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IFRS 13FAIR VALUE MEASUREMENT

The IASB published IFRS 13: Fair Value Measurement, in May 2011 and it is effective from 1 January 2013. FV has been required or permitted under many IASs/IFRSs.The concept of FV has long been debated. In general, IFRS 13 establishes new requirements for the measurement of FV. However, it does not provide guidance as regard to when FV should be used. This article will summarise key points of the standard.

SCOPE

IFRS 13:• Defines FV• Sets out in a single IFRS framework for

measuring FV• Requires disclosures about FV

measurements.

IFRS 13 applies when another IFRS requires or permits FV measurements or disclosures about FV (measurements such as FV less cost to sell on FV or disclosures about those measurements). IFRS 13 does not apply to IFRS 2 Share-based Payment, IAS 17 Leases and measurements that have similarities to FV, but that are not FV

such as “net realisable value” in IAS 2 or “value in use” in IAS 36.

DEFINITION

IFRS 13 defines FV 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).

Under the key definitions of the standard we see “exit price” as “the price that would be received to sell an asset or paid to transfer liability”. This indicates that FV is the exit price between market participants who are asset holders or debtors at the measurement date.

FV is market based, rather than an entity-specific measurement. It is measured using the assumptions that market participants would use when pricing the asset or liability including assumptions about risk (IFRS 13.2-3)

Assist. Prof. Dr. B. B. YILMAZ

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We can say that principal market is the best market for FV measurement, because it gives so many transactions to find identical or similar transactions. Most advantageous markets must be used in the absence of principal markets.

HIGHEST AND BEST USE

“Highest and best use” only relates to “non-financial assets” such as inventories, PPEs and intangibles. FV of a non-financial asset considers a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use (IFRS 13.27). Highest and best use refers to the use of a non-financial asset by market participants, that would maximise the value of the asset, or the group of assets and liabilities (e.g. a business) within which the asset would be used (IFRS13 Appendix A).

IFRS 13 at para. 28 states that, the highest and best use of a non-financial asset takes into account the use of the asset that is;

1. Physically possible2. Legally permissible3. Financially feasible

“Fair Value is market based, rather than an entity-specific measurement”

IFRS 13

THE FV MEASUREMENT APPROACH

IFRS 13 states that, the objective of a FV measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions. An entity must consider all of the following (IFRS 13.B2):

• The particular asset or liability that is the subject of the measurement (consistently with its unit of account)

• For a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its highest and best use)

• The principal (or most advantageous) market for the asset or liability

• The valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the FV hierarchy within which the inputs are categorised.

PRINCIPAL MARKET ANDMOST ADVANTAGEOUS MARKET

FV measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market or the most advantageous market (IFRS 13.16).

IFRS 13 also defines principal market and most advantageous market. Principal market is one with the greatest volume and level of activity for the asset or liability. Most advantageous market is the market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs (IFRS13. Appendix A).

INITIAL RECOGNITION

In many cases the transaction price will equal the FV, however, in some circumstances it may not.

IFRS 13 at para. 57 describes this as follows:

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IFRS 13

Market Approach

A valuation technique that uses prices and other relevant information generated by market transactions (IFRS 13. Appendix A)

Cost Approach

A valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset

(IFRS 13. Appendix A).

Income Approach

Valuation techniques that convert future amounts to a single current amount. The FV measurement is determined on the basis of the value indicated by current market expectations about those future amounts (IFRS 13. Appendix A)

“When an asset is acquired or a liability is assumed in an exchange transaction for that asset or liability, the transaction price is the price paid to acquire the asset or received to assume the liability (an entry price).

In contrast, the FV of the asset or liability is the price that would be received to sell the asset or paid to transfer the liability (an exit price).

Entities do not necessarily sell assets at the prices paid to acquire. Similarly, entities do not necessarily transfer liabilities at prices received to assume them”.

When determining whether FV at initial recognition equals the transaction price, an entity must consider factor specific to the transaction and to the asset or liability (IFRS 13. B4).

VALUATION TECHNIQUES

According to IFRS 13, an entity must use valuation techniques to measure FV. Valuation techniques must be appropriate in the circumstances. In some cases a single valuation technique will be appropriate, whereas in other cases multiple valuation techniques will be appropriate (IFRS 13.63).

The objective of using a valuation technique is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants and the measurement date under current market conditions.

IFRS 13 describes three widely used techniques that are market approach, cost approach and income approach (IFRS 13.62).

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IFRS 13

FV HIERARCHY

IFRS 13 establishes a “FV hierarchy” to increase consistency and comparability in FV measurements.

The hierarchy categorises into three levels the inputs used in valuation techniques.

It gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (level 1 inputs) and the lowest priority to unobservable inputs (level 3 inputs) (IFRS 13.72). A quoted market price in an active market provides the most reliable evidence of FV and must be used without adjustment to measure FV whenever available, with limited exceptions (IFRS 13.77).

The diagram below shows the approach to determining the classification of FV measurements in the FV hierarchy of IFRS 13.

APPLICATION OF FV HIERARCHY

If the inputs used to measure FV of an asset or a liability are categorised within different levels of the FV hierarchy, the FV measurement is categorised in its entirety in the same level of the FV hierarchy as the lowest level input that is significant to the entire measurement (IFRS 13.73).

Level 1 Inputs - Highest priority

Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date (IFRS 13.76). (e.g. stock closing prices in the London Stock Exchange)

Level 2 Inputs

Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly (IFRS 13.81). (e.g. a level 2 input would be the LIBOR swap rate for an interest rate swap based on LIBOR)

Level 3 Inputs - Lowest priority

Unobservable inputs for the asset or liability (IFRS13.86).(e.g. for interest rate swap, level 3 input would be an adjustment to a mid-market consensus (non-binding) price for the swap developed using data that are not directly observable and cannot otherwise be corroborated by observable market data)

Source: KPMG LLP

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IFRS 13DISCLOSURE REQUIREMENTS

According to IFRS 13, an entity must disclose information that helps users of its financial statements assess both of the following (IFRS 13.91):

• for assets and liabilities that are measured at FV on a recurring or non-recurring basis in the statement of financial position after initial recognition, the valuation techniques and inputs used to develop those measurements

• for recurring FV measurements using significant unobservable inputs (level 3), the effect of the measurements on profit or loss or other comprehensive income for the period.

IFRS 13 (para.93) sets out the certain minimum disclosures of the standard.

An entity must disclose at a minimum;

• the FV measurement at the end of the reporting period, the reason for the measurement.

• the level of the FV hierarchy within which the FV measurements are categorised.

• the amounts of any transfers between level 1 and level 2 of the hierarchy.

• technique(s) and inputs used in the FV measurement.

• a detailed description of the valuation processes used by the entity for level 3.

CONCLUSION

One of the reasons for issuing IFRS 13 was to increase convergence with USGAAP. By publishing IFRS 13, the IASB and FASB have issued common FV measurements and disclosure requirements.

Another highlight in IFRS 13 is that judgement may be required when applying FV measurement concepts (for example when determining valuation techniques or when applying FV hierarchy).

Deep knowledge of the structure of assets, liabilities, equities will be needed for making judgement. For this reason, management, accountants, valuation professionals, auditors and lawyers should be involved in the process.