Fair Value Measurement Standards

🔍📈 𝐅𝐫𝐚𝐦𝐞𝐰𝐨𝐫𝐤 𝐅𝐨𝐫 𝐄𝐪𝐮𝐢𝐭𝐲 𝐕𝐚𝐥𝐮𝐚𝐭𝐢𝐨𝐧 𝐢𝐧 𝐋𝐞𝐯𝐞𝐫𝐚𝐠𝐞𝐝 𝐂𝐨𝐦𝐩𝐚𝐧𝐢𝐞𝐬: 𝐀 𝐌𝐮𝐬𝐭-𝐑𝐞𝐚𝐝 𝐟𝐨𝐫 𝐕𝐚𝐥𝐮𝐚𝐭𝐢𝐨𝐧 𝐏𝐫𝐚𝐜𝐭𝐢𝐭𝐢𝐨𝐧𝐞𝐫𝐬 As valuation professionals, we often face the intricate task of determining the fair value of equity interests in privately held, leveraged companies. My latest LinkedIn article delves deep into this subject, guided by the principles of FASB ASC 820. 𝐇𝐞𝐫𝐞'𝐬 𝐰𝐡𝐲 𝐭𝐡𝐢𝐬 𝐚𝐫𝐭𝐢𝐜𝐥𝐞 𝐢𝐬 𝐚 𝐦𝐮𝐬𝐭-𝐫𝐞𝐚𝐝: - 𝐂𝐨𝐦𝐩𝐫𝐞𝐡𝐞𝐧𝐬𝐢𝐯𝐞 𝐈𝐧𝐬𝐢𝐠𝐡𝐭𝐬: Understand the critical role of fair value measurement from a market participant's perspective and how it impacts transaction decisions. - 𝐃𝐞𝐚𝐥𝐢𝐧𝐠 𝐰𝐢𝐭𝐡 𝐂𝐨𝐦𝐩𝐥𝐞𝐱𝐢𝐭𝐢𝐞𝐬: Grasp the nuances of valuing companies with a mix of debt and equity, and learn how specific terms like change in control provisions can significantly affect equity valuation. - 𝐒𝐭𝐫𝐚𝐭𝐞𝐠𝐢𝐜 𝐂𝐨𝐧𝐬𝐢𝐝𝐞𝐫𝐚𝐭𝐢𝐨𝐧𝐬: Discover how the expected duration of equity holding and various investment strategies play a pivotal role in determining value. - 𝐏𝐫𝐚𝐜𝐭𝐢𝐜𝐚𝐥 𝐌𝐞𝐭𝐡𝐨𝐝𝐨𝐥𝐨𝐠𝐢𝐞𝐬: Explore how valuation models are calibrated to transaction prices and subsequently adjusted to reflect changes in market conditions and expected cash flows. - 𝐃𝐢𝐯𝐞𝐫𝐬𝐞 𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨𝐬 𝐀𝐧𝐚𝐥𝐲𝐬𝐢𝐬: Gain insights into different valuation approaches and scenarios, highlighting the versatility required in equity valuation. - 𝐑𝐢𝐬𝐤 𝐚𝐧𝐝 𝐋𝐢𝐪𝐮𝐢𝐝𝐢𝐭𝐲 𝐅𝐚𝐜𝐭𝐨𝐫𝐬: Learn about incorporating market liquidity, risks, and probability-weighted scenarios, especially in uncertain conditions. - 𝐑𝐞𝐚𝐥-𝐖𝐨𝐫𝐥𝐝 𝐄𝐱𝐚𝐦𝐩𝐥𝐞: Dive into a detailed example of my experience that illustrates these concepts, providing a clear, practical understanding of the valuation process. Whether you're a seasoned professional or new to the field, this article offers valuable knowledge and strategies to enhance your approach to equity valuation in complex financial environments. #EquityValuation #FinancialAnalysis #PrivateCompanies #FASB #ValuationPractitioners #Leverage #MarketAnalysis #ProfessionalDevelopment #FinanceCommunity #valuation

The International Private Equity & Venture Capital Valuation (IPEV) Guidelines are the global standard for valuing private capital investments. They bring consistency and transparency. But, they also rely heavily on judgment, may leave critical gaps in areas like ESG and early-stage VC, and diverge between IFRS and US GAAP. For GPs, LPs, and valuation professionals, the guidelines are both essential and imperfect, understanding their strengths and weaknesses is critical. Key takeaways from this IPEV PDF: ❂ Backtesting may be less about being "right" and more about improving assumptions. ❂ Entry multiples don’t lock in a permanent discount or premium. ❂ Fair Value assumes a hypothetical sale today, regardless of investor intentions. ❂ Contingent payments like earnouts are contractual rights, not speculative extras. ❂ Minority stakes are often worth less than pro-rata enterprise value. ❂ Debt deductions reflect negotiated market value, not always par value. ❂ Indicative offers rarely set fair value. ❂ Market dislocations do not suspend valuations. Why these IPEV Guidelines Matter: ❂ Provides comparability across funds and geographies. ❂ Gives LPs the transparency needed for allocation and oversight. ❂ Helps GPs calibrate valuations, negotiate, and manage risk. ❂ Covers complex realities like distressed markets, structuring impacts, and measurable ESG factors. Potential IPEV Weaknesses to Note: ❂ Heavy reliance on subjective judgment. ❂ ESG treatment is limited and excludes qualitative factors. ❂ Limited guidance for early-stage and structured instruments. ❂ Ambiguities in debt valuation. IPEV is the foundation of fair value reporting, but it is not flawless. True expertise lies in applying the guidelines with transparency, discipline, and awareness of their limitations.

Real question from a client: “We bought a bond for CU 1,000, but its fair value was estimated at CU 1,050. Do we recognize the CU 50 gain in P&L?” Answer: It depends on how you measured that fair value. If the CU 50 difference is backed by observable inputs (e.g. market yields, prices of similar bonds), you recognize it immediately in profit or loss. If it’s based on unobservable inputs (e.g. internal credit spread assumptions), you defer it. Then you recognize it gradually over time, but only as market-participant factors (including time) change. And it is very important to make this distinction, because in my practice I often witnessed immediate recognition in profit or loss. But, see IFRS 9.B5.1.2A. So how this could look like in practice: Let’s say the fair value of the bond on Day 1 was CU 1,050 (based on unobservable inputs), but the transaction price was CU 1,000. The CU 50 difference is deferred. In Year 1, the entity earns interest income of CU 47, based on the effective interest rate applied to the CU 1,050 fair value. However, if the market-based yield for a similar bond is only CU 42, then the difference of CU 5 reflects the portion of the Day-1 gain that can now be recognized, because part of the valuation difference is now supported by observable market inputs (e.g. passage of time). Have you encountered a Day-1 gain that didn’t go to P&L? Let’s compare notes.

Dear Accounting Aces, Let’s clarify a common error in financial reporting: the treatment of interest-free loans to employees. Often, such loans are recorded simply by debiting the Staff Loan account and crediting Bank with the full loan amount. However, under IFRS 9 – Financial Instruments, this approach fails to reflect the substance of the transaction. When a company grants interest-free or below-market interest loans to employees, IFRS 9 requires the loan to be initially recognized at fair value, not the cash disbursed. The difference between the loan amount and its fair value is treated as a benefit (employee cost) and expensed immediately. Key Requirements under IFRS 9: 1. Initial Measurement: - At fair value (typically present value of future cash flows discounted at market rate). 2. Subsequent Measurement: - Measured at amortized cost using the effective interest method. 3. Recognition of Benefit: - The difference between loan amount and fair value is treated as staff cost or employee benefit expense. Scenario: On January 1, 2025, Fast Energy Limited grants an interest-free loan of ₦1,000,000 to an employee, repayable in 2 years (January 1, 2027) in one lump sum. Assume the market interest rate for similar loans is 10% per annum. Step 1: Calculate Fair Value of Loan Present Value (PV) = ₦1,000,000 / (1 + 10%)² = ₦1,000,000 / 1.21 ≈ ₦826,446 - Loan disbursed: ₦1,000,000 - Fair value (PV): ₦826,446 - Employee benefit expense: ₦173,554 Step 2: Accounting Entries At Initial Recognition (Jan 1, 2025): - Dr: Staff Loan (Asset) – ₦826,446 - Dr: Employee Benefit Expense – ₦173,554 - Cr: Bank – ₦1,000,000 Step 3: Subsequent Measurement – Yearly Interest Recognition Year 1 (Dec 31, 2025): Interest income at 10% on opening balance (₦826,446 × 10%) = ₦82,645 - Dr: Staff Loan – ₦82,645 - Cr: Interest Income – ₦82,645 Year 2 (Dec 31, 2026): Interest income on updated balance = (₦826,446 + ₦82,645) × 10% = ₦90,910 - Dr: Staff Loan – ₦90,910 - Cr: Interest Income – ₦90,910 Final Repayment (Jan 1, 2027): - Dr: Bank – ₦1,000,000 - Cr: Staff Loan – ₦1,000,000 Summary: - Always discount interest-free loans using a market rate to find fair value. - Recognize the benefit as an expense immediately. - Accrete the loan over time using the effective interest rate method. - Helps ensure accurate financial reporting and compliance with IFRS 9. I hope this is helpful.