IFRS 13 - Fair Value Measurement - Essay Example

THE OUTLINE I. Introduction Fair value refers to unbiased and rational estimate of the possible or potential market price of an asset, good, or service. Fair value measurement estimates the price at which orderly transactions to transfer liability or sell the asset takes place. Market participant are widely involved in estimating prices at the measurement data under existing market conditions Thesis Statement: IFRS 13 – Fair Value Measurement seeks to increase comparability and consistency in virtually all fair value measurements and several related disclosures through level 1, level 2 and level 3 inputs of fair value hierarchy. II. Background and history Project on fair value measurement was integrated into the agenda of IASB on September 2005 Discussion paper on fair value measurement was eventually published on 30th November 2006 and the Exposure Draft Fair Value Measurement published on 28th May, 2009 IFRS 13 – Fair Value Measurement was successfully issued on 12th May 2011 and further amendments done to it on 12th December 2013 The Annual Improvements IFRSs 2011-2013 Cycle would then facilitate further amendments on 12th December, 2013 III. New Rule The International Standard uses ‘fair value hierarchy’, resulting in a market-based rather than entity-specific measurement. Level 1 input(s) refers to the quoted prices in active or dynamic markets for identical liabilities or assets that the business entity can access and utilize at the measurement date. A quoted price is often used to measure fair value without any adjustment, but with limited exceptions. Level 2 inputs refer to the kind of inputs included within level other than quoted market prices. These inputs are normally observable directly or indirectly for the liability or asset Level 3 inputs are inputs that are usually unobservable for the liability or asset. Unobservable inputs are crucial in measuring fair value, especially to the extent that other relevant observable inputs are occupied or simply unavailable. Level 3 allows for some little market activity for the liability or asset at the measurement date IV. Comparison to Old Rule New Rule offers fairly practical guidance for measuring fair value and marks a departure from the Old Rule of keeping books at historical cost. The New Rule also makes accounting information more relevant, as well as ensures that fair value measurement assumes a reasonably orderly transaction among market participants at the measurement date, taking into account the current market conditions. Fair value measurement assumes particular transactions taking place in the market for the liability or asset, or in the absence of the market – the advantageous market for the liability or asset. IFRS 13 of financial or non-financial liability, on the other hand, assumes the liability is transferred to a particular market participant at the measurement date V. Trade Publications Deloitte IFRS Podcast (May 2011) IFRS In Focus Newsletter The In Focus Newsletter highlights the new standards on a fair value disclosure and measurement that IASB issued VI. Academic Publications Many academic publications emphasize the role of fair value hierarchy in analyzing quoted prices in active markets for assets or liabilities. The hierarchy typically gives priority to quoted prices (though unadjusted) in active markets for identical liabilities or assets. The IFRS 13 hierarchy gives the lowest priority to unobservable inputs. Overall, the hierarchy categorizes all the inputs used in valuation systems/techniques into three primary levels. After formal issuance in May 2011, IFRS 13 now applies to annual or yearly periods starting on or after January 2013 VII. My Opinion Fair value plays an integral part in eliminating incentives to purpose-built gain trading and assets securitization thus increasing the credibility of financial reporting. The primary objective of fair value measurement is to estimate the price at which orderly transactions to transfer a liability or sell an asset would take place Entities should disclose information (under disclosure objective) that will enable users of its financial statements to assess and review IFRS 13 for assets and liabilities measured at fair value on either recurring or non-recurring basis after initial recognition VIII. Conclusion IFRS 13 permits entities to measure particular assets and liabilities at their fair values as at the reporting dates. Fair value is basically a hypothetical value and is typically market-based. Fair value plays an integral part in eliminating incentives to purpose-built gain trading and assets securitization thus increasing the credibility of financial reporting. The International Standards deem the notion of ‘exit price’ as the basis or underpinning of the definition of fair value measurement An entity must disclose facts and basis when applying IFRS 13 to an earlier accounting period Fair Value Measurement Introduction Fair value refers to unbiased and rational estimate of the possible or potential market price of an asset, good, or service. It may also denote the price that would be paid to transfer a liability or received to sell an asset in an orderly transaction, involving market participants/players at the measurement date. Objective factors such as supply vs. demand, production costs, replacement costs, actual utility, acquisition costs, and cost of substitutes primarily determine the eventual estimates of an asset’s market price (Jones 28). Apart from the objective factors, fair value takes into consideration subjective factors, such as risk characteristics, cost of capital, return on capital, and individually perceived or supposed utility. International Accounting Standards Board adopted the Fair Value Measurement, IFRS 13, on May 12, 2011. IFRS 13 provides essential guidance on the most useful approach to executing Fair Value Measurement under IFRS (Jones 28). However, IFRS 13 does not offer guidance on the situation or occasion to use fair value. In essence, fair value is a form of certainty in relation to an asset or liability’s market value. The US GAAP (FAS 157) refers to fair value as the amount or price at which a commodity, service or asset could be purchased or sold in current transactions between willing parties (Jones 28). It could also mean the price at which an asset is transferred to an equivalent party except in a liquidation sale. Overall, Fair value measurement (IFRS 13) aims to increase comparability and consistency in virtually all fair value measurements and several related disclosures through level 1, level 2 and level 3 inputs of fair value hierarchy. Background and history The project on fair value measurement was integrated into the agenda of IASB on September 2005. Discussion paper on fair value measurement was eventually published on 30th November 2006 and the Exposure Draft Fair Value Measurement published on 28th may, 2009 (Zacharski et al. 36). Meanwhile, Fair Value Measurement’s draft Measurement Uncertainty Analysis Disclosure was finally issued on 29th June, 2010. IASB formally released the staff draft on IFRS fair value measurement on 19th August, 2010. IFRS 13 – Fair Value Measurement was successfully issued on 12th May 2011 and further amendments done to it on 12th December 2013 by a Cycle dubbed Annual Improvements IFRS 2010-2012 (Zacharski et al. 36). The Annual Improvements IFRSs 2011-2013 Cycle would then facilitate further amendments on 12th December, 2013. IASB Amendments under consideration The International Accounting Standards Board is considering further amendments to IFRS 13 - Unit of account and Research Project – Discount rates. Meanwhile, the IASB is looking forward to conducting post-implementation review of IFRS 13, beginning in 2015. IFRS 13 Summary IFRS 13 defines fair value and spells out (in a single IFRS) the framework for measuring fair value. Also, IFRS 13 typically requires disclosures about fair value measurements (Procházka 989). Apparently, IFRS 13 mostly applies in circumstances where another IFRS permits or requires fair value disclosures or measurements about fair value measurements except for [IFRS 13:5-7]. The disclosures about fair value measurements may also entail measurements, such as less costs to sell (of fair value) mainly based on disclosures or fair value about those measurements (Procházka 989). New Rule The International Standards basically consider the notion of ‘exit price’ as the basis or underpinning of the definition of fair value measurement. An ‘exit price’ refers to the price that would be paid to transfer a liability or price received to sell an asset. In addition, the International Standard uses the ‘fair value hierarchy’, resulting in a market-based, instead of entity-specific measurement (Williams & Joseph 1). The ‘fair value hierarchy’ would facilitate IFRS 13’s attempt to increase comparability and consistency in fair value measurements and related disclosures. Meanwhile, IFRS 13 Fair Value Management largely applies to IFRSs that apparently require or permit disclosures or fair value measurements and provides a single framework of IFRS for measuring fair value. IFRSs may require disclosures about the actual process and task of fair value measurement (Williams & Joseph 1). i. Level 1 inputs Level 1 Inputs refer to the quoted prices in active or dynamic markets for identical liabilities or assets that the business entity can access and utilize at the measurement date. The quoted market price (in an active market) provides the most consistent and reliable evidence in relation to fair value (Stickney 111). A quoted price is often used to measure fair value without any adjustment, but with limited exceptions. An entity that holds a single liability or asset and the liability or asset is traded in an active market will have its asset or liability fair value measured at Level 1. The measurement would generally be the product or result of the quoted price for the individual liability or asset and the actual quantity that the entity holds (Stickney 111). The insufficiency of the market’s day-to-day trading volume to absorb the amount/quantity held or even placing orders to sell the position in a single transaction will ultimately affect the quoted price. ii. Level 2 inputs Level 2 inputs refer to the kind of inputs included within level other than quoted market prices. These inputs are normally observable directly or indirectly for the liability or asset (Jones 28). They include quoted prices for similar or identical assets or liabilities in active markets and quoted prices for similar or identical liabilities or assets in markets that are not active. Examples of inputs that are observable to the liability or asset include implied volatilities, credit spreads, and yield curves and interest rates observable at commonly quoted intervals (Jones 28). Finally, inputs that are principally corroborated by or derived from observable market data also fall into the category of Level 2 inputs. iii. Level 3 inputs Level 3 inputs are inputs that are usually unobservable for the liability or asset. Unobservable inputs are particularly vital in measuring fair value, especially to the extent that other relevant observable inputs are occupied or unavailable (Stickney 111). As a result, Level 3 allows for some little market activity for the liability or asset at the measurement date. Apparently, an entity would develop unobservable inputs using the available information on the situations or conditions that might include the data of the entity (Stickney 111). Nevertheless, information about various assumptions of the market participants ought to be reasonably available to make level 3 inputs a reality, as well as to ensure continued market activity for liability or asset despite the absence of observable inputs. Comparison to Old Rule IFRS 13, unlike the Old Rule, offers practical guidance for measuring fair value. In particular, IFRS 13 ensures that fair value measurement assumes a reasonably orderly transaction among market participants at the measurement date, taking into account the current market conditions (Reilly 5). Similarly, fair value measurement assumes particular transactions taking place in the market for the liability or asset, or in the absence of the market – the advantageous market for the liability or asset. Fair value measurement of financial or non-financial liability, on the other hand, assumes the liability is transferred to a particular market participant at the measurement date (Reilly 5). This usually happens without settlement, cancelation, or extinguishment at the measurement date. Also, the fair value of an entity’s liability is a reflection of non-performance risk, including the credit risk of the entity and assuming similar non-performance risk before or after transfer of liability (Reilly 5). Meanwhile, an optional exception often applies for certain financial liabilities and financial assets with offsetting positions in counterparty credit risk or market risks (Reilly 5). Nevertheless, this optional exception for financial assets and liabilities with offsetting positions must meet additional disclosure and other vital conditions for fair value measurement. Trade Publications Deloitte IFRS Podcast (May 2011) IFRS In Focus Newsletter The In Focus Newsletter highlights the new standards on a fair value disclosure and measurement that IASB issued Academic Publications and Resources Many academic publications emphasize the role of fair value hierarchy in analyzing quoted prices in active markets for assets or liabilities. The hierarchy typically gives priority to quoted prices (though unadjusted) in active markets for identical liabilities or assets. On the other hand, the hierarchy gives the lowest priority to unobservable inputs (Williams & Joseph 1). Overall, the hierarchy categorizes all the inputs used in valuation systems/techniques into three primary levels. After formal issuance in May 2011, IFRS 13 now applies to annual or yearly periods starting on or after January 2013. Since the essential inputs used to measure fair value are often categorized into different, diverse levels of fair value hierarchy, the fair value measurement would eventually be classified entirely at the level of the lowest significant input (Williams & Joseph 1). The lowest input of fair value measurement is fundamental to the entire measurement, ostensibly based on the application of judgment. My Opinion In my view, fair value plays an integral part in eliminating incentives to purpose-built gain trading and assets securitization thus increasing the credibility of financial reporting. Besides, fair value measurement would lose its objectivity if an entity has fallen short of determining fair value explicitly or unambiguously. Similarly, the entity cannot measure fair value based on subjective assumptions if quoted market prices are missing. However, fair value measurement is arguably an inconsistent form of measurement within financial statements. A valuation technique plays an incredible role to estimate the price at which an orderly transaction to transfer the liability or to sell the asset would take place. The widely used valuation techniques include market approach, a cost approach, and an income approach. I also believe that the primary objective of fair value measurement is to estimate the price at which orderly transactions to transfer a liability or sell an asset would take place. Market participants are widely involved in determining prices for the measurement data under existing market conditions (Procházka 989). An entity should meet or attain a number of conditions set out by the approach to make fair value measurement a reality. For instance, an entity must ensure that the specific liability or asset, which is subject to measurement, is consistent with conventional units of account. The valuation premise for a non-financial asset should be appropriate for the measurement – consistently with its best and highest use (Procházka 989). The most advantageous (or principal) market for the asset or liability must be in place or put into account. Lastly, the valuation technique should be appropriate or fitting for measurement given the availability of data with which the entity can develop inputs that represent assumptions that the market participants would employ some level of fair value hierarchy (Procházka 989). Finally, I believe that entities should disclose information (under disclosure objective) that will enable users of its financial statements to assess and review IFRS 13 for assets and liabilities measured at fair value on either recurring or non-recurring basis after initial recognition. The entities should further disclose information for fair value measurements with the help of Level 3 (significant unobservable inputs). This will help to determine the measurements of loss or profit or any other comprehensive income for that particular period. Judgment is pertinent when determining the appropriate classes of both assets and liabilities for which an entity would provide disclosures about fair value measurement. Conclusion In summary, fair value measurement (IFRS 13) aims to increase comparability and consistency in virtually all fair value measurements and several related disclosures through level 1, level 2 and level 3 inputs of fair value hierarchy. It also permits or obliges entities to measure particular assets and liabilities at their fair values as at the reporting dates. In this regard, fair value is a hypothetical value and is currently market-based. However, the market value is not always observable directly. The global economic crisis and financial crunch between 2007 and 2009 sparked the debate on the usefulness of fair value accounting (Miller & Paul 30). Many of the opponents of fair value accounting believe that financial reporting that is based on fair value measurement has significantly accelerated the global financial crisis. In addition, they maintain that IFRS 13-based financial reporting has immensely worsened the impact on affected entities. IFRS 13 is generally applicable to annual reporting periods, starting on or even 1st January, 2013. An entity must disclose the facts and basis when applying IFRS 13 to an earlier accounting period (Miller & Paul 30). Lastly, the entity would take into account the attributes of an asset or liability being measured that most market participants would consider when pricing an asset or liability at the measurement date. For instance, an entity ought to consider the location and condition of an asset and any other restrictions on the use or sale of the asset. Most entities use valuation techniques appropriate in the situations or circumstances and for which adequate data are available for measuring the fair value, maximizing use of observable inputs, and minimizing use of unobservable inputs. Works Cited Elifoglu, I. H., Adrian P. Fitzsimons, and Benjamin R. Silliman. "New Guidance on Fair Value of Liabilities; Exposure Draft on Disclosure of Fair-Value Measurements." Commercial Lending Review (2009): 41-5. Esquivel, Omar, and Sylwia Gornik-Tomaszewski. "Fair Value Measurements in Impairment Testing: How SFAS no. 157 Increases Consistency and Comparability." Review of Business 27.4 (2007): 19-24. Jones, Jefferson P. "Present Value-Based Measurements and Fair Value." The CPA Journal 69.10 (1999): 28-33. McCarroll, John, and Goind Ram Khatri. "Fair Value Measurement under IFRS 13." Accountancy Ireland 44.4 (2012): 22-3. Miller, Paul B. W., and Paul R. Bahnson. "Refining Fair Value Measurement." Journal of Accountancy 204.5 (2007): 30,32,34,36. Neal, Terry L. "Accounting Standards Update no. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements." Miller GAAP Update Service 10.5 (2010): 1-4. Procházka, David. "The Role of Fair Value Measurement in the Recent Financial Crunch." Economics, Management and Financial Markets 6.1 (2011): 989-1001. Reilly, Robert F. "The Impact of SFAS no. 157 Fair Value Measurements on Property Tax Appraisals." Journal of Property Tax Assessment & Administration 5.4 (2008): 5-15. Stickney, Clyde P. Financial Accounting: An Introduction to Concepts, Methods, and Uses. Mason, OH: South-Western/Cengage Learning, 2010. Print. Williams, Jan R., and Joseph V. Carcello. "Examples of the Application of FASB Statement no. 157, Fair Value Measurements, and FASB Interpretation no. 48, Accounting for Uncertainty in Income Taxes." Miller GAAP Update Service 7.5 (2007): 1-8. Zacharski, Anthony H., et al. "FASB Statement on Fair Value Measurements." The Journal of Investment Compliance 8.1 (2007): 36-9. Read More