Fair Value Framework (IFRS 13)

Fair value is defined in IFRS 13 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 (IFRS 13.9). In other words, it is a current exit price and it is applicable regardless of whether an entity intends to use an asset or to sell it.

The approach for measuring fair value, set out in paragraph IFRS 13.B2, requires and entity to determine:

  • the particular asset or liability being measured and its unit of account,
  • the valuation premise appropriate for the measurement (applicable to non-financial assets only),
  • the principal (or most advantageous) market for the asset or liability, and
  • the valuation technique(s) appropriate for the measurement.

IFRS 13 clarifies that the fair value measurement relates to a particular asset or liability and its characteristics should be taken into account when measuring fair value. Such characteristics can include the condition and location of the asset and any restrictions on its sale or use. The effect on the measurement arising from a particular characteristic will differ depending on how that characteristic would be taken into account by market participants (IFRS 13.11-12).

Care must be taken when assessing the impact of restrictions on the fair value measurement. The restrictions that are specific to the reporting entity only should not be taken into account if they would not apply to market participant that acquires the asset. See Examples 8 and 9 accompanying IFRS 13.

See also the approach to restrictions preventing the transfer of a liability or an entity’s own equity instrument.

Unit of account is the level at which an asset or a liability is aggregated or disaggregated in an IFRS Standard for recognition purposes. Depending on requirements of a particular IFRS, fair value might be measured for a stand-alone asset or liability, a group of assets, a group of liabilities or a group of assets and liabilities (e.g. a cash-generating unit). Additionally, IFRS 13 has some specific provisions in this respect (IFRS 13.13-14).

The ‘PxQ’ issue relates to holdings of many identical assets or liabilities (usually shares in a listed entity). The question then is whether the fair value of such a holding should be equal to PxQ (price times quantity) or determined for the holding treated as one unit of account (e.g. whether to include control premium in the fair value measurement).

IFRS 13 explicitly requires that when an entity holds a position in a single asset or liability (including a position comprising a large number of identical assets or liabilities, such as a holding of financial instruments) and the asset or liability is traded in an active market, the fair value of the asset or liability should be measured within Level 1 as PxQ. That is the case even if a market’s normal daily trading volume is not sufficient to absorb the quantity held and placing orders to sell the position in a single transaction might affect the quoted price (IFRS 13.80).

The PxQ rule is generally accepted for financial instruments within the scope of IFRS 9, but it is much more controversial when it comes to measuring investments in subsidiaries, associates and joint ventures. Many argue that the whole investment should be treated as one unit of account as this is consistent with the general principle of fair value measurement, i.e. that the characteristics of an asset should be taken into account when measuring fair value. For example, many finance professionals argue that the fact that a shareholding in a subsidiary gives control over it would be taken into account by market participants and therefore it should be allowed to include control premium in fair value measurement. The issue remains controversial, however paragraph IFRS 13.80 makes it clear that PxQ applies to fair value measurement of shares held in subsidiaries, associates and joint ventures traded in an active market.

Valuation premise for non-financial assets is discussed on a separate page. In general, fair value of non-financial assets may be determined with the assumption that they are used with other assets. This does not override the determination of unit of account specified by other IFRS. For example, an investment property will be a unit of account as specified in IAS 40, but its fair value can be measured in combination with other assets as a group or with other assets and liabilities (IFRS 13.32).

A fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date under current market conditions. For the measurement purposes, it should be assumed that the transaction takes place in the principal market for the asset or liability. Principal market is the market with the greatest volume and level of activity for the asset or liability and which the entity has access to.

In the absence of a principal market, in the most advantageous market for the asset or liability should be used as a reference point. This is 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 (IFRS 13.15-16).

An orderly transaction is defined (IFRS 13.Appendix A) as a transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; and it is not a forced transaction (e.g. a forced liquidation or distress sale). Paragraphs IFRS 13.B43-B44 provide guidance on identifying transactions that are not orderly.

See more discussion in paragraphs IFRS 13.17-21 and the Example 6 accompanying IFRS 13.

The fair value of an asset or a liability should be measured using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest (IFRS 13.22-23). Market participants are defined as buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics (IFRS 13.Appendix A):

  • are independent of each other,
  • 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,
  • are able to enter into a transaction for the asset or liability, and
  • are motivated but not forced or otherwise compelled to enter into a transaction.

See also Example 1 accompanying IFRS 13.

An expanded definition of fair value states that it 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 costs should not be taken into account in fair value measurement as they are a characteristic of a transaction, not of an asset or liability that is measured. Some IFRS Standards require measurement at fair value adjusted for ‘costs of disposal’ but it is then clearly stated in a given standard (e.g. IFRS 5). There are IFRS Standards that allow also including transaction costs in the carrying amount at initial recognition for an item that is subsequently measured at fair value (e.g. IAS 40). If this is the case, transaction costs will be effectively taken out of the carrying amount at next valuation, as fair value excludes transaction costs.

Transport costs are not treated as transaction costs by IFRS 13 and they are deducted from fair value measurement if location is a characteristic of the asset. Transport costs are the costs that would be incurred to transport an asset from its current location to its principal (or most advantageous) market (IFRS 13.25-26).

In many cases the transaction price will equal the fair value, but it cannot be assumed that this is always the case. The transaction price is the entry price, whereas, as it was said earlier, fair value is an exit price. Paragraph B4 gives examples of conditions that may indicate that the transaction price may not represent the fair value (IFRS 13.57-59).

When an item is initially recognised at fair value, the difference between the fair value and the transaction price is immediately recognised in P/L unless a given IFRS Standard has other specific provisions (IFRS 13.60). For example IFRS 9 has specific provisions on day 1 gains/losses.

See also considerations relating to bid-ask spreads for financial instruments.

See other pages relating to fair value:

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