- clarifies the definition of fair value,
- provides a clear framework for measuring fair value, and
- enhances the disclosures about fair value measurements.
IFRS 13 Fair Value Measurement applies to IFRSs that require or permit fair value measurements or disclosures. It does not introduce new fair value measurements, nor does it eliminate practicability exceptions to fair value measurements. In other words, IFRS 13 specifies how an entity should measure fair value and disclose information about fair value measurements. It does not specify when an entity should measure an asset, a liability or its own equity instrument at fair value.
For IFRS 13 Fair value is defined 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’, also referred to as the willing buyer-willing seller principle. It is important to note that fair value is a market-based measurement and not an entity-specific measurement.
When determining fair value of an asset or liability, notice must be given to what the market participants would consider when determining an appropriate price to pay or receive for that asset or liability. However, matters that market participants would consider include the condition and location of the asset as well as the restrictions on the sale or use of the asset.
IFRS 13 is very clear that transaction costs should not be included in the fair value of the asset or liability as these costs are not a characteristic of the asset or liability.
Generally, the fair value of non-financial assets proves to the be most difficult to determine, given the fact that it may be difficult to determine the correct market as well as the characteristics that market participants would consider when determining an acceptable price. IFRS 13 states that the fair value of non-financial assets must be determined regarding the highest and best use of the asset, even when the counter-party to the transaction will not use the asset in the same manner as the seller. However, the seller’s current use of the asset is the highest and best use of the asset.
When performing the fair value calculations, entities must use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.
To increase the consistency and comparability in fair value measurements and related disclosures, IFRS 13 established a fair value hierarchy that categorizes the inputs to valuation techniques into three levels:
- Level 1: Quoted (unadjusted) market prices in active markets for identical assets or liabilities,
- Level 2: Valuation techniques for which the lowest level input that is significant to the fair value measurement is directly or indirectly observable,
- Level 3: Valuation techniques for which the lowest level input that is significant to the fair value measurement is unobservable.
IFRS 13 requires entities to apply valuation techniques consistent with any of the following three methods:
(see also Practical Guidance)
The cost approach reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost). From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. That is because a market participant buyer would not pay more for an asset than the amount for which it could replace the service capacity of that asset. Obsolescence encompasses physical deterioration, functional (technological) obsolescence and economic (external) obsolescence and is broader than depreciation for financial reporting purposes (an allocation of historical cost) or tax purposes (using specified service lives). In many cases the current replacement cost method is used to measure the fair value of tangible assets that are used in combination with other assets or with other assets and liabilities.
The market approach uses prices and other relevant information generated by market transactions involving identical or comparable (i.e. similar) assets, liabilities or a group of assets and liabilities, such as a business. For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparables. Multiples might be in ranges with a different multiple for each comparable. The selection of the appropriate multiple within the range requires judgment, considering qualitative and quantitative factors specific to the measurement. Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value some types of financial instruments, such as debt securities, without relying exclusively on quoted prices for the specific securities, but rather relying on the securities’ relationship to other benchmark quoted securities.
The income approach converts future amounts (e.g. cash flows or income and expenses) to a single current (i.e. discounted) amount. When the income approach is used, the fair value measurement reflects current market expectations about those future amounts.
Those valuation techniques include, for example, the following:
Determining the fair value of a financial asset or liability can be a complicated process. The following illustrations highlight some of the more common misinterpretations when applying the requirements of IFRS 13, especially regarding categorization into the fair value hierarchy. They address aspects of IFRS 13 but are not intended to provide interpretative guidance.
Generally, intangible assets cannot be traded in an active market. An active market is defined as a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. Based on this, the sale (and purchase) of intangible assets should be at the very least categorized as a level 2 fair value measurement. Further to this, the disclosure required will most likely only be included on the acquisition date as subsequent to purchase, the asset would be measured at cost (less accumulated amortization and impairment).
Debt issuers must consider the extent of actively trading in an active market; if trade is not active, it is incorrect to classify their own debt instruments as being with the level 1 hierarchy.
The inputs used to determine fair value of investment properties are often not observable, in which case they cannot be included in the level 2 hierarchy. Observable inputs are defined as inputs that are developed using market data, such as publicly available information about actual events or transactions, and that reflect the assumptions that market participants would use when pricing the asset or liability.
Operational financial instruments
Operational financial instruments, such as trade receivables and trade payables, finance leases, loans receivable and loans payable, cannot be included in the level 2 hierarchy due to the inputs not being observable.
Interim financial statements
Entities that are required to prepare interim statements in accordance with IAS 34 Interim Financial Reporting are reminded that the disclosure requirements contained in IFRS 13 Fair Value Measurement are also required in the interim statements, where items are measured at fair value and the fair values of those items were also determined at the interim period.