IFA-I Chapter 2: Fair Value & Impairment Measurement PDF

Chapter 2: Fair Value & Impairment measurement Learning objectives  Fair Value measurement  Impairment measurement 1  2.1 Fair value measurement  Definition of fair value  IFRS 13 defines fair value as the price that would be re...

Chapter 2: Fair Value & Impairment measurement Learning objectives  Fair Value measurement  Impairment measurement 1  2.1 Fair value measurement  Definition of fair value  IFRS 13 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 (an exit price).  IPSAS 17, defines fair value as 'the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction 2  Measurement of fair value  Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in the principal market for the asset or liability or, in the absence of a principal market.  IFRS 13 applies to all transactions and balances (whether financial or non-financial), with the exception of: share- based payment transactions accounted for under IFRS 2, share-based payment, and leasing transactions within the scope of IAS 17, Leases. 3  Fair value at initial recognition  IFRS 13 indicates that an entity must determine the following to arrive at an appropriate measure of fair value:  (i) the asset or liability being measured (consistent with its unit of account);  (ii) the principal (or most advantageous) market in which an orderly transaction would take place for the asset or liability;  (iii) for a non-financial asset, the highest and best use of the asset and whether the asset is used in combination with other assets or on a stand-alone basis.  (iv) the appropriate valuation technique(s) for the entity to use when measuring fair value, focusing on inputs a market participant would use when pricing the asset or liability; and  (v) those assumptions a market participant would use when pricing the asset or liability. 4  Fair Valuation techniques IFRS 13 describes three valuation techniques that an entity might use to determiner fair value as follows: (i) the market approach. Uses the prices associated with actual market transactions for similar or identical assets and liabilities to derive a fair value. For example, the prices of securities held can be obtained from a national exchange on which these securities are routinely bought and sold. (ii) the income approach. The income approach to fair value measurement estimates the fair value of an entity, intangible assets, or other assets and liabilities by calculating the present value of future cash flows that the entity or asset is expected to generate over its lifetime (iii) The cost approach: reflects the amount that would be required currently to replace the service capacity of an asset. This approach is often referred to as current replacement cost and is typically used5 to measure the fair value of tangible assets such as plant and equipment. Fair value hierarchy  Fair value measurements are categorized into a three-level hierarchy as follows:  Level 1: assets include listed stocks, bonds, funds, or any assets that have a regular mark-to-market mechanism for setting a fair market value. These assets are considered to have a readily observable, transparent prices, and therefore a reliable fair market value.  Level 2: assets are financial assets and liabilities that do not have regular market pricing, but whose fair value can be determined based on other data values or market prices.  Level 3: assets are financial assets and liabilities that are considered to be the most illiquid and hardest to value. Assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs. Examples of Level 3 assets include mortgage-backed securities (MBS), private equity shares, complex derivatives, foreign stocks, and distressed debt. 6 Fair Value Disclosure  IFRS 13 requires an entity to disclose information that helps users of its financial statements assess both of the following: [IFRS 13:91]  for assets and liabilities that are measured at fair value on a regular basis in the statement of financial position after initial recognition, the valuation techniques and inputs used to develop those measurements.  for fair value measurements using significant unobservable inputs (Level 3), the effect of the measurements on profit or loss or other comprehensive income for the period.  Total gain/loss on in relation to fair value  Purchase or sales of derivative securities at fair value  the fair value measurement at the end of the reporting period 7  2.2. Impairment: Definition  The core principle in IAS 36 is that an asset must not be carried in the financial statements at more than the highest amount to be recovered through its use or sale. If the carrying amount exceeds the recoverable amount, the asset is described as impaired.  IPSAS 21 and 26 define impairment as a loss in the future economic benefits or service potential of an asset, over and above the systematic recognition of the loss of the asset's future economic benefits or service potential through depreciation.  In practice, assets are considered impaired when the book value, or net carrying value, exceeds expected future cash flows. This occurs if a business spends money on an asset, but changing circumstances caused the purchase to become a net loss. 8 Impairment Application exception  IAS 36 applies to all assets except: 1) assets arising from construction contracts (-IAS 2) 2) deferred tax assets (-IAS 12) 3) assets arising from employee benefits (IAS 19) 4) financial assets (IAS 39) 5) investment property carried at fair value (IAS 40) 6) agricultural assets carried at fair value (IAS 41) 7) insurance contract assets (- IFRS 4) 8) non-current assets held for sale (-IFRS 5) 9 Impairment Application  Therefore, IAS 36 applies to (among other assets): 1. land 2. Buildings 3. Machinery and equipment 4. investment property carried at cost 5. intangible assets 6. goodwill 7. investments in subsidiaries, associates, and joint ventures carried at cost 8. assets carried at revalued amounts under IAS 16 and IAS 38 10  Key concepts  In general, asset impairment indicates that an asset costs more to a business than it is worth.  Impairment loss: the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount  Carrying amount: the amount at which an asset is recognized in the balance sheet after deducting accumulated depreciation and accumulated impairment losses  Recoverable amount: the higher of : (a) the fair value less costs to sell and (b) the value in use (i.e., the present value of future cash flows expected to be derived from the CGU).  Value in use: the present value of the future cash flows expected to be derived from cash-generating unit or assets.  Cash-generating Unit: is the smallest group of assets that includes the asset and generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. 11  Indications of impairment  External sources:  Internal sources:  market value declines  obsolescence or  negative changes in physical damage technology, markets,  asset is idle, part of a economy, or laws restructuring or held  increases in market for disposal interest rates  worse economic  net assets of the performance than company higher than expected market capitalization 12 Example on recoverable amount For machinery, the details are given below. a)Open market value of the machinery=$62,000. b) The disposal cost (costs to sell) of machinery is ignored. c) The cash inflows will accrue to an amount of $23,000 in the future for three years. The appropriate discount rate is 10%. Required: what is the recoverable amount of the machinery? 13 Solution:  Fair value = $62,000  Calculation of Value in use will be –  Value in Use = Regular cash flow*(PVFOA @r=10%, n=3) Value in uses= 23,000*2.48685 = $57,198  Thus, the recoverable amount of the machinery shall be higher of the FVLCTS ($62,000) and Value in Use ($57, 198).  Accordingly, the recoverable amount comes to be FVLCTS, i.e., $62,000, being higher of the two amounts 14 Reversal of impairment  Reversal of impairment is a situation where a company can declare an asset to be valuable where it has previously been declared a liability.  An impairment loss may only be reversed if there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment loss had been recognized. If this is the case, then the carrying amount of the asset shall be increased to its recoverable amount. 15 Disclosure impairment  Disclosure by class of assets: [IAS 36.126]  impairment losses recognized in profit or loss  impairment losses reversed in the statement of comprehensive income  impairment losses on revalued assets  impairment losses on revalued assets reversed in other comprehensive income  Events causes impairment losss 16 The End of Chapter 2 Thank you for coming! 17