DipIFR Syllabus B. Elements of financial statements - Fair Value - Notes 1 / 1
Fair value considers the characteristics of the asset
For example
The condition and location of an asset
Any restrictions on the sale or use of an asset
This means that when revaluing its property, plant and equipment, an entity should consider:
the highest and best use of the assets
Fair value assumes the sales takes place in:
The Principal market
the market with greatest volume and level of activity for the asset or liability
The most advantageous market
The market that maximises the amount that would be received paid for the asset
Valuation Techniques
Market approach
Prices from similar market transactions
e.g. quoted prices of listed equity, debt securities or futures, or market interest rates
Income approach
This converts future cash flows to a single discounted amount; e.g. discounted cash flow models and option pricing models
Cost approach
This reflects the amount required currently to replace the service capacity of an asset, i.e. the current replacement cost
When measuring fair value, an entity is required to maximise the use of relevant observable inputs and minimise the use of unobservable inputs
| Level 1 | Level 2 | Level 3 | |
|---|---|---|---|
| Definition | Quoted prices in active markets for identical assets or liabilities | Observable inputs | Unobservable inputs |
| Example | Share prices on a stock exchange | Current market rents for similar properties and market interest rates for the FV of an investment property | Projected cash flows used to value a none public business |
How does all this work in practice?
E.g. An entity owns 10,000 ordinary shares in M & S
Since there is an active market for these shares through the London stock exchange, the entity must use a market approach (level 1 input).
However, the measurement of the fair value of an unlisted debt security may require the use of an income approach, e.g. a discounted cash flow model using market interest rate for similar debt securities (level 2 input) and market credit spreads adjusted for entity-specific credit risk (level 2 or 3 inputs).