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IFRS Valuation of financial instruments

IFRS Valuation of financial instruments

IFRS Valuation of financial instruments: Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. There is a general presumption that fair value can be reliably measured for all financial instruments. In looking for a reliable measure of fair value, IAS 39 provides a hierarchy to be used in determining an instrument’s fair value.

IFRS Valuation of financial instruments

Active market – quoted market price: the existence of published price quotations in an active market is the best evidence of fair value, and they are used to measure the financial instrument. ‘Quoted in an active market’ means that quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis. The price can be taken from the most favourable market readily available to the entity, even if that was not the market in which the transaction actually occurred. The quoted market price cannot be  adjusted for ‘blockage’ or ‘liquidity’ factors. The fair value of a portfolio of financial instruments is the product of the number of units of the instrument and its quoted market   prices.

IFRS Valuation of financial instruments

No active market – valuation techniques: if the market for a financial instrument is not active, fair value is established by using a valuation technique. Valuation techniques that are well established in financial markets include recent market transactions, reference to a transaction that is substantially the same, discounted cash flows and option pricing models. An acceptable   valuation technique incorporates all factors that market participants would consider in setting a price and should be consistent with accepted economic methodologies for pricing financial instruments. The amount paid or received for a financial instrument is normally the best estimate  of fair value at inception. However, where all data inputs to a valuation model are obtained from observable market transactions, the resulting calculation of fair value can be used for initial recognition.

IFRS Valuation of financial instruments

No active market – equity instruments: it is possible normally to estimate the fair value of an equity instrument that an entity has acquired from an outside party. However, if the range of reasonable fair value estimates is significant and no reliable estimate can be made, an entity is permitted to measure the equity instrument at cost less impairment as a last resort. A similar dispensation applies to derivative financial instruments that can only be settled by physical delivery of such unquoted equity  instruments.

It might be possible in some circumstances to recognise a gain on initial recognition of a financial instrument. However, the circumstances in which this will be permitted are tightly   controlled.

IFRS Valuation of financial instruments

Impairment of financial assets

A financial asset or a group of financial assets is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of a past event that occurred subsequent to the initial recognition of the asset. Expected losses as a result of future events, no matter how likely, are not recognised.

An entity assesses at each balance sheet date whether there is objective evidence that a financial asset or group of assets may be impaired

The disappearance of an active market or the downgrade of an entity’s credit rating is not itself evidence of impairment, although it may be evidence of impairment when considered with other information. A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of  impairment.

IFRS Valuation of financial instruments

If there is objective evidence that impairment has been incurred and the carrying amount of a financial asset carried at amortised cost exceeds its estimated recoverable amount, the asset is impaired. The recoverable amount is the present value of the expected future cash flows discounted at the instrument’s original effective interest rate. The use of this rate prevents a market value approach from being imposed for loans and receivables. The carrying amount is reduced to its recoverable amount either directly or through the use of an allowance account. The amount of the loss is included in net profit or loss for the  period.

IFRS Valuation of financial instruments

If there is objective evidence of impairment of available-for-sale financial assets carried at fair value, the cumulative net loss (difference between amortised acquisition cost and current fair value less any impairment loss previously recognised in the income statement) that has previously been recognised in equity is removed and recognised in the income statement, even though the asset has not been sold. Entities are prohibited from reversing impairments on investments in equity securities. However, if the fair value of an available-for-sale debt instrument increases and the increase can be objectively related to an event occurring after the loss was recognised, the loss may be reversed through the income statement.

IFRS Valuation of financial instruments

For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics (for example, on the basis of a credit risk evaluation or grading process that considers asset type, industry, geographical location, collateral  type,

past-due status and other relevant factors). Those characteristics should be relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors’  ability to pay all amounts due according to the contractual terms of the assets being   evaluated.

Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets in the group and historical loss experience for assets with credit risk characteristics similar to those in the group. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist  currently.

IFRS Valuation of financial instruments

Estimates of changes in future cash flows for groups of assets should reflect and be directionally consistent with changes in related observable data from period to period (such as changes in unemployment rates, property prices, payment status and other factors indicative of changes in the probability of losses in the group and their magnitude). The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience.

IFRS Valuation of financial instruments

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