IFRS 13, Fair value measurement-the essentials. Part ΙΙ

Athens, October 2017
Chris Ragkavas, BA, MA, FCCA, CGMA
IFRS technical expert, financial consultant.

The concept of fair value and its application in acquisition accounting

Acquirers/investors, must attach a monetary fair value to almost all assets and liabilities of the subsidiary/investee, on the date of acquisition. This will result into the net assets of the investee being reflected at fair value, so that when compared to the fair value of the forms of consideration, goodwill arising on acquisition is also reflected at fair value. 

Fair value is 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. A fair value measurement of a non-financial asset takes into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use.

In order to calculate fair value for assets and liabilities acquired as part of a business combination, entities should primarily use market derived (Level 1, or Level 2, observable) inputs to calculate the fair value of the element at stake. When this is not possible, (Level 3, unobservable) inputs must be used. In any case, the inputs must be developed from the viewpoint of the market participants, i.e. the entity must make the same assumptions as the ones that market participants would make.

Allowable valuation techniques:

  • The market approach. Deemed suitable when there is a market for similar or identical assets or liabilities, as the one measured. We use Level 1/2 inputs to perform this approach.

  • The cost approach (referred to, as the ‘replacement cost’). This reflects the amount that would be required currently to replace the service capacity of the asset measured. It is often used to measure tangible assets used in combination with other assets and / or liabilities. The entity estimates the amount that would be required to construct a substitute of the asset measured, of comparable utility. Inputs include the condition of the asset, the environment in which it operates, including physical wear and tear, external conditions as economic and technical obsolescence.

  • The income approach. Future cash flows, income, expenses are discounted. The fair value measurement is determined on the basis of current market expectations about those cash flows. Methods may include:

    • Present value techniques. This must be either the discounted rate adjustment or the expected cash flow technique.

    • Option pricing models, e.g. Black-Scholes-Merton, or binomial models that incorporate both present value techniques and reflect time value and intrinsic value of an option.

    • Multi-period excess earnings method mainly used to measure intangible assets.

Final remarks on approaches, inputs and techniques

An approach can occasionally attract inputs from various sources, whereas in other cases just one source would be enough. I present a short overview of potential combinations.

Valuation of an owner occupied property

Option 1
As there are recent transactions of identical assets in the principal market, the entity uses Level 1, observable inputs.

Option 2
There are no recent transactions of identical assets, as the asset in question is very specific, custom-made, and in a relatively isolated area (e.g. a parking spot in a national road). The entity would use Level 3, unobservable inputs, in order to calculate fair value, incorporating market participants’ assumptions about the asset’s highest and best use.

Valuation of a piece of machinery
The machinery was custom-made to the entity’s specification 4 years prior to the valuation exercise. There is a very limited number of identical models in the market, however a greater number of similar models is available.

The entity would apply the cost approach, and use Level 2 observable inputs, and perhaps also Level 3 inputs, again, from the viewpoint of the market participants.

Note, that the standard prioritizes levels of input amongst themselves, expressing a preference for maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs. It does not, however, prioritize valuation techniques used to measure fair value.

If an observable input requires an adjustment using an unobservable input and that adjustment results in a significantly higher or lower fair value measurement, the resulting measurement would be categorized within Level 3 of the fair value hierarchy.

For example, if a market participant would take into account the effect of a restriction on the sale of an asset when estimating the price for the asset, an entity would adjust the quoted price to reflect the effect of that restriction. If that quoted price is a Level 2 input and the adjustment is an unobservable input that is significant to the entire measurement, the measurement would be categorized within Level 3 of the fair value hierarchy.​

Present value techniques’ multiple usability

Present value techniques can be applied:

  • To calculate fair value as described within the context of IFRS 13;

  • To calculate value in use, within the context of IAS 16.

The paramount difference is that in the latter case, the present value of the expected cash flows will be entity specific, without any reference, for example, to the asset’s highest and best use.

Principal market 

For the purpose of calculating fair value, we assume that the element at stake is traded in the principal market, that is, the market with the greatest volume and level of activity. It is not necessarily the market the reporting entity mostly trades in, neither the market where the entity obtains the highest benefits from. However, the entity must have access to that market on the measurement date.

Most advantageous market 

In the absence of a principal market, the fair value may be obtained from the most advantageous market. This is the market that maximizes the amount that the entity would receive by selling the asset, after taking into account the transaction and transport costs.

Transaction costs are considered in order to define the most advantageous market. They are defined as “the costs to sell an asset (or transfer a liability) that are directly attributable to the transaction and meet both criteria:

  • They result directly from, and are essential to, the transaction.

  • They would not have been incurred by the entity, had the decision to enter into the transaction not been made.

They are ignored when the reporting entity defines fair value. They are specific to a transaction and will differ depending on how an entity enters into a transaction, they are not considered to be a characteristic of the asset or liability in question [IFRS 13:25]. Fair value is adjusted by deducting transport costs, though [IFRS 13: 26].


The acquirer can not determine the principal market for an asset acquired as part of a business combination, i.e. this is an asset of the acquiree.  The asset is traded in 2 different markets, both of which have comparable levels and volumes of activity.

Therefore, the acquirer will  first determine the most advantageous market, and then will calculate fair value by using information from that market, i.e. by deducting transport costs only, from sales price.


All amounts in £ Market A Market B
Sales price 26 25
Transport costs (2) (2)
Transaction costs (3) (1)
Profit  21 22

The most advantageous market is B, as it will result into the highest profits for the entity, when the asset is disposed, of. Fair value is £ (25 – 2) = £ 23.

Note that the entity should not “cut corners” and determine that as Market A results into the highest fair value as defined by the standard, £ (26 – 2) =£ 24, that the most advantageous market is A, and so fair value is £ 24.

Queries, comments, are welcome at [email protected]

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