Chapter Two

Fair value measurement and Impairments

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 Definition of Fair value measurement
 FVM: to estimate the price at which an orderly
transaction to sell the asset or to transfer the liability
would take place between market participants at the
measurement date under current market conditions.
 FV refers to the measurement of assets and liabilities
primarily investments at the expected price they
would bring in the current market.
 The Statement also establishes a three-level hierarchy
of inputs used to measure FV.
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Definition of Fair value measurement (Cont’d)
 IFRS 13 FVM applies to IFRS that require or
permit FVM or disclosures and provides a single
IFRS framework for measuring FV and requires
disclosures about FVM.

 The Standard defines FV on the basis of an 'exit

price' notion and uses a 'FV hierarchy', which
results in a market-based, rather than entity-
specific, measurement.

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 IFRS 13 FV
 IFRS 13 is a common framework for measuring
FV.

 “FV is the estimated price for the transfer of an asset

or liability between identified knowledgeable and
willing parties that reflects the respective interests of
those parties.”
 Respective advantages and disadvantages -
International Valuation Standards (IVS)
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 Fair Value Measurement (FVM)
 IFRS 13 requires any advantages that would not be
available to market participants generally to be
disregarded.

 Accordingly, management needs to be aware of this

difference in concept in order to ensure any values
used for financial reporting that are obtained from
appraisals, whether external or internal, are
consistent with the objective of a FVM.
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 Fair Value at Initial Recognition
 At initial recognition, an entity measures a
financial asset or a financial liability at its
FV plus or minus, in the case of a financial

asset or a financial liability not at FV

through profit or loss, transaction costs that
are directly attributable to the acquisition or
issue of the financial asset .

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 Look the Following Example for PPE
 Asset Value ETB.1,000,0000
 Depreciation SLM over a period of 5 year
 At the end of the 4th year it was re-determined
at a further period of 5 year
 Carrying amount of ETB.4,000,0000 will be
depreciated at ETB.800,000 every year for the
next 5 year
Depreciation A/c Dr 800,000
To PPE A/c 800,000
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 Example for Financial Instruments
 A Ltd holds Biya Ltd shares purchased at
ETB.50,000
 A Ltd sell the shares to B Ltd.
 The Investment has been sold for
ETB.500,000
 FV on the date of Sale is ETB.1,300,000

 How do we account for the same?

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 A/c Entry in A Ltd
 Initial Measurement

 FV on the date of purchase is ETB.100,000

 Shares in Biya Ltd A/c Dr 100,000

 To Bank A/c 50,000

 To Gain on Purchase 50,000

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 A/c Entry in A Ltd
 On the date of sale - Revision of FV at
ETB.1,300,000
 Shares in Biya Ltd A/c Dr 1,200,000
 To Mark to Fair Value 12,00,000

 Bank A/c Dr 5,00,000

 Loss on Sale Dr 8,00,000
 To Shares in Biya Ltd A/c 13,00,000
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 A/c Entry in B Ltd
 On the date of purchase

 Shares in Biya Ltd A/c Dr 13,00,000

 To Bank A/c 500,000

 To Gain on Purchase 800,000

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 Valuation Techniques
 IFRS 13 describes three valuation techniques

1. Market approach

2. Income approach

3. Cost approach

 One or several valuation techniques might be

used If a range of values are indicated, select the
point within that range most representative of fair
value.
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 Market Approach

 It is valuation techniques that 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, such as a

business.
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 Income Approach
 A valuation techniques that convert future
amounts e.g. cash flows or incomes and
expenses to a single current (i.e.
discounted)amount.
 The FVM is determined on the basis of the
value indicated by current market
expectations amount those future amounts.
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 Cost Approach

 A valuation techniques that reflects the

amount that would be required currently to

replace the service capacity of an

asset(often referred as current replacement

costs.

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 Fair value hierarchy(FVH)
 Definition. The FVH categorises the inputs
used in Valuation techniques into three
levels. The hierarchy gives the highest
priority (Level 1) to (unadjusted) quoted
prices in active markets for identical assets
or liabilities and the lowest priority (Level 3)
to unobservable inputs.

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 Fair value hierarchy (Cont’d)
 IFRS 13 includes a FVH for disclosure purposes which
prioritises the inputs in a FVM:

 Level 1 – Quoted prices (unadjusted) in an active

market for identical assets that the entity can access at
the measurement date.

 Level 2 – Observable inputs other than quoted prices

 Level 3 – Unobservable inputs

 Amount of disclosures depends on Level Classification

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 Level 2 Fair value hierarchy

 Level 2 assets are financial assets and

liabilities that do not have regular market
pricing, but whose fair value can be
determined based on other data values or
market prices.
 Level 2 assets are the middle classification
based on how reliably their fair market
value can be calculated.
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 Level 3 Fair Value Hierarchy inputs
 Level 3 inputs: inputs are unobservable inputs for the asset or
liability.

 Unobservable inputs are used to measure fair value to the extent that
relevant observable inputs are not available, thereby allowing for
situations in which there is little, if any, market activity for the asset
or liability at the measurement date.

 An entity develops unobservable inputs using the best information

available in the circumstances, which might include the entity's own
data, taking into account all information about market participant
assumptions that is reasonably available.

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 Disclosure Principles
 Disclose information that helps users assess the following:
a. For assets measured at FV on a recurring or non-recurring
basis after initial recognition, valuation techniques and
inputs used to develop those measurements.
b. For recurring FVM using significant unobservable inputs
(Level 3), the effect of measurements on profit or loss or
other comprehensive income for the period.
c. FV disclosures are required separately for each class of
assets
d. Quantitative disclosures are presented in a tabular format
unless another format is more appropriate.
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 Agriculture – IAS 41
 Purchase of Livestock

 Fair Value – 6000

 Purchase Cost 500

Livestock A/c Dr 6000

To Bank 500

To Gain on Purchase 5500

 ( Measurement is at fair value under IAS 41)

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 Income Taxes – IAS 12
 An entity’s PPE Carrying Value –
ETB.1,000,000
 Revalued at ETB.1,500,000
 Rate of Tax 20%
 What is the Deferred Tax Liability and the
entry to be passed?

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 Income Tax Cont’d)
 CV is ETB.1,500,000 after revaluation.
 Tax Liability – 20%*( 1,500,000-1,000,000)
 Deferred Tax Liability is ETB.100,000
PPE A/c Dr ETB.500,000
To Revaluation Surplus A/c ETB.500,000
Revaluation Surplus A/c Dr ETB.100,000
To Deferred Tax Liability A/c ETB.100,000
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 2.2. IMPAIRMENT (IAS 36)
 IAS 36 – Overview
• Objective and scope

• Identifying an asset that might be impaired

• Recognizing and measuring an impairment loss

for an individual asset

• Recognizing and measuring an impairment loss

for cash-generating units and goodwill

• Reversing an impairment loss

• Disclosure
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 INTRODUCTION
• Impairment: means sudden diminution in value of an
individual non-current asset or cash generating
unit (CGU)

• CGU 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

• CGUs are likely to follow the way in which management

monitors and makes decisions about different parts of the
business

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 Definition Impairment
 In accounting, impairment is a permanent
reduction in the value of a company asset.
 It may be a fixed asset or an intangible asset.
 When testing an asset for impairment, the
total profit, cash flow, or other benefit that
can be generated by the asset is periodically
compared with its current book value.
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 IAS 36 – Objective and Scope
• IAS 36 ensures that assets are reported on the statement of

financial position at no more than the entity can

recover from their use or sale.

• Impairment loss is “the amount by which the carrying

amount of an asset or a cash-generating unit (CGU) exceeds

its recoverable amount”

• Impairment loss = CA /CGU > RA

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 Scope of IAS 36
• IAS 36 applies to:

1. Property, Plant and Equipment (IAS 16)

2. Investment Property at Cost (IAS 40)

3. Intangible assets (IAS 38)

4. Good will (IFRS 3)

5. Investment in Subsidiaries, associate and

Joint arrangement carried at cost

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 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.

•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.

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 IMPAIRMENT OF ASSETS

Fundamental principles

• To prescribe the procedures to ensure that non-current

assets and CGUs are recorded at no more than their

recoverable amounts (RA)

• RA is the higher of fair value less costs of disposal

(FVLCD) and value in use (VIU)

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IAS 36 – Identifying an Asset that May be Impaired
• At the end of each reporting period:

1. Assess for indications of impairment

2. If indications of impairment, test for

impairment

• For intangibles with indefinite lives (including Goodwill)

and intangible assets not yet ready for use annually test for

impairment regardless of indications of impairment

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 Identifying an Asset that May be Impaired (Cont’d)

Impairment Indications

• External sources

1. Decline in assets’ market value

2. Adverse changes in technological, market,

economic or legal environment

3. Market interest rates

4. Amount of the net assets is more than market

capitalisation

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Identifying an Asset that May be Impaired (Cont’d)
• Internal sources

1. Obsolescence or physical damage of an asset

2. Plans for a significant reorganisation/discontinuation or sale

of an asset

3. Evidence that an asset’s performance is worse than expected

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 Impairment Testing Level
• Principle: test for impairment at the individual
asset level

• Application guidance for corporate assets:

• Because corporate assets do not generate

separate cash inflows, the recoverable
amount of an individual corporate asset
cannot be determined unless management has
decided to dispose of the asset.

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 IAS 36 – Identifying an Asset that May be Impaired
Testing for impairment:

1. Estimate asset/CGU’s recoverable amount.

If RA > CA, no impairment

2. RA is higher of:
• Fair value less costs to sell, and

• Value in use

3. Disposal costs: include legal costs, transaction taxes,

removal costs, costs to put in condition for sale

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 Fair value less costs to sale (FVLCS)
• FVLCS is the arm's length sale price between
knowledgeable willing parties less costs of disposal.

• Value in use is present value of the future cash flows

expected from asset/CGU’s use and ultimate disposal

Two approaches:
1. Most likely cash flows from use and disposal discounted using
risk-adjusted discount rate.

2. Probability-weighted cash flows from use and disposal

discounted using remaining risk-adjusted discount rate.

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 Value in use (VIU) or economic value (EV)

• VIU or EV is the present value of the future cash

flows derived by the asset from its continuing

use and ultimate disposal

• Two key decisions – the discount rate to be

used and estimating future cash flows

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 Cash Flows
• Expected cash flows should be based on:

1. Reasonable and supportable assumptions of management’s best

estimates of the economic conditions.

2. Cash flows should not include:

 future cash inflows or outflows that are expected to arise

from a future restructuring to which an enterprise is not yet
committed

 future capital expenditure that will improve or enhance

the CGU or asset

 cash inflows / outflows from financing activities

 income tax payments or receipts
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 Value in use: example
• Estimated CF with a 40% probability they will be $120
and a 60% probability they will be $80. Value in use?
• Method 1: Most likely cash flows (CF )= $80.
• This amount is discounted using a rate that takes into
account all risks including the uncertainty of the CF
amounts.
• Method 2: Expected value of CF = (120 × 40%) + (80
× 60%) = $96.
• This amount is discounted using a rate that includes
remaining risks.
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 Process of Recognizing Impairments in
summary
If impairment indicators are present, then an impairment test must be conducted.

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Recognizing Impairments: Example
Assume that ABC Company performs an impairment test for its
equipment. The Carrying Amount of ABC’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
Carrying amount Compared to Recoverable amount

No Impairment

Higher of

Fair value less

Value in use
 costs to sell

 $180,000 $205,000
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Recognizing Impairments: Example (Cont’d)
Example: Assume the same information for ABC Company except that
the value-in-use of ABC’s equipment is $175,000 rather than
$205,000.
$ 20,000 Impairment Loss
$ 200,000 $180,000
Carrying amount Compared to Recoverable amount

Higher of

Fair value less

Value in use
costs to sell
$180,000 $175,000

ABC makes the following entry to record the impairment loss.

Loss on Impairment 20,000

Accumulated Depreciation—Equipment 20,000

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 Reversal of Impairment Loss
Depreciation expense and related carrying amount after the
impairment.

Year Depreciation expenses Carrying amount

2016 $90,000(180,000/2) $90,000
2017 $90,000(180,000/2) $0
At the end of 2016, Yes determines that the recoverable
amount of the equipment is $96,000. Yes reverses the
impairment loss.

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 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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IAS 36 – Recognizing and Measuring an Impairment
Loss for CGUs and Goodwill

• CGU’s carrying amount = carrying amount of

all assets used to generate the relevant stream of

cash flows

• Includes assets

 directly involved, and

 those allocated to the CGU on a reasonable basis

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 IAS 36 – Recognizing and Measuring an
Impairment Loss for CGUs and Goodwill
Testing CGUs for impairment

1. CGUs with related G/W not allocated specifically:

• Test when an indication of impairment

 Loss = CGU carrying amount excluding G/W

recoverable amount

2. CGUs with G/W allocated to it

• Test at least annually

 Loss = CGU carrying amount including G/W

recoverable amount

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IAS 36 – Recognizing and Measuring an Impairment
Loss for CGUs and Goodwill
• Impairment loss for a CGU or group of CGUs:
 1st allocate the loss to CA of G/W allocated to the CGU or
group

 2nd allocate remainder to assets in CGU on basis of relative

CA

• However, cannot reduce the CA of any asset below the

highest of nil, fair value less costs to sell and value in
use (if determinable)
 3rd reallocate any excess impairment to other assets of the
CGU
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 Cash generating unit (CGU) impairment

 example using cost model

At 31 December 2014 a fish harvesting CGU’s assets:

• carrying amount = $2,300,000

 $1,500,000 fishing boat

 $500,000 fishing license

 $300,000 goodwill

• recoverable amount = $1,600,000 (value in use)

 fair value of fishing boat = $1,400,000

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 Cash generating unit (CGU) impairment (Cont’d)

 example using cost model

• CGU’s asset impairment loss (an expense) = $700,000

• i.e. $2,300,000 CA less $1,600,000 RA

• Allocate $700,000 impairment loss to CGU’s assets, as follows:

• 1st allocate $300,000 loss to goodwill

• 2nd allocate remaining $400,000 loss: $300,000 to the boat and

$100,000 to the license (pro rata on carrying amount)

• 3rd reallocate $200,000 loss from boat to license.

• After impairment the CA of the CGU’s assets are:

• nil goodwill, $1,400,000 boat and $200,000 license

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 Reversing impairment loss
• General principles:
• at reporting date assess whether there is any indication that
impairment has reversed if any such indication exists,
estimate RA reverse impairment in profit or loss if CA <

RA, but reversal cannot increase the CA above the

CA that would have been determined (net of
amortization or depreciation) had no
impairment loss been recognized in prior years.

• goodwill impairment cannot be reversed

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 CGU reversal of prior period impairment
 example using cost model extended
At 31 December 2015 the fish harvesting CGU’s assets:
• Carrying amount = $1,200,000
• $1,050,000 fishing boat + $150,000 fishing license + nil goodwill
• Recoverable amount = $1,800,000 (value in use)
• fair value of fishing boat = $1,250,000

• Hypothetical carrying amount if no impairment in 2014 = $1,725,000

• i.e. $1,125,000 fishing boat + $375,000 fishing license + $225,000
goodwill
• Maximum potential impairment loss reversal (income) = $600,000
• i.e. $1,800,000 RA less $1,200,000 CA

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 CGU reversal of prior period impairment
 example cost model extended
Allocate reversal of impairment loss to CGU’s assets, as follows:

• nil to goodwill because cannot recognize (new) internally generated

goodwill.
• $525,000 to the boat and $75,000 to the license (pro rata on carrying
amount)
• But limit gain on boat and license to $75,000 and
$225,000 respectively because cannot exceed what CA would be
had the 2014 impairment not occurred
Because there are no other assets in the CGU to ‘absorb’ the unallocated
potential prior period impairment reversal, the gain (income) from the
reversal of the prior period impairment is limited to $300,000 in 2015
• $75,000 fishing boat + $225,000 fishing license
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 After reversal
• After reversing impairment loss
• adjust the depreciation/amortization
charge for the asset in future periods to
allocate the asset’s revised CA, less its
residual value (if any), on a systematic
basis over its remaining useful life.

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 Disclosure
• For each class of assets:
 Amount of impairment losses and reversals
recognised in profit or loss and line item in
statement of comprehensive income in which they are
included
 Amount of impairments and reversals recognised
directly in equity during the period
 Details of assets or CGU’s subject to impairments or
reversal of impairments
 Whether recoverable amounts are fair value less costs to
sell or value in use and any relevant discount rates
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