When measuring the fair value of financial or non-financial liabilities or an entity’s own equity instruments, it is assumed that these are being transferred to a market participant on the measurement date. Under IFRS 13.34, this transfer is characterised by two key assumptions:
- The liability remains outstanding and the receiving market participant (the transferee) is obliged to fulfil the existing obligations. This value is not equivalent to the amount a current creditor would accept to cancel the liability.
- The entity’s equity instrument also remains active, with the transferee assuming all associated rights and responsibilities. This value differs from what a current equity holder would accept to surrender their interest.
Ideally, the fair value of a liability or equity instrument should reflect the quoted price for transferring an identical or similar item (IFRS 13.37, 40). However, this is often not feasible as liabilities are seldom transferred. In the absence of such quoted prices, the subsequent guidelines apply and IFRS 13’s Examples 10-13 further clarify them.
Liabilities and equity instruments held by other parties as assets
If another party holds a liability or equity instrument as an asset, its fair value should be measured from the viewpoint of a market participant who owns a similar asset. According to IFRS 13.37-38, this can be done by:
- Utilising the quoted price in an active market for the same asset, if available.
- In the absence of such a price, using other observable inputs like the price in a less active market for the same asset.
- If neither of the above are available, alternative valuation techniques like income or market approaches can be employed.
Adjustments to quoted prices might be necessary to reflect asset-specific factors not relevant to the fair value measurement of the liability or equity instrument (refer to IFRS 13.39 for examples).
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Liabilities and equity instruments not held by other parties as assets
For liabilities or equity instruments not held as assets by other parties (e.g., a decommissioning liability), fair value is measured using suitable valuation techniques from the perspective of a market participant who owes the liability or has issued the equity claim. This approach can include (IFRS 13.40-41):
- Estimating future cash outflows that a market participant would likely incur in fulfilling the obligation, along with any compensation required for assuming such obligations (detailed further in IFRS 13.B31–B33 and Example 11 in IFRS 13).
- Determining the amount a market participant would demand for taking on an identical liability or issuing a similar equity instrument, considering the same assumptions market participants would use in pricing (e.g., credit characteristics) in the principal or most advantageous market for issuing an instrument with identical contractual terms.
Non-performance risk
In valuing a liability, it is crucial to consider non-performance risk, which remains constant before and after transferring the liability (IFRS 13.42). Non-performance risk refers to the possibility that an entity may fail to fulfil an obligation. This risk primarily includes the entity’s own credit risk but may also encompass other risks, such as operational risk. Therefore, an entity must consider its credit risk and any other factors that could affect the fulfilment of its obligations (IFRS 13.43).
When assessing non-performance risk, it’s essential to align it with the unit of account. For example, any credit enhancements that are accounted for separately from the liability should not be included in its fair value measurement (IFRS 13.44). Generally, credit enhancements offered by the issuer (like collateral) are included in the fair value measurement of the related liability. In contrast, enhancements provided by a third party (such as a financial guarantee) are excluded. Illustrations of these principles can be found in IFRS 13.IE32 and Example 10 in IFRS 13.
Restrictions on transfer
According to IFRS 13.45-46, restrictions that prevent the transfer of a liability or an entity’s own equity instrument should not be considered separately in the fair value measurement process. Such restrictions are already factored into other valuation components, either implicitly or explicitly.
Financial liabilities with a demand feature
The fair value of a financial liability that includes a demand feature, such as a demand deposit, must not be lower than the amount payable on demand, discounted from the earliest date it could be due (IFRS 13.47).
Application to financial assets and liabilities with offsetting market or credit risks
Entities holding a mix of financial assets and liabilities are subject to market and credit risks, as defined in IFRS 7. If these entities manage their assets and liabilities based on their net exposure to these risks, they may use a specific exception in IFRS 13.48 to measure fair value. This exception allows the fair value of a group of financial assets and liabilities to be determined based on the price to sell a net long position (an asset) or transfer a net short position (a liability) for a particular risk exposure. This measurement must reflect how market participants would price the net risk exposure. To use this exception, entities must manage their assets and liabilities according to their net exposure to a specific market or credit risk, as per their documented risk management strategy, report this information to key management personnel as defined in IAS 24, and measure these assets and liabilities at fair value in their financial statements.
However, this exception does not apply to financial statement presentation. In cases where the presentation of financial instruments differs from their measurement basis, entities may need to allocate portfolio-level adjustments to individual assets or liabilities within the group. This allocation should be done reasonably and consistently, using an appropriate methodology. Importantly, this exception is only applicable to financial assets, financial liabilities, and other contracts that fall under the scope of IFRS 9 (IFRS 13.48-52).
The exception in IFRS 13.48 requires that the risks within the group are substantially the same. For instance, an entity should not combine risks from different categories, like interest rate risk with commodity price risk, as this does not effectively mitigate the exposure. Additionally, any basis risk arising from non-identical market risk parameters must be considered in the fair value measurement. Furthermore, the duration of exposure to the market risks must be closely aligned. For example, if an entity uses a 12-month futures contract to hedge against a 12-month interest rate risk on a five-year financial instrument, the fair value should be measured on a net basis for the 12-month risk and on a gross basis for the remaining period (IFRS 13.53-55).
In the context of credit risk with a specific counterparty, when using this exception, the entity must include the effect of the net exposure to the counterparty’s credit risk in the fair value measurement. This includes considering any arrangements that mitigate credit risk in case of default, such as a master netting agreement or an agreement for collateral exchange based on each party’s net exposure. The fair value measurement should reflect how market participants would view the likelihood of these arrangements being legally enforceable in the event of default (IFRS 13.56).
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