All details about Indian accounting standard 113 i.e. Ind AS 113.
WHAT IS FAIR VALUE?
Normally assets and liabilities have being exchanged between parties at a particular agreed terms and conditions which are based on the prices, which might be related to the entity or event-based or, in other words, not at arm’s length prices.
To define fair values, one must ensure that the values reflect all assumptions/ adjustments to change from transaction-specific/ entity specific to the normal transaction, which is common for all interested parties.
In other words, it is a market-based value rather than an entity-specific price, and this price should be received for selling an asset or paid for transferring a liability in a normal transaction (e.g. other than any sale which is stressed etc.). Fair Value is an exit price and it is not a price at which an Asset or liability sold or purchases otherwise.
OBJECTIVES Indian accounting standard 113 i.e. Ind AS 113
The objective of fair value measurement is:
- For estimating the price.
- At which an orderly transaction can be done for selling the asset or for transferring the liability will take place.
- In the middle of market participants.
- At the date of measurement.
- Under the current market conditions.
When a price for an asset or liability which is identical is not observable, for an entity to measure the fair value by using another valuation technique that:
- Maximizes the use of relevant observable inputs.
- Minimizes the use of unobservable inputs.
SCOPE OF Ind AS 113
Many Ind AS requires measuring assets/liabilities at fair value, and whenever it is required to be fair valued, one looks at Ind AS 113. It means that this Standard will cover all such requirements of another standard where fair value measurement and disclosure is needed. However, there are some specific scope exclusions. It applies to initial measurement and subsequent measurement as required by the respective Accounting Standard.
What is not covered in this Accounting Standard ?
The standard specifically describes the below exceptions, which the Accounting Standard does not cover. Hence, one has to look at the respective standards themselves to identify the process to calculate Fair Values of the standard items.
The scope exclusion will be applied on below:
Measurement and disclosure exclusion-
(a) Transactions of share-based payment within the scope of Ind AS 102, Share-based Payment.
(b) Leasing transactions accounted for following Ind AS 116, Leases.
(c) Measurements that is having some similarities to fair value but are it is not fair value, such as net realisable value mentioned in Ind AS 2, Inventories, or value in use in Ind AS 36, Impairment of Assets.
Disclosure exclusion of Ind AS 113 presentation
(a) Plan assets measured at fair value following Ind AS 19, Employee Benefits.
(b) Recoverable amount of an asset which is having fair value fewer disposal costs following Ind AS 36.
DEFINITION of Indian accounting standard 113
Under this Ind AS, the fair value as the price that would be able to be received for selling an asset or payable for transferring a liability in an orderly transaction between market participants at the measurement date.
To understand the definition of fair value, some of the major terms as used in the definition need to be understood, which are as follows:
The asset or liability.
ASSET OR LIABILITY SPECIFIC FAIR VALUE
Ind AS 113 presentation states that a fair value measurement usually considers the characteristics of the asset or liability, e.g. the condition and location of the asset and restrictions, if any, on its sale or use.
The restriction or condition relating to the asset that can affect the future economic benefit from the asset needs to be considered in determining the asset’s fair value.
The standard emphasis that to get a fair value of an asset/ liability, the restrictions or conditions that might be related to a particular entity should not be taken into account because a fair value will be based on market participant assumptions rather to entity-specific conditions or restriction which normally will not affect the fair valuation of an asset/ liability.
The restrictions could be entity-specific or asset/ liability specific; hence, all such restrictions that are asset/liability specific & being transfer to the buyer as it is will be considered while calculating fair value. In contrast, if the restrictions are entity-specific, then they will not be considered.
UNIT OF COUNT
Ind AS 113 presentation describes how to measure fair value, not what is being measured at fair value. Other Ind AS specify whether a fair value of land measurement considers an individual asset or liability or a group of assets or liabilities.
Whether the asset or liability is considered as a stand-alone asset or stand-alone liability, a group of assets or liabilities or a group of assets and liabilities for recognizing or disclosing purposes which depends on its unit of account.
The part of an account for the asset or liability should be determined following the Ind AS that is requiring or permitting the fair value measurement, except as provided in this Ind AS.
It essentially defines the level of aggregation or disaggregation while calculating Fair Values of the Assets/ Liabilities.
A fair value measurement usually assumes that the asset or liability can be exchanged in an orderly transaction between market participants for selling the asset or transferring the liability at the measurement date under various current market conditions.
A fair value measurement can be assumed that the transaction for selling the asset or transfer the liability takes place either-
(a) Assets or Liability’s principal market.
(b) In the principal market, the most advantageous market for the asset or liability is not present.
There could be different principal markets for different reporting entities, even if they belong to the same group. The top market/ most advantageous market would separately be evaluated for different assets/ liabilities under the fair valuation requirements budget.
The market is normally where the assets/liabilities are being transacted with the highest volume with a high level of activities compared with any other market available for similar transactions.
If there is a presence of principal market, then the price in the market must be used even if the prices in the other market are more advantageous campaign.
Because the principal market is the most liquid market for the asset or liability, that market will provide the most representative input for fair value measurement.
Most Advantageous Market:
- This is the market that either maximizes the amount received when an entity sells an asset or minimises the amount to be paid while transferring the liability.
- In the absence of a principal market, this market is used for Fair Valuation of the Assets/ Liabilities. In many cases, the Principal market & most advantageous market will be the same.
- The market will be assessed based on net proceeds from the sale, which will deduct expenses associated with such a sale in the most advantageous market.
Fair value measurement is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement uses market participants’ assumptions when pricing the asset or liability.
An entity should be calculating the fair value of an asset or a liability by using the assumptions that the market participants would be use while pricing the asset or liability, by assuming that the act of market participants in their economic best interest.
What are market participants?
The parties which eventually transact the assets/ liabilities either in the principal market or most advantageous market in their best economic interest:
- They should be independent and not a related party. However, if related parties have done similar transactions at an arm’s length price, it can be between related parties.
- The parties should not be under any stress or force to enter into these transactions.
- All parties should have good and sufficient information about the same.
Fair value is the price that can be received for selling an asset or paid for transferring a liability in an orderly transaction in the principal or it would be most advantageous if the market is at the measurement date under the current market conditions (i.e. an exit price) regardless of whether that price can be directly observable or it has been estimated using another valuation technique.
A fair value is being assessed based on the principal market, and if the principal market is not available, then based on the most advantageous market.
Transaction cost in Indian accounting standard 113
The transaction costs are not a characteristic of an asset or a liability but a characteristic of the transaction.
Hence, it will not be appropriate for considering any transaction cost further while assessing fair values from such principal markets.
Transport costs are different from transaction costs. It is the cost which is incurred for transporting the asset from its current location to its principal or it can be most advantageous market. Unlike other transaction costs, which arise from a transaction and do not change the characteristics of the asset or liability, transport costs arise from an event (transport) that does change a characteristic of an asset (its location).
Suppose location is a characteristic of the asset (as might be the case, for example, for a commodity). In that case, the principal or the most advantageous market price should be adjusted for the costs, if any, then that would be incurred for transporting the asset from its current location to that market.
It will be considered if it is an inherent part of the Assets/ Liability so transacted, e.g. commodity.
APPLICATION OF THE FAIR VALUE RULES ON NON-FINANCIAL ASSETS
The financial assets that is not having alternative uses because they are having specific contractual terms and it can also have a different use only if the characteristics of the financial assets (i.e. the contractual terms) have been changed.
Fair valuation in the case of non-financial assets, especially buildings and other property, plants and equipment, often requires looking for the best and highest use by its market participants. That can be the reference point to evaluate the fair value of such non-financial assets.
Best and Highest Use:
The best and highest use is a valuation concept used to value many non-financial assets (e.g. real estate). The best and highest use of a non-financial asset must be possible physically, legally permissible and feasible financially.
An equitable value measurement of a non-financial asset considers a market participant’s ability for generating economical benefits by the usage of the asset in its best and highest use or by selling it to some another market participant that would be using the asset in its best and highest use.
The best and highest use can be determined from the market participant perspective. It doesn’t matter whether the entity intends to use the asset differently.
Analysis of Highest and best use for a non-financial asset in IND AS 113:
- The best and highest use would determine an indicative price for a non-financial asset that usually not having any frequently traded market, unlike for other financial products.
- The concept emphasis that to find an equitable value of such non-financial products, one have to define its best possible use, which is making the non-financial asset different from any specific entity that would like to use such asset in their specific purposes, which may or may not be its using at its best.
- For finding out the best possible use, one have to identify its market participants and then to find the best legitimate use of this non-financial asset which normally one would do.
- All restrictions are specific to any market participant that wouldn’t be considered while finding out the equitable value of the non-financial asset.
- It is imperative to understand the best use while evaluating such fair values, as there is no need to exhaust all possible uses of such non-financial assets before concluding the highest and best use,
- In the absence of potential best use, which is not easily available, its current use would be considered as best use.
Fair value measurement of non-financial assets would be based on either
1) In combination with other assets.
2) On a standalone basis.
Standard requires to use best-used value if such non-financial asset is used in combination with some other assets. It is demonstrated that other market participants widely use the combination to find the best use for the non-financial asset.
APPLYING THE FAIR VALUE RULES FOR LIABILITIES AND AN ENTITY’S EQUITY
A fair value measurement can be assumed that a financial or non-financial liability or an entity’s equity instrument (e.g. equity interests issued as consideration in a business combination) is transferred to a market participant at the measurement date.
Often, a liability or an equity instrument of an entity have being transferred to some other market participant as the part of a transaction, e.g. a business combination, etc., where certain liabilities or equity instruments have being issued in consideration of such acquisitions.
The standard specifies an assumption that liabilities and equity instruments so transferred will remain outstanding on the measurement date. Standard prescribes using all observable inputs (if direct quoted prices are unavailable) and should minimize any unobservable inputs. The transaction considered to find fair value should be evaluated in line with an orderly transaction (not entity-specific).
The standard specifically guides the respective scenarios while evaluating fair values of the liabilities and own equity instruments in case direct quoted prices are not available.
When other parties hold liability and equity instruments as assets in ind AS 113:
When direct quoted prices are not available for liabilities or equity instruments, an entity should use an identical price of similar liabilities or equity instruments that market participants as an asset hold. The quoted prices of such assets at the measurement date should be used. However, if quoted prices are not available, then observable inputs can be used. In the absence of observable inputs, the valuation techniques such as income approach or market approach etc., may be used.
When other parties do not hold liability and equity instruments as assets:
When other parties do not hold these, then valuation techniques from the perspective of a market participant that owes the liability or have been issued the claim on equity would be used to evaluate such fair values.
APPLYING FAIR VALUE RULES TO FINANCIAL ASSETS & FINANCIAL LIABILITY WITH OFFSETTING POSITION IN MARKET
Assets and liabilities managed by an entity would be affected by its market risk, i.e. interest rate risk, currency risk etc. and credit risk relating to its respective counterparties.
There are many situations where a group of assets and liabilities are managed on a net basis preferably than on an individual basis by an Entity.
Suppose the entity manages that group of financial assets and liabilities based on its net exposure to market risks or credit risk. In that case, the entity can apply an exception to this Ind AS for calculating fair value.
That exception can permits an entity for measuring the fair value of a group of financial assets and financial liabilities based on the price that would be received to sell a net long position (i.e. an asset) for a particular risk exposure.
Paid to transfer a net short position (i.e. a liability) for particular risk exposure in an orderly transaction between market participants at the calculation of date under current market conditions. Accordingly, an entity shall consistently measure the fair value of the group of financial assets and financial liabilities with how market participants would price the net risk exposure at the measurement date.
Analysis of applying for offsetting position in market or credit risk in Indian accounting standard 113 i.e. Ind AS 113
- This exception is allowed only if the other market participants also manage similar risks on a net basis.
- There should ideally be the same information and market practice available for making these assets/ liabilities net.
- Once the exception to fair value certain assets/ liabilities on a net basis is being used, then a unit of account to measure fair value would be considered net.
- Market risk should be the same while combining any asset/ liability.
- Duration of market risk should be identical to use the exception for valuing assets/ liabilities on a net basis.
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