IFRS 13 Fair Value Measurement: Summary, Worked Example & Practice Questions

Fair value is a selling-side idea, not a buying-side one. The number represents what would be collected on disposing of an asset, or what would have to be handed over to get somebody to take on a liability, in a normal (not forced) transaction between unrelated parties at the measurement date (IFRS 13.9). It is deliberately a price, not a value in use — the question is what the market would pay, not what the item is worth to the entity that holds it.

Because the price belongs to the market rather than the owner, the assumptions used must be those a typical buyer would bring: their expectations about cash flows, their view of risk, and the compensation they would demand for bearing it (IFRS 13.22). An entity cannot inflate the figure because it happens to have a special use for the asset, and cannot depress it because it is short of cash and would sell cheaply.

Two further points are frequently misread. First, IFRS 13 never tells an entity to measure something at fair value — IFRS 9, IAS 16, IAS 40, IFRS 3 and others do that, and IFRS 13 simply supplies the mechanics once they have (IFRS 13.5). Second, the measurement is item-specific: characteristics a buyer would take into account, such as condition, location and restrictions on sale, are built into the price (IFRS 13.11).

The date matters too. Fair value is measured as at the reporting date using conditions prevailing then — later news that changes what the item would fetch belongs to the following period, not to the measurement just made.

Prices for the same asset often differ across venues, so the standard fixes which venue's price to use. The default is the market with the greatest activity for that asset — the one the entity routinely deals in — and its price is used even if some other market would deliver more money (IFRS 13.16). Only when no such market exists does the entity look for the venue giving the best net outcome after deducting both the cost of moving the item and the cost of doing the deal.

Whichever market is selected, the fair value is that market's price adjusted only for what it would cost to physically get the asset there (IFRS 13.25–26). Fees, commissions and other costs of executing the sale are excluded from the measurement — they belong to the transaction, not to the asset. This produces the result that trips people up in exams: those same execution costs are used to decide which market is most advantageous, then dropped when the number itself is computed.

• Transport costs — deducted, because a buyer in that market is paying for the asset delivered there.
• Transaction costs — never deducted from fair value, but relevant when ranking candidate markets in the absence of a principal one.
• Entity-specific selling plans, hoped-for prices and internal budgets — ignored entirely.

The entity must be able to access the chosen market at the measurement date, though it does not need an actual sale in progress; the measurement is hypothetical throughout (IFRS 13.20).

For items such as land, buildings and plant, the price a buyer offers depends on what they intend to do with the asset. IFRS 13 therefore measures these assets on the basis of the most valuable use that is physically workable, legally allowed and financially sensible — judged from a buyer's perspective, not the owner's (IFRS 13.27–28).

A site currently used as a car park but zoned for apartments illustrates the point: if a developer would pay more for it than a car-park operator, the higher figure sets the measurement, less any cost of clearing the current use. The owner's decision to keep running the car park does not lower the number, though the standard does expect a defensive holding — an asset deliberately kept idle to protect another part of the business — to be measured on the same market basis rather than at nil (IFRS 13.29–30).

The best use can be either on its own or bundled with other assets. Where value depends on the group, the measurement assumes a buyer already holding the complementary assets (IFRS 13.31).

The technique chosen must suit the circumstances, have enough data behind it, and squeeze as much observable evidence into the answer as possible (IFRS 13.61). Three broad approaches are described, and more than one may be applied and weighted where the results diverge.

• Market approach — build the answer from prices and multiples seen in deals for comparable items, adjusting for differences.
• Cost approach — start from what it would take to obtain an equivalent asset today and strip out obsolescence of every kind, physical and economic.
• Income approach — convert future amounts, whether cash flows or earnings, into a single present figure using a rate that reflects the risks a buyer would price in.

Whichever route is taken, the technique should be used consistently from period to period; a switch is allowed only when it produces a measurement that better represents the price a buyer would pay, and it is treated as a change in estimate rather than in policy (IFRS 13.65–66).

Inputs are the assumptions feeding the technique. Those drawn from real market data are preferred; those built internally are permitted only where market data runs out, and even then they must be set to reflect what an outside buyer would assume rather than what management hopes (IFRS 13.67–89).

Every fair value measurement is sorted into one of three levels, ranked by how observable the inputs behind it are. The point is comparability: a reader can see at a glance how much of a reported figure rests on hard market evidence and how much on management judgement (IFRS 13.72).

• Level 1 — a quoted price for the identical item in an active market that the entity can reach at the measurement date, used without adjustment. Listed shares are the standard case, and the quoted price times the number of units is the answer even for a large holding (IFRS 13.76–80).
• Level 2 — observable evidence that is not a Level 1 price: quotes for similar items, quotes for identical items in a market that trades thinly, or observable rates, yields and spreads feeding a model (IFRS 13.81–85).
• Level 3 — inputs with no observable backing, such as internally forecast cash flows or a growth rate based on management's own projections, used only where observable data is unavailable (IFRS 13.86–89).

The level attaches to the whole measurement, not to individual inputs, and it is set by the lowest-level input that has a significant effect on the result. A model fed mostly by observable rates but hinging on one unobservable credit assumption is a Level 3 measurement (IFRS 13.73).

Movements between levels happen when the observability of the key input changes — a share that stops trading actively drops out of Level 1, and a model input that becomes observable can lift a measurement up. The entity sets and applies a consistent policy for when such a transfer is deemed to occur (IFRS 13.95).

Disclosure volume scales with judgement. Users must be able to see the techniques and inputs behind each measurement and, where unobservable inputs were used, how those choices affected profit or loss and other comprehensive income (IFRS 13.91).

• The fair value at the reporting date and the hierarchy level for each class of asset and liability, split between recurring and one-off measurements (IFRS 13.93).
• A description of the technique and the inputs used for Level 2 and Level 3, plus quantitative detail on the significant unobservable ones.
• For Level 3, a reconciliation of opening to closing balances showing gains and losses, purchases, sales, issues, settlements and transfers, and a sensitivity discussion of reasonably possible alternative assumptions.
• The amounts of, and reasons for, transfers between Level 1 and Level 2, and the policy governing when transfers are recognised.

Classes are determined by the nature and risk profile of the items and by their level in the hierarchy, so a single line in the statement of financial position may need splitting across several disclosure classes (IFRS 13.94).