The different IFRS valuation premises are?

IFRS 13 requirement

What to think of it?

Unit of account – The determination of the unit of account must be established prior to determining fair value and is defined as the level at which an asset or a liability is aggregated or disaggregated in an IFRS for recognition purposes.

The unit of account is determined under the IFRS applicable to the asset or liability (or group of assets and liabilities) that requires fair value measurement.

• The item for which fair value is determined may be a single asset or liability such as a derivative instrument or a share in a publicly traded entity or it may be a group of assets (i.e. a portfolio of receivables), group of liabilities (i.e. a portfolio of deposits) or group of assets and liabilities (e.g. a cash-generating unit, a business or an asset group which is held for sale).
• IFRS 13 does not generally provide specific guidance on the determination of the unit of the account – rather it directs preparers to other IFRSs to make this determination. IFRS 13 does specifically address one area relating to the unit of account in the form of guidance for financial assets and financial liabilities with offsetting positions. Here IFRS 13 includes a “portfolio exception” allowing a specified level of grouping when a portfolio of financial assets and financial liabilities are managed together with offsetting markets risks or counterparty credit risk. This exception is subject to your entity meeting certain eligibility criteria. (IFRS 13 48-52).

Market – Fair value measurement under IFRS 13 assumes that a transaction to sell an asset or to transfer a liability takes place in the principal market (or the most advantageous market in the absence of the principal market).

The principal market is the market with the greatest volume and level of activity for the asset or liability. The most advantageous market is the market that maximizes the amount that would be received to sell the asset or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs.

• If there is a principal market, the price in that market must be used, either directly or as an input into a valuation technique. IFRS 13 does not permit the use of a price in the most advantageous market if a principal market price is available!
• This said, it is not necessary to perform an exhaustive search of all possible markets to identify the principal market (or, in the absence of a principal market, the most advantageous market). However, all information that is reasonably available should be considered and the basis for your conclusions should be documented.
• There is a presumption in the standard that the market in which the entity normally transacts to sell the asset or transfer the liability is the principal or most advantageous market unless there is evidence to the contrary.
• Where your entity transacts in various markets (such as when assets are sold on multiple commodity and/or equity exchanges), your entity should document which particular market price is used and what process was followed to determine the appropriate market to use for determining fair value.

Market participant assumptions – A fair value measurement under IFRS 13 requires an entity to consider the assumptions a market participant, acting in their economic best interest, would use when pricing the asset or a liability.

Market participants are defined as having the following characteristics:

• Independent of each other (i.e. unrelated parties).
• Knowledgeable and using all available information.
• Able of entering into the transaction.
• Willing to enter into the transaction (i.e. not a forced transaction).

• The key concept here is that the standard requires your entity to put itself in the place of a market participant and exclude any entity-specific factors that might impact the price that your entity is willing to accept in the sale of an asset or be paid in the transfer of a liability.
• So, for example, relevant characteristics of an asset might include or relate to:
  • The condition and location of the asset; and
  • Restrictions, if any, on the sale or use of the asset.
• Here, you would need to consider the extent to which a market participant would take the above characteristics into account when pricing the asset or liability at the measurement date. The extent to which restrictions on the sale or use of the asset should be reflected in fair value are very much contingent on where the source of the restriction comes from and whether or not the restriction is separable from the asset.
• Depending on the particular item that is the subject of the fair value measurement, the analysis of determining exactly what a market participant would consider may, in some cases, prove to be challenging. As such, in more challenging cases, we would recommend consultation with your auditors and advisors.

Inputs and valuation techniques – IFRS 13 does not mandate the use of a particular valuation technique(s) but sets out a principle requiring an entity to determine a valuation technique that is “appropriate in the circumstances”, for which sufficient data is available and for which the use of relevant observable inputs is maximized.

IFRS 13 discusses three widely used valuation techniques which are:

• The market approach
• The cost approach
• The income approach

Valuation techniques should be applied consistently from one period to the next.

• IFRS 13 is clear that the valuation technique your entity uses must maximize the use of relevant observable inputs and minimize the use of unobservable inputs. For example, if a quoted price is available for a specific asset, this price must be used instead of an entity-specific assumption about the price.
• Further, there is a direct correlation between the level of disclosures required and the level of unobservable inputs – the more the degree of unobservable data used in your valuation technique, the more the degree of disclosure that you must include in your financial statements.
• A change in a valuation technique can be made but only if the change results in a measurement that is equally or more representative of fair value. Any such change, where justified, is considered to be a change in estimate (IFRS 13 66).

Layered within the requirements of IFRS 13 are specific considerations related to certain elements of the financial statements. These considerations effectively add an additional dimension to the base requirements of the standard.

Non-financial assets (such as items within the scope of IAS 36, IAS 40 and IFRS 5) are subject to a valuation premise referred to as the “highest and best use”. This requires that fair value be determined based on the highest and best use of the asset from the perspective of a market-participant.

The measurement of non-financial assets at the highest and best use is a significant change from previous guidance and requires judgment to be applied.

Highest and best use must meet certain criterion and barriers limiting the assets ability should be examined to ensure that the asset’s use is:

• Physically possible – Are there any issues with the location or size of the property?
• Legally permissible – Are there any zoning implications restricting use?
• Financially feasible – Will the use generate adequate cash flows to produce a return acceptable by market participants?

An entity can presume that the current use of an asset is its highest and best use. However, if the asset is being used defensively (e.g. to protect a competitive position), this presumption may be inappropriate.

Liabilities and own equity instruments must be measured on the assumption that the liability or equity is transferred to a market participant at the measurement date. This differs (sometimes significantly so) from a measurement that is based on the assumption of settlement of a liability or cancellation of an entity’s own equity instrument.

IFRS 13 further requires that the fair value of a liability must factor in non-performance risk. Anything that could influence the likelihood of an obligation being fulfilled is considered a non-performance risk. This could include the risk of physically extracting or transporting an asset or the entity’s own credit risk.

It is important to recognize that the specific approach to fair value liabilities and an entity’s own equity instruments sometimes differs from the concepts to fair value an asset. This is summarized in the decision tree  above.

The dynamics

In today’s financial reporting environment, no IFRS is static. The issuance of other new standards and interpretations can at times prompt a review of aspects of the guidance. Further, it is only after the initial implementation and application of a new standard that some of the practical or interpretative issues are encountered. Items under constant discussion are:

• Determination of fair value of a publicly quoted associate, subsidiary or joint arrangement: This issue relates to whether or not the determination of fair value in this circumstance can incorporate any adjustments to the quoted price (such as control premiums).

• Business combinations involving shares with a trading restriction: It is common for publicly-traded entities to pay for acquisitions using shares and in some cases there may be a restriction attached to the shares either through legend or through a separate agreement. A careful assessment of the nature of the restriction will be required to determine the appropriate accounting under IFRS 13.