With the June reporting season now imminent, it is increasingly important for Boards and finance teams to assess and understand how the COVID-19 pandemic may affect fair value measurement come June 30.
AASB 13 Fair Value Measurement defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions. Valuation techniques that are appropriate maximise the use of relevant observable inputs and minimise the use of unobservable inputs.
Some key areas to consider when measuring fair value as a result of the pandemic include:
- The pandemic has had a direct effect on observable inputs (such as prices quoted on a stock exchange) however due to significant declines in trading volumes and market activity, observable inputs relied upon in measuring the fair value of some assets and liabilities may not be observable or will require adjustment to reflect changes in the current market conditions at the measurement date. As a result, significant estimates and judgements may be required which will require additional financial statement disclosure
- Observable inputs (unadjusted) based on pre pandemic transactions are unlikely to be appropriate inputs on a standalone basis for fair value measurements at June 30, 2020 and either adjustments to these inputs or alternative valuation techniques and inputs may need to be considered
- Many fair value measurements may require reclassification if significant inputs become less observable compared to prior periods
- Certain unobservable inputs (such as cash flow or profitability forecasts) will also be challenging with the continuously changing economic environment and higher levels of uncertainty that exist. Probability based modelling may need to be utilised and discount rates adjusted for
the risks inherent in future cash flows
- Valuation techniques used in measuring fair value may need to be reassessed if inputs previously used are no longer available or if changes in market conditions indicate another valuation technique is more appropriate
- For non-financial assets (such as real estate and vehicles), fair value is measured based on the non-financial assets highest and best use determined from the perspective of market participants – the use that market participants would maximise the value of the asset in the current environment. Changes in market conditions due to the pandemic may change previous assessments of a non-financial asset’s highest and best use and therefore change the valuation premise used to measure fair value.
Fair value measurement is a challenging area at the best of times however with the unprecedented current economic conditions caused by the pandemic it is expected to be a highly judgemental and significant area of focus for Boards, finance teams, auditors and regulators in the upcoming reporting season.
This article was published in the 2020 Winter edition of Financial Times.