IFRS 13 is the International Financial Reporting Standards (IFRS) that provide guidance on fair value measurement. Fair value is the amount at which an asset could be exchanged between knowledgeable and willing parties in an arm’s length transaction. The standard sets out the framework for measuring fair value and provides guidance on how to apply fair value in financial statements.
Rules and Descriptions:
The standard defines fair value 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. The fair value measurement is based on the perspective of market participants, not the entity’s specific circumstances.
IFRS 13 establishes a fair value hierarchy that classifies inputs used in measuring fair value into three levels:
Level 1 inputs: quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 inputs: inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3 inputs: unobservable inputs for the asset or liability.
To illustrate, suppose a company holds a portfolio of stocks, and it wants to determine the fair value of the portfolio for financial reporting purposes. The company would need to use the following steps:
Determine the level of the inputs used to value each security in the portfolio.
For securities with Level 1 inputs, use the quoted market prices.
For securities with Level 2 inputs, use observable data, such as market prices for similar securities or discounted cash flows.
For securities with Level 3 inputs, use unobservable data, such as the company’s own internal models or assumptions.
IFRS 13 is a principle-based standard, which means that it does not provide prescriptive rules for determining fair value. Instead, it provides guidance on how to apply fair value principles in practice. Companies must exercise judgment when measuring fair value, taking into account the specific facts and circumstances of each transaction.
One example of how fair value measurement requires judgment is the valuation of intangible assets. Intangible assets, such as patents, trademarks, and customer relationships, can be challenging to value because they do not have a readily observable market price. Companies must rely on assumptions, such as the expected future cash flows generated by the asset or the cost to replace the asset, to estimate fair value.
In recent years, there have been several developments related to fair value measurement. One such development is the increasing use of technology to assist with fair value measurement. Software tools can help companies collect and analyze data, automate processes, and reduce the risk of errors.
Another development is the increasing emphasis on transparency and disclosure related to fair value measurement. Regulators, investors, and other stakeholders are increasingly demanding more information about how fair value measurements are made, including the inputs and assumptions used.
In conclusion, fair value measurement is an important concept in accounting and financial reporting. IFRS 13 provides a framework for measuring fair value and guidance on how to apply fair value principles in practice. Companies must exercise judgment when measuring fair value, taking into account the specific facts and circumstances of each transaction. With the increasing use of technology and demand for transparency, fair value measurement will continue to evolve in the future