TOPIC 4: Fair Value Accounting and Financial Reporting Standards
Financial statements are used by many people — like investors, creditors, and government
agencies — to make decisions. That’s why the information in them must be relevant, accurate,
and useful.
Traditionally, companies used the historical cost method — which records assets and liabilities
at their original purchase price. This method is stable and reliable, but it doesn’t always show the
current market value of assets and liabilities.
Because of this, many people now prefer fair value accounting, which shows how much an
asset or liability is worth today in the market. Fair value reflects up-to-date and realistic values,
helping users understand the company’s true financial position.
Why Fair Value Accounting?
● It provides more current and relevant information than historical cost.
● It helps investors and stakeholders make better decisions.
● It improves transparency and comparability in financial reports.
Accounting Standards That Use Fair Value
Fair value measurement is used in several key International Financial Reporting Standards
(IFRS), such as:
● IFRS 13 – Fair Value Measurement: Explains how to measure and disclose fair value.
● IFRS 3 – Business Combinations: Applies fair value when a company buys or merges
with another.
● IAS 38 – Intangible Assets: Covers fair value for intangible assets like patents or
trademarks.
● IAS 36 – Impairment of Assets: Uses fair value to check if an asset’s carrying value is
too high (impairment testing).
● IAS 39 – Financial Instruments: Measures certain financial assets and liabilities at fair
value.
● IAS 40 – Investment Property: Measures real estate investments at fair value.
● IAS 41 – Agriculture: Measures biological assets (like livestock or crops) at fair value.
Important Distinction
● IFRS 13 tells us how to measure fair value (the method).
● The other standards (like IFRS 3, IAS 36, etc.) tell us when and which items should be
measured at fair value.
7.2 Measurement Requirements of Fair Value under IFRS 13
Before IFRS 13 was introduced, the rules for fair value accounting were spread out across many
different standards.
Some standards gave a lot of guidance, others gave very little, which caused:
● Confusion
● Inconsistency
● Different interpretations of what “fair value” meant and how it should be disclosed
Why IFRS 13 Was Introduced
IFRS 13 was created to unify and clarify everything about fair value measurement.
It became the main reference standard that explains how to measure and disclose fair value, no
matter what kind of asset or liability you’re valuing.
Exceptions (When IFRS 13 Does NOT Apply)
There are certain cases where IFRS 13’s rules do not apply, because other standards have their
own special measurement methods.
These exceptions include:
● IFRS 2 – Share-based Payments (e.g., employee stock options)
● IAS 17 – Leases
● IAS 2 – Inventories (which uses net realizable value, not fair value)
● IAS 36 – Impairment of Assets (which uses value in use)
Also, the disclosure requirements of IFRS 13 do not apply to:
● Plan assets (under IAS 19 – Employee Benefits)
● Retirement plan investments (under IAS 26)
● Fair value less costs of disposal (under IAS 36)
So basically, IFRS 13 isn’t used everywhere—only where fair value is the proper measurement
basis.
What IFRS 13 Focuses On
The standard centers around three main areas:
1. Definition of Fair Value – What “fair value” really means
2. Framework for Fair Value Measurement – How to measure fair value properly
3. Disclosures about Fair Value Measurement – What information companies must report
about their fair value calculations
Definition of Fair Value
Before IFRS 13 (issued in May 2011), “fair value” was defined as:
“The amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.”
This older definition sounded fine, but it had problems:
1. It didn’t say whether the entity was buying or selling the asset.
2. It didn’t explain who the liability was being settled with (why “willing parties” instead of
actual creditors?).
3. It didn’t say when the transaction happened (no measurement date).
The New IFRS 13 Definition
The IASB (International Accounting Standards Board) improved the definition to make it clearer
and more consistent.
Under IFRS 13, fair value means:
“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.”
Key Points in the New Definition
1. Exit Price (not Entry Price):
○ Exit price = the price you’d get if you sell an asset or transfer a liability now.
○ Entry price = the price you pay to buy the asset or receive to take on a liability.
○ Fair value uses exit price because it reflects current market value at the time of
measurement.
○ Sometimes entry and exit prices can be the same — but they shouldn’t
automatically be assumed to be equal.
When Entry Price ≠ Fair Value
The transaction price might differ from fair value when:
● The transaction is between related parties (not at arm’s length).
● It’s a forced sale or distressed transaction (e.g., selling cheap just to get cash fast).
● The unit of account is different (e.g., buying properties in bulk at a “block discount”).
● The transaction happens in a different market (e.g., retail vs. wholesale market).
Other Important Details
● Fair value is based on an orderly transaction, not a rushed or forced one.
● It is market-based, not entity-specific — meaning it reflects what market participants
(buyers and sellers) would agree to, not what the company personally believes.
● It reflects current market conditions on the measurement date.
Fair Value vs. Fair Market Value
Although their wording differs slightly:
● Fair value = exit price (IFRS 13)
● Fair market value = exchange price (used in valuation practice)
In many real-world cases, they turn out to be similar or even identical, since transaction costs are
excluded from both definitions.
Framework for Fair Value Measurement
The framework under IFRS 13 guides how to measure fair value and what factors to consider.
It helps ensure fair value reflects real market conditions and not just what the company
personally thinks.