Chapter 2:

Fair Value Measurement (IFRS 13)

and Impairment Concept (IAS 36)

Learning outcome:

 understanding the fair value measurement and impairment concept

By: Mulualem G. @AcFn/COBE/BDU 2023/2024

 Chapter outlines
 Define key terms  Definition of Impairment

 Definition of Fair Value  Key principles of IAS 36

 Key principles of IFRS 13  Recognition and

 Fair value hierarchy measurement of impairment

 Techniques for measuring losses

fair value  Impairment indicators

By: Mulualem G. @AcFn/COBE/BDU

 Defined terms
• Active market: a market in which transactions for the asset or
liability take place with sufficient frequency and volume to provide
pricing information on an ongoing basis.

• Entry price: the price paid to acquire an asset or received to assume

a liability in an exchange transaction.

• Exit price: the price that would be received to sell an asset or paid
to transfer a liability.

• Inputs: the assumptions that market participants would use when

pricing the asset or liability,

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 Defined terms
• Most advantageous market: the market that maximises the
amount that would be received to sell the asset or minimises the
amount that would be paid to transfer the liability, after taking into
account transaction costs and transport costs.

• Observable inputs: inputs that are developed using market data,

such as publicly available information about actual events or
transactions, and that reflect the assumptions that market
participants would use when pricing the asset or liability.

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 Defined terms
• Orderly transaction: 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 (eg a
forced liquidation or distress sale).
• Principal market: the market with the greatest volume and level of
activity for the asset or liability.
• A market participant is a buyer and seller in the principal (or most
advantageous) market for the asset or liability that have all of the
following characteristics:

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 Defined terms
a) They are independent of each other, i.e. they are not related parties
as defined in IAS 24, (may be used, if the entity has evidence that
the transaction was entered into at market terms)

b) They are knowledgeable, having a reasonable understanding about

the asset or liability and the transaction using all available
information.

c) They are able to enter into a transaction for the asset or liability.

d) They are willing to enter into a transaction for the asset or liability,
i.e. they are motivated but not forced to do so.

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 Defined terms
• Unobservable inputs: inputs for which market data are not
available and that are developed using the best information
available about the assumptions that market participants would use
when pricing the asset or liability.
• Financial assets are essentially investments or securities that
represent a claim on a real or physical asset. This includes stocks,
bonds, and derivatives.
• 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.

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 Characteristics of fair value
• It is a market based measurement (not entity-specific value)
8
• It is an exit value
• It reflects all changes that market participants factor into pricing at the
measurement date
• It has a clear measurement objective
• It requires judgement to measure (especially Level 3 measurements)
– determine the appropriate valuation technique/s and inputs that
market participants would use when pricing the asset or liability.
• Market participant perspective: consequently, the entity’s intention to
hold an asset is not relevant when measuring fair value.

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 Old definition of fair value

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 Application guidance

• When measuring fair value use assumptions that market participants

would use when pricing the asset or liability under current market
conditions, including assumptions about risk, such as the following:

a) the risk inherent in a particular valuation technique used to measure

fair value (such as a pricing model); and

b) the risk inherent in the inputs to the valuation technique.

• Inputs may be observable or unobservable.

• Pricing models often require various assumptions about future cash

flows, discount rates, growth rates, and other factors that can
significantly impact the resulting fair value estimate.
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 Application guidance

• Characteristics of a particular asset or liability that a market participant

would take into accounting when pricing the item at the measurement
date, include:
i. Age, condition and location of the asset
ii. restrictions, if any, on the sale or use of the asset.

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 Application to non-financial assets

• A fair value measurement of a non-financial asset takes into account

a market participant’s ability to generate economic benefits by using
the asset in its highest and best use or by selling it to another
market participant that would use the asset in its highest and best
use.

• Highest and best use refers to the use of a non-financial asset by

market participants that would maximise the value of the asset or
the group of assets and liabilities (e.g. a business) within which the
asset would be used.

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 The concept of highest and best use

• Under IFRS 13, an entity’s current use of an asset is generally taken

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.

• If such factors exist, management should estimate a fair value based

on the hypothetical exit price, assuming the asset’s highest and best
use by market participants.

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 The concept of highest and best use

• The highest and best use of a non-financial asset takes into account
the use of the asset that is

 physically possible, (e.g. the location or size of a property).

 legally permissible, (e.g. the zoning regulations applicable to a

property).

 Financially feasible, (e.g. taking into account the costs of

converting the asset to that use)

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 Example
• Land acquires in a business combination is currently developed for
industrial use as a site for a factory. Nearby sites have recently been
developed for residential use as sites for high-rise apartment
buildings. It was determined that the land could be used to develop
residential high rise apartments. How is the highest and best used
determined?

• The highest and best use of the land would be determined by

comparing both of the following:

a) the value of the land as currently developed for industrial use.

b) the value of the land as a vacant site for residential use

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 Example

Note that: in determining the highest and best use of the land

• Taking into account the costs of demolishing the factory and other
costs (including the uncertainty about whether the entity would be
able to convert the asset to the alternative use) necessary to convert
the land to a vacant site (i.e. the land is to be used by market
participants on a stand-alone basis).

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The highest and best use - valuation premise

• The board identified two valuation premises that may be relevant

when measuring the fair value of an asset:

a) The in-exchange valuation premise, (on a stand-alone basis)

b) The in-use valuation premise, (in combination with other assets)

 Assumed the complementary assets are available to market

participants.

 Assumptions must be consistent for all assets of the relevant

group.

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 Example - the in-use valuation premise,

• Assume a manufacturer has unique work in progress inventory which

market participants would convert into finished goods.

• To measure the fair value of the unique work in progress the

manufacturer assumes that market participants have the machinery
necessary to convert the unique work in progress inventory into
finished goods

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 Fair value at initial recognition
• When an asset is acquired or a liability is assumed in an exchange
transaction for that asset or liability, the transaction price is the price
paid to acquire the asset or received to assume the liability (an entry
price).
• Entities do not necessarily sell assets at the prices paid to acquire
them. Similarly, entities do not necessarily transfer liabilities at the
prices received to assume them.
• In many cases the transaction price will equal the fair value (e.g that
might be the case when on the transaction date the transaction to
buy an asset takes place in the market in which the asset would be
sold).

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 Fair value at initial recognition
• The transaction price might not represent the fair value of an
asset or a liability at initial recognition if any of the following
conditions exist:
o The transaction is between related parties.
o The transaction takes place under duress or the seller is forced to
accept the price in the transaction.
o The unit of account represented by the transaction price is different
from the unit of account for the asset or liability measured at fair value.
o The market in which the transaction takes place is different from the
principal market (or most advantageous market).

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 Valuation techniques
• An entity shall use valuation techniques that are appropriate in the
circumstances and for which sufficient data are available to measure
fair value, maximising the use of relevant observable inputs and
minimising the use of unobservable inputs.

• IFRS 13 requires entities to apply valuation techniques consistent with

any of the following three methods:

a) Market approach

b) Cost approach

c) Income approach

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 Valuation techniques
(a) Market approach - uses prices and other relevant information
generated by market transactions involving identical or comparable
(i.e. similar) assets, liabilities or a group of assets and liabilities.

(b) Cost approach - reflects the amount that would be required currently
to replace the service capacity of an asset (often referred to as
current replacement cost).

(c) Income approach - converts future amounts (e.g. cash flows or

income and expenses) to a single current (i.e. discounted) amount.

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 Fair value hierarchy - three levels.
• The highest priority is given to Level 1 inputs and the lowest priority to
Level 3 inputs. An entity must maximize the use of Level 1 inputs and
minimize the use of Level 3 inputs.

Is there a quoted price in an active market for an identical asset or liability?

Yes No

Use this quoted price to

Replicate a market price through a valuation
measure fair value
technique (maximize use of observable inputs)
(Level 1 measurement)*

* An entity shall not No use of significant Use of significant

make adjustments to unobservable inputs unobservable inputs
quoted prices (Level 2 measurement) (Level 3 measurement)
 Presentation and disclosure
• An entity shall disclose information that helps users of its financial
statements assess both of the following:

(a) for assets and liabilities that are measured at fair value on a
recurring or non-recurring basis in the statement of financial
position after initial recognition, the valuation techniques and
inputs used to develop those measurements.

(b) for recurring fair value measurements using significant

unobservable inputs (Level 3), the effect of the measurements on
profit or loss or other comprehensive income for the period.

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 Impairments (IAS 36)
Defined terms
• Value in use is the present value of the future cash flows expected
to be derived from an asset or cash-generating unit.
• The recoverable amount of an asset or a cash-generating unit is
the higher of its fair value less costs of disposal and its value in
use.
• An impairment loss is the amount by which the carrying amount
of an asset or a cash-generating unit exceeds its recoverable
amount.
• Fair value less costs to sell means what the asset could be sold
for after deducting costs of disposal.
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Impairments (IAS 36)
Defined terms
• Carrying amount is the amount at which an asset is recognised
after deducting any accumulated depreciation (amortisation) and
accumulated impairment losses thereon. IFRS uses the terms
carrying value, carrying amount, and book value interchangeably.
• A cash-generating unit is the smallest identifiable group of
assets that generates cash inflows that are largely independent of
the cash inflows from other assets or groups of assets.
• Corporate assets are assets other than goodwill that contribute to
the future cash flows of both the cash-generating unit under
review and other cash-generating units.
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Impairments (IAS 36) - Recognizing Impairments

• 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.
• In assessing whether there is any indication that an asset may be
impaired, an entity shall consider, as a minimum, the following
indications:
a) External sources of information: significant changes with
an adverse effect on the entity, in the technological, market,
economic or legal environment.
b) Internal sources of information: obsolescence or physical
damage of an asset.
Impairments (IAS 36) - Recognizing Impairments

• An impairment loss shall be recognised immediately in profit or

loss, unless the asset is carried at revalued amount in accordance
with another Standard (for example, in accordance with the
revaluation model in IAS 16).
• Any impairment loss of a revalued asset shall be treated as a
revaluation decrease in accordance with that other Standard.
• After the recognition of an impairment loss, the depreciation
(amortisation) charge for the asset shall be adjusted in future
periods to allocate the asset’s revised carrying amount, less its
residual value (if any), on a systematic basis over its remaining
useful life.
Recognizing Impairments

If impairment indicators are present, then an impairment test

must be conducted.

If either the fair value less

costs to sell or value-in-
use is higher than the
carrying amount, there is
no impairment.
Recognizing Impairments
Example: Assume that Cruz Company performs an impairment
test for its equipment. The carrying amount of Cruz’s equipment is
€200,000, its fair value less costs to sell is €180,000, and its value-
in-use is €205,000.

€200,000 €205,000
No
Impairment

€180,000 €205,000
Recognizing Impairments
Example: Assume the same information for Cruz Company except
that the value-in-use of Cruz’s equipment is €175,000 rather than
€205,000.
€20,000 Impairment Loss

€200,000 €180,000

€180,000 €175,000
Recognizing Impairments
Example: Assume the same information for Cruz Company except
that the value-in-use of Cruz’s equipment is €175,000 rather than
€205,000.
€20,000 Impairment Loss

€200,000 €180,000

Cruz makes the following entry to record the impairment loss.

Loss on Impairment 20,000

Accumulated Depreciation—Equipment 20,000
Impairment Illustrations
Case 1
At December 31, 2016, Hanoi Company has equipment with a cost of
VND26,000,000, and accumulated depreciation of VND12,000,000. The
equipment has a total useful life of four years with a residual value of
VND2,000,000. The following information relates to this equipment.
1. The equipment’s carrying amount at December 31, 2016, is
VND14,000,000 (VND26,000,000 - VND12,000,000).
2. Hanoi uses straight-line depreciation. Hanoi’s depreciation was
VND6,000,000 [(VND26,000,000 - VND2,000,000) ÷ 4] for 2016 and
is recorded.
3. Hanoi has determined that the recoverable amount for this asset at
December 31, 2016, is VND11,000,000.
4. The remaining useful life of the equipment after December 31,
2016, is two years.
Impairment Illustrations

Case 1: Hanoi records the impairment on its equipment at

December 31, 2016, as follows.

VND3,000,000 Impairment Loss

VND14,000,000 VND11,000,000

Loss on Impairment 3,000,000

Accumulated Depreciation—Equipment 3,000,000
Impairment Illustrations

Equipment VND 26,000,000

Less: Accumulated Depreciation-Equipment 15,000,000
Carrying value (Dec. 31, 2016) VND 11,000,000

Hanoi Company determines that the equipment’s total useful life

has not changed (remaining useful life is still two years). However,
the estimated residual value of the equipment is now zero. Hanoi
continues to use straight-line depreciation and makes the
following journal entry to record depreciation for 2017.

Depreciation Expense 5,500,000

Accumulated Depreciation—Equipment 5,500,000
Impairment Illustrations
Case 2
At the end of 2015, Verma Company tests a machine for impairment. The
machine has a carrying amount of $200,000. It has an estimated remaining
useful life of five years. Because there is little market-related information on
which to base a recoverable amount based on fair value, Verma determines
the machine’s recoverable amount should be based on value-in-use. Verma
uses a discount rate of 8 percent. Verma’s analysis indicates that its future
cash flows will be $40,000 each year for five years, and it will receive a
residual value of $10,000 at the end of the five years. It is assumed that all
cash flows occur at the end of the year.
Impairment Illustrations
Case 2: Computation of the impairment loss on the machine at
the end of 2015.
$33,486 Impairment Loss

$200,000 $166,514

Unknown $166,514
Impairment Illustrations
Case 2: Computation of the impairment loss on the machine at
the end of 2015.
$33,486 Impairment Loss

$200,000 $166,514

Loss on Impairment 33,486

Accumulated Depreciation—Machinery 33,486

Unknown $166,514
Reversal of Impairment Loss

Illustration: Tan Company purchases equipment on January 1,

2015, for HK$300,000, useful life of three years, and no residual
value.

At December 31, 2015, Tan records an impairment loss of

HK$20,000.
Loss on Impairment 20,000
Accumulated Depreciation—Equipment 20,000
Reversal of Impairment Loss

Depreciation expense and related carrying amount after the

impairment.

At the end of 2016, Tan determines that the recoverable amount of

the equipment is HK$96,000. Tan reverses the impairment loss.

Accumulated Depreciation—Equipment 6,000

Recovery of Impairment Loss 6,000

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IMPAIRMENTS

Cash-Generating Units
• When it is not possible to assess a single asset for impairment
because the single asset generates cash flows only in combination
with other assets, companies identify the smallest group of assets
that can be identified that generate cash flows independently of
the cash flows from other assets.

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IMPAIRMENTS

Impairment of Assets to Be Disposed Of

 Report the impaired asset at the lower-of-cost-or-net
realizable value (fair value less costs to sell).

 No depreciation or amortization is taken on assets held

for disposal during the period they are held.

 Can write up or down an asset held for disposal in future

periods, as long as the carrying amount after the write up
never exceeds the carrying amount of the asset before
the impairment.

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 IMPAIRMENTS

End of Chapter 2