Fair Values are being used as one of the measurement requirements to recognize certain transactions/ Assets/ Liabilities as required by respective Accounting Standards (i.e. Ind-As).
With a few scope exceptions, whenever there is a need to Fair Value any element of a Financial Statements, one has to look at Ind-As 113- “Fair Value Measurement” and its related requirements.
One can understand that how important the Standard is, as the Fair Value concept is used very commonly across various standards and one has to refer this standard to calculate such fair values as per its defined methodology.
The Article is mainly focused on some important terminology that is being used and often our readers request to provide more insight on these specific terms, hence we would be focusing on the mentioned terms only.
Let’s have a standard reference on the “Principal Market & Most Advantageous Market” and subsequently we will discuss its practical use by using some examples-
Ind-As-113– Fair Value Measurment
Para-16– A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either:
(a) in the principal market for the asset or liability; or
(b) in the absence of a principal market, in the most advantageous market for the asset or liability.
Let’s have some frequently asked questions on this subject by many of our readers and try to explain further to have a flavor of the topic-
Q-1 -How a principal market is identified?
A-1 -It is normally the market in which the assets/ liability is being transacted with highest volume with high level of activities comparing with any other market available for similar transactions.
Q-2 –Share of a Company which is listed at BSE and NYSE has different closing prices at the year end. The price at BSE has greatest volume and activity whereas at NYSE it is less in terms of volume transacted in the period. Which price will be used to measure fair value of share in the Company?
A-2 -Since BSE has got highest volume and significant level of activity comparing to other market, hence even the closing price would have been higher at NYSE, the closing price at BSE would be taken.
Q-3 –Diamond has got a Domestic market where the prices are lesser comparing to the price available for export of similar Diamonds. The Govt. has a policy to cap the export of Diamond max upto 10% of total output by any such manufacturer. Determine the principal market and most advantageous market and define which rate would be used to find fair value?
A-3 -The normal activities of Diamond is being done at domestic market only i.e. 90% and balance 10% only can be sold via export. The highest level of activities with highest volume is being done at domestic market; hence Principal market for Diamond would be Domestic market. Export prices are more than Principal Market, and hence export market would give highest return comparing to the domestic market. The export market would be most advantageous market.
However as per the standard, if principal market is available, then its prices would be used for fair valuation of such Assets/ liabilities.
Q-4 –What period / duration of transactions should be used to find such Principal market and/or most advantageous market?
A-4 -Unfortunately there is nothing mentioned in the Ind-As- 113 or IFRS-13 about the duration/ period for which such analysis should be done. Management/ Auditor should use their own judgment about the same by complying it consistently.
Q-5 –What is the periodicity (how frequent) to update this analysis?
A-5 -Again there is nothing specific mentioned in the standard about the frequency. However one can repeat this analysis once there are changes in the level of activities of the business.
Q-6 A financial product (future, options. Swap etc) which is being sold by a Bank in wholesale market as well as retail market. However an “Entity X” which deals in similar financial product has got access to sell its product in retail market only? It is generally observed that Wholesale market rates would be cheaper comparing to the retail market. What would be the guidance on accessing the market which could influence the analysis of determining principal or most advantageous market?
A-6– As per Para 19 of Ind-As 113– “The entity must have access to the principal (or most advantageous) market at the measurement date. Because different entities (and businesses within those entities) with different activities may have access to different markets, the principal (or most advantageous) market for the same asset or liability might be different for different entities (and businesses within those entities). Therefore, the principal (or most advantageous) market (and thus,market participants) shall be considered from the perspective of the entity, thereby allowing for differences between and among entities with different activities”. Now, since the Bank has got two markets where it can sell its financial products and wholesale market is cheaper than retail market, however major/ active transactions are being done at wholesale market in case of bank. Hence Wholesale market price would be its principal market even the prices are lesser than retail market.
It is worth to be noted that in case of a Bank, if at the measurement date i.e. closing date, only the retail market prices were available, then it could not be argued to take retail rates for such fair valuation, because entity has access to wholesale market which do not preclude to use other marker rate just because the rates were not available at measurement date.
Coming to the Entity X which can access only of retail market and hence for him the principal market would be retail and the rates of retail market will be used for any such fair valuation.
To summaries it, there could be different principal markets for different reporting entities even belongs to the same group. The principal market/ most advantageous market would separately be evaluated for different assets/ liabilities under the fair valuation requirements. Management has to gear-up the process and procedures to capture such markets assessments and make a proper documentation to avoid any audit findings.
Readers will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at firstname.lastname@example.org or Whatsapp +91-9634706933)