Fair value measurement (IFRS 13)
IFRS 13 Fair Value Measurement defines fair value and sets out a framework for measuring the fair
value of assets, liabilities and an entity's own equity instruments in a single IFRS.
It applies to all IFRS standards where a fair value measurement is required except (para. 6):
 Share-based payment transactions (IFRS 2)
 Leasing transactions (IFRS 16)
 Measurements which are similar to, but not the same as, fair value, eg:
o Net realisable value of inventories (IAS 2)
o Value in use (IAS 36)
Fair value: 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)
3.1 Measurement
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.
Unit of account
Fair value measurements are based on an asset or a liability’s unit of account. The unit of account is
defined in IFRS 13 as ‘the level at which an asset or a liability is aggregated or disaggregated in an IFRS
for recognition purposes’ (IFRS 13: Defined terms). The unit of account is specified by each IFRS
Accounting Standard where a fair value measurement is required. For most assets and liabilities, the
unit of account is the individual asset or liability, but in some instances may be a group of assets or
liabilities (IFRS 13: para. 13-14).
Illustration 3
Fair value
A premium or discount on a large of the same shares (because the market’s normal daily trading volume
is not sufficient to absorb the quantity held by the entity) is not considered when measuring fair value:
the quoted price per share in an active market is used.
However, a control premium is considered when measuring the fair value of a controlling interest,
because the unit of account is the controlling interest. Similarly, any non-controlling interest discount is
considered where measuring a non-controlling interest.
Valuation techniques
When market activity declines an entity must use a valuation technique to measure fair value.
IFRS 13 specifies three valuation techniques, each of which can be used on its own or in combination
with the others (IFRS 13: para. 62):
(a) Income approach: valuation techniques that convert future amounts (eg cash flows or income
and expenses) to a single current (ie discounted) amount. The fair value measurement is
determined on the basis of the value indicated by current market expectations about those
future amounts.
(b) Market approach: a valuation technique that uses prices and other relevant information
generated by market transactions involving identical or comparable (ie similar) assets,
liabilities or a group of assets and liabilities, such as a business.
(c) Cost approach: a valuation technique that reflects the amount that would be required
currently to replace the service capacity of an asset (often referred Tomas current replacement
cost).
Fair value hierarchy
Fair value is a market-based measure, not an entity-specific one. Therefore, valuation techniques used
to measure fair value maximise the use of relevant observable inputs and minimise the use of
unobservable inputs.
To increase consistency and compatibility in fair value measurements and related disclosures, IFRS 13
establishes a fair value hierarchy that categorises the inputs to valuation techniques into three levels:
Level 1 inputs
Quoted prices (unadjusted) in active markets for identical assets or liabilities that
the entity can access at the measurement date (IFRS 13: para. 76).
Level 2 inputs
Inputs other than quoted prices included within Level 1 that are observable for the
asset or liability, either directly (ie prices) or indirectly (ie derived from prices). For
example quoted prices for similar assets in active markets or for identical or similar
assets in non-active markets or use of quoted interest rates for valuation purposes
(IFRS 13: para. 81-82).
PPE
Level 3 inputs
Unobservable inputs for the asset or liability, eg discounting estimates of future
cash flows (IFRS 13: para. 86).
Based on internal
data and own Level 3 inputs are only used where relevant observable inputs are not available or
judgement
not where the entity determines that transaction price or quoted price does not
market value
represent fair value.
Active market: A market in which transactions for the asset or liability take place with sufficient
frequency and volume to provide pricing information on an ongoing basis. (IFRS 13: Appendix A)
Examples of inputs used to measure fair value:
Asset or liability
Input
Level 1
Equity shares in a listed company Unadjusted quoted prices in an active market.
Level 2
Licencing arrangement arising Valuation multiple (eg multiple of earnings or
from a business combination
revenue or a similar performance measure) derived
from observable market data, eg from prices in
observed transactions involving comparable
businesses.
Finished goods inventory at a Price to customers adjusted for differences
retail outlet
between the condition and location of the
inventory item and the comparable (ie similar)
inventory items
Level 3
Building held and used
Price per square metre for the derived from
observable market data, eg prices in observed
transactions involving comparable buildings in
similar locations
Cash generating unit
Financial forecast (eg of cash flows or profit or loss)
developed using this the entity’s own data
Three-year option on exchange- Historical volatility, ie the volatility for the shares
traded shares
derived from the shares’ historical prices
Interest rate swap
Adjustment to a mid-market consensus (nonbinding) price for the swap developed using data
not directly observable or otherwise corroborated
by observable market data
The fair value measurement approach
To determine the fair value of an asset or liability, the entity must determine (IFRS 13: para. B2)
(a) The particular asset or liability, including its unit of account
(b) For a non-financial asset, the valuation premise that is appropriate, consistent with the asset’s
highest and best use
(c) The principal or most advantageous market for the asset or liability
(d) The valuation technique(s) appropriate for the measurement
Highest and best use
For non-financial assets, the fair value measurement is the value for using the asset in its highest and
best use (the use that would maximise its value) or by selling it to another market participant that
would use it in its highest and best use (IFRS 13: paras. 27-29).
The highest and best use of a non-financial asset takes into account the use that is physically possible,
legally permissible and financially feasible.
Illustration 5
Highest and best use
An entity acquires control of another entity which owns land. The land is currently used as a factory
site.
The local government zoning rules also now permit construction of residential properties in this
area, subject to planning permission being granted. Apartment buildings have recently been
constructed in the area with the support of the local government.
Market values are as follows:
$m
20
30
Value in its current use
Value as a development site
(including uncertainty over whether planning permission would be granted)
Demolition costs to convert the land to a vacant site
2
The fair value of the land is $28m ($30m - $2m) as this is its highest and best use because market
participants would take into account the site’s development potential when pricing the land.
Principal or most advantageous market
A fair value measurement assumes that the transaction takes place either:
(a) In the principal market for the asset or liability; or
(b) In the most advantageous market (in the absence of a principal market).
The most advantageous market is assessed after taking into account transaction costs and transport
costs to the market. Fair value also takes into account transport costs, but excludes transaction costs.
The fair value should be measured using the assumptions that market participants would use when
pricing the asset or liability, assuming that market participants act in their best economic interest.
Illustration 4
Principal market v most advantageous market
An asset is sold in two different active markets at the following prices per item:
Selling price
Transport costs to market
Transaction costs
European market
$
53
(3)
50
(3)
47
North American market
$
54
(6)
48
(2)
46
The principal market (the one with the greatest volume and level of activity) is the North American
market. The company normally trades in the European market, but it can access both markets.
The fair value of the asset is therefore $48 per item, ie the price after taking into account transport
costs in the principal market for the asset.
If, however, neither market were the principal market, the fair value would be measured using the
price in the most advantageous market. The most advantageous market is the European market
after considering both transaction and transport costs ($47 in European market v $46 in the North
American market) and so the fair value measure would be $50 per item (as fair value is measured
before transaction costs).
Fair value of a liability
The measurement of the fair value of a liability assumes that the liability remains outstanding and the
market participant transferee would be required to fulfil the obligation, rather than it being
extinguished (IFRS 13: para. 34). The fair value of a liability also reflects the effect of non-performance
risk (the risk that an entity will not fulfil an obligation), which includes, but may not be limited to, an
entity’s own credit risk (ie risk of non-payment) (IFRS 13: para. 42).
Illustration 6
Fair value of a liability
Energy Co assumed a contractual decommissioning liability when it acquired a power plant from a
competitor.
The plant will be decommissioned in 10 years’ time.
Assumptions made by Energy Co equivalent to those that would be used by market participants,
assuming Energy Co was allowed to transfer the liability, are:
Estimated labour, material and overhead cost
$6m
$8m
$10m
Estimated probability
40%
50%
10%
Third party contractors typically add a 20% mark-up in the industry and expect a premium of 5% of
the expected cash flows (after including the effect of inflation) to take into account risk that cash
flows may be more than expected.
Inflation is expected to be 3% annually on average over the 10 years.
The risk-free interest rate for a 10 year maturity is 4%.
An appropriate adjustment to the risk-free rate for Energy Co’s non-performance risk is 2% (giving
an entity-specific discount rate of 4% + 2% = 6%).
Calculation of the fair value of the decommissioning liability:
Expected cash flow [(6 x 40%) + (8 x 50%) + (10 x 10%)]
Third party contractor mark-up (7.4 x 20%)
Inflation adjustment ((8.88 x 1.03’°) – 8.88)
Risk premium (11.934 x 5%)
Fair value (present value of expected cash flow adjusted for market risk 12.531 x
1/1.0610)
$m
7.400
1.480
8.880
3.054
11.934
0.597
12.531
6.997