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IFRS 13 Fair Value Measurement governs the financial reporting requirements for fair value. Entities apply this standard for all assets and liabilities that require or allow fair value as their measurement. For instance, the standard is applied for:
- Investment property measured using the fair value model.
- Fair value measurement for intangible assets or property, plant and equipment measured using the revaluation model.
- Measurement at fair value for non-monetary grants.
- Measurement of contingent consideration at fair value in business combination.
The standard sets out a single framework for measuring fair value. Additionally, it also stipulates the required disclosures about the fair value measurement. However, the standard does not intend to establish valuation standards or affect valuation practice outside financial reporting.
Let’s now get into the details of IFRS 13.
What is fair value?
Firstly, let‘s understand the definition of fair value. IFRS 13 defines fair value as 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. Accordingly, fair value is a market-based and not an entity-specific measurement.
In addition, fair value of asset or liability is not necessarily the same as transaction price. Transaction price is the price paid to acquire the asset or received to assume the liability – i.e., an entry price.
Entities, however, do not necessarily sell assets at its acquisition price. Similarly, entities may not transfer liabilities at the prices received to assume them.
As such, transaction price is an entry price, while fair value is an exit price for entities that hold the assets or owe the liabilities.
Secondly, let’s us now understand the key components in the fair value definition.
The asset and liability
In fair value determination, entities need to consider the characteristics of the asset or liability. Entities include the characteristics of the asset or liability only if market participants take them into account when pricing the asset or liability at the measurement date.
The characteristics depend on the specific asset or liability, but may include:
- Firstly, the condition and location of the asset.
- Secondly, the restrictions on the sale or use of the asset.
The definition of fair value also emphasises the fact for the transaction to take place in an orderly transaction. Accordingly, fair value measurement assumes that the transaction takes place:
- Firstly, in the principal market for the asset or liability.
- Secondly, in the absence of a principal market, in the most advantageous market for the asset or liability.
But what is the principal market? Also, what is ‘most advantageous market’? The table explains the concepts:
|Principal market||Most advantageous market|
|The market with the greatest volume and level of activity for the asset or liability.||The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability. This amount is after considering transaction costs and transport costs.|
Nevertheless, entities do not need to take an exhaustive search of all possible markets to identify the principal market or the most advantageous market. In fact, IFRS 13 states that entities assume the market in which the entity would normally enter into a transaction for the asset or liability as the principal market or the most advantageous market.
Entities must have access to the principal market at the measurement date. Accordingly, the principal market may be different for different entities for the same asset or liability. Although IFRS 13 requires entities to have access to the market, entities do not need to be able to sell the asset or transfer the liability in such market.
The third component is market participants. In determining the fair value, entities assume market participants act in their economic best interest. In addition, entities do not need to identify the specific market participants. Entities generally consider the factors specific to the following:
- Firstly, the asset and liability.
- Secondly, the principal or most advantageous market for the asset or liability.
- Lastly, market participants with whom the entity would enter into a transaction in that market.
The last component of fair value measurement is the price. The price can either be directly observable or estimated using another valuation technique. Additionally, the price in the market should not be adjusted for transaction costs as it is not a characteristic of an asset or liability. In addition, transaction costs are specific to a transaction and differ depending on how an entity enters into the transaction.
Valuation techniques in IFRS 13 Fair Value Measurement
We now come to the important part of fair value measurement – the valuation techniques. Specifically, on how do we measure the fair value for assets or liabilities? In general, IFRS 13 requires entities to use appropriate valuation techniques to measure the fair value of assets or liabilities.
To clarify this, IFRS 13 states that the valuation techniques must be appropriate in the circumstances as well as sufficient data are available. Entities should also maximise the use of observable input and minimise the use of unobservable inputs.
There are three widely used valuation techniques – first, the market approach, second, the cost approach, and finally, the income approach.
|Market approach||Cost approach||Income approach|
|Uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets and liabilities. Example is matrix pricing.||Reflects the amount that would be required currently to replace the service capacity of an asset.||Converts future amounts (i.e. cash flows or income and expenses) to a single current (i.e. discounted) amount. It reflects current market expectations about those future amounts.|
Some assets or liabilities require a single valuation technique to be used while some others require multiple valuation technique to be used. Nevertheless, IFRS 13 does not restrict the use of either single or multiple valuation techniques.
Change in a valuation technique
Above all, the valuation techniques used must be applied consistently. Nevertheless, a change in a valuation technique or its application is possible and appropriate, only if such change results in a measurement that is more representative of fair value in the circumstances.
But then, how do we account for a change in the valuation technique used or its application? IFRS 13 explains that such change is a change in accounting estimate, as fair value measurement is an estimate. Accordingly, entities follow the guidance in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors will help you to understand how to account for such a change.
Application of fair value measurement
IFRS 13 also provides requirements on the application of fair value measurement as follows:
Application to non-financial assets
Fair value measurement takes into consideration a market participant’s ability to generate economic benefits by using the asset in its highest and best use, or by selling it to another market participant that would use it in its highest and best use.
For this, entities consider whether the highest and best use is physically possible, legally permissible, and financially feasible. In addition, the application of the highest and best use ignores how entity intends to use the asset. Instead, it is considered from the perspective of market participants. An entity’s current use nevertheless is presumed to be its highest and best use, unless market and other factors suggest otherwise.
Application to liabilities and an entity’s own equity instruments
An entity assumes the fair value measurement is transferred to the market participant at the measurement date. In addition, it is assumed that:
- The liability remains outstanding and transferee would be required to fulfil the obligation.
- An entity’s own equity instrument remain outstanding and transferee would take on the rights and responsibilities associated with the instrument.
In addition, IFRS 13 provides the following requirements:
- Firstly, where the liabilities and equity instruments held by other parties as assets. In this situation, when a quoted price for the transfer of an identical liability or entity’s own equity instrument is not available, an entity measures the fair value from the perspective of a market participant that holds the identical item as an asset.
- Secondly, when the liabilities and equity instruments not held by other parties as assets. Accordingly, an entity measures the fair value using a valuation technique from the perspective of a market participant that owes the liability or has issued the claim on equity.
Fair value hierarchy
What is fair value hierarchy? Fair value hierarchy aims at categorising the inputs to valuation techniques used into three levels. In addition, fair value hierarchy gives highest priority to unadjusted quoted prices in active market and the lowest priority to unobservable inputs. The table below explains each level of the fair value hierarchy.
|Level 1 inputs||Level 2 inputs||Level 3 inputs|
|Quoted prices (unadjusted) in active market for identical assets or liabilities that an entity can access at the measurement date.||Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.||Unobservable inputs for the asset or liability.|
Importantly, no adjustment should be made to a Level 1 input except in certain circumstances. In contrast, entities make various adjustments to Level 2 inputs. These adjustments depends on factors specific to the asset or liability. The final level, Level 3 uses unobservable inputs to measure fair value to the extent that relevant observable inputs are not available. In this situation, entities develop unobservable inputs using the best information available, which may include the entities’ own data.
Disclosures on fair value information
IFRS 13 also requires extensive disclosure of fair value information in the financial statements. This is to help users to assess:
- Firstly, the assets and liabilities measured at fair value on a recurring or non-recurring basis. This includes the valuation techniques and inputs used to develop those measurements.
- Secondly, the effect of measurements on profit or loss or other comprehensive income. This is for recurring fair value measurements using significant unobservable inputs (Level 3).
Disclosure for assets and liabilities measured at fair value
To achieve the two objectives above, an entity should disclose the information in the table below. The information is disclosed for each class of assets and liabilities measured at fair value:
|Fair value measurement at the end of the reporting period||Yes||Yes||Yes||Yes||Yes||Yes|
|Reason for the measurement||No||No||No||Yes||Yes||Yes|
|Level of fair value hierarchy||Yes||Yes||Yes||Yes||Yes||Yes|
|Amount of transfer, the reasons and the entity’s policy for determining the transfers between levels||Yes||Yes||No||No||No||No|
|Description of valuation techniques||No||Yes||Yes||No||Yes||Yes|
|Description of inputs used||No||Yes||Yes||No||Yes||Yes|
|Change in valuation techniques or use of an additional valuation technique||No||Yes||Yes||No||Yes||Yes|
|Quantitative information on significant unobservable inputs used||No||No||Yes||No||No||Yes|
|Reconciliation from opening balance to the closing balance||No||No||Yes||No||No||No|
|The amount of total gains or losses for the period||No||No||Yes||No||No||No|
|Description of the valuation processes used||No||No||Yes||No||No||Yes|
|Narrative description of the sensitivity of fair value measurement to changes in unobservable inputs, including interrelationship between those inputs to other unobservable inputs||No||No||Yes||No||No||No|
|Changes in one or more of the unobservable inputs for financial assets and financial liabilities||No||No||Yes||No||No||No|
|The fact if the highest and best use differs from its current use and the reason||Yes||Yes||Yes||Yes||Yes||Yes|
Disclosure for assets and liabilities where fair value are disclosed
Entities may also disclose the fair value of certain assets and liabilities that are not measured at fair value. For these assets and liabilities, IFRS 13 simplifies the disclosure requirements.
For these assets and liabilities, entities will only need to disclose:
- First, the level of the fair value hierarchy.
- Second, a description of the valuation techniques and the inputs used for those categorised within Level 2 and 3.
- Third, the fact and reasons if the highest and best use of non-financial assets differ from the current use.
For a liability measured at fair value and issued with an inseparable third-party credit enhancement, IFRS 13 requires the issuer to disclose the existence of that credit enhancement. In addition, entities should also disclose whether the existence of credit enhancement is reflected in the fair value measurement of the liability.
The above sums up the principles in fair value measurement of assets and liabilities. Having said this, there are lots of judgements and estimates involved in determining fair value in practice. IFRS 13 provides a detailed guidance and examples on these principles.
We will continue our discussion on other financial reporting requirements in our future articles. Meantime, enjoy other articles in the Financial Accounting Section.