Ind AS 113, Fair Value Measurement, Important Questions with Solutions for CA Final FR May & Nov 2021 Exams
Question 1 –
An asset is sold in 2 different active markets at different prices. An entity enters into transactions in both markets and can access the price in those markets for the asset at the measurement date.
In Market A:
The price that would be received is Rs.78, transaction costs in that market are Rs.9 and the costs to transport the asset to that market are Rs.6.
In Market B:
The price that would be received is Rs. 75, transaction costs in that market are Rs.3 and the costs to transport the asset to that market are Rs. 6.
You are required to calculate:
i. The fair value of the asset, if market A is the principal market, and
ii. The fair value of the asset, if none of the markets is principal market.
Solution
i. If Market A is the principal market
If Market A is the principal market for the asset (i.e., the market with the greatest volume and level of activity for the asset), the fair value of the asset would be measured using the price that would be received in that market, after taking into account transport costs.
Fair Value of the asset will be
| Rs. | |
| Price receivable | 78 |
| Less: Transportation cost | (6) |
| Fair value of the asset | 72 |
ii. If neither of the market is the principal market
If neither of the market is the principal market for the asset, the fair value of the asset would be measured using the price in the most advantageous market. The most advantageous market is the market that maximises the amount that would be received to sell the asset, after taking into account transaction costs and transport costs (i.e., the net amount that would be received in the respective markets).
Determination of most advantageous market:
| Rs. | Rs. | |
| Market A | Market B | |
| Price receivable | 78 | 75 |
| Less: Transaction cost | (9) | (3) |
| Less: Transportation cost | (6) | (6) |
| Fair value of the asset | 63 | 66 |
Since the entity would maximise the net amount that would be received for the asset in Market B i.e. Rs.66, the fair value of the asset would be measured using the price in Market B.
Fair value of the asset will be
| Rs. | |
| Price receivable | 75 |
| Less: Transportation cost | (6) |
| Fair value of the asset | 69 |
Question 2 –
You are a senior consultant of your firm and are in process of determining the valuation of KK Ltd. You have determined the valuation of the company by two approaches i.e. Market Approach and Income approach and selected the highest as the final value. However, based upon the discussion with your partner you have been requested to assign equal weights to both the approaches and determine a fair value of shares of KK Ltd. The details of the KK Ltd. are as follows:
| Particulars | Rs. in crore |
| Valuation as per Market Approach | 5268.2 |
| Valuation as per Income Approach | 3235.2 |
| Debt obligation as on Measurement date | 1465.9 |
| Surplus cash & cash equivalent | 106.14 |
| Fair value of surplus assets and Liabilities | 312.4 |
| Number of shares of KK Ltd. | 8,52,84,223 shares |
Determine the Equity value of KK Ltd. as on the measurement date on the basis of above details.
Solution –
Equity Valuation of KK Ltd
| Particulars | Weights | (Rs. in crore) |
| As per Market Approach | 50 | 5268.2 |
| As per Income Approach | 50 | 3235.2 |
| Enterprise Valuation based on weights (5268.2 x 50%) + (3235.2 x 50%) | 4,251.7 | |
| Less: Debt obligation as on measurement date | (1465.9) | |
| Add: Surplus cash & cash equivalent | 106.14 | |
| Add: Fair value of surplus assets and liabilities | 312.40 | |
| Enterprise value of KK Ltd. | 3204.33 | |
| No. of shares | 85,284,223 | |
| Value per share | 375.72 |
Question 3 –
Comment on the following by quoting references from appropriate Ind AS.
i. DS Limited holds some vacant land for which the use is not yet determined. the land is situated in a prominent area of the city where lot of commercial complexes are coming up and there is no legal restriction to convert the land into a commercial land.
The company is not interested in developing the land to a commercial complex as it is not its business objective.
Currently the land has been let out as a parking lot for the commercial complexes around.
The Company has classified the above property as investment property. It has approached you, an expert in valuation, to obtain fair value of the land for the purpose of disclosure under Ind AS. On what basis will the land be fair valued under Ind AS?
ii. DS Limited holds equity shares of a private company. In order to determine the fair value’ of the shares, the company used discounted cash flow method as there were no similar shares available in the market.
Under which level of fair value hierarchy will the above inputs be classified?
What will be your answer if the quoted price of similar companies were available and can be used for fair valuation of the shares?
Solution –
i. As per Ind AS 113, 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. The highest and best use of a non-financial asset takes into account the use of the asset that is physically possible, legally permissible and financially feasible, as follows:
a. A use that is physically possible takes into account the physical characteristics of the asset that market participants would take into account when pricing the asset (eg the location or size of a property).
b. A use that is legally permissible takes into account any legal restrictions on the use of the asset that market participants would take into account when pricing the asset (eg the zoning regulations applicable to a property).
c. A use that is financially feasible takes into account whether a use of the asset that is physically possible and legally permissible generates adequate income or cash flows (taking into account the costs of converting the asset to that use) to produce an investment return that market participants would require from an investment in that asset put to that use.
Highest and best use is determined from the perspective of market participants, even if the entity intends a different use.
Therefore, the fair value of the land is the price that would be received when sold to a market participant who is interested in developing a commercial complex.
ii. As per Ind AS 113, unobservable inputs shall be used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. The unobservable inputs shall reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk.
In the given case, DS Limited adopted discounted cash flow method, commonly used technique to value shares, to fair value the shares of the private company as there were no similar shares traded in the market. Hence, it falls under Level 3 of fair value hierarchy.
If an entity can access quoted price in active markets for identical assets or liabilities of similar companies which can be used for fair valuation of the shares without any adjustment, at the measurement date, then it will be considered as observable input and would be considered as Level 2 inputs.
Question 4 –
On 1st April 2017, A Ltd. assumes a decommissioning liability in a business combination. The entity is legally required to dismantle and remove an offshore oil platform at the end of its useful life, which is estimated to be 10 years. A Ltd. uses the expected present value technique to measure the fair value of the decommissioning liability. If A Ltd. was contractually allowed to transfer its decommissioning liability to a market participant, it concludes that a market participant would use the following inputs, probability-weighted as appropriate, when estimating the price, it would expect to receive:
i. Labour costs are developed on the basis of current market place wages, adjusted for expectations of future wage increases, required to hire contractors to dismantle and remove offshore oil platforms. A Ltd. assigns probability assessment (based A Ltd.’s experience with fulfilling obligations of this type and its knowledge of the market) to a range of cash flow estimates as follows:
| Cash flow estimate (Rs.) | Probability assessment |
| 50,000 | 25% |
| 62,500 | 50% |
| 87,500 | 25% |
ii. A Ltd. estimates allocated overhead and equipment operating costs to be 80% of expected labour costs in consistent with the cost structure of market participants.
iii. A Ltd. estimates the compensation that a market participant would require for undertaking the activity and for assuming the risk associated with the obligation to dismantle and remove the asset as follows:
- A third-party contractor typically adds 20% mark-up on labour and allocated internal costs to provide a profit margin on the job.
- A Ltd. estimates 5% premium of the expected cash flows, including the effect of inflation for uncertainty inherent in locking in today’s price for a project that will not occur for 10 years.
iv. Entity A assumes a rate of inflation of 4% over the 10-year period on the basis of available market data.
v. The risk-free rate of interest for a 10-year maturity on 1st April, 2017 is 5 %. A Ltd. adjusts that rate by 3.5 per cent to reflect its risk of non-performance (ie the risk that it will not fulfil the obligation), including its credit risk.
A Ltd. concludes that its assumptions would be used by market participants. In addition, A Ltd. does not adjust its fair value measurement for the existence of a restriction preventing it from transferring the liability.
Measure the fair value of its decommissioning liability. Discount factor:
| @ 5% for 10th year | 0.6139 |
| @ 3.5% for 10th year | 0.7089 |
| @ 8.5% for 10th year | 0.4423 |
Solution –
Measurement of the fair value of its decommissioning liability
| Expected cash flows (Rs.) 1st April 2017 | |
| Expected labour costs (Refer W.N.) | 65,625 |
| Allocated overhead and equipment costs (0.80 × Rs. 65,625) | 52,500 |
| Contractor’s profit mark-up [0.20 × (Rs. 65,625 + Rs. 52,500)] | 23,625 |
| Expected cash flows before inflation adjustment | 1,41,750 |
| Inflation factor (4% for 10 years) on compounding | 1.4802 |
| Expected cash flows adjusted for inflation | 2,09,818 |
| Market risk premium (Rs. 2,09,818 x 5%) | 10,491 |
| Expected cash flows adjusted for market risk | 2,20,309 |
| Expected present value using discount rate of (5 +3.5) 8.5% for 10 years | 97,443 |
Working Note:
| Cash flow estimate (Rs.) | Probability assessment | Expected cash flows (Rs.) |
| 50,000 | 25% | 12,500 |
| 62,500 | 50% | 31,250 |
| 87,500 | 25% | 21,875 |
| 65,625 |
Question 5 –
An asset is sold in two different active markets at different prices. Manor Ltd. enters into transactions in both markets and can access the price in those markets for the asset at the measurement date.
In Mumbai market, the price that would be received is Rs.290, transactions costs in that market are Rs.40 and the costs to transport the asset to that market are Rs.30. Thus the net amount that would be received is Rs.220.
In Kolkata market the price that would be received is Rs.280, transaction costs in that market are Rs.20 and the costs to transport the asset to that market are Rs.30. Thus, the net amount that would be received in Kolkata market is Rs.230.
i. What should be the fair value of the asset if Mumbai Market is the principal market? What should be fair value if none of the markets is principle market?
ii. If the net realisation after expenses is more in export market, say Rs.280 but Government allows only 15% of the production to be exported out of India. Discuss what would be fair value in such case.
Solution –
i. Fair value :
a. If Mumbai is the principal market
If Mumbai is the principal market for the asset (i.e., the market with the greatest volume and level of activity for the asset), the fair value of the asset would be measured using the price that would be received in that market, after taking into account transport costs.
Fair Value of the asset will be
| Rs. | |
| Price receivable | 290 |
| Less: Transportation cost | (30) |
| Fair value of the asset | 260 |
b. If neither of the market is the principal market
If neither of the market is the principal market for the asset, the fair value of the asset would be measured using the price in the most advantageous market. The most advantageous market is the market that maximises the amount that would be received to sell the asset, after taking into account transaction costs and transportation costs (i.e., the net amount that would be received in the respective markets).
| Rs. | Rs. | |
| Mumbai Market | Kolkata Market | |
| Fair value of the asset as per the question | 220 | 230 |
Since the entity would maximise the net amount that would be received for the asset in Kolkata Market i.e. Rs. 230, the fair value of the asset would be measured using the price in Kolkata Market.
Fair value in such a case would be
| Rs. | |
| Price receivable | 280 |
| Less: Transportation cost | (30) |
| Fair value of the asset | 250 |
ii. Export prices are more than the prices in the principal market and it would give highest return comparing to the domestic market. Therefore, the export market would be considered as most advantageous market. But since the Government has capped the export, maximum upto 15% of total output, maximum sale activities are being done at domestic market only i.e. 85%. Since the highest level of activities with highest volume is being done at domestic market, principal market for asset would be domestic market. Therefore, the prices received in domestic market would be used for fair valuation of assets.
Question 6 –
ABC Ltd. acquired 5% equity shares of XYZ Ltd. for Rs. 10 crore in the year 2011-12. The company is in process of preparing the financial statements for the year 2012-13 and is assessing the fair value at subsequent measurement of the investment made in XYZ Ltd. Based on the observable input, the ABC Ltd. identified a similar nature of transaction in which PQR Ltd. acquired 20% equity shares in XYZ Ltd. for Rs. 60 crore. The price of such transaction was determined on the basis of Comparable Companies Method (CCM)- Enterprise Value (EV) / EBITDA which was 8. For the current year, the EBITDA of XYZ Ltd. is Rs. 40 crore. At the time of acquisition, the valuation was determined after considering 5% of liquidity discount and 5% of non-controlling stake discount. What will be the fair value of ABC Ltd.’s investment in XYZ Ltd. as on the balance sheet date?
Solution –
Determination of Enterprise Value of XYZ Ltd.
| Particulars | Rs. in crore |
| EBITDA as on the measurement date | 40 |
| EV/EBITDA multiple as on the date of valuation | 8 |
| Enterprise value of XYZ Ltd. | 320 |
Determination of subsequent measurement of XYZ Ltd.
| Particulars | Rs. in crore |
| Enterprise Value of XYZ Ltd. | 320 |
| ABC Ltd.’s share based on percentage of holding (5% of 320) | 16 |
| Less: Liquidity discount & Non-controlling stake discount (5%+5%=10%) | (1.6) |
| Fair value of ABC Ltd.’s investment in XYZ Ltd. | 14.4 |