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ACCA Strategic Professional · Strategic Business Reporting (International) · Fair value measurement

Hadley plc acquired Orsa Ltd and must measure at fair value a decommissioning liability assumed. Hadley would perform the work itself, with expected cash outflows of $10 million in 5 years, which includes only the entity's own cost. A market participant contractor would charge $12 million in 5 years for the work, including a 20% profit margin on cost of $10 million. Risk-free rate is 4% and there is no non-performance risk adjustment. Which is the correct approach under IFRS 13 to measuring the liability's fair value?

Hadley should discount the $12 million that a market participant would charge, including its profit margin, at the 4% rate. IFRS 13 uses a transfer-based, market participant view rather than the entity's own cost, and time value must be reflected, giving about $9.86 million.

  1. ADiscount $10 million at 4% because it is the entity's own expected cost
  2. BDiscount $12 million at the risk-free rate, because market participant cost including profit margin reflects a transfer priceCorrect
  3. CDiscount $10 million and add the profit margin as an undiscounted amount
  4. DMeasure at $12 million undiscounted, because the liability will be settled in the future

Explanation

IFRS 13 requires fair value to reflect what a market participant would require to assume the obligation, including compensation (profit margin) for performing the work. Entity-specific cost is irrelevant. The $12 million should be discounted: $12m/1.04^5 ≈ $9.86m. Using $10 million ignores the margin; not discounting ignores time value.

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