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This appendix explains only selected aspects of fair value measurement and valuation techniques
important for groups. Valuation techniques and methods are described only in general. It is recommended to make use of other literature, particularly valuation literature, for a full scope of
fair value measurement and the application and handling of appropriate valuation techniques
including the details required by each method.
Principles of Group Accounting under IFRS. Andreas Krimpmann.
2015 John Wiley & Sons, Ltd. Published 2015 by John Wiley& Sons, Ltd.
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2.Definition
IFRS 13.9 defines 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. Due to this definition, the price determined is an
exit price (assuming a sale). Even if this definition is very comprehensive, several
facts and circumstances have to be determined in assuming the fair value:
Assets that are subject to a fair value measurement
Subject to fair value measurements are all assets and liabilities that
require a recording at fair values. IFRS 13.5 addresses the application if
any standard requires a fair value measurement. Accordingly, some items
are exempt from an application.
Item
Covered by standard
Intangible assets
IAS 38
Yes
Only if revaluation
model is applied
Property, plant
& equipment
Asset measurement: value
in use
Asset measurement: fair
value less cost of disposal
Financial assets
Investment property
Agricultural assets
Mineral resources
IAS 16
Yes
IAS 36
No
IAS 36
Yes
Only if revaluation
model is applied
Similarity to fair value
given but not fair value
Disclosures not
required
IFRS 9
IAS 40
IAS 41
IFRS 6
Yes
Yes
Yes
Yes
Inventories
Share-based payments
Leasing
Pensions: plan assets
Retirement benefit plan
investments
Business combinations
IAS 2
IFRS 2
IAS 17
IAS 19
IAS 26
No
No
No
Yes
Yes
IFRS 3
Yes
Financial liabilities
Provisions, liabilities
IFRS 9
IAS 37
Yes
No
Yes
Only if revaluation
model is applied
Disclosures not required
Yes
Yes
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To adjust the initial price asset to its fair value, day one gains or losses
arise. Reasons for those dissenting prices are:
Subsequent measurement
Measuring the fair value of an asset in subsequent periods assume an
exit price, so a price that can be achieved on an active market. The full set
of fair value tools can be applied.
Regardless of which method is applied to determine the fair value of an asset
or liability, IFRS 13.72 defines a fair value hierarchy that has to be applied. This
hierarchy is a guideline regarding which inputs are most suitable when valuation
techniques are used. The intention of this hierarchy is to increase consistency and
comparability.
Level Rationale
1) Quoted prices in active
markets
Comment
Quoted prices are always unadjusted prices. An adjustment is
only appropriate if
Large amounts of similar assets and liabilities are held but
the quoted price is not readily accessible.
Quoted price does not equal fair value (e.g. due to timing
issues, the fair value measurement date does not equal the
acquisition date or significant events have changed the fair
value).
Observed identical assets and liabilities are subject to
adjustments.
Active markets trade assets frequently and in a certain volume.
This is primarily the principal market and only in the absence
of this market the most advantageous market.
Only if level 1 inputs are not available, level 2 has to be applied.
Similar assets and liabilities are not defined any further by
IFRS 13. Identifying such items requires not only judgement
but also an understanding of the terms and other factors that
affect the fair value and an identification and assessment of
any differences in the terms compared to the asset subject to
measurement.
Similar to quoted prices, adjustments to quoted prices for iden
tical or similar assets may be necessary to reflect the behaviour
of the asset subject to measurement. Typical examples are risk
alignments, conditions and locations.
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The order of the fair value hierarchy ensures that observable inputs have to
be preferably applied as they are market related (external) and therefore provide
more assurance than internal ones.
If assets cannot be reliably measured by using similar assets in active markets,
the application of valuation techniques, as outlined in IAS 13.61, is an appropriate method in deriving fair value. Valuation techniques vary depending on the
nature of the underlying asset to be measured. IFRS 13.62 provides three valu
ation approaches that can be used:
Market approach;
Cost approach;
Income approach.
Various valuation techniques are available for each approach.
3.1. Market approach
This approach uses market data to derive fair value for the asset under review.
Market data can be derived from transactions with similar or comparable assets.
Data can also be derived from current or similar markets. Due to the various
market data and the application on the asset to be valued, several methods are
available.
Analogy methods
Analogy methods observe transactions with similar assets in active
markets and try to derive a value for the asset subject to valuation from
these transactions. The challenge in applying analogy methods is to find
active markets and similar assets. Active markets are markets where the
group operates in. Similar assets mean that these assets have to have the
same characteristic and service capacity as the original asset. If observed
assets deviate from the original asset appropriate adjustments are necessary.
Analogy methods apply to assets that are traded in markets. Typical
examples of markets and assets are merger & acquisition transactions
of companies or markets for new or used machines. Analogy methods
regularly fail for self-constructed assets or assets with specific purposes.
To get better confidence, peer groups (a set of similar transactions) are
often used.
Multiples
Similarly to analogy, this method determines the value of an asset
through observation. The value of the comparable asset is transferred
to standardized values relative to key statistics to cal
cu
la
te valuation
multiples. These multiples are applied to the asset subject to estimate its
value. Multiples must have a relationship with the market. They are often
based on earnings, cash flows or other market measures like enterprise
values or price-earnings ratios. Like analogy methods, multiples face the
same challenges in identifying assets and markets.
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Matrix pricing
This is a mathematical method where the value of an asset is derived
against several benchmarks or quoted prices in the market. So a multiple
reference is used to determine the fair value. Matrix pricing is a common
method used for financial instruments (so assets and liabilities).
Direct market prices
The assets value can be taken directly from the market. Direct prices
interfere with the size of the market. Also, the volume of an assets trade
in the market, compared to the volume of the asset subject to valuation,
has to be considered. This is important in the case of assumed bulk sales
of the asset: such transactions have the ability to change the observed
market price. Direct market prices are often applied to financial assets and
liabilities, such as securities.
3.2. Cost approach
This approach focuses on the asset itself and reflects the amount required
to replace the asset in its current condition. Replacing an asset can occur in two
ways: either by replacing the asset through a substitute (a product that is available in the market) or by rebuilding the asset. Appropriate valuation methods are
available for both ways.
Replacement costs
The replacement cost method assumes that the asset can be replaced
by a substitute, so an asset with the same characteristics as the original
one. The substitute has to have the same service capacity as the original
asset. Replacement costs might be adjusted by obsolescence if necessary.
Obsolescence comprises physical deterioration, technological and econ
omic obsolescence.
Reproduction costs
The reproduction cost method assumes that the asset in its current
condition is built up right from scratch. Any improvements to the product
due to new standards, production processes and similar issues are not
considered. The method uses historical costs that are indexed to adjust
historical costs to current conditions. This adjustment has to consider all
costs incurred: labour costs, materials as well as an appropriate overhead
portion.
3.3.Income approach
This approach is based on the ability of an asset to generate future cash flows or
profits. The amount determined reflects the market expectation of the fair value of
these future cash flows. Applying the income approach demands an application
of discounted cash flow models and consequently an estimation of discount rates
(e.g. by using weighted average costs of capital based on capital asset pricing models), planning data of future cash flows the asset will generate, market parameters
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like inflation and market growth rates and tax effects. In particular, planning data
is important as this data reflects the underlying business. Therefore, management
accounting is involved in preparing the data by considering pricing and volume
of products and services, cost structures related to the asset and the product portfolio, so the mix of products and services expected to be sold or delivered.
As future cash flows depend on the underlying assets and its character, a set
of measurement methods is available:
Option pricing models
These models are mathematical methods which determine the fair
value of an equity option by considering various market metrics. The
most known models are the Black-Scholes model and the binominal
model proposed by Cox, Ross and Rubinstein. Option pricing models are
applicable for financial assets.
Direct cash flows
These methods apply only if an asset has the ability to generate
measureable cash flows. These cash flows might be subject to adjustments
as appropriate before discounting to determine the value of the asset.
Incremental cash flows (ICF)
The incremental cash flow method compares the cash flows of the
company carrying the asset with a fictitious company with similar cash
flows but without the asset. The difference between both cash flows
represents the cash flow attributable to the asset.
Incremental cash flows are popular not only for determining the value
of an asset but also for determining the consequences of management
decisions, the profitability of projects and investments. The method usually
ignores any sunk cost and overhead costs but considers opportunity costs,
side effects and changes in net-working capital.
Comparative income differential method (CIDM)
Similar to incremental cash flows, this method estimates the income
differential of an asset between its utilization and its absence. Applying
this method requires appropriate knowledge about the assets and its use
and utilization. The more complex an asset is the more effects require
attention. Typical effects are cost savings, interactions with other assets
and revenue impacts.
Multi-period excess earnings method (MEEM)
This method estimates the fair value based on expected future
economic earnings that is generated by a business unit or a group of assets.
The method is the preferred choice if cash flows generated by an asset
cannot be reliably directly measured. To determine the fair value of an
asset, charges for all other assets involved are deducted from cash flows of
the business unit or group of assets. The residual cash flow then represents
the cash flow assigned to the asset which will be discounted to arrive at the
value of the asset.
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Primary
category
Alternate
category
Applicable
measurement
methods
Comments
Assembled workforce
Cost
Income
Multi-periodexcess-earnings
method
One charge of
the model
Capitalized intangible
assets
Copyrights
Customer relationships,
non-contractual
Cost
Income
Income
Market
Market
Distribution networks
Franchise rights
In process research &
development
Inventory
Management
information software
Non-compete agreements
Orders
Cost
Income
Cost
Income
Market
Income
Cost
Income
Income
Discount due to
ageing!
Multi-periodexcess-earnings
method
Market
CIDM
Item
Primary
category
Alternate
category
Other rights
Patents
Income
Income
Market
Market
Product software
Self-constructed and
used non-current assets
(fixed assets)
(Tax amortization
benefits)
Income
Cost
Market
Income
Applicable
measurement
methods
759
Comments
Income
Market
Multi-periodOne charge of
excess-earnings the model
method
Relief from royalty method,
Incremental cash
flow method