The debate over the best measurement method for assets and liabilities is not a new one in the accounting arena. Discussions of the decision-usefulness of various models of current value accounting have occupied huge space pages in accounting journals and were the focus of the research of many institutes. Current accounting standards primarily rely on the use of historical cost but the use of fair values has become increasingly common in recent years, particularly with the focus on financial instruments. The standard setters hence decided that it was time to make an accounting standard on fair value measurement, with the focus on how to measure fair value rather than on when to use those fair values. This has resulted in the issue of IFRS 13 Fair Value Measurement.
IFRS 13 has a new definition of fair value which seeks to explain questions raised in the application of the definition in current accounting standards. A key characteristic of that definition is that fair value is a current exit price rather than an entry price. The concepts of orderly transactions and market participants help in determining the nature of the market in which the fair value is to be measured.
The determination of fair value necessitates an entity to undertake four steps in the valuation process. Concepts such as the valuation premise that is appropriate to the measurement and the highest and best use of an asset are critical in the measurement process. IFRS 13 also provides valuation techniques that can be applied. Critical to the measurement process are the assumptions that market participants make when using a valuation technique. The assumptions or inputs are classified into three levels; the classification being based on the use of observable and non-observable inputs. In selecting a valuation technique an entity should seek to maximize the number of observable inputs used. A fair value measure is categorized in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement.
A major element of IFRS 13 is the requirement to disclose sufficient information about the fair value measures applied. Users of financial statements should be able to appraise the methods and inputs used to develop the fair value measurements, and to see the effects on income.
The standard setters have not yet completed the Conceptual Framework, on measurement. As there is a connection between how to measure fair value and when to use fair value measures, there is still a lot of work to be done by the standard setters to convince users of financial statements that disclosed fair values are in fact fair.