Fair value is widely used in financial reporting from the revaluation model in IAS 16®, Property, Plant and Equipment to the widespread application in the more complex IFRS 9 Financial Instruments. Prior to IFRS 13®, Fair Value Measurement, there was no coherent definition of fair value despite its widespread use.
IFRS was issued in May 2011 and defines fair value, establishes a framework for measuring fair value and requires significant disclosures relating to fair value measurement. The International Accounting Standards Board (the Board) wanted to enhance disclosures for fair value in order that users could better assess the valuation techniques and inputs that are used to measure fair value. There are no new requirements as to when fair value accounting is required but rather it relies on guidance regarding fair value measurements in existing standards.
The guidance in IFRS 13 does not apply to transactions dealt with by certain standards. For example share based payment transactions in IFRS 2, Share-based Payment, leasing transactions in IFRS 16, Leases, or to measurements that are similar to fair value but are not fair value – for example, net realisable value calculations in IAS® 2, Inventories or value in use calculations in IAS 36, Impairment of Assets. Therefore, IFRS 13 applies to fair value measurements that are required or permitted by those standards not scoped out by IFRS 13. It replaces the inconsistent guidance found in various IFRS standards with a single source of guidance on measurement of fair value.
Historically, fair value has had a different meaning depending on the context and usage. The Board’s definition of fair value is 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. Basically it is an exit price. Consequently, fair value is focused on the assumptions of the market place, is not entity specific and so takes into account any assumptions about risk. This means that fair value is measured using the same assumptions used by market participants and takes into account the same characteristics of the asset or liability. Such conditions would include the condition and location of the asset and any restrictions on its sale or use.
Interestingly an entity cannot argue that prices are too low relative to its own valuation of the asset and that it would be unwilling to sell at low prices. The prices to be used are those in ‘an orderly transaction’. An orderly transaction is one that assumes exposure to the market for a period before the date of measurement to allow for normal marketing activities to take place and to ensure that it is not a forced transaction. If the transaction is not ‘orderly’ then there will not have been enough time to create competition and potential buyers may reduce the price that they are willing to pay. Similarly if a seller is forced to accept a price in a short period of time, the price may not be representative. Therefore, it does not follow that a market in which there are few transactions is not orderly. If there has been competitive tension, sufficient time and information about the asset, then this may result in an acceptable fair value.
A fair value measurement is for a particular asset or liability and when measuring the fair value an entity will take into account the characteristics of the asset or liability if the market participant would take the characteristics into account eg the condition and location of the asset or any restrictions on sale or use of an asset.
Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in the principal market for the asset or liability or, in the absence of a principal market, in the most advantageous market for the asset or liability. The principal market is the one with the greatest volume and level of activity for the asset or liability that can be accessed by the entity.
The most advantageous market is the one, which maximises the amount that would be received for the asset or paid to transfer the liability after transport and transaction costs. Often these markets would be the same.
Sensibly an entity does not have to carry out an exhaustive search to identify either market but should take into account all available information. Although transaction costs are taken into account when identifying the most advantageous market, the fair value is calculated before adjustment for transaction costs because these costs are characteristics of the transaction and not the asset or liability. However, if location is a factor, then the market price is adjusted for the costs incurred to transport the asset to that market. Market participants must be independent of each other and knowledgeable, and able and willing to enter into transactions for the asset or liability.
EXAMPLE 1
The June 2021 DipIFR examination required knowledge of IFRS 13 while discussing various other IFRS standards. This example is from Q3 Exhibit 1: