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Table 1:
Valuation
techniques
Table 2:
Fair value
hierarchy
and inputs
Market
approach
Uses prices and other relevant
information generated
by market transactions
Level
3
Level
2
Level
1
amount that it approximates its fair value
when allocating the fair value of the asset
group to the individual assets of the group.
HKFRS 13 assumes that the asset is
sold consistent with the unit of account
(i.e. what is being measured for financial
reporting purposes). Management will need
to determine whether the unit of account
is an individual asset or a group of assets
and associated liabilities. This is specified
in HKFRS 13, which requires or permits
the fair value measurement. The valuation
premise and unit of account may differ in
some circumstances, for example where a
property is part a mixed use development.
The unit of account may be an individual
property but this property may be grouped
with the complementary properties when
measuring fair value. Fair value is the price
for the individual property as the buyer is
assumed to already hold the complementary
properties and will not therefore pay more
for the property simply because it is sold as
part of the group.
Valuation techniques
Management will need to ensure the valuation
technique used is appropriate in the
circumstances and sufficient data is available
to measure fair value using that technique.
HKFRS 13 does not prioritize the use of one
valuation technique over another. The valuation
technique chosen should maximize the
use of observable inputs, including market
data from recent property transactions, and
minimize the use of unobservable inputs,
Income
approach
Converts future amounts
such as cash flows to a
single current (i.e. discounted)
amount
Quoted prices in active markets for
identical assets and liabilities
Cost
approach
Reflects the amount that
would currently be required
to replace the service
capacity of the asset
Inputs, other than quoted prices within level 1, that are
observable for the asset or liability either directly or indirectly
Unobservable inputs for the asset or liability
including management’s own forecasts and
assumptions. It should also be consistent with
one of the approaches summarized in table 1.
The use of more than one valuation technique
will be appropriate where the reliability
of the resulting fair value measurement
is improved as a result. If the results of the
two approaches differ significantly this may
indicate the need to reconsider the comparable
properties chosen and the adjustments
under the market approach or the forecast
cash flows and discount rate used under the
income approach.
Using more than one technique may
produce a range of fair value indications.
Management will need to assess the
reliability of each technique and the inputs
it uses in determining the point within the
range that is most representative of fair value.
Valuation techniques should be applied
consistently unless a change in technique
or its application results in a measurement
that is equally or more representative of fair
value. This might be the case where new
information becomes available or valuation
techniques improve.
Fair value hierarchy
HKFRS 13 introduces a new three-level fair
value hierarchy for nonfinancial assets such
as property as summarized in table 2.
The valuation technique used must
prioritize higher-level inputs over lower-level
ones. The inputs used will determine the
appropriate classification of the fair value
measurement within the hierarchy, which
A PLUS
will in turn affect the nature and extent of
financial statement disclosures required.
In some cases multiple inputs will be used,
which may fall within different levels of the
hierarchy. Classification is then based on the
lowest level of input that is significant to the
entire measurement.
Given that most properties are unique,
market prices for identical properties are not
likely to be available. Property valuations
will therefore commonly be classified within
level 2 or level 3 of the hierarchy. A level 2
input for a property valuation might be the
price per square foot derived from recent
market transactions for similar properties
in a similar location. Management will
need to assess whether any adjustments to
level 2 inputs for differences between the
property being valued and the comparable
properties are based on unobservable
inputs and are significant to the overall
fair value measurement. Where this is the
case, the valuation is classified as level 3.
Some specialized properties may rarely
be sold except as part of a continuing
business. In the absence of any observable
market transactions for such properties, the
valuation will also be classified as level 3.
Disclosure requirements
HKFRS 13 includes significant additional
disclosure requirements about the valuation
techniques and inputs used to develop
fair value measurements. Extensive
disclosures must be provided for all level 3
fair value measurements because they
are more subjective than those based on
market prices. Management will want to
ensure valuation reports contain sufficient
information to satisfy HKFRS 13’s disclosure
requirements. Dialogue with the external
valuers on the content of their reports may
need to start earlier rather than later.
Conclusion
HKFRS 13 introduces new valuation
requirements that may impact some
property valuations used for financial
reporting purposes. Management will want
to ensure there is clear communication with
their external valuers about the techniques
and assumptions to be used so that
valuations comply with the standard.
Gary Stevenson is principal, technical and training, at BDO
in Hong Kong.
December 2012 47