IFRS 13: Fair Value Measurement Principles and Challenges

Fair Value Measurement (FVM) under IFRS 13 is a comprehensive framework that standardizes fair value measurement and disclosure requirements. Developed jointly by the IASB and FASB, it aims to enhance comparability and simplify financial reporting across IFRS and US GAAP.

1. Core Definition and Measurement Objective:

• Fair Value as an Exit Price: IFRS 13 defines 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.” (IFRS 13.9, Insights into IFRS 13). This clarifies that FVM is an exit price, not an entry price or an entity-specific measurement. The concept of an “orderly transaction” emphasizes that it’s not a forced or distressed sale. (Insights into IFRS 13, PwC Practical Guide Nov 2011).
• Market-Based Measurement: Fair value reflects current market conditions and the assumptions that market participants would use when pricing an asset or liability, acting in their economic best interest. It is explicitly “not affected by an entity’s intentions towards the asset, liability or equity item that is being fair valued.” (IFRS 13.20, PwC Practical Guide Nov 2011).
• Comparability and Consistency: The joint development aimed to “improve the comparability of financial statements prepared in accordance with IFRSs and US GAAP” and “reduce diversity in the application of fair value measurement requirements.” (IFRS13_BC_1-22.pdf, BC10).

2. Scope of IFRS 13:

• Applicability: IFRS 13 applies to all fair value measurements or disclosures required or permitted by other IFRS standards, both at initial and subsequent recognition. (IFRS 13.6, Insights into IFRS 13).
• Key Exclusions: Certain measurements are specifically excluded, such as share-based payment transactions (IFRS 2), leases (IAS 17), and measures that are similar to but not fair value (e.g., net realizable value in IAS 2, value in use in IAS 36). (IFRS13_BC_1-22.pdf, BC243, PwC Practical Guide Nov 2011).
• Disclosure-Only Scope: For some items (e.g., defined benefit plan assets under IAS 19, impaired assets under IAS 36 using FVLCTS), IFRS 13 applies to the measurement but does not mandate its disclosure requirements. (IFRS 13.5, Insights into IFRS 13).

3. Key Concepts in Fair Value Measurement:

• The Asset or Liability Characteristics: FVM takes into account the characteristics of the asset or liability, such as its condition, location, and any restrictions on its sale or use, if market participants would consider them. (IFRS 13.11, IFRS13_BC_1-22.pdf, BC42).
• Transaction vs. Transport Costs: Transaction costs are not adjusted for in the fair value price, as they are transaction-specific. Transport costs, however, are adjusted for if location is a characteristic of the asset. (IFRS 13.26, IFRS13_BC_1-22.pdf, BC44).
• Principal and Most Advantageous Market: Fair value is measured assuming a transaction in the “principal market” (highest volume and activity) or, in its absence, the “most advantageous market” (maximizes sale amount or minimizes transfer payment, considering transaction and transport costs). An entity must have access to that market. (IFRS 13.16-17, KPMG Handbook, A. An introduction).
• Market Accessibility: The ability of different entities to access different markets means the principal/most advantageous market can vary between reporting entities. (PwC Practical Guide Nov 2011).
• Highest and Best Use (for Non-financial Assets): FVM for non-financial assets considers their “highest and best use” from a market participant’s perspective, even if the entity’s intended use differs. This use must be “physically possible, legally permissible, and financially feasible.” (IFRS 13.27, IFRS13_BC_1-22.pdf, BC68, Insights into IFRS 13). This premise dictates whether the asset is valued on a stand-alone basis or in combination with other assets. (Insights into IFRS 13).
• “When revising IFRS 3 in 2008, the IASB decided that an entity must recognise such an asset at fair value because the intention of IFRS 3 was that assets, both tangible and intangible, should be measured at their fair values regardless of how or whether the acquirer intends to use them.” (IFRS13_BC_1-22.pdf, BC69).
• Liabilities and Own Equity Instruments: Fair value measurement for liabilities and own equity instruments assumes a “transfer” to a market participant, not a settlement. This means the item remains outstanding, and the transferee fulfills the obligation. (IFRS 13.34, PwC Practical Guide Nov 2011).
• Non-performance Risk: The fair value of a liability must reflect the effect of non-performance risk, which includes the entity’s own credit risk. This risk is assumed to be the same before and after the transfer. (IFRS 13.42, IFRS13_BC_1-22.pdf, BC93).
• Portfolio Measurement Exception: An exception allows entities to measure the fair value of a group of financial assets and liabilities on a net exposure basis if they are managed for particular market or credit risks that are “substantially the same.” (IFRS 13.48, 54, IFRS13_BC_1-22.pdf, BC116, KPMG Handbook, L. Portfolio measurement). This is an exception to measuring individual instruments.
• “An entity’s net risk exposure is a function of the other financial instruments held by the entity and of the entity’s risk preferences (both of which are entity-specific decisions and, thus, do not form part of a fair value measurement).” (IFRS13_BC_1-22.pdf, BC116).
• Fair Value at Initial Recognition: In many cases, the transaction price equals the fair value at initial recognition. However, if they differ, a “Day One” gain or loss may arise. Under IFRS, this gain/loss on a financial instrument is recognized only if fair value is evidenced by a Level 1 input or a valuation technique using only observable market data. (PwC FVOctober2019, 4.3).

4. Valuation Approaches and Techniques:

• Three Main Approaches: IFRS 13 permits the use of valuation techniques consistent with one or more of three approaches:
• Market Approach: Uses prices and information from market transactions of identical or comparable assets/liabilities (e.g., market multiples, matrix pricing). (IFRS 13.B5, Insights into IFRS 13).
• Cost Approach: Reflects the amount currently required to replace the service capacity of an asset (current replacement cost), adjusted for obsolescence. (IFRS 13.B8, Insights into IFRS 13).
• Income Approach: Converts future amounts (e.g., cash flows, income) to a single discounted current amount (e.g., DCF, option pricing models, multi-period excess earnings method). (IFRS 13.B10, Insights into IFRS 13).
• Maximizing Observable Inputs: Entities must “maximise the use of relevant observable inputs and minimise the use of unobservable inputs” to meet the fair value objective. (IFRS 13.61, PwC Practical Guide Nov 2011).
• No Prioritization of Techniques: IFRS 13 does not prescribe or prioritize specific valuation techniques, but allows the most appropriate one(s) based on circumstances and data availability. (IFRS 13.63, Insights into IFRS 13).
• Calibration: If the transaction price equals fair value at initial recognition, and a valuation technique using unobservable inputs is used, the technique must be calibrated to match the transaction price at initial recognition. (IFRS 13.64, PwC Practical Guide Nov 2011).
• Bid and Ask Prices: When bid and ask prices exist, the fair value is the price “within the bid-ask spread that is most representative of fair value.” The use of mid-market pricing is permitted as a practical expedient. (IFRS 13.70-71, Insights into IFRS 13).

5. Fair Value Hierarchy:

• Three Levels: FVM are categorized into three levels based on the observability of inputs:
• Level 1: “Unadjusted quoted prices in active markets for identical assets and liabilities.” These are considered the most reliable. (IFRS 13.76, IFRS13_BC_1-22.pdf, BC165). Adjustments to Level 1 inputs are generally not permitted, except in specific, limited circumstances (e.g., large number of similar assets, significant events after market close). (IFRS 13.79, PwC Practical Guide Nov 2011).
• Level 2: “Other observable inputs not included within Level 1.” This includes quoted prices for similar assets/liabilities, observable interest rates, yield curves, implied volatilities, and credit spreads. (IFRS 13.81, IFRS13_BC_1-22.pdf, BC165).
• Level 3: “Unobservable inputs,” including an entity’s own data (adjusted to reflect market participant assumptions). These are used when relevant observable inputs are not available and are associated with the greatest level of subjectivity and uncertainty. (IFRS 13.86, IFRS13_BC_1-22.pdf, BC165).
• Categorization Rule: “The fair value measurement is categorised in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement.” (IFRS 13.73, PwC Practical Guide Nov 2011).
• Market Inactivity: IFRS 13 provides guidance for measuring fair value when market activity has significantly decreased. Entities must focus on whether transactions are “orderly” rather than solely on market activity. (IFRS13_BC_1-22.pdf, BC178).

6. Disclosure Requirements:

• Objectives: Disclosures aim to help users “assess valuation techniques and inputs used to develop” fair value measurements and “the effect on profit or loss or other comprehensive income of recurring Level 3 fair value measurements.” (IFRS 13.91, PwC Practical Guide Nov 2011).
• Minimum Disclosures: Include fair value at period-end, hierarchy level, and reasons for non-recurring measurements. (IFRS 13.93).
• Level 3 Specifics: More extensive disclosures are required for Level 3 FVM due to their higher subjectivity. These include quantitative information about significant unobservable inputs, reconciliations from opening to closing balances, descriptions of valuation processes, and a narrative sensitivity analysis. (IFRS 13.93, Insights into IFRS 13, IFRS13_BC_1-22.pdf, BC188, BC207).
• Quantitative sensitivity analysis is also required for financial instruments categorized within Level 3. (IFRS 13.93(h)(ii)).
• Transfers between Levels: Disclosure of amounts and reasons for significant transfers into and out of Levels 1 and 2 is required, along with the entity’s policy for determining when transfers occur. (IFRS 13.93(c), IFRS13_BC_1-22.pdf, BC213).
• Usefulness Concerns: While many stakeholders find disclosures about fair values important, some users find them generic, and preparers find some Level 3 disclosure requirements burdensome, questioning their usefulness when aggregated. (Request-for-information-PIR-IFRS-13.pdf, Introduction).
• “Many users of financial statements said that disclosures about fair values were important although they found many of the disclosures provided in financial statements generic, reducing the usefulness of the information.” (Request-for-information-PIR-IFRS-13.pdf, Introduction).
• “Most preparers said that some disclosure requirements for Level 3 fair value measurements are burdensome and fail to reflect entities’ business management.” (Request-for-information-PIR-IFRS-13.pdf, Introduction).

7. Implementation and Challenges:

• Joint Project Outcome: IFRS 13 resulted from a joint effort between the IASB and FASB to converge fair value measurement and disclosure requirements in IFRSs and US GAAP. (IFRS13_BC_1-22.pdf, BC9-10).
• Challenges in Emerging Economies: Entities in emerging and transition economies expressed concerns about applying IFRS 13 due to lack of detailed guidance and skilled practitioners. The IASB concluded that education material would be beneficial. (IFRS13_BC_1-22.pdf, BC226-235).
• P×Q Issue (Unit of Account vs. Level 1 Input): A significant ongoing debate relates to how to measure fair value when Level 1 inputs exist (e.g., individual share price) but do not correspond to the unit of account (e.g., a controlling investment). Many stakeholders suggest valuing the investment as a whole, adjusting for control premiums or synergies, while users often support P×Q for verifiability. (Request-for-information-PIR-IFRS-13.pdf, Question 3, ap7f-ifrs-13-detailed-analysis-of-feedback-received.pdf, 95-115).
• Highest and Best Use Application: Challenges arise in applying the highest and best use concept, particularly for specialized assets or when assessing legal permissibility and evidence required for alternative uses. Diversity in practice exists due to varying interpretations and customary practices across jurisdictions. (Request-for-information-PIR-IFRS-13.pdf, Question 4, ap7f-ifrs-13-detailed-analysis-of-feedback-received.pdf, 120-141).
• Judgment in Active Market and Input Significance: Assessing whether a market is active and whether an input is significant and unobservable remains challenging for many stakeholders, often due to lack of specific guidance in less liquid markets or for complex financial instruments. (Request-for-information-PIR-IFRS-13.pdf, Question 5, ap7f-ifrs-13-detailed-analysis-of-feedback-received.pdf, 145-156).
• Biological Assets and Unquoted Equity Instruments: Measuring fair value for these items in the absence of active markets remains challenging, leading to calls for additional guidance or educational material. (Request-for-information-PIR-IFRS-13.pdf, 6. Education, Appendix 6).
• Educational material aims to assist entities by describing valuation techniques like comparable company valuation multiples, income approach (DCF, DDM), and adjusted net asset method. (education-ifrs-13-eng.pdf, Chapter 2).

This briefing synthesizes the key tenets of IFRS 13, its impact on financial reporting, and the ongoing areas of discussion and refinement identified during its post-implementation review.