ifrs investment funds issue 5 8267

7/27/2019 Ifrs Investment Funds Issue 5 8267

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IFRS FOR INVESTMENT FUNDSSeptember 2012,Issue 5

In this issue: Fair value measurement ofnancial assets and fnancial liabilitiesFair value measurement lies at the heart o accounting or investment unds

(unds) that invest in nancial instruments because they would commonly

measure such investments at air value or reporting purposes.

Here we cover the ollowing questions on the air value measurement o nancial

assets and nancial liabilities.

1. What is air value?

2. How do you apply the air value hierarchy?

3. Is the price quoted in an active market?4. Bid, mid, ask or something else?

5. What i a transaction is not orderly?

6. What are the main considerations when applying a valuation technique?

7. What inputs into valuation techniques are commonly used by marketparticipants?

8. What i air value estimates are sourced rom brokers or pricing services?

9. How do you determine the air value o an investment in an open-ended

investment und?

10. How do you determine the air value o a nancial liability?11. Are there instances when air value cannot be reliably measured?

12. Is it possible to recognise a gain on initial recognition o a nancial asset or

nancial liability?

This issue does not cover air value measurement o an entitys own equity

instruments.

Welcome to theseries

Our series o IFRS

or Investment Funds

publications addresses

practical application issues

that investment unds may

encounter when applying

IFRS. It discusses the key

requirements and includes

guidance and illustrative

examples.

This series considers

accounting issues rom

currently eective IFRS

as well as orthcoming

requirements. For details

o previous issues, seepage 29. Further discussion

and analysis about IFRS are

included in our publication

Insights into IFRS.


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2 | IFRS or Investment Funds

2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

IntroductionFunds that invest in securities that are traded in an active market and whose prices are readily available will nd the air value

measurement process relatively straightorward. Other unds that invest in instruments that, although not traded in an active

market, are valued using observable inputs and well-established valuation models will need to put in place more involved

processes to measure air value. Arriving at air value is likely to be most complex and involve most judgement or unds, such

as private equity unds, that invest in securities whose valuation relies on signicant unobservable inputs. In addition, air

value considerations or unds are not limited to their investments but extend to the units issued, which are oten regarded as

liabilities under IFRS.

The current guidance on measuring the air value o nancial instruments is included in IAS 39 Financial Instruments:

Recognition and Measurement. This guidance will be superseded by IFRS 13 Fair Value Measurement, which is eective

or annual periods beginning on or ater 1 January 2013. IFRS 13 replaces the air value measurement guidance contained in

individual IFRSs, including IAS 39, with a single ramework or air value measurement.

The principal requirements o IFRS 13 relating to nancial instruments are largely similar to those in IAS 39. However, some o

the key denitions, such as the denition o air value, have been changed, resulting in subtle dierences that may potentially

impact application o the standard. IFRS 13 expands and articulates in more detail the concepts and principles behind air

value, including introducing some new concepts such as the principal market. Each question in this publication deals with the

relevant requirements o both IAS 39 (and, where applicable, its interactions with currently eective requirements o IFRS 7

Financial Instruments: Disclosuresand IFRS 9 Financial Instruments) and IFRS 13 and explains any dierences between the

two standards in the area discussed. However, market practice in applying IFRS 13 may be urther rened once the standardbecomes eective and as potential new implementation issues are identied and considered.


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IFRS or Investment Funds | 3


1. What is air value?

Fair value is dened in IAS 39 as the amount or which an asset could be exchanged or a liability settled, between

knowledgeable and willing parties in an arms length transaction. The objective o determining air value is to estimate the price

at which an orderly transaction would take place between market participants at the measurement date.

Fair value is a market-based measurement, rather than an entity-specic measurement. Fair value is measured using the

assumptions that market participants would use when pricing the asset or liability. For example, the act that a und asserts that

prices in orderly transactions are too low relative to its own expectations, and that accordingly it would be unwilling to sell at such

prices, is not relevant.

Generally, air value is determined on an instrument-by-instrument basis. See Question 4 or a discussion o the open net position

valuation or unds with assets and liabilities with osetting market risks.

Some unds use industry valuation guidance. In our view, although the valuation determined using these methods may be used

as a starting point in determining air value, adjustments may be required to determine an IFRS-compliant air value. Valuationsusing these methods may result in a more conservative measure o value than current market-based air value, which is the

objective o air value measurement under IFRS.

IFRS 13

Defnition o air value

IFRS 13 denes air value as the price that would be received to sell an asset or paid to transer a liability in an orderlytransaction between market participants at the measurement date. Thereore, air value is an exit price. The amended

denition no longer reers to an amount at which a liability could be settled see Question 10 or urther discussion.

Market participants are independent (not related parties under IAS 24 Related Party Disclosures), knowledgeable, able and

willing to enter into a transaction, although the price in a related party transaction may be used as an input to a air value

measurement i the und has evidence that the transaction was entered into on market terms.

The exit transaction is assumed to take place either:

in the principal market or that asset or liability; or

in the absence o a principal market, in the most advantageous market or the asset or liability.

See Question 3 or a discussion o the concepts o principal and most advantageous markets.

Unit o account and unit o valuation

IFRS 13 does not generally speciy whether an individual asset or liability or a group o assets or liabilities is considered or

air value measurement. The unit o account is usually determined under the IFRS that requires or permits the air value

measurement. For example, the unit o account in IAS 39 or IFRS 9 is generally an individual nancial instrument.

Although it is not dened in IFRS, the term unit o valuation is used in this publication or convenience, to indicate the level

at which an asset or a liability is aggregated or disaggregated or the purpose o measuring air value.

Generally, the unit o account and the unit o valuation are the same. However, there could be situations in which the unito valuation is dierent. For example, IFRS 13 permits an entity to measure the air value o a group o nancial assets and

liabilities on the basis o the net risk position in certain circumstances. In such cases, the unit o valuation or a particular

risk exposure would be the net risk position (group o nancial assets and nancial liabilities), whereas the unit o account

determined under IAS 39 or IFRS 9 would be an individual nancial instrument.


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2. How do you apply the air value hierarchy?

IAS 39 requires entities to maximise the use o market data in determining the air value o a nancial instrument. I a published

price in an active market is available or a particular instrument, then that price is used. I no published price in an active

market is available and so a und estimates air value using a valuation technique, then that technique has to maximise the

use o observable inputs. However, although it prioritises the use o published prices in an active market and the use o other

observable inputs, IAS 39 does not explicitly reer to a air value hierarchy. The levels in the air value hierarchy are included in

IFRS 7, which requires disclosure o the air value hierarchy or nancial instruments measured at air value in accordance with

IAS 39.

The fowchart below summarises the approach to determining the classication o air value measurements under IFRS 7.

Level 3

Quoted price for an

identical item in an active

market available?

Any significant

unobservable inputs?

Price requires adjustment? Level 1

Level 2

No

No

Yes

Yes

Yes

No

Financial assets and nancial liabilities are measured using quoted prices i a published price quotation in an active market is

available or the instruments. Generally, quoted prices should not be adjusted when valuing large holdings. For example, a und

cannot depart rom the quoted price in an active market solely because independent estimates indicate that it would obtain a

higher or lower price by selling the holding as a block. See Question 3 or a discussion o how to determine whether a market in

a nancial instrument is active.

When a nancial instrument is not traded in an active market, its air value is determined using a valuation technique. Such a

measurement is Level 2 or Level 3in the air value hierarchy.

Sometimes quoted prices are readily available rom brokers or pricing services on enquiry, but the prices are not published.

A und may hold a large number o such investments; in this case, the und may use a pricing service that does not relyexclusively on quoted prices or each identical instrument i.e. a matrix-pricing methodology as a practical expedient on cost-

benet grounds. This is permitted only i the und obtains evidence that provides reasonable assurance that the resulting value

represents air value. The evidence should support a conclusion that there would be no more than trivial dierences between

the prices used and the quoted prices that would be obtained rom a relevant broker or dealer. I air value is determined using a

matrix-pricing methodology, then the air value measurement would not be Level 1. This is despite the act that the investment

is regarded as quoted in an active market. See Question 8 or urther discussion o the air value sourced rom pricing services

or brokers.

A air value measurement is classied in its entirety into one o the levels o the air value hierarchy based on the lowest-level input that is signicant to the air value measurement. When multiple unobservable inputs are used, in our view the

unobservable inputs should be considered individually and in total or the purposes o determining their signicance. When

actors such as volatility inputs are used, a und could apply some orm o comparability methodology e.g. a stress test on an

options volatility input or a with-and-without comparison to assist in determining signicance.


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Valuation techniques that are based on inputs that are observable result in Level 2 measurements. Valuation techniques thatuse inputs requiring signicant adjustments based on unobservable inputs result in Level 3 measurements. Dierentiating

between Level 2 and Level 3 air value measurements i.e. assessing whether inputs are observable and whetherunobservable inputs are signicant may require judgement and a careul analysis o the inputs used to measure air value,

including consideration o actors specic to the asset or liability. An input is observable i it can be observed as a market price

or can be derived rom an observed market price. In each case, it is not necessary or the market to be active. See Question 6

or urther discussion o valuation techniques.

Irrespective o the level in the air value hierarchy used to measure the air value o a nancial instrument, the method chosen

must maximise the use o relevant observable inputs and minimise the use o unobservable inputs.

IFRS 13

Fair value hierarchy

Guidance on the air value hierarchy currently included in IFRS 7 has been incorporated into IFRS 13 (or measurement

as well as disclosure). The guidance has been expanded considerably but is largely consistent with the general concepts

currently in IAS 39.

However, there are some changes. In its discussions about quoted prices in active markets, IAS 39 reers to prices in the

most advantageous active market to which the entity has immediate access (see Question 3). In dening a Level 1 input,

IFRS 13 states that the published price quotation is to be sourced rom the entitys principal market or, in the absence o a

principal market, rom its most advantageous market.

As under IAS 39 and as discussed earlier in this chapter, adjustments to Level 1 prices are not generally permitted under

IFRS 13. However, as a practical expedient, a und may measure the air value o certain assets and liabilities using an

alternative method (such as matrix pricing) that does not rely exclusively on quoted prices. This practical expedient isappropriate only when:

the entity holds a large number o similar assets and liabilities that it measures at air value; and

a quoted price in an active market is available but not readily accessible or each instrument individually.

The matrix-pricing method involves using a selection o data points (usually quoted prices) or yield curves to calculate prices

or separate nancial instruments that share characteristics similar to the data points. Matrix pricing using observable

market-based data points will usually result in Level 2 air value measurements.

It appears that the use o such an alternative method as a practical expedient is also subject to the condition that it results

in a price that is representative o air value. We believe that application o a practical expedient is not appropriate i it would

lead to a measurement that is not representative o an exit price at the measurement date.

Specifc guidance on blockage actors and discounts and premiums

A und selects inputs that are consistent with the characteristics o the asset or liability that market participants would

take into account when determining the exit price o an asset or a liability. Sometimes it may be appropriate to make

an adjustment to a preliminary value indication in respect o a control premium or a non-controlling interest discount in

measuring air value o an asset or a liability.

A und does not apply a premium or discount i:

it is inconsistent with the items unit o account;

it refects size as a characteristic o the entitys holding e.g. a blockage actor;

the characteristic is already refected in the preliminary value indication; or

there is a quoted price in an active market or an identical asset or liability i.e. a Level 1 input.


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A und may hold a large number o identical nancial instruments where the market or the instruments does not have

sucient trading volume to absorb the quantity held without aecting the price. IFRS 13 provides specic guidance or such

circumstances. It denes a blockage actor as a discount that adjusts the quoted price o an asset or a liability because the

markets normal trading volume is not sucient to absorb the quantity held by the und. The standard claries that a blockage

actor is not a characteristic o an asset or a liability but a characteristic o the size o the entitys holding, and it expressly

prohibits application o a blockage actor.

There is currently some uncertainty about the application o valuation adjustments under IFRS 13. This arises in part

because:

the IFRS that requires a air value measurement may not be explicit in identiying the appropriate unit o account; and

IFRS 13 is not explicit in identiying all circumstances in which the unit o account guidance in the IFRS giving rise to the

air value measurement is overridden by the unit o valuation guidance in IFRS 13.

In particular, the interaction o IFRS 13s and other IFRSs guidance on the unit o account may be inconsistent in certain

cases with its requirement to use Level 1 prices without adjustment, when they are available.


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3. Is the price quoted in an active market?

Under IAS 39, a published price quotation in the most advantageous active market to which the und has immediate access

(a Level 1 air value measurement) is the best indicator o the air value o a nancial asset or nancial liability and, i one is

available, is used. Thereore, determining whether the market is active is the rst step in valuing a nancial instrument.

A nancial instrument is regarded as being quoted in an active market i quoted prices are readily and regularly available rom

an exchange, dealer, broker, industry group, pricing service or regulatory agency and those prices represent actual and regularly

occurring market transactions on an arms length basis. In our view, whether transactions are taking place regularly is a matter

o judgement and depends on the acts and circumstances o the market or the instrument.Quoted market prices may not be indicative o the air value o an instrument i the activity in the market is inrequent, the

market is not well-established, only small volumes are traded or bid-ask spreads are very wide. Determining whether a market

is activeinvolves judgement.

In our view, characteristics o an inactive market (Level 2 or Level 3 air value measurements) include the ollowing.

There is a signicant decline in trading volume and level o trading activity.

Available prices vary signicantly over time or between market participants.

Available prices are not current.

A signicant trading volume is between related parties.

There are restrictions on trading.

Example 1 Active market

Fund o unds F holds units in an open-ended unlisted Fund B.

Units in B are not traded on a stock exchange and can be bought rom and sold to the und only. This means that transactions

cannot take place directly between investors.

B calculates the price o the units only at a specic time each day to acilitate the purchase and sale o the units. Transactionstake place only at that specic time each day at the price determined by B.

Are units in B quoted in an active market?

In our view, it is not necessary or there to be a large number o dealers or brokers or an active market to exist. As long as

F is able to dispose o or acquire a reasonable quantity o a particular nancial instrument at a price that is not discountedsignicantly or does not include a signicant premium, then it may be concluded that the nancial instrument is traded in an

active market.

In this example, whether units in B are quoted in an active market will depend on whether daily pricing is sucient to meet

the readily and regularly available criterion and whether the number and requency o trades that occur in the units qualiy

as regularly occurring transactions. Daily pricing is likely to constitute evidence o regularly available prices. Judgement willthen have to be applied to determine whether the number o trades occurring is sucient to meet the regularly occurring

transactions criterion. I it is concluded that actual transactions occur regularly then, notwithstanding that the units are being

bought rom and sold to the und only, the units would be regarded as quoted in an active market.

I or some reason the quoted price does not represent air value at the measurement date e.g. because signicant events

occur ater the close o the market but beore the measurement date then the quoted price is adjusted to arrive at air valueand the air value measurement is not a Level 1 measurement.


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Example 2 Adjusted quoted price

Fund P invests in shares o Company C that are listed on a national stock exchange. On the last day o the reporting period,

P obtains the closing price o the shares rom the exchange. However, subsequent to the close o the market but still on

the last day o the reporting period, C makes a public announcement that has an impact on the air value o the shares as

evidenced by prices or a small number o ater-market transactions in depository receipts o the shares o C that are traded

in another jurisdiction.

Should P adjust the closing price rom the exchange to refect the ater-market transactions?

In this case, P uses the ater-market prices to make appropriate adjustments to the closing price rom the exchange to arrive

at the air value o the shares at the measurement date. The resulting air value measurement is a Level 2 measurement

because the exchange price has been adjusted or events occurring subsequent to the closing o the market and thosesubsequent events are observable.

It is explicit in the concept o a Level 1 measurement that the instrument being valued is the same as other existing instruments

o the same type. In some cases, instruments may be similar but not exactly the same. For example, over-the-counter

derivative contracts are individual agreements between specic counterparties and thereore cannot be the subject o a Level 1

measurement because there is unlikely to be an active market or an identical instrument.

In some cases, conditions attached to a nancial instrument may not be refected in the quoted price in an active market and

in our view this may justiy an adjustment to the quoted price to arrive at the instruments air value. For example, assume that

an investor is contractually bound by lock-up provisions that prohibit or restrict the sale o the instrument or a specied period.

In our view, it can be argued that these contractual lock-up provisions are characteristics o the instrument held by the investor

and that this instrument is thereore not identical to the one with the quoted price. I the contractual lock-up provisions are

considered characteristics o the instrument held by the investor, then we believe that it is appropriate to use a valuation model

to make adjustments to the quoted price.

IFRS 13

More detailed guidance

As noted in Question 2, IFRS 13 provides more detailed guidance on applying the air value hierarchy. The elements o this

guidance with specic relevance to Level 1 measurement are highlighted below.

Active market

IFRS 13 amends the denition o an active market to a market in which transactions or the asset or liability take place with

sucient requency and volume to provide pricing inormation on an ongoing basis.We do not expect the amendmentto represent a signicant change and we expect that in practice it is likely to be interpreted in the same way as the currentdenition in IAS 39.

Principal and most advantageous market

IFRS 13 introduces the concepts o principal and most advantageous markets. It states that air value measurement

assumes that the transaction to sell the asset or transer the liability takes place in the principal market or the asset orliability i.e. the market with the greatest volume and level o activity. In the absence o a principal market, the transaction

is assumed to take place in the most advantageous market. This is the market that maximises the amount that would be

received to sell the asset or minimises the amount that would be paid to transer the liability, ater considering transaction

costs and transport costs. In many cases, the principal market and the most advantageous market will be the same.

A und must be able to access the market in which the transaction is assumed to occur at the measurement date. The

concepts o principal and most advantageous markets are considered rom the perspective o the und, allowing ordierences between entities with dierent activities. For example, when a transaction takes place between an investment

bank and a und, the ormer may have access to wholesale and retail markets whereas the latter may have access only to

retail markets.


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IFRS 13 does not provide detailed guidance on:

how an entity should identiy the principal market;

over what period it should analyse transactions in the asset or liability to determine what is the principal (or most

advantageous) market; or

how oten it should update its analysis.

It appears that a und should update its analysis to the extent that events have occurred or activities have changed in a

manner that could change its determination o the principal (or most advantageous) market or the asset or the liability.

A und is not required to undertake an exhaustive search o all possible markets to identiy the principal market or, in the

absence o a principal market, the most advantageous market. However, it should take account o all inormation that is

reasonably available. In the absence o evidence to the contrary, the principal (or most advantageous) market is presumed tobe the market in which the und normally enters into transactions to sell the asset or transer the liability.

Characteristics o the asset or liability being measured

A und should take into account characteristics o the asset or liability that market participants would take into account in a

transaction or the asset or liability at the measurement date. In the case o a nancial asset, these characteristics include,

or example, restrictions, i there are any, on the sale or use o the asset.

It is important to distinguish a characteristic o an asset or liability rom a characteristic arising rom an entitys holding o

the asset or liability, which is an entity-specic characteristic. Factors used to evaluate whether a restriction on an asset is a

characteristic o the asset or entity-specic may include whether the restriction is:

transerred to a (potential) buyer;

imposed on a holder by regulations;

part o the contractual terms o the asset; or

attached to the asset through a purchase contract or another commitment.

For example, Fund D oers securities in a public oering and enters into an underwriting agreement with Company E.

The underwriting agreement between D and E contains a lock-up provision that prohibits D and its ounders, directors and

executive ocers rom selling their securities or a period o 180 days. The lock-up provision may be based on a contract

separate rom the security (i.e. resulting rom the underwriting agreement) and apply only to those parties that signed

the contract (e.g. the issuing entity, D) and their aliates. In that case, these restrictions may represent entity-specic

restrictions that would not be considered in the air value measurement o the securities. However, there may be situationsin which a lock-up provision is determined to be a characteristic o the security and not entity-specic based on the specic

terms and nature o the restriction. In that case, the restriction would be considered in the air value measurement o the

securities.

Explicit requirement or a policy on adjustments to market price

IFRS 13 explicitly requires entities to establish a policy or identiying events that might aect air value measurement,

including events that might indicate that a quoted price in an active market does not represent air value at themeasurement date.


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4. Bid, mid, ask or something else?

I a published price quotation in an active market is used to determine air value, then a question arises over which price should

be used: bid, mid, ask or something else? IAS 39 generally requires the use o bid prices or nancial assets and ask prices

or nancial liabilities when they are available. However, it allows entities that have assets and liabilities with osetting market

risks to:

use mid-market prices as a basis or establishing air value or the osetting risk positions; and

apply the bid or ask price to the open net position as appropriate.

Problems are oten encountered by unds as they oer unit-linked investment products i.e. when the unds obligation to unit

holders is linked to the value o the unds underlying investments. The units are oten redeemable on demand and the und is

required by its prospectus to issue and redeem units to its investors at a unit price that refects mid-market prices or its assets.

For the purposes o the unds nancial statements, the investments held by the und are valued at bid prices. The units issued

are valued in accordance with the contractual agreement between it and the unit holders i.e. in this example, refecting mid-

market prices or its assets.

This causes a presentation issue because a mismatch arises between:

assets o the und valued at bid prices; and

unit liabilities valued on the basis o mid-market prices or the unds assets.

In our view, one solution may be to present the unit liability in a two-line ormat.

The rst line would be the amount o the net assets attributable to holders o redeemable shares measured at the

redemption amounts determined in accordance with the prospectus, which refects the actual redemption amount at which

redeemable shares would be redeemed at the end o the reporting period.

The next line would include an adjustment or the dierence between this and the amount recognised in the statement onancial position.

This refects the act that, or a und with no equity, or with minimal equity, all, or almost all, recognised income and expenses

should be attributed to unit holders, which also means that a dilution levy o that amount would be required i all units were

redeemed. See our publication Illustrative fnancial statements: Investment undsor an illustration o this presentation.

When current bid and ask prices are not available, a und may use the price o the most recent transaction in the particular

nancial instrument, provided that there has been no signicant change in economic circumstances since that transaction.

Adjustments are made i signicant changes have occurred since.

IFRS 13

Bid and ask prices

For assets measured at air value that have a bid and an ask price, IFRS 13 requires the use o the price within the bid-ask

spread that is most representative o air value in the circumstances. The bid-ask spread includes transaction costs and

may include other components. A price in the principal or most advantageous market is not adjusted or transaction costs.

Thereore, an entity makes an assessment o what the bid-ask spread represents when determining the price that is

most representative o air value within the bid-ask spread. The use o bid prices or long positions and ask prices or short

positions is permitted but not required.
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The standard does not prohibit the use o mid-market prices or other pricing conventions generally used by market

participants as a practical expedient or air value measurements within a bid-ask spread. However, it appears that the use

o mid-market prices is subject to the condition that a mid-market price provides a reasonable approximation o an exit price.

We believe that using the practical expedient does not override the general air value measurement guidance, and it should

not be used i it leads to a measurement that is not representative o air value. Thereore, a und should not ignore available

evidence that a mid-market price does not result in a price that is representative o air value. For example, i the bid-ask

spread is particularly wide, or i the applicable bid-ask spread has widened signicantly or a specic asset or liability, then a

mid-market price may not be representative o air value.

Financial assets and liabilities with osetting positions in market risk(s) or credit risk

IFRS 13 permits an exception to measure the air value o a group o nancial assets and liabilities that are within the scope

o IAS 39 or IFRS 9 on the basis o net exposure to a particular market risk(s) and/or credit risk i certain conditions are met.

The fowchart below summarises application o those conditions.

Group managed on basis of net exposure to particular market risk or credit

risk of a particular counterparty in accordance with documented risk

management or investment strategy?

Provide information to key management personnel on that basis?

Measured at fair value in the statement of financial position on a recurring basis?

Measurement on a net basis permitted

Measure

individual

assets and

liabilities;

measurement

on a net

basis

prohibited

Yes

Yes

Yes

No

No

No

It appears that the application o the portolio measurement exception changes the unit o valuation rom the individual

nancial asset or nancial liability to the net position or a particular risk exposure. We believe that the size o the net risk

exposure is a characteristic to be considered when measuring the air value o the net risk exposure.

A und that measures air value on the basis o net exposure to a particular market risk(s):

applies the price within the bid-ask spread that is most representative o air value; and

ensures that the nature and duration o the risk(s) to which the exception is applied are substantially the same.

I the und is permitted to use the exception or some or all o the portolios that it holds, then it should choose an accounting

policy, to be applied consistently, or a particular portolio. However, a und is not required to maintain a static portolio.

The above measurement exception or a group o nancial instruments does not extend to the presentation o those

instruments in the nancial statements. Accordingly, i items in the portolio are presented separately, then the bid-ask or

credit adjustments that have been calculated or the portolio as a whole have to be allocated to the individual assets and

liabilities on a reasonable and consistent basis.

See also 2.4A.200 in the 9th Edition 2012/13 o our publication Insights into IFRS(7.6.267 in the 8th Edition 2011/12) or more

discussion o the portolio measurement exception.


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5. What i a transaction is not orderly?

Underlying the concept o air value in IAS 39 is the presumption that the entity is a going concern and does not have an

intention or a need to undertake a transaction on adverse terms. Thereore, air value is not normally an amount that a undwould receive or pay in a orced transaction, involuntary liquidation or distress sale.

Fair value is intended to represent the price in an orderly transaction (not orced) between market participants at the

measurement date. In our view, an orderly transaction involves market participants that are willing to transact and allows or

adequate exposure to the market.

I a transaction is determined to be orced, then it is not used to measure air value. Determining whether a transaction is orcedrequires analysis o the acts and circumstances and the use o judgement. In our view, it cannot be automatically assumed that

all transactions in an inactive market or all transactions initiated during bankruptcy are orced. Further, we do not believe that an

imbalance between supply and demand (e.g. ewer buyers than sellers) always results in a orced transaction.

We believe that the indicators o a orced transaction may include:

a legal requirement to transact e.g. a regulatory mandate;

an immediate necessity to sell an asset with insucient time or customary marketing; or

a single potential buyer as a result o imposed legal or time restrictions.

In our view, i a und sells assets to market participants to meet regulatory requirements, the regulator does not establish the

transaction price and the entity has a reasonable amount o time to market the asset, then the transaction provides evidence oair value.

IFRS 13

Transactions that are not orderly

IFRS 13 introduces a denition o an orderly transaction: A transaction that assumes exposure to the market or a period

beore the measurement date to allow or marketing activities that are usual and customary or transactions involving such

assets or liabilities; it is not a orced transaction (eg a orced liquidation or distress sale).

The standard provides guidance on circumstances that may indicate that a transaction is not orderly, which include the

ollowing.

There was inadequate exposure to the market to allow usual and customary marketing activities. The seller marketed the asset or liability to a single market participant.

The seller is in distress.

The seller was orced to sell to meet regulatory or legal requirements.

The transaction price is an outlier compared with other recent transactions in identical or similar items.


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When the volume or level o activity has signicantly decreased, the market is not active and prices are volatile, we expect

the ollowing matters to be o greater signicance.

I the evidence indicates that a transaction was not orderly, then the transaction price is given little, i any, weight in

measuring air value.

I the evidence indicates that the transaction was orderly, then the transaction price is taken into account when measuring

air value. The amount o weight given to the transaction price will depend on actors such as transaction volume,

comparability to the measured asset or liability, and proximity to the measurement date.

I the und does not possess sucient inormation to conclude whether the transaction was orderly, then the transaction

price is taken into account when measuring air value, but with less weight placed on it compared with the transactions

known to be orderly.

Although a und need not undertake exhaustive eorts to determine whether a transaction was orderly, it should not ignore

inormation that is reasonably available. I an entity is party to a transaction, then it is presumed to have sucient inormation

to conclude whether the transaction was orderly.


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6. What are the main considerations whenapplying a valuation technique?

Determining air value may be more complex or nancial instruments that are not traded in an active market because the air

value o such instruments is determined using a valuation technique. The table below outlines the key requirements that a

valuation technique has to meet to comply with IAS 39.

Feature Requirements

Objective o

a valuation

technique

The objective o a valuation technique is to establish what a transaction price would have been:

on the measurement date;

in an arms length exchange; and

motivated by normal business conditions.

In our view, the valuation technique used should refect current market conditions and appropriate risk

adjustments that market participants would make or credit and liquidity risks on the measurement date.

Principal

characteristics

A valuation technique has the ollowing principal characteristics. It:

is commonly used by market participants;

is consistent with accepted economic methodologies and techniques; uses inputs that market participants would usually consider;

maximises the use o observable data;

relies as little as possible on entity-specic actors; and

is validated periodically against actual market transactions.

Using

observable

data

Regardless o the level o trading activity in the market, a valuation technique has to take into account

actual market transactions or identical or similar instruments that are not orced transactions. Such

transactions cannot be ignored when measuring air value using a valuation technique, although they

might require signicant adjustments based on unobservable data.

Incorporating

credit risk

Fair value refects the credit quality o the nancial instrument. For example, valuation techniques or

derivative instruments refect the credit risk o the counterparty and the credit risk o the reporting entity

(own credit risk) as appropriate, including consideration o collateral and margining requirements, and theeect o master netting arrangements. See Question 10 or a discussion o the inclusion o credit risk in

the valuation o nancial liabilities.

Treatment o

entity-specifc

actors

In our view, it is inappropriate to adjust the results o a model-based valuation or entity-specic actors

e.g. uncertainty in estimated cash fows, liquidity or administration costs. We believe that such actors

should be incorporated into a valuation model based on the amounts that market participants as a whole

would consider in setting a price.

Furthermore, it is not appropriate to adjust the result o a valuation technique to refect model risk unless

other market participants would make similar adjustments. Adjustments or known model weaknesses

are more common or complex instruments. When a model requires adjustment or such a model

weakness, in general, a und would not expect the adjustment to persist over the longer term. This isbecause over time new techniques become available and thereore a model adjustment that corrects a

known weakness should become unnecessary.


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Feature Requirements

A model

providing

a range o

estimates as

an output

When the outcome o the valuation model is a range o estimates, the probabilities o the estimates

within the range are determined and applied to arrive at a single estimate o air value. In our view, i

dierent models are used and each model gives a dierent outcome, then judgement should be used in

determining which outcome is likely to be the most reliable. We do not believe that it is appropriate simply

to average the outcomes o the various valuations.

A und selects a valuation technique that is commonly used by market participants to measure the air value o the nancial

instrument concerned, i that technique has been demonstrated to provide reliable estimates o prices obtained in actual

market transactions.

Examples o valuation techniques include:

discounted cash fow analyses;

using recent market transactions or an identical instrument, adjusted or changes in market actors between the date o

such recent transactions and the measurement date;

current or recent market transactions in a similar nancial instrument, adjusted or actors unique to the instrument beingvalued; and

option pricing models.

Applying a valuation technique may involve judgement, especially i one o the inputs into the valuation model is not observable.

Example 3 Illiquid private equity (PE) investments

PE Fund E has a non-controlling interest in Company C. The market or shares o C is not active. E estimated the air value othe investment at 5.00 per share using a valuation model with Level 3 inputs. Fund F, another investor in C, estimated the air

value at 5.10 per share.

What is the air value o Cs shares?

Applying a valuation technique may involve judgement and so it is possible or dierent investors to arrive at dierent airvalue estimates at the same measurement date, and or both estimates to meet the objective o air value measurement

in IAS 39. Dierent air value estimates refect the inherent uncertainty o estimating the air value o instruments that do

not have prices quoted in an active market. A single entity, however, has to ensure that it applies its judgement consistently

(across time and by type o instrument) to measure the air value o dierent instruments. Thereore, depending on the acts

and circumstances, it might be possible or the air value o Cs shares to be determined to be 5.00 per share in Es nancialstatements and 5.10 in Fs nancial statements.

IFRS 13

Valuation techniques

IFRS 13 does not establish requirements or a specic valuation technique(s) to be used unless there is a quoted price in an

active market or an identical asset or a liability that the entity can access at the measurement date. The standard reers to a

valuation approach as a broad category o techniques, whereas a valuation technique reers to a specic technique e.g.

a particular option pricing model. The standard explains that valuation techniques used to measure air value all into the

ollowing approaches (only those applicable to nancial instruments are listed):

market approach; and

income approach.


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Either o these approaches, or a combination o them, can be used to measure air value i the techniques are appropriate in

the circumstances.

Most commonly, air value measurements o nancial instruments perormed using a market approach will all into Level 1

o the air valuation hierarchy. However, i a market approach uses prices or similar, rather than identical, assets or usesmatrix pricing, then it would not all into Level 1 because it would not use inputs that are quoted prices (unadjusted) in active

markets or identical assets or liabilities. Valuation techniques that all under the market approach will also oten derive

market multiples rom a set o comparable assets. A market multiple expresses the value o a business or other asset in

terms o its ratio to a nancial, operating or physical metric. For example, a price-to-earnings ratio expresses an entitys

per-share value in terms o a multiple o its earnings per share. The multiple can then be applied to the metric o an entity

with similar characteristics but dierent scale, subject to adjustments or dierences between the entity and the selected

comparable.

Valuation techniques under the income approach convert uture amounts such as cash fows or income streams to a current

amount on the measurement date.

Common valuation techniques alling under the income approach include present value techniques and option pricing

models.


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7. What inputs into valuation techniques arecommonly used by market participants?

In determining the inputs to valuation models that comply with IAS 39, market inormation is considered whenever possible.

Typical inputs to valuation models or nancial instruments include the ollowing.

Inputs Description

Time value

o money

i.e. risk-ree

interest rate

A risk-ree rate implies the interest rate or a completely credit risk-ree investment. However, a trulyrisk-ree rate does not exist in the market because all instruments carry a certain amount o risk.

Thereore, a basic interest rate, derived rom observable prices o high-quality instruments, such as

utures or government bills, notes or bonds (US treasuries or UK gilts), is oten used as a market proxy

or the risk-ree rate. However, in some countries government bonds may carry signicant credit risk and

may not provide a stable benchmark rate or instruments denominated in that currency. Some entities in

that country may have a better credit standing. In such cases, basic interest rates may be determined with

reerence to the highest-rated corporate bonds issued in the currency o that jurisdiction. Well-accepted

and readily observable general rates such as LIBOR may also be used as a benchmark rate, when

appropriate.

Credit risk An appropriate credit spread may be derived rom quoted prices or corporate bonds o similar credit

quality and maturity to the instrument being valued, or rates charged to borrowers o a similar credit rating

or a similar maturity.

Liquidity

(or close-

out/bid-ask

adjustments)

The liquidity adjustment represents the amount that would be incurred to close out a position.

I a nancial instrument is initially valued using mid-market data, such as an interest rate curve, a liquidity/

close-out adjustment is needed to arrive at an appropriate bid price (or assets) or ask price (or liabilities).

Most common yield curves, such as LIBOR, have observable bid-ask spreads, which are generally

available rom news and pricing services, such as Reuters and Bloomberg (in both data point and graphic

curve ormats) and can be used to calculate the liquidity adjustment.

Foreign

exchange risk

Foreign currency rates are usually quoted in daily nancial publications and electronic nancial databases.

Commodity

prices

Observable market prices are available or most commodities.

Equity prices Quoted market prices are oten available or equity securities. For unquoted equity securities, valuation

techniques based on discounted cash fows may be used to estimate air value.

Volatility Measures o the volatility o actively traded items can normally be estimated on the basis o historical

market data or by using volatilities implied in current market prices. When historic measures are used, it is

important to consider how uture outcomes may dier rom past experience.

Prepayment/

surrender risk

Expected prepayment patterns or nancial assets and surrender patterns or nancial liabilities can be

estimated on the basis o historical data. When historic measures are used, it is important to consider

how uture outcomes may dier rom past experience.

Servicing

costs

The costs o servicing can be estimated using comparisons with current ees charged by other market

participants. I the costs o servicing a nancial instrument are signicant and other market participantswould ace comparable costs, then they would be considered in determining air value.


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Although a valuation model should maximise the use o relevant observable market data, some inputs into the model may beunobservable, which may cause the overall air value measurement o the nancial instrument to all into Level 3 o the air

value hierarchy (see Question 2). Assessing whether inputs are observable and whether the unobservable inputs are signicantmay require judgement and a careul analysis o the inputs used to measure air value, including the consideration o actors

specic to the asset or liability.

Examples o observable and unobservable inputs

Observable inputs generally leading to Level 2

valuations

Unobservable inputs leading to Level 3 valuations i

they are signifcant

Transaction prices in markets that are not active or

identical instruments

Quoted prices in active markets or similar, but not

identical, instruments

Transaction prices in markets that are not active or similar,

but not identical, instruments

Interest rates derived rom quoted bond prices

Quoted oreign exchange and interest rates e.g. orward

currency rates and swap rates

Implied volatilities derived rom quoted option prices

Credit spreads derived rom quoted credit deault swapprices

Foreign currency interest rates that:

are not observable; and

cannot be corroborated by observable market data or

the term o the nancial instrument being valued

Volatility or a share option derived rom the shareshistorical prices, because it does not generally represent

current market expectations about uture volatility

Assessing the signicance o an unobservable input requires judgement, considering actors specic to an asset or a liability.

When a air value measurement is developed using inputs rom multiple levels o the air value hierarchy, the inclusion o alower-level input in a unds measurement may indicate that the input is signicant because o the unds decision to include it

in the overall measurement o air value. However, the nal decision on whether an input is signicant is a matter o judgement

that will require unds to consider the importance o the input to the overall air value measurement o the instrument.

IFRS 13

Observable inputs

IFRS 13 includes a denition o observable inputs: Inputs that are developed using market data, such as publicly available

inormation about actual events or transactions and that refect the assumptions that market participants would use whenpricing the asset or liability.

See Question 2 or a discussion o valuation premiums and discounts.


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8. What i air value estimates are sourcedrom brokers or pricing services?

Funds oten obtain prices rom brokers or pricing services to determine the air value o their holdings o nancial instruments.

When assessing the appropriateness o using such prices or the purposes o air value measurement in nancial statements, a

und has to consider:

whether the price represents the air value o the relevant nancial instrument; and

the level in the air value hierarchy that the price represents.

Does the price represent the air value o the fnancial instrument?

Prices sourced rom a broker or pricing service may represent air value estimated in accordance with IAS 39, but it cannot be

automatically assumed that they do. A und has to obtain an understanding o how the prices have been determined and satisyitsel that they represent air value beore using the prices or the purposes o its nancial statements.

Which level in the air value hierarchy do the prices represent?

Prices obtained rom brokers or pricing services are not considered observable under IAS 39 simply because they were

obtained rom a third party. Whether those prices represent an observable or unobservable input depends on their nature andsources.

The use o a pricing service or a broker does not change the analysis o the categorisation o the inputs in the air value

hierarchy. Accordingly, a und should obtain an understanding o the source o the inputs used by the pricing service or broker.Depending on the outcome o this analysis, the price obtained rom the pricing service potentially can be categorised as

Level 1, Level 2 or Level 3.

Consensus pricing services obtain inormation rom multiple subscribers that submit prices to the pricing service. The pricing

service returns consensus prices to each subscriber based on the data received. When assessing the consensus data, it is

important to understand what the prices submitted represent. I the estimates submitted to the service do not represent

executable quotes or are not based on observable prices, then the air value measurement derived rom the consensus price

would be a Level 3 measurement. However, i the inputs to the price received rom the pricing service are Level 1 or Level 2

inputs, then the use o those prices generally results in a Level 2 measurement.

Similar considerations apply to prices obtained rom brokers. A broker quote is generally an indicative price and not a binding

oer. Even i it is a binding oer, it may not represent the price at which an orderly transaction would take place between market

participants. Evaluation o a price obtained rom a broker would include the ollowing: understanding the nature o the price or quote provided (see the table on page 20);

understanding the valuation technique used, i applicable e.g. sources o inputs, calibration process (see Questions 6and 7);

considering whether the price is consistent with other available market inormation e.g. i there are current market

transactions in the same or a similar instrument available, then the broker price should be consistent with those transactions;

and

considering whether the broker has a substantial presence in the market and the experience and expertise to provide a

reliable quote.

When markets are not active, brokers or pricing services are likely to rely more on models because market transactions may

occur inrequently.


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The table below provides examples o how some o the characteristics o prices obtained rom brokers and pricing servicescould align with levels in the air value hierarchy.

Fair value

hierarchy levelExample

Level 1 An unadjusted quoted price rom an active market or an identical instrument provided by a pricing service

Level 2 A broker quote that refects actual current market transactions in a similar instrument

Level 2 or

Level 3

An indicative price based on the brokers or pricing services valuation models may represent a Level 2 or

Level 3 input depending on the signicance o the unobservable inputs used

Level 3 A consensus price i the estimates submitted to the service do not represent executable quotes or are notbased on observable prices

In the absence o an active market, i several broker quotes are obtained or the same instrument and the dierence between

these quotes is signicant, then it is likely that one o the quotes better represents air value i.e. the average o quotes should

not generally be used. Accordingly, it is necessary to understand how the prices have been derived and whether the methods

and assumptions used are consistent with the air value principles in IFRS.

IFRS 13

The standard provides specic guidance on using pricing services and brokers quotes that is consistent with the general

principles currently in IAS 39 and outlined above.


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9. How do you determine the air value o aninvestment in an open-ended investmentund?

When valuing an investment in an open-ended und under IAS 39, a question oten arises over whether the air value o a unit

or shares (hereater units) issued by such a und is equal to its pro rata share o net asset value (NAV). Because the instrument

held by the investor is an ownership interest in the und and not an interest in the underlying assets o the und, the value o the

two may not be the same. Examples o items to consider when valuing units in a und include:

actual transactions in the units with the und and in the secondary market;

the nature o the underlying assets and liabilities o the und; and

other rights and obligations inherent in the ownership interest e.g. in some instances, an interest in a und may oblige the

investor to meet uture cash calls made by the und. Any adjustments or rights or obligations should be consistent with the

unit o account being measured.

An evaluation o whether NAV is representative o air value encompasses two steps, which are illustrated in the table below.

The rst step is to assess whether the NAV or another price is representative o a quoted price in an active market. I it is, then

it has to be used to value the investment. I there is not a quoted price in an active market, then the second step is to assess

whether the NAV is otherwise representative o the air value o the investment in the und.

Is NAV representative o air value?

Step 1

Is NAV per unit

representative

o a quoted

price in

an active

market at themeasurement

date (Level 1)?

To assess whether the NAV or another price is representative o a quoted price in an active market, aninvestor should consider the manner in which units in the und are traded. Oten, units in open-ended

investment unds are traded only with the und or its agent at a published price, either NAV or NAV plus

or minus an adjustment. Depending on how oten the published unit prices are updated, and the trading

volume at these prices, the published prices may represent a quoted price in an active market.

NAV per unit may be a Level 1 measurement o air value when it represents a quoted market price in an

active market (as discussed in Question 3). I there is a quoted price in an active market or an investmentin a und (i.e. a Level 1 input), then the quoted price is determinative o air value, whether or not it is

equal to the NAV.

Units in a und may trade at a premium or discount to NAV due to the volume o supply and demand orother actors specic to the und. For example, units may trade at a discount because a market participant

may consider an investment in the und less attractive than a direct investment in the underlyingassets o the und due to uture investment management changes or the loss o control over portolio

management decisions. Conversely, market participants may be willing to pay a premium to invest in a

und managed by a specic investment manager.


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Is NAV representative o air value?

Step 2

Is NAV per

unit otherwise

representative

o a air value

(Level 2 or

Level 3)?

To assess whether NAV is otherwise representative o the air value o the investment in the und, the

investor exercises judgement taking into account all relevant acts and circumstances. Examples o

actors that may be relevant include consideration o whether:

the NAV is dated as o the investors measurement date;

the NAV is calculated in a manner consistent with IFRS air value measurement principles;

the investment can be redeemed at NAV at the measurement date (e.g. some unds may suspend

redemptions, introduce a lock-up period or impose gates on redemptions1); and

there are no other terms attached to the investment (e.g. a commitment to make uture investments).

Funds also consider the nature and reliability o the evidence that supports the calculation o NAV.

In determining whether NAV approximates air value, the weight placed on the evidence provided by

transactions with the und (i.e. subscriptions and redemptions) is impacted by:

market changes since the transaction activity occurred;

the volume o both redemptions and subscriptions;

the extent to which subscriptions were received rom new investors; and

limitations or expected limitations on the investors ability to redeem in the uture.

I the investor concludes that there are rights or obligations attributable to the unit that are not refected in

the NAV measurement o the und and so NAV requires adjustment to arrive at air value, then NAV is not

representative o air value.

I NAV is not representative o air value but is used as an input into a valuation model, then the investor

should still understand how NAV is calculated, including the key inputs and valuation techniques used by

the und to value the underlying assets and liabilities.

IFRS 13

Valuation o investments in another und

IFRS 13 does not provide specic guidance on valuation o investments in another und. The above guidance based on IAS 39

will continue to be relevant when applying IFRS 13.

1 Some investment unds (generally hedge unds) impose gates on redemptions, which are restrictions placed on the amount o withdrawals romthe investment und during a redemption period. The terms (e.g. the redemption amount, notice period etc.) surrounding such restrictions arenormally stated in the investment unds prospectus.


23/33



10. How do you determine the air value o anancial liability?

In general, the approach to determining the air value o nancial liabilities under IAS 39 mirrors that or nancial assets (see

Question 1). However, IAS 39 reers to air value being an amount at which a liability could be settled, which is unclear because

the denition does not reer to the creditor, but to knowledgeable, willing parties. As a result, some dierences in interpretation

have arisen in practice.

IAS 39 contains a specic requirement that the air value o a nancial liability with a demand eature is not less than the amount

payable on demand, discounted rom the rst date on which the amount could be required to be repaid.

IFRS 13

Transer notion

IFRS 13 denes air value as the price that would be received to sell an asset or paid to transer a liability in an orderly

transaction between market participants at the measurement date. The new denition no longer reers to the settlement

o a liability. When measuring the air value o a liability, it is assumed that the liability remains outstanding but is transerred

to a market participant at the measurement date.

IFRS 13 introduces specic requirements or the application o the air value measurement ramework to liabilities. The

fowchart below summarises the approach as it relates to nancial liabilities.

1. Fair value is based on the quoted price for the transfer of an identical or similar liability.

If this is not available, then ...

2. Fair value is based on a quoted price in an active market for an identical item held by another

party as an asset.


3. Fair value is based on other observable inputs for an identical item held by another

party as an asset.


4. Fair value is based on another valuation technique from the perspective of a market participant

holding an identical item as an asset.


5. Fair value is based on a valuation technique from the perspective of a market participant

that owes the liability.


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In our experience, there are many cases in which there is no observable market to provide pricing inormation about the

transer o a liability. Also, in many cases an entity may not be willing or able to transer its liability to a third party. However,

there may be an observable market or such items i they are held by other parties as assets. Thereore, the air values o

most nancial liabilities are measured rom the perspective o a market participant that holds an identical instrument as an

asset. I a und measures a liability rom the perspective o a market participant that holds the identical instrument as anasset, then it has to adjust the price or any eatures that are present in the asset but not in the liability or vice versa. For

example, an investment und may have issued units with a guarantee rom the unds sponsor. From the perspective o the

holder, the individual unit may be the combined instrument containing both the amount due rom the investment und and

the guarantee. From the investment unds point o view, the air value measurement o the units issued ollows the unit o

account o the liability or nancial reporting purposes. I that unit excludes the guarantee, then the air value o the obligation

excludes the impact o the guarantee. However, neither IAS 39 nor IFRS 9 states explicitly whether such a guarantee is part

o the liabilitys unit o account.

IFRS 13 retains the IAS 39 guidance on the air value o a liability with a demand eature. Its air value cannot be less than the

amount payable on demand, discounted rom the rst date on which the amount could be required to be paid.

Non-perormance risk

Currently, the denition o air value or nancial liabilities in IAS 39 reers to the price at which a liability could be settled.There can be diversity in whether and how entities adjust or own credit risk when measuring the air value o their liabilities,

particularly derivative liabilities. In some cases, this may be infuenced by the belie that little i any discount or own credit

risk would be obtained in a negotiated early settlement o the liability with the counterparty. As a result, an adjustment or

own credit risk in measuring a derivative liability under IAS 39 might be lower than the adjustment or credit risk in measuring

the corresponding asset recognised by the counterparty to the instrument.

By contrast, the denition o air value in IFRS 13 instead reers to the (exit) price at which a liability would be transerred to

a market participant on the assumption that the non-perormance risk, including the eect o the entitys own credit risk,remains the same beore and ater the transer. In addition, in the absence o a quoted market price or the transer o a

liability, the liabilitys air value should be measured rom the perspective o a market participant that holds the liability as an

asset. This would imply greater consistency between the calculation o own credit risk adjustments and counterparty credit

risk adjustments in measuring derivative assets and liabilities.

In principle, and assuming no dierences in the unit o account, the credit risk adjustments made in the air value

measurement o a nancial instrument should be the same or both counterparties to the instrument. The credit risk o both

counterparties may be relevant to measuring the air value o an instrument that may change rom being an asset to a liability

or vice versa e.g. an interest rate swap.

Example 4 Fair values o units issued by limited lie und

Fund L is a closed-ended investment und with a limited lie o seven years. On liquidation o L, investors in Ls units are

entitled to a pro rata share o its net assets. The units are not quoted in an active market. The units are rarely bought and sold

between investors. To the extent that transactions took place in the past, the units were sold/bought at prices that were

not equal to Ls NAV per unit at the time. The issued units are classied and presented as a nancial liability under IAS 32

Financial Instruments: Presentation.

L invests in nancial assets and measures the assets at air value with gains and losses recognised in prot or loss. For its

nancial statements, L adopted the presentation shown in Example 7 o IAS 32, which is relevant or entities such as mutual

unds whose share capital is not equity as dened by the standard. In line with the example, the statement o nancial

position describes the net assets o L (which exclude units issued) as Net assets attributable to unit holders.

How does this presentation impact air value disclosure requirements or a und that reports under IFRS 13?


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When the units are not measured at air value, IFRS 7 requires an entity to disclose the air value o each class o nancial

instruments in a way that permits it to be compared with its carrying amount. Example 7 o IAS 32 permits an entity to

present, in its statement o nancial position, a line item Net assets attributable to unit holders, being the dierence

between its total assets and total liabilities (excluding units issued). I a und ollows this presentation ormat, then it needs

to assess, or the purposes o disclosure under IFRS 7, whether the line item Net assets attributable to unit holders (NAV)

represents the aggregate air value o the issued units.

L cannot automatically assume that, because its assets are measured at air value, the air values o its issued units will

be equal to NAV. L has to apply the fowchart on page 23 to measure the air value o an individual unit. This may refect a

premium or a discount to NAV, depending on the circumstances. The aggregate air value will be equal to the air value o an

individual unit times the number o units issued.


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11. Are there instances when air value cannotbe reliably measured?

Generally, under IAS 39 it is presumed that the air value o all nancial instruments is reliably measurable. This presumption can

be overcome only or the ollowing instruments that may be measured at cost less impairment:

an equity instrument that does not have a quoted price in an active market and whose air value cannot be reliably measured;

and

a derivative that is linked to and settled by the delivery o such an equity instrument.

This exemption is only applied in rare cases when it can be demonstrated that a valuation technique generates a wide range o

possible air values and the probability o the various outcomes cannot be estimated. The exemption is very limited because it is

unlikely that an investment would be bought i its air value could not be estimated.

An issue sometimes arises over whether a unds investment in another und can be valued reliably. In most cases, even i the

other und invests in unlisted instruments, it should be possible to determine the air value o the investments in that und.

Example 5 Valuation o unquoted equity investment

PE Fund P holds unquoted shares issued by Company C. The nature o Cs operations is such that the valuation o Cs shares

generates a wide range o possible air values and the probabilities o the various outcomes are dicult to estimate. There

were no transactions in Cs shares or the past three years.

Can P use the exemption under IAS 39 to measure investment in C at cost less impairment?

Although the valuation o shares issued by C is dicult, entities such as unds that undertake signicant investing

activities use some orm o valuation technique or the purpose o evaluating investment decisions. In our view, in these

circumstances the same techniques should be used subsequently to determine the air values o investments.

IFRS 9

Using cost as an approximation o air value

Under IFRS 9, investments in equity instruments are measured at air value. The exception currently in IAS 39 to use cost to

measure certain equity investments and derivatives linked to them has been removed.However, in certain limited circumstances the standard allows cost to be used as an approximation o air value or unquoted

equity instruments and certain contracts linked to them. This exception does not apply to equity investments held by

particular entities such as nancial institutions and unds. Funds that are currently using the IAS 39 exception to value certain

investments in equity instruments would need to reconsider the valuation approach under IFRS 9.


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12. Is it possible to recognise a gain on initialrecognition o a nancial asset or nancialliability?

Sometimes, a und acquires a nancial instrument in one market and intends to sell it or to issue an osetting instrument in a

dierent market. An issue arises over whether the instrument may be initially measured at its air value in the selling market and

thereore a gain recognised on initial recognition (day one gain) under IAS 39.

The best evidence o the air value o a nancial instrument on initial recognition is normally the transaction price (i.e.consideration paid or received). However, a day one gain may be recognised on initial recognition when the air value that is

higher than the transaction price is:

evidenced by comparison with other observable current market transactions in the same nancial instrument without

modication or repackaging; or

based on a valuation technique that uses only observable market data as inputs.

Example 6 Day one gain

Fund Z acquires a portolio o impaired loans or 30 (its ace value is 100). Z specialises in high-yield loans and has superior

cash-collection processes in place. Z expects to recover a higher proportion o cash fows than a market participant wouldand, based on a discounted cash fow analysis, values the loan portolio at 35.

Can Z recognise a day one gain o 5 on this investment?

In our view, it would be inappropriate to conclude that the transaction price o 30 does not represent the air value o the loan

portolio at initial recognition.

The valuation technique used by Z to arrive at the value o 35 takes into account Zs specic cash-collection processes, which

is inappropriate (because it is entity-specic rather than refecting a market participants perspective) and unobservable. A

subsequent sale transaction with an independent counterparty on the market would ignore Zs cash-collection processes.

Consequently, Z should recognise the acquired portolio o loans at the transaction price o 30.

I a day one gain or loss is not recognised on the initial recognition o a nancial instrument, then it is recognised subsequently

only to the extent that it arises rom a change in a actor (including time) that market participants would take into account when

pricing the instrument.

IFRS 13

Day one gain

IFRS 13 does not substantively change the threshold or recognising day one gains. However, the consequential

amendments introduced by IFRS 13 align the guidance on measurement in IAS 39 with the denitions in IFRS 13. Under the

amended IAS 39 guidance, the initial measurement o the nancial instrument is based on air value as dened in IFRS 13,

but the carrying amount o the nancial instrument is adjusted to deer any dierence between the air value measurement

and the transaction price. An exception arises when the air value measurement is evidenced by a quoted price in an active

market or an identical asset or liability i.e. a Level 1 input or based on a valuation technique that uses only observable

market data. I this observability condition is met at initial recognition, then any dierence is recognised in prot or lossimmediately. I the observability condition is not met, then the deerred dierence is subsequently recognised as a gain orloss only to the extent that it arises rom a change in a actor (including time) that market participants would take into account

when pricing the asset or liability.


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Other ways KPMG member frmsproessionals can help

A more detailed discussion o the accounting issues that arise rom the application o IFRS can be ound in the 9th Edition2012/13 o our publication Insights into IFRS. In particular, air value measurement requirements are discussed in Chapter 2.4A.

The requirements o IFRS 13 Fair Value Measurement, which was issued in May 2011 and is eective or periods beginning on

or ater 1 January 2013, along with various application issues, are also discussed in First Impressions: Fair Value Measurement.

Questions and interpretative responses on air value measurement under US GAAP1 and IFRS are included in Issues in Depth:

Questions and Interpretative Responses or Fair Value Measurement.

You may also nd our publication IFRS Practice Issues or Banks: Fair value measurement o derivatives the basicsuseul. Itdiscusses issues relevant to the valuation o derivatives under IFRS, including making adjustments or credit, liquidity and other

actors at a portolio level, and how some o the accounting requirements are made operational.

In addition, you may nd it helpul to visit kpmg.com/irs to keep up to date with the latest developments in IFRS and browse

our suite o publications. Whether you are new to IFRS or a current user o IFRS, you can nd digestible summaries o recent

developments, detailed guidance on complex requirements and practical tools such as illustrative nancial statements and

checklists.

For a sector-specic or local perspective, including urther reading on the valuation o nancial instruments, ollow the links to

the IFRS resources available rom KPMG member rms around the world, which are also available at kpmg.com.

All o these publications are relevant or those involved in external IFRS reporting. The In the Headlinesseries provides a high-

level brieng or audit committees and boards.

Your need Publication series

Briefng In the Headlines

IFRS Newsletters

The Balancing Items

New on the Horizon

First Impressions

Application issues IFRS Practice Issues

IFRS Handbooks

Interim and annual reporting Illustrative nancial statements

Disclosure checklist

GAAP comparison IFRS compared to US GAAPSector-specifc issues IFRS Sector Newsletters

Application o IFRS

Accounting under IFRS

Impact o IFRS

For access to an extensive range o accounting, auditing and nancial reporting guidance and literature, visit KPMGs

Accounting Research Online. This web-based subscription service can be a valuable tool or anyone who wants to stay inormed

in todays dynamic environment. For a ree 15-day trial, go to aro.kpmg.com and register today.

1 FASB ASC Topic 820 Fair Value Measurements and Disclosures, as amended by ASU 2011-04 Amendments to Achieve Common Fair ValueMeasurement and Disclosure Requirements in US GAAP and IFRSs.
http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/first-impressions/Documents/first-impressions-fair-value-measurement.pdfhttp://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Issues%20In-Depth%2012-2.pdfhttp://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Issues%20In-Depth%2012-2.pdfhttp://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/IFRS-Practice-Issues/Documents/IFRS-practice-issues-valuation-derivatives.pdfhttp://www.kpmg.com/ifrshttp://www.kpmg.com/http://www.aro.kpmg.com/http://www.aro.kpmg.com/http://www.kpmg.com/http://www.kpmg.com/ifrshttp://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/IFRS-Practice-Issues/Documents/IFRS-practice-issues-valuation-derivatives.pdfhttp://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Issues%20In-Depth%2012-2.pdfhttp://www.kpmg.com/Ca/en/IssuesAndInsights/ArticlesPublications/Documents/Issues%20In-Depth%2012-2.pdfhttp://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/first-impressions/Documents/first-impressions-fair-value-measurement.pdf


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Also in this series

Classication o nancialassets and liabilities under

IFRS 9 (May 2012)

Liability vs equity classicationor nancial instruments

issued by investment unds

(February 2012)

Segment reporting

(December 2011)

Presentation and

measurement o nancialassets carried at air value

(November 2011)

Coming soonPresentation

Functional currency

Acknowledgements

We would like to acknowledge the principal contributors to this publication. They are Ewa Bialkowska and Arina Tomiste o the

KPMG International Standards Group.
http://www.kpmg.com/GI/en/IssuesAndInsights/ArticlesPublications/Publicationseries/