Rules for determining fair value Based on IFRS 13

First, let's look at the IFRS 13 Fair Valuation Measurement standard. It clearly outlines the main principles for Dubai audit services and company audit teams on determining the fair value of any item.

IFRS 13 also includes some notes on non-financial assets. But what about the fair value, you may ask? It is the amount that companies in Dubai, UAE, would receive to sell an asset or pay to transfer a liability in an orderly trade between market participants at the measurement time.

One exception applies to non-financial assets, though:

  • Fair value for non-financial assets needs to reflect the best and highest use of the asset as per market participants.
  • Market participants should maximize asset value (or group) by making the most efficient use.

When valuing non-financial assets, company financial audit teams should always consider the best and highest use.

  • Is there another use for the asset?
  • How would a different use of an asset affect its fair value?

Let us see an example: If a Dubai firm is developing land for industrial purposes, it might want to build a warehouse or a plant there. However, the company realizes that many developers built residential apartments on the lands around its property. The firm should consider how its land could be used for residential purposes. Let's assume that the industrial land has a value of AED 100 000 and the residential land has a value of AED 140 000. The Dubai entity must pay AED 10000 to secure permissions and zoning decisions.

To make it possible, or to change the landform industrial to residential, the net value for residential land is 140 000 x 10 000, equal to AED 130000. You can see that residential use is the best and most efficient use of your land. Its fair value is 130 000. Typically, internal auditors assume that the company's current asset use is the best and highest use. But we showed you the above example only to jog your memory.

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Valuation Techniques

Let's get back to the machine. Suppose there is no market data exists for the customized 2-year-old machine. Internal audit services for the company will need to use a specific valuation method in this instance.

IFRS 13 Permits Three Valuation Techniques:

Market Approach 

  • This is where the auditing team calculates the machine's fair value using market transactions with similar or identical devices. This is because there are no similar machines due to certain levels of customization.

Income approach 

  • Here audit firms in Dubai must estimate future cash flows from the asset and then discount them to their present value.

Cost Approach or Replacement Cost Approach. 

  • Fair value is the amount needed to replace the existing asset.

Which Valuation Method Should Audit Services In Dubai And Company Auditors Use?

Although there is no prioritization in the standards, financial audit experts should maximize observable inputs, such as the market prices, to these techniques. One can't use observable inputs if one doesn't know the market prices. It would help internal auditors choose the proper procedure for their company. Sometimes auditors can use multiple techniques. The fair value may differ if an entity uses different methods to value an asset.

Therefore, you should take an honest look at these fair values to choose the most appropriate one for your situation. It takes a lot of your judgment, and that is why I said that I couldn't give you one recipe.

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Illustration: Valuation Techniques

Let's illustrate this all with our machine starting today's question.

First, let's assume that the current machine's use is its highest use. We don't have to consider other options. Let's say that the machine generates cash flows on its own, so we can also apply the income and cost approaches. Using a market approach would not be reasonable because the machine was highly customized. This is not a judgmental statement. If customization is minor, you can use the market approach with adjustments.

Suppose that a Dubai company first wants to use the income approach.

The machine's assumed revenues and all expenses are listed. The auditors then discount this to the present value to get AED 75 000. Then they apply the cost approach. Consider many factors, including the machine's current condition, wear and tear, and installation cost. Then they can calculate the cost of AED 65 000.

Which Fair Value Should Audit Services In Dubai UAE Use?

Use Judgment Again

The cost approach is more representative because it requires fewer judgments and less subjective inputs than the income approach. In the income approach, company financial auditors determine cash inflows using some forecasts. Still, they can also be subject to uncertainty.

However, internal auditors should most likely consider the current selling prices for identical machines from authentic vendors using the cost approach. This input is, therefore, less subjective. According to the cost approach,  we would estimate that AED 65 000 is the fair value. It is not easy because each situation and every asset are different. Financial audit teams need to use common sense often.

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