On Demand technology With and Without

IFRS 13 On Demand technology With and Without – Estimates the fair value of an asset by comparing the value of the business inclusive of the subject asset, to the hypothetical value of the same business excluding the subject asset. The with and without method is used to separate one intangible asset with a significant value from other intangibles.  For example in case of bringing new technology to the market, the value of the new technology can be estimated as follows:

Value of the (existing) business with new technology On Demand technology With and Without

-/-

Value of the (existing) business without new technology, where customer relationships are re-created

Value of the new technology

Best used when: On Demand technology With and Without
• Customers are NOT the primary assets or On Demand technology With and Without
Customer relationships can be re-created On Demand technology With and Without
• Time to re-create the customer relationships is short and does not change the structure of the business

Calculation: On Demand technology With and Without

On Demand technology With and Without

WACC = Weighted Average Cost of Capital | COGS = Cost of Goods Sold |  G&A = General & Administrative (or Overhead) |S&M = Sales & Marketing | TAB = Tax Amortisation Benefit

The with or without valuation method is frequently used in the valuation of:

  • Non-competition agreements;
  • Franchises; and
  • Processes and technologies.

The present value formula:

  1. Free cash flow forecast for business ‘with’ the subject asset On Demand technology With and Without
  2. Enterprise-wide discount rate On Demand technology With and Without
  3. Expected life of business On Demand technology With and Without
  4. Free cash flow forecast ‘without’ the subject asset
  5. Enterprise-wide discount rate excluding asset
  6. Expected period to replace asset + costs
  7. Tax amortization benefit (asset values, tax rates, tax amortization rates)

Compound instruments

Another use of the with and without method is in valuing each component if compound instruments have to be recognised at initial measurement at fair value. Sometimes issued non-derivative financial instruments contain both liability and equity elements. In other words, one component of the instruments meets the definition of a financial liability and another component of the instrument meets the definition of an equity instrument. Such instruments are referred to as compound instruments.

A common form of compound financial instrument is a debt instrument with an embedded conversion option, such as a bond convertible into ordinary shares of the issuer, and without any other embedded derivative features.

IAS 32 28 states that the issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets or equity instruments, as follows :

  1. The issuer’s obligation to make scheduled payments of interest and principal is a financial liability that exists as long as the instrument is not converted. On initial recognition, the fair value of the liability component is the present value of the contractually determined stream of future cash flows discounted at the rate of interest applied at the time by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without the conversion option.
  2. The equity instrument is an embedded option to convert the liability into equity of the issuer. The fair value of the option comprises its time value and its intrinsic value, if any. This option has value on initial recognition even when it is out of the money.

How to recognize the initial carrying amounts of the liability and equity components of the compound instrument?

To determine the initial carrying amounts of the liability and equity components, entities apply the so-called with-and-without method. The fair value of the instrument is determined first including the equity component. The fair value of the instrument as a whole generally equals the proceeds (consideration) received in issuing the instrument. The liability component is then measured separately without the equity component. The equity component is assigned the residual amount after deducting from the fair value of the compound instrument as a whole the amount separately determined for the liability component.

Example :

Entity A issues a bond with a principal amount of $100,000. The holder of the bond has the right to convert the bond into ordinary shares of Entity A. On issuance, Entity A receives proceeds of $100,000. By discounting the principal and interest cash flows of the bond using interest rates for similar bonds without an equity component, Entity A determines that the fair value of a similar bond without any equity component would have been $91,000.

Therefore, the initial carrying amount of the liability component is $91,000. The initial carrying amount of the equity component is computed as the difference between the total proceeds (fair value) of $100,000 and the initial carrying amount of the liability component of $91,000. Thus the initial carrying amount of the equity component is $9,000. Entity A makes this journal entry:

Cash

100,000

Financial liability

91,000

Equity

9,000

See also: The IFRS Foundation

On Demand technology With and Without