IFRS 13 Fair Value Measurement

Background

‘’IFRS 13 Fair Value Measurement "applies to IFRSs that require or allow fair value measurements or disclosures and provides a single IFRS framework for measuring fair value and requires disclosures about fair value measurement.

It applies when another Standard requires or allows fair value measurements, except in specific circumstances where other Standards govern (see scope section).

Therefore, IFRS 13 describes "How" fair value should be calculated although "When" should be calculated is defined in the other respective standards.

Objective

This IFRS:

(a) defines fair value;

(b) sets out in a single IFRS a framework for measuring fair value; and

(c) requires disclosures about fair value measurements.

 

Scope

IFRS 13 applies when another IFRS requires or allows fair value measurements or disclosures about fair value measurements (and measurements, such as fair value less costs to sell, based on fair value or disclosures about those measurements), except:

· Share-based payment transactions within the scope of IFRS 2 Share-based payment

· Finance lease transactions within the scope of IAS 17 Leases

· Measurements that have some similarities with fair value but are not, such as the net realizable value in IAS 2 Inventories or the value in use in IAS 36 Impairment of assets.

The disclosures required by this IFRS are not necessary for the following:

· Plan assets measured at fair value in accordance with IAS 19 Employee Benefits;

· Retirement benefit plan investments measured at fair value in accordance with IAS 26 Accounting and reporting for retirement benefit plans; and

· Assets whose recoverable amount is the fair value less the disposal costs in accordance with IAS 36. 

Key definition

Fair value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date

Active market

A market in which transactions for the asset or liability are made with sufficient frequency and volume to provide continuous pricing information

Exit price

The price that would be received to sell an asset or would be paid to transfer a liability.

Highest and best use

The use of a non-financial asset by market participants that would maximize the value of the asset or the group of assets and liabilities (for example, a business) within which the asset would be used

Most advantageous market

The market that maximizes the amount that would be received to sell the asset or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and transportation costs.

Principal market

The market with the highest volume and level of activity for the asset or liability. 

What’s Fair Value?

IFRS 13 defines fair value as the price that would be received to sell an asset or would be paid to transfer a liability (it is called the exit price) in an orderly transaction between market participants (since its market is not based on the entity ) on the measurement date.

Measurement

Asset or liability: When determining the fair value of an asset or liability, the entity must consider who are the market participants to determine an appropriate price to pay or receive for that asset or liability.

Market participants would include the condition and location of the asset, as well as restrictions on the sale or use of the asset.

This Standard is very clear that transaction costs should not be included in the fair value of the asset or liability as these costs are not a characteristic of the asset or liability, however the fair value must be adjusted to consider any transport costs.

A fair value measurement assumes that the transaction to sell the asset or transfer the liability is carried out:

(a) in the main market of the asset or liability; or

(b) in the absence of a main market, in the most advantageous market for the asset or liability.

Non-financial assets: Measuring the fair value of non-financial assets turns out to be the most difficult to determine, given the fact that it can be difficult to determine the correct market, as well as the characteristics that market participants would consider when determining an acceptable price The Standard states that the fair value of non-financial assets must be determined with respect to the highest and best use of the asset, even when the counterparty to the transaction will not use the asset in the same way as the seller. However, the current use of the asset by the seller is the best and highest use of the asset.

Measurement exceptions: When any entity has financial assets and liabilities with a clearing position, the entity will calculate fair value on a net basis.

Application to an entity's own liabilities and equity instruments

A measurement of the fair value of a financial or non-financial liability or of an entity's own equity instruments assumes that it is transferred to a market participant on the measurement date, without settlement, termination or cancellation on the measurement date.

In the first instance, an entity shall establish the fair value of the liability or equity instrument by referring to the quoted market price of the identical instrument, if available.

If the quoted price of the identical instrument is not available, then the fair value measurement depends on whether the liability or the equity instrument is owned by other parties as assets or not:

• If the liability or the equity instrument is owned by another party as an asset, then
• If there is a quoted price in an active market for the identical instrument held by another party, use it (adjustments are possible for asset-specific factors, but not for the liability / equity instrument)
• If there is no quoted price in an active market for the identical instrument held by another party, use other observable data or another valuation technique

• If the liability or equity instrument is not owned by another party as an asset, use a valuation technique from the market participant's perspective.     

Its simplified in below table:

 

Non-performance risk

The fair value of a liability reflects the effect of the risk of default: the risk that an entity does not fulfill its obligation.

Default risk includes, among others, an entity's own credit risk.

For example, default risk may be reflected in different borrowing rates for different borrowers due to their different credit rating. As a result, they would have to discount the same amount at a different discount rate, therefore, the present value of a liability would be different.

Transfer restrictions

An entity shall not include a separate entry or an adjustment to other entries related to the potential restriction that prevents the transfer of the item to another person.

Demand characteristic

The fair value of a liability with a demand characteristic is not less than the amount payable on demand discounted from the first date the amount could be required to be paid.

  

For fair value calculation, Entities should use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.

Valuation techniques

The objective of using a valuation technique is to estimate the price at which an orderly transaction would be made to sell the asset or transfer the liability between market participants and the measurement date under current market conditions.

This Standard requires entities to apply valuation techniques consistent with any of the following three methods:

1. market approach: uses prices and other relevant information generated by market transactions involving identical or comparable (similar) assets, liabilities, or a group of assets and liabilities (for example, a business)
2. cost approach: reflects the amount that would currently be required to replace the service capacity of an asset (current replacement cost)
3. income approach: converts future amounts (cash flows or income and expenses) into a single current (discounted) amount, reflecting current market expectations for those future amounts.

To increase consistency and comparability in fair value measurements and related disclosures, this Standard established a fair value hierarchy that classifies inputs to valuation techniques at three levels:

Disclosure

Disclosure objective

IFRS 13 requires an entity to disclose information that helps users of its financial statements evaluate the following:

· For assets and liabilities that are measured at fair value on a recurring or non-recurring basis in the statement of financial position after initial recognition, the valuation techniques and inputs used to develop those measurements

· For fair value measurements using significant unobservable data (Level 3), the effect of the measurements on the period result or other comprehensive result for the period.

Note - Refer Scope section for ‘’Disclosure exemptions’’.

Identification of classes

When disclosures are required to be provided for each class of asset or liability, an entity determines the appropriate classes based on the nature, characteristics and risks of the asset or liability, and the level of the fair value hierarchy within which it is measures fair value is categorized

Determining the appropriate classes of assets and liabilities for which disclosures about fair value measurements must be provided requires judgment. An asset and liability class will often require greater disaggregation than the items presented in the statement of financial position. The number of classes may need to be greater for fair value measurements classified within Level 3.

Some disclosures differ in whether the measurements are:

· Periodic fair value measurements: the fair value measurements required or permitted by other IFRSs to be recognized in the statement of financial position at the end of each reporting period

· Non-recurring fair value measurements are fair value measurements that other IFRSs require or allow to be measured in the statement of financial position.

Specific disclosures required

To meet the disclosure objective, the following minimum disclosures are required for each class of assets and liabilities measured at fair value (including measurements based on fair value within the scope of this IFRS) in the statement of financial position after recognition Initial (note these are the requirements have been outlined and additional disclosure is required when needed):

· The measurement of fair value at the end of the reporting period

· For non-recurring fair value measurements, the reasons for the measurement

· The level of the fair value hierarchy within which the fair value measurements are classified in their entirety (Level 1, 2 or 3)

· For assets and liabilities held on the reporting date that are measured at fair value on a recurring basis, the amounts of any transfers between Level 1 and Level 2 of the fair value hierarchy, the reasons for those transfers and the policy of the entity to determine when transfers between levels are considered to have occurred, separately disclosing and discussing transfers within and outside each level

· For fair value measurements classified within Level 2 and Level 3 of the fair value hierarchy, a description of the valuation techniques and inputs used in the fair value measurement, any changes in valuation techniques and the reasons for making such a change (with some exceptions)

· For fair value measurements classified within Level 3 of the fair value hierarchy, quantitative information on the significant unobservable data used in fair value measurement (with some exceptions)

· For recurring fair value measurements classified within Level 3 of the fair value hierarchy, a reconciliation of opening balances to closing balances, revealing separate changes during the period attributable to the following:

o   total gains or losses for the period recognised in profit or loss, and the line item(s) in profit or loss in which those gains or losses are recognised – separately disclosing the amount included in profit or loss that is attributable to the change in unrealised gains or losses relating to those assets and liabilities held at the end  of the reporting period, and the line item(s) in profit or loss in which those unrealised gains or losses are recognised

o   total gains or losses for the period recognised in other comprehensive income, and the line item(s) in other comprehensive income in which those gains or losses are recognised purchases, sales, issues and settlements (each of those types of changes disclosed separately)

o   the amounts of any transfers into or out of Level 3 of the fair value hierarchy, the reasons for those transfers and the entity's policy for determining when transfers between levels are deemed to have occurred. Transfers into Level 3 shall be disclosed and discussed separately from transfers out of Level 3

·       for fair value measurements categorised within Level 3 of the fair value hierarchy, a description of the valuation processes used by the entity

·       a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs if a change in those inputs to a different amount can result in a significantly higher or lower fair value measurement. If there are interrelationships between those inputs and other unobservable inputs used in fair value measurement, the entity also provides a description of those interrelationships and how they might increase or mitigate the effect of changes in unobservable inputs on value measurement. reasonable

·       for financial assets and financial liabilities, if the change of one or more of the unobservable entries to reflect reasonably possible alternative assumptions would significantly change the fair value, an entity shall declare that fact and disclose the effect of those changes. The entity shall disclose how the effect of a change was calculated to reflect a reasonably possible alternative assumption.

·       If the highest and best use of a non-financial asset differs from its current use, an entity shall disclose that fact and why the non-financial asset is being used in a way that differs from its highest and best use.

     The above list indicates that disclosure is also applicable to a class of assets or liabilities that is not measured at fair value in the statement of financial position but for which fair value is disclosed.

Quantitative disclosures are required to be presented in a tabular format unless another format is more appropriate. 

Illustrations for more clarity on following categories

Determining the fair value of a financial asset or liability can be a complicated process. The following illustrations highlight some of the more common misinterpretations when applying the requirements of IFRS 13, especially regarding categorisation into the fair value hierarchy. They address aspects of IFRS 13 but are not intended to provide interpretative guidance.

Summary

 IFRS 13 Fair Value Measurement is a single source of guidance for fair value measurement that clarifies the definition of fair value, provides a clear framework for measuring fair value, and improves disclosures about fair value measurements. It is also the result of the efforts of the IASB and FASB to ensure that fair value has the same meaning in IFRS and US GAAP and that their respective fair value measurement and disclosure requirements are the same (except for minor differences. in writing and style). IFRS 13 Fair Value Measurement applies to IFRSs that require or allow fair value measurements or disclosures. It does not introduce new fair value measurements, nor does it eliminate practicability exceptions to fair value measurements. In other words, IFRS 13 Fair Value Measurement specifies how an entity should measure fair value and disclose information about fair value measurements. It does not specify when an entity should measure an asset, a liability, or its own equity instrument at fair value.