Fair Value

NotesQuizPaper exam

Fair value considers the characteristics of the asset

For example

  • The condition and location of an asset

  • Any restrictions on the sale or use of an asset

This means that when revaluing its property, plant and equipment, an entity should consider:

the highest and best use of the assets

Fair value assumes the sales takes place in:

  1. The Principal market

    the market with greatest volume and level of activity for the asset or liability

  2. The most advantageous market

    The market that maximises the amount that would be received paid for the asset

Valuation Techniques

  • Market approach

    Prices from similar market transactions 

    e.g. quoted prices of listed equity, debt securities or futures, or market interest rates

  • Income approach

    This converts future cash flows to a single discounted amount; e.g. discounted cash flow models and option pricing models

  • Cost approach

    This reflects the amount required currently to replace the service capacity of an asset, i.e. the current replacement cost

When measuring fair value, an entity is required to maximise the use of relevant observable inputs and minimise the use of unobservable inputs

Level 1 Level 2 Level 3
Definition Quoted prices in active markets for identical assets or liabilities  Observable inputs  Unobservable inputs 
Example Share prices on a stock exchange Current market rents for similar properties and market interest rates for the FV of an investment property  Projected cash flows used to value a none public business 

How does all this work in practice?

E.g. An entity owns 10,000 ordinary shares in M & S

Since there is an active market for these shares through the London stock exchange, the entity must use a market approach (level 1 input).

However, the measurement of the fair value of an unlisted debt security may require the use of an income approach, e.g. a discounted cash flow model using market interest rate for similar debt securities (level 2 input) and market credit spreads adjusted for entity-specific credit risk (level 2 or 3 inputs).

NotesQuizPaper exam