An entity acquires assets and assumes liabilities in a business combination [Refer:IFRS 3]. One of the groups of assets acquired comprises Assets A, B and C. Asset C is billing software integral to the business developed by the acquired entity for its own use in conjunction with Assets A and B (ie the related assets) [Refer:paragraph B3(e)]. The entity measures the fair value of each of the assets individually, consistently with the specified unit of account for the assets. The entity determines that the highest and best use of the assets is their current use and that each asset would provide maximum value to market participants principally through its use in combination with other assets or with other assets and liabilities (ie its complementary assets and the associated liabilities). [Refer:paragraph 31(a)] There is no evidence to suggest that the current use of the assets is not their highest and best use. [Refer:paragraph 29]

In this situation, the entity would sell the assets in the market in which it initially acquired the assets (ie the entry and exit markets from the perspective of the entity are the same). [Refer:paragraph 16] Market participant [Refer:paragraphs 22 and 23] buyers with whom the entity would enter into a transaction in that market have characteristics [Refer:paragraph 23] that are generally representative of both strategic buyers (such as competitors) and financial buyers (such as private equity or venture capital firms that do not have complementary investments) and include those buyers that initially bid for the assets. Although market participant buyers might be broadly classified as strategic or financial buyers, in many cases there will be differences among the market participant buyers within each of those groups, reflecting, for example, different uses for an asset and different operating strategies.

As discussed below, differences between the indicated fair values of the individual assets relate principally to the use of the assets by those market participants within different asset groups:

The fair values of Assets A, B and C would be determined on the basis of the use of the assets as a group within the strategic buyer group (CU360, CU260 and CU30). [Refer:paragraph 31(a)] Although the use of the assets within the strategic buyer group does not maximise the fair value of each of the assets individually, it maximises the fair value of the assets as a group (CU650).

An entity acquires land in a business combination [Refer:IFRS 3]. The land is currently developed for industrial use as a site for a factory. The current use of land is presumed to be its highest and best use unless market or other factors suggest a different use [Refer:paragraph 29]. Nearby sites have recently been developed for residential use as sites for high‑rise apartment buildings. On the basis of that development and recent zoning and other changes to facilitate that development, the entity determines that the land currently used as a site for a factory could be developed as a site for residential use (ie for high‑rise apartment buildings) because market participants would take into account the potential to develop the site for residential use when pricing the land. [Refer:paragraph 29]

The highest and best use of the land would be determined by comparing both of the following:

The highest and best use of the land would be determined on the basis of the higher of those values [Refer:paragraphs 27⁠–⁠30]. In situations involving real estate appraisal, the determination of highest and best use might take into account factors relating to the factory operations, including its assets and liabilities [Refer:paragraph 31(a)].

An entity acquires a research and development (R&D) project in a business combination [Refer:IFRS 3]. The entity does not intend to complete the project. If completed, the project would compete with one of its own projects (to provide the next generation of the entity’s commercialised technology). Instead, the entity intends to hold (ie lock up) the project to prevent its competitors from obtaining access to the technology. In doing this the project is expected to provide defensive value [Refer:paragraph 30], principally by improving the prospects for the entity’s own competing technology. To measure the fair value of the project at initial recognition, the highest and best use of the project would be determined on the basis of its use by market participants. [Refer:paragraphs 22, 23 and 29] For example:

An entity acquires a machine in a business combination [Refer:IFRS 3]. The machine will be held and used in its operations. The machine was originally purchased by the acquired entity from an outside vendor and, before the business combination, was customised by the acquired entity for use in its operations. However, the customisation of the machine was not extensive. The acquiring entity determines that the asset would provide maximum value to market participants through its use in combination with other assets or with other assets and liabilities (as installed or otherwise configured for use). There is no evidence to suggest that the current use of the machine is not its highest and best use [Refer:paragraph 29]. Therefore, the highest and best use of the machine is its current use in combination with other assets or with other assets and liabilities. [Refer:paragraph 31(b)]

The entity determines that sufficient data are available to apply the cost approach [Refer:paragraphs B8 and B9] and, because the customisation of the machine was not extensive, the market approach [Refer:paragraphs B5⁠–⁠B7]. The income approach [Refer:paragraphs B10 and B11] is not used because the machine does not have a separately identifiable income stream from which to develop reliable estimates of future cash flows. Furthermore, information about short‑term and intermediate‑term lease rates for similar used machinery that otherwise could be used to project an income stream (ie lease payments over remaining service lives) is not available. The market and cost approaches are applied as follows:

The entity determines that the higher end of the range indicated by the market approach is most representative of fair value and, therefore, ascribes more weight to the results of the market approach [Refer:paragraph 63]. That determination is made on the basis of the relative subjectivity of the inputs, taking into account the degree of comparability between the machine and the similar machines. In particular:

Accordingly, the entity determines that the fair value of the machine is CU48,000.

If customisation of the machine was extensive or if there were not sufficient data available to apply the market approach (eg because market data reflect transactions for machines used on a stand‑alone basis, such as a scrap value for specialised assets, rather than machines used in combination with other assets or with other assets and liabilities), the entity would apply the cost approach. When an asset is used in combination with other assets or with other assets and liabilities, the cost approach assumes the sale of the machine to a market participant buyer with the complementary assets and the associated liabilities [Refer:paragraph 31(b)]. The price received for the sale of the machine (ie an exit price) would not be more than either of the following:

An entity acquires a group of assets [Refer:IAS 16 paragraph 24]. The asset group includes an income‑producing software asset internally developed for licensing to customers and its complementary assets (including a related database with which the software asset is used) and the associated liabilities. To allocate the cost of the group to the individual assets acquired, the entity measures the fair value of the software asset. The entity determines that the software asset would provide maximum value to market participants [Refer:paragraphs 22 and 23] through its use in combination with other assets or with other assets and liabilities (ie its complementary assets and the associated liabilities [Refer:paragraph 31(a)]). There is no evidence to suggest that the current use of the software asset is not its highest and best use [Refer:paragraph 29]. Therefore, the highest and best use of the software asset is its current use. (In this case the licensing of the software asset, in and of itself, does not indicate that the fair value of the asset would be maximised through its use by market participants on a stand‑alone basis. [Refer:paragraph 31(b)])

The entity determines that, in addition to the income approach [Refer:paragraphs B10 and B11], sufficient data might be available to apply the cost approach [Refer:paragraphs B8 and B9] but not the market approach [Refer:paragraphs B5⁠–⁠B7]. Information about market transactions for comparable software assets is not available. The income and cost approaches are applied as follows:

Through its application of the cost approach, the entity determines that market participants would not be able to construct a substitute software asset of comparable utility. Some characteristics of the software asset are unique, having been developed using proprietary information, and cannot be readily replicated. The entity determines that the fair value of the software asset is CU15 million, as indicated by the income approach. [Refer:paragraph 63]

An asset is sold in two different active markets at different prices. An entity enters into transactions in both markets [Refer:paragraph 17] and can access [Refer:paragraph 76] the price in those markets for the asset at the measurement date. In Market A, the price that would be received is CU26, transaction costs [Refer:paragraph 25 and Appendix A] in that market [Refer:paragraph 26] are CU3 and the costs to transport the asset to that market are CU2 (ie the net amount that would be received is CU21). In Market B, the price that would be received is CU25, transaction costs in that market are CU1 and the costs to transport the asset to that market are CU2 (ie the net amount that would be received in Market B is CU22).

If Market A is the principal market [Refer:paragraph 16(a)] for the asset (ie 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 (CU24).

If neither 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. [Refer:paragraph 16(b)] 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 (ie the net amount that would be received in the respective markets).

Because the entity would maximise the net amount that would be received for the asset in Market B (CU22), the fair value of the asset would be measured using the price in that market (CU25), less transport costs (CU2), resulting in a fair value measurement of CU23. Although transaction costs are taken into account when determining which market is the most advantageous market, the price used to measure the fair value of the asset is not adjusted for those costs (although it is adjusted for transport costs).

Entity A (a retail counterparty) enters into an interest rate swap in a retail market with Entity B (a dealer) for no initial consideration (ie the transaction price is zero). Entity A can access only the retail market. Entity B can access both the retail market (ie with retail counterparties) and the dealer market (ie with dealer counterparties).

From the perspective of Entity A, the retail market in which it initially entered into the swap is the principal market [Refer:paragraph 16(a)] for the swap. If Entity A were to transfer its rights and obligations under the swap, it would do so with a dealer counterparty in that retail market. In that case the transaction price (zero) would represent the fair value of the swap to Entity A at initial recognition, ie the price that Entity A would receive to sell or pay to transfer the swap in a transaction with a dealer counterparty in the retail market (ie an exit price). That price would not be adjusted for any incremental (transaction) costs [Refer:paragraph 25] that would be charged by that dealer counterparty.

From the perspective of Entity B, the dealer market (not the retail market) is the principal market for the swap. If Entity B were to transfer its rights and obligations under the swap, it would do so with a dealer in that market. Because the market in which Entity B initially entered into the swap is different from the principal market for the swap, the transaction price (zero) would not necessarily represent the fair value of the swap to Entity B at initial recognition. If the fair value differs from the transaction price (zero), Entity B applies IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments [Refer:IFRS 9 paragraphs 5.1.1A and B5.1.2A] to determine whether it recognises that difference as a gain or loss at initial recognition.

An entity holds an equity instrument (a financial asset) for which sale is legally or contractually restricted for a specified period. (For example, such a restriction could limit sale to qualifying investors.) The restriction is a characteristic of the instrument and, therefore, would be transferred to market participants. [Refer:paragraph 11(b)] In that case the fair value of the instrument would be measured on the basis of the quoted price for an otherwise identical unrestricted equity instrument of the same issuer that trades in a public market, adjusted to reflect the effect of the restriction. The adjustment would reflect the amount market participants would demand because of the risk relating to the inability to access a public market for the instrument for the specified period. The adjustment will vary depending on all the following:

A donor contributes land in an otherwise developed residential area to a not‑for‑profit neighbourhood association. The land is currently used as a playground. The donor specifies that the land must continue to be used by the association as a playground in perpetuity. Upon review of relevant documentation (eg legal and other), the association determines that the fiduciary responsibility to meet the donor’s restriction would not be transferred to market participants if the association sold the asset, ie the donor restriction on the use of the land is specific to the association. Furthermore, the association is not restricted from selling the land. Without the restriction on the use of the land by the association, the land could be used as a site for residential development. In addition, the land is subject to an easement (ie a legal right that enables a utility to run power lines across the land). Following is an analysis of the effect on the fair value measurement of the land arising from the restriction and the easement:

On 1 January 20X7 Entity A, an investment bank with a AA credit rating, issues a five‑year fixed rate note to Entity B. The contractual principal amount to be paid by Entity A at maturity is linked to an equity index. No credit enhancements are issued in conjunction with or otherwise related to the contract (ie no collateral is posted and there is no third‑party guarantee [Refer:paragraph 44]). Entity A designated this note as at fair value through profit or loss. The fair value of the note (ie the obligation of Entity A) during 20X7 is measured using an expected present value technique [Refer:paragraphs B23⁠–⁠B30]. Changes in fair value are as follows:

On 1 January 20X1 Entity A assumes a decommissioning liability in a business combination [Refer:IFRS 3]. 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.

On the basis of paragraphs B23⁠–⁠B30 of the IFRS, Entity A uses the expected present value technique to measure the fair value of the decommissioning liability.

If Entity A was contractually allowed to transfer its decommissioning liability to a market participant [Refer:paragraphs 22 and 23], Entity A concludes that a market participant would use all the following inputs, probability‑weighted as appropriate, when estimating the price it would expect to receive:

The significant assumptions used by Entity A to measure fair value are as follows:

Entity A concludes that its assumptions would be used by market participants [Refer:paragraphs 69 and 87]. In addition, Entity A does not adjust its fair value measurement for the existence of a restriction preventing it from transferring the liability [Refer:paragraphs 45 and 46]. As illustrated in the following table, Entity A measures the fair value of its decommissioning liability as CU194,879.

On 1 January 20X1 Entity B issues at par a CU2 million BBB‑rated exchange‑traded five‑year fixed rate debt instrument with an annual 10 per cent coupon. Entity B designated this financial liability as at fair value through profit or loss.

On 31 December 20X1 the instrument is trading as an asset in an active market [Refer:Appendix A (definition of an active market)] at CU929 per CU1,000 of par value after payment of accrued interest. Entity B uses the quoted price of the asset in an active market as its initial input into the fair value measurement of its liability (CU929 × [CU2 million ÷ CU1,000] = CU1,858,000).

In determining whether the quoted price of the asset in an active market represents the fair value of the liability, Entity B evaluates whether the quoted price of the asset includes the effect of factors not applicable to the fair value measurement of a liability, for example, whether the quoted price of the asset includes the effect of a third‑party credit enhancement if that credit enhancement [Refer:paragraph 39(b)] would be separately accounted for from the perspective of the issuer. Entity B determines that no adjustments are required to the quoted price of the asset. Accordingly, Entity B concludes that the fair value of its debt instrument at 31 December 20X1 is CU1,858,000. Entity B categorises and discloses the fair value measurement of its debt instrument within Level 1 [Refer:paragraphs 76⁠–⁠80] of the fair value hierarchy.[Refer:paragraphs 72⁠–⁠90]

On 1 January 20X1 Entity C issues at par in a private placement a CU2 million BBB‑rated five‑year fixed rate debt instrument with an annual 10 per cent coupon. Entity C designated this financial liability as at fair value through profit or loss.

At 31 December 20X1 Entity C still carries a BBB credit rating. Market conditions, including available interest rates, credit spreads for a BBB‑quality credit rating and liquidity, remain unchanged from the date the debt instrument was issued. However, Entity C’s credit spread has deteriorated by 50 basis points because of a change in its risk of non‑performance [Refer:paragraphs 42⁠–⁠43]. After taking into account all market conditions, Entity C concludes that if it was to issue the instrument at the measurement date, the instrument would bear a rate of interest of 10.5 per cent or Entity C would receive less than par in proceeds from the issue of the instrument.

For the purpose of this example, the fair value of Entity C’s liability is calculated using a present value technique [Refer:paragraphs B12⁠–⁠B30]. Entity C concludes that a market participant would use all the following inputs (consistently with paragraphs B12⁠–⁠B30 of the IFRS) when estimating the price the market participant would expect to receive to assume Entity C’s obligation:

On the basis of its present value technique [Refer:paragraphs B12⁠–⁠B30], Entity C concludes that the fair value of its liability at 31 December 20X1 is CU1,968,641.

Entity C does not include any additional input into its present value technique for risk or profit that a market participant might require for compensation for assuming the liability [Refer:paragraph 41(a)]. Because Entity C’s obligation is a financial liability, Entity C concludes that the interest rate already captures the risk or profit that a market participant would require as compensation for assuming the liability [Refer:paragraph B32]. Furthermore, Entity C does not adjust its present value technique for the existence of a restriction preventing it from transferring the liability. [Refer:paragraphs 45 and 46]

Entity A invests in a junior AAA‑rated tranche of a residential mortgage‑backed security on 1 January 20X8 (the issue date of the security). The junior tranche is the third most senior of a total of seven tranches. The underlying collateral for the residential mortgage‑backed security is unguaranteed non‑conforming residential mortgage loans that were issued in the second half of 20X6.

At 31 March 20X9 (the measurement date) the junior tranche is now A‑rated. This tranche of the residential mortgage‑backed security was previously traded through a brokered market. However, trading volume in that market was infrequent, with only a few transactions taking place per month from 1 January 20X8 to 30 June 20X8 and little, if any, trading activity during the nine months before 31 March 20X9.

Entity A takes into account the factors in paragraph B37 of the IFRS to determine whether there has been a significant decrease in the volume or level of activity for the junior tranche of the residential mortgage‑backed security in which it has invested. After evaluating the significance and relevance of the factors, Entity A concludes that the volume and level of activity of the junior tranche of the residential mortgage‑backed security have significantly decreased [Refer:paragraph B37]. Entity A supported its judgement primarily on the basis that there was little, if any, trading activity for an extended period before the measurement date.

Because there is little, if any, trading activity to support a valuation technique using a market approach, Entity A decides to use an income approach using the discount rate adjustment technique described in paragraphs B18⁠–⁠B22 of the IFRS to measure the fair value of the residential mortgage‑backed security at the measurement date. Entity A uses the contractual cash flows from the residential mortgage‑backed security (see also paragraphs 67 and 68 of the IFRS).

Entity A then estimates a discount rate (ie a market rate of return) to discount those contractual cash flows [Refer:paragraph B13(c) and (d)]. The market rate of return is estimated using both of the following:

Entity A took into account the following information when estimating the adjustments in paragraph IE53(b):

Entity A estimates that one indication of the market rate of return that market participants would use when pricing the junior tranche of the residential mortgage‑backed security is 12 per cent (1,200 basis points). This market rate of return was estimated as follows:

As an additional indication of the market rate of return, Entity A takes into account two recent indicative quotes (ie non‑binding quotes) provided by reputable brokers for the junior tranche of the residential mortgage‑backed security that imply yields of 15⁠–⁠17 per cent. Entity A is unable to evaluate the valuation technique(s) [Refer:paragraphs 61⁠–⁠66] or inputs [Refer:paragraphs 67⁠–⁠71] used to develop the quotes [Refer:paragraphs B45⁠–⁠B47]. However, Entity A is able to confirm that the quotes do not reflect the results of transactions.

Because Entity A has multiple indications of the market rate of return that market participants would take into account when measuring fair value, it evaluates and weights the respective indications of the rate of return, considering the reasonableness of the range indicated by the results.

Entity A concludes that 13 per cent is the point within the range of indications that is most representative of fair value under current market conditions. Entity A places more weight on the 12 per cent indication (ie its own estimate of the market rate of return) for the following reasons:

For assets and liabilities measured at fair value at the end of the reporting period, the IFRS requires quantitative disclosures about the fair value measurements for each class of assets and liabilities [Refer:paragraph 94]. An entity might disclose the following for assets to comply with paragraph 93(a) and (b) of the IFRS:

For recurring fair value measurements categorised within Level 3 of the fair value hierarchy [Refer:paragraphs 72, 73 and 86], the IFRS requires a reconciliation from the opening balances to the closing balances for each class of assets and liabilities. An entity might disclose the following for assets to comply with paragraph 93(e) and (f) of the IFRS:

Gains and losses included in profit or loss for the period (above) are presented in financial income and in non‑financial income as follows:

For fair value measurements categorised within Level 2 and Level 3 of the fair value hierarchy, the IFRS requires an entity to disclose a description of the valuation technique(s) [Refer:paragraphs 61⁠–⁠66] and the inputs [Refer:paragraphs 67⁠–⁠71] used in the fair value measurement [Refer:paragraph 93(d)]. For fair value measurements categorised within Level 3 of the fair value hierarchy [Refer:paragraphs 72, 73 and 86], information about the significant unobservable inputs used must be quantitative [Refer:paragraph 93(d)]. An entity might disclose the following for assets to comply with the requirement to disclose the significant unobservable inputs used in the fair value measurement in accordance with paragraph 93(d) of the IFRS:

In addition, an entity should provide additional information that will help users of its financial statements to evaluate the quantitative information disclosed [Refer:paragraphs 91 and 92]. An entity might disclose some or all the following to comply with paragraph 92 of the IFRS: 

For fair value measurements categorised within Level 3 [Refer:paragraphs 73 and 86] of the fair value hierarchy, the IFRS requires an entity to disclose a description of the valuation processes used by the entity [Refer:paragraph 93(g)]. An entity might disclose the following to comply with paragraph 93(g) of the IFRS:

For recurring fair value measurements categorised within Level 3 of the fair value hierarchy [Refer:paragraphs 72, 73 and 86], the IFRS requires an entity to provide a narrative description of the sensitivity of the fair value measurement to changes in significant unobservable inputs and a description of any interrelationships between those unobservable inputs. An entity might disclose the following about its residential mortgage‑backed securities to comply with paragraph 93(h)(i) of the IFRS:

The significant unobservable inputs used in the fair value measurement of the entity’s residential mortgage‑backed securities are prepayment rates, probability of default and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.