Strategic Professional

Strategic Business Reporting (SBR)

CHAPTER
20
IFRS 13: Fair Value
Measurement

Contents
1 Introduction to IFRS 13
2 Measurement
3 Valuation techniques
4 Liabilities and an entity’s own equity instruments
5 Disclosure

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Introduction to IFRS 13

 Background
 Definition of fair value
 The asset or liability
 Market participants

1 Introduction to IFRS 13

1.1 Background
There are many instances where IFRS requires or allows entities to measure or disclose
the fair value of assets, liabilities or their own equity instruments.

Examples include (but are not limited to):

IASs 16/38 Allows the use of a revaluation model for the measurement of
assets after recognition.
Under this model, the carrying amount of the asset is based on
its fair value at the date of the revaluation.
IAS 40 Allows the use of a fair value model for the measurement of
investment property.
Under this model, the asset is fair valued at each reporting date.
IAS 19 Defined benefit plans are measured as the fair value of the plan
assets net of the present value of the plan obligations.
IFRS 9 All financial instruments are measured at their fair value at
initial recognition.
Financial assets that meet certain conditions are measured at
amortised cost subsequently. Any financial asset that does not
meet the conditions is measured at fair value.
Subsequent measurement of financial liabilities is sometimes at
fair value.
IFRS 7 If a financial instrument is not measured at fair value that
amount must be disclosed.
IFRS 3 Measuring goodwill requires the measurement of the
acquisition date fair value of consideration paid and the
measurement of the fair value (with some exceptions) of the
assets acquired and liabilities assumed in a transaction in which
control is achieved.
IFRS 2 Requires an accounting treatment based on the grant date fair
value of equity settled share based payment transactions.

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Other standards required the use of measures which incorporate fair value.
IASs 36 Recoverable amount is the lower of value in use and fair value
less costs of disposal.
IFRS 5 An asset held for sale is measured at the lower of its carrying
amount and fair value less costs of disposal.
Some of these standards contained little guidance on the meaning of fair value. Others
did contain guidance but this was developed over many years and in a piecemeal
manner.
Purpose of IFRS 13
The purpose of IFRS 13 is to:
define fair value;
set out a single framework for measuring fair value; and
specify disclosures about fair value measurement.
IFRS 13 does not change what should be fair valued nor when this should occur.
The fair value measurement framework described in this IFRS applies to both initial
and subsequent measurement if fair value is required or permitted by other IFRSs.
Scope of IFRS 13
IFRS 13 applies to any situation where IFRS requires or permits fair value
measurements or disclosures about fair value measurements (and other measurements
based on fair value such as fair value less costs to sell) with the following exceptions.
IFRS 13 does not apply to:
share based payment transactions within the scope of IFRS 2; or
measurements such as net realisable value (IAS 2 Inventories) or value in use
(IAS 36 Impairment of Assets) which have some similarities to fair value but are
not fair value.
The IFRS 13 disclosure requirements do not apply to the following:
plan assets measured at fair value (IAS 19: Employee benefits);
retirement benefit plan investments measured at fair value (IAS 26: Accounting
and reporting by retirement benefit plans); and
assets for which recoverable amount is fair value less costs of disposal in
accordance with IAS 36.

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1.2 Definition of fair value

Definition: Fair value

Fair value is 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 (i.e. it is an exit price).
This definition emphasises that fair value is a market-based measurement, not an
entity-specific measurement. In other words, if two entities hold identical assets
these assets (all other things being equal) should have the same fair value and this is
not affected by how each entity uses the asset or how each entity intends to use the
asset in the future.
The definition is phrased in terms of assets and liabilities because they are the
primary focus of accounting measurement. However, the guidance in IFRS 13 also
applies to an entity’s own equity instruments measured at fair value (e.g. when an
interest in another company is acquired in a share for share exchange).
Note that the fair value is an exit price, i.e. the price at which an asset would be sold.

Definition: Exit and entry prices

Exit price: The price that would be received to sell an asset or paid to transfer a
liability.
Entry price: The price paid to acquire an asset or received to assume a liability in
an exchange transaction.

1.3 The asset or liability

A fair value measurement is for a particular asset or liability.
Whether the fair value guidance in IFRS 13 applies to a stand-alone asset or liability or
to a group of assets, a group of liabilities or to a group of assets and liabilities
depends on the unit of account for the item being fair valued.

Definition: Unit of account

Unit of account: The level at which an asset or a liability is aggregated or
disaggregated in an IFRS for recognition purposes.
The unit of account for the asset or liability must be determined in accordance with
the IFRS that requires or permits the fair value measurement.
An entity must use the assumptions that market participants would use when
pricing the asset or liability under current market conditions when measuring fair
value. The fair value must take into account all characteristics that a market
participant would consider relevant to the value. These characteristics might
include:
the condition and location of the asset; and
restrictions, if any, on the sale or use of the asset.

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1.4 Market participants

Definition: Market participants

Market participants: Buyers and sellers in the principal (or most advantageous)
market for the asset or liability.
Market participants have all of the following characteristics:
They are independent of each other;
They are knowledgeable, having a reasonable understanding about the asset or
liability and the transaction using all available information, including
information that might be obtained through due diligence efforts that are usual
and customary.
They are able to enter into a transaction for the asset or liability.
They are willing to enter into a transaction for the asset or liability, i.e. they are
motivated but not forced or otherwise compelled to do so.

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Measurement

 Measuring fair value

 Principal or most advantageous market
 Fair value of non-financial assets – highest and best use

2 Measurement

2.1 Measuring fair value

Fair value measurement assumes that the asset (liability) is exchanged in an orderly
transaction between market participants to sell the asset (transfer the liability) at the
measurement date under current market conditions.
Sometimes it might be possible to use observable market transactions to fair value
an asset or a liability (e.g. a share might be quoted on a stock exchange). For other
assets and liabilities this may not be possible. However, in each case the objective is
the same, being to estimate the price at which an orderly transaction to sell the asset
(or transfer a liability) would take place between market participants at the
measurement date under current market conditions.
Active market
If an active market exists then it will provide information that can be used for fair
value measurement.
A quoted price in an active market provides the most reliable evidence of fair
value and must be used to measure fair value whenever available.
It would be unusual to find an active market for the sale of non- financial assets
so some other sort of valuation technique would usually be used to determine
their fair value.

Definition: Active market

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.
If there is no such active market (e.g. for the sale of an unquoted business or surplus
machinery) then a valuation technique would be necessary.

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2.2 Principal or most advantageous market

Fair value measurement is based on a possible transaction to sell the asset or
transfer the liability in the principal market for the asset or liability.
If there is no principal market fair value measurement is based on the price
available in the most advantageous market for the asset or liability.

Definitions: Most advantageous market and principal market

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 taking into account transaction costs and transport costs.
Principal market: The market with the greatest volume and level of activity for the
asset or liability.

Identifying principal market (or most advantageous market)

It is not necessary to for an entity to make an exhaustive search to identify the
principal market (or failing that, the most advantageous market). However, it
should take into account all information that is reasonably available.
Unless there is evidence to the contrary, principal market (or failing that, the most
advantageous market) is the one in which an entity normally enters into
transactions to sell the asset or to transfer the liability being fair valued.
If there is a principal market for the asset or liability, the fair value measurement
must use the price in that market even if a price in a different market is potentially
more advantageous at the measurement date.
The price in a principal market might either be directly observable or estimated
using a valuation technique.

Transaction costs
The price in the principal (or most advantageous) market used to measure the fair
value of the asset (liability) is not adjusted for transaction costs. Note that:
fair value is not “net realisable value” or “fair value less costs of disposal”; and
using the price at which an asset can be sold for as the basis for fair valuation
does not mean that the entity intends to sell it

Transport costs
If location is a characteristic of the asset the price in the principal (or most
advantageous) market is adjusted for the costs that would be incurred to transport
the asset from its current location to that market.

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Example: Fair valuation

An entity holds an asset which could be sold in one of two markets.
Information about these markets and the costs that would be incurred if a sale
were to be made is as follows:
Market A Market B
$ $
Sale price 650 625
Transport cost (50) (50)
600 575
Transaction cost (75) (25)
Net amount received 525 550
(a) What fair value would be used to measure the asset if Market A were the
principal market?
(b) What fair value would be used to measure the asset if no principal market
could be identified?

Answer
(a) If Market A is the principal market for the asset the fair value of the asset
would be measured using the price that would be received in that market,
after taking into account transport costs ($600).
(b) If neither market is the principal market for the asset, the fair value of the
asset would be measured using the price in the most advantageous market.
The most advantageous market is the market that maximises the amount
that would be received to sell the asset, after taking into account transaction
costs and transport costs (i.e. the net amount that would be received in the
respective markets). This is Market B where the net amount that would be
received for the asset would be $550.
The fair value of the asset is measured using the price in that market ($625),
less transport costs ($50), resulting in a fair value measurement of $575.
Transaction costs are taken into account when determining which market is
the most advantageous market but the price used to measure the fair value
of the asset is not adjusted for those costs (although it is adjusted for
transport costs).

Different entities might have access to different markets. This might result in
different entities reporting similar assets at different fair values.

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2.3 Fair value of non-financial assets – highest and best use

Fair value measurement of a non-financial asset must value the asset at its highest
and best use.
Highest and best use is a valuation concept based on the idea that market
participants would seek to maximise the value of an asset.

Definition: Highest and best use

Highest and best use: 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 (e.g. a
business) within which the asset would be used.
This must take into account use of the asset that is:
physically possible;
legally permissible; and
financially feasible.
The current use of land is presumed to be its highest and best use unless market or
other factors suggest a different use.

Example: Highest and best use

X Limited acquired a plot of land developed for industrial use as a factory. A
factory with similar facilities and access has recently been sold for $50 million.
Similar sites nearby have recently been developed for residential use as sites for
high-rise apartment buildings.
X Limited determines that the land could be developed as a site for residential use
at a cost of $10 million (to cover demolition of the factory and legal costs associated
with the change of use). The plot of land would then be worth $62 million.
The highest and best use of the land would be determined by comparing the
following:

$ million
Value of the land as currently developed 50
Value of the land as a vacant site for residential use
($62 million – $10 million) 52
Conclusion: The fair value of the land is $52 million.

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Valuation Techniques

 Objective of valuation techniques

 Inputs to valuation techniques
 Fair value hierarchy
 Bid/offer prices

3 Valuation techniques

3.1 Objective of valuation techniques

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 at the measurement date under current market
conditions.
IFRS 13 requires that one of three valuation techniques must be used:
market approach – uses prices and other relevant information from market
transactions involving identical or similar assets and liabilities;
cost approach – the amount required to replace the service capacity of an asset
(also known as the current replacement cost);
income approach – converts future amounts (cash flows, profits) to a single
current (discounted) amount.
An entity must use a valuation technique that is appropriate in the circumstances
and for which sufficient data is available to measure fair value, maximising the use
of relevant observable inputs and minimising the use of unobservable inputs.

3.2 Inputs to valuation techniques

An entity must use valuation techniques that are appropriate in the circumstances
and for which sufficient information is available to measure fair value.
A valuation technique should be used to maximise the use of relevant observable
inputs and minimise the use of unobservable inputs.

Definition: Inputs
Inputs: The assumptions that market participants would use when pricing the
asset or liability, including assumptions about risk, such as the following:
(a) the risk inherent in a particular valuation technique used to measure fair
value (such as a pricing model); and
(b) the risk inherent in the inputs to the valuation technique.
Quoted price in an active market provides the most reliable evidence of fair value
and must be used to measure fair value whenever available.

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3.3 Fair value hierarchy

IFRS 13 establishes a fair value hierarchy to categorise inputs to valuation
techniques into three levels.
Definition Examples
Level 1 Quoted prices in active Share price quoted on the London
markets for identical Stock Exchange
assets or liabilities that the
entity can access at the
measurement date
Level 2 Inputs other than quoted Quoted price of a similar asset to the
prices included within one being valued.
Level 1 that are observable Quoted interest rate.
for the asset or liability,
either directly or
indirectly.
Level 3 Unobservable inputs for Cash flow projections.
the asset or liability.

3.4 Bid /Offer prices

For some assets (liabilities) markets quote prices that differ depending on whether
the asset is being sold to or bought from the market.
The price at which an asset can be sold to the market is called the bid price (it is
the amount the market bids for the asset).
The price at which an asset can be bought from the market is called the ask or
offer price (it is the amount the market asks for the asset or offers to sell it for).
The price within the bid-ask spread that is most representative of fair value in the
circumstances must be used to measure fair value.
Previously, bid price had to be used for financial assets and ask price for financial
liabilities but this is no longer the case.

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Liabilities and an entity’s own equity instruments

 General principles
 Liabilities and equity instruments held by other parties as assets
 Liabilities and equity instruments not held by other parties as assets
 Financial assets and financial liabilities managed on a net basis

4 Liabilities and an entity’s own equity instruments

4.1 General principles

Fair value measurement assumes the transfer of an item to a market participant at
the measurement date.
The fair valuation of a liability assumes that it will not be settled with the
counterparty at the measurement date but would remain outstanding. In other
words, the market participant to whom the liability could be transferred would be
required to fulfil the obligation.
The fair valuation of an entity’s own equity instrument assumes that the market
participants to whom the instrument could be transferred would take on the rights
and responsibilities associated with the instrument.
The same guidance that applies to the fair value of assets also applies to the fair
value of liabilities and an entity’s own equity instruments including that:
an entity must maximise the use of relevant observable inputs and minimise the
use of unobservable inputs; and
quoted price in an active market must be used to measure fair value whenever
available.
In the absence of an active market there might be an observable market for items
held by other parties as assets.

4.2 Liabilities and equity instruments held by other parties as assets

If a quoted price for the transfer of an identical or a similar liability or entity’s own
equity instrument is not available it may be possible to measure fair value from the
point of view of a party that holds the identical item as an asset at the measurement
date.
If this is the case fair value is measured as follows:
using the quoted price in an active market (if available) for the identical item
held by another party as an asset; or failing that
using other observable inputs (e.g. quoted price in a market that is not active for
the identical item held by another party as an asset); or failing that
another valuation technique (e.g. using quoted prices for similar liabilities or
equity instruments held by other parties as assets (market approach).

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Adjustments to quoted price

There might be factors that are specific to the asset held by the third party that are
not applicable to the fair value of the liability or entity’s own equity.
The quoted price of such items is adjusted for such factors. For example, a quoted
price might relate to a similar (but not identical) liability or equity instrument held
by another party as an asset.
However, the price of the asset must not reflect the effect of a restriction preventing
the sale of that asset.

4.3 Liabilities and equity instruments not held by other parties as assets
In this case fair value is measured from the perspective of a market participant that
owes the liability or has issued the claim on equity.
For example, when applying a present value technique an entity might take into
account the future cash outflows that a market participant would expect to incur in
fulfilling the obligation (including the compensation that a market participant
would require for taking on the obligation).

4.4 Financial assets and financial liabilities managed on a net basis

An entity might manage a group of financial assets and financial liabilities on the
basis of its net exposure to either market risks or credit risk.
In this case the entity is allowed to measure the fair value net position (i.e. a net
asset or a net liability as appropriate).
This is an exception to the general rules in IFRS 13 which would otherwise apply
separately to the asset and the liability. It applies only to financial assets and
financial liabilities within the scope of IFRS 9: Financial instruments.
The exception is only allowed if the entity does all the following:
It manages the group of financial assets and financial liabilities on the basis of
the entity’s net exposure to a particular risk (market risk or credit risk of a
particular counterparty) in accordance with its documented risk management
or investment strategy;
It provides information on that basis about the group of financial assets and
financial liabilities to the entity’s key management personnel; and
It measures those financial assets and financial liabilities at fair value in the
statement of financial position at the end of each reporting period.

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Disclosure

 Recurring and non-recurring fair value measurement

 Overall disclosure objective
 Disclosures

5 Disclosure

5.1 Recurring and non-recurring fair value measurement

The fair value measurement of assets and liabilities might be recurring or non-
recurring.
Recurring fair value measurements are those that are required or permitted in
the statement of financial position at the end of each reporting period (e.g. the
fair value of investment property when the IAS 40 fair value model is used);
Non-recurring fair value measurements are those that are required or permitted
in the statement of financial position in particular circumstances (e.g. when an
entity measures an asset held for sale at fair value less costs to sell in accordance
with IFRS 5).
Disclosures are necessary in respect of each of the above.

5.2 Overall disclosure objective

Information must be disclosed to help users assess both of the following:
the valuation techniques and inputs used to measure the fair value assets and
liabilities on a recurring or non-recurring basis;
the effect on profit or loss or other comprehensive income for the period of
recurring fair value measurements using significant unobservable inputs (Level
3).
All of the following must be considered to meet the above objectives:
the level of detail necessary to satisfy the disclosure requirements;
how much emphasis to place on each of the various requirements;
how much aggregation or disaggregation to undertake; and
the need for additional information.
Classes of assets and liabilities
Classes of assets and liabilities must be identified for the purpose of fulfilling the
minimum disclosure requirements of IFRS 7: Financial Instruments: Disclosure.
Appropriate classes are identified on the basis of the following:
the nature, characteristics and risks of the asset or liability; and
the level of the fair value hierarchy within which the fair value measurement is
categorised.

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5.3 Disclosures
The following information must be disclosed as a minimum for each class of assets
and liabilities measured at fair value in the statement of financial position after
initial recognition.
For recurring and non-recurring fair value measurements
The fair value measurement at the end of the reporting period and the reasons for
the measurement for non-recurring fair value measurements
The level of the fair value hierarchy within which the fair value measurements are
categorised in their entirety (Level 1, 2 or 3).
For fair value measurements categorised within Level 2 and Level 3 of the fair value
hierarchy:
a description of the valuation technique(s) and the inputs used in the fair value
measurement;
the reason for any change in valuation technique;
Quantitative information about the significant unobservable inputs used in the fair
value measurement for fair value measurements categorised within Level 3 of the
fair value hierarchy.
A description of the valuation processes used for fair value measurements
categorised within Level 3 of the fair value hierarchy.
The reason why a non-financial asset is being used in a manner that differs from its
highest and best use when this is the case.
For recurring fair value measurements
The amounts of any transfers between Level 1 and Level 2 of the fair value
hierarchy, the reasons for those transfers and the entity’s policy for determining
when transfers between levels are deemed to have occurred.
For fair value measurements categorised within Level 3 of the fair value hierarchy:
a reconciliation of opening balances to closing balances, disclosing separately
changes during the period attributable to the following:
 total gains or losses recognised in profit or loss (and the line items in which
they are recognised);
 unrealised amounts included in the above;
 total gains or losses recognised in other comprehensive income (and the line
item in which they are recognised);
 purchases, sales, issues and settlements;
 details of transfers into or out of Level 3 of the fair value hierarchy;
for recurring fair value measurements categorised within Level 3 of the fair
value hierarchy:
 a narrative description of the sensitivity of the fair value measurement to
changes in unobservable inputs;

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 the fact that a change to one or more of the unobservable inputs would
change fair value significantly (if that is the case) and the effect of those
changes.
Other
If financial assets and financial liabilities are managed on a net basis and the fair
value of the net position is measured that fact must be disclosed.

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