Page 1 of 13

IFRS 13 - FAIR VALUE MEASUREMENT

Introduction

Many accounting standards require or allow items to be measured at fair value. Some
examples from your prior studies include:

 IAS 16 Property, Plant and Equipment, which allows entities to measure property,
plant and equipment at fair value
 IFRS 3 Business Combinations, which requires the identifiable net assets of a
subsidiary to be measured at fair value at the acquisition date.

IFRS 13 provides a single source of guidance for fair value measurement where it is required
by a reporting standard, rather than it being spread throughout several reporting standards.

Objective

IFRS 13 aims to:

 Define fair value
 Set out in a single IFRS a framework for measuring fair value
 Require disclosure about fair value measurements

Scope

IFRS 13 does not apply to:

 Share-based payment transactions (IFRS 2 Share-based Payments)

 Leases (IFRS 16 Leases).
 Net Realisable value as in IAS 2 Inventories or value in use as in IAS 36 Impairment of
assets.

About IFRS 13 (Sequence)

1. IFRS 13 is not about ‘when to’ standard (when to measure fair value) instead it is
about ‘How to’ standard (hoe to measure fair value).
2. Identify the item or unit of account, for the fair value measurement.
3. Identify the market and market participants.
4. Determine the valuation method for fair value measurement.
5. Determine the inputs for fair value measurement.
6. Non-financial assets.

Page 1 of 13
 Page 2 of 13

IFRS 13 - Fair Value Measurement

THE DEFINITION:

Fair value is defined 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, para 9).

SPECIFIC TERMINOLOGIES
Some Terminologies need clarity to move forward:

The Principal Market is the market with the greatest activity (volume) for the asset or
liability being measured. IFRS 13 says that fair value should be measured by reference to the
principal market.

The Most Advantageous Market is the one that maximizes the net amount received from
selling an asset (or minimizes the amount paid to transfer a liability).

An Orderly Transaction: Not a forced transaction. (An orderly transaction is

a transaction that assumes exposure to the market for a period prior to the measurement
date to allow for marketing activities that are usual and customary for transactions involving
such assets or liabilities.)

Market participants are knowledgeable, third parties. When pricing an asset or a liability,
they would take into account:
 Condition
 Location
 Restrictions on use.

It should be assumed that market participants are not forced into transactions (i.e. they are
not suffering from cash flow shortages) Orderly Transaction.

Exit Price: The price that would be received to sell an asset or paid to transfer a liability.

Entry Price: The price paid to acquire an asset or received to assume a liability in an
exchange transaction.

Fair value is a market-based measurement, not an entity-specific measurement. It focuses on

assets and liabilities and on exit (selling) prices.

Transaction costs: Such as legal and broker fees and this cost will play a role in deciding
which market is most advantageous. The price in the principal (or most advantageous)

Page 2 of 13
 Page 3 of 13

market used to measure the fair value of the asset (liability) is not adjusted for transaction
costs.

Note:
 Fair value is not “net realizable value” or “fair value less costs of disposal”;
 Price at which an asset can be sold for as the basis for fair valuation does not mean
that the entity intends to sell it.

Transportation Cost: The costs that would be incurred to transport an asset from its current
location to its principal (or most advantageous) market.

Transportation cost (location) is a characteristic of the asset so the price in the principal (or
most advantageous) market is adjusted for the costs that would be incurred to transport the
asset from its current location to that market.

Fair value is not adjusted for transaction costs because they are a characteristic of the
market, rather than the asset. However the transaction cost is adjusted to determine the fair
value.

Page 3 of 13
 Page 4 of 13

IFRS 13: DETAILS

Fair value is defined 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, para 9).

Identify the item or unit of account, for the fair value measurement.
For whom we are measuring fair vaue?
1. Stand-alone Asset OR Liability OR
2. Unit of Account

Details

The fair value definition refers to an asset or a liability, but it is possible that the fair value is
not measured for a stand-alone asset or liability, but rather for a group of assets, group of
liabilities or a group of assets mixed together with liabilities (eg a CGU or an entire business).

When the measurement of fair value is to take place on a group basis is referred to as the
measurement’ unit of account.

Identify the Market and Market Participants.

The definition of fair value specifically refer, orderly transactions, between market
participants.

 Orderly transaction means not a forced transaction.

 Market participants refers to buyers and sellers in either the principal market or most
advantageous market.

Fair value is a market-based measurement, not an entity-specific measurement. It focuses

on assets and liabilities and on exit (selling) prices.

It also takes into account market conditions at the measurement date. In other words, it
looks at the amount for which the holder of an asset could sell it and the amount which the
holder of a liability would have to pay to transfer it. It can also be used to value an entity's
own equity instruments.

Because it is a market-based measurement, fair value is measured using the assumptions

that market participants would use when pricing the asset, taking into account any relevant
characteristics of the asset.
Page 4 of 13
 Page 5 of 13

It is assumed that the transaction to sell the asset or transfer the liability takes place either:
 In the Principal Market for the asset or liability; or
 In the absence of a principle market, in the Most Advantageous market for
the asset or liability.

The entity must be able to access the principal market at the measurement date. This means
that the principal market for the same asset can differ between entities.

In most cases the principal market and the most advantageous market will be the same.

IFRS 13 Says, if there is no principal market, then fair value is measured by reference to
prices in the most advantageous market.

Fair Value Measurement With Most Advantageous Market.

The price received when an asset is sold (or paid when a liability is transferred) may differ
depending on the specific market where the transaction occurs.

Under IFRS 13, transaction costs are not a feature of the asset or liability, but may be taken
into account when determining the most advantageous market.

Fair value is not adjusted for transaction costs.

Page 5 of 13
 Page 6 of 13

Example 1:

Jammee has business in two markets, Europe and Asia. Jammee has to place a fair value on
an asset it hold for accounting purposes. The market price of the asset in the two markets is
$120 and $125 respectively.

Details relating to the: asset in the two markets is as follows:

Europe Asia
$ $
Market price 120 125
Transaction cost (5) (11)
Transport costs (5) (2)
110 112

Solution 1:

If Europe was deemed to be the principal market for the asset then fair value would be $115
(price - transport cost).

If neither Europe nor Asia were the principal markets for this asset then Jammee would take
the most advantageous price to be fair value. This would reflect the best price available to
sell the asset after deducting transaction and transport costs.

In this situation Asia is the most advantageous market giving net proceeds of $112 v $110 in
Europe. However, $112 is not the fair value of the asset. The fair value is $123, the price less
transport costs.

If the item was a liability then the most advantageous market would be Europe and the fair
value of the liability would be $115. This reflects the amount the entity would have to pay to
settle the liability, which is obviously better than having to settle at $123.

When measuring fair value, the entity is required to maximize the use of observable inputs
and minimize the use of unobservable inputs. To this end, the standard introduces a fair
value hierarchy, which prioritizes the inputs into the fair value measurement process.

Page 6 of 13
 Page 7 of 13

Fair Value Measurement (Valuation Methods & Inputs)

Valuation Methods – Fair Value Measurement

IFRS 13 notes that there are various approaches to determining the fair value of an asset or
liability:
 Market approaches (valuations based on recent sales prices)
 Cost approaches (valuations based on replacement cost)
 Income approaches (valuations based on financial forecasts).

Whatever approach is taken, the aim is always the same - to estimate the price that would
be transferred in a transaction with a market participant.

Inputs for Valuation Methods – Fair Value Measurement

Fair value is a market-based measurement, not one that is entity specific. Therefore the
valuation techniques used to measure fair value maximize the use of relevant observable
inputs from an active market and minimize the use of unobservable inputs.

 An Active Market is a market where transactions for the asset or liability occur
frequently.
 Observable input are inputs derived from market information. Examples: stock
exchanges, dealer markets, and broker markets.
 Unobservable inputs are used when there is no market information available.
Example: Company's own data, adjusted for other reasonably available information.

IFRS 13 states that valuation techniques should maximise the use of relevant observable
inputs and minimise the use of unobservable inputs.

IFRS 13 establishes a fair value hierarchy that categories inputs into valuation techniques
into three levels.

Level 1 inputs Quoted prices (unadjusted) for identical assets/liabilities in active

markets
Level 2 inputs Observable prices that are not level 1 in puts. This may include:
 Quoted prices for similar assets in active markets
 Quoted prices for identical assets in less active markets
 Observable inputs that are not prices (such as interest rates).
Level 3 inputs Unobservable Inputs. This could include cash or profit forecasts using an
entity's own data (like estimating discounted future cash flows).

Page 7 of 13
 Page 8 of 13

Examples: Inputs to determine fair value

IFRS 13 gives the following examples of inputs used to determine fair value:

Asset Example
Level 1 Equity shares in a listed Unadjusted quoted prices in an active market.
entity
Level 2 Building held and used Price per square metre for the building from
observable market data, such as observed
transactions for similar buildings in similar
locations.
Level 3 Cash-generating unit Profit or cash flow forecast using own data.

Note
1. Priority is given to level 1 inputs. The lowest priority is given to level 3 inputs.
2. A significant adjustment to a level 2 input would lead to it being categorized as a level
3 input.
3. Level 3 inputs are only used where relevant observable inputs are not available or
where the entity determines that transaction price or quoted price does not
represent fair value.

Examples: 2

Baklava has an investment property that is measured at fair value. This property is rented
out on short-term leases.

The directors wish to fair value the property by estimating the present value of the net cash
flows that the property will generate for Baklava. They argue that this best reflects the way
in which the building will generate economic benefits for Baklava.

The building is unique, although there have been many sales of similar buildings in the local
area.
Required:
Discuss whether the valuation technique suggested by the directors complies with
International Financial Reporting Standards.

Solution 2

The directors' estimate of the future net cash flows that the building will generate is a level 3
input. IFRS 13 gives lowest priority to level 3 inputs. These should not be used if a level 1 or
level 2 inputs exists.

Page 8 of 13
 Page 9 of 13

Observable data about the recent sales prices of similar properties is a level 2 input. The fair
value of the building should therefore be based on these prices, with adjustments made as
necessary to reflect the specific location and condition of Baklava's building.

More Description: Knowledge Purpose

When measuring fair value, the entity is required to maximize the use of observable inputs
and minimize the use of unobservable inputs. To this end, the standard introduces a fair
value hierarchy, which prioritizes the inputs into the fair value measurement process.

Level 1 inputs are quoted prices (unadjusted) in active markets for Items identical to the
asset or liability being measured. As with current IFRS, if there is a quoted price in an active
market, an entity uses that price without adjustment when measuring fair value. An example
of this would be prices quoted on a stock exchange. The entity needs to be able to access
the market at the measurement date. Active markets are ones where transactions take place
with sufficient frequency and volume for pricing information to be provided. An alternative
method may be used where it is expedient. The standard sets out certain criteria this may be
applicable. For example, where the price quoted in an active market does not represent fair
value at the measurement date. An example of this may be where a significant event takes
place after the close of the market such as a business reorganization or combination.

The determination of whether a fair value measurement is level 2 or level 3 inputs depends
on whether the inputs are observable inputs are observable inputs and their significance.

Level 2 inputs are inputs other than the quoted prices in level 1 that are directly or indirectly
observable for that asset or liability. They are quoted assets or liabilities for similar items in
active markets or supported by market data. For example, interest rates, credit spreads or
yield curves. Adjustments may be needed to level 2 inputs and if this adjustment is
significant, then it may require the fair value to be classified as level 3.

Level 3 Inputs are unobservable inputs. The use of these Inputs should be kept to a
minimum. However, situations may occur where relevant inputs are not observable and
therefore these inputs must be developed to reflect the assumptions that market
participants would use when determining an appropriate price for the asset or liability. The
entity should maximize the use of relevant observable inputs and minimize the use of
unobservable Inputs. The general principle of using an exit price remains and IFRS 13 does
not preclude an entity from using its own data. For example, cash flow forecasts may be
used to value an entity that is not listed. Each fair value measurement is categorized based
on the lowest level input that is significant to it.

Page 9 of 13
 Page 10 of 13

SPECIFIC ISSUE: NON-FINANCIAL ASSETS

What is a non-financial asset?

Financial assets include:

 Contractual rights to receive cash (such as receivables)
 Investments in equity shares.

Non-financial assets include:

 Property, plant and equipment
 Intangible assets.

The Fair Value of Non-Financial Asset: (PPE)

IFRS 13 says that the fair value of a non-financial asset should be based on its highest and
best use.

The highest and best use of an asset is the use that a market participant would adopt in
order to maximize its value.

The current use of a non-financial asset can be assumed to be the highest and best use,
unless evidence exists to the contrary.

The highest and best use should take into account uses that are:
 Physically possible
 Legally permissible
 Financially feasible.
IFRS 13 says a use can be legally permissible even if it is not legally approved.

Page 10 of 13
 Page 11 of 13

Example 3

Five Quarters has purchased 100% of the ordinary shares of Three Halves and is trying to
determine the fair value of the net assets at the acquisition date.

Three Halves owns land that is currently developed for industrial use. The fair value of the
land if used in a manufacturing operation is $5 million.

Many nearby plots of land have been developed for residential use (as high-rise apartment
buildings). The land owned by Three Halves does not have planning permission for
residential use, although permission has been granted for similar plots of land. The fair value
of Three Halves' land as a vacant site for residential development is $6 million. However,
transformation costs of $0.3 million would need to be incurred to get the land into this
condition.

Required:
How should the fair value of the land be determined?

Solution:
Land is a non-financial asset. IFRS 13 says that the fair value of a non-financial asset should
be based on its highest and best use. This is presumed to be its current use, unless evidence
exists to the contrary.

The current use of the asset would suggest a fair value of $5 million.

However, there is evidence that market participants would be interested in developing the
land for residential use.

Residential use of the land is not legally prohibited. Similar plots of land have been granted
planning permission, so it is likely that this particular plot of land will also be granted
planning permission.

If used for residential purposes, the fair value of the land would be $5.7 million ($6m -
$0.3m).

It would seem that the land’s highest and best use is for residential develop. Its fair value is
therefore $5.7 million.

Page 11 of 13
 Page 12 of 13

Investor Perspective

Below is an extract from a disclosure note about the fair value of an entity's financial assets
and liabilities:

Fair value of financial instruments

Level 1 Level 2 Level 3

$m $m $m
Financial asset - traded equities 110
Financial liability - contingent 33
consideration

The fair values of the traded equities have been determined by reference to market price
quotations.

The fair value of contingent consideration is estimated based on the forecast future
performance of the acquired business over a timeframe determined as part of the
acquisition agreement, discounted as appropriate. Key assumptions include growth rates,
expected selling volumes and prices and direct costs during the period.

This disclosure informs investors that the fair value of investments in equities has been
derived using level 1 inputs (quoted prices for identical assets in active markets). This
measurement involves no judgement, eliminating the risk of bias, and can be verified by
knowledgeable third parties.

In contrast, the disclosure informs investors that the fair value of the contingent liability has
been derived using level 3 inputs. This measurement involves a high level of judgement,
increasing the risk of management bias. It also makes it more likely that the amount
eventually paid by the entity will differ materially from the year-end carrying amount. For
this reason, the disclosure provides additional information about how management have
estimated the fair value of the liability, so that the investors can assess the adequacy of the
methodology used and reach a conclusion as to whether the level of measurement
uncertainty is acceptable to them.

Due to the level of risk, some investors may decide to sell their shares in an entity if its fair
value measurements are overly reliant on level 3 inputs.

Page 12 of 13
 Page 13 of 13

The Conceptual Framework

The Conceptual Framework says that the purpose of financial reporting is to provide useful
financial information to users of the financial statements.

Required:
Discuss how the application of IFRS 13 enhances the usefulness of financial information. Your
answer should refer to the qualitative characteristics of useful financial information.

Solution

To be useful, financial information must be relevant and provide a faithful representation of

the transaction that an entity has entered into. A completely faithful representation is
complete, neutral and free from error.

Measuring items at fair value is often argued to provide relevant information to an entity’s
stakeholders. However, IFRS 13 does not specify when assets or liabilities should be
measured at fair value – this is governed by other IFRS and IAS Standards.

When measuring fair value, IFRS 13 requires entities to use a level 1 input when available –
quoted prices for identical assets in active markets. These inputs require no judgement and
so the resulting measurement should be neutral.

The prioritisation of observable inputs in IFRS 13 – both level 1 and level 2 – mean that the
resulting valuations are verifiable.

IFRS 13 enhances comparability between entities. For example, management estimates –

level 3 inputs – should only be used if no other inputs are available. Similarly, IFRS 13
requires entities to measure fair value from the perspective of a market participant, rather
than an individual entity, which will aid investors when comparing one entity with another.

Requirements to measure fair value using the principal market, and to base the fair value of
non-financial assets using the highest and best use, reduce the scope for management bias
and ensure that entities are determining fair value consistently.

Requirements to disclose estimation methods when a fair value is determined using level 3
inputs help ensure that financial statements are understandable.

Page 13 of 13