Fair value measurement guidance is spread across various standards. In certain standards the guidance is incomplete or silent. This creates a potential for inconsistencies in the interpretation and application when determining an estimate of fair value.

IFRS 13 consolidates the fair value guidance from across the various standards into a single standard. It clarifies the definition of fair value and provides additional disclosure requirements. It does not change when fair value can or should be used as it only addresses how to measure fair value.

Definition

The new fair value definition is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The exit price approach relates to expectations about the future cash flows from the perspective of market participants at the measurement date, under current market conditions.

IFRS 13 formalises the definition of market participants which is lacking in other standards. Market participants are buyers and sellers in the principal (or most advantageous) market who are independent of each other, knowledgeable about the asset or liability and able and willing to enter into a transaction for the asset or liability. Fair value is determined using market participants assumptions, not entity-specific assumptions. When measuring fair value it should be assumed that market participants act in their economic best interest.

Fair value hierarchy

The standard introduces the concept of a fair value hierarchy that categorises the inputs used in valuation techniques into three levels:

  • Level 1 – Quoted prices in active markets for identical assets and liabilities that the entity can access at the measurement date. This provides the most reliable evidence of fair value.
  • Level 2 – Inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
  • Level 3 – Inputs that are unobservable. An entity develops unobservable inputs using the best information available which will include the entity’s own data, taking into account all information about market participants assumptions that is reasonably available.

Measurement of fair value

A fair value measurement requires an entity to determine all of the following:

  • Asset or liability to be measured

  • The principal (or most advantageous) market

  • Valuation technique

  • Level of fair value hierarchy

Valuation techniques

An entity uses valuation techniques 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.

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 and the measurement date under current market conditions. Three widely used valuation techniques are: 

  • Market approach: Uses prices generated by market transactions involving comparable assets.

  • Cost approach: Reflects the replacement cost.

  • Income approach: Discounts future income and expenses reflecting current market expectations.

Effective date

IFRS 13 is applicable to annual report periods beginning on or after 1 January 2013. An entity may early adopt IFRS 13 but if doing so it must disclose the fact.

Ananda Blignaut-de Waal

Audit Partner, Tshwane