A Guide to Complying with the IFRS 13 – Fair Value Measurement

IFRS 13 provides guidance on fair value measurement and disclosure requirements for financial instruments, intangible assets, and other non-financial assets and liabilities. It aims to improve consistency and comparability in fair value measurements and disclosures across different financial reporting frameworks.

Fair value is a widely recognized accounting concept, while IFRS 13 being the framework responsible for fair value measurement.

Globalization has led to the opening of markets and borders, resulting in a decrease in international tariffs and an increase in foreign investors. To address the lack of homogeneity in accounting language, international accounting standards have been created to unify accounting rules and reports. These standards are known as IFRS and are issued and reviewed by the IASB. More than 140 countries adopt and follow these international accounting standards.

What Is IFRS 13?

IFRS 13 is an international accounting standard that provides guidance on fair value measurement and disclosure requirements for financial instruments, intangible assets, and other non-financial assets and liabilities. It aims to improve consistency and comparability in fair value measurements and disclosures across different financial reporting frameworks. IFRS 13 was issued by the International Accounting Standards Board (IASB) in May 2011 and is effective for annual periods beginning on or after January 1, 2013.

What Are the Entities That Must Comply With IFRS 13?

IFRS 13 applies to all entities that prepare financial statements in accordance with International Financial Reporting Standards (IFRS), including public and private companies, non-profit organizations, and government entities. It is applicable to all industries and sectors and requires entities to disclose fair value measurements in their financial statements, regardless of the nature of the asset or liability being measured.

What is the relationship between fair value and recoverable value?

Fair value and recoverable value are related but distinct concepts in accounting.

Fair value is the estimated price that an asset or liability would fetch in an arm’s length transaction between knowledgeable, willing parties in the open market. It is often used as a basis for measuring the value of assets and liabilities in financial statements, as required by accounting standards such as ASC 820 and IFRS 13.

Recoverable value, on the other hand, is the higher of an asset’s fair value less costs to sell or its value in use. It is used to assess whether an asset’s carrying value on the balance sheet exceeds its recoverable value, which may indicate that the asset is impaired and needs to be written down.

While fair value is used to measure the value of assets and liabilities, the recoverable value is used to assess whether an asset is impaired and needs to be written down.

What factors can impact the determination of fair value?

There are several factors that can impact the determination of fair value, including:

1. Market conditions: Changes in market conditions, such as supply and demand, can impact the fair value of an asset or liability.
2. Economic factors: Economic factors such as inflation, interest rates, and currency exchange rates can also have an impact on fair value.
3. Company-specific factors: Company-specific factors such as financial performance, management changes, and new product launches can impact the fair value of an asset or liability.
4. Industry-specific factors: Factors specific to an industry, such as changes in regulations, new competitors, or changes in consumer behavior, can also impact the fair value of an asset or liability.
5. Timing: The timing of the valuation can also impact fair value, as market conditions and other factors can change over time.
6. Availability and quality of data: The availability and quality of data used in the valuation process can also impact the determination of fair value. The use of reliable and relevant data is critical in determining fair value.

Other important concepts for IFRS 13

Active market

An active market is a market where assets or liabilities are frequently traded, allowing for price information to be continuously available.

Exit price

The exit price is the price that a company would receive when selling its assets or the price it would pay when transferring a liability.

Greater and better use

The concept of “highest and best use” refers to the use of a non-financial asset that maximizes its value for market participants, taking into account the asset’s specific characteristics and market conditions.

More advantageous market

A more advantageous market is one that provides a higher selling price for an asset or a lower transfer price for a liability, after taking into account transaction and transportation costs.

Main Market

The main market is the market that has the highest capacity and activity level for the assets or liabilities being valued.

What are the three levels of the fair value hierarchy, and how are they defined?

To enhance the consistency and comparability of fair value measurements and disclosures, IFRS 13 established a fair value hierarchy that categorizes valuation inputs into three levels. The hierarchy provides guidance on how to prioritize the use of observable market data, as opposed to unobservable data, in determining fair value. The highest priority is given to Level 1 inputs, which are based on quoted prices in active markets for identical assets or liabilities. Level 2 inputs are derived from observable market data for similar assets or liabilities, while Level 3 inputs rely on unobservable data, such as internal models or assumptions. The hierarchy helps ensure that the fair value estimate is based on the most reliable and relevant inputs available.

Level 1

Quoted prices 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 for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities, interest rates, or yield curves.

Level 3

Unobservable inputs that are not based on observable market data, such as an entity’s own assumptions about the asset or liability’s expected cash flows, risk, or other factors.

These levels are used to categorize the inputs used in determining the fair value of an asset or liability. Level 1 inputs are considered the most reliable because they are based on quoted prices in active markets, while Level 3 inputs are considered the least reliable because they are based on unobservable data and require significant management judgment. The hierarchy helps ensure consistency and comparability in fair value measurements across different financial reporting frameworks.

What are the key requirements of IFRS 13 for determining fair value, and how do they impact the valuation process?

There are some requirements in IFRS 13 to calculate the fair value of each asset, liability, or a group of both. Therefore, a manager needs to consider some characteristics of the assets and liabilities to determine this type of value. After all, he will be able to find this value by comparing his data with that of other companies in the market.

Restrictions on use or sale;

Location;

Historical data of assets and liabilities;

Condition.

What are the most commonly used techniques for assessing fair value, and how are they applied in practice?

Entities are required to use appropriate valuation techniques that consider the specific circumstances of the asset or liability being measured at fair value. Sufficient data must be collected to enable a reliable and accurate calculation of fair value, and these techniques should maximize the use of relevant observable data while minimizing the use of unobservable data. The goal of any valuation technique is to provide an estimate of the price at which an asset could be sold or a liability could be transferred in an unforced transaction between market participants, taking into account current market conditions. The three widely used valuation techniques are the market approach, the income approach, and the cost approach.

Market-based Approach

The market approach is a valuation technique used to determine the fair value of an asset or liability by relying on market-based information. This approach uses prices from actual market transactions for identical or comparable assets and liabilities, as well as a group of assets and liabilities.

Under the market approach, the fair value of an asset or liability is determined by considering the price that would be obtained in a hypothetical transaction between market participants, where both the buyer and the seller are willing and able to transact at arm’s length. The information used to determine fair value may include actual market transactions, as well as market data from publicly available sources, such as industry reports or stock exchange listings.

The market approach is often used for financial assets that are traded in active markets, such as publicly traded securities or commodities. It is also used for real estate and business valuations, where comparable transactions are available. Overall, the market approach is one of the three widely used valuation techniques for determining fair value, along with the income approach and the cost approach.

Cost-based Approach

The cost approach is a valuation technique used to determine the fair value of an asset or liability by estimating the cost of replacing the asset or settling the liability, adjusted for any relevant depreciation or obsolescence. Under the cost approach, the fair value of an asset or liability is determined by estimating the cost to acquire or construct a replacement asset, which would have the same utility as the original asset.

This estimate includes all costs required to acquire or construct the replacement asset, including direct and indirect costs, and any other necessary adjustments for depreciation, obsolescence, or other factors that may affect the value of the asset. The cost approach is often used for valuing tangible assets, such as property, plant, and equipment, as well as intangible assets, such as patents and copyrights.

It is also used for real estate valuations, where replacement cost is used as a basis for estimating the fair value of a property. Overall, the cost approach is one of the three widely used valuation techniques for determining fair value, along with the income approach and the market approach. This is particularly useful when there is a lack of comparable market transactions, or when the value of an asset or liability is primarily determined by its replacement cost.

Income Approach

The income approach is a valuation technique used to determine the fair value of an asset or liability by estimating the present value of its expected future cash flows. Under the income approach, the fair value of an asset or liability is based on the discounted value of its expected future cash flows, using an appropriate discount rate that reflects the time value of money and the risk associated with those cash flows. This discount rate is usually determined based on the specific characteristics of the asset or liability being valued, as well as the prevailing market conditions.

The income approach is often used for valuing income-generating assets, such as bonds, stocks, and real estate, as well as intangible assets, such as trademarks and patents. It is also used for determining the fair value of liabilities, such as debt instruments, by estimating the discounted value of their future cash outflows.

Overall, the income approach is one of the three widely used valuation techniques for determining fair value, along with the cost approach and the market approach. It is particularly useful when there is a reliable forecast of future cash flows, and when the value of an asset or liability is primarily determined by its income-generating potential.

How do ASC 820 and IFRS 13 define fair value, and what are the key similarities and differences between the two standards?

What Is ASC 820?

ASC 820 is an accounting standard under the US Generally Accepted Accounting Principles (GAAP) that provides guidance on the measurement of fair value for financial reporting purposes. ASC 820 is also commonly referred to as the Fair Value Measurement standard. The standard applies to all entities that are required to use fair value measurements in their financial statements, and it outlines a hierarchy of inputs that can be used to measure fair value. ASC 820 also requires disclosures related to fair value measurements to provide users of financial statements with relevant information about the inputs used and the valuation techniques applied to arrive at fair value measurements.

ASC 820 and IFRS 13 both define fair value 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, assuming the transaction takes place in the principal market for the asset or liability (or in the absence of a principal market, the most advantageous market).

One of the key similarities between ASC 820 and IFRS 13 is that both standards require the use of a fair value hierarchy that distinguishes between observable and unobservable inputs in determining fair value. Both standards classify inputs into three levels, with Level 1 being the most reliable and Level 3 being the least reliable.

One of the key differences between ASC 820 and IFRS 13 is that IFRS 13 provides more guidance on the application of fair value, including detailed guidance on how to determine the principal market for an asset or liability. In contrast, ASC 820 provides less detailed guidance and allows for more judgement in determining the appropriate inputs and valuation techniques to use. Another difference between the two standards is the way they address the issue of the highest and best use of an asset. Under IFRS 13, fair value should reflect the highest and best use of an asset, while ASC 820 requires that the fair value of an asset should be based on its current use.

Overall, while there are some differences between ASC 820 and IFRS 13 in terms of their application and guidance, both standards share a common goal of providing guidance on fair value measurements and disclosures that are relevant and reliable for financial reporting purposes.

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