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Fair value measurement of financial instruments - 3

IFRS Watch - Issue 28


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Fair value measurement at initial recognition

IAS 39:43 requires that all financial assets and financial liabilities should be recognised initially on the basis of 'fair value'. IFRS 13 notes that in many cases the transaction price (i.e. the price paid to acquire an asset or received to assume a liability) will equal fair value (e.g. when the transaction date is the same as the measurement date and the asset is acquired in the market in which the asset would be sold). [IFRS 13:58]

When determining whether the fair value at initial recognition equals the transaction price, an entity should take into account factors specific to thetransaction and to the asset and liability. For example, the transaction price might not represent the fair value of an asset or a liability at initial recognition if any of the following conditions exist.

(a)The transaction is between related parties, although the price in a related party transaction may be used as an input into a fair value measurement if the entity has evidence that the transaction was entered into at market terms.

(b)The transaction takes place under duress or the seller is forced to accept the price in the transaction.

(c)The unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value.
(d)The market in which the transaction takes place is different from the principal market (or most advantageous market).

Day 1 profit or loss

When there is a difference between the fair value at initial recognition and the transaction price, IFRS 13:60 states that any resulting gain or loss should be recognised in profit or loss unless another IFRS specifies otherwise.

With respect to financial instruments, an entity should understand the reason for any difference between the fair value at initial recognition and the transaction price. This difference may represent consideration for goods or services between the two entities or a capital contribution or deemed distribution in circumstances when one party is acting in its  capacity as an owner. Other IFRSs will determine how such amounts are accounted for.

Interest-free loan (1)

On 1 January 20X0, Parent A grants an interest-free loan of N250m to a wholly-owned subsidiary, Subsidiary B. The loan is repayable on 31 December 20X0 and is not callable prior to that date by Parent A. The market rate of interest for a loan to the subsidiary would be 10 per cent. Consideration paid is made up as follows:

  1. N227.27m is the fair value of the financial asset (i.e. N100/1.10).
  2. N22.73 is a capital contribution. This amount represents the fair value of Parent A's providing Subsidiary B with interest-free finance. The amount should be recognised directly in equity as a deemed distribution because it does not meet the definition of income of the Conceptual Framework for Financial Reporting.

Interest-free loan (2)

On 1 January 20X0, Subsidiary C grants an interest-free loan of N250 to its parent, Parent A. The loan is repayable on 31 December 20X0 and is not callable prior to that date by Subsidiary C. The market rate of interest for a loan to Parent A would be 10 per cent. Consideration paid is made up as follows:

  1. N227.27 is the fair value of the financial asset (i.e. CU100/1.10).
  2. N22.73 is in substance a distribution from Subsidiary C to Parent A. This amount represents the fair value of the Subsidiary C's providing its parent with interest-free finance.
    The amount should be recognised directly in equity as a deemed distribution because it does not meet the definition of an expense in the Conceptual Framework for Financial Reporting

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