(18) 313
86
475
856
Gains recognized in the income statement
350
152 141 94 737
Settlements
(86) (56)
(13)
(180)
(335)
Transfers out of level 3
– (228)
– –
(228)
Net fair value of contracts at 31 December 2014
246 181
214
389
1,030
$
million
Oil
Natural gas
Power
price
price
price Other Total
Net fair value of contracts at 1 January 2013
105
304
(43)
71
437
Gains (losses) recognized in the income
statement
(47)
62 81 – 96
Purchases
110
1
–
–
111
New contracts
–
–
–
475
475
Settlements
(143)
(52) 10 (71)
(256)
Transfers out of level 3
(43)
(1)
36
–
(8)
Exchange adjustments
–
(1)
2
–
1
Net fair value of contracts at 31 December 2013
(18)
313
86
475
856
The amount recognized in the income statement for the year relating to level 3 held for trading derivatives still held at 31 December 2014 was a $456 million gain (2013 $110 million gain related to derivatives still held at 31 December 2013).
The most significant gross assets and liabilities categorized in level 3 of the fair value hierarchy are US natural gas
contracts. At 31 December 2014, the gross US natural gas price instruments dependent on inputs at level 3 of the fair
value hierarchy were an asset of $586 million and liability of $526 million (net fair value of $60 million), with
$126 million, net, valued using level 2 inputs. US natural gas price derivatives are valued using observable market data
for maturities up to 60 months in basis locations that trade at a premium or discount to the NYMEX Henry Hub price,
and using internally developed price curves based on economic forecasts for periods beyond that time. The significant
unobservable inputs for fair value measurements categorized within level 3 of the fair value hierarchy for the year ended 31 December 2014 are presented below.
Weighted
Range
average
Unobservable inputs
$/mmBtu
$/mmBtu
Natural gas price contracts
Long-dated market price
3.44-6.39
4.64
If the natural gas prices after 2019 were 10% higher (lower), this would result in a decrease (increase) in derivative
assets of $85 million, and decrease (increase) in derivative liabilities of $64 million, and a net decrease (increase) in profit before tax of $21 million.
1088 Chapter 14
Extract 14.4: Rio Tinto plc (2017)
Notes to the 2017 financial statements [Extract]
30 Financial instruments and risk management continued [Extract]
C(c) Level 3 financial assets and financial liabilities
The table below shows the summary of changes in the fair value of the Group’s Level 3 financial assets and financial liabilities.
2017 2016
Level 3 financial
Level 3 financial
assets and financial
assets and financial
liabilities
liabilities
US$m US$m
Opening balance
479
456
Currency translation adjustments
8
(2)
Total realised gains/(losses) included in:
– Consolidated sales revenue
1
1
– Net operating costs
(5)
(28)
Total unrealised (losses)/gains included in:
– Consolidated sales revenue
17
–
– Net operating costs(a)
(508)
11
Additions
–
43
Impairment
–
(2)
Disposals/maturity of financial instruments
(5)
–
Transfers
6
–
Closing balance
(7)
479
Total (losses)/gains for the year included in the income statement for
assets and liabilities held at year end
(491)
11
(a) (Losses)/gains on embedded commodity derivatives not qualifying for hedge accounting which are included within
net operating costs.
Sensitivity analysis in respect of Level 3 derivatives
The values of forward contracts and options that are determined using observable inputs are calculated using appropriate
discounted cash flow and option model valuation techniques. The most significant of these assumptions relate to long-term pricing wherein aluminium prices are flatlined beyond the market forward curve and increased by a projected inflation after the ten year LME curve. A ten per cent increase in long-term metal pricing assumptions would result in a US$41 million
(31 December 2016: US$38 million) decrease in carrying value. A ten per cent decrease in long-term metal pricing
assumptions would result in a US$22 million (31 December 2016: US$64 million) increase in carrying value.
20.3.9
Highest and best use
As discussed at 10 above, if the highest and best use of a non-financial asset differs from
its current use, entities are required to disclose this fact and why the non-financial asset
is being used in a manner that differs from its highest and best use. [IFRS 13.93(i)]. The
Boards believe this information is useful to financial statement users who project
expected cash flows based on how an asset is actually being used.
20.4 Disclosures for unrecognised fair value measurements
For each class of assets and liabilities not measured at fair value in the statement of
financial position, but for which the fair value is disclosed (e.g. financial assets carried
Fair value measurement 1089
at amortised cost whose fair values are required to be disclosed in accordance with
IFRS 7), entities are required to disclose the following:
(a) the level of the fair value hierarchy within which the fair value measurements are
categorised in their entirety (Level 1, 2 or 3);
(b) if categorised within Level 2 or Level 3 of the fair value hierarchy:
(i)
a description of the valuation technique(s) used in the fair value measurement;
(ii) a description of the inputs used in the fair value measurement;
(iii) if there has been a change in valuation technique (e.g. changing from a market
approach to an income approach or the use of an additional valuation technique):
• the change; and
• the reason(s) for making it; and
(c) for non-financial assets, if the highest and best use differs from its current
use, an
entity must disclose that fact and why the non-financial asset is being used in a
manner that differs from its highest and best use. [IFRS 13.97].
None of the other IFRS 13 disclosures are required for assets and liabilities whose fair
value is only disclosed. For example, even though certain fair value disclosures are
categorised within Level 3, entities are not required to provide quantitative information
about the unobservable inputs used in their valuation because these items are not
measured at fair value in the statement of financial position.
20.5 Disclosures regarding liabilities issued with an inseparable
third-party credit enhancement
IFRS 13 includes an additional disclosure requirement for liabilities measured at fair
value that have been issued with an inseparable third-party credit enhancement (refer
to 11.3.1 above for further discussion regarding these instruments). The standard requires
that an issuer disclose the existence of the third-party credit enhancement and whether
it is reflected in the fair value measurement of the liability. [IFRS 13.98].
21
APPLICATION GUIDANCE – PRESENT VALUE
TECHNIQUES
This section focuses on the application guidance in IFRS 13 regarding the use of present
value techniques to estimate fair value.
21.1 General principles for use of present value techniques
A present value technique is an application of the income approach, which is one of the
three valuation approaches prescribed by IFRS 13. Valuation techniques under the
income approach, such as present value techniques or option pricing models, convert
expected future amounts to a single present amount. That is, a present value technique
uses the projected future cash flows of an asset or liability and discounts those cash flows
at a rate of return commensurate with the risk(s) associated with those cash flows. Present
value techniques, such as discounted cash flow analyses, are frequently used to estimate
the fair value of business entities, non-financial assets and non-financial liabilities, but are
also useful for valuing financial instruments that do not trade in active markets.
1090 Chapter 14
The standard does not prescribe the use of a single specific present value technique, nor
does it limit the use of present value techniques to those discussed. The selection of a
present value technique will depend on facts and circumstances specific to the asset or
liability being measured at fair value and the availability of sufficient data. [IFRS 13.B12].
The application guidance in IFRS 13 regarding the use of present value techniques
specifically focuses on three techniques: a discount rate adjustment technique and two
methods of the expected cash flow (expected present value) technique. These
approaches are summarised in the following table.
Figure 14.11:
Comparison of present value techniques described in IFRS 13
Discount rate adjustment
Expected present value technique
technique
Method 1
Method 2
(see 21.3 below)
(see 21.4 below)
(see 21.4 below)
Nature of cash flows
Conditional cash flows –
Expected cash flows
Expected cash flows
may be contractual or
promised or the most
likely cash flows
Cash flows based on
No Yes
Yes
probability weighting?
Cash flows adjusted
No Yes
– cash risk
No
for certainty?
premium is deducted.
Cash flows represent a
certainty-equivalent
cash flow
Cash flows adjusted
No
Yes
Yes – to the extent
for other market risk?
not already captured
in the discount rate
Discount rate
Yes – uses an observed or
No – already captured
No – already captured
adjusted for the
estimated market rate of
in the cash flows
in the cash flows
uncertainty inherent
return, which includes
in the cash flows?
adjustment for the possible
variation in cash flows.
Discount rate
Yes No
– represents time
Yes – represents the
adjusted for the
value of money only
expected rate of
premium a market
(i.e. the risk-free rate is
return (i.e. the risk-
participant would
used)
free rate is adjusted to
require to accept the
include the risk
uncertainty?
premium)
Additional considerations when applying present value techniques to measuring the fair
value of a liability and an entity’s own equity instrument not held by other parties as
assets are discussed at 11 above.
Fair value measurement 1091
21.2 The components of a present value measurement
Present value measurements use future cash flows or values to estimate amounts in the
present, using a discount rate. Present value techniques can vary in complexity
depending on the facts and circumstances of the item being measured. Nevertheless, for
the purpose of measuring fair value in accordance with IFRS 13, the standard requires a
present value technique to capture all the following elements from the perspective of
market participants at the measurement date:
• an estimate of future cash flows for the asset or liability being measured;
• expectations about the uncertainty inherent in the future cash flows (i.e. the
possible variations in the amount and timing of the cash flows);
• the time value of money – represented by a risk-free interest rate. That is, the rate
on risk-free monetary assets that have maturity dates (or durations) that coincide
with the period covered by the cash flows and pose neither uncertainty in timing
nor risk of default to the holder;
• a risk premium (i.e. the price for bearing the uncertainty inherent in the cash flows);
• other factors that market participants would take into account in the circumstances; and
• for a liability, the non-performance risk relating to that liability, including the
entity’s (i.e. the obligor’s) own credit risk. [IFRS 13.B13].
Since present value techniques may differ in how they capture these elements, IFRS 13
sets out the following general principles that govern the application of any present value
technique used to measure fair value:
(a) both cash flows and discount rates should:
• reflect assumptions that market participants would use when pricing the asset
or liability;
• take into account only the factors attributable to the asset or liability being
measured; and
• have internally consistent assumptions.
For example, if the cash flows include the effect of inflation (i.e. nominal cash
flows), they would be discounted at a rate that includes the effect of inflation,
for example, a rate built off t
he nominal risk-free interest rate. If cash flows
exclude the effect of inflation (i.e. real cash flows), they should be discounted
at a rate that excludes the effect of inflation. Similarly, post-tax and pre-tax cash
flows should be discounted at a rate consistent with those cash flows; and
(b) discount rates should also:
• be consistent with the underlying economic factors of the currency in which
the cash flows are denominated; and
• reflect assumptions that are consistent with those assumptions inherent in the
cash flows.
This principle is intended to avoid double-counting or omitting the effects of risk
factors. For example, a discount rate that reflects non-performance (credit) risk is
appropriate if using contractual cash flows of a loan (i.e. a discount rate adjustment
technique – see 21.3 below). The same rate would not be appropriate when using
1092 Chapter 14
probability-weighted cash flows (i.e. an expected present value technique –
see 21.4 below) because the expected cash flows already reflect assumptions
about the uncertainty in future defaults. [IFRS 13.B14].
21.2.1
Time value of money
The objective of a present value technique is to convert future cash flows into a present
amount (i.e. a value as at the measurement date). Therefore, time value of money is a
fundamental element of any present value technique. [IFRS 13.B13(c)]. A basic principle in
finance theory, time value of money holds that ‘a dollar today is worth more than a dollar
tomorrow’, because the dollar today can be invested and earn interest immediately.
Therefore, the discount rate in a present value technique must capture, at a minimum, the
time value of money. For example, a discount rate equal to the risk-free rate of interest
encompasses only the time value element of a present value technique. If the risk-free
rate is used as a discount rate, the expected cash flows must be adjusted into certainty-
equivalent cash flows to capture any uncertainty associated with the item being measured
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 215
