Fair Value Framework (IFRS 13)

Fair value, as defined in IFRS 13, is the price that would be obtained from selling an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (IFRS 13.9). This essentially means it represents the current exit price, irrespective of whether the entity plans to use the asset or sell it.

To measure fair value as outlined in IFRS 13.B2, an entity must determine:

  • The specific asset or liability in question and its unit of account.
  • For non-financial assets only, the appropriate valuation premise.
  • The principal or most advantageous market for the asset or liability.
  • Suitable valuation techniques for the measurement.

Let’s delve deeper.

Specific asset or liability and its characteristics

IFRS 13 emphasises that fair value measurement should focus on a specific asset or liability, considering its unique characteristics. These might encompass its condition, location, and any restrictions on its sale or use. How these characteristics impact the valuation depends on their relevance to market participants (IFRS 13.11-12). In particular, restrictions on sale or use that are only pertinent to the reporting entity and wouldn’t be applicable to a market participant acquiring the asset should not impact the fair value measurement.

In certain borrowing arrangements, an investor may pledge securities as collateral to support their debt or other financial commitments. When securities are pledged in this way, the investor is prohibited from selling them while the debt or commitment remains outstanding. Such restrictions on the securities are specific to the entity and should not be taken into account when measuring their fair value.

See also Examples 8 and 9 of IFRS 13.

Unit of account

The ‘unit of account’ refers to how assets or liabilities are grouped or separated in IFRSs for recognition. Depending on the specific IFRS, fair value may be measured for an individual asset or liability, a group of assets, liabilities, or both. The unit of account should be determined in accordance with the IFRS that requires or permits the fair value measurement, unless IFRS 13 specifies otherwise.

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PxQ (price multiplied by quantity)

The ‘PxQ’ issue pertains to holdings of many identical assets or liabilities, such as shares in a publicly traded company. The debate is whether the fair value should equate to PxQ or be measured considering the entire holding as a single unit of account. IFRS 13 clearly states that if an entity holds a position in a single asset or liability (including a significant number of identical ones) traded in an active market, its fair value should be measured at Level 1 as PxQ. This remains true even if selling all at once might influence the quoted price (IFRS 13.80).

Whilst the PxQ rule is widely accepted for financial instruments in IFRS 9’s scope, it becomes contentious for investments in subsidiaries, associates, and joint ventures. The debate centres around whether control premiums should be factored into fair value measurements. IFRS 13.80, however, specifies that PxQ should be applied to shares in actively traded subsidiaries, associates, and joint ventures.

Valuation premise for non-financial assets

The valuation premise for non-financial assets is discussed on a separate page. Generally, the fair value of these assets may be measured under the presumption that they’re used alongside other assets. However, this does not supersede the ‘unit of account’ definitions provided by other IFRSs. For instance, an investment property’s unit of account is defined in IAS 40, but its fair value might be measured alongside other assets or combined with assets and liabilities (IFRS 13.32).

The transaction

Fair value measurement assumes that an asset or liability is exchanged in an orderly transaction between market participants, reflecting its sale or transfer under prevailing market conditions at the measurement date. Ideally, this transaction should occur in the asset or liability’s principal market, which is the market with the greatest volume and activity level that the entity can access.

If a principal market doesn’t exist, the reference should be the most advantageous market for the asset or liability. This is the market where selling the asset would yield the highest return, or transferring the liability would incur the least cost, after factoring in transaction and transport costs (IFRS 13.15-16).

Determining if a transaction is orderly becomes challenging when there’s a significant decline in the volume or activity level for the asset or liability in question relative to its normal market activity. It’s not appropriate to assume all transactions in such a market are not orderly. Indicators of a potentially disorderly transaction include inadequate market exposure prior to the measurement date, the asset or liability being marketed to only one participant, the seller facing financial distress or bankruptcy, a forced sale due to legal requirements, or the transaction price being notably different from similar recent transactions. Entities must assess available evidence to determine if a transaction is orderly.

When measuring fair value or estimating market risk premiums, entities should weigh the evidence. If a transaction appears disorderly, it should have minimal impact on fair value determination. On the contrary, if it’s deemed orderly, the transaction price should be factored in, with the weight given dependent on factors like transaction volume, its comparability to the asset or liability being measured, and the transaction’s closeness to the measurement date.

In situations where there’s inadequate information to determine orderliness, the transaction price is still considered, albeit with caution, and compared against transactions known to be orderly. Entities aren’t expected to exhaustively verify transaction orderliness but shouldn’t neglect readily available information. If an entity is part of a transaction, it’s assumed they can determine its orderliness (IFRS 13.17-21, B43-B44). Refer also to Example 6 accompanying IFRS 13.

Market participants

The fair value of an asset or a liability should reflect the assumptions market participants would utilise in pricing, under the presumption they are acting in their economic best interest (IFRS 13.22-23). Such participants should (IFRS 13 Appendix A):

  • Be independent of one another.
  • Be well-informed with a comprehensive understanding of the asset, liability, and transaction, using all accessible information (including information that might be obtained through due diligence efforts that are usual and customary).
  • Possess the capability to undertake a transaction for the asset or liability.
  • Be willing but not under any pressure to transact.

See also Example 1 in IFRS 13.

The price

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (i.e., an exit price) regardless of whether that price is directly observable or estimated using another valuation technique (IFRS 13.24).

Transaction and transport costs

While determining fair value, transaction costs are excluded as they pertain more to the transaction than the asset or liability itself. Some IFRSs, however, do take into account the ‘costs of disposal’ when determining fair value, and this is specifically noted where relevant (e.g., FVLCTS). Additionally, standards like IAS 40 might allow the inclusion of transaction costs upon initial recognition of an item later measured at fair value. In such scenarios, these costs are effectively removed from the carrying amount during the next valuation, since fair value excludes them.

Transport costs differ from transaction costs. As per IFRS 13, transport costs are deducted from fair value measurements if location plays a role in determining an asset’s value. They represent the costs involved in moving an asset to its principal or most beneficial market (IFRS 13.25-26). Refer also to Example 6 in IFRS 13.

Fair value at initial recognition

Often, the transaction price might reflect the fair value, but this isn’t a universal rule. The transaction price is the entry price, whereas fair value represents the exit price. For instance, the transaction price may not reflect the fair value in (IFRS 13.57-59, B4):

  • Dealings between related parties, unless there’s evidence the deal was at market terms.
  • Situations where the transaction occurs under pressure, such as when the seller faces financial challenges.
  • Cases where the unit of account for the transaction price differs from that of the asset or liability’s fair value, like in a business combination.
  • Contracts where the price includes transaction costs.
  • When the transaction’s market differs from the principal or most advantageous market.

When initially recognising an item at fair value, any discrepancy between the fair value and transaction price is immediately recognised in P/L, unless another specific IFRS applies (IFRS 13.60). For instance, IFRS 9 restricts immediate recognition of ‘day 1’ gains and losses in profit or loss.

Additional considerations can be found in sections discussing bid-ask spreads for financial instruments.

More about fair value

See other pages relating to fair value:

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