Valuation Principles & Techniques in Ind AS
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The document provides an overview of the Indian Accounting Standards (Ind AS) focusing on valuation principles and techniques, particularly related to fair value measurement. It discusses the transition to Ind AS, applications under various standards, and details methods such as the relative valuation method and discounted cash flow method. The document outlines the principles of assessing fair value including factors affecting measurements, valuation techniques, and the fair value hierarchy.
Valuation Principles & Techniques in Ind AS
- 1. 3rd September 2016 Gurgaon Branch of ICAI Valuation Principles & Techniques in Ind-AS
- 2. - Overview - Fair Value - Principles of Fair Value - Fair Value Techniques - Fair Value Hierarchy - Application under different Ind AS - Relative Valuation method - Discounted Cash Flow method Agenda – Ind AS
- 3. Introduction to Ind AS Transition to Ind AS Advantages of Transition Fundamental changes due to Ind AS Indian corporates are in the process of transitioning to a new set of accounting standards called the Indian Accounting Standards (Ind AS) which converge closely with the International Financial Reporting Standards (IFRS). • Improved Comparability • Transparency • Qualitative Financial Statements • Global Acceptability Significant increase in focus on FAIR VALUE accounting (Approx. 75% of Balance Sheet size need Fair Value)
- 4. Applicability of Ind AS Financial year Mandatorily applicable to 2016-17 Companies (listed and unlisted) whose net worth is equal to or greater than 500 crore INR 2017-18 Unlisted companies whose net worth is equal to or greater than 250 crore INR and all listed companies 2018-19 onwards When a company’s net worth becomes greater than 250 crore INR
- 5. Ind AS using Fair Value as their guiding principle Ind AS Description Ind AS 113 Dedicated Standard on Fair Value Measurement Ind AS 103 Business Combination Ind AS 38 Intangible Assets Ind AS 16 Property Plant & Equipment Ind AS 36 Impairment of Assets Ind AS 102 Share – based payment Ind AS 109 Financial Instrument Ind AS 40 Investment Property
- 6. Disclosures about fair value FRAMEWORK for measuring fair value Defines FAIR VALUE Objective of Ind AS 113
- 7. Fair Value Definition The PRICE that would be RECEIVED TO SELL AN ASSET or PAID TO TRANSFER A LIABILITY in an ORDERLY TRANSACTION between MARKET PARTICIPANTS at the MEASUREMENT DATE. • Fair Value is a market-based measurement, NOT an entity-specific measurement • It is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. As a result, an entity’s intention to hold an asset or to settle or otherwise fulfill a liability is NOT relevant when measuring fair value
- 8. Important considerations of Asset or Liability while determining fair value The Characteristics of the Asset or Liability Market participants would take into account At Measurement Date Ex - The condition & Location of the asset Restrictions on sale or use of the asset
- 9. Principal Market or Most Advantageous Market The entity must have access to the principal (or most advantageous) market The principal market shall be considered from the perspective of the entity The entity does not need to be able to sell the particular asset or transfer particular liability Transaction Assumptions in Fair Value measurement Considering all information reasonably available
- 10. The Price Directly Observable Estimated using another valuation technique Recommended Price for Non Financial Asset is Highest and Best Use (HABU) that is Physically possible, Legally permissible and Financially feasible.
- 11. Fair Value – Use of Valuation Techniques An entity shall use valuation techniques to measure Fair Value which is- • For which Sufficient Data is available and • Maximizing use of relevant Observable Inputs and • Minimize use of Unobservable Inputs Valuation Techniques used to measure FAIR VALUE shall be applied consistently Examples of Markets in which inputs might be Observable (Ex – Financial Instruments) include Stock Exchange Markets, Dealer Markets, Brokered Markets etc. • Appropriate in the Circumstances and
- 12. Fair Value Techniques prescribed in Ind AS - 113 Market Approach Market Approach uses prices and other relevant information generated by market transactions involving comparable assets/liabilities/business, considering qualitative and quantitative factors (Comparable Companies Valuation Method) Cost Approach Cost Approach reflects the amount that would be required currently to replace asset (Replacement Cost method) Income Approach Income Approach converts future amounts to current (i.e. Discounted) amount (ex-Cash Flows or Income and Expenses) resulting in the current market expectations about those future amounts. Income Approach Techniques could include- •Present Value Techniques (Discounted Cash Flow Method) •Option Pricing Models (Black Scholes or Binomial models) •Multi period excess earning method (used for Intangibles)
- 13. Choice of Valuation Techniques When a single valuation technique will be appropriate? Ex - When valuing an Asset or Liability using Quoted prices in an Active market for identical assets or liabilities When multiple valuation techniques will be more appropriate? Ex- When valuing a Cash generating unit How to Conclude Value ? If multiple valuation techniques are used to measure Fair Value, the results shall be evaluated considering reasonableness of the range of values. Fair Value measurement is the point within the range that is most representative of the Fair Value in the circumstances.
- 14. Components of Present Value Measurement (Discounted Cash Flow Method) • An estimate of future cash flows for the asset/liability being measured; • Expectations about possible variations in amount and timing of cash flows representing uncertainty inherent in cash flows; • Time value of money, represented by the rate on Risk Free Monetary Assets having maturity coinciding with period of cash flows (Risk Free rate) • Price for bearing the uncertainty inherent in cash flows (Risk Premium) • Other factors that market participants would take (CSRP) Notes 1. An entity shall develop unobservable inputs using best information available in circumstances. An entity may begin with own data but shall adjust that if market participants would use different data (which is reasonably available). Discount rates should reflect assumptions consistent with those inherent in Cash Flows. 2. Assumptions about Cash Flows and Discount rates should be internally consistent (Nominal Cash Flows v, Real Cash Flows, Tax adjustments etc.) 3. Discount rates should be consistent with underlying economic factors of currency in which cash flows are denominated
- 15. Quoted Price - Unadjusted (whether that price is directly observable or estimated using another valuation technique) If there is principal market for asset or liability with Quoted Price Fair Value Hierarchy prescribed in Ind AS - 113 Quoted Price for Comparable Companies (CCM Method) If there is principal market for asset or liability but quoted price is not available Unobservable Inputs shall be used, where there is little, market activity for the asset/liability at the measurement date. An entity may begin with own data but shall adjust that if market participants would use different data (which is reasonably available). Level -1 Level-3Level -2 Adjustments to Level-2 Inputs are permitted including for condition or location of Asset; Volume of activity in markets within which inputs are observed Discounted Cash Flow Method Black Scholes or Binomial models Other methods
- 16. Discounts & Premium Depending on the Characteristics of the Assets or Liabilities that market participants would take into account, the application of Adjustments might be required. These adjustments can be defined as – 1. Premium or 2. Discounts (Ex. Control Premium or Non Controlling Interest Discount allowed) However, Fair Value measurement shall not incorporate a Premium or Discount that is inconsistent with the unit of account Premium or Discounts that reflect Size as a characteristic of entity’s holding are not permitted in a fair value measurement (Ex- a blockage factor that adjusts the quoted price of an Asset or Liability because market’s normal daily trading volume is not sufficient to absorb the quantity held by the entity)
- 17. Application Under Different Ind-AS
- 18. Ind AS 103: Business Combination Particulars IGAAP (AS 14) Ind AS 103 Scope • The transactions that meet the definition of amalgamations under the Companies Act are accounted for in compliance with AS 14 • Goodwill arises, only if an amalgamation is in the nature of purchase • If an acquirer obtains CONTROL of a business then acquisition will be accounted as a business combination • Goodwill will be recognized if a business is acquired irrespective of the legal structure of an acquisition (Except Common Control Acquisitions) Initial Recognition Assets and Liabilities reflected in the books of the acquiree and acquired by the acquirer will be considered while arriving at the Goodwill • Fair Value of the identifiable assets (tangible and intangible) and liabilities as of the acquisition date. PPA methodology to be followed • Intangible will get amortized over their estimated useful economic life which will impact the profit and loss statement going forward Impairment Testing Timing Goodwill arising on amalgamation is to be amortized over a period not exceeding 5 years Goodwill arising on business combination is to be tested for impairment annually Identifiable Assets - • Contingent consideration • Contingent Assets / Liabilities • Intangible Assets (Trademarks, Patents, Licenses) • Non Controlling interests
- 19. Ind AS 16: Property Plant & Equipment (PPE) Particulars IGAAP (AS 10) Ind AS 16 Scope • Revaluation is permitted • One time option is given on the Transition Date to opt for either of the two accounting models viz. Fair Value or Cost • PPE may be revalued at fair value periodically • Revaluations do not affect the income statement, but rather are recognized in equity, unless the revaluation decreases an asset value below its net book value • Component approach is to be followed for accounting of PPE
- 20. Ind AS 102: Share Based Payments Particulars Guidance Note by the ICAI and SEBI guidelines Ind AS 102 Scope • Option is to measure based on the fair value or intrinsic value of the equity instruments as on the grant date • Disclosure needed if fair value not used • Measured on grant date based on fair value only • Fair Value should be determined based on observable market values for identical or similar instruments • If observable market values are not available, then use other estimation techniques such as option pricing models (Black Scholes, Binomial model)
- 21. Ind AS 109: Financial Instruments Particulars IGAAP (AS 13 / 30) Ind AS 109 Scope • Measurement is currently not mandatory (AS 30) • All financial instruments are initially measured at fair value • With deal structures becoming increasingly more sophisticated and complex financial instruments becoming popular, application of Ind AS 109 will increase Initial Recognition • Investments are classified as long term or current depending on intended holding period on the date the investment • Long term investments are carried at cost less provision for permanent diminution in value • Current investments are carried at lower of cost and fair value • All financial instruments are classified as measured at amortized cost or Measured at Fair Value Subsequent Recognition Measurement depends on how the financial instrument is classified
- 22. Ind AS 36: Impairment of Assets Ind AS 38: Intangible Assets (Impairment) Particulars IGAAP (AS 28) Ind AS 38 Scope • Applies to all assets except inventories, assets arising from construction contracts, deferred tax assets, assets arising from employee benefits, financial assets and investments. • Applies to all assets except inventories, assets arising from construction contracts, deferred tax assets, assets arising from employee benefits and financial assets that are within the scope of Ind AS 39. • Applies to financial assets classified as subsidiaries, associates and joint ventures. Timing of Impairment Testing Annual Impairment irrespective of whether the impairment indicators exits or not •An intangible asset not yet available for use •An intangible asset with an estimated useful life of more than ten years Annual Impairment of following assets: •An intangible asset not yet available for use •An intangible asset with an indefinite useful life •Goodwill acquired in a business combination
- 24. Pros/Cons of Different Multiples PE Multiple Book Value Multiple EV/EBITDA Multiple EV/Sales Earnings : Audited Earnings (PAT) :TTM Earnings (PAT) Price : Latest / Volume Weighted / Simple Average of say 6 Months (+) Easy to apply Net Profitability linked (-) Prone to Accounting Adjustments • Best multiple to apply • Considers Operational Profits • Not prone to Accounting Adjustments (Depreciation & Amortizations) • Values irrespective of Debt levels • Book Value is the Investment (Net Worth) that equity shareholders have put in & earned in Company • Not much relevant as Earnings not factored in (other than mature cos) (+) Simplest to apply even when in Losses •Used to Value e-Commerce Companies / Media Companies in Losses (-) Not a preferred method as such, other than for Mature Companies
- 26. DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off. DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off. Discounted Free Cash Flow Method (DFCF)
- 27. Understand Business Model Identify Business Cycle Analyze Historical Financial Performance Review Industry and Regulatory Trends Understand Future Growth Plans (including Capex needs) Segregate Business and Other Cash Generating Assets Identify Surplus Assets (assets not utilized for Business say Land/Investments) Create Business Projections (Profitability statement and Balance Sheets) Discount Business Projections to Present (Explicit Period and Perpetuity) Add Value of Surplus Assets and Subtract Value of Contingent Liabilities DFCF Valuation Process
- 28. Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period. Free Cash Flows – Value Trend
- 29. Free cash flows to firm (FCFF) is calculated as EBITDAEBITDA Taxes Change in Non Cash Working capital Capital Expenditure Free Cash Flow to Firm Note that an alternate to above is following (FCFE) method in which the value of Equity is directly valued in lieu of the value of Firm. Under this approach, the Interest and Finance charges is also deducted to arrive at the Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows) over the definite period of Cash Flows and also in Perpetuity workings. Theoretically, the value conclusion should remain same irrespective of the method followed (FCFF or FCFE), (Provided, assumptions are consistent). FREE CASH FLOWS Free Cash Flows Calculation
- 30. DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL Where: D = Debt part of capital structure E = Equity part of capital structure Kd = Cost of Debt (Post tax) Ke = Cost of Equity (Kd x D) + (Ke x E) (D + E) In case of following FCFE, Discount Rate is Ke and Not WACC WACC Cost of Capital Calculation
- 31. DISCOUNT RATE - COST OF EQUITY Where: Rf = Risk free rate of return (Generally taken as 10-year Government Bond Yield) B = Beta Value (Sensitivity of the stock returns to market returns) Ke = Cost of Equity Rm= Market Rate of Return (Generally taken as Long Term average return of Stock Market) SCRP = Small Company Risk Premium CSRP= Company specific Risk premium Mod. CAPM Model ke = Rf + B ( Rm-Rf) + SCRP + CSRP The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing Model (Mod. CAPM) Cost of Equity Calculation
- 32. PERPETUITY FORMULA – Usually comprises a Large part of Total Value and is sensitive to small changes – Capitalizes FCF after definite forecast period as a growing perpetuity; – Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows – Gordon Formula is often used to derive the Terminal Cash Flows by applying the last year cash flows as a multiple of the growth rate and discounting factor – Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows (1 + g) (WACC – g) IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis. Terminal Value Calculation
- 33. Where Things can go Wrong Choice of Peer Companies Discounts &Premiums Cross Holdings & Investments Excess Cash / Non operating Assets Accounting Practices and Tax issues
- 34. We must Analyze the whole Balance Sheet and take necessary Actions to Align them with new Accounting requirements of Ind AS
- 35. Chander Sawhney FCA, ACS, Certified Valuer (ICAI) Partner & Head – Valuation & Deals M: +91 9810557353; E: chander@indiacp.com D-28, South Extension, Part-I, New Delhi-110049 www.corporatevaluations.in