IFRS 13 - Fair Value Measurement

A Brief Article on IFRS 13

Objective

Defines fair value
Sets out in a single IFRS a framework for measuring fair value
Requires disclosures about fair value measurements.

Scope

IFRS 13 applies when another IFRS requires or permits fair value measurements or disclosures about fair value measurements (and measurements, such as fair value less costs to sell, based on fair value or disclosures about those measurements), except for:
Share-based payment transactions, leasing transactions, measurements that have some similarities to fair value but that are not fair value, such as net realisable value in IAS 2, and value in use in IAS 36. Additional exemptions apply to the disclosures required by IFRS 13.

Fair Value

New Definition: The price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction (not a forced sale) between market participants (market-based view) at the measurement date (current price).

Fair value is a market-based measurement (it is not an entity-specific measurement).
Consequently, the entity’s intention to hold an asset or to settle or otherwise fulfil a liability is not relevant when measuring fair value.

Old Definition: The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

It did not specify whether an entity is buying or selling the asset.
It was unclear about what settling meant because it did not refer to the creditor.
It was unclear about whether it was market-based.
It did not state explicitly when the exchange or settlement takes place.

Measurement of Fair Value

A fair value measurement requires an entity to determine all of the following:

The particular asset or liability that is the subject of the measurement consistently with its unit of account. For a non-financial asset, the valuation premise that is appropriate for the measurement consistently with its highest and best use.
The principal or most advantageous market for the asset or liability.
The valuation technique(s) appropriate for the measurement, considering:
The availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and,
The level of the fair value hierarchy within which the inputs are categorized.

Fair value measurements are categorized into a three-level hierarchy, based on the type of inputs to the valuation techniques used, as follows:

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Level 1 Inputs are unadjusted quoted prices in active markets for items identical to the asset or liability being measured. As with current IFRS standards, if there is a quoted price in an active market, an entity uses that price without adjustment when measuring fair value.
An example of this would be prices quoted on a stock exchange.
The entity needs to be able to access the market at the measurement date. Active markets are ones where transactions take place with sufficient frequency and volume for pricing information to be provided.
Where the prices quoted in an active market does not represent fair value. Then, the determination of whether a fair value measurement is based on level 2 or level 3 inputs depends on
(i) whether the inputs are observable inputs or unobservable and
(ii) their significance.

Level 2 inputs are inputs other than the quoted prices in determined in level 1 that are directly or indirectly observable for that asset or liability. They are likely to be quoted assets or liabilities for similar items in active markets or supported by market data.
For example, interest rates, credit spreads or yields curves. Adjustments may be needed to level 2 inputs and, if this adjustment is significant, then it may require the fair value to be classified as level 3.

Level 3 inputs are unobservable inputs. These inputs should be used only when it is not possible to use Level 1 or 2 inputs. The entity should maximise the use of relevant observable inputs and minimize the use of unobservable inputs. However, situations may occur where relevant inputs are not observable and therefore these inputs must be developed to reflect the assumptions that market participants would use when determining an appropriate price for the asset or liability. The general principle of using an exit price remains and IFRS 13 does not preclude an entity from using its own data.
For example, cash flow forecasts may be used to value an entity that is not listed. Each fair value measurement is categorized based on the lowest level input that is significant to it.

Valuation Techniques

An entity uses valuation techniques appropriate in the circumstances and for which sufficient data are available to measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.

The objective of using a valuation technique is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants and the measurement date under current market conditions. Three widely used valuation techniques are:

Market approach – uses prices and other relevant information generated by market transactions involving identical or comparable (similar) assets, liabilities, or a group of assets and liabilities (e.g. a business).
Cost approach – reflects the amount that would be required currently to replace the service capacity of an asset (current replacement cost)
Income approach – converts future amounts (cash flows or income and expenses) to a single current (discounted) amount, reflecting current market expectations about those future amounts.

In some cases, a single valuation technique will be appropriate, whereas in others multiple valuation techniques will be appropriate.

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Categories: IFRS