Scope of IFRS 13
IFRS 13 applies to all fair value measurements required or permitted by other IFRS. Certain exceptions are specified in paragraphs IFRS 13.6-7.
Definition of fair value and measurement approach
Fair value is defined 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 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
- the valuation technique(s) appropriate for the measurement
The asset or liability
Particular asset or liability and its characteristics
IFRS 13 clarifies that fair value measurement is for 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 the sale or use of the asset. 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).
Restrictions on the sale or use of the asset
Care must be taken when assessing the impact of restrictions on the fair value measurement. The restrictions that are specific only to the reporting entity 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.
Different and more specific treatment of restrictions applies to liabilities, see below.
Unit of account
Overview of the unit of account issue
Unit of account is the level at which an asset or a liability is aggregated or disaggregated in an IFRS 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).
PxQ (price times quantity)
The ‘PxQ’ issue relates to holdings of many identical assets or liabilities (usually shares in a listed entity). The question is then 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).
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. It is argued that e.g. 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.
In 2014 IASB issued a proposed amendment to relevant IFRS Standards to explicitly clarify that PxQ should also be used for measuring recoverable amount based on fair value less costs of disposal of CGUs that correspond to a subsidiary listed on an active market. This amendment in now included in post-implementation review to IFRS 13 and it is not yet decided whether IASB will finalise it.
For now, 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.
Unit of account and the valuation premise for non-financial assets
Valuation premise for non-financial assets is discussed later in this chapter. 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, which 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, which 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
- are motivated but not forced or otherwise compelled to enter into a transaction
See also Example 1 accompanying IFRS 13.
The price in the fair value definition
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 and transport costs
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 to include 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).
Application to non-financial assets
Highest and best use for non-financial assets
Fair value of a non-financial asset should be determined with reference to its highest and best use, i.e. the use that would maximise the value of the asset. Highest and best use is determined from a perspective of market participants, even if the entity intends a different use or no use at all. If the highest and best use of an asset is to use the asset in combination with other assets (and liabilities) as a group, the fair value is determined assuming that the other assets (and liabilities) are available to market participants. See paragraphs IFRS 13.27-30; IFRS 3.B43 for more discussion. See also Examples 1-3 accompanying IFRS 13.
The reasons for developing additional valuation premise for non-financial assets (as compared to financial assets) are given in paragraph IFRS 13.BC63.
Valuation on a stand-alone basis or with other assets as a group
Depending on the determination of the highest and best use, the fair value of a non-financial asset can be measured (IFRS 13.31; B3):
- on a stand-alone basis
- in combination with other assets as a group or with other assets and liabilities. An asset’s use in combination with other assets can be incorporated into the fair value measurement through:
- Adjustments to the value of the asset used on a stand-alone basis. For example, the determination of fair value of installed and configured machinery starts with a fair value of an uninstalled and not configured items, and is then increased by the installation and configuration costs.
- The assumptions made by market participants that have acquired or would acquire other necessary other assets. For example, work in progress inventory can be measured with the assumption that market participants would convert the work in progress into finished goods.
- Valuation technique used to measure the fair value of the asset. Multi-period excess earnings method is a typical example of this approach. See the example on valuation of a customer base acquired in a business combination below.
- Allocation of a fair value of the whole group of assets to individual assets of the group using reasonable allocation methods.
Liabilities associated with the asset and with the complementary assets include liabilities that fund working capital, but do not include liabilities used to fund assets other than those within the group of assets. Financing liabilities are entity specific and should be excluded from calculation of fair value of assets.
Assumptions about the highest and best use of a non-financial asset should be consistent for all the assets (for which highest and best use is relevant) of the group of assets or the group of assets and liabilities within which the asset would be used (IFRS 13.31).
Example 1 accompanying IFRS 13 illustrates application of the valuation premise described above.
Application to liabilities and an entity’s own equity instruments
Overview of requirements relating to liabilities and own equity instruments
A fair value measurement assumes that a financial or non-financial liability or an entity’s own equity instrument is transferred to a market participant at the measurement date. The transfer assumes the following (IFRS 13.34):
(a) A liability remains outstanding and the market participant transferee is required to fulfil the obligation (i.e. it is not a price that would be paid to a current creditor to extinguish the liability).
(b) An entity’s own equity instrument remains outstanding and the market participant transferee takes on the rights and responsibilities associated with the instrument (i.e. it is not a price that would be paid to a current equity holder to extinguish the instrument).
If possible, the fair value of a liability or entity’s own equity instrument should be based on a quoted price for the transfer of an identical or a similar item (IFRS 13.37,40). This is however hardly ever possible as liabilities are rarely transferred. If there is no quoted price for transfer available, the requirements summarised in the following sections apply.
Examples 10-13 accompanying IFRS 13 illustrate the requirements relating to measuring liabilities covered below.
Liabilities and equity instruments held by other parties as assets
When a liability or entity’s own equity instrument is held by another party as an asset, the fair value should be measured from the perspective of a market participant that holds the identical item as an asset. In such cases, the fair value should be measured (IFRS 13.37-38):
(a) using the quoted price in an active market for the identical item held by another party as an asset, if that price is available.
(b) if that price is not available, using other observable inputs, such as the quoted price in a market that is not active for the identical item held by another party as an asset.
(c) if the observable prices in (a) and (b) are not available, using another valuation technique, such as an income approach or market approach (covered below in section on valuation techniques)
Quoted prices may need to be adjusted for factors specific to the asset and not applicable to the fair value measurement of the liability or equity instruments (examples are given in paragraph IFRS 13.39).
Liabilities and equity instruments not held by other parties as assets
If a liability or entity’s own equity instrument is not held by another party as an asset (e.g. decommissioning liability), the fair value should be measured using appropriate valuation techniques from the perspective of a market participant that owes the liability or has issued the claim on equity. For example, the valuation technique can take into account (IFRS 13.40-41):
(a) 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 (more discussion in paragraphs IFRS 13.B31–B33 and see Example 11 accompanying IFRS 13).
(b) the amount that a market participant would receive to enter into or issue an identical liability or equity instrument, using the assumptions that market participants would use when pricing the identical item (e.g. having the same credit characteristics) in the principal (or most advantageous) market for issuing a liability or an equity instrument with the same contractual terms.
The fair value of a liability reflects the effect of non-performance risk which should be assumed to be the same before and after the transfer of the liability (IFRS 13.42). Non-performance risk is the risk that an entity will not fulfil an obligation. Non-performance risk includes mainly the entity’s own credit risk, but can include also other risks, e.g. operational risk. Therefore, an entity takes into account the effect of its credit risk and any other factors that might influence the likelihood that the obligation will or will not be fulfilled (IFRS 13.43).
It is important to treat non-performance risk consistently with the unit of account, e.g. to exclude from the fair value measurement any credit enhancements that are accounted for separately from the liability (IFRS 13.44). Generally speaking, credit enhancements provided by the issuer (e.g. collateral) will be included in the fair value measurement of a related liability, whereas credit enhancements provided by a third party (e.g. a financial guarantee) will be excluded.
See an example in paragraph IFRS 13.IE32 and Example 10 accompanying IFRS 13.
Restrictions preventing the transfer
As discussed in paragraphs IFRS 13.45-46, restrictions preventing the transfer of a liability or an entity’s own equity instrument are not treated as a separate input to fair value measurement.
Financial liability with a demand feature
The fair value of a financial liability with a demand feature (e.g. a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid (IFRS 13.47).
Application to financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk
An entity that holds a group of financial assets and financial liabilities is exposed to market risks (currency risk, interest rate risk, other price risk) and to the credit risk of each of the counterparties. If the entity manages that group of financial assets and financial liabilities on the basis of its net exposure to either market risks or credit risk, the entity is permitted to apply an exception to IFRS 13 for measuring fair value. That exception permits an entity to measure the fair value of a group of financial assets and financial liabilities on the basis of the price that would be received to sell a net long position (i.e. an asset) for a particular risk exposure or paid to transfer a net short position (i.e. a liability) for a particular risk exposure in an orderly transaction between market participants at the measurement date under current market conditions (IFRS 13.48). An entity may use this exception if it meets the criteria set out in paragraph IFRS 13.49.
See more discussion in paragraphs IFRS 13.50-56.
Fair value at initial recognition
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 below.
Overview of valuation techniques
The three widely used valuation techniques cited by IFRS 13 are the market approach, the cost approach and the income approach. Entities should choose a technique, or combination of techniques, that is most appropriate in the circumstances and for which sufficient data are available to measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs (IFRS 13.61-63).
When a fair value at initial recognition equals the transaction price and subsequent fair valuation uses unobservable inputs, the valuation technique should be calibrated so that the result of the valuation technique equals the transaction price at initial recognition. This is a way of validating the valuation technique and is discussed further in paragraph IFRS 13.64.
Changes to valuation techniques
Valuation techniques used to measure the fair value of an item should be applied consistently. A change in a valuation technique or its application can be made if it results in a measurement that is equally or more representative of fair value in the circumstances. Paragraph IFRS 13.65 gives examples of events that may warrant a change in a valuation technique or its application.
Change in a valuation technique or its application is accounted for as a change in accounting estimate, i.e. prospectively (IFRS 13.66). However, IAS 8 disclosures do not apply as IFRS 13 has its own disclosure requirements in this respect (IFRS 13.93(d)).
The market approach uses prices and other relevant information generated by market transactions involving identical or similar assets and liabilities. Valuation techniques based on market approach often use market multiples derived for certain comparables. For example, businesses are often valued based on their revenue or EBITDA multiples. Matrix pricing is another example given by IFRS 13, where fair value of certain financial instruments (usually bonds) is measured by interpolating values for similar instruments (e.g. similar credit rating of the issuer, maturity etc) arranged in a matrix format (IFRS 13.B5-B7).
Market approach is usually used for measurement of:
- cash generating units (CGU) and businesses (by reference to quoted prices or transactions in the same industry and based on revenue/EBITDA/other multiples)
- properties (by reference to transactions for similar properties)
The cost approach, often referred to as a current replacement cost, aims to reflect the amount that would be currently required to replace the service capacity of an asset adjusted for obsolescence (e.g. physical deterioration, technological or economic obsolescence). This valuation technique assumes that a market participant would not pay more for an asset than the amount for which it could obtain the service capacity of that asset elsewhere.
Cost approach is usually used for measurement of:
- tangible assets that are developed internally or
- assets that are used in combination with other assets and liabilities (IFRS 13.B8-B9)
Example: current replacement cost of specialised equipment
On 1 January 20X1, Entity A acquired a specialised piece of equipment for $1 million. 31 December 20X4, Entity A was acquired by Entity X and Entity X must recognise this equipment at fair value under IFRS 3 requirements. The equipment was heavily tailored for the needs of Entity A and there is no identical or even very similar equipment available ‘off the shelf’. In order to overcome this obstacle, Entity X obtains price lists of pieces of equipment similar to that held by Entity A at 1 January 20X1 and 31 December 20X4 and determined that they have risen by 20%. Entity X determines that this is the reasonable approximation of an increase in price that would have to be paid to obtained the tailored equipment held by Entity A. Therefore, the replacement cost of a new piece of identical equipment is determined to be $1.2 million. This however is not equal to the fair value as at 31 December 20X4, as it has to adjusted to take obsolescence into account. Field experts working at Entity A determined that the equipment should be valued at 70% of the new equivalent. Therefore, the fair value is determined to be $0.84 million ($1.2 m x 70%).
Overview of income approach
The income approach converts future amounts (e.g. cash flows or income and expenses) to a single discounted amount taking into account, inter alia, risk and uncertainty (see IFRS 13.B15-B17). When the income approach is used, the fair value measurement reflects current market expectations about those future amounts. Examples of valuations techniques consistent with income approach given by IFRS 13 include present value techniques, option pricing models and the multi-period excess earnings method (IFRS 13.B10-B11).
Present value techniques
Overview of present value techniques
Present value techniques are covered relatively extensively in application guidance to IFRS 13 (IFRS 13.B12-B30). IFRS 13 focuses on discount rate adjustment technique and expected cash flow technique, but this does not limit the use of other techniques (IFRS 13.B12). In general, present value techniques discount estimated future cash flows to a present amount using an appropriate discount rate. Paragraph IFRS 13.B13 lists elements that a present value technique should incorporate whereas general principles can be found in IFRS 13.B14.
Discount rate adjustment technique and expected cash flow technique covered by IFRS 13 differ in how they adjust for risk and in the type of cash flows they use. See more discussion in paragraphs IFRS 13.B15-B17.
Present value techniques are usually used for measurement of:
- cash generating units (CGU) and businesses (based estimated revenue and expenses)
- financial assets/liabilities when quoted prices are not available for identical or similar items (based on contractual and/or estimated cash flows)
- investment properties (based estimated rental revenue and operating expenses)
Discount rate adjustment technique
The discount rate adjustment technique uses a single set of cash flows from the range of possible estimated amounts, whether contractual/ promised or most likely cash flows. These cash flows are then discounted using an observed or estimated market rate of return. All the risk is therefore reflected in the discount rate. See more discussion and a simple example contained in paragraphs IFRS 13.B18-B22. Discount rate adjustment technique is used much more often than the expected present value technique covered below.
Expected present value technique
Expected present value technique is built on an expected value that is widely used is statistics. It starts with a number of possible future cash flows with assigned probabilities that make up a single amount being the probability-weighted average. See more discussion in paragraphs IFRS 13.B23-B24.
IFRS 13 distinguishes 2 methods of executing the expected value technique (see IFRS 13.B25-B30), however this distinction is overkill in my opinion and I cannot imagine Method 1 to be common in practice. Therefore, when expected present value technique is referred on this website, it is Method 2 as specified by IFRS 13. The difference between the expected present value technique and the discount rate adjustment technique boils down to the treatment of uncertainty of the cash flows as illustrated below.
Example: difference between discount rate adjustment technique and expected present value technique
Assume that expectations about cash flows from a financial asset in one year time are as follows, risk-free interest rate is 5% and market risk premium is 3% (IFRS 13.B27):
|Possible cash flows||Probability|
The fair value measurement using the two techniques is as follows:
|Technique||Expected present |
|Cash flows||$780 (1)||$800 (2)|
|Discount rate breakdown:|
|Market risk premium||3%||3%|
|Premium for the uncertainty of the cash flows||n/a (3)||2.80%|
(1) Probability-weighted cash flows.
(2) Most likely cash flows.
(3) Already included in the probability-weighted cash flows.
Multi-period excess earnings method
Multi-period excess earnings method is mentioned in IFRS 13 as a method to measure the fair value of an intangible asset because that valuation technique specifically takes into account the contribution of any complementary assets and the associated liabilities in the group in which such an intangible asset would be used (IFRS 13.B3(d); B11(c)). Some indirect references are also made in basis for conclusions to IFRS 3, where this method is described as a valuation technique where a contributory asset charge is required to isolate the cash flows generated by the intangible asset being valued from the contribution to those cash flows made by other assets and the contributory asset charges are described as hypothetical ‘rental’ charges for the use of those other contributing assets (IFRS 3.BC177). See the example of application of multi-period excess earnings method to the measurement of fair value of a customer base and customer relationship acquired in a business combination.
Multi-period excess earnings method is usually used for measurement of intangible assets that are not readily obtainable by other entities (e.g. customer base – see example below).
Entity AC is a company providing cable TV to its customers. On 1 January 20X1, it acquires Entity TC – one of its local competitors. TC has 100,000 customers on acquisition date. Acquisition accounting (see IFRS 3) requires AC to recognise the acquired customer base at fair value separately from goodwill. Therefore AC prepared a valuation using multi-period excess earnings method that is presented below. I highly recommend that you see the calculations in an excel file available for download.
Cash flow projections for the customer base and customer relationship:
Note: you can scroll the table horizontally if it doesn’t fit your screen
|Customer care costs||200.0||193.3||183.3||177.3||166.7||160.0|
|Allocation of |
|Profit before tax||294.0||284.2||269.5||260.7||245.0||235.2|
|Hypothetical tax at 20%||58.8||56.8||53.9||52.1||49.0||47.0|
|Cash flow after tax||235.2||227.4||215.6||208.5||196.0||188.2|
(1) The terminal year represents cash flow projection beyond the period covered by the forecast, it usually is equal or close to the last year covered by the forecast.
(2) Revenue is declining as customers switch to competitors, no new customers are taken into account as this valuation relates to existing customer base only.
Other inputs to the valuation are:
- Post-tax discount rate at 7% (can be WACC which is discussed in chapter covering IAS 36, but may be adjusted depending on the nature of the asset being measured) and
- PGR (perpetuity growth rate) at 4.36% – estimated growth rate beyond period covered by cash flow projections (it will always be negative for customer base – see the comment for revenue under the table above).
The calculation gives a total fair value of $2,231m, which can be split as follows:
- $924m: Present value of cash flows for years 20X1 to 20X5
- $1,307m: Present value of terminal year
As said above, all calculations are available in an excel file.
Relief from royalty method
Relief from royalty method is used for valuations of assets that are subject to licensing, such as brands or patents. Under this method, the fair value of such an asset is calculated as a present value of royalties that would have to be paid to the hypothetical owner of the brand (or other asset).
Use of multiple valuation techniques
IFRS 13 notes that there will be cases where multiple valuation techniques will be appropriate to measure fair value. In such cases, it is likely that different valuation techniques will yield different results and fair value measurement should be the point within that range that is most representative of fair value in the circumstances (IFRS 13.63). A wide range of fair value measurements may be an indication that further analysis is needed (IFRS 13.B40). Examples 4 and 5 accompanying IFRS 13 illustrate the use of multiple valuation techniques.
International valuation standards
The International Valuation Standards Council (IVSC), an independent organisation, publishes International Valuation Standards (IVS) that can used as a best practice in preparing a valuation. They are gaining in popularity and recognition among valuation experts.
Inputs to valuation techniques
Valuation techniques used to measure fair value shall maximise the use of relevant observable inputs and minimise the use of unobservable inputs (IFRS 13.67). Inputs should be consistent with the characteristics of an item being measured that market participants would take into account in a transaction for the item. When there is no quoted price available (Level 1 input – see below), an adjustment to a valuation technique may be needed to reflect the characteristics of an item being measured (IFRS 13.69).
Examples of markets in which inputs might be observable include exchange markets, dealer markets, brokered markets and, much less often, principal-to-principal markets (IFRS 13.B34).
Premiums or discounts
Premium or discounts can be taken into account when measuring fair value if they are consistent with the unit of account and would be taken into account by market participants. For example, control premium for a controlling stake in a unlisted subsidiary can be taken into account, i.e. the fair value of a an investment in a subsidiary is greater than the fair value of individual assets and liabilities (IFRS 13.69). There is however as specific ‘PxQ‘ prescription for subsidiaries listed in an active market as discussed above.
Premiums or discounts that reflect size the entity’s holding rather than a characteristic of the asset or liability are not permitted in a fair value. Specifically, a blockage factor is not allowed to be taken into account (IFRS 13.69;80). Blockage factor is an adjustment to the quoted price of an asset or a liability to reflect the fact that market’s normal daily trading volume is not sufficient to absorb the quantity of instruments held by the entity.
Bid and ask prices
If an asset or a liability measured at fair value has a bid price and an ask price, IFRS 13 permits to use (IFRS 13.70-71):
- price within the bid-ask spread
- bid prices for assets and ask prices for liabilities
- mid-market pricing or other pricing conventions that are used by market participants
Fair value hierarchy
Overview of fair value hierarchy
For disclosure and comparability purposes, IFRS 13 establishes a fair value hierarchy that categorises the inputs to valuation techniques used to measure fair value into three levels (IFRS 13.72):
- Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date
- Level 2: inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly
- Level 3: unobservable inputs
When inputs used to measure fair value fall into different levels, the whole fair value measurement is categorised in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement (IFRS 13.73, 75).
Level 1 inputs
Overview of level 1 inputs
As mentioned earlier, Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. A typical examples of Level 1 inputs are prices of financial assets and liabilities traded on stock exchanges that meet the definition of an active market.
A quoted price in an active market provides the most reliable evidence of fair value and should be used without adjustment to measure fair value whenever available (IFRS 13.76-77). As an exception to this rule, adjustments to Level 1 inputs are permitted in circumstances specified in paragraph IFRS 13.79.
An active market is 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 (IFRS 13.Appendix A).
Level 2 inputs
Overview of level 2 inputs
As mentioned earlier, Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly (including market-corroborated data). Examples of Level 2 inputs are given in paragraph IFRS 13.82 and paragraph IFRS 13.B35 gives examples of Level 2 inputs for particular assets and liabilities.
Over-the-counter (OTC) derivatives
Over-the-counter (OTC) derivatives are very common among entities and serve as hedging instruments (irrespective of whether the hedge accounting is applied). OTC derivatives cannot, by definition, be included in Level 1 inputs as they are tailored to meet the needs of a particular entity and there are no quoted prices for identical instruments.
Level 3 inputs
As mentioned earlier, Level 3 inputs are unobservable inputs and are used when relevant observable inputs are not available. Unobservable inputs should be developed using the information available to the entity, which can often be entity’s own data adjusted to take into account assumptions of other market participants and exclude entity-specific factors (IFRS 13.86-87, 89). As noted in paragraph IFRS 13.88, fair value measurement based on Level 3 inputs should take assumptions about risk into account.
Paragraph IFRS 13.B36 gives examples of Level 3 inputs for particular assets and liabilities.
Disclosure requirements are set out in paragraphs IFRS 13.91-99. It is worth noting that these disclosure requirements do not apply to fair value measurement at initial recognition (IFRS 13.BC184).
Other IFRS Standards require disclosure of fair value for assets and liabilities that are not measured at fair value in the statement of financial position (e.g. IFRS 7 for financial assets and liabilities). Certain disclosure requirements of IFRS 13 apply also to such disclosures as specified in paragraph IFRS 13.97.
Disclosure requirements of IFRS 13 are illustrated in Examples 15-19 accompanying this standard.
© 2018-2019 Marek Muc
Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.