Fair Value Measurement
The Boards continued their discussions on fair value measurements in accordance with the project plan presented at the December 2009 joint meeting.
Measuring the fair value of a financial instrument
As part of their deliberations on measuring the fair value of a financial instrument, the Boards were asked:
- if the highest and best use concept is relevant for the measurement of liabilities and financial assets;
- if the valuation premise concept is relevant for liabilities and financial assets;
- how the fair value of a financial instrument should be measured when there are offsetting risk positions; and
- if valuation adjustments should be made in a fair value measurement using valuation techniques.
Without much deliberation the Boards tentatively agreed that the 'highest and best use' concept is only relevant for non-financial assets because financial assets do not have alternative uses, as changes in the terms of the financial asset will result in a different asset. A similar principle applies to liabilities where a change in the terms of a liability will result in a different liability. The Boards then also agreed that if the highest and best use concept does not apply to liabilities and financial assets, the valuation premise is not relevant either. This will avoid the need to determine a valuation premise for liabilities and financial assets when there is only one possible result.
The Boards then considered whether to provide a practical expedient allowing entities to measure fair value of a financial asset or a financial liability by considering offsetting market risk positions, including credit risk in Levels 2 and 3 of the fair value hierarchy. In considering the merits of the practical expedient, the Boards were presented with two illustrative examples prepared by the staff (these were not made public) dealing separately with credit risk adjustments and other market risk adjustments.
The Boards deliberated at length whether an adjustment should be made for credit risk when financial instruments are valued as part of a portfolio. Several Board members noted that they support the view in the illustrative examples where an adjustment for credit risk have been made, although they acknowledged that such a view is not in accordance with existing and proposed guidance on fair value measurement. The staff explained that this is the reason why a practical expedient has to be included in the guidance. By a very small margin, the Boards tentatively supported the adjustment for credit risk. One Board member reminded the Boards that such a significant change to the proposed guidance will require re-exposure of the guidance and may result in this Board member dissenting from the proposed guidance.
The Boards then considered the illustrative example dealing with offsetting other market risk positions. Both Boards indicated that such an adjustment would not be in accordance with existing guidance, with some members questioning why an entity would make adjustments for offsetting market risk positions when presentation in the statement of financial position will be on a gross basis. The majority of Board members did not support the staff recommendation to allow entities to measure fair value by considering offsetting market risk positions.
The Boards also deliberated the valuation adjustments that may be needed when measuring the fair value of a financial instrument when there is not a quoted price that instrument (that is, when a valuation technique is used). The Boards tentatively agreed to describe the type of valuation adjustments that might be needed in measuring fair value, without being too prescriptive.
It was also agreed to include a requirement that any valuation adjustments must be consistent with the objective of fair value measurement, that is, only including those adjustments that market participants would include.
Premiums and discounts in a fair value measurement
Comments received on the IASB's ED and at round-table discussions highlighted divergent interpretations of the term 'blockage factor'. The Boards were asked to clarify what a blockage factor is. The Boards agreed that is an estimate of the reduction in a quoted price that would occur if a market participant were to sell a large holding of instruments at one time. A blockage factor is, therefore, specific to the transaction and not to the instrument - for this reason it should not be included in a fair value measurement at any level of the fair value hierarchy.
The Boards also tentatively confirmed that this does not preclude the application of other premiums and discounts within Levels 2 and 3, such as control premiums, lack of marketability discounts, and minority interest discounts, because those are adjustments that a market participant would consider in pricing and asset of liability.
Valuation premise for non-financial assets
In the ED, the IASB asked whether the proposed guidance for the in-use and the in-exchange valuation premise is appropriate. Some respondents commented that they do not agree that an asset is sold individually in the in-use valuation premise because the assets are typically sold as a group. The Boards were asked to confirm their assumption that the asset is sold individually.
The Boards confirmed that the in-use valuation premise assumes that the individual asset's value is measured in the context of its use with other assets as a group and that the market participant buyer has the complementary asset - the right to manage or operate it. The Boards therefore tentatively agreed that the in-use and in-exchange valuation premise assume that the asset is sold individually and not as part of a group of assets or a business.
There appears to be confusion about the terms 'in-use' and 'in-exchange' as both relate to the use of an asset, and both rights are sold in exchange transactions. The Boards were presented with two alternatives for resolving the confusion:
- Approach 1: retain the existing methodology but better explain the meaning of the terms; or
- Approach 2: delete the terms and rather describe the objective each in the standard.
One Board member recommended that the guidance should be written in such a way that not only valuers will understand the meaning, and that the meaning of the terms should be made clearer in way that 'ordinary' people will be able to understand what the standard requires them to do. The Boards tentatively expressed support for Approach 2, subject to the understanding that the objectives are expressed in a better way.
Highest and best use
At their January 2010 joint meeting, the Boards tentatively confirmed that fair value measurement reflects market participant views. At this meeting, the Boards tentatively agreed that as market participant buyers will consider how they will use the non-financial asset when determining the price they are willing to pay - the price will reflect the asset's highest and best use by market participants.
In addition, the Boards were asked whether to include and describe the terms 'physically possible', 'legally permissible', and 'financially feasible' in the context of 'highest and best use' in the proposed standard. The Boards agreed to include a description of the terms and their impact on highest and best use in the proposed standard.
The IASB's ED referred to incremental value as the difference between the current use value of an asset and its fair value (highest and best use value). The Boards considered whether to require entities to separate the fair value of an asset into two components or only require the disclosure of relevant information when an entity uses an asset (recognised at fair value) together with other assets in a way that differs from its highest and best use.
Staff recommended that disclosures should only be provided when an asset is used in a way that is different from highest and best use, and this would be expected to occur only in rare circumstances. One Board member commented that the issue has been raised at the Hong Kong roundtable meetings, where it may be possible to operate a hotel on a site that can be of higher and better use as an apartment building; however, it would take a number of years to convert the hotel.
The Boards had a short discussion on whether assets should be componentised, but when asked to vote, the majority tentatively supported the staff's proposal to require disclosure only.