International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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under IFRS (e.g. a requirement to separate under IFRS 9), we generally do not believe
it is appropriate to consider the unit of account at a level below that of the legal form of
the asset or liability being measured. A valuation methodology that uses a ‘sum-of-the-
parts’ approach may still be appropriate under IFRS 13; for example, when measuring
complex financial instruments, entities often use valuation methodologies that attempt
to determine the value of the entire instrument based on its component parts.
However, in situations where fair value can be determined for an asset or liability as a
whole, we would generally not expect that an entity would use a higher amount to
measure fair value because the sum of the parts exceeds the whole. Using a higher value
inherently suggests that the asset would be broken down and the various components,
or risk attributes, transferred to different market participants who would pay more for
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the pieces than a market participant would for the asset or liability as a whole. Such an
approach is not consistent with IFRS 13’s principles, which contemplate the sale of an
asset or transfer of a liability (consistent with its unit of account) in a single transaction.
5.2
Characteristics of the asset or liability
When measuring fair value, IFRS 13 requires an entity to consider the characteristics of
the asset or liability. For example, age and miles flown are attributes to be considered
in determining a fair value measure for an aircraft. Examples of such characteristics
could include:
• the condition and location of an asset; and
• restrictions, if any, on the sale or use of an asset or transfer of a liability (see 5.2.2,
10.1 and 11.4 below).
The fair value of the asset or liability must take into account those characteristics that
market participants would take into consideration when pricing the asset or liability at
the measurement date. [IFRS 13.11, 12]. For example, when valuing individual shares in an
unlisted company, market participants might consider factors such as the nature of the
company’s operations; its performance to date and forecast future performance; and
how the business is funded, including whether it is highly leveraged.
The requirement to consider the characteristics of the asset or liability being measured
is not new to fair value measurement under IFRS. For example, prior to the issuance of
IFRS 13, IAS 41 referred to measuring the fair value of a biological asset or agricultural
produce in its present location and condition and IAS 40 stated that an entity should
identify any differences between the investment property being measured at fair value
and similar properties for which observable market prices are available and make the
appropriate adjustments for those differences. [IFRS 13.BC46].
5.2.1
Condition and location
An asset may not be in the condition or location that market participants would require
for its sale at an observable market price. In order to determine the fair value of the
asset as it currently exists, the market price needs to be adjusted to the price market
participants would be prepared to pay for the asset in its current condition and location.
This includes deducting the cost of transporting the asset to the market, if location is a
characteristic of the asset being measured, and may include deducting the costs of
converting or transforming the asset, as well as a normal profit margin.
For non-financial assets, condition and location considerations may influence, or be
dependent on, the highest and best use of an asset (see 10 below). That is, an asset’s
highest and best use may require an asset to be in a different condition. However, the
objective of a fair value measurement is to determine the price for the asset in its current
form. Therefore, if no market exists for an asset in its current form, but there is a market
for the converted or transformed asset, an entity could adjust this market price for the
costs a market participant would incur to re-condition the asset (after acquiring the asset
in its current condition) and the compensation they would expect for the effort.
Example 14.1 below illustrates how costs to convert or transform an asset might be
considered in determining fair value based on the current use of the asset.
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Example 14.1: Adjusting fair value for condition and location
An entity owns a pine forest. The pine trees take approximately 25 years to mature, after which they can be
cut down and sold. The average age of the trees in the forest is 14 years at the end of the reporting period.
The current use of the forest is presumed to be its highest and best use.
There is no market for the trees in their current form. However, there is a market for the harvested timber
from trees aged 25 years or older. To measure the fair value of the forest, the entity uses an income approach
and uses the price for 25 year-old harvested timber in the market today as an input. However, since the trees
are not yet ready for harvest, the cash flows must be adjusted for the costs a market participant would incur.
Therefore, the estimated cash flows include costs to manage the forest (including silviculture activities, such
as fertilising and pruning the trees) until the trees reach maturity; costs to harvest the trees; and costs to
transport the harvested logs to the market. The entity estimates these costs using market participant
assumptions. The entity also adjusts the value for a normal profit margin because a market participant
acquiring the forest today would expect to be compensated for the cost and effort of managing the forest for
the period (i.e. 11 years) before the trees will be harvested and the timber is sold (i.e. this would include
compensation for costs incurred and a normal profit margin for the effort of managing the forest).
5.2.2
Restrictions on assets or liabilities
IFRS 13 indicates that the effect on fair value of a restriction on the sale or use of an
asset will differ depending on whether the restriction is deemed to be a characteristic
of the asset or the entity holding the asset. A restriction that would transfer with the
asset in an assumed sale would generally be deemed a characteristic of the asset and,
therefore, would likely be considered by market participants when pricing the asset.
Conversely, a restriction that is specific to the entity holding the asset would not transfer
with the asset in an assumed sale and, therefore, would not be considered when
measuring fair value. Determining whether a restriction is a characteristic of the asset
or of the entity holding the asset may be contractual in some cases. In other cases, this
determination may require judgement based on the specific facts and circumstances.
The following illustrative examples highlight the distinction between restrictions that
are characteristics of the asset and those of the entity holding the asset, including how
this determination affects the fair value measurement. [IFRS 13.IE28-29]. Restrictions on
non-financial assets are discussed further at 10 below.
Example 14.2: Restrictions on assets
An entity holds an equity instrument for which sale is legally restricted for a specified period
. The restriction
is a characteristic of the instrument that would transfer to market participants. As such, the fair value of the
instrument would be measured based on the quoted price for an otherwise identical unrestricted equity
instrument that trades in a public market, adjusted for the effect of the restriction. The adjustment would
reflect the discount market participants would demand for the risk relating to the inability to access a public
market for the instrument for the specified period. The adjustment would vary depending on:
• the nature and duration of the restriction;
• the extent to which buyers are limited by the restriction; and
• qualitative and quantitative factors specific to both the instrument and the issuer.
Example 14.3: Entity-specific restrictions on assets
A donor of land specifies that the land must be used by a sporting association as a playground in perpetuity.
Upon review of relevant documentation, the association determines that the donor’s restriction would not
transfer to market participants if the association sold the asset (i.e. the restriction on the use of the land is
specific to the association). Furthermore, the association is not restricted from selling the land. Without the
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restriction on the use of the land, the land could be used as a site for residential development. In addition, the
land is subject to an easement (a legal right that enables a utility to run power lines across the land).
Under these circumstances, the effect of the restriction and the easement on the fair value measurement of
the land is as follows:
(a) Donor restriction on use of land – The donor restriction on the use of the land is specific to the association
and thus would not transfer to market participants. Therefore, regardless of the restriction on the use of
the land by the association, the fair value of the land would be measured based on the higher of its
indicated value:
(i) as a playground (i.e. the maximum value of the land is through its use in combination with other
assets or with other assets and liabilities); or
(ii) as a residential development (i.e. the fair value of the asset would be maximised through its use by
market participants on a stand-alone basis).
(b) Easement for utility lines – Because the easement for utility lines is a characteristic of the land, this
easement would be transferred to market participants with the land. The fair value of the land would
include the effect of the easement, regardless of whether the land’s valuation premise is as a playground
or as a site for residential development.
In contrast to Example 14.2 above, Example 14.3 illustrates a restriction on the use of
donated land that applies to a specific entity, but not to other market participants.
The calculation of the fair value should take account of any restrictions on the sale or
use of an asset, if those restrictions relate to the asset rather than to the holder of the
asset and the market participant would take those restrictions into account in his
determination of the price that he is prepared to pay.
A liability or an entity’s own equity instrument may be subject to restrictions that
prevent the transfer of the item. When measuring the fair value of a liability or equity
instrument, IFRS 13 does not allow an entity to include a separate input (or an
adjustment to other inputs) for such restrictions. This is because the effect of the
restriction is either implicitly or explicitly included in other inputs to the fair value
measurement. Restrictions on liabilities and an entity’s own equity are discussed further
at 11 below.
IFRS 13 has different treatments for restrictions on assets and those over liabilities. The
IASB believes this is appropriate because restrictions on the transfer of a liability relate
to the performance of the obligation (i.e. the entity is legally obliged to satisfy the
obligation and needs to do something to be relieved of the obligation), whereas
restrictions on the transfer of an asset generally relate to the marketability of the asset.
In addition, nearly all liabilities include a restriction preventing the transfer of the
liability. In contrast, most assets do not include a similar restriction. As a result, the effect
of a restriction preventing the transfer of a liability, theoretically, would be consistent
for all liabilities and, therefore, would require no additional adjustment beyond the
factors considered in determining the original transaction price. If an entity is aware that
a restriction on the transfer of a liability is not already reflected in the price (or in the
other inputs used in the measurement), it would adjust the price or inputs to reflect the
existence of the restriction. [IFRS 13.BC99, BC100]. However, this would be rare because
nearly all liabilities include a restriction and, when measuring fair value, market
participants are assumed by IFRS 13 to be sufficiently knowledgeable about the liability
to be transferred.
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5.2.2.A
In determining the fair value of a restricted security, is it appropriate to
apply a constant discount percentage over the entire life of the restriction?
We generally do not believe a constant discount percentage should be used to measure
the fair value of a restricted security because market participants would consider the
remaining time on the security’s restriction and that time period changes from period to
period. Market participants, for example, would generally not assign the same discount
for a restriction that terminates in one month, as they would for a two-year restriction.
One approach to value the restriction may be through an option pricing model that explicitly
incorporates the duration of the restriction and the characteristics of the underlying
security. The principal economic factor underlying a discount for lack of marketability is
the increased risk resulting from the inability to quickly and efficiently return the investment
to a cash position (i.e. the risk of a price decline during the restriction period). One way in
which the price of this risk may be determined is by using an option pricing model that
estimates the value of a protective put option. For example, restricted or non-marketable
securities are acquired along with a separate option that provides the holder with the right
to sell those shares at the current market price for unrestricted securities. The holder of
such an option has, in effect, purchased marketability for the shares. The value of the put
option may be considered an estimate of the discount for the lack of marketability
associated with the restricted security. Other techniques or approaches may also be
appropriate in measuring the discount associated with restricted securities.
6
THE PRINCIPAL (OR MOST ADVANTAGEOUS) MARKET
A fair value measurement contemplates an orderly transaction to sell the asset or
transfer the liability in either:
(a) the principal market for the asset or liability; or
(b) in the absence of a principal market, the most advantageous market for the asset
or liability. [IFRS 13.16].
IFRS 13 is clear that, if there is a principal market for the asset or liability, the fair value
measurement represents the price i
n that market at the measurement date (regardless
of whether that price is directly observable or estimated using another valuation
technique). The price in the principal market must be used even if the price in a different
market is potentially more advantageous. [IFRS 13.18]. This is illustrated in Example 14.4.
[IFRS 13.E19-20].
Example 14.4: The effect of determining the principal market
An asset is sold in two different active markets at different prices. An entity enters into transactions in both
markets and can access the price in those markets for the asset at the measurement date.
Market A
Market B
CU
CU
Price that would be received
26
25
Transaction costs in that market
(3)
(1)
Costs to transport the asset to the market
(2)
(2)
Net amount that would be received
21
22
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If Market A is the principal market for the asset (i.e. the market with the greatest volume and level of activity
for the asset), the fair value of the asset would be measured using the price that would be received in that
market, even though the net proceeds in Market B are more advantageous. In this case, the fair value would
be CU24, after taking into account transport costs excluding transactions costs.
The identification of a principal (or most advantageous) market could be impacted by
whether there are observable markets for the item being measured. However, even
where there is no observable market, fair value measurement assumes a transaction
takes place at the measurement date. The assumed transaction establishes a basis for
estimating the price to sell the asset or to transfer the liability. [IFRS 13.21].
6.1
The principal market
The principal market is the market for the asset or liability that has the greatest volume
or level of activity for the asset or liability. [IFRS 13 Appendix A]. There is a general
presumption that the principal market is the one in which the entity would normally