Last week, I was developing training materials for an IFRS update course which included application of IFRS 9 Financial Instruments and IFRS 13 Fair Value Measurements. At GAAP Dynamics, in addition to covering the technical accounting guidance in our course materials, we incorporate mini cases and examples into our training to highlight application issues as we believe these group discussions contribute to a more effective, memorable, and enjoyable learning experience. With IFRS 9 now effective, there is one in particular relating to valuing equity investments at cost that I’d like to share with you.

The slide image below provides some background information on the Leprechaun Fund, which is the example, publicly traded investment fund in our scenario that prepares their financial statements under IFRS.

In its audited financial statements, the Leprechaun Fund notes:

“As per December 31, 2017, the fund owns 1,994 shares or 7.6% fully diluted in JUMO World Limited. JUMO is valued as per the most recent transaction in the company in December 31, 2016 and the fund’s stake is valued at USD 12.7 million as per December 31, 2017. JUMO is categorized as a level 2 investment.”

JUMO is a mobile money marketplace for people, small businesses, mobile network operators, and financial service providers. JUMO operates across numerous African markets like Tanzania, Ghana, Zambia, and Uganda while through 2017, launching their offering in the sub-continent in Pakistan. Group headquarters are in Cape Town, South Africa.

JUMO was founded in 2014 and the fund first invested in JUMO in 2015. The fund has invested a total of USD 11.6 million over the course of three funding rounds, where the latest investment of USD 1.6 million was concluded in December 2016. As per December 31, 2017, JUMO is valued on the basis of the latest transaction, with a valuation of USD 12.7 million for the fund’s 7.6% ownership in the company.

The question is: Is the valuation of JUMO shares at cost appropriate?

In contemplating the issue of the appropriateness of valuing the equity investment at cost, the two accounting standards that apply are IFRS 9 Financial Instruments and IFRS 13 Fair Value Measurements.

IFRS 9 permits valuing equity securities at cost under limited circumstances. However, an entity must consider available information and if relevant factors exist that indicate cost might not be representative of fair value, then the entity must measure fair value.

Specifically, IFRS 9 indicates that:

All investments in equity instruments and contracts on those instruments must be measured at fair value. However, under limited circumstances, cost may be an appropriate estimate of fair value. That may be the case if insufficient more recent information is available to measure fair value, or if there is a wide range of possible fair value measurements and cost represents the best estimate of fair value within that range.

An entity shall use all information about the performance and operations of the investee that becomes available after the date of initial recognition. To the extent that any such relevant factors exist, they may indicate that cost might not be representative of fair value. In such cases, the entity must measure fair value.

Cost is never the best estimate of fair value for investments in quoted equity instruments (or contracts on quoted equity instruments).

Under IFRS 13, the objective of a fair value measurement is to reflect the exit price for the investment at the measurement date.

So, under consideration of both IFRS 9 and IFRS 13, defaulting to cost as the estimate of fair value would generally not be appropriate. Cost may be used as a basis to estimate fair value. But both IFRS 9 and IFRS 13 require further analysis to determine whether const represent the best estimate of fair value.

Calibration may be used to assess the inputs to the valuation model that are consistent with the entry price, provided that the transaction price reflects fair value at initial recognition, and then at later measurement dates, these inputs would then be updated to reflect company-specific progress and current market conditions.

IFRS 9 Financial Instruments was issued in its final form in July 2014.  The mandatory effective date is for annual periods beginning on or after January 1, 2018. With the effective date now upon us, we here at GAAP Dynamics have been busy developing training to help assist you with understanding the requirements of IFRS 9. Check out our fair value topic page for more resources! 

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