IFRS in India

Migrating to Fair Value concept

By:Valuation GroupSPA Capital Advisors Limited

In the past company balance sheets have shown asset and liabilityvalues as per their original price, but come April 2011, this is set tochange. As per the fair value practices outlined by the IFRS, assets andliabilities have to be valued at their current market value.

There could be intangibles like brands, trademarks, and customerrelations which would now show up in the balance sheet of the acquirer.

FAIR VALUE PRACTICES OUTLINED BY IFRSFAIR VALUE PRACTICES OUTLINED BY IFRS

relations which would now show up in the balance sheet of the acquirer.So the composition of the balance sheet will change.

IFRS also dictates that companies will have to charge these componentsto profits in the future.

IFRS defines Fair value as under:

“Fair value is the amount for which an asset could be exchanged, or aliability settled, between knowledgeable, willing parties in an arm’slength transaction.”

IFRS defines Fair value as under:“Fair value is the amount for which an asset could be exchanged, or aliability settled, between knowledgeable, willing parties in an arm’slength transaction.”

Major Components:

• Could be exchanged or settled

What is Fair ValueWhat is Fair Value

• Knowledgeable & willing Parties

• Arms length transaction

Requisites to be a Requisites to be a valuervaluerA person:

• Who holds a recognized & relevant Professional qualification

• Has sufficient experience in the field of valuation

• Has requisite market knowledge & understanding

• Is independent to give fair views

Use of Fair Values in IFRSUse of Fair Values in IFRS

IFRSIFRS 22 ShareShare basedbased PaymentPayment• Requires share based payments to be measured at fair value. For equity-settled

transactions, this fair value is measured at the date of grant only. For cash settledand share-based payments with cash alternatives, the fair value of the liability ismeasured at fair value at each balance sheet date.

IFRSIFRS 33 BusinessBusiness CombinationsCombinations

• IFRS 3 Business Combinations, requires the allocation of the purchase price in apurchase combination to be allocated between tangible and intangible assetsbased on fair value. IFRS 3 will require the identification of more intangible assetsthan is currently the norm.

• The fair value concept applies on all acquisitions of subsidiaries, associates andjoint ventures

IAS 16 Property, Plant and Equipment IAS 16 Property, Plant and Equipment

• allows property to be carried at re-valued amount, which is the item’s fair value.

IAS 38 Intangible Assets IAS 38 Intangible Assets • allows the use of fair value when an active market exists for those intangibles

IAS 39 Financial Instruments: Recognition and Measurement IAS 39 Financial Instruments: Recognition and Measurement • requires certain financial assets and financial liabilities to be measured at fair

value. These include derivative instruments, assets available for sale, and assetsheld for trading. In addition, IAS 39 provides an option to fair value certain

Use of Fair Values in IFRSUse of Fair Values in IFRS

held for trading. In addition, IAS 39 provides an option to fair value certainfinancial assets and financial liabilities that are not required to be measured at fairvalue.

IAS 40 Investment Property IAS 40 Investment Property • allows investment property to be measured under a fair value model or cost

model.

IAS 41 Agriculture IAS 41 Agriculture • requires that biological assets and agricultural produce be carried at fair value.

Financial Assets Financial Assets -- SummarySummary

Category

MeasurementFVTPL

HTM

assetsReceivables /

Payables *AFS *

Initial Fair

Value

FV

+/- TC

FV

+/- TC

FV

+/- TC

Subsequent Fair Amortised Amortised Fair

IAS 39 IAS 39 -- Financial Instruments: Recognition and MeasurementFinancial Instruments: Recognition and Measurement

Subsequent Fair

value

Amortised

cost

Amortised

cost

Fair

value

Gains / Losses P&L P&L P&L Equity

Impairment /

DerecognitionP&L P&L P&L P&L

ReclassificationNot

permittedAFS

Not

applicableHTM

* Short term receivables / payables & unquoted equity instruments for which fair value is not ascertainable, measurement should be at cost

IFRS 9 IFRS 9 -- Financial Assets Classification TreeFinancial Assets Classification Tree

ValuationValuation-- under under IFRS/ IASIFRS/ IAS

With IFRS all set to come to India, emphasis will be more on fair value accountingthan cost based accounting. Some of the standards where there will be need of fairvaluation opinions are:

Share-based Payment (IFRS 2) Business Combination (IFRS 3) Financial Instruments Presentation (IAS 32 & IFRS 7) Impairment of Assets (IAS 36)Property Plant & Equipment (IAS 16)Employee Benefits (IAS 19)Employee Benefits (IAS 19) Financial Instruments Measurement (IAS 39) Investment Properties (IAS 40)Agriculture (IAS 41)

SPA provides valuationvaluation reportreport, which servesserves thethe purposepurpose ofof financialfinancial reportingreporting,including, but not limited to, the effective date of valuation, the methods andsignificant assumptions applied in estimating fair value and if applicable, the extentto which the values were determined by reference to observable prices in an activemarket or recent market transactions at arm’s length terms or were estimated usingother valuation techniques, which enables the client to make decisions on the mostappropriate accounting treatment and to account for the different assets (orliabilities) employed in the enterprise in a compatible fashion.

SPA Valuation ServicesSPA Valuation ServicesWe provide independent valuation services utilizing accepted valuation methodologyto produce well reasoned, supportable valuation and financial consulting services.Our valuation passes two tests. First, it reaches an accurate value conclusion.Second, it clearly and convincingly establishes how the conclusion was reached. Agood business valuation can be successfully defended and supported under criticalscrutiny.

TheThe TeamTeamQuality valuations are performed by experienced, capable appraisers. SPA pridesQuality valuations are performed by experienced, capable appraisers. SPA pridesitself on its professional experience and expertise in the field of corporate valuations.As a financial consulting firm, our major specialty is valuing businesses and corporatesecurities. The team consists of Chartered Accountants, CFAs, Company Secretariesand ICAIICAI CertifiedCertified ValuationValuation expertsexperts..

ClientsClients WhoWho CountCount OnOn UsUsWe have done more than 10001000 valuationsvaluations across industries. Our clientele consist ofdomestic and multinational companies including variousvarious FortuneFortune 500500 companiescompanies..

Referrals from existing clients constitute the largest single source of clients for SPA.Other valued reference sources for new assignments include, accounting firms, lawfirms, and investment banking organizations.

The valuation services we provide broadly cover the following: Business Valuation

• Acquisition- Domestic & Cross Border• Assessment of Merger Swap Ratio• Fairness Opinion• Valuation of business segments/divisions for spin off/restructuring• Share Purchase/Investment/Fund Raising• Good will & Asset Impairment testing (US GAAP/IFRS/Indian GAAP)• Investment Impairment testing for accounting purposes• Fair valuation for statutory/regulatory purposes

Mélange of Valuation ServicesMélange of Valuation Services

• Fair valuation for statutory/regulatory purposes Intangible Asset valuation

• Brand valuation• Intellectual property valuation• Asset valuation for purchase price allocation for accounting for business

combinations (US GAAP/IFRS)• Carried Interest valuation• Derivative Valuation under IFRS• Recognition and Measurement of financial assets and liabilities

Employee Stock Options Valuation• Equity Shares/Common Stock for Perquisites taxation• Sweat Equity• Stock Options through Black-Scholes and Binomial or Lattice technique• Share based payment awards valuation under IFRS

Intangible Asset ValuationIntangible Asset Valuation-- Brand, IPR etc.Brand, IPR etc.

Market Approach

Relief From Royalty

Real Options

We, at SPA, provide Valuation Report which uses internationally accepted Valuation Report which uses internationally accepted complex methods but is still easily understandable.complex methods but is still easily understandable.

Intangible Asset Valuation

Income Approach

Discounted Cash Flow

Cost Approach

Replacement Cost

Actual Cost

IAS 39 requires that all derivatives are marked at fair value (mark to market)

IAS sets out a hierarchy for the determination of fair value:

• For instruments traded in active markets, use a quoted price.

• For instruments for which there is not an active market, use a recent market

transaction.

• For instruments for which there is neither an active market nor a recent market

Derivatives valuation under IFRSDerivatives valuation under IFRS

• For instruments for which there is neither an active market nor a recent market

transaction, use a valuation technique.

Implications:

• A large section of the derivatives market use valuation techniques with

parameters implied from known points.

• If valuation technique cannot be calibrated back to market (e.g. complex

products) then fair value is the price at which the trade was done -> Initial “Day

One” P&L cannot be recognised.

The BlackBlack--ScholesScholes modelmodel is a mathematical model based on the notion that pricesof stock follow a stochastic process, in other words the price of a stock in time t+1 isindependent from the price in time t. This is also referred to as random walk

The BinomialBinomial optionsoptions pricingpricing modelmodel approach is widely used as it is able to handle avariety of conditions for which other models cannot easily be applied. This is largelybecause the BOPM is based on the description of an underlyingunderlying instrumentinstrument over aperiod of time rather than a single point. As a consequence, it is used to value

Derivatives valuation under IFRSDerivatives valuation under IFRSStock Options valuation techniquesStock Options valuation techniques

period of time rather than a single point. As a consequence, it is used to valueAmericanAmerican optionsoptions that are exercisable at any time in a given interval as well asEuropeanEuropean optionsoptions that are exercisable at specific instances of time.

In terms of theory, MonteMonte CarloCarlo valuationvaluation relies on risk neutral valuation.[1] Here theprice of the option is its discounted expected value; see risk neutrality and Rationalpricing: Risk Neutral Valuation. The technique applied then, is (1) to generateseveral thousand possible (but random) price paths for the underlying (orunderlying) via simulation, and (2) to then calculate the associated exercise value(i.e. "payoff") of the option for each path. (3) These payoffs are then averaged and(4) discounted to today. This result is the value of the option.Deciding on the appropriate valuation model is a key decision for accounting for stock options

Derivatives valuation under IFRSDerivatives valuation under IFRSForeign Exchange Option valuation techniquesForeign Exchange Option valuation techniques

FX options are generally European and hence can use a standardstandard B&SB&S modelmodel. Likean equity option, currency options can be priced using a standard black and scholesoption model with a dividend yield. With a currency option, the dividend yieldrepresents the foreign currency's continually compounded risk-free interest rate. Inthe same way, FOREX option pricing will need to consider:

Underlying Price (the Spot FOREX rate), Interest Rate = Local Currency Interest RateDividend Yield = Foreign Currency Interest Rate, Strike Price = The cross rate at whichthe currency will be exchanged, Expiration Date = The expiry date of the optionthe currency will be exchanged, Expiration Date = The expiry date of the optionVolatility = The expected future volatility of the exchange rate over the life of theoption

GarmanGarman andand KohlhagenKohlhagen extended the Black-Scholes model to cope with thepresence of two interest rates (one for each currency). Suppose that rd is the risk-free interest rate to expiry of the domestic currency and rf is the foreign currencyrisk-free interest rate (where domestic currency is the currency in which we obtainthe value of the option; the formula also requires that FX rates - both strike andcurrent spot be quoted in terms of "units of domestic currency per unit of foreigncurrency").Then the domestic currency value of a call option into the foreign currency is:

Valuation for Business CombinationValuation for Business Combination• Traded financial instruments (eg. investments) at market values• Unquoted financial instruments based on estimated values such as price-earning

ratio, dividend yield, growth rates of similar traded instruments• Long-term receivables and other long-term assets at present values determined

at appropriate current interest rates less allowances for doubtful receivables andcollection costs

• Inventories- Finished goods at selling price less sum of cost of disposal and profitallowance for acquirer’s effort Work-in-progress at selling price of finished goods less sum of cost to

complete, cost of disposal and profit allowance for acquirer’s effort complete, cost of disposal and profit allowance for acquirer’s effort Raw materials at replacement cost

• Land and building at market values• Plant and equipment at market values determined by an appraiser. In absence

of market value depreciated replacement cost• Net employee defined benefit asset or liability at present value less fair value of

plan assets• Long-term liability at present values at appropriate interest rates

* Reassess the fair values originally determined, Any remaining excess is recognised in P & L immediately

Cost of Business

Combination- Fair Value of

assets, liabilities and contingent

liabilities assumed

> 0 Goodwill

< 0Negative

Goodwill*

Valuation Group: Select ClienteleValuation Group: Select Clientele

ACME TELE POWER LTD

BHARATI AIRTEL LTD.

DOMINOS

ESCORTS LTD.

EVEREST INDUSTRIES LTD.

HIMALYA INTERNATIONAL

JINDAL POLYFILMS LTD

JINDAL STEEL & POWER LTD

ARUBA NETWORKS, INC

AUSTRALIA AND NEW ZEALAND BANKING GROUP LTD

BECTON, DICKINSON AND COMPANY

CREDIT SUISSE GROUP

ECO SECURITIES GROUP PLC

EMC CORPORATION

CGI GROUP INC

FIRST CONSULTING GROUP, INC JINDAL STEEL & POWER LTD

LUMINOUS POWER

MAX HEALTHCARE

MOSER BAER LTD

NATIONAL GENERAL INDUSTRIES LTD

SONATA SOFTWARE

TELEVISION EIGHTEEN INDIA LTD.

NETWORK 18 FINCAP LTD

TV TODAY NETWORK LTD

VIKAS WSP

HEWITT ASSOCIATES, INC

INTEL CORPORATION

JOHNSON MATTHEY

LSI CORPORATION

MOSAIC COMPANY

NATIONAL SEMICONDUCTOR CORPORATION, INC

NDS GROUP PLC

NETLOGIC MICROSYSTEMS INC

PRINCIPAL FINANCIAL GROUP INC.

QUALITY ENGINEERING AND SOFTWARE TECHNOLOGIES INC.

Why SPA ?Why SPA ?

ExperienceExperience && ClienteleClientele:: SPA prides itself on its professional experience andexpertise in the field of corporate valuations. We have done more than 500valuations across industries. Our clientele consist of domestic and multinationalcompanies including various Fortune 500 companies.

TeamTeam:: Quality valuations are performed by experienced, capable appraisers.The team consists of Chartered Accountants, CFAs, Company Secretaries andICAI Certified Valuation experts.ICAI Certified Valuation experts.

QualityQuality outputoutput:: As a result of clear understanding of applicable laws and passionto excel and deliver, our valuation passes two tests. First, it reaches an accuratevalue conclusion. Second, it clearly and convincingly establishes how theconclusion was reached. Our valuation can be successfully defended andsupported under critical scrutiny.

TouchTouch ofof advisoryadvisory:: We understand that, clients require more than just the report.We are more than willing to provide advisory and support before and after therendering of services.

CLIENT QUOTESCLIENT QUOTES

“Very professional and prompt in services”Very professional and prompt in services” - CFO, of an IT Major

“Kept to deadlines, and excellent self explanatory report”Kept to deadlines, and excellent self explanatory report” - Director Finance, of Media Company

““Timely and clear communication, during process and final product Timely and clear communication, during process and final product was worth the moneywas worth the money” - CFO, Telecommunication Company

““What they delivered was beyond the assignment, it had a touch of What they delivered was beyond the assignment, it had a touch of advisory, which was pricelessadvisory, which was priceless”- CEO, Healthcare Company

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