Fair value measurement in short

Fair value measurement in short is a brief introduction to some of the key terms used in fair value measurement, as well as a diagram that shows the flow in relation to the process of measuring fair value and determining the appropriate disclosures.

The key term that drives this process is fair value: 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 an exit price (e.g. the price to sell an asset rather than the price to buy that asset). An exit price embodies expectations about the future cash inflows and cash outflows associated with an asset or liability from the perspective of a market participant (i.e. based on buyers and sellers who have certain characteristics, such as being independent and knowledgeable about the asset or liability).

Fair value is a market-based measurement, rather than an entity-specific measurement, and is measured using assumptions that market participants would use in 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 in measuring fair value.

Fair value is measured assuming a transaction in the principal market for the asset or liability (i.e. the market with the highest volume and level of activity). In the absence of a principal market, it is assumed that the transaction would occur in the most advantageous market. This is the market that would maximize the amount that would be received to sell an asset or minimize the amount that would be paid to transfer a liability, taking into account transaction and transportation costs. In either case, the entity needs to have access to that market, although it does not necessarily have to be able to transact in that market on the measurement date.

A fair value measurement is made up of one or more inputs, which are the assumptions that market participants would make in valuing the asset or liability. The most reliable evidence of fair value is a quoted price in an active market. When this is not available, entities use a valuation approach to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.

These inputs also form the basis of the fair value hierarchy, which is used to categorize a fair value measurement (in its entirety) into one of three levels. This categorization is relevant for disclosure purposes. The disclosures about fair value measurements are extensive, with more disclosures being required for measurements in the lowest category (Level 3) of the hierarchy. In summary:

IFRS 13 The Fair Value Measurement Framework

Fair value measurement in short

In practice, navigating the fair value framework may be more straight-forward for certain types of assets (e.g., assets that trade in a formalised market) than for others (e.g., intangible assets). For non-financial assets that derive value when used in combination with other assets or for which a developed market does not exist, resolving the circular nature of the relationship between valuation premise, highest and best use and exit market is important in applying the fair value framework.

IFRS 13 provides the guidance on the measurement of fair value, including the following:

  • An entity takes into account the characteristics of the asset or liability being measured that a market participant would take into account when pricing the asset or liability at measurement date (e.g. the condition and location of the asset and any restrictions on the sale and use of the asset) [IFRS 13 11]
  • Fair value measurement assumes an orderly transaction between market participants at the measurement date under current market conditions [IFRS 13 15]
  • Fair value measurement assumes a transaction taking place in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability [IFRS 13 24] Fair value measurement in short
  • A fair value measurement of a non-financial asset takes into account its highest and best use [IFRS 13 27] Fair value measurement in short
  • A fair value measurement of a financial or non-financial liability or an entity’s own equity instruments assumes it is transferred to a market participant at the measurement date, without settlement, extinguishment, or cancellation at the measurement date [IFRS 13 34] Fair value measurement in short
  • The fair value of a liability reflects non-performance risk (the risk the entity will not fulfil an obligation), including an entity’s own credit risk and assuming the same non-performance risk before and after the transfer of the liability [IFRS 13 42] Fair value measurement in short
  • An optional exception applies for certain financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk, provided conditions are met (additional disclosure is required). [IFRS 13 48, IFRS 13 96] Fair value measurement in short

See also valuation techniques for details on valuation calculations.

Fair value measurement in short

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