Changes to IFRS are changes to Canadian GAAP.
Last issue I provided an overview of the development of IFRS 13. This column will highlight some of the accounting issues associated with IFRS 13.
IFRS 13 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” (an exit price). The key is that fair value is a market-based measurement, not an entity-specific measurement. When measuring fair value, an entity uses the assumptions that market participants would use when pricing the asset or liability under current market conditions, including assumptions about risk.
- Price: IFRS 13 deems fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions regardless of whether that price is directly observable or estimated using another valuation technique.
- Transaction: IFRS 13 assumes that the fair value measurement is determined when the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date under current market conditions. In addition, IFRS 13 assumes that the transaction to sell the asset or transfer the liability takes place in the principal market for the asset or liability, or in the absence of a principal market, in the most advantageous market for the asset or liability.
- Participants: IFRS 13 requires an entity to measure the fair value of an asset or a liability using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. Even though market participants often act irrationally, the standard assumes rational behaviour by noting that an entity need not identify specific market participants.
Valuation Techniques
IFRS 13 directs an entity to use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimising the use of unobservable inputs.
There are three widely used valuation techniques: the market approach, the cost approach, and the income approach.
- The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities, or a group of assets and liabilities, such as a business.
- The cost approach reflects the amount that would be required to replace the service capacity of an asset, often referred to as current replacement cost.
- The income approach converts future amounts such as cash flows or income and expenses to a single current amount. When the income approach is used, the fair value measurement reflects current market expectations about those future amounts.
The Fair Value Hierarchy
To increase consistency and comparability in fair value measurements and related disclosures, IFRS 13 uses the fair value hierarchy initially issued as part of IFRS 7 (which was taken from FASB’s SFAS 157). The hierarchy categorizes the inputs to valuation techniques used to measure fair value into three levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).
Fair Value Hierarchy
- Level 1 Inputs: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date.
- Level 2 Inputs: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
- Level 3 Inputs: Inputs for the asset or liability that are unobservable, including the entity’s own data, which are adjusted if necessary to reflect market participants’ assumptions.
With the release of IFRS 13, Canadian GAAP changes, but there will be no differences with IFRS. For more in-depth coverage, head over to PD Net where you can sign up for a professional development course entitled Fair Value Measurement.