Fair value measurement

Definition
• Fair value is 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 at active market.
• Fair value accounting refers to the practice of measuring your business’s liabilities and assets at their current market value.
• In other words, “fair value” is the amount that an asset could be sold for (or that a liability could be settled for) that’s fair to
both buyer and seller.

Valuation techniques
An entity uses valuation techniques appropriate in the circumstances and for which sufficient data are available to measure fair
value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.
The objective of using a valuation technique is to estimate the price at which an orderly transaction to sell the asset or to transfer
the liability would take place between market participants and the measurement date under current market conditions. Three
widely used valuation techniques are:
1. market approach – uses prices and other relevant information generated by market transactions involving identical or
comparable (similar) assets, liabilities, or a group of assets and liabilities (e.g. a business)
2. cost approach – reflects the amount that would be required currently to replace the service capacity of an asset (current
replacement cost)
3. income approach – converts future amounts (cash flows or income and expenses) to a single current (discounted)
amount, reflecting current market expectations about those future amounts.
In some cases, a single valuation technique will be appropriate, whereas in others multiple valuation techniques will be appropriate.

IMPAIRMENTS
What is impairment?
Impairment is most commonly used to describe a drastic reduction in the recoverable value of a fixed asset. The impairment may
be caused by a change in the company's legal or economic circumstances or by a casualty loss from an unforeseeable disaster.

Key definitions
➢ Impairment loss: the amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable
amount.
➢ Carrying amount: the amount at which an asset is recognized in the balance sheet after deducting accumulated
depreciation and accumulated impairment losses.
➢ Recoverable amount: the higher of an asset's fair value less costs of disposal* (sometimes called net selling price) and its
value in use.
➢ Fair value: 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.
➢ Value-in-use: is the present value of cash flows expected from the future use and eventual sale of the asset at the end of
its useful life.

Recognizing Impairments
A long-lived tangible asset is impaired when a company is not able to recover the asset’s carrying amount either through using
it or by selling it. To determine whether an asset is impaired, on an annual basis, companies review the asset for indicators of
impairments—that is, a decline in the asset’s cash-generating ability through use or sale. This review should consider internal
sources (e.g., adverse changes in performance) and external sources (e.g., adverse changes in the business or regulatory
environment) of information.

If impairment indicators are present, then an impairment test must be conducted. This test compares the asset’s recoverable
amount with its carrying amount. If the carrying amount is higher than the recoverable amount, the difference is an impairment
loss. If the recoverable amount is greater than the carrying amount, no impairment is recorded.

Recoverable amount is defined as the higher of fair value less costs to sell or value-in-use. Fair value less costs to sell means
what the asset could be sold for after deducting costs of disposal. Value-in-use is the present value of cash flows expected
from the future use and eventual sale of the asset at the end of its useful life.

If either the fair value less costs to sell or value-in-use is higher than the carrying amount, there is no impairment. If both the
fair value less costs to sell and value-in-use are lower than the carrying amount, a loss on impairment occurs.
Example: No Impairment
Assume that Maxi Company performs an impairment test for its equipment. The carrying amount of Maxi’s equipment is
Br200,000, its fair value less costs to sell is Br180,000, and its value-in-use is Br205,000. In this case, the value-in-use of Maxi’s
equipment is higher than it’s carrying amount of Br200,000. As a result, there is no impairment.
Example: Impairment
Assume the same information for Maxi Company above except that the value-in-use of Maxi’s equipment is Br175,000 rather
than Br205,000. Maxi measures the impairment loss as the difference between the carrying amount of Br200,000 and the higher
of fair value less costs to sell (Br180,000) or value-in-use (Br175,000). Maxi therefore uses the fair value less cost of disposal to
record an impairment loss of Br20,000 (Br200,000 - Br180,000). Maxi makes the following entry to record the impairment loss.
Loss on Impairment ……………………...20,000
Accumulated Depreciation—Equipment………………………. 20,000

The Loss on Impairment is reported in the income statement in the “Other income and expense” section. The company then
either credits Equipment or Accumulated Depreciation—Equipment to reduce the carrying amount of the equipment for the
impairment.