IFRS 13 - Fair Value Measurement (detailed review)
Objective
This standard defines fair value along with the guidelines to be used by the entity for the determination (measurement) of fair value of asset, liability and own equity instrument. It also prescribes the disclosure requirements relating to the fair value.
Scope
The requirements of this standard are applicable for the determination of fair value of asset, liability and own equity instrument of an entity, both at initial and subsequent measurement other than the following:
- Determination of fair value of equity instrument granted in a share based payment, which is covered under IFRS 2
- Determination of net realizable value of inventory, which is covered under IAS 2
- Determination of value in use, which is used in impairment testing and covered under IAS 36
Definition
Active market
The market in which transactions related to a specified asset or liability occur with an adequate frequency and quantity and which reflects pricing information relating to that specified asset or liability on continuous basis.
Cost Approach
It is the technique which is used for valuation and it reflects the amount which is needed currently to replace an asset with the same operating capacity. It is normally termed as current replacement cost.
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Income Approach
It is technique which is used for valuation under which fair value is based on the estimated future net cash inflows of an asset and those estimated future net cash inflows are determined from the market participant’s point of view.
Market Approach
It is a technique used for valuation under which fair value of asset or liability is based on the values and other related information reflected by transactions in the market, involving identical or similar, assets or liabilities.
Exit Price
It is the amount which will be received from selling an asset or required to be paid, in order to transfer the liability.
Highest and Best Use
The manner of use of non-financial asset which will maximize the value for an asset or the group of assets and liabilities from the market participant’s point of view
Inputs
These are the assumptions or estimations which are used by the market participants in determination of value of the asset or liability.
Market Participants
These are the buyers and sellers in the market for the asset or liability and have the following features:
- They are not dependent on each other i.e. independent parties and are not related parties as per IAS 24
- They have adequate understanding and knowledge relating to the asset or liability, and about the transaction including all the relevant information
- They have capacity to establish a transaction relating to the asset or liability.
- They are agreed to establish the transaction relating to the asset or liability, i.e. they are not forced do so.
Principal Market
It is the market in which transactions for an asset or liability take place with the greatest volume and frequency.
Most Advantageous Market
It is the market which maximizes the value that could be received from selling the asset and minimizes the value which is needed to be paid in order to transfer a liability, considering the effect of transport costs and transaction costs both.
Unobservable Inputs
The information which is not available from market and it has to be developed on the basis of best information from market participant’s perspective to determine the value of an asset or liability.
Fair value
It is the amount which will be received from selling an asset or needed to be paid in order to transfer the liability in an orderly transaction involving market participants at the date of measurement in the present conditions, irrespective of the fact, whether such value is determined from the market or using other measurement techniques.
The entity should consider the following points in determination of fair value:
- Fair value should be determined from the market participant’s point of view and is based on the values and other related information reflected by transactions in the market involving identical or similar assets or liabilities. It is not determined using the assumptions from entity’s perspective instead it is a market based measurement.
- The asset and liability for which market based information is not available, the entity is required to determine the fair value such asset or liability using other measurement technique. However, in use of other measurement techniques the entity should ensure the maximum use of market based information and minimum use of unobservable inputs, as the fair value is determined from the market participant’s point of view and is based on the values and other related information reflected by transactions in the market
- Fair value is an exit price i.e. the amount which will be received from selling an asset or needed to be paid in order to transfer the liability. It is not an entry price.
- Fair value can be determined for the following:
a) Any individual asset or liability (financial or non-financial), or
b) Any combination of assets, combination of liabilities or combination of assets and liabilities
- The entity should consider the relevant attributes of asset or liability in determination of fair value such as location, condition, use, any restrictions and other relevant factors, if market participants will take into account such attributes of asset or liability in determination of fair value
- The entity can determine the fair value of the asset or liability as:
a) Primarily from the related principal market and
b) If the principal market is not available, from the related most advantageous market
- The standard does not require the entity to perform extensive search of all available markets for the identification of principal market or the most advantageous market, if principal market is not available. However the entity should consider all the information which is reasonably available in the current circumstances to identify the principal market or the most advantageous market, if principal market is not available.
- Normally, the market in which the entity establishes transactions in order to sell the asset or to transfer the liability is assumed to be the principal market or the most advantageous market, if principal market is not available.
- The determination of principal market or the most advantageous market, if principal market is not available, will be made from the entity’s perspective
- The entity should not consider the transaction cost in determination of fair value. However, transport cost will be taken in to account in determination of fair value of asset or liability
- In determination of fair value of a non-financial asset, the entity should consider the highest and best use of the asset from the market participant’s perspective, and for this purpose the entity should consider the use of asset which is physically achievable (operating capacity), legally allowable (any restriction on use) and financially viable (profitable).
- The entity should consider the highest and best use of the asset from the market participant’s perspective. However, the current use of the non-financial asset by the entity is assumed to be its highest and best use, except market circumstances or other relevant factors indicates that use of asset in a different manner will maximize its value.
- If market circumstances reflect that the highest and best use of a non-financial asset requires it to be used with other assets as a group to maximize the value of the asset, then the fair value of such asset will be determined assuming that the asset will be used with other assets
Application to Liabilities and Entity's own Equity Instruments
General principles
In determination of fair value of liability or own equity instrument of the entity, the entity should ensure the maximum use of market based information and minimum use of unobservable inputs as the fair value is determined from the market participant’s point of view and is based on the values and other related information reflected by transactions in the market.
However, the entity should consider the following aspects in determination of fair value of liability or own equity instrument of the entity:
i) The entity will primarily use the quoted price of identical item held by the other party as an asset obtained from an active market.
ii) If such price is not determinable, the entity will use the other market based information such as the quoted price of identical item held by the other party as an asset obtained from non-active market
iii) If prices in (i) and (ii) both are not determinable, then the entity will use income approach for this purpose
- In determination of fair value of liability, the entity should also consider the effect of any prevalent risk attached to it
- The entity can adjust the quoted price of a liability or own equity instrument of the entity held by another party as an asset, which is determined as fair value of liability or own equity instrument of the entity, if certain conditions relating to the asset are not relevant for the fair value of liability or own equity instrument of the entity.
Fair value hierarchy
This standard has structured a fair value hierarchy to increase the comparability and consistency of fair value determination, which is classified into three levels. Quoted prices (unadjusted) from active markets for identical assets or liabilities have highest priority in the fair value hierarchy and are ranked in (Level 1). While, the unobservable inputs have lowest priority in the fair value hierarchy and are ranked in (Level 3)
Level 1 Inputs
The guidelines in level 1 require the entity to determine the fair value as the quoted price (without any adjustment) from the principal market or from the most advantageous market if principal market is not available. Quoted price (without any adjustment) from such market is more reliable
- However, the entity can adjust the quoted price, if it holds a large number of similar (but not identical) assets or liabilities for which quotes prices are available from the market, but it is impracticable for the entity to determine the quoted price of large number of similar (but not identical) assets or liabilities on individual basis on the measurement date. In such circumstance, the entity can determine the fair value of large number of similar (but not identical) assets or liabilities using any other appropriate method, but it would result in classification of such fair value determined using other relevant method in the lower level of the fair value hierarchy
- Similarly, when the entity determines the fair value of liability or its own equity instrument as the quoted price for the identical item treated as an asset by the other party, from an active market. If the entity needs to adjust the such quoted price, which is determined as fair value of a liability or own equity instrument of the entity held by the other party as an asset, because certain conditions relating to the asset are not relevant for the fair value of liability or own equity instrument of the entity then the adjustment to the quoted price will result in classification of such fair value In the lower level of the fair value hierarchy
Level 2 inputs
Level 2 inputs are the information which is other than the information available in Level 1, and it includes the determination of fair value using the following aspects:
a) Quoted price (adjusted as required by circumstances) of identical asset or liability determined from the principal market or from the most advantageous market, if principal market is not available
b) Quoted prices of similar assets or liabilities determined from the principal market or from the most advantageous market, if principal market is not available
c) Quoted prices obtained from non-market
d) Price determined using other market based information
- The entity may be need to adjust the information in level 2 due to the following factors:
a) The location or condition of the asset
b) The quantity or volume of activity in the markets from which value is taken
- However, any substantial adjustment to the Level 2 information may result in the fair value being classified in level 3 if adjustment made uses substantial unobservable information
Level 3 inputs
Level 3 inputs require the use of unobservable information to determine the fair value of the asset or liability. It includes the use of different valuation techniques such as income approach, cost approach or other relevant techniques. However, the entity should ensure the maximum use of market based information and minimum use of unobservable inputs, as the fair value is determined from the market participant’s point of view and is based on the values and other related information reflected by transactions in the market
Disclosures
The entity is required to disclose the following in respect of the fair value:
- Assets and liabilities which are measured at fair value
- Fair value of assets and liabilities at the end of reporting period
- Any changes in fair value of assets or liabilities recognized during the current accounting period
- The basis used for the determination of fair value
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