IFRS 13 Fair Value Measurement © IFRS Foundation

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Agenda Part I: context and scope Part II: measurement of fair value Part III: valuation approaches and techniques Part IV: disclosures Part V: effective date and transition 3 © IFRS Foundation

Part I Context and scope © IFRS Foundation

Part I: context and scope Why IFRS 13 is necessary Scope—when IFRS 13 applies Scope—what IFRS 13 does not apply to 5 © IFRS Foundation

Before IFRS 13–dispersed and conflicting guidance 6 IAS 40IAS 39/IFRS 9IAS 41IAS 36 Etc. IFRS 13 Single source of measurement guidance Clear measurement objective Consistent and transparent disclosures about fair value Topic 820 in US GAAP (codified SFAS 157) © IFRS Foundation

The previous definition of fair value 7 Fair value definitionIts weaknesses The amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction. It did not specify whether an entity is buying or selling the asset ? It was unclear about what ‘settling’ meant because it did not refer to the creditor It was unclear about whether it was market-based It did not state explicitly when the exchange or settlement takes place © IFRS Foundation

When does IFRS 13 apply? When another IFRS requires or permits fair value measurements or disclosures about fair value measurements IFRS 13 also applies to measurements, such as fair value less cost to sell, based on fair value or disclosures about those measurements 8 © IFRS Foundation

When does IFRS 13 apply? 9 For example, if you own a biological asset… IAS 41 A biological asset shall be measured on initial recognition and at the end of each reporting period at its fair value less cost to sell IFRS 13 What and when How © IFRS Foundation

What does IFRS 13 not apply to? 10 Excluded from the scope IFRS 2 and IAS 17 Disclosures in IFRS 13 not required for Plan assets (IAS 19) Retirement benefit plan investments (IAS 26) Assets for which recoverable amount is fair value less cost of disposal (IAS 36) Not required for measurement similar to fair value IAS 2 (net realisable value) IAS 36 (value in use) © IFRS Foundation

Part II Measurement of fair value © IFRS Foundation

Part II: measurement of fair value Definition of fair value and measurement principles Considerations specific to non-financial assets Considerations specific to liabilities 12 © IFRS Foundation

Definition of fair value and measurement principles © IFRS Foundation

IFRS 13’s ‘new’ definition of fair value 14 New fair value definitionComments … 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. It specifies that the entity is selling the asset It refers to the transfer of a liability It is clear it is market-based It states explicitly when the sale or transfer takes place It is not a forced or distressed sale © IFRS Foundation

Fair value at initial recognition Transaction price (entry price) = Fair value (exit price) unless: –Transaction takes place in different markets –Transactions are for different units of account –Seller is distressed or forced –Transactions are between related parties 15 © IFRS Foundation

A hypothetical transaction price 16 Market participant buyer Market participant seller Fair value of Principal market (or most advantageous market) an asset a liability at the measurement date © IFRS Foundation

Who would transact for the item? Market participants are buyers and sellers in the principal (or most advantageous) market who are: Market participants act in their economic best interest –Maximise the value of the asset –Minimise the value of the liability 17 IndependentKnowledgeable Able to enter into a transaction Willing to enter into a transaction © IFRS Foundation

What is being measured? Unit of account –IAS 41: A biological asset shall be measured … at its fair value less costs to sell… Characteristics –Which characteristics would a market participant buyer take into account? –age and remaining economic life –condition –location –restrictions on use or sale –contractual terms 18 © IFRS Foundation

Where would the transaction take place? In most cases, these markets will be the same –arbitrage opportunities will be competed away The entity must have access to the principal (or most advantageous) market 19 Fair value is the price in the … Principal market Or, if no principal market, the most advantageous market The market with the greatest volume and level of activity for the asset or liability The market that maximises the amount that would be received to sell the asset and minimises the amount that would be paid to transfer the liability © IFRS Foundation

Transaction and transport costs 20 DescriptionIncluded in fair value? Transaction costs The costs to sell the asset or transfer the liability that are directly attributable to the disposal of the asset or the transfer of the liability No(Although they are considered in the assessment of which market is most advantageous) They are a characteristic of the transaction, not of the asset or liability Transport costs The costs that would be incurred to transport an asset from its current location to its exit market YesTransport changes a characteristic of the asset (its location) © IFRS Foundation

How do we arrive at a market-based measurement? 21 Is there a quoted price in an active market for an identical asset or liability? Use this quoted price to measure fair value (Level 1) Replicate a market price through a valuation technique* (using observable + and unobservable inputs: Levels 2 and 3) No significant unobservable (Level 3) inputs ‡ = Level 2 measurement Use of significant unobservable (Level 3) inputs ‡ = Level 3 measurement Must use without adjustment YesNo * Valuation techniques include the market approach, income approach and cost approach. + Maximise the use of relevant observable inputs and minimise the use of unobservable inputs. Observable inputs include market data (prices and other information that is publicly available). ‡ Unobservable inputs include the entity’s own data (budgets, forecasts), which must be adjusted if market participants would use different assumptions. © IFRS Foundation

Considerations specific to non-financial assets © IFRS Foundation

Highest and best use Fair value assumes a non-financial asset is used by market participants at its highest and best use –the use of a non-financial asset by market participants that maximises the value of the asset –physically possible –legally permissible –financially feasible 23 © IFRS Foundation

Highest and best use continued Highest and best use is determined from the perspective of market participants, even if the entity intends a different use. However, an entity’s current use of a non-financial asset is presumed to be its highest and best use unless market or other factors suggest that a different use by market participants would maximise the value of the asset. 24 © IFRS Foundation

Highest and best use continued Highest and best use is usually (but not always) the current use –if for competitive reasons an entity does not intend to use the asset at its highest and best use, the fair value of the asset should still be measured assuming its highest and best use by market participants (defensive value) Does not apply to financial instruments or liabilities 25 © IFRS Foundation

Valuation premise A non-financial asset either: –provides maximum value through its use in combination with other assets and liabilities as a group –is its value influenced by it being ‘operated’ with other assets? –an example: equipment used in production facility –market participants are assumed to hold complementary assets –provides maximum value through its use on a stand-alone basis –is its value independent of its use with other assets? –an example: a vehicle or an investment property Does not apply to financial instruments or liabilities 26 © IFRS Foundation

Considerations specific to liabilities © IFRS Foundation

Transfer notion–liabilities and an entity’s own equity instruments Fair value assumes a transfer to a market participant who takes on the obligation. The transfer assumes: 28 Liability or equity remains outstanding Restrictions on transfer are already reflected in inputs; no additional adjustment required Fair value of a liability reflects the effect of non-performance risk © IFRS Foundation

Decision tree—liability measurement 29 Is there an observable market price to transfer the instrument? Does somebody hold the corresponding asset? Fair value = observable market price of instrument Fair value = fair value of the corresponding asset Is there an observable market price for the instrument traded as an asset? Fair value = another valuation technique* No Yes No Yes Fair value = observable market price of asset No Fair value = another valuation technique * Using the perspective of a market participant that owes the liability or issued the claim on equity Level 2 or 3 © IFRS Foundation

No corresponding asset Two possible ways to approach it: 1.Use the future cash flows that a market participant would expect to incur in fulfilling the obligation, including the compensation that a market participant would require for taking on the obligation. Such compensation includes: –the cost to fulfil the obligation plus a return for undertaking the activity; and –a risk premium to compensate for the risk that actual cash flows might differ from expected cash flows. 30 © IFRS Foundation

No corresponding asset continued 2.Use the amount that a market participant would receive to enter into or issue an identical liability or equity instrument. 31 © IFRS Foundation

Part III Valuation approaches and techniques © IFRS Foundation

Part III: valuation techniques Valuation approaches Valuation techniques—illustration for unquoted equity instruments Bid and ask spread, premiums and discounts Measuring the fair value of portfolios 33 © IFRS Foundation

Valuation approaches © IFRS Foundation

Valuation approaches Market approach –prices from market transactions for identical or similar assets or liabilities, for example: –using market multiples (eg of earnings or cash flows) from a set of comparable companies and applying those multiples to the earnings or cash flows of the company being valued 35 Measure fair value using valuation techniques that are appropriate in the circumstances and for which sufficient data are available. © IFRS Foundation

Valuation approaches continued Cost approach –the cost to acquire or reconstruct a substitute asset of comparable utility, adjusted for physical, functional and economic obsolescence –often used for PP&E and some intangibles Income approach –converts future amounts (eg cash flows) to a single current discounted amount, for example: –present values –option pricing models –multi-period excess earnings method 36 © IFRS Foundation

Selecting a valuation approach 37 Level 2 Level 1 Level 3 Market approach Market price is available Price needs adjustment Observable inputs Price for identical item Must be used without adjustment Cost approach (eg replacement cost) Income approach (eg discounted cash flow) Observable inputs Rare Observable inputs Rare Price needs adjustment Unobservable inputs Not directly income-producing No identical market price Price needs adjustment Directly identifiable cash flows © IFRS Foundation

Valuation techniques—illustration for unquoted equity instruments © IFRS Foundation

Measuring the fair value of unquoted equity instruments Scope of this particular illustration: –Unquoted equity instruments  not quoted in an active market –Non-controlling interest within the scope of IFRS 9 A range of valuation techniques can be used. Judgement is involved –in the selection of a valuation technique (given specific facts and circumstances, some techniques might be more appropriate than others) –when applying the valuation technique © IFRS Foundation

Valuation approaches and techniques Valuation approaches Valuation techniques Market approachTransaction price paid for an identical or a similar instrument of an investee Comparable company valuation multiples Income approachDiscounted cash flow (DCF) method Dividend discount model (DDM) Constant-growth DDM Capitalisation model A combination of approaches may be used Adjusted net asset method 40 © IFRS Foundation

Market approach Uses prices and other relevant information that have been generated by market transactions that involve identical or comparable assets. Techniques that are most commonly referred to for valuing unquoted equity instruments are related to the data sources that they use: –transaction price paid for an identical or a similar instrument of an investee –comparable company valuation multiples derived from quoted prices (ie trading multiples) or from prices paid in transactions such as mergers and acquisitions (ie transaction multiples) 41 © IFRS Foundation

Valuation multiples 42 © IFRS Foundation

Fair value measurement using valuation multiples–four steps Identify comparable company peers. Select the performance measure that is most relevant to assessing the value for the investee. Apply the appropriate valuation multiple to the relevant performance measure of the investee to obtain an indicated fair value of the investee’s equity value or the investee’s enterprise value. Make appropriate adjustments to ensure comparability (eg non-controlling interest discount). 43 © IFRS Foundation

Commonly used valuation multiples 44 © IFRS Foundation

Example–applying comparable company peers’ multiples Investor has 5% non-controlling interest in Entity J (private company) and measures it at fair value. Financial information about Entity J –Normalised EBITDA = CU*100 million –Debt at FV = CU350 million Six comparable public company peers (same business and geographical region) EV/EBITDA multiple was chosen because there are differences in capital structure and depreciation policies between J and peers. No relevant non-operating items. 45 © IFRS Foundation * CU = currency units

Example–applying comparable company peers’ multiples continued Step 1  Identify comparable peers The investor has selected six comparable public company peers that operate in the same business and geographical region as Entity J. Step 2  Select the performance measure that is most relevant to assessing the value for the investee. The investor has chosen the EV/EBITDA multiple to value Entity J because there are differences in the capital structure and depreciation policies between Entity J’s comparable company peers and Entity J. 46 © IFRS Foundation

Example–applying comparable company peers’ multiples continued Step 3  Apply valuation multiple to obtain fair value Trading multiples of the comparable public company peers are: 47 Upon further analysis, these entities are considered comparable (ie similar risk, growth and cash flow-generating profiles © IFRS Foundation

Example–applying comparable company peers’ multiples continued 48 © IFRS Foundation

Example–applying comparable company peers’ multiples continued Step 4  Make appropriate adjustments to ensure comparability No non-controlling interest discount is required because the valuation multiples used to measure the fair value of Entity J were derived from the trading prices of the comparable public company peers and are consistent with holding a five per cent non-controlling equity interest in Entity J. 49 © IFRS Foundation

Example–applying comparable company peers’ multiples continued 50 © IFRS Foundation

Income approach Income approach converts future amounts (eg cash flows) to a single current (ie discounted) amount. –Discounted Cash Flow method (DCF) –Dividend Discount Model (DDM) –Constant growth DDM –Capitalisation model 51 © IFRS Foundation

Enterprise value 52 © IFRS Foundation

WACC: cost of debt capital component and computation 53 © IFRS Foundation

WACC: cost of equity capital component 54 © IFRS Foundation

Example–DCF method using enterprise value An investor has 5% non-controlling interest in Entity R. FCFF of Y 1 to Y 5 of CU100m and terminal value from Y 5 onwards is CU1,121.8m (assumption: inflation is offset by market shrinkange, no growth in nominal terms) WACC  8.9% Fair value of debt = CU240m Non-controlling interest discount  CU8m Discount for the lack of liquidity  CU4.09m 55 © IFRS Foundation

Example–DCF method using enterprise value continued 56 © IFRS Foundation

Example–DCF method using enterprise value continued 57 © IFRS Foundation

A combination of approaches– adjusted net asset method Involves deriving the fair value of an investee’s equity instruments by reference to the fair value of its assets and liabilities (recognised and unrecognised). Appropriate for an investee whose value is mainly derived from the holding of assets (rather than from deploying those assets as part of a broader business). Requires measurement of the fair value of the individual assets and liabilities. Non-controlling interest and liquidity discounts may be applicable. 58 © IFRS Foundation

Bid and ask spread, premiums and discounts © IFRS Foundation

Pricing within a bid-ask spread 60 The price at which the dealer will… For an asset, the non-dealer entity’s… For a liability, the non-dealer entity’s… Bid price buyexit priceentry price Ask (offer) price sellentry priceexit price © IFRS Foundation

Pricing within a bid-ask spread continued If an asset or a liability measured at fair value has a bid and an ask price, use the price within the bid- ask spread that is most representative of fair value Mid-market pricing or other pricing conventions can be used as a practical expedient for fair value measurements within a bid-ask spread if these conventions do not contravene the principle 61 © IFRS Foundation

Premiums and discounts Any premium or discount applied must be consistent with: –characteristics of asset or liability –the unit of account in the IFRS requiring fair value No block discounts –an adjustment to a quoted price for reduction that would occur if a market participant were to sell a large holding of assets or liabilities in one or a few transactions 62 © IFRS Foundation

Measuring the fair value of portfolios © IFRS Foundation

IFRS 13 permits an entity to measure a group of financial assets and financial liabilities on the basis of the net risk exposure to either market risks or credit risks. This practice was already allowed in IAS 39/IFRS 9 The “exception” was permitted because: –derivatives often cannot be sold, but management can mitigate risk exposure by entering into an offsetting position –portfolio composition is entity-specific (depends on entity’s risk preferences) 64 Portfolios of financial instruments © IFRS Foundation

Portfolios of financial instruments continued Conditions that need to be met: –Entity must have documented risk management strategy –The entity provides information on the basis of the net risk exposure to key management personnel –Only for portfolios of instruments measured at FV Accounting policy decision Does not affect presentation in IAS 32. –Allocations shall be performed on a reasonable and consistent basis. Portfolio-level adjustments may need to be allocated to the unit of account for presentation purposes. 65 © IFRS Foundation

If there are offsetting market risks: –can apply bid-ask spread to net open risk position –offsetting risks must be “substantially the same” –duration of instruments leading to exposure to market risk must be “substantially the same” 66 Market risk: the risk that the price will fluctuate because of changes in market prices (currency risk, interest rate risk and other price risk). Portfolios of financial instruments continued © IFRS Foundation

If the entity is exposed to the credit risk of a particular counterparty, an entity shall include the effect of: –its net exposure to the credit risk of the counterparty. –the counterparty’s net exposure to its credit risk. –any existing arrangements that mitigate credit risk exposure if market participants expect that such arrangements would be legally enforceable in the event of default. 67 Credit risk: the risk the entity or the counterparty will not pay or otherwise perform as agreed. Portfolios of financial instruments continued © IFRS Foundation

Part IV: Disclosures © IFRS Foundation

General Fair value at end of reporting period Level in hierarchy Transfers between levels Valuation techniques and inputs used If highest and best use is different from current use 69 © IFRS Foundation

General continued Disclosures also required for unrecognised amounts (ie that are only disclosed) or amounts recognised using a different measure (eg amortised cost) –eg financial asset at amortised cost, but IFRS 7 requires disclosure of asset’s fair value Quantitative disclosures in a table unless another format is better 70 © IFRS Foundation

General continued 71 Illustrative Example 15 - Fair values at the end of the reporting period and level of the fair value hierarchy for recurring fair value measurements… © IFRS Foundation

General continued 72 Illustrative Example 15 - Fair values at the end of the reporting period and level of the fair value hierarchy for non-recurring fair value measurements… © IFRS Foundation

More information about Level 3 Quantitative disclosure of unobservable inputs and assumptions used Reconciliation of opening to closing balances Description of valuation process in place 73 © IFRS Foundation

More information about Level 3 continued Sensitivity analysis: –narrative discussion about sensitivity to changes in unobservable inputs, including inter- relationships between inputs that magnify or mitigate the effect on the measurement –quantitative sensitivity analysis for financial instruments More detail in determining classes 74 © IFRS Foundation

More information about Level 3 continued 75 Illustrative Example 17 – Quantitative information about significant unobservable inputs used © IFRS Foundation

More information about Level 3 continued An entity might disclose the following: (a) For the group within the entity that decides the entity’s valuation policies and procedures: –its description; –to whom that group reports; and –the internal reporting procedures in place (eg whether and, if so, how pricing, risk management or audit committees discuss and assess the fair value measurements); (b) the frequency and methods for calibration, back testing and other testing procedures of pricing models; (c) the process for analysing changes in fair value measurements from period to period; (d) how the entity determined that third-party information, such as broker quotes or pricing services, used in the fair value measurement was developed in accordance with the IFRS; and (e) the methods used to develop and substantiate the unobservable inputs used in a fair value measurement. 76 Illustrative Example 18 – Valuation processes: © IFRS Foundation

More information about Level 3 continued 77 Illustrative Example 19 – Narrative discussion about sensitivity to changes in unobservable inputs: The significant unobservable inputs used in the fair value measurement of the entity’s residential mortgage-backed securities are prepayment rates, probability of default and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates. © IFRS Foundation

Part V: Effective date and transition © IFRS Foundation

Effective date and transition Effective 1 January 2013 Earlier application permitted Prospective application, no comparatives 79 © IFRS Foundation