Compiled By CA.

Jai Chawla

INDAS 113 Fair Value Measurement

Many INDAS standards require you to measure the fair value of some items. Just name
the examples: financial instruments, biological assets, assets held for sale and many
other.

INDAS 113 applies in all situations where

another IndAS permits or requires the use of
Fair Value.
Why INDAS 113?
The objectives of INDAS 113 are:

 to define fair value;

 to set out in a single INDAS a framework for measuring fair value; and
 to require disclosures about fair value measurements.

OBJECTIVES OF INDAS 113

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Fair value is a MARKET-BASED (Not Entity Based that means own situation)
measurement, not an entity-specific measurement. It means that an entity:

 shall look at how the market participants would look at the asset or liability under
measurement
 shall not take own approach (e.g. use) into account.

What is 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.

Also called as Exit Price.

When an entity performs the fair value measurement, it must determine all of the
following:

 the particular ASSET OR LIABILITY that is the subject of the

measurement (consistently with its unit of account)

 for a non-financial asset, the valuation premise that is appropriate for the
measurement (consistently with its highest and best use)

 the PRINCIPAL (OR MOST ADVANTAGEOUS)

MARKET for the asset or liability

 the VALUATION TECHNIQUES appropriate for the measurement,

considering:
o the availability of data with which to develop inputs that represent the
assumptions that market participants would use when pricing the asset or
liability; and
o the level of the fair value hierarchy within which the inputs are categorized.

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Asset or liability
When measuring fair value, an entity takes into account the characteristics of the asset
or liability that a market participant would take into account when pricing the asset or
liability at measurement date.

These characteristics include for example:

 the condition and location of the asset

 the restrictions on the sale or use of the asset.

Transaction
A fair value measurement assumes that the asset or liability is exchanged in an orderly
transaction between market participants at the measurement date under current market
conditions.

Orderly transaction

The transaction is orderly when 2 key components are present:

 there is adequate market exposure in order to provide market participants the

ability to obtain knowledge and awareness of the asset or liability necessary for a
market-based exchange
 market participants are motivated to transact for the asset or liability (Not
Forced).

Market participants

Market participants are buyers and sellers in the principal or the most advantageous
market for the asset or liability, with the following characteristics:

 independent
 knowledgeable
 able to enter into transaction

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  willing to enter into transaction.

Principal vs. the most advantageous market

A fair value measurement assumes that the transaction to sell the asset or transfer the
liability takes place either:

 in the principal market for the asset or liability; or

 in the absence of a principal market, in the most advantageous market for the
asset or liability.

Principal market is the market with the GREATEST VOLUME AND LEVEL OF
ACTIVITY for the asset or liability. Different entities can have different principal
markets, as the access of an entity to some market can be restricted (please watch the
video below for deeper explanation).

In which the entity normally transacts unless evidence suggests otherwise.

The most advantageous market is the market THAT MAXIMIZES THE AMOUNT THAT
WOULD BE RECEIVED TO SELL THE ASSET OR MINIMIZES THE AMOUNT
THAT WOULD BE PAID TO TRANSFER THE LIABILITY, after taking into account
transaction costs and transport costs.

Application to non-financial assets

Fair value of a non-financial asset shall be measured based on its Highest And Best
Use from a market participant’s perspective.
The highest and best use takes into account the use of the asset that is:

 physically possible − it takes into account the physical characteristics that market
participants would consider (for example, property location or size);
 legally permissible – it takes into account the legal restrictions on use of the asset
that market participants would consider (for example, zoning regulations); or
 financially feasible – it takes into account whether a use of the asset generates
adequate income or cash flows to produce an investment return that market
participants would require. This should incorporate the costs of converting the
asset to that use.

Application to financial liabilities and own

equity Instruments

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In the first instance, an entity shall set the fair value of the liability or equity instrument
by the reference to the QUOTED MARKET PRICE of the identical instrument, if
available.

If the quoted price of identical instrument is not available, then the fair value
measurement depends on whether the liability or equity instrument is held by other
parties as assets or not:

 If the liability or equity instrument is held by other party as an asset, then

o If there is the quoted price in an active market for the identical instrument
held by another party, then use it (adjustments are possible for the factors
specific for the asset, but not for the liability/equity instrument)
o If there is no quoted price in an active market for the identical instrument
held by another party, then use other observable inputs or another
valuation technique
 If the liability or equity instrument is not held by other party as an asset, then use
a valuation technique from the perspective of market participant

This is illustrated in the following simplified scheme:

Fair value at initial recognition

When an entity acquires an asset or assumes a liability, the price paid/received or
the transaction price is an entry price.

However, INDAS 113 defines fair value as the price that would be received to sell the
asset or paid to transfer the liability and that’s an exit price.

In most cases, transaction or entry price equals to exit price or fair value. But there are
some situations when transaction price is not necessarily the same as exit price or fair
value:

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  The transaction happens between related parties
 The transaction takes place under duress or the seller is forced to accept the price
in the transaction
 The unit of account represented by the transaction price is different from the unit
of account for the asset or liability measured at fair value
 The market in which the transaction takes place is different from principal or the
most advantageous market.

If the transaction price differs from the fair value, then an entity shall recognize the
resulting gain or loss (“Day 1 profit“) to profit or loss unless another INDAS standard
specifies other treatment.

Valuation techniques
When determining fair value, an entity shall use valuation techniques:

 Appropriate in the circumstances

 For which sufficient data are available to measure fair value
 Maximizing the use of relevant observable inputs
 Minimizing the use of unobservable inputs.

Valuation techniques used to measure fair value shall be applied consistently.

However, an entity can change the valuation technique or its application, if the change
results in equally or more representative of fair value in the circumstances.

An entity accounts for the change in valuation technique in line with IAS 8 as for
a change in accounting estimate.

INDAS 113 allows 3 valuation approaches:

 Market approach: uses prices and other relevant information generated by market
transactions involving identical or comparable (ie similar) assets, liabilities, or a
group of assets and liabilities, such as a business
 Cost approach: reflects the amount that would be required currently to replace the
service capacity of an asset (often referred to as current replacement cost).
 Income approach: converts future amounts (e.g. cash flows or income and
expenses) to a single current (i.e. discounted) amount. The fair value
measurement is determined on the basis of the value indicated by current market
expectations about those future amounts.

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Fair value hierarchy
INDAS 113 introduces a fair value hierarchy that categorizes inputs to valuation
techniques into 3 levels. The highest priority is given to Level 1 inputs and the lowest
priority to Level 3 inputs.

An entity must maximize the use of Level 1 inputs and minimize the use of Level 3 inputs.

Level 1 inputs

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or
liabilities that the entity can access at the measurement date.

An entity shall not make adjustments to quoted prices, only under specific
circumstances, for example when a quoted price does not represent the fair value (ie
when significant event takes place between the measurement date and market closing
date).

Level 2 inputs

Level 2 inputs are inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly.

Level 3 inputs

Level 3 inputs are unobservable inputs for the asset or liability.

An entity shall use Level 3 inputs to measure fair value only when relevant observable
inputs are not available.

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The following scheme outlines the fair value hierarchy together with examples of inputs
to valuation techniques:

Disclosure
INDAS 113 requires extensive disclosure of sufficient information to asses:

 Valuation techniques and inputs used to develop fair value measurement for both
recurring and non-recurring measurements;
 The effect of measurements on profit or loss or other comprehensive income for
recurring fair value measurements using significant Level 3 inputs.

As the disclosures are really extensive, here, the examples of the minimum
requirements are listed:

 Fair value measurement at the end of the reporting period;

 The reasons for measurement (for non-recurring)
 The level in which they are categorized in the fair value hierarchy,
 Description of valuation techniques and inputs used;
 And many others.

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