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Chapter 10 - Measuring Fair Value of Liabilities and Equity Instruments
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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- Anthem Press
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- 15 September 2022
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- 17 May 2022, pp 89-116
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Summary
Guiding Principle
The Standards include a chapter dedicated to the manner in which a reporting entity should apply the fair value measurement to its liabilities and equity instruments. Generally speaking, it may be said that, in most cases that require a reporting entity to measure the fair value of its liabilities, the measured liabilities will be financial ones. For instance, under International Financial Reporting Standards (IFRS), in certain situations, IFRS 9 includes provisions that allow the reporting entity to designate financial liabilities as at fair value through profit or loss, and under certain circumstances (such as in the case of financial liabilities held for trading), it even requires the liability to be measured at fair value. In addition, the fair value of financial liabilities is also required to be measured at initial recognition, including when separating an embedded derivative that is not closely related to the host debt contract, or when separating a compound instrument into the debt component and the complementary equity component. Such measurement is also required when significant contractual changes are made to the terms of a financial liability.
It may be said that it is not often that IFRSs (or US Generally Accepted Accounting Principles (US GAAP) Standards, in this regard) require reporting entities to measure the fair value of their own equity instruments. This stems from the fact that IFRS 2—Share-Based Payment is excluded from the provisions of IFRS 13 (for more information, see Chapter 2, Section 2.2) as are Accounting Standards Codification (ASC) Topic 718—Compensation—Stock Compensation and ASC 505– 50—Equity—Equity-Based Payments to Non-Employees with regard to ASC 820's scope.
Furthermore, normally, under IFRS when the reporting entity buys or issues its own equity instrument, International Accounting Standard (IAS) 32—Financial Instruments: Presentation requires to measure such a transaction at cost. Therefore, in our view, the most common cases in which a reporting entity may be required to measure the fair value of its equity instruments under the provisions of IFRS 13 are when the reporting entity pays consideration in a business combination (or acquires significant influence in an associate or joint control in a joint venture), by way of issuing or transferring its equity instruments.
Chapter 11 - Application to Financial Instruments with Netting Positions
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Overview
Sometimes, financial institutions and other similar reporting entities manage a group of financial assets and financial liabilities (a portfolio) on the basis of the net exposure to market risks or to credit risk (of a particular counterparty). This means a portfolio that includes financial assets and financial liabilities with risks that offset one another, which is done intentionally (rather than arbitrarily or incidentally).
As a rule, fair value is measured at the level of the relevant unit of account. Normally the unit of account of financial instruments is an individual instrument (for more details, see Chapter 3, Section 3). The offset (netting) of mutual exposures within the portfolio (e.g., offsetting a mutual credit risk) is an entity-specific characteristic rather than a separate characteristic of each of the portfolio's instruments. Therefore, it cannot be taken into account in the measurement of fair value in an ordinary situation. This means that if a portfolio has a shared characteristic that causes a certain risk to be mitigated or diversified, such as a master netting agreement (for more information, see Chapter 10, Section 5.3), this characteristic will generally not be taken into consideration in a fair value measurement of its components. Furthermore, even if from the perspective of a market participant it made sense to transfer the financial assets along with the financial liabilities, the Standards reject the joint valuation premise when it comes to financial instruments (for more information, see Chapter 9, Section 3), and therefore, such an assumption should not be made.
In other words, according to the ordinary principles established by the Standards, each of the exposures within the portfolio should be estimated separately (on a gross basis). Indeed, this accounting treatment may be different from the reporting entity's internal risk management and may even require the reporting entity to maintain a dual system: one for risk management purposes (based on net exposures) and another to estimate the risk for financial statement purposes.
Chapter 8 - Fair Value at Initial Recognition
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Does the Transaction Price Represent the Fair Value?
Under International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP), certain standards stipulate that assets or liabilities should initially be measured at fair value (or on the basis of fair value plus transaction costs). This applies particularly to financial instruments but also to assets or liabilities that are recognized in a business combination. Under IFRS, however, a day 1 gain or loss on a financial instrument is recognized only when the fair value of that instrument is evidenced by observable inputs or market transactions.
One of the basic questions IFRS 13 and Accounting Standards Codification (ASC) 820 deal with in this context is whether it is conceptually possible that the fair value at initial recognition will be different than the transaction price. The answer to that question is that the definition of fair value is based on the exit price, whereas the transaction price is an entry price. In other words, there are certainly circumstances in which the entry price will not equal the exit price, and the Illustrative Examples provided by the Standards even clarify explicitly that the Standards do not purport to suggest such a presumption. Statement of Financial Accounting Standard (SFAS) 157's Basis for Conclusions stated clearly that the fact that no such presumption exists was a departure from US GAAP Concepts Statement 7, which stated that cash and cash equivalents paid or received are usually assumed to approximate fair value in the absence of evidence to the contrary. On the other hand, the Standards note that, in many cases, the transaction price will, indeed, equal the exit price and will therefore also represent the fair value of the asset or liability (e.g., that might be the case when the transaction to acquire an asset takes place in the market in which the asset would be sold). Therefore, reporting entities should exercise judgment in order to determine whether the transaction price represents the fair value.
Chapter 9 - Application to Nonfinancial Assets
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Overview
The fair value basis is relevant, among other things, to the measurement of various classes of nonfinancial assets. Specifically, this basis is relevant, or may be relevant under International Financial Reporting Standards (IFRS), to investment property; property, plant and equipment; intangible assets; biological assets; cash-generating units; or noncurrent assets held for sale (for more details, see Chapter 1, Section 2). While discussing the provisions of the Standards, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) reached the conclusion that they should include specific measurement (and disclosure) provisions that are applicable only to nonfinancial assets. In principle, as described in detail below, it may be said that the said guidelines deal with the issue of the highest and best use of non-financial assets and with the related issue of the valuation premise. In practice, these or similar principles existed long before the current Standards were finalized, within general practices for valuation of nonfinancial assets (and within specific practices regarding land appraisal), and those principles were formally incorporated into the Standards. Among other things, the highest and best use principle is incorporated into International Valuation Standards (IVS), as well as into Royal Institution of Chartered Surveyors (RICS) Professional Standards (“Red Book”), which are widely accepted appraisal standards that adopted the IVS. It was also mentioned in Statement of Financial Accounting Standards (SFAS) 157 and in US Generally Accepted Accounting Principles (US GAAP) Concepts Statement 7.
The guidelines regarding the principle of highest and best use and the valuation premise are irrelevant to financial assets or financial liabilities, due to, among other things, the view whereby financial assets and financial liabilities (unlike nonfinancial items) do not have an alternative use, such that the manner in which they are used or utilized depends only on their contractual terms.
The Highest and Best Use Premise
Guiding principle
Generally, the fair value of nonfinancial assets is measured under the highest and best use premise. The Standards define the highest and best use as the use of a nonfinancial asset by market participants that would maximize the value of the asset or the group of assets and liabilities within which the asset would be used, such as a business or a cash-generating unit.
Chapter 13 - Disclosure Provisions
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Overview
The Standards establish extensive disclosure requirements regarding fair value measurement. These requirements relate, among other things, to the valuation techniques used, the inputs used and the quality of these inputs (with an emphasis on Level 3 inputs, which are much more subjective); to the transfer between levels of the fair value hierarchy; and so forth.
In principle, reporting entities shall present the quantitative disclosures required by the Standards in a tabular format unless another format is more appropriate. Detailed illustrative examples were published as an appendix to the Standards; these examples illustrate, among other things, quantitative disclosure in a tabular format, which includes disaggregation into classes. The examples included in this section are based (with some changes) on the examples in the appendix to International Financial Reporting Standard (IFRS) 13.
The Scope of the Disclosure Requirements
Under IFRS, it should be mentioned that the disclosure section does not apply to certain fair value measurements, which are subject to IFRS 13's measurement provisions (for more information, see Chapter 2, Section 2.3).
The disclosure chapter of the Standards includes provisions that relate only to measurement of assets or liabilities. Therefore, when the reporting entity measures fair value, but not in the context of assets or liabilities (e.g., measuring the fair value of equity instruments issued as consideration as part of a transaction for the extinguishment of a financial liability with equity instruments, which is accounted for under IFRS in accordance with International Financial Reporting Interpretations Committee's Interpretation 19 (IFRIC 19)), in our view, such disclosure provisions will not apply. Furthermore, in our view, a similar conclusion applies to the measurement of fair value of the equity instruments of the reporting entity used as consideration in a business combination.
IFRS 13's explanatory notes clarify that the disclosure provisions apply only to subsequent measurements (regardless of whether those measurements are recurring or nonrecurring; see below), and they do not apply to fair value measured at initial recognition of assets or liabilities. This is also the case in the August 2018 amendments in Accounting Standards Codification (ASC) 820 described in Section 3. Thus, for example, the disclosure provisions do not apply to measurement of the fair value of financial instruments at initial recognition or to measurement of the fair value of assets and liabilities recognized in a business combination
Chapter 7 - Definition of an Orderly Transaction
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Guiding Principle
Fair value is the amount that would have been received in an orderly transaction. The term “orderly transaction” is defined as a transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (e.g., a forced liquidation or distress sale).
International Financial Reporting Standard (IFRS) 13 and Accounting Standards Codification (ASC) 820 recognize that the sale price that will be determined in a transaction between market participants may also depend on the extent of exposure to the market and on the situation of the parties to the transaction. As an example, let us assume that a reporting entity is required to measure the fair value of a large office building it owns. The selling process of such an office building may take time (e.g., six months), due to the size of the transaction, the need to find a suitable buyer, the performance of due diligence procedures (to evaluate financial, legal and physical aspects of the building and transaction) by potential buyers, conducting negotiations, raising funding by the buyer and so forth. If the reporting entity will be forced to dispose of the building quickly, this might be reflected in a lower transaction price, since under such circumstances, the reporting entity will be unable to find an optimal buyer or to allow buyers to complete sufficient due diligence procedures or raise adequate funding, which will increase the level of risk undertaken by the potential buyers and may lead them to offer a significantly lower price for the property in order to justify their undertaking of the risk. It is also recognized that the normal period of marketing efforts depends on the nature of the measured item. While a relatively long period of market exposure is required for the abovementioned office building, more standard assets, such as cars or apartments, usually require a shorter normal period.
The term “orderly transaction” is important for two main reasons:
Firstly, this term instructs the reporting entity to measure the fair value as the price that would have been obtained in a hypothetical orderly transaction, even if the reporting entity has not actually taken steps to sell the asset prior to the measurement date.
Preface
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Fair value, currently a very significant measurement base in financial statements, and a commonly used term in itself, is, somewhat surprisingly, a relatively new term in the world of accounting. Just to illustrate, the Framework for the Preparation and Presentation of Financial Statements, originally published in 1989 by the International Accounting Standards Board (IASB), makes no reference whatsoever to this term. This is despite the fact that measurement bases having similar or overlapping principles, such as present value or realizable value, are, indeed, mentioned.
The term “fair value” was first mentioned in US Generally Accepted Principles (US GAAP) in Statement of Financial Accounting Concepts No. 7 regarding Using Cash Flow Information and Present Value in Accounting Measurements, published by the Financial Accounting Standards Board (FASB) in 2000, although parts of the definition itself but not the term “fair value” were already used in Statement of Financial Accounting Concepts No. 6 regarding Elements of Financial Statements, originally published in 1985.
Over the years, fair value has been used increasingly by the world's leading accounting standard-setting bodies, both for measurement and for disclosure purposes. Thus, for example, using fair value as a measurement base is currently widespread in measurement of financial instruments and business combinations, and under International Financial Reporting Standards (IFRSs), fair value is also employed to measure investment property. As fair value became an increasingly used measurement base, the need to formulate a uniform and consistent rationale for fair value measurement has arisen, along with the need to put in place comprehensive disclosure principles that will provide financial statements’ users with additional information, among other things, about the reliability of fair value estimates. This rationale was first reflected in US GAAP in Statement of Financial Accounting Standards No. 157—Fair Value Measurements (SFAS 157) and thereafter in the provisions of IFRS upon publication of IFRS 13—Fair Value Measurement, which, in effect, converged with the American standard.
This book aims to serve as a comprehensive guide to fair value measurement. In this book, we gradually unfold a comprehensive framework of fair value measurement from a detail-oriented and practical standpoint, both pursuant to IFRS 13 and Accounting Standards Codification (ASC) 820. This is done while referring to subtle nuances between the two accounting standard systems, including with regard to disclosure.
Chapter 1 - Background
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Overview
While the rule-based US Generally Accepted Accounting Principles (US GAAP) do not widely adopt fair value as a measurement basis, this is not the case with the International Financial Reporting Standards (IFRSs). The latter currently use fair value quite extensively, both for measurement and for disclosure purposes, with one of the key differences lying in the revaluation of investment property and property, plant and equipment (PPE) allowed only under IFRS.
However, fair value as a measurement basis is a relatively new accounting concept, at least from a historical perspective. Interestingly, the Framework for the Preparation and Presentation of Financial Statements (for International Accounting Standards (IASs)), originally published in 1989, made no mention of the term. It did mention several other possible measurement bases, such as historical cost, present value, current cost and realizable value. However, the conceptual difference, if any, between the various measurement bases—other than historical cost—was not clearly explained.
Over the years, the IASs underwent significant changes, with one of the most important presumably being the growing use of fair value as a measurement basis. Fair value also sometimes doubles as an acceptable basis for disclosure. However, prior to the formulation of IFRS 13—Fair Value Measurement, other IASs offered no unified definition of this measurement basis, nor did they provide a consistent framework for its estimation. Consequently, certain IASs that made use of fair value (for several current examples, see Section 2), as well as the related practice, were not always consistent in applying the measurement principles and even in its basic definition. In addition, some of the Standards, such as IAS 39—Financial Instruments: Recognition and Measurement, which was later superseded by IFRS 9—Financial Instruments, included a relatively detailed set of guidelines regarding the measurement of fair value, while other Standards, such as IAS 41—Agriculture, only included limited guidelines.
Originally published in 2000, US GAAP Concepts Statement 7 did discuss the fair value basis of measurement, but a similar phenomenon of multiple definitions and limited guidance was also the case under US GAAP prior to the publication of Statement of Financial Accounting Standards No. 157—Fair Value Measurements in 2006 (SFAS 157). The US national accounting standardsetter, the Financial Accounting Standards Board (FASB), was the first of the two accounting standard-setters to address this problem, with the publication of SFAS 157.
Chapter 6 - Defining the Transaction Price
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Exit Price
Fair value is the exit price, which is defined as the price that would be received to sell an asset or paid to transfer a liability. It is apparent from this definition that the exit price takes into account the perspective of the selling market participant, whereas the entry price, which is the price paid to buy an asset or the price received to assume a liability, takes into consideration the perspective of the buying market participant.
Certain International Financial Reporting Standards (IFRSs) (such as IFRS 3 or IFRS 9) stipulate that upon initial recognition, certain assets or liabilities should be measured at their fair value or based on their fair value. Similar provisions also exist within Accounting Standards Codification (ASC) 805 and ASC 815. In other words, for the purpose of measurement at initial recognition, the fair value is, in fact, calculated under the notional sale assumption. That is to say, the question of whether the reporting entity intends to hold the asset or the liability is irrelevant to the definition of fair value, which is measured under a sale assumption. The issue of the price that best represents the fair value was discussed during the development of IFRS 13 and ASC 820 in the context of selecting the entry price as a potential alternative to the definition of fair value upon initial recognition. Indeed, it was decided to reject this alternative, among other reasons, on the grounds that when the buying and selling are performed in the same market, in the same manner and on the same date, the exit price from the perspective of market participants equals the entry price (for more information, see Chapter 8). Nevertheless, the cases for which the exit price is not necessarily the price that best reflects the objective of the measurement were excluded from the scopes of IFRS 13 and ASC 820 (for more information, see Chapter 2, Sections 2.1– 2.4).
Transaction Costs
IFRS 13 and ASC 820 refer specifically to adjustments to the transaction price and stipulate that the price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. In other words, the transaction price should not be reduced when the transaction involves an asset, and it should not be increased when the transaction involves a liability.
Chapter 4 - Determining the Market in Which the Transaction Will Take Place
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Fair value is defined 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.” This definition requires to characterize the relevant market under the current conditions of which the transaction will be conducted and the identity of the participants in that market (for more information, see Chapter 5). This is required since the market in which the transaction is conducted may impact the transaction price.
However, it should be noted that the term “market” is not expressly defined. In certain situations, such as in the case of financial instruments that are traded on several stock exchanges, the term appears to be sufficiently understandable, and the issue in question is which stock exchange's quoted prices should the instrument's fair value be based on. However, at times, the term may take on a more abstract meaning. Thus, for example, under International Financial Reporting Standard (IFRS) and according to the provisions of International Accounting Standard (IAS) 41—Agriculture, a reporting entity selling agricultural produce (e.g., apples) is required to measure the fair value of its produce at the point of harvest (under US Generally Accepted Accounting Principles (US GAAP), agricultural products are measured using historical cost until harvested). The apples are sold by the reporting entity in many markets (e.g., in wholesale markets as well as in retail markets), and they definitely have the potential of being exported to numerous countries worldwide, whose markets are characterized by different price levels. Here, according to the provisions of IFRS 13 (and Accounting Standards Codification (ASC) 820), in order to determine the fair value, it is essential to first select the market in which the measurement will take place.
Other cases in point include products such as cars. When determining the fair value of cars, it is first essential to identify the market in which the transaction will take place. Thus, for example, market sale prices in transactions between car importers and leasing companies (the leasing market) may be lower than the sale prices for private customers.
Fair Value in Accounting
- From Theory to Practice
- Shlomi Shuv, Yevgeni Ostrovsky
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Fair Value Accounting: From Theory to Practice is a comprehensive guide to fair value measurement - one of the foundations of modern-day accounting. Fair value measurement is extremely important since it touches upon both accounting and finance. Many items in the financial statements are measured at fair value, e.g. financial instruments, items acquired in business combinations and, under IFRS, investment property. In addition, fair value is used extensively as a valuation base by corporate finance and valuation specialists. The book gradually unfolds the full theoretical framework for measuring fair value for accounting purposes, while providing clear, hands-on implementation guidelines. It includes concise and informative explanations, focusing on the theoretical and practical issues arising from the relevant accounting standards and using illustrative examples and further analysis.
The book covers fair value in accordance with the two most prevalent accounting systems used worldwide: International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP). Although they take very similar approaches to the topic, there are some slight, albeit significant, differences between them that are thoroughly discussed in the book.
The book combines professional accounting literature, standards and practice into a single well-rounded and user-friendly resource. The book is intended as an essential tool not only for professionals involved in preparing or auditing financial statements – such as accountants and financial managers – but also for practitioners in related domains, such as appraisers and preparers of valuations for legal proceedings based on fair value. The book includes many practical examples for students (specifically, accounting students as well as individuals preparing to take the CPA exams) and accounting and finance researchers as well as for other academic purposes.
Frontmatter
- Shlomi Shuv, Yevgeni Ostrovsky
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Chapter 2 - Definition and Scope of Fair Value
- Shlomi Shuv, Yevgeni Ostrovsky
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Summary
Definition of Fair Value and the Fair Value Measurement Approach
International Financial Reporting Standard (IFRS) 13 and Accounting Standards Codification (ASC) 820 define 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. Despite the fact that this definition is relatively short, each of its components (exit price, orderly transaction, market participants and the measurement date) is of great significance. First, it is explicitly noted in the definition that the theoretical transaction is carried out on the measurement date, thereby emphasizing that the market conditions to be taken into consideration for the purpose of determining the valuation should be those at the valuation date rather than past market conditions or market conditions that may exist in the future. Furthermore, the definition means that to determine fair value, the reporting entity is required to refer to several issues:
a. Identify the item to be measured (in view of the unit of account) (for more information, see Chapter 3 ).
b. Identify the principal market (and in some cases, the most advantageous market) for the asset or the liability (for more information, see Chapter 4 ).
c. For nonfinancial assets, identify the highest and best use of the asset, subject to existing restrictions (for more information, see Chapter 9).
d. Identify and select the appropriate valuation techniques while maximizing the use of available market input and taking into consideration the assumptions of market participants (for more information, see Chapter 12).
Items within the Scope of the Standards
Overview
Generally speaking, the scopes of IFRS 13 and ASC 820 are considerable, which make them relevant to most cases where fair value measurements are made.
Formally, the Standards apply when another IFRS or US Generally Accepted Accounting Principles (US GAAP) topic requires or allows fair value measurements to be carried out. The Standards also apply in cases where measurements are based on fair value, that is, whether the fair value is the final outcome or an intermediate stage. Under IFRS, a case where fair value serves as the final outcome is the measurement required by International Accounting Standards (IAS) 40, in which the reporting entity opts to measure investment property at fair value on subsequent dates (for more examples, see Chapter 1, Section 2).
Contents
- Shlomi Shuv, Yevgeni Ostrovsky
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Chapter 3 - Identifying the Asset or Liability to Be Measured
- Shlomi Shuv, Yevgeni Ostrovsky
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Summary
Overview
Before measuring the fair value, it is first required to identify the item whose value is to be measured, since the type of item to be measured may impact the outcome of the valuation. To identify the item to be measured, the reporting entity should take into account the specific characteristics of the asset or the liability that market participants would have also taken into account when determining the transaction price. These characteristics will be taken into consideration when determining the fair value, unlike characteristics specific to the reporting entity, which are not transferred along with the asset or liability and which are not to be taken into consideration when determining the fair value. The question of the item to be measured is closely related to the unit of account question, which is relevant to the asset or liability (for more information, see Section 3). The unit of account is the level at which the asset or liability is aggregated or disaggregated, that is, the unit of account will determine whether the item is measured on a standalone basis or in combination with a group of items that may include either assets or liabilities or both assets and liabilities. It should be clarified that even when the unit of account is defined as an individual asset, it is still possible that the valuation premise will be that, from the perspective of a potential market participant, the asset will be operated with other assets or liabilities, even if those assets or liabilities are not part of the unit of account and are not part of the relevant transaction (for more information, see Chapter 9, Section 3).
Characteristics of an Asset or Liability versus
Characteristics of the Entity Holding the Asset
Fair value measurement is carried out from a market participant's perspective and relates to a specific asset or liability (i.e., while taking into account relevant characteristics of the asset or liability). As a rule, fair value measurement should take into consideration characteristics of an asset or a liability if and only if market participants would have done so. The extent to which the influence of a certain characteristic should be taken into consideration is the extent to which it would have been attributed to that characteristic by market participants.
Chapter 12 - Valuation Techniques
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Overview
The Standards require fair value to be measured by way of some calculation. In some cases, this calculation can be quite simple. For example, when the fair value is estimated based on a quoted price in an active market of an identical asset or liability, such as an investment in listed shares held by the reporting entity. In such cases, the reporting entity shall multiply the quoted price in the active market by the number of instruments (e.g., shares) it holds. This calculation is sometimes called P × Q (for more information, see Section 2.2).
Another example of a relatively simple calculation is when the fair value of a certain item (such as an investment property) is estimated based on the price paid in an orderly and recent transaction involving that specific asset. For instance, when the reporting entity holds, as of the measurement date, a nonspecific half of a particular building and measures the fair value of that half according to the price in an orderly and current transaction in which the other nonspecific half of the building was recently sold.
Sometimes, however, the calculation will be much more complex, and performing it or selecting the inputs to be used will require the reporting entity to exercise more significant judgment. Thus, for example, it is possible that the market inputs being used in the measurement or the valuation technique itself may need to be adjusted due to unique characteristics of the measured item or due to other factors. Sometimes, reporting entities will need to use various forecasts or relatively complex mathematical methods and formulae and so forth.
The calculation used to measure the fair value (regardless of whether it is a simple or a complex calculation) is called in the Standards a “valuation technique.” The Standards provide provisions and guidelines regarding various aspects of valuation techniques, such as:
a. Considerations in selecting a valuation technique (for more information,
b. Principal approaches of valuation techniques (for more information, see Section 3);
c. Using multiple valuation techniques (for more information, see Section 4);
d. Calibration of valuation techniques (for more information, see Section 5);
e. Changing the valuation techniques (for more information, see Section 6);
f. Adjusting inputs used in the valuation or adjusting the valuation techniques themselves (for more information, see Section 7); and
g. Selecting the inputs used in the valuation technique and the fair value hierarchy (for more information, see Section 8).
Chapter 5 - Identifying Market Participants
- Shlomi Shuv, Yevgeni Ostrovsky
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- Fair Value in Accounting
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Summary
Another significant key element of the definition of the fair value is the use of assumptions that would have been made by market participants when pricing an asset or a liability, since the measurement is not specific to the reporting entity. Accordingly, after the characteristics of the item and the relevant market are defined (for more information, see Chapters 3 and 4), the market participants in a specific market should also be identified, in a manner that is consistent with the nature of the asset or liability and with the preliminary identification of the market in which the hypothetical transaction will take place to sell the asset or transfer the liability being measured.
The reporting entity is required to identify the characteristics that are generally unique to participants in the market in which the measurement is being made, but it is not necessarily required to identify specific participants (e.g., to specifically identify the particular buyers that may participate in the relevant transaction).
Market participants are defined as buyers and sellers in the principal market (or most advantageous market, as the case may be) that have all the following characteristics:
a. They are independent of each other, that is, they are not related parties (as defined in International Accounting Standard (IAS) 24—Related Party Disclosures or Accounting Standards Codification (ASC) Topic 850—Related Party Disclosures, respectively), although the price in a related party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms (for more information, see Chapter 7).
b. They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary. The premise here is that the knowledge and understanding of the investors will be sufficient to enable them to identify the relevant risk factors and take those factors into consideration when calculating the transaction price.
c. They are able to enter into a transaction for the asset or liability—that is, no restriction is placed on market participants that may prevent them from entering into the transaction (e.g., restrictions imposed by the Antitrust Authority or restrictions due to financial or operational capabilities).