Key Steps in the Fair Value Framework
The process of measuring fair value involves six key steps:
1. Identify the characteristics of the asset or liability
→ Understand what exactly you’re valuing (e.g., location, condition, restrictions).
→ For non-financial assets, identify their highest and best use from the market’s
perspective, not the company’s.
2. Identify the principal or most advantageous market
→ Determine where the asset or liability is normally traded — the market with the most
activity and fair prices.
→ The company must have access to that market.
3. Identify market participants
→ Figure out who would buy or sell the asset — buyers and sellers who are
knowledgeable, willing, and acting in their best economic interest.
4. Select appropriate valuation techniques
→ Choose the most suitable method to estimate value (e.g., income, market, or cost
approach).
→ Use assumptions that market participants would use, not the company’s own view.
→ Maximize observable inputs (public data) and minimize unobservable inputs
(subjective estimates).
5. Determine valuation inputs and hierarchy
→ Inputs (data used for valuation) are ranked in a fair value hierarchy:
○ Level 1: Observable quoted market prices
○ Level 2: Indirect observable data (e.g., similar assets)
○ Level 3: Unobservable estimates (e.g., internal models)
→ Also consider premiums, discounts, and risk adjustments that reflect market
conditions.
6. Perform valuation and disclosure
→ Calculate the fair value using the chosen technique and inputs.
→ In financial statements, disclose how the value was determined — especially if
unobservable data was used.
Characteristics of the Valuation Subject
When valuing an asset or liability, consider its specific characteristics, because these affect how
market participants would price it.
Examples:
● Location and condition – If an asset needs to be moved or repaired, deduct those costs
from its fair value.
● Restrictions –
○ If the restriction transfers with the asset, it affects fair value.
Example: Restricted shares that can only be sold to specific investors.
○ If the restriction is entity-specific, it’s ignored.
Example: Land that only your company is restricted to use for a school — but
others could use for any purpose.
Highest and Best Use (for Non-Financial Assets)
For non-financial assets (like land, buildings, or equipment), fair value is based on how the asset
could create the most economic benefit — from the market’s point of view, not the owner’s.
Example:
A company owns land in a city’s business district and currently uses it as a parking lot.
Market participants, however, would get more value by building a commercial building on it.
Therefore, fair value should reflect its potential as a commercial building site, not as a parking
lot.
When determining highest and best use, it must be:
1. Physically possible – considering the asset’s location, size, and condition.
2. Legally permissible – respecting zoning laws and regulations.
3. Financially feasible – able to generate sufficient returns to make economic sense.
The asset can be valued alone or in combination with other assets (e.g., land plus building).
Principal or Most Advantageous Market
● The principal market is the market with the greatest activity and highest volume of
transactions for that asset or liability.
● The company must have access to this market at the measurement date.
● Even if another market offers a slightly better price, fair value uses the principal market’s
price (because that’s where the entity normally trades).
● Different entities might have different principal markets depending on where they
operate.
Simplified Explanation of Fair Value Measurement under IFRS 13
What Fair Value Means
Fair value is:
“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.”
In short: it’s the market-based selling price (exit price) — not the cost when you bought it (entry
price).
Principal Market vs. Most Advantageous Market
Principal Market
● The main market where the asset or liability is most actively traded.
● Example:
If Co. A sells most of its product in Market X, then Market X is its principal market even
if another market (Z) is larger, but not accessible to Co. A.
Most Advantageous Market
● If no principal market can be identified, use the market that gives the best net return (after
transaction and transport costs).
● Example:
Market X price = ₱10 – ₱3 (transaction) – ₱1 (transport) = ₱6
Market Y price = ₱12 – ₱2 (transaction) – ₱3 (transport) = ₱7
Market Y is most advantageous because it gives the higher net amount.
Market Participants
● Independent (not related parties)
● Knowledgeable (well-informed buyers/sellers)
● Willing and able to transact in an orderly (not forced) way
● Act in their best economic interest
Fair value assumes what market participants, not the specific company, would pay.
Valuation Techniques (3 Approaches)
IFRS 13 allows 3 main ways to estimate fair value: