IFRS 13 Fair Value Measurement came into effect on 1st January 2013, specifically to improve the consistency of the fair value measurement and disclosure requirements across the IFRSs that use fair value.
HOW DOES IT RELATE TO ASSET VALUATION?
Valuation of assets and liabilities can be done for various purposes, which include:
- Buying or Selling Property
- Rent Function
- Security of loans or Mortgage
- Compulsory acquisition
- Financial Reporting
Each of the above highlighted valuation purposes has fundamental principles, upon which they are based. This principle is called Basis of Valuation. Valuation basis is determined upon knowing the purpose, whilst the method of carrying out the valuation is premised on the valuation basis.
There are various valuation standards and guidance that governs valuation applications. Each of these standards are produced by different bodies and are internationally applicable regulations or standards e.g International Financial Reporting Standards, (IFRS) International Valuation Standards (IVSs) RICS Valuation – Professional Standards (the ‘Red Book’) European Valuation Standards (EVS)/TEGoVA etc
Among these various standards, is the International Financial Reporting Standards (IFRS), which are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.
As regard property or asset valuation, (IFRS) measures fair value for specifically accounting purpose. IFRSs is not intended to establish valuation standards or affect valuation practices outside of financial reporting i.e. When and where a valuation is required for accounting purpose or balance sheet, the IFRS guidance is to be adopted.
ADOPTION OF IFRS IN NIGERIA FINANCIAL REPORTING
Sequel to adoption of the International Financial Reporting Standards (IFRS) by governments around the world, every Nigerian company has been mandated to comply as well. Actually, Nigeria started considering adopting IFRS in 2007. In fact, the Central Bank of Nigeria (CBN) disclosed that banks should adopt IFRS from 2008, while the Securities and Exchange Commission (SEC) advertised 2009.
IFRS Standards are required for the financial statements of all ‘public interest entities’, which includes not only quoted and unquoted companies but also governments, government organizations, and not-for-profit entities that are required by law to file returns with regulatory authorities
On 28 July 2010, the Nigerian Federal Executive Council approved 1 January 2012 as the effective date for adoption of International Financial Reporting Standards (IFRS Standards) in Nigeria. The Council directed the (former) Nigerian Accounting Standards Board (NASB), under the supervision of the Nigerian Federal Ministry of Commerce and Industry, to take action necessary to achieve that objective.
In Nigeria, IFRS Standards were phased in as follows:
- For quoted companies and companies with significant public interest the adoption of IFRS Standards was effective in January 2012.
- For other public interest entities the adoption of IFRS Standards was effective January 2013.
- For SMEs the adoption of the IFRS for SMEs Standard was effective January 2014
- For “Not for Profit” entities (NGOs, religious bodies) was effective January 1st 2015
The Financial Reporting Council of Nigeria (FRCN), formerly the Nigerian Accounting Standards Board (NASB), is an organization charged with setting accounting standards in Nigeria.
On 18 May 2011 the Senate passed the Financial Reporting Council of Nigeria Bill, which repealed the Nigerian Accounting Standards Board Act and replaced it with a new set of rules
COMPANIES REQUIRING CONFORMITY WITH IFRS VALUATION STANDARDS
In Nigeria today, the extent to which a company will be affected by IFRS 13 depends on the types of assets and liabilities held. IFRS 13 will have the most significant impact on:
1. Acquisitive companies across all industries and those with significant goodwill and indefinite-lived intangible assets on the balance sheet: In the various sectors in Nigeria, there are companies seeking expansion in their current trade or seeking to diversify into other sectors. The expansion or diversification can be done either through mergers and acquisition.
Where the valuers come in is based on Securities and Exchange Commission (SEC) rules, which provide for mergers defined by three thresholds, which are determined by valuing either the combined assets or turnover, or the combined assets and turnover of the merging companies.
Official data on mergers and acquisitions by the Securities and Exchange Commission (SEC) indicated that three mergers and 21 acquisitions were consummated in 2014 alone. The transactions cuts across financial and non financial sectors, highlighted by the business combination between Nigerian Breweries and Consolidated Breweries, the acquisition of Mainstreet Bank Limited by Skye Bank Plc and acquisition of ConocoPhillips Nigeria’s business by Oando Energy Resources, a subsidiary of Oando Plc. Asset Valuations should/may have been provided before these transactions were consummated.
For any company or conglomerate intending to acquire companies or assets, a valuer with requisite knowledge on fair value measurement should be engaged to provide valuation services as required by IFRS 13
2. Financial services and other companies with financial instruments at fair value: Commercial banks, money lending institutions, discount houses, Primary Mortgage Institutions (PMI) Insurance Carriers and Finance Houses falls in to this category of companies expected to comply with IFRS13 as regard valuation.
3. Industrial companies that revalue their property, plant and equipment: There are about 12 sectors companies listed on The Nigerian Stock Exchange
- Agriculture: Crop Production. Fishing/Hunting/Trapping, Livestock/ Animal Specialties
- Construction/ Real Estate: Real Estate Development, Real Estate Investment Trusts (REITs) etc
- Consumer Goods: Automobiles/Auto Parts, Beverages–Non-Alcoholic Personal/Household Products Brewers/Distillers
- Healthcare: Healthcare Providers, Medical Supplies – Pharmaceuticals
- Information & Communications Technology: Telecommunications Services Internet Service Providers
- Industrial Goods: Packaging/Containers, Tools and Machinery
- Natural Resources Chemicals: Non-Metallic Mineral Mining, Mining Services
- Oil & Gas: integrated Oil and Gas Services, Petroleum and Petroleum Products Distributors, Petroleum Bulk Stations and Terminals
- Utilities: Electric Power Generation, Electric Power Transmission, Electric Power Distribution, Water Treatment and Distribution
- Conglomerates: This sector comprises companies that incorporate engineering and production to manufacture a varied group of products
4. Real estate developers, retail companies and others with investment properties at fair value: This sector includes companies mainly engaged in the construction of buildings which include the construction of a house, farm, industrial, commercial or other building structures, and carrying out alterations, additions, and renovation or general repairs to these buildings
5. Investment companies measuring subsidiaries or other investments at fair value: Comprises companies whose main business is holding securities for investment purposes. e.g Stock brokers, Investment houses, Investment banks, other capital and money market operators.
Companies that fall under each of the above categories in Nigeria are affected by IFRS13. Hence, their valuations must strictly adhere to the standards and guidance of IFRS.
UNDERSTANDING FAIR VALUE MEASUREMENT
Valuations being carried out in Nigeria today by many valuers (for financial reporting), are not in total compliance with the IFRS 13 fair value measurement. Why is this so? It is simply because the valuers may not really understand what IFRS 13 aims to achieve, neither do they understand its application. Valuers often adopt the guidance of either RICS or IVS, within the context of Market value assessment, assuming all valuations are based on market value, whether the purpose is for financial reporting or otherwise.
IFRS uses the term Fair Value and IVS the term Market Value to describe the estimate of a price obtainable in a hypothetical market transaction between willing parties. The actual definitions and detailed narratives supporting them in both IVS and IFRS indicate that these are essentially similar concepts; however, some differences do exist because of specific assumptions that are required to be made in applying fair value to certain types of asset and liability under IFRS.
For the purpose of better understanding, similarities and differences between these valuation basis would be examined below
FAIR VALUE AND MARKET VALUE DEFINED
In IFRS 13, fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Accordingly, this price is an exit price.
Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in the principal market for the asset or liability or, in the absence of a principal market, in the most advantageous market for the asset or liability. The principal market is the one with the greatest volume and level of activity for the asset or liability that can be accessed by the entity.
The most advantageous market is the one that maximizes the amount that would be received for the asset or paid to extinguish the liability after transport and transaction costs. Often these markets would be the same.
Overview of fair value measurement approach
The objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions. A fair value measurement requires an entity to determine all of the following: [IFRS 13:B2]
- the particular asset or liability that is the subject of the measurement (consistently with its unit of account)
- for a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest and best use)
- the principal (or most advantageous) market for the asset or liability
- the valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorized.
Market value– the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.
Market Value under the IVS is the price that would be achieved in a transaction between hypothetical third parties in a normal, arm’s-length sales process. It excludes the differing outcomes that might result from a non-standard sales process (e.g in a distressed situation), and the unique negotiating positions of the parties or sources of value that would not be available to buyers in general, for example buyer-specific synergies.
The IVS then build on the Market Value concept by introducing Fair Value, the latter being: “…the value of an asset to the owner or a prospective owner for individual investment or operational objectives”3.This represents the price that would be agreed between identified buyers, taking into account the respective advantages or disadvantages that each would gain from the transaction. These definitions are followed by RICS, which has adopted the IVS for its valuation standards (‘The Red Book’).
VALUATION PROCESS IN CONFORMITY WITH IFRS 13
A lot has changed from what it used to be back then to what it is now and what will evolve, as regards valuation techniques and applications of these techniques to modern day asset valuation.
The usual norm is that, once a valuer gets a brief for a valuation job, he goes for site visitation and inspection, gets back to the office/desk, prepares a report and submits the report back to the end user(s).
However, there is more to asset valuation than the practice/style described above. Valuation process seldom comes with an air of obscurity, with many knowing what 1 and 2 are, but not the steps that go in between to arrive at 3 and 4.
Valuation requirements under IFRS 13 fair value measurement must be handled by competent valuers, as this may be confused with the valuation basis on market value
There are processes that need to be followed when establishing the correct value of a property. Some of these processes would be highlighted below
Step 1 Brief
Upon the appointment of the valuer, discussion should be held with the beneficiary of the report as regards
i. Fee Payable
ii. Time Line for valuation delivery
iii. Knowing purpose of valuation:
As posited earlier in this article, all valuations are required for specific purposes. The purpose determines the basis and the valuation basis determines the applicable valuation approach. This article is about valuation conforming to IFRS 13, which is for fair value measurement. Hence the purpose would most likely be for financial reporting (balance Sheet, Acquisition or merger, Taxation etc)
Step 2: Property Physical Inspection:
A physical inspection of the property is extremely important to
- Identify the location and existence of the property
- Take the details of the asset/property
- Carryout an analysis of the neighbourhood characteristics
- Measurement of the property
- A photograph of the property.
Step 3: Examine Factors That May Impact Property Value
Various influencing factors are determined and investigated before arriving at a value for the property. Data would also be gathered from internal and external sources in the area where property is domiciled and these should centre around
- Comparable sales,
- Tenures and title of the property or interest held thereon
- Zoning and planning details
Government plan in the area on road widening, acquisition etc
Step 4: Data Processing and Analysis, leading up to valuation finalization
The next and last critical part is the analysis of field data gathered in order to produce an accurate and incontestable fair value for the property/asset. What is to be determined is the fair value, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Fair value measurements are categorized into a three-level hierarchy, based on the type of inputs to the valuation techniques used, as follows
Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date.
Level 2 inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3 inputs are unobservable inputs for the asset or liability.
IFRS 13 sets out a valuation approach that refers to a broad range of techniques. These techniques are threefold: the market, income and cost approaches. Hence when measuring fair value, the entity is required to maximize the use of observable inputs and minimize the use of unobservable inputs. i.e more of level 1 and level 2.
After taking the above steps, a value is arrived at, which would be communicated to the beneficiary of the report as a draft. If the feedback is positive, then a final report would be produced and delivered to the beneficiary.
BENEFITS OF IFRS 13 TO NIGERIA COMPANIES/INDIVIDUALS NEEDING VALUATIONS FOR FINANCIAL REPORTING
An important benefit of IFRS 13 is that it will increase the transparency of fair values reported in the financial statements. In particular, the standard will clarify which fair values are based on quoted market prices and which are derived from models. The additional information about the assumptions used when fair values are measured using models (such as Level 3) will give investors and analysts a better understanding of the relative subjectivity of the measurement and what the key value drivers are, with more clarity than before. By helping ensure that companies perform fair value measurements consistently, having a single and clear objective when doing so and that they provide information about the measurements commensurate with the level of subjectivity in them, IFRS 13 represents a significant step forward in the application of fair value in financial reporting.
This article is merely an overview of what it entails in carrying out valuations in Nigeria, in conformity with IFRS13 fair value measurement. It is not a substitute for such professional advice or services and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business, without consulting a qualified real estate Advisor.
Ademola Ladega is a registered real estate valuer in Nigeria (ANIVS, RSV) and Team lead of the Valuation department at Ismail and Partners, Lagos, Nigeria (www.ismailandpartners.com)
Mr Ladega has extensive experience of providing valuation services in Nigeria to large public and private companies in many sectors including utilities, banking, insurance, financial services, agro-industrial, shipping, commercial and trading sectors. As well as experience in reporting in accordance with the regulatory requirements of Nigeria, in full compliance with IFRS, RICS, and IVS
Other useful websites and materials on this article
International Valuation Standards 2011