The fair value standard and its audit impacts

Current state of play Shortage of liquidity Interest rates up Asian demand for commodities UK and US Property markets down Risk Appetite? Volatility

What does “fair value” mean? IFRS The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction Number of different FV measurements throughout A-IFRS

AASB 2 Share based payments AASB 3 Business combinations IFRS & Fair value Standard What is being measured? Guidance Suggests AASB 2 Share based payments Equity settled share based payment Valuation technique for options. Diverse models Cash settled share based payment (liability) Valuation technique for liability. Diverse models AASB 3 Business combinations Cost of combination Based on valuation of components. Currently includes transaction costs Assets and liabilities acquired Valuation technique (except AASB 5)

IFRS & Fair Value Standard What is being measured? Guidance Suggests AASB 5 Non current assets held for sale Assets held for sale Exit value (less costs to sell) AASB 102 Inventories Inventory (measured at the lower of cost and net realisable value) Lower of cost and net realisable fair value AASB 116 Property plant and equipment Revaluation model PPE, land Market value or depreciated replacement cost Revaluation model Specialised PPE Could be an exit price, value in use or a depreciated replacement cost

AASB 119 Employee Benefits IFRS & Fair Value Standard What is being measured? Guidance Suggests AASB 119 Employee Benefits Plan assets Specific guidance overrides standard use of fair value AASB 136 Impairment Assets Fair value or value in use with fundamentally different assumptions AASB 138 Intangible Revaluation of intangible assets Quoted market price (bid, ask, average??) Initial recognition of financial assets or liabilities Fair value hierarchy. Ask for liabilities and bid for assets.

AASB 140 investment property IFRS & Fair Value Standard What is being measured? Guidance Suggests AASB 140 investment property Fair value model Market valuation less costs to sell AASB 141 Agriculture Biological assets Market value or valuation less estimated point-of-sale costs

The problems with current IFRS & FV Piecemeal development of IFRS Guidance incomplete and dispersed over many IFRS Inconsistent measurement bases Subjectivity in estimates Complexity and diversity in practice

The solution? IASB fair value measurement project which seeks to To establish a single source of guidance for all fair value measurements Clarify the FV definition and enhance disclosures

Key Requirements of ASA 545 Auditor’s consideration based on information available at time of audit Understand the entity’s process for determining FV Client’s control activities over determination of FV Expertise of those determining FV Accounts & transactions requiring FV measurement Extent to which the client relies on a service organisation or an expert to provide FV measurements Significant management assumptions, methods used to develop and documentation to support them

Key Requirements of ASA 545 Appropriateness of FV measurements and disclosures Method for measuring stipulated by AASB? Eg marketable securities Valuation method to be utilised Evidence to support management’s intent to carry out a specific course of action and it’s ability to do so Consistent application of valuation methods and assumptions

Key Requirements of ASA 545 Using an expert (ASA 620) Consistent assumptions with those of management Substantive procedures Testing management’s significant assumptions Appropriateness of model used Relevance of information Comparison to accuracy of valuations made in prior periods Considering the effects of subsequent events

Key Requirements of ASA 545 Substantive procedures Discounted cash flow analysis Length of forecast period Number of significant and complex assumptions Degree of subjectivity and uncertainty Availability of subjective data Sensitivity analysis

Implications for Audits at June 2008 Understanding relevant measurement bases and challenging assumptions used Is the market active or non-active or has this changed? External environment Higher interest rates Decreasing consumer sentiment Volatility in earnings Impairment events (ie. Related party transaction propping up the price) Independent external valuation or internal (ASA XXX)

Case Study Pools-R-Us