Fair Value Measurement under IndAS 113

Fair Value Measurement as per Indian Accounting Standard (IndAS)

Introduction to Fair Value

Every industry witnesses ground-breaking changes, in Financial reporting one such is advent of IndAS. New to Indian soil, IndAS are Indian moulded version of IFRS. Fair value as we will study today has derived its form from IFRS 13: Fair Value Measurements.

Let us understand Fair value with one small example;

Mr. A takes a loan of Rs. 100 @ 5%, when market rate was 10%. He recorded it at Rs. 100, but this is not Fair value of the loan. Loan shall be adjusted to the tune of 5% to be brought down to it Fair value.

Brief aspects of Governing pronouncement, IndAS 113

IndAS 113 provides that assets and liabilities shall be recorded at Fair value at measurement date and provides means and principles of measurement, recognition and disclosures. This IndAS would be crucial one because it provides framework for all other IndAS which requires Fair value measurement or disclosure.

Scope of IndAS 113: Fair Value Measurement

IndAS 113 applies when any IndAS requires or permits Fair value measurement or disclosures, except for;

i. Share based payment transactions under IndAS 102
ii. Leasing transactions under IndAS 17
iii. Measurements having similarities with Fair Value but are not Fair value Eg: NRV, Value in use, etc.

Definition of Fair Value as per IndAS 113

Let us understand meaning of a few words used in definition:

The Market (Principal or the most advantageous market):

o  The principal market is the market with greatest volume and level of activity for sale or transfer of Asset and Liabilities.

o  The most advantageous market is the market where entity would fetch maximum amount for sale of asset and minimizes the amount for transfer of liability, considering transaction costs in respective market.

Eg: Bharti Airtel is listed on both NSE and BSE. On closure of 3/12/2015 following data is available:

Particulars	NSE	BSE
Closing price	319.55	319.70
Volume	3,973,225	570,224
Market type	Principal Market	Most Advantageous Market
Fair Value	Rs. 319.55

Market participants:

o They are buyers and sellers in the principal market who are;

- Independent or not related parties
- Knowledgeable
- Able to transact
- Willing to transact

Price and Orderly transaction:

o  An orderly transaction is one which assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for sale or transfer of such A&L and doesn't consider a forced transaction.

o  The price would be the amount that could be received on sale or transfer of asset but excludes transaction cost as same is not an attribute.

Note:

Price determination under most advantageous market:

As for above said Bharti Airtel's Securities: (Not considering NSE as principal market for the sake of this example)

Particulars	NSE	BSE
Price	319.55	319.70
Transaction cost (Min. Brokerage charges)	20	18.5
Net Price	299.55	301.20
Most advantageous market	No	Yes

Asset or Liabilities: (Hereinafter referred as "A&L" )

o  Such attributes of A&L should be considered which will be considered by market participants Eg:

- Location of A&L
- Condition of A&L, etc.

How Fair value is to be computed or assessed:

Following principle points are laid down for assessing Fair Value, which are as follows;

Example: Measuring Fair Value of a liability using present value technique.

Company	TATA Motors Ltd.
Instrument	Debentures
Coupon Rate	10%
Date of issue	1/04/2013
Tenure	10 years
Credit rating as issue	CRISIL A
Measurement Date	31/04/2015
Credit rating	CRISIL BBB
Market Expected rate due to demotion	10.5%
Valuation technique employed	Present Value
Inputs Considered	- CRISIL BBB rating - Remaining tenure of 8 years - Principal amount of Rs. 100 Crores - Revised minimum return of 10.5% and credit spread
Present value of its obligation as an asset for market on 31/03/15 (Fair Value)	Rs. 98.857 Crores

Hierarchy of Fair Value:

IndAS 113 incorporates a three level hierarchy for inputs used in valuation for measurement of Fair value. The hierarchy gives the highest priority to quoted prices and lowest to unobservable inputs.

Categories of Inputs:

Level 1 Inputs: Quoted prices

i. Level 1 inputs are quoted prices in active market for identical A&L.
ii. The entity can access principal market at the measurement date.
iii. The quoted price shall be used without adjustment except:

o Alternative pricing method is used for a large number of similar A&L for which quoted prices are available but not readily accessible.

o When a quoted price in active market doesn't represent fair value or requires adjustment.

Level 2 Inputs: Other than quoted market prices within Level 1

i. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the A&L, either directly or indirectly.

ii. Level 2 inputs include;

o Quoted price for similar A&L in active markets
o Quoted prices for similar or identical A&L in markets that are not active markets

Inputs other than quoted market prices that are observable like;

i. Interest rates and yield curves (Bonds, debenture instruments)
ii. Implied volatilities (Options)
iii. Credit spreads[1], etc.

o Market corroborated inputs

Examples of level 2 Inputs:

Arrangement	Level 2 Input
Receive-fixed, pay-variable interest rate swop based on the Mumbai Interbank Offered rate (MIBOR) swap rate	MIBOR swap rate
Finished goods inventory at a retail outlet	Price requiring least adjustment: Retail price to customer or wholesale price
Buildings held and used	Per square meter of comparable building in similar location
Cash generating units	Multiple for revenue or earnings Eg. P/E ratio

Level 3 Inputs: Unobservable Inputs

a. Level 3 inputs are unobservable inputs for the A&L
b. Are used only when observable inputs are not available
c. Such inputs shall be developed with best information available, includes entity level estimates, but shall be adjusted if reasonable information is made available.

Arrangement	Level 3 Inputs
Three-year option on exchange-traded shares	Historical volatility
Decommissioning liability assumed in business combination	Expected future cash outflows obligations, discounted into current estimate.
Cash generating unit	Entity's own developed financial forecast

Fair value at Initial Recognition:

Difference between on-going Transaction price and Fair Value :

Measurement For	Transaction price	Fair Value
Assets	Price paid to acquire	Price that would be received to sell the asset
Liabilities	Amount received to assume the liability	Amount that would be paid to settle or transfer the liability

Where transaction price is different the entity shall recognize profit or loss unless that IndAS specifies otherwise.

There may be situation where transaction price differs from Fair value such as;

o Where transaction is carried out;

- With related parties
- Under duress or forced transaction

o Unit of account represented by transaction price is different from that under fair value Eg: Transaction price includes transaction cost.

o Market in which transaction takes place is other than principal market

Measurement criteria:

A&L type	Measurement criteria	Special consideration
Non-Financial asset	For Usage: Highest and best use For Selling: Price to be fetched by market participants	Highest and best use considers considerations such as; - Physical - Legal - Financial
Liabilities and equity instruments held as assets	Fair value of identical items held as asset by market participant
Liabilities and equity instruments not held as assets	Fair value using a valuation technique from perspective of market participant that owes the liability or has issued the claim on equity
Financial liability with a demand feature	Not less than amount repayable on demand discounted from first date that the amount could be repaid.

Valuation Technique:

- Use of valuation technique which maximises use of observable inputs and minimises use of unobservable inputs.
- Multiple techniques may be required.

Disclosures:

An entity shall disclose such information that helps the users of its financial statements assess both of the following:

o Valuation technique and inputs used to measure fair value.

o  Effect of recurring fair value measurement using significant unobservable inputs (Level III) on profit or loss or other comprehensive income for the period.

Illustrative Disclosure: (Extracts from Oxford instruments, UK and Paladin energy, Australia)

Inputs used in valuation	a. The fair value of interest rate swaps is based on broker quotes. b. The fair value of forward exchange contracts is their market price at the Consolidated Statement of Financial Position date, being the present value of the forward price.
Technique used	c. The fair value of the unlisted securities is determined using valuation techniques. Such techniques include using recent arm's length market transactions, net asset values and by an external valuer using the Black-Scholes model
Measurement date	d.  The identifiable assets acquired and the liabilities assumed are measured at their acquisition date fair values

Disclosure of quantitative details of significant Unobservable inputs

Disclosure of Transfer in and out of levels of fair value hierarchy

Reconciliation for Level 3 fair value movements

b

2010 2009
US$M US$M
Opening balance 3.9 4.5
Other comprehensive income/(loss) 0.4 (0.6)
Disposals (0.8) -
Closing balance 3.5 3.9
Total gain or loss stated in the table above for assets held at the end of the period - -

Disclosure of Levels of Fair Value Hierarchy used in measurement:

o The fair value of interest rate swaps is based on broker quotes. Those quotes are tested for reasonableness by discounting estimated future cash flows based on the terms and maturity of each contract and using market interest rates for a similar instrument at the measurement date.

o The fair value of forward exchange contracts is their market price at the Consolidated Statement of Financial Position date, being the present value of the forward price.

Disclosure of principles of Fair Value Measurement:

Business combinations are accounted for using the acquisition method. The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquire and the equity issued by the acquirer, and the amount of any non-controlling interest in the acquiree.

Disclosure of measurement of Business Combination:

					Book	Provisional	Provisional
					Value	Adjustments	Fair Value
Intangible fixed assets					9.40	70.20	79.60
Tangible fixed assets					6.00	( 4.00)	2.00
Inventories					11.10	3.00	14.10
Trade and other receivables					10.30	-	10.30
Trade and other payables					(13.50)	( 1.30)	( 14.80)
Deferred tax					( 0.50)	( 15.60)	( 16.10)
Cash					17.20	-	17.20
Net assets acquired					40.00	52.30	92.30
Goodwill							83.00
Total consideration							175.30
Cash acquired							( 17.20)
Net cash outflow relating to the acquisition							158.10

Assumptions of discounting factor and other measures for Fair Value measurement of Financial Instruments:

The key assumptions are those regarding discount rates, growth rates, expected selling volumes and prices and direct costs during the period.

The growth rates are based on industry growth factors. Changes in selling prices and direct costs are based on past practices and expectations of future changes in the market.

The pre-tax weighted average costs of capital used for Nanotechnology Tools, Industrial Products and Service in impairment testing are 10.95%–11.45% (2013: 12.25%), 10.45%–10.95% (2013: 11.75%) and 10.45% (2013: 11.25%) respectively in line with the risk associated with each of the business segments. Management have estimated these discount rates by reference to past experience and an industry average weighted cost of capital as adjusted for appropriate risk factors reflecting current economic circumstances and the risk profiles of each CGU.

Thank you.
Apurv Parikh
Manubhai & Shah (Ahmedabad)

[1] Credit spreads are difference in yields between any type of bond and a treasury receipt of the same maturity