IFRS 9 requires equity investments (except those accounted under the equity method of accounting or those related to a consolidated investee), to be measured at FV.
In limited circumstances, IFRS 9 permits an entity to use the cost as an appropriate estimate of the FV of unquoted equity investments. For example:
- When insufficient more recent information is available to measure fair value;
- When there is a wide range of possible fair value measurements and cost represents the best estimate of fair value in the range.
Indicators that cost might not be representative of fair value include:
- A significant change in the performance of the investee compared with budgets, plans or milestones.
- Changes in expectation that the investee’s technical product milestones will be achieved.
- Significant change in the market for the investee’s equity or its products or potential products.
- A significant change in the global economy or the economic environment in which the investee operates.
- A significant change in the performance of comparable entities, or in the valuations implied by the overall market.
- Internal matters of the investee such as fraud, commercial disputes, litigation, changes in management or strategy.
- Evidence from external transactions in the investee’s equity, either by the investee (such as a fresh issue of equity), or by transfers of equity instruments between third parties.
Points to note:
- The impact of this change will particularly affect unquoted equity investments in start-up companies and companies involved in evaluation and exploration of resources where measurement at cost may have been justified in the past. In accordance with IFRS 9, these investments would have to be measured at fair value.
- While it may be fairly easy to justify that cost approximates fair values at inception, more detailed assessment would be required in subsequent periods to determine if cost still approximates fair value. Fair value will have to be determined on an ongoing basis at each reporting period.
- Valuing unquoted equity instruments is complex and the input of valuation experts would likely be needed to determine fair value for subsequent measurement.
- IFRS 13 Fair Value Measurement will be used to determine fair value when required by IFRS 9.
- IFRS 13 requires extensive disclosures on recurring level 3 fair value measurements which include unquoted equity instruments.
The following is a summary of valuation techniques which are discussed in the IASB educational material:
- Market approach
- Transaction price paid for identical or similar instrument of an investee
- Comparable company valuation multiples
- Income approach
- Discounted cash flow (DCF)
- Dividend discount model (DDM)
- Constant growth DDM
- Capitalization model
- Adjusted net asset method