Are you ready for IFRS 13?
By David Raggay and Sunil Kansal
IFRS 13 was published by the International Accounting Standards Board (IASB) in May 2011. It is effective for financial periods beginning on or after January 1, 2013 and has the following key characteristics
The concept of fair value measurement and related disclosures has existed for many years in International Financial Reporting Standards (IFRS). Until recently, however there were several concerns about its application:
The foregoing was addressed by the Board as part of a wider issue which included off balance sheet financing. Consequently, the following standards were also addressed:
Prior to the issue of IFRS 13, Fair Value was defined in IAS 32 Financial Instruments: Presentation as: "the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction"
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". A key focus of the revised definition is the fact that FV is market-based (as opposed to entity-based) and the need to include in the measurement of FV all assumptions which would be considered by market participants.
FAIR VALUE HIERARCHY
The Fair Value Hierarchy was introduced for financial periods beginning on or after January 1, 2009 as an amendment to IFRS 7-Financial Instrument Disclosures. As the foregoing suggests, the impact related only to the disclosures on issues pertaining to financial instruments.
The salient features of the hierarchy are as follows:
Under IFRS 13, the hierarchy is applied not just to financial instruments, but to all assets, liabilities and equity. The standard, while not changing the timing for the determination of fair values, provides increased guidance on how to measure fair value when such measurements or disclosures, or those based on fair value, are required or permitted by IFRS.
In addition to the normal scope exclusions relating to standards which specifically address certain issues, (IFRS 2 Share-based Payment & IAS 17 Leases), IFRS 13 does not apply to measurements which are similar to, but not fair value. Such measurements include "net realizable value" and "value in use".
In addition to the foregoing, there are several complexities involved in the standard, including the following:
In general, the market in which the entity transacts more frequently is also the market with the greatest volume and deepest liquidity. In these instances, the principal market would likely be the same as the most advantageous market (this would be the case with most of the financial instruments), however, when this is not the case, applying IFRS 13 would change the current practice.
For example, those markets might be different if the entity is a swap dealer that enters into transactions with customers in the retail market, but the principal (or most advantageous) market for the exit transaction is with other dealers in the dealer market.
As another example, if an
entity previously measured the FV of agriculture produced based on its local market but there is a more deeper and liquid
market for the same agriculture produced (for which transport costs are not prohibitive), the latter market would be deemed
the principal market and would be used to determine the FV.
Market A is the Principal market because it has the highest volume, however, the most advantageous market is Market C since it has the highest net proceeds. Therefore, quote from the principal market should be used.
The price used to measure fair value should not be adjusted for transaction costs, because such costs are incremental costs of the transaction and thus do not constitute an attribute of the asset or liability itself. However, if the location of the asset or liability is deemed an attribute of the asset or liability (e.g., for a commodity), the price used to determine fair value should be adjusted for any costs necessary to transport it to (or from) its principal or most advantageous market.
CONSIDERATIONS IN THE MEASUREMENT OF FAIR VALUE
The guidance in the standard requires that, inter alia, the following be contemplated:
IFRS 13 specifies how an entity should measure fair value and disclose information about fair value measurements. It does not specify when the related financial statement items should be measured at fair value.
WHAT WILL CHANGE?
David Raggay B.Sc., M.Sc., CA is Managing Principal of IFRS Consultants. Sunil Kansal is Head of Global IFRS Desk.