IFRS 13 talks about "How FVM" should be if you want use. It is not dealt with "WHEN" it should be applied. It leaves it to Other IFRS standards. This standard gives concepts and measurement to use in other IFRS.
Introduction
3 important words and the meaning of those words on which this IFRS is built. This IFRS better to be called as "Dictionary Friendly IFRS". Reading various dictionaries to understand this IFRS is needed
- Word "Fair" means Treating Equal. No Cheating. Look good and better
- Word "Value"- means Estimate of Money worth.
- Word "Measurement" gives methods to have fair value
Having the above meanings, I will try to give "fair" justice to my analysis by making this article with 12 points. Wherever possible I will use my favourite "TEA" AS an example to explain the concept :-)
1. Name of IFRS 13 - Fair Value Measurement. This standard became mandatory on 1st Jan 2013. It took 8 years since 2005 to evolve itself as a mandatory standard in 2013. Ind AS 113 is the Indian version of IFRS 13. It is prospective IFRS. No retrospective is necessary even for comparison.
2. Objective of this IFRS gives scope of this standard. It says that "Framework" will be set for Fair Value measurement (FVM) and Disclosures.
It is market based measurement, not entity specific. It is FVM for assets and liabilities too. Fair Value for Sell of Assets or Paid to transfer a liability
3. IFRS 13 Determine 4 major points/areas
a) Assets/liability
b) Non Financials Assets
c) Principal /Advantages Market and
d) Valuation Technique
4. IFRS 13 had introduced new concept of "Fair Level Hierarchy" to disclose in Financial Statement (FS) . Level 1 input to Level 3 introduced. From Best Better to OK model
Independency +Knowledge of information are key in this hierarchy. It is journey from Knowing area of Pricing to Unknown Price area.
The hierarchy gives the highest priority to (un adjusted) quoted prices in active markets for identical assets or liabilities and the lowest priority to un observable inputs
5. Level Input 1 - if Identical Assets r there in market - are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date
Eg - Finding Price of Tea powder of other companies for valuation.
6. Level Input 2 - Similar Assets - When Identical Assets are not available. Quoted prices for similar assets or liabilities in active markets quoted prices for identical or similar assets or liabilities in markets that are not active inputs other than quoted prices that are observable for the asset or liability
eg - If we find no Other Tea company powder market available, we need to look for Coffee powder market and adjust
7. Level 3 - When 1 and 2 are not available - Unobservable inputs - Unobservable inputs are used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date
An entity develops unobservable inputs using the best information available in the circumstances, which might include the entity's own data, taking into account all information about market participant assumptions that is reasonably available
8. An entity must takes into account the characteristics of the asset or liability being measured that a market participant would take into account when pricing the asset or liability at measurement date.
eg - Tea must be compared with TEA companies of India, not rate of Pakistan. Characters and geographical condition must be taken into account
9. Fair value measurement assumes an orderly transaction between market participants at the measurement date under current market conditions.
Eg - Tea must have good market. It means there should clear Market of buyer and seller. Market where TEA is widely used. Eg : Assam. It is not place “ Coffee “ is main drink
Fair value measurement assumes a transaction taking place in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability
A fair value measurement of a non-financial asset takes into account its highest and best use
10. IFRS 13 gives 3 valuation Techniques or approach. Maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs must be aim to achieve by entity while in FVM. It must be appropriate and sufficient data to be used.
a) Market approach - Most advisable approach for valuation. Entity must try to have Market approach. It is when Principal or Advantages market is available.
b) Cost Approach - Replacement Cost -reflects the amount that would be required currently to replace the service capacity of an asset. Value of asset can be ascertained through replacement cost method Market is not available.
c) Income Approach -converts future amounts (cash flows or income and expenses) to a single current (discounted) amount, reflecting current market expectations about those future amounts.
Again approach must be in hierarchy. Entity must try to have market approach, of not Cost approach. if nothing both, then last approach
11. Tabular Specific quantitative disclosure is asked by the standard to have clear and full disclosure for each class of assets or liability
- The fair value measurement at the end of the reporting period*
- for non-recurring fair value measurements, the reasons for the measurement*
- Fair level hierarchy and fair level measurement applied for level 1 , 2 and 3
12. Example - As this IFRS 13 or Ind AS 113 is more like concept of disclosure, I gone through 3 Annual Reports 2019 20 of Indian Software Companies. I felt TCS had better and clear disclosure compare to Infosys and Wipro. Same is placed here to have an idea of FMV disclosure.
Conclusion
FVM is changing concept of FS from historic costs to relevant information. FVM makes FS as more usable and reliable. Investors can place their weight age more on FS if FVM is applied. IFRS 13 gives you concept and method to look "Fair" and better. However it is not allowing Window Dressing.
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