International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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indicative broker quotes to estimate an appropriate discount rate for its RMBS.
Although these quotes are specific to the RMBS being valued, Entity A puts less weight
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on these quotes since they are not binding and are not based on actual transactions.
Furthermore, Entity A was unable to evaluate the valuation techniques and underlying
data used by the brokers.
Importantly, the illustrative example is not intended to imply that an entity’s own
assumptions carry more weight than non-binding broker quotes. Rather, the example
illustrates that each indication of value needs to be assessed based on the extent these
indications rely on observable versus unobservable inputs.
Even though the market approach could not be used because of limited trading activity
for the RMBS, Entity A was able to corroborate many of the assumptions used in
developing the discount rate with relevant observable market data. As a result, the
decision by the entity to place additional weight on its own market-corroborated
assumptions (and less on the broker quotes) was warranted. When differences between
broker quotes or pricing service data and an entity’s own determination of value are
significant, management should seek to understand the reasons behind these
differences, if possible.
9 THE
PRICE
‘Fair value is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction in the principal (or most advantageous) market at the
measurement date under current market conditions (i.e. an exit price) regardless of
whether that price is directly observable or estimated using another valuation
technique’. [IFRS 13.24].
IFRS 13 requires the entity to estimate fair value based on the price that would be
received to sell the asset or transfer the liability being measured (i.e. an exit price). While
the determination of this price may be straightforward in some cases (e.g. when the
identical instrument trades in an active market), in others it will require significant
judgement. However, IFRS 13 makes it clear that the price used to measure fair value
shall not be adjusted for transaction costs, but would consider transportation costs.
[IFRS 13.25, 26].
The standard’s guidance on the valuation techniques and inputs to these techniques
used in determining the exit price (including the prohibition on block discounts) is
discussed at 14 and 15 below.
9.1 Transaction
costs
Transaction costs are defined as the costs to sell an asset or transfer a liability in the
principal (or most advantageous) market for the asset or liability that are directly
attributable to the disposal of an asset or the transfer of the liability. In addition, these
costs must be incremental, i.e. they would not have been incurred by the entity had the
decision to sell the asset or transfer the liability not been made. [IFRS 13 Appendix A].
Examples of transaction costs include commissions or certain due diligence costs. As
noted above, transaction costs do not include transportation costs.
Fair value is not adjusted for transaction costs. This is because transaction costs are not
a characteristic of an asset or a liability; they are a characteristic of the transaction.
Fair value measurement 985
While not deducted from fair value, an entity considers transaction costs in the context
of determining the most advantageous market (in the absence of a principal market –
see 6.2 above) because in this instance the entity is seeking to determine the market that
would maximise the net amount that would be received for the asset.
9.1.1
Are transaction costs in IFRS 13 the same as ‘costs to sell’ in other
IFRSs?
As discussed at 2.1.2 above, some IFRSs permit or require measurements based on fair
value, where costs to sell or costs of disposal are deducted from the fair value
measurement. IFRS 13 does not change the measurement objective for assets accounted
for at fair value less cost to sell. The ‘fair value less cost to sell’ measurement objective
includes: (1) fair value; and (2) cost to sell. The fair value component is measured in
accordance with the IFRS 13.
Consistent with the definition of transaction costs in IFRS 13, IAS 36 describes costs of
disposal as ‘the direct incremental costs attributable to the disposal of the asset or cash-
generating unit, excluding finance costs and income tax expense’. [IAS 36.6]. IAS 41 and
IFRS 5 similarly define costs to sell.
As such, transaction costs excluded from the determination of fair value in accordance
with IFRS 13 will generally be consistent with costs to sell or costs of disposal, determined
in other IFRSs (listed at 2.1.2 above), provided they exclude transportation costs.
Since the fair value component is measured in accordance with IFRS 13, the standard’s
disclosure requirements apply in situations where the fair value less cost to sell
measurement is required subsequent to the initial recognition (unless specifically
exempt from the disclosure requirements, see 20 below). In addition, IFRS 13 clarifies
that adjustments used to arrive at measurements based on fair value (e.g. the cost to sell
when estimating fair value less cost to sell) should not be considered when determining
where to categorise the measurement in the fair value hierarchy (see 16 below).
9.1.2
Transaction costs in IFRS 13 versus acquisition-related transaction
costs in other IFRSs
The term ‘transaction costs’ is used in many IFRSs, but sometimes it refers to transaction
costs actually incurred when acquiring an item and sometimes to transaction costs
expected to be incurred when selling an item. While the same term might be used, it is
important to differentiate between these types of transaction costs.
IAS 36, IAS 41 and IFRS 5 discuss costs to sell or dispose of an item (as discussed
at 9.1.1 above).
In contrast, other standards refer to capitalising or expensing transaction costs incurred
in the context of acquiring an asset, assuming a liability or issuing an entity’s own equity
(a buyer’s perspective). IFRS 3, for example, requires acquisition-related costs to be
expensed in the period incurred. [IFRS 3.53].
IFRS 13 indicates that transaction costs are not included in a fair value measurement. As
such, actual transaction costs (e.g. commissions paid) that are incurred by an entity when
acquiring an asset would not be included at initial recognition when fair value is the
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measurement objective. Likewise, transaction costs that would be incurred in a
hypothetical sales transaction would also not be included in a fair value measurement.
Some standards permit acquisition-related transaction costs to be capitalised at initial
recognition, then permit or require the item, to which those costs relate, to be
subsequently measured at fair value. In those situations, some or all of the acquisition-
related transaction costs that were capitalised will effectively be expensed as part of the
resulting fair value gain or loss. This is consistent with current practice. For example,
IAS 40 permits transa
ction costs to be capitalised as part of an investment property’s
cost on initial recognition. [IAS 40.20]. However, if the fair value model is applied to the
subsequent measurement of the investment property, transaction costs would be
excluded from the fair value measurement.
Similarly, at initial recognition, financial assets or liabilities in the scope of IFRS 9 are
generally measured at their ‘fair value plus or minus, in the case of a financial asset or
liability not at fair value through profit or loss, transaction costs that are directly
attributable to the acquisition or issue of the financial asset or liability’. [IFRS 9.5.1.1]. For
those items subsequently measured at amortised cost, these transaction costs will be
captured as part of the instrument’s effective interest rate.
9.2 Transportation
costs
Transportation costs represent those that would be incurred to transport an asset or
liability to (or from) the principal (or most advantageous) market. If location is a
characteristic of the asset or liability being measured (e.g. as might be the case with a
commodity), the price in the principal (or most advantageous) market should be adjusted
for transportation costs. The following simplified example illustrates this concept.
Example 14.10: Transportation costs
Entity A holds a physical commodity measured at fair value in its warehouse in Europe. For this commodity,
the London exchange is determined to be the principal market as it represents the market with the greatest
volume and level of activity for the asset that the entity can reasonably access.
The exchange price for the asset is CU 25. However, the contracts traded on the exchange for this commodity
require physical delivery to London. Entity A determines that it would cost CU 5 to transport the physical
commodity to London and the broker’s commission would be CU 3 to transact on the London exchange.
Since location is a characteristic of the asset and transportation to the principal market is required, the fair
value of the physical commodity would be CU 20 – the price in the principal market for the asset CU 25, less
transportation costs of CU 5. The CU 3 broker commission represents a transaction cost that would not adjust
the price in the principal market.
10
APPLICATION TO NON-FINANCIAL ASSETS
Many non-financial assets, either through the initial or subsequent measurement
requirements of an IFRS or, the requirements of IAS 36 for impairment testing (if
recoverable amount is based on fair value less costs of disposal), are either permitted or
required to be measured at fair value (or a measure based on fair value). For example,
management may need to measure the fair value of non-financial assets and liabilities
when completing the purchase price allocation for a business combination in
accordance with IFRS 3. First-time adopters of IFRS might need to measure fair value
Fair value measurement 987
of assets and liabilities if they use a ‘fair value as deemed cost’ approach in accordance
with IFRS 1 – First-time Adoption of International Financial Reporting Standards.
The principles described in the sections above apply to non-financial assets. In addition,
the fair value measurement of non-financial assets must reflect the highest and best use
of the asset from a market participant’s perspective.
The highest and best use of an asset establishes the valuation premise used to measure
the fair value of the asset. In other words, whether to assume market participants would
derive value from using the non-financial asset (based on its highest and best use) on its
own or in combination with other assets or with other assets and liabilities. As discussed
below, this might be its current use or some alternative use.
As discussed at 4.2 above, the concepts of highest and best use and valuation premise in
IFRS 13 are only relevant for non-financial assets (and not financial assets and liabilities).
This is because:
• financial assets have specific contractual terms; they do not have alternative uses.
Changing the characteristics of the financial asset (i.e. changing the contractual
terms) causes the item to become a different asset and the objective of a fair value
measurement is to measure the asset as it exists as at the measurement date;
• the different ways by which an entity may relieve itself of a liability are not
alternative uses. In addition, entity-specific advantages (or disadvantages) that
enable an entity to fulfil a liability more or less efficiently than other market
participants are not considered in a fair value measurement; and
• the concepts of highest and best use and valuation premise were developed within
the valuation profession to value non-financial assets, such as land. [IFRS 13.BC63].
10.1 Highest and best use
Fair value measurements of non-financial assets take into account ‘a market
participant’s ability to generate economic benefits by using the asset in its highest and
best use or by selling it to another market participant that would use the asset in its
highest and best use’. [IFRS 13.27].
Highest and best use refers to ‘the use of a non-financial asset by market participants
that would maximise the value of the asset or the group of assets and liabilities (e.g. a
business) within which the asset would be used’. [IFRS 13 Appendix A].
The highest and best use of an asset considers uses of the asset that are:
(a) physically possible: the physical characteristics of the asset that market
participants would take into account when pricing the asset (e.g. the location or
size of a property);
(b) legally permissible: any legal restrictions on the use of the asset that market
participants would take into account when pricing the asset (e.g. the zoning
regulations applicable to a property); and
(c) financially feasible: whether a use of the asset that is physically possible and legally
permissible generates adequate income or cash flows (taking into account the costs
of converting the asset to that use) to produce an investment return that market
participants would require from an investment in that asset put to that use. [IFRS 13.28].
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Highest and best use is a valuation concept that considers how market participants
would use a non-financial asset to maximise its benefit or value. The maximum value
of a non-financial asset to market participants may come from its use: (a) in
combination with other assets or with other assets and liabilities; or (b) on a stand-
alone basis.
In determining the highest and best use of a non-financial asset, paragraph 28 of IFRS 13
indicates uses that are physically possible, legally permissible (see 10.1.1 below for
further discussion) and financially feasible should be considered. As such, when
assessing alternative uses, entities should consider the physical characteristics of the
asset, any legal restrictions on its use and whether the value generated provides an
adequate investment return for market participants.
Provided there is sufficient evidence to support these assertions, alternative uses that
would enable market participants to maximise value should be considered, but a search
for p
otential alternative uses need not be exhaustive. In addition, any costs to transform
the non-financial asset (e.g. obtaining a new zoning permit or converting the asset to the
alternative use) and profit expectations from a market participant’s perspective are also
considered in the fair value measurement.
If there are multiple types of market participants who would use the asset differently,
these alternative scenarios must be considered before concluding on the asset’s highest
and best use. While applying the fair value framework may be straightforward in many
situations, in other instances, an iterative process may be needed to consistently apply
the various components. This may be required due to the interdependence among
several key concepts in IFRS 13’s fair value framework (see Figure 14.2 at 4.2 above).
For example, the highest and best use of a non-financial asset determines its valuation
premise and affects the identification of the appropriate market participants. Likewise,
the determination of the principal (or most advantageous) market can be important in
determining the highest and best use of a non-financial asset.
Determining whether the maximum value to market participants would be achieved
either by using an asset in combination with other assets and liabilities as a group, or by
using the asset on a stand-alone basis, requires judgement and an assessment of the
specific facts and circumstances.
A careful assessment is particularly important when the highest and best use of a non-
financial asset is in combination with one or more non-financial assets.
As discussed at 10.2 below, assets in an asset group should all be valued using the
same valuation premise. For example, if the fair value of a piece of machinery on a
manufacturing line is measured assuming its highest and best use is in conjunction
with other equipment in the manufacturing line, those other non-financial assets in
the asset group (i.e. the other equipment on the manufacturing line) would also be
valued using the same premise. As highlighted by Example 14.13 at 10.2.2 below,
once it is determined that the value for a set of assets is maximised when considered
as a group, all of the assets in that group would be valued using the same premise,
regardless of whether any individual asset within the group would have a higher