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Fair Value Measurement

Date recorded:

Project plan

Before beginning the first of several sessions this week on aspects of the fair value measurement guidance project, the staff reviewed the proposed project plan. The staff intend to present the following topics at the January 2009 meeting:

  • fair value measurement disclosures (taking into consideration the comments received on the exposure draft of improvements to IFRS 7 Financial Instruments: Disclosures);
  • an assessment of which fair value measurements in current IFRSs should be included or excluded from the scope of an IFRS on fair value measurement;
  • transition; and
  • the comment period for the exposure draft.

The staff stated that they had begun drafting an exposure draft of an IFRS on fair value measurement guidance and that they were 'in good shape' to complete the pre-ballot draft shortly after the January 2009 meeting.

Defensive intangible assets acquired in a business combination

The Board held a lengthy debate on the fair value of intangible assets acquired in a business combination that the acquirer does not intend to use directly or intends to use in a way that is different from the way other market participants would use them (referred to as 'defensive intangible assets').

Throughout the discussion, the Board referred to the following staff example:

Situation 1

Situation 2

Situation 3

If the reporting entity would...

lock-up or abandon the asset (if the reporting entity continues to use the asset, it is not a defensive intangible asset)

lock-up the asset

abandon the asset

and market participants would...

continue using the asset

lock-up the asset to generate economic benefit for the market participants' own existing assets

abandon the asset (eg it does not earn a market rate of return or is unnecessary in the business)

...the highest and best use of the asset is to...

continue using the asset

lock-up the asset to generate economic benefit for other assets

abandon the asset

...the fair value...

reflects the value of the asset as if it were being used (assuming market participants have complementary assets). The fair value assumes continued investment in the asset.

reflects the value of the asset as if it were being locked up (assuming market participants have complementary assets). The fair value assumes no continued investment in the asset.

typically is nominal (and might be zero in many cases)

An example:

Entity A acquires a research and development asset that it does not intend to complete. Other market participants would complete the project. The fair value would be determined based on the price that would be received in a current transaction to sell the project to a market participant who would complete the project.

Entity A acquires a research and development asset that it does not intend to complete. Other market participants also would lock up the project. The fair value would be determined based on the price that would be received in a current transaction to sell the project to a market participant who would lock up the project.

Entity A acquires a research and development asset that it does not intend to complete. Other market participants would discontinue the development of the project. The fair value would be determined based on the price that would be received in a current transaction to sell the project to a market participant who would abandon the project (which in this case is likely to be zero).

The Board confirmed its decision in IFRS 3 (revised in 2008) that defensive intangible assets should be recognised and measured at fair value in a business combination. The Board affirmed that it had determined in that IFRS that a defensive intangible asset meets the asset recognition criteria and should not reconsider this decision in the fair value measurement project.

In reaching this decision, the Board did not discuss Situation 1 in any depth, and agreed with the conclusion summarised therein. However, Situations 2 and 3 generated much more comment. Board members and the staff agreed that 'defensive intangible assets' laid bare the tension between several parts of the fair value measurement project-in particular it exacerbated the problems in the notions of market value and entity-specific values that underlay many constituents' concerns.

A Board member noted that there was a fundamental difference between abandoned assets and assets that were 'locked up': an entity could no longer control an abandoned asset and thus it could not be termed to be defensive. For example, a patent might not be renewed, giving others the right to access the patented item.

Whether to provide explicit guidance on measuring defensive intangible assets

The Board decided not provide explicit valuation guidance on measuring the fair value of defensive intangible assets. The Board agreed that the measurement of defensive intangible assets has been developed by practice that has evolved under the current IFRS 3.

In making this decision, the Board agreed with the staff that the fundamental question was whether the ED should propose explicit guidance on how to determine the fair value of a defensive intangible asset (the Board agreed it should not); or include a discussion of the methodologies that might be used, a discussion of the appropriate reference market, etc, similar to the discussion in FAS 157 (the Board agreed that the ED should include such a discussion).

Issues related to IAS 36 and IAS 38

The Board did not agree with a staff recommendation that IAS 36 should be amended to address the impairment testing of defensive intangible assets. Board members were critical of IAS 36 and were of the view that amending it would only make it worse.

The Board did not agree with a staff recommendation that IAS 38 should be amended:

  • to provide guidance about determining the useful life of a defensive intangible asset;
  • to state that the amortisation period and useful life for defensive research and development intangible assets begins on the date of acquisition because that is the point at which they are available for use (thus avoiding a misinterpretation of paragraph 97, which might be read to suggest that defensive research and development intangible assets are indefinite lived until their completion date); and
  • require entities to distinguish in their disclosures the intangible assets acquired in a business combination between those being actively used in the business and those being used defensively, by asset class.
  • Restrictions on assets and liabilities

The staff introduced this session by noting the Board's previous decision that a fair value measurement should consider the attributes (or characteristics) of an asset or liability that a market participant would consider when pricing the asset or liability. Implicit in this decision is that a market participant would consider a restriction on an asset or liability only if that restriction would transfer to market participants. The staff noted that FAS 157 addresses restrictions in the context of assets, but not liabilities. There is limited guidance in IFRSs about restrictions on assets and no guidance about restrictions on liabilities. The staff summarised the guidance in FAS 157 and that existing in IFRS. In addition, the staff noted that the IFRIC had referred an issue to the Board about restrictions on financial assets. The issue before the IFRIC turned on the meaning of 'immediate access' in IAS 39.AG71.

With reference to assets, the Board agreed that, if a restriction on the use or sale of an asset that transfers to market participants, the restriction is an attribute of the asset and should be reflected in a fair value measurement. In addition, if restrictions on an asset would not transfer to a market participant buyer, they would not affect the fair value of the asset.

The Board agreed that the ED should clarify that 'the ability to access' in the definition of a 'Level 1' input means that the entity only has to be able to access the market for the asset or liability, not necessarily that the entity must sell the asset on that date (that is, the 'reference market' is the market in which the entity would sell an asset. This conclusion applies even though it could not sell the asset at the reporting date because of restrictions [assuming no forced sale]).

With respect to liabilities, the Board agreed that the fair value of a liability is, almost by definition, an exit value. Restrictions on transfer do not affect the fair value measurement. There was some discussion of the effect on fair value of privileges (as opposed to restrictions) (e.g. prepayment rights) on the determination of fair value. The Board agreed that two loans, identical in all respects except that one may be repaid in full at any time and the other may be repaid only at term, would have different fair values.

Valuation premise

The Board discussed whether a fair value measurement consider whether market participants would maximise the value of an asset principally through its use in combination with other assets as a group (in-use) or on a standalone basis (in-exchange).

Board members thought that the staff had reached the correct conclusions and were prepared to support their recommendations, but that the route by which they reached those conclusions and recommendations was extremely tortuous and not always intuitive. They encouraged the staff to explain very clearly and carefully in the Basis for Conclusions the rationale for the Board's conclusions.

The Board agreed that:

  • a fair value measurement considers whether market participants would maximise the value of an asset principally through its use in combination with other assets as a group or on a standalone basis;
  • the valuation premise and highest and best use concepts are not relevant for financial assets;
  • the valuation premise should not explicitly be reflected in the definition of fair value; and
  • the exposure draft should not change or introduce new terminology for the valuation premise.

With respect to liabilities, the Board agreed that the valuation premise and highest and best use concepts are not relevant. This conclusion is consistent with the conclusions in FAS 157, which applies these concepts to assets only.