May 2023
Top tutor Tom Clendon explain the concept of fair value measurement with the help of an example.
Question
How do you arrive at the fair value when there are competing numbers given in a question? Can you please explain and illustrate?
Tom’s answer
The objective of the standard IFRS 13 Fair Value Measurement is to provide a single source of guidance for fair value measurement where it is required by a reporting standard. IFRS 13 does not extend the use of fair value, rather it provides guidance on how it should be determined when an initial or subsequent fair value measurement is required by a reporting standard.
Fair value is defined 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”. Thus, the standard defines fair value on the basis of an ‘exit price’ notion and uses a ‘fair value hierarchy’, which results in a market-based, rather than entity-specific, measurement.
So much for theory. Let us see how fair values are applied in practical situations.
Question: Brampton
An investor has acquired control of Brampton and is conducting a review of its net assets to ascertain their fair value at the date of acquisition in order to determine goodwill.
Brampton has owned some land for many years adjacent to its head office in the centre of the city. The land is currently used by staff for parking. The land is carried at its original cost of $2 million in the financial statements of Brampton. On the basis that the land is used as a car park then it is estimated that it has a value of $3 million. If the land were to be sold, then a buyer might be expected to pay $10 million because of the development potential.
Required
Explain the fair value of the land that Brampton will recognise.
Answer: Brampton
Fair value in the context of an asset is the amount that the asset can be sold for in an orderly transaction between market participants at the measurement date. With a non-financial asset – like land – in arriving at the fair value it is necessary to consider alternative legal uses in order to arrive at the best price.
That Brampton has no plans to sell the land and uses it as a car park is therefore not relevant to determining its fair value. On the open market the land would be valued with its development potential in mind.
In the group accounts, the fair value of this land at the date of acquisition is $10 million. This results in a fair value adjustment of $8 million and in effect reduces the measurement of any goodwill that arises.
- Tom Clendon is an online ACCA SBR lecturer. See www.tomclendon.co.uk. He loves WhatsApp (07725 350793) to communicate direct with his students
