)
Disposals (0.8) -
Closing balance 3.5 3.9
Total gain or loss stated in the table above for assets held at the end of the period - -

Disclosure of Levels of Fair Value Hierarchy used in measurement:

o The fair value of interest rate swaps is based on broker quotes. Those quotes are tested for reasonableness by discounting estimated future cash flows based on the terms and maturity of each contract and using market interest rates for a similar instrument at the measurement date.

o The fair value of forward exchange contracts is their market price at the Consolidated Statement of Financial Position date, being the present value of the forward price.

Disclosure of principles of Fair Value Measurement:

Business combinations are accounted for using the acquisition method. The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquire and the equity issued by the acquirer, and the amount of any non-controlling interest in the acquiree.

Disclosure of measurement of Business Combination:

 

Book

Provisional

Provisional

   

Value

Adjustments

Fair Value

Intangible fixed assets

   

9.40

70.20

79.60

Tangible fixed assets

   

6.00

( 4.00)

2.00

Inventories

     

11.10

3.00

14.10

Trade and other receivables

   

10.30

-

10.30

Trade and other payables

   

(13.50)

( 1.30)

( 14.80)

Deferred tax

     

( 0.50)

( 15.60)

( 16.10)

Cash

       

17.20

-

17.20

Net assets acquired

   

40.00

52.30

92.30

Goodwill

           

83.00

Total consideration

       

175.30

Cash acquired

         

( 17.20)

Net cash outflow relating to the acquisition

   

158.10

Assumptions of discounting factor and other measures for Fair Value measurement of Financial Instruments:

The key assumptions are those regarding discount rates, growth rates, expected selling volumes and prices and direct costs during the period.

The growth rates are based on industry growth factors. Changes in selling prices and direct costs are based on past practices and expectations of future changes in the market.

The pre-tax weighted average costs of capital used for Nanotechnology Tools, Industrial Products and Service in impairment testing are 10.95%–11.45% (2013: 12.25%), 10.45%–10.95% (2013: 11.75%) and 10.45% (2013: 11.25%) respectively in line with the risk associated with each of the business segments. Management have estimated these discount rates by reference to past experience and an industry average weighted cost of capital as adjusted for appropriate risk factors reflecting current economic circumstances and the risk profiles of each CGU.

Thank you.
Apurv Parikh
Manubhai & Shah (Ahmedabad)

[1] Credit spreads are difference in yields between any type of bond and a treasury receipt of the same maturity