FAIR VALUE MEASUREMRNTSIND AS 113

Karun NagpalCA, DISA (ICAI), Registered Valuer S&FA, Insolvency professional (IBBI)

US - FAS 157 & ASC 820Rest of World - IFRS 13

CONTENTS

FV definition as per Ind AS, Scope of Ind AS,

Exclusions

Fair Value

Measuring Fair Value, Valuation Premise, Fair

Value Hierarchy

Fair Value Measurement

Three Valuation approaches – Market, Income and

Cost approaches, Valuation adjustments

Valuation Approaches

Fair Value reporting disclosures, Covid Impact on

Fair Value reporting

Disclosures

About me

With over 12 years of experience in financial accounting,

global consolidation, financial reporting, statutory &

regulatory compliances for big multinationals companies

like Infosys, General Electric and HSBC Bank USA, Karun

has started practicing as a chartered accountant. Over the

years he has gained enormous international exposure and

is currently serving some of the national and international

clients for their local compliances.

CA Karun Nagpal

Beside Registered Valuer, Karun is also a

Insolvency Professional and is a Partner at

Synergy Insolvency Professionals LLP an

IPE registered with IBBI vide registration

number IBBI/IPE/0104.

Fair Value Measurement (IND AS 113)

Standard defines fair value

Establishes a framework for

measuring fair value

Requires disclosures about fair

value measurements

Ind AS 113 defines FV as

The price that would be received to sell anasset or paid to transfer a liability (exitprice notion) in an orderly transactionbetween market participants at themeasurement date.

FAIR VALUE

FAIR VALUE

Fair value is market based measurement, not an entityspecific.

An entity shall measure the fair value of an asset or aliability using the assumptions that market participantswould use when pricing the asset or liability, assumingthat market participants act in their economic bestinterest.

Measured using the assumptions that market participants would use when pricing the asset or liability, including riskassumptions.

Entity intention to hold an assets or to settle or otherwise fulfill a liability is NOT relevant when measuring fair value.

Excluded from it scope items in following standard even though they are measured at fair value:• Ind AS 102 ( Share-based Payments )• Ind AS 17 ( Leases )• Ind AS 2 ( Inventories )• Ind AS 36 ( Impairment of Assets )

Disclosures in Ind AS 113 not apply for:• Disclosure of plan Assets measured at fair value - Employee

Benefits (Ind AS 19)• Assets for which recoverable amount is fair value less costs of

disposal (Ind AS 36)

Exclusions

What is orderly transaction ?

• Inadequate exposure to market to allow usual and customary marketing activities

• Asset/liability marketed to single marketparticipant

• Seller is in insolvency or bankruptcy• Transaction price is outlier

“A transaction that assumes exposure to the market for a period before the measurementdate to allow for marketing activities that are usual and customary for transactionsinvolving such as assets or liabilities; it is not a forced transaction (e.g. a forcedliquidation or distress sale)”

When a transaction is not orderly ?

When measuring fair value an entity shalltake into account the characteristics ofthe asset or liability, for example,

a) the condition and location of the asset

b) restrictions, if any, on the sale or use ofthe asset.

A fair value measurement assumes that the transaction takes place either:

a) in the principal market

b) in the absence of a principal market, in the most advantageous market

Measuring Fair Value

Markets for Fair Value Measurement

Stock X Market A Market B

Price (₹) 20 22

Average trade/day 2,00,000 50,000

Stock Y Market A Market B

Price (₹) 31 30

Average trade/day 1,00,000 1,00,000

Transaction Cost (₹) 3 1

Transportation Cost (₹) 5 5

Net price 23 24

Principal market - The market with the greatest volume and level of activity for the assetor liability

Here, “Market A” would be thePrincipal market for Stock X

Most advantageous market - The market that maximizes the amount that would bereceived to sell the asset or minimizes the amount that would be paid to transfer theliability, after taking into account transaction costs and transport costs

Here “Market B” would be the most

advantageous market for Stock Y

Measuring Fair Value

The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs.

The price shall be adjusted for transportation costs, if any, that would be incurred to transport the asset from its current location to that market.

In this example,Most advantageous market

will be Market B

FV will be ₹ 25

Stock Y Market A Market B

Price (₹) 31 30

Average trade/day 1,00,000 1,00,000

Transaction Cost (₹) 3 1

Transportation Cost (₹) 5 5

Net Price (for determining most

advantageous

market)

=23

(31-3-5)

=24

(30-1-5)

Fair Value for financial reporting =26

(31-5)=25

(30-5)

Fair Value at

Initial RecognitionThe fair value at initial

recognition equals the

transaction price (an entry

price).

When an asset is acquired or a

liability is assumed in an

exchange, transaction price is the

price paid to acquire the asset or

received to assume the liability

(an entry price).

The transaction price might not represent the fair value if:

Category 1

Transaction is between related parties

Category 3

The unit of account representedby the transaction price isdifferent from the unit ofaccount for the asset or liabilitymeasured at fair value. eg.,business combination.

Category 2

Transaction takes place

under duress or seller is

forced to enter into

transaction.

Category 4

The market in which thetransaction takes place isdifferent from the principalmarket (or mostadvantageous market).

Valuation Premise

✓ Highest and best use

✓ Going concern value

✓ As-is-where-is basis

✓ Orderly Liquidation

✓ Forced transaction

A fair value measurement of a non-financial asset takes intoaccount a market participant's ability to generate economicbenefits by using the asset in its highest and best use or byselling it to another market participant that would use the assetin its highest and best use.

The highest and best use of a non-financial asset takes intoaccount the use of the asset that is –

• Physically Possible

• Legally Permissible

• Financially feasible

For recurring and nonrecurring fair value measurements, if the highest andbest use of a nonfinancial asset differs from its current use, a reporting entityshall disclose that fact and why the non-financial asset is being used in amanner that differs from its highest and best use.

Highest and best use

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hyFair value hierarchy

Level 1: Quoted prices

Level 2: Observable Prices

Level 3: UnObservable Prices

Ind AS 113 establishes a fair valuehierarchy that categorizes into threelevels, Level 1, 2 & 3.

The fair value hierarchy gives the highestpriority to observable Level 1 inputs and thelowest priority to unobservable inputs Level3 inputs.

LEVEL 3

UNOBSERVABLE INPUTS

LEVEL 1 & 2

OBSERVABLE INPUTS

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Observable inputs - that are developed using market data, suchas publicly available information about actual events ortransactions, and that reflect the assumptions that marketparticipants would use when pricing the asset or liability.

Unobservable inputs - for which market data are not available and that aredeveloped using the best information available about the assumptions thatmarket participants would use when pricing the asset or liability.

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02 0301

Inputs used to measureFV are Observable.

Quoted prices in active markets for identical assets or liabilities

(Unadjusted)

Inputs used to measure FV areObservable.

Quoted prices in active markets for Similar assets or liabilities

(adjustment permitted)

Quoted prices in markets that are not active

Indirectly observable inputs eg., Yield curve, Impliedvolatility, Credit spreads

Inputs used to measure FV are Unobservable.

Using the best information available

including the entity's own data and assumptions

Eg., DCF, Income capitalization

LEVEL LEVEL LEVEL

❑ RBI/FEMA

❑ Income Tax

❑ SEBI

❑ Companies Act

❑ Insolvency &

Bankruptcy

❑ Sale/Purchase of

business

❑ Merger/Demerger

❑ Fund raising

❑ Purchase price

allocation

❑ Portfolio valuation

❑ FairValue

reporting

❑ Impairment

testing

❑ ESOP Valuation

❑ Litigation

❑ Family

settlement

Valuation Requirement

RegulatoryBusiness

RestructuringFinancial Reporting

Others

19

Valuation Approaches

Market

Approach

Income

Approach

Cost

Approach

Valuation approach thatquantifies the NPV of futurebenefits associated withownership of the asset. The

estimated future benefits

are discounted or

capitalized at a rate

appropriate for the risks

associated with those

future benefits.

Valuation approach thatuses prices and otherrelevant informationgenerated by markettransactions involvingidentical or comparable(i.e., similar) assets orliabilities.

Valuation approach that

reflects the amount that

would be required

currently to replace or

reproduce the service

capacity of an asset

(often referred to as

current replacement

cost reproduction cost).

A valuation approach is the methodology used to determine the fair value of an asset or liability or a business. Valuation techniques used

shall maximize the use of observable inputs and minimize the use of unobservable inputs. The most common valuation approaches are

Market approach – uses prices and other relevant information

generated by market transactions involving identical or comparable (similar)

assets, liabilities, or a group of assets and liabilities (e.g. a business

segment)

Evaluates the value on the basis of prices quoted on stock exchange

Where the asset has fewer market comparable or not traded in the active

market, valuer may consider using other valuation approaches.

Market Price Method - traded price over a reasonable period in the active

market. Weighted average or volume weighted average may be

considered to reduce the impact of volatility.

Guideline Companies Method/Comparable Companies Multiple (CCM)

Method - Valuing an asset based on market multiples derived from prices of

market comparable traded on active market, eg. Listed peers

Comparable Transaction Multiple - involves valuing an asset based on

transaction multiples derived from the transactions in the past. Transaction

multiple are computed based on comparable transactions or financial

metrics for eg., EBITDA multiple, PE multiple for market comparable.

Market

approach

Income approach – Converts future amounts (cash flows or

income and expenses) to a single current (discounted) amount, reflecting

current market expectations about those future amounts.

Discounted cash flow (DCF) is a valuation method used to estimate the

value of an asset based on its future expected cash flows using a

discount rate.

Income Capitalization - economic benefits for a representative single

period are converted through value through division by a capitalization

rate.

Intangible asset valuation methods

▪ Relief from royalty - based on hypothetical royalty calculated as a %

of revenue

▪ With and without method - used to value non compete agreements

▪ Multi period excess earning (MEEM) - used for valuation of primary

intangibles

▪ Distributor method - used for customer related intangibles

Derivatives valuation methods

• Binomial model – Discrete-time model for pricing of option

• Black Scholes model - used to determine the fair value of option

Income

approach

Discounted cash flow (DCF)The discounted cash flow (DCF) projects future earnings and discounts them by an annual

rate to derive a present value.

CF CF CF

In this equation, CF = Cash Flow in that period; n = Period Number; r = Discount Rate

(1+r)1 (1+r)2 (1+r)nDCF = ..…..++ +

Cash flow used for Projections are

• Free cash flow to firm (FCFF) – cash flow available to all equity shareholders, preference

shareholders and lenders.

• Free cash flow to equity (FCFE) – Cash flow available to equity shareholders after interest and

dividend.

Discount rate – return expected by a market participant, shall time value of money and the risk

inherent in the asset or business. Discount rate commonly used- cost of equity, Weighted average

cost of capital, Internal rate of return.

Terminal Value

Terminal Value – Terminal Value represents the present value at the end of explicit forecast period of all

subsequent cash flows to the end of the life of an asset or into perpetuity if the asset has an indefinite life.

Gordon (Constant) Growth Model – Computed by dividing perpetuity maintainable cash flows with the discount rate as reduced by the growth rate.

Variable Growth model – this method assumes that the asset grows or decline at a variable rate beyond explicit forecast period.

Exit multiple – involves application of market evidence based capitalization factor. Eg., EV/EBITDA, EV/Sales etc to the perpetuity income.

Salvage or Liquidation value – salvage or realizable value less cost to sell

Last year free

cash flowTerminal Value = +1 + Growth rate (terminal)

WACC – Growth rate

(terminal)

Cost Approach - the amount that would be required currently

to replace the service capacity of an asset

Commonly used to value acquired or internally generated intangibleassets like software, technology, assembled workforce, etc.

The cost approach should be used with discretion and generally forintangible assets that are not the primary business drivers and for which amarket participant may not be willing to pay a significant premium.

Reproduction Cost Method involves valuing an asset based on the costthat a market participant shall have to incur to recreate a replica of theasset to be valued, adjusted for obsolescence.

Replacement Cost Method involves valuing an asset based on the costthat a market participant shall have to incur to recreate an asset withsubstantially the same utility (comparable utility) as that of the asset to bevalued, adjusted for obsolescence.

Cost

approach

Valuation Adjustments

Discount for lack of marketability (DLOM)

Discount for lack of Control (DLOC)

Tax concessions

Auditors qualification / due diligence findings

COVID-19 impact

Recurring fair value measurements relate to those wheremeasurement is required at the end of each reporting period-end. e.g., available for sale investments are required to bereported at FV.

Non-recurring measurements which are driven by a particularevent or transaction. Non-recurring measurements arise due toa period specific event such as

• Held for sale classification• Financial or non-financial instrument impairments

Non Recurring

The level of disclosures required depends onwhether the fair value measurement is recurring ornon-recurring subsequent to initial recognition.

Recurring

❑ Assets and Liabilities Recorded at Fair Value on aRecurring Basis (fair value hierarchy Level 1, 2 or 3)

❑ Transfers between Level 1 and Level 2 of the fair valuehierarchy, the reasons for those transfers

❑ Information on Level 3 assets and liabilities,a) reconciliation from the opening balances to the closing balancesb) description of the valuation technique(s) and the inputs used, any change in the valuation

techniques and the reason(s) for making such changec) a narrative description of the sensitivity of the fair value measurement to changes in unobservable

inputs if a change in those inputs to a different amount might result in a significantly higher or lower fair value measurement

d) Significant Transfers Into and Out of Level 3 Measurements

❑ Assets and Liabilities Recorded at Fair Value on a Non-recurring Basis (FV hierarchyLevel 1, 2 or 3)

❑ Significant Unobservable Inputs for Non-Recurring Fair Value Measurements❑ Additional Disclosures about the Fair Value of Financial Instruments that are Not

Carried at Fair Value on the Consolidated Balance Sheet

How FV reporting developed?

Assets 2009 2008

Investments 2500 2400

Notes to

accounts

2009 2008

Company A 250 240

Company B 150 130

Company C 180 210

Company D 570 460

Company E 510 530

Company F 340 320

Company G 100 100

Company H 400 410

Total 2500 2400

Assets Level 1 Level 2 Level 3 Total

Investments 500 600 1400 2500

Investments Level 3

Op. Bal 1300

OCI

Earnings

Sale

Purchase

Transfers

Cl. Bal 1400

Investments 1400 Cr

Valuation technique

Unobservable Inputs

Range of Inputs

Weighted average

Sensitivity analysis

Requirement as of today

Fair Value Hierarchy

Level 3 roll forwardLevel 3 additional details

Notes to accounts

Historical Balance Sheet

Disclosure requirementRecurring

measurements

Non-recurring

measurements

Areas not

measured at fair

value but for

which another Ind

AS requires fair

value disclosure

FV measurement at end of reporting period √ √

Reasons for the FV measurement √

Level within FV hierarchy (1,2,3) √ √ √

Transfers between L1 and L2 with reasons √

Description of valuation technique (L2, L3) √ √ √

Quantified unobservable inputs (L3) √ √

Reconciliation of opening and closing balance (L3) √

Description of valuation processes used (L3) √ √

Description of sensitivity to changes in unobservable inputs (L3) √

Quantification of sensitivity to changes in unobservable inputs (L3) √

The table below provides a synopsis of the fair value disclosure requirements for recurring, non-recurring and disclosure only items:

COVID-19 Impact

onFair Value Measurements

COVID-19 impact on Fair value hierarchy

COVID-19 may affect the classification in the fair value hierarchy

Company may need to make an adjustment to an observable input eg., Domino's Pizza Inc^

Company may have to replace an observable inputs with unobservable inputs

For investments deemed not active but valued using observable inputs (Level 2) additional scrutiny may be needed

Company may need to use different inputs or the source of those inputsmay change

Company may need to assess whether the transactions represent orderlytransactions or forced, as market transactions become less frequent

Challenges in FV assessment due to COVID-19

Issue in Forecasting future cash flows

Difficulty in selection of valuation methods

Impact on assumptions e.g. discount rates, credit-spread

Difficulty obtaining comparable data

Thinly traded/dormant stock – Unusual fluctuations

Difficulty in making adjustments, e.g. DLOM

Difficulty assessing the Covid-19 relief impact

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Thank you !CA Karun Nagpal