Question

The International Financial Reporting Standard IFRS13 Fair value measurement was jointly issued by the IASB and the FASB in May 2011. The standard defines fair value, establishes framework for measuring fair value and requires significant disclosures relating to fair value measurement.

Required:

a. Discuss the main principles of fair value measurement as set out in IFRS 13.

b. Describe the three-level hierarchy of inputs into valuation techniques provided for in IFRS 13.

c. Describe the valuation techniques.

d. List five disclosures required under IFRS 13.

Answer 1

A. Principles of fair value measurement:

Fair value measurement assumes that the asset or liability exchanged in an orderly transaction between market participants under current market conditions at the measurement date.

The measurement assuming that the transaction took place either:

(a) in the principal market for the asset or liability or

(b) in the absence of a principal market, in the most advantageous market for the asset or liability.

Fair value measurement is based on Exit price not the entry price.

The price in the principal market should be used as fair value and it should not be adjusted for transaction costs. Transaction costs do not include transport costs. The price in the principal or most advantageous market shall be adjusted for the costs that would be incurred to transport the asset from its current location to that market.

B. Three-level hierarchy of inputs:

i. Level 1: Inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date. The quoted price is the most reliable evidence, hence it should be used without adjustment whenever available, except in very limited situations outlinein IFRS 13.

ii. Level 2 : Inputs other than quated prices included with Level 1 which are observable directly or indirectly such as:

- Quated prices for similar assets or liabilities in the active markets.

- Quoted prices for identical or similar asstes or libilities in markets that are not active.

- Inputs other than quoted prices that are observable for the asset or liability for ex: implied volatities.

- Market corroborated inputs.

Level 2 inputs can be adjusted and such adjustment can be considering the following:

- the condition or location of asset.

- the extent to which inputs relate to items that are comparable to the asset or liability.

- the volume or level of activity in the markets within which inputs are observed.

iii. Level 3 : These inputs are unobservable inputs for the asset or liability. these inputs are used only to the extent observable are not available. Unobservable inputs shall reflect the assumptions that market participants would use when pricing the asset or liability including assumptions about risk

C. Valuation techniques:

1. Market approach : This approach uses price and other relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets & liabilities, such as a business.

2. Income approach : This approach converts future amounts to a single current present value. This is based on the current market expectations about those future amounts.

3. Cost approach : A valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset

D. Disclosures under IFRS 13:

For assets and liabilities that are measured at fair value on a recurring or non recurring basis in the balancesheet after initial recognition, the following shall be disclosed:

- Reasons for fair value measurement

- Fair value hierachy

- Valuation technique, change in valuation technique

- quantitative information about significant unobservable inputs

- Unrealized gains or losses included in assets or liabilities.

- Description of valuation process