CHAPTER Fair Value Accounting and Financial Reporting Standards 7.1 Why Fair Value Accounting? Financial statements are important financial inputs for various uscrs such as shar holders, potential investors, bankers, creditors, customers, governmental agenci and authorities in making various economic and strategic decisions. Financial statements should provide relevant and quality information to the users of finan- cial statements, Over many years, the International Accounting Standards Board (IASB) has continuously carried out various research projects, made changes to accounting standards and developed new International Financial Reporting Stan dards (IFRS) for the purpose of improving the preparation of financial statements that are relevant, transparent and useful. How assets and liabilities are measured and presented is crucial accountin information for users of financial statements and therefore one of the areas that the IASB has focused on and improved upon. Traditionally, the measurement basis that is most commonly adopted by companies in preparing their financial statements is historical cost as it is considered more conservative, stable and reli- able. However, many users of financial statements prefer fair value instead of his torical cost and believe thar fair value is the better measurement basis as it reflects up-to-date market expectations in relation to assets and liabilities. 139140 CHAPTER? «+ Fair Value Accounting and Financial Reporting Standards Fair value measurement is commonly adopted in some of the IFRS as shown. below: © International (IFRS 13) International Financial Reporting Standard 3 Bissiness Combinations (IFRS 3) International Accounting Standard 38 Intangible Assets (IAS 38) International Accounting Standard 36 Impairment of Assets (LAS 36) International Accounting Standard 39 Financial Instruments: Recognition and Measurement (IAS 39) International Accounting Standard 40 Investment Property (IAS 40) + International Accounting Standard 41 Agriculture (IAS 41) nancial Reporting Standard 13 Fair Value Measurement wees Of the above standards, IFRS 13 provides the guidance on fair value measure- ment and fair value disclosure but it does not specify when an asset or a liabilit is required to be measured at fair value. In contrast, the remaining, standards such as IFRS 3, [AS 39, IAS 40 and IAS 41 determine which asset or liability need ro be measured at fair value and when such fair value measurement is required. For the purpose of this book, we will only look at the key applications of IFRS 13, TFRS 3, IAS 38 and IAS 36.! Specifically, we will discuss the basic measure- ment requirements of fair value for financial reporting under IFRS 13, followed by the concept of purchase price allocation in a business combination and the valuation of intangible assets under IFRS 3 and IAS 38. Finally, we will discuss how to perform impairment testing for goodwill under [AS 36. 7.2 Measurement Requirements of Fair Value under IFRS 13 Prior to the introduction of IFRS 13, fair value accounting was introduced pro- gressively over the years and the guidance on fair value was scattered amongst the relevant IFRS. Some IFRS contained lirtle guidance about fair value measurement whereas others introduced extensive guidance about fair value, resulting in gaps and inconsistencies amongst the aecounting standards, not only on the fair valuc measurement requirement but also the disclosure on information about such fair value measurements. The introduction of IFRS 13 has provided a single source of guidance for fair value measurement and disclosure which can be applied across all the IFRS. ‘However, it is important to note the following © Measurement and disclosure requirements of IERS 13 do not apply to transac tions within the scope of IFRS 2 Share-based Payment and IAS 17 Leases as well as the measurement concepts of ‘net realisable value’ required in IAS 2 Inventories and ‘value in use’ in IAS 36 Impairment of Assets: and 1. IPRS 13,1PRS 3, IAS 38 and IAS 36 of 2017 IFRS Standards (Blue Book)7.2 Measurement Requirements of Fair Value under IFRS 13 42 * Thedisclosure requirement of IFRS 13 does not apply to fair value of pl. under IAS 19 Employee Benefits, fair value of ‘retirement benefit plan invest ments’ under LAS 26 Accounting ard Reporting by Retirement Benefit Plans ‘fair value less costs of disposal’ required in IAS 36 lnpairment of Assets. TERS 13 specifically focuses on the following three areas: * Definition of fair value, * Framework for fair value measurement, and * Disclosures about fair value measurement. Definition of Fair Value For details Prior to the introduction of IFRS 13 in May 2011 by the IASB, the definition of fair value was referenced as “the amount for which an asset could be exchanged, ability settled, between knowledgeable, willing parties in an arm’s length transaction’, This definition of fair value is similar to thar of fair market value as commonly adopted by valuers in conducting business valuation. The accou standards also further explained the terms used in the fair value defi ‘knowledgeable’, willing parties’ (i.e. willing buyers and willing sellers} and ‘arm’s length transaction’, However, such definitions have been criticised as follows: They do not determine if an entity * They do not explain why a liability instead of creditors; and * They do not determine which date the exchange or settlement takes place. To address the above points, the [ASB revised and defined the fair value in IFRS 13 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’. This definition emphasises thar fair value is an ‘exit price’, not an ‘entry pri Exit price is the price that the entity will receive when selling an asset or will pay when transferring a liability whereas the entry price (or transaction price) is the price the entity pays to acquire the assct or receives to assume the liability at a measurement date (which is also known as the valuation date). It is observed in many situations that ‘exit peice’ and ‘entry price’ may be identical. However, this does not mean that transaction price can be presumed to represent the fair value of an asset of a liability upow initial recognition. The standard further describes certain circumstances and conditions in a transaction that may lead to the differ- ence between the transaction price (entry price) and the fair value (exit price) of an asset or a liability S805 able, willing parties s buying or selling the is settled to knowledg * The transaction is between related parties unless there is evidence that the transaction was entered into at marker terms; © Itis a forced transaction or distressed sale. For example, the seller was expe- riencing financial difficulty and would be willing to sell the asset at a price below the market price to get quick cash; the disclosures requirement, refer to 2017 IFRS Standards (Blue Book) = IFRS 13 paragraphs 91-99.142 CHAPTER 7 + Fair Value Accounting and Financial Reporting Standards © 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. For example, when an entity purchased a block of ten units of property, the transaction price might already include a blockage discount and hence the transaction price per unit of property might not represent the fair value for cach acquired property unit; or © The transaction takes place in a market that is different from the principal market (or most advantageous market). An example is when a trading and wholesale entity entered into transactions with customers in the retail market, but the principal (or most advantageous) market for the exit transaction is with other traders and retailers in the wholesale market. Another important point to nate is that the transaction (ise. selling an asset or transferring a liability) for the determination of fair value would be orderly and therefore is not a forced transaction or distressed sale. Finally, fair value is a market-based measurement, not an entity-specific measurement, and therefore is determined based on assumptions market participants would consider in pricing an asset or a liability, Though the definitions of “fair value’ and ‘fair market value’ look different, the [ASB has also learned that there might not be differences between fair value (exit price) and fair market value (an exchange amount or entry price) of iden- tifiable assets acquired and liabilities assumed in a business combination, as the transaction costs are not a component included in either definition, It is believed that the definition of fair value introduced in IFRS 13 not only closes the gap with the generally accepted accounting principles in the United States (US GAAP) but also resolves the shortcomings of the previous fair value definition (prior to the introduction of IFRS 13) with a focus on market-based measurement (not entity-specific measurement) and exit price in an orderly trans- action that reflects up-to-date market conditions, Framework for Fair Value Measurement As shown in Figure 7.1, the key components of the fair value measurement frame- work can be summarised as follows: 1. First, a valuer has te the characteristics of the subject asset or liability. In particular, if the asset is non-financial, the valuer has to identify its highest and best use not from the entity’s perspective but from market participants’ perspective; 2. Second, the valuer has to identify the principal market or most advantageous market in which the subject of valuation is normally traded in an orderly transaction and more importantly, whether the reporting entity can gain access to such markets; 3. Third, the valuer has to identify the characteristics of the market players {i.e., buyers and sellers) who are able and willing to transact the subject of valuation in the principal or most advantageous market; 4. Fourth, the valuer has to determine the appropriate valuation technique for the valuation of the subject asset or liability. The valuation technique should take into account considerations and assumptions which market participants,7.2 Measurement Requirements of Fair Value under IFRS 13 143 Maximising the Value Market Participants’ Perspective? Who Transact? Consideration and Assumptions for Pricing Purposes? Maximising Economic Best interest? Fair Value Hierarchy Maximising the Use of ‘Observable Inputs? Premiums and Discounts: Risk Premiums. FIGURE 7.1. Framework for Fair Value Measurement . normally use for pricing the subject jon technique also maximises the use of in view of their best economic inter of valuation. In addition, the valu observable inputs and minimises the use of unobservable inputs: 5. Fifth, valuation inputs are categorised in a fair value hierarchy which gives more priority to observable inputs and less priority to unobservable inputs. In addition, the valuer has to consider the valuation inputs, including premiums and discounts, that consistently reflect the characteristics of the valuation sub- ject. The valuer must also consider other assumptions such as risk premiums144 CHAPTER? * Fair Value Accounting and Financial Reporting Standards which account for the uncertainty of cash flows arising from the valuation sub- ject that market participants would take into account for pricing purposes; and 6. Finally, the valuer performs a valuation of the subject asset or liability based on the valuation techniques and inputs which are analysed and selected from the previous steps. Valuation techniques and inputs used (especially significant unobservable inputs and effects of the measurements on financial results) are required to be disclosed in the financial statements of the reporting entity We will naw discuss briefly the key concepts of the fair value measurement framework. Characteristics of the valuation subject As highlighted in Chapter 1, one of the key components of the valuation process is understanding the subject of valuation and business. Similarly, the account- ing standards recognise how important it is for the reporting entity or valuer to consider the characteristics of the valuation subject when performing, fair value measurements for financial reporting purposes. Such characteristies should par- ticularly be taken into account by market participants when pricing the valuation subject. Some of the chara stics can inelude the following: = Location and condition of an asset. If the assct is not in the location or condi- tion that market participants would require for its sale at an observable mar- ket price, then a valuer would need to adjust the price for which a market participant would pay for the asset in its current condition and location, For example, a valuer should deduct the cost of transporting the asset to the mar- ket if location is a characteristic of the subject asset. «Restrictions, if any, on the sale or use of an asset or transfer of a liability. If a restriction is transferred with the asset in a sale transaction, it would be deemed a characteristic of the asset and therefore will likely be taken into account by market participants in their pricing of the subject asset. Take for example a case where the subject of valuation is investment in restricted shares, which specifies that any entity holding such restricted shares can only sell the shares to certain approved investors or during a fixed period. Such a restriction is a characteristic of the restricted shares and therefore should be considered in the valuation of the restricted shares. Therefore, the fair value measurement of restricted shares reflects the risk that any market participant could not have access to a public market with all potential buyers or could not make a sale in the public market during a certain period. On the other hand, if a restriction is only specific to the entity that holds the asset and is nor transferred with the asset in a sale transaction, such a restriction will not be considered im assess- ing the value of the subject asset. Take for example the case where the subject of valuation is a piece of land held by A Pte Led (‘Co A’). The land was previ ously given by the local authority to Co A for the purpose of development of an international school, Based on the agreement between Co A and the local authority, Co A can only use the land for developing and running an inter- ational university should it hold the land. However, the local authority also allows Co A to sell the land at any time to any buyer who can use the land for other purposes including residential or commercial property development. In7.2 Measurement Requirements of Fair Value under IFRS13 145 this example, the restriction on mn the use of land for the development of an inter: national school is only specific to Co A and would not be applicable to. othe: market participants should the land be cransferred to them. Therefore, such a restriction should be excluded from the fair value measurement of the land, In other words, a valuer will not be bound to value the land on the basis that it will be developed into an international school but the valuer can consider other purposes such as the development of residential or commercial property that any market participant would take into account, Highest and best use for non-financial assets In valuing a non-financial asset, a valuer is required by the accounting standards to consider the context in which such an asset ean generate benefits that represent its highest and best use. Highest and best use is determined from the perspective of market participants, even if the entity holding the subject asset intends to have fferent use. However, an entity’s present use of the subject asset is supposed to be its highest and best use unless existing factors suggest thar market participants would maximise the value of the subject asset in a different use. For example, an I district of a city and presently leases it out as a parking lot for surrounding office buildings. From the market participants’ perspective, the land will generate the most economi hencfits if it is used for the development of a commercial building, This means the use for the development of a commercial building is the highest and best use of this ayser. ‘Therefore, the valuer should value this asset on the premise that it will be devel- oped into a commercial building instead of a parking lot. When determining the highest and best use of a non-financial asset, a val ler the following: is physically possible. A valuer will take into account the physical istics of the assct that market participants would consider when pric- ing the asset such as the location or the size of the asset; + Nuse that is legally permissible. A valuer will take into account any Le} restrictions on the use of the asset that market participants would consider when pricing the asset such as local authority regulations; and * Ase that is financially feasible. A valucr will take into account whether a use generates adcquate incame or cash flows (considering the costs of converting the assct to that use) to produce a return that market participants would expect. Finally, the hest and best use of a non-financial asset can be assessed on a stand-alone basis of as part of a group in combination with other complementary assets and/or liabilities. Principal or most advantageous market The principal market is the market with the greatest volume and level of activity for the subject assct or subject liability, not based on the entity's activity in a certain mar ket. The entity must have access to the principal market at the measurement date, and normally it is the market where the entity usually runs its business activities or trans- acts its products. The price in the principal market is used to measure fair value, eve:446 CHAPTER7 * Fair Value Accounting and Financial Reporting Standards if a price in a different market can be porentially more advantageous as at the mea- surement date. The principal market is considered from the perspective of the report- ing entity, and therefore the principal market can be different for different entities, Example 7.1 Principal market A Pte Ltd (‘Co A) can only sell product B in markets X and Y whereas market partici- pants can sell product 8 in markets X, Y and Z. The allocation of the total sales volume for product B transacted in the three markets X, Y and Z are summarised in Table 7.1 ity for As shown in Table 7.1, market Z has the greatest volume and level of ai product B. However, Go A does not have access to market Z and therefore market Z cannot be the principal market for product B from Go A’s perspective, Co A has 70% of its sales volume in market X as compared to 30% in market Y. From the whole market perspective, the sales volume for product B in market X is also higher than thar in market Y. Therefore, market X will be considered as the prin- cipal marker for product B. TERS 13 also introduces the concept of the most advantageous market in the case where the principal market cannot be identified. It is the market (after taking into account transaction costs and transport costs) that maximises the amount which would be received to sell the asset or minimises the amount which would be paid to transfer the liability. Basically, the marker that would yield the highest price for the assets (after deducting transaction costs and transport casts) is the most advantageous market. Example 7.2 Most advantageous market A Pte Ltd ('Co A’) can sell product B equally in markets X and Y and neither market can be clearly identified as the principal market. Selling prices and relevant costs for product B in each market are summarised in Table 7.2. TABLE 7.1 Sales Volume Allocation for Product B CoA Total Marker = oe Market X 70% 30% Market ¥ 30% 10% Market Z, 0% 60% Total 100% 100% TABLE 7.2 Selling Price and Relevant Costs for Product B (Ss) Marner X Marner ¥ Selling price 10 12 Transaction cost @) (2) Transport cost a) —B Net proceeds 6 7 ee7.2 Measurement Req ments of Fair Value under IFRS 13 147 As shown in Table 7.2, Co A can generate net proceeds of $7 for product B in market ¥ as compared to that of $6 when it sells product B in market X. There- fore, Market Y will be the most advantageous market for product B. Under IFRS 13, the fair value measurement is based on a hypothetical transac- tion that will take place in the principal or most advantageous market as at the measurement date under present market conditions, and such a transaction will be orderly in nature. An orderly transaction assumes that the asset or lia is exposed to the market prior to the measurement date for a period that nor- mally suffices for information dissemination and marketing. In other words, in an orderly transaction, market participants who are independent of each other would have sufficient knowledge of the asset or liability for pricing consideration purposes. Market participants Market participants are buyers and sellers in the principal (or most advanta- geous) market for the asset or liability. When performing fair valuc measurement, 2 valuer is required to use the assumptions that market participants acting in their economic best interest would use when pricing the asset or liability. For example, when estimating the discount rate such as the weighted average cost of capital (WACC) for the valuation of an entity using the discounted cash flows methad, relevant assumptions including debr-equity ratio and cost of debt are generally based on market data observed for comparable companies instead of the entity's unique capital structure and costs of debt. An entity does not need to identify specific market participants; instead, it should identify characteristics of market participants that would generally trans- act for the asset or liability being measured. In determining the characteristics of the marker participants, a valuer should consider + factors that are specific to the subject asset or liability, © principal or most advantageous market for the subject asset or liability and © marker participants that would transact with the reporting entity in that market. ‘The principal or most advantageous market is determined from the perspective of the reporting entity, and therefore other entities operating in the same industry as the reporting entity are most likely to be considered as market participants However, market participants can be outside of the reporting entity’s industry when assessing the fair value of an asset on a stand-alone basis. For example, a real estate development company can be considered as a market participant when assessing the fair value of a vacant land owned by a manufacturing company if the vacant land’s highest and best use is the development of a commercial property. In addition, IERS 13 also highlights the following key characteristics of mar- ket participants when presenting the definition: * Market participants are independent of each other. This means they are not related parties as defined in IAS 24 Related Party Disclosures, IFRS 13 does not allow the price in a related party transaction to be used as an input to fair value measurement unless the entity has evidence showing that such a transac tion was on an arm's length basis and entered into at market terms;148 © CHAPTER? = Fair Value Accounting and Financial Reporting Standards + Markee participants are presumed to be knowledgeable, having a reasonable understanding of the asset or liability, using all available information includ ing that obtained through market participants’ efforts and. © Marker participants are able and willing to enter into a transaction for the asset oF liability Valuation techniques IFRS 13 recognises the three widely used valuation techniques for fair value mea- surement as shown below: © ‘The market approach uses prices and other relevant information generated by market transactions involving identical or comparable (i.c., similar) assets, liabilities or a group of assets and liabilities, such as a business, © The income approach converts future amounts (e.g., cash flows or income and expenses) to a single current (i.¢., discounted) amount. The fair value mea- surement is determined on the basis of the value indicated by current market expectations about those future amounts. © The cost approach reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replace- ment cost). The standard further explains that ‘From the perspective of a mar- ket participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. That is because a mar- ket participant buyer would not pay more for an asset than the amount for which it could replace the service capacity of that asset’. Obsolescence does not simply mean depreciation for accounting oF tax purposes but consists of physical deterioration, functional (technological) obsolescenee and economic (external) obsolescence. IFRS 13 requires a valuet to 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. It is clear that the standard does not prioritise the valuation approaches or techniques but instead it prioritises the valuation inputs used in these valuation approaches oF techniques. This also means that a valuer should exclude valuation approaches or techniques that use assumptions not consistent with market participants’ assumptions and therefare the resultant value is not representative of fair value. In general, a valuer has to usc valuation approaches or techniques that would be considered by market participants in pricing the sub- ject asset or liability. When a valuer uses multiple valuation techniques leading to divergent results, this may indicate a misapplication of one or all the techniques and therefore would require further additional analysis. A further thorough analysis might assist the valucr to identify those valuation techniques using assumptions that are not consistent with marker participants’ assumptions; such assumptions are less reliable and therefore will be excluded from the valuation, It is important to note that valuation techniques used to measure the fair value should be applied consistently amongst similar assets or liabilities and7.2 Measurement Requirements of Fair Value under IFRS 13 149 across reporting periods. Any change in the valuation technique or its applica- tion should only happen on the premise that such a change results in a measure meat that is equally representative (or more representative) of fair value. IFRS 13 further identifies certain events in which a change in valuation technique might occur, such as the following: New markets develop, New information becomes available, Information previously used is no longer available, Valuation techniques improve or Marker conditions change. Valuation inputs In accordance with IFRS 13, inputs to be used in a valuation technique are required to * be consistent with the characteristics of the valuation subject that marker par- ticipants would take into account in a transaction for that valuation subject; * exclude other premiums or discounts if they are inconsistent with the unit of account. IFRS 13 defines unit of account as the level at which an asset or liability is aggregated or disaggrcgated in an IFRS for recognition purposes. In practice, if the valuation premise differs from the unit of account, fair value may need to be allocated/adjusted to ensure it is consistent with the unit of account; and. * exclude premiums or discounts that reflect size as a characteristic of the enti- ty’s holding as opposed to a characteristic of the item being measured. For example, a blockage factor adjusts the quoted price of an asset because the marker’s normal daily trading volume is not sufficient to absorb the quantity held by the entity, Accordingly a blockage factor is excluded fram the valua- tion of the subject asset. Itis required by IFRS 13 that the fair value measurement shall maximise the use of relevant observable inputs and minimise the use of unobservable inputs regardless of the valuation techniques being used. This is consistent with the market-based fair value measurement principle which uses available and relevant market-based observable data. Fair value hierarchy IFRS 13 establishes a fair value hierarchy that assigns three levels of inputs to valuation techniques used to measure fair value as shown in Table 7.3. According to the IASB, Level 1 inputs obtained from an active market are observable inputs and therefore generally provide the most reliable evidence and should be used whenever available. Observable inputs are developed based on market data, such as publicly available information about actual events or trans- actions, and reflect the assumptions that market participants would use when pricing the asset or liability. The standard further defines an active market as ‘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’. The150 © CHAPTER? * Fair Value Accounting and Financial Reporting Standards 0s a MR ne RNR OT TABLE 7.3 Fal Level 2 Level 3 Value Hierarchy DerinTion Examee | Quoted prices (unadjusted) in Quoted prices for an equity secu- active markets for identical assets rity that trades on the Singapore or liabilities that the entity can Stock Exchange access at the measurement date Inputs other than quoted prices Quoted prices far identical or included within Level 1 that are similar assets in markets that are observable for the asset or liability, | not active either directly or indirectly Unobservable inputs for the asset__| Projected cash flows used in a or liability discounted cash flow calculation TASB notes that there are certain cases when an entity can hold a large number of similar assets and liabilities but active markets for such assets or liabilities may not be available and/or accessible, In such situations, the entity can use an alter- native pricing method which does nat rely exclusively on quoted prices. How- ever, such measurement and application should not be categorised under Level Land might be grouped under Level 2 which normally includes inputs that are based on or supported by observable market data such as market corroborated inputs (derived principally from or corroborated by observable market data by correlation or other means) or quoted prices for identical assets and liabilities in non-active’ markets. Any significant adjustment using unobservable evidence to Level 2 inputs might result in the categorisation of the inputs to Level 3 in the fair value hierarchy. Level 3 inputs are unobservable and more subjective. Unob- servable inputs are inputs for which market data are not available and that are developed using the best information available, One important thing to note is that even if Level 3 inputs are unobservable, such inputs should still reflect the assumptions and considerations that market participants take into account when pricing the subject asset or liability; this is because the ultimate abjective is to derive a fair value that meets the fair value definition of IFRS 13. The standard further emphasises that‘an entity shall develop unobservable inputs using the best information available in the circumstances, which might include the entity's own data. In developing unobservable inputs, an entity may begin with its own data, bur it shall adjust those data if the reasonably available information indicates that other market participants would use different data or if there is something particular to the entity that is nor available to other market participants (c.g., am entity-speeific synergy). An entity need not undertake exhaustive efforts to obtain information about market participant assumptions. However, an entity shall rake 3. For further detailed guidance on measuring fair value when the volume or level af activity for an asset or a liability has significantly decreased, refer to 2017 IFRS Standards (Bluc Book) ~IFRS 13 paragraphs B37-R47,7.2 Measurement Requirements of Fair Value under IFRS 13 151 Level 2 Level 3 FIGURE 7.2 Determination Process of Fair Value Hierarchy into account all information about marker participant assumptions that is reason ably available. Unobservable inputs developed in the manner described above are considered market participant assumptions and meet the objective of a fair value measurement’. In summary, the fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markers for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs). In this regard, the fair value hierarchy prioritises valuation inputs in a fair value measurement and increases consistency as well as comparability in disclosure requirements. Figure 7.2 summarises the determination process of the fair value hierarchy. Premiums and discounts Premiums or discounts that reflect size as a characteristic of the entity's holding (c.g. a blockage factor) are prohibited in a fair value measurement. According to the IASB, a blockage factor is only specific to the entity and can be realised subject to the entity’s decision. The LASB further explains that ‘an entity would realise a blockage factor when that entity decides to enter into a transaction to sell a block consisting of a large number of identical assets or liabilities. There- fore, blockage factors are conceptually similar to transaction costs in that they will differ depending on how an entity enters into a transaction for an asset or a liability. The boards concluded that if an entity decides to enter into a transaction to sell a block, the consequences of that decision should be recognised when the decision is carried out regardless of the level of the fair value hierarchy in which the fair value measurement is categorised’. On the other hand, the IASB concluded that control premiums and discounts such as discounts for non-contralling interests and discounts for lack of market- ability that are related to characteristics of the asset or liability being measured will be considered in a fair value measurement. However, IFRS 13 does not pro- vide explicit guidance on how such premiums or discounts should be considered152 CHAPTER? * Fair Value Accounting and Financial Reporting Standards 7.3 IFRS or applied in a fair value measurement for financial reporting purposes, Instead, the standard indicates that the application of premiums and discounts reflects the characteristics of the asset or liability being measured and market participants, acting in their best economic interests, would consider these premiums or dis- counts when pricing the asset or liability. Risk premiums Risk premium is defined under IFRS 13 as ‘compensation sought by risk-averse market participants for bearing the uncertainty inherent in the cash flows of an asset or a liability. Also referred to as a “risk adjustmenc”. This means that market participants would consider a risk premium that reflects the uncertainty inherent in the cash flows of an asset or liability when pricing the subject asset or liability. Such a risk premium should be assessed in an orderly transaction {not a forced or distressed sale) and reflect market participants’ assumptions about risk under current market conditions. The higher the risk attached to an asset, the lower the fair value of such an asset, as market participants would likely pay less for the uncertainty inherent the asset. If such uncertainty is accounted for in the discount rate, rather than in the forecast cash flows associated with the asset, it would normally result in an upward adjustment to the discount rate used in the valuation of the asset. 13 and US GAAP In developing IFRS 13, the IASB made references to US GAAP, and hence the defi nition of fair value and measurement requirements under IFRS 13 is similar to that under US GAAP as specified in the Statement of Financial Accounting Stan- dards No. 157 Fair Value Measurement (SEAS 157) issued in September 2006 by the Finaneial Accounting Standards Board (FASB) and subsequently codified as Topic 820 Fair Value Measurement and Disclosures (ASC 820). Similar to IFRS 13, the main purpose of SFAS 157 was to define fair value and establish a frame- work that inereases the consistency and comparability in fair value measurements and disclosures.‘ Right after the introduction of SFAS 157, fair valuc or mark-to- warket accounting. was criticised by many including the American Bankers Asso- ciation as one of the main reasons for the financial crisis in 2008. According to economist Brian Wesbury, ‘Mark-ro-marker accounting rules have turned a large problem into a humongous one. A vast majority of mortgages, corporate bonds, and structured debts are still performing, But because the marker is frozen, the prices of these assets have fallen below their true value.” He argues that *... mark- ing to market pushed many banks toward insolvency and forced them to unload assets at fire-sale prices, which then caused values to fall even further." In response 4. Financial Accounting Standards Board (2006). Reference Library: Financial Accounting Standards Board [online]. Available at hrepithuww-fash.org/pdiifas 57 pdf. 5. Posen, R. C., 2009, Harvard Business Review. [Online] uir-to-hlame-fair-value-accounting for-the-finanei lable ar: hupsi/hbrorg’2009/1 1‘6. US. Congress, 2008, EDsyst sspo.govilslsysipkp/STATUTE- 122/pd/STATUTE-122-Px.3765. pal, ‘The SEG has expressed no view regarding the analysis, findings or conclusions contained in the SEC report ‘The Staff of the U.S, Sect mission. fontine]. As F.2IFRS13andUSGAAP 153 to the financial crisis, the Emergency Economie Stabilization Act of 2008 (2008 Act), enacted by the US Senate and House of Representatives on 3 October 2008. provides ‘authority for the Federal Government to purchase and insure certain types of troubled assets for the purposes of providing stability to and preventing disruption in the economy and financial system and protecting taxpayers With regard to fair value accounting, the 2008 Act specified the following key points: * Section 132 of the 2008 Act gave the US Securities and Exchange Commis- sion (SEC) the authority to suspend the application of SEAS 157 for any issuer {as such a term is defined in the US Securities Exchange Act of 1934) or with respect to any class or category of transaction the SEC determines is necessary or appropriate in the public interest and is consistent with the protection of investors; and * Section 133 of the 2008 Act required the SEC to conduct a study on mark- to-market accounting (which is also known to some investors as fair value accounting) standards attached with SEAS 157. In December 2008, the Staff of the SEC released the study report on mark-to- marker accounting standards (SEC repert)” in which it recommended that existing fair value and mark-to-market requirements should nat be sus pended and accordingly SFAS 157 should not be suspended but would need to be improved. In addition, the SEC report found among other things that “fair value accounting did not appear to play a meaningful role in the bank failures occurring during 2008. Rather, bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and, in certain cases, eroding lender and investor confidence. For the failed banks thar did recognize sizeable fair value losses, it does not appear that the reporting of these losses was the reason the bank failed’. The SEC report also highlighted that investors are generally of the view that fair value accounting provides transparency in financial reporting and hence facilitates better invest ment decision making, Over the years, the [ASB has worked closely with the FASB and aimed to develop common requirements for fair value measurement and disclosure which would improve the comparability of financial statements, reduce the diversity in the application of fair value measurement requirements and simplify the financial reporting. Therefore the meaning of fair value definition and the requirements of fair value measurement and disclosure stated or implied in either IFRS 13 or US GAAP (ASC 820) should nor be different except for the wordings due to preference. nent Publishing Office. [Online] Available at: hreps:/iwww mission (2008). Newsroom: U.S. Securities and Exchange Com: stomarket 12 3008.pelf, ies and Exchange Cor hitps:ewwsec povlnews/studies/2008/im bi154 CHAPTER? © Fair Value Accounting and Financial Reporting Standards 7.4 Summary In summary, over the years, the IASB has developed new accounting standards with a focus on fair value measurement. Until the introduction of IFRS 13, there were gaps and inconsistency amongst IFRS standards in terms of fair value defini- tion, measurement and disclosure. IFRS 13, issued on 12 May 2011 by the IASB, forms a single framework for measuring fair value for the purposes of financial reporting. IFRS 13 provides guidance on the definition and measurement of fair value as well as the disclo- sure requirement that can be used across IFRS. This improves the consistency in applying fair value principles across the IFRS and will not result in fundamencal changes to fair value measurement guidance already presented in the IFRS. The key concepts of the valuation framework under IFRS 13 include char- acteristics of the valuation subject, highest and best use for non-financial assets, principal or most advantageous market, characteristics of market participants, valuation techniques and valuation inputs, The fair value hierarchy categorises the inputs used in valuation techniques into three levels, of which it gives the highest priority to quoted prices (unad- justed) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). TERS 13 does not eliminate the judgment in fair value estimation but instead aims to build a framework that can improve consistency as well as comparability in fair value measurements for the purposes of financial reporting,