In November 2006 the International Accounting Standards Board (IASB) published a discussion paper Fair Value Measurements, using the US Financial Accounting Standards Board (FASB) Statement No 157, Fair Value Measurements (Statement 157) (subsequently codified as Topic 820) as a basis for its preliminary views. The IASB used Statement 157 as a starting point for its deliberations given its consistency with much of the fair value measurement guidance in the International Financial Reporting Standards (IFRS) and the desire by the IASB for convergence with US Generally Accepted Accounting Principles (US GAAP).
In May 2009 the IASB published an exposure draft on fair value measurement. The IASB received many comment letters in response to the proposals. One of the most common suggestions from these was that the IASB and the FASB should work together to develop common fair value measurement and disclosure requirements because there were inconsistencies between the IASB proposals and Topic 820.
The IASB and FASB began to work together on this project and, in June
2010, the IASB issued a proposal to require a quantitative sensitivity analysis related to unobservable inputs in a fair value measurement while the FASB concurrently exposed amendments to Topic 820. After further joint re-deliberations, the project culminated in May 2011 in the release of IFRS 13 and a revised Topic 820 containing largely consistent fair value measurement requirements.
By issuing IFRS 13 Fair Value Measurement (IFRS 13), the IASB intended to establish a single source of guidance for all fair value measurements. IFRS 13 will not change when an entity is required to use fair value but rather it provides guidance on how to measure fair value under IFRS.
IFRS 13 shall be applied prospectively for annual periods beginning on or after 1 January 2013. Early application is permitted and the new disclosures are
only required for periods beginning after IFRS 13 is adopted and comparative disclosures for prior periods are not required.
The three main reasons why the IASB issued IFRS 13 are:
- To reduce complexity and improve consistency in application when measuring fair value
- To enhance disclosures for fair value. The IASB believes the new disclosures will help users assess the valuation techniques and inputs to measure fair value
- To increase convergence with US GAAP which has also been amended by the FASB.
Defining 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 a transaction between market participants at the measurement date, i.e. it is an ‘exit price’. Fair value takes into account the characteristics of the asset or liability that would be considered by market participants and is not based on the entity’s specific use or plans. Such characteristics may include the following:
- The condition and location of an asset or liability
- Restrictions, if any, on the sale or use of an asset or liability and that would transfer with the asset or liability.
The effects of applying IFRS 13 are likely to vary by entity and, for some entities, the effects could be significant.
The measurement of the asset or liability
A fair value measurement considers those characteristics of the asset or liability that market participants would consider.
Fair value is a market based measurement rather than an entity specific measurement. Fair value is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk.
Principal and most advantageous markets
A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the:
- Principal market – the market with the greatest volume and level of activity for the asset or liability; or
- Most advantageous market – 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, after considering transaction costs.
An example of this is when a swap transaction takes place between an investment bank and a commercial entity. The former may have access to
wholesale and retail markets while the latter only has access to retail markets.
An entity is not required to undertake an exhaustive search of all possible markets to identify the principal market or, in the absence of a principal market, the most advantageous market. However, it should take into account all information that is reasonably available.
For example, if reliable information about volumes transacted is available in trade magazines, then it may be appropriate to take this information into account to determine the principal market. Absent evidence to the contrary, the principal (or advantageous) market is presumed to be the market in which an entity normally enters into transactions for the asset or liability.
Highest and best use
A fair value measurement considers a market participant’s ability to generate economic benefits by using a non-financial asset or by selling it to another market participant who will use the asset in its highest and best use. Highest and best use refers to the use of a non-financial asset by market participants that would maximise the value of the asset or the group of assets and liabilities with which the asset would be used.
For example, if an entity previously did not consider the highest and best use of an asset when determining the fair value when revaluing its property, plant and equipment, adopting IFRS 13 could result in a higher fair value than it would have previously determined.
Fair value hierarchy
When measuring fair value, IFRS 13 establishes a fair value hierarchy based on the inputs to valuation techniques used to measure fair value to increase consistency and comparability. The inputs are categorised into three levels, with the highest priority given to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority given to unobservable inputs.
The diagram below outlines the approach to determining the classification of fair value measurements in the fair value hierarchy.
IFRS 13 refers to a ‘valuation approach’ as a broad category of techniques whereas a ‘valuation technique’ refers to a specific technique such as a particular option pricing model. There are three approaches for valuation techniques used to measure fair value:
- Market approach: uses prices and other relevant information from market transactions involving identical or similar assets or liabilities
- Income approach: converts future amounts (e.g. cash flows or income and expenses) to a single current (discounted) amount
- Cost approach: reflects the amount required currently to replace the service capacity of an asset (frequently referred to as current replacement cost, which differs from the cost incurred).
Management must use valuation techniques that are appropriate in the circumstances and for which sufficient data is available. In some cases, this will
result in more than one technique being used (for example, using both an income and a market approach to value a business or cash generating unit). It is recommended that whichever technique is used by entities, observable inputs should be used rather than unobservable inputs.
Other topics covered in IFRS 13
IFRS 13 also describes the following concepts that may have an impact on how some entities determine fair value:
- For non-financial assets, management must consider the highest and best use of the asset by market participants
- For liabilities, a fair value measurement reflects non-performance risk which is assumed to be the same before and after the transfer of a liability
- The fair value of a liability and an entity’s own equity instruments are measured from the perspective of a market participant holding the identical instrument as an asset
- Transaction price is often, but not always, the best indicator of fair value at initial recognition because entry and exit prices are conceptually different
- When an entity manages a group of financial assets and liabilities based on its net exposure to market risks or credit risks, an entity is permitted to measure the fair value of that group based on the sale or transfer of its net position but only if certain criteria are met.
US GAAP comparison
IFRS 13 is largely consistent with Topic 820 but there are some differences:
- Measuring the fair value of investments in investment entities – US GAAP contains a practical expedient that permits use without adjustment of the reported net asset value of an investment in an investment entity as a measure of the fair value if certain criteria are met. IFRS 13 does not include a similar practical expedient.
- Measuring the fair value of a financial liability with a demand feature – US GAAP describes the fair value measurement of a deposit liability as the amount payable on demand at the reporting date. Under IFRS 13 the fair value measurement of a financial liability with a demand feature cannot be less than the present value of the amount payable on demand.
- Disclosures – There are some differences in disclosure requirements. For example, IFRS 13 requires a quantitative sensitivity analysis for financial instruments that are measured at fair value and categorized in Level 3 of the fair value hierarchy. This is not required by Topic 820 which also has different disclosures for non-public entities.
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