IFRS 13 : Fair Value Part 2

Question 1

VALUATION TECHNIQUES

Answer 1

VALUATION TECHNIQUES

Question 2

There are two key distinctions between the way previous IFRSs considered valuation techniques and the approach in IFRS 13. On adoption of the standard, these distinctions, in and of themselves, may not have changed practice. However, they may have required
management to reconsider their methods of measuring fair value.

Answer 2

Firstly, IFRS 13’s requirements in relation to valuation techniques apply to all methods of measuring fair value. Traditionally, references to valuation techniques in IFRS have indicated a lack of market-based information with which to value an asset or liability.
Valuation techniques as discussed in IFRS 13 are broader and, importantly, include market-
based approaches.

Question 3

Secondly, IFRS 13 does not prioritise the use of one valuation technique over another, unlike existing IFRSs, or require the use of only one technique (with the exception of the requirement to measure identical financial instruments that trade in active markets
at price multiplied by quantity (P×Q)). Instead, the standard establishes a hierarchy for the inputs used in those valuation techniques, requiring an entity to maximise observable inputs and minimise the use of unobservable inputs (the fair value hierarchy is discussed further at THE FAIR VALUE HIERARCHY below). [IFRS 13.74].

Answer 3

In some instances, the approach in IFRS 13 may be consistent with previous requirements in IFRS. For example, the best indication of fair value continues to be a quoted price in an active market. However, since IFRS 13 indicates that multiple techniques should be used when appropriate and sufficient data is available, judgement will be needed to select the techniques that are appropriate in the circumstances. [IFRS 13.61].

Question 4

Selecting appropriate valuation techniques 1

IFRS 13 recognises the following three valuation approaches to measure fair value.

• Market approach: based on market transactions involving identical or similar assets or liabilities;

Answer 4

• Income approach: based on future amounts (e.g. cash flows or income and expenses) that are converted (discounted) to a single present amount; and
• Cost approach: based on the amount required to replace the service capacity of an asset (frequently referred to as current replacement cost).

Question 5

Selecting appropriate valuation techniques 2

IFRS 13 requires that an entity use valuation techniques that are consistent with one or more of the above valuation approaches (these valuation approaches are discussed in more detail at Market approach to Income approach below). [IFRS 13.62]. These approaches are consistent with generally accepted valuation methodologies used outside financial reporting. Not all of the approaches will be applicable to all types of assets or liabilities.

Answer 5

However, when measuring the fair value of an asset or liability, IFRS 13 requires an entity to use valuation techniques that are appropriate in the circumstances and for which sufficient data is available. As a result, the use of multiple valuation techniques may be required.
[IFRS 13.61, 62].

Question 6

Selecting appropriate valuation techniques 3

The determination of the appropriate technique(s) to be applied requires: significant judgement; sufficient knowledge of the asset or liability; and an adequate level of expertise regarding the valuation techniques. Within the application of a given approach, there may be a number of possible valuation techniques.

Answer 6

For instance, there are a number of different techniques used to value intangible assets under the income
approach (such as the multi-period excess earnings method and the relief-from-royalty method) depending on the nature of the asset.

Question 7

Selecting appropriate valuation techniques 4

As noted above, the fair value hierarchy does not prioritise the valuation techniques to be used; instead, it prioritises the inputs used in the application of these techniques. As such, the selection of the valuation technique(s) to apply should consider the exit market (i.e. the principal (or most advantageous) market) for the asset or liability and use valuation inputs that are consistent with the nature of the item being
measured.

Answer 7

Regardless of the technique(s) used, the objective of a fair value measurement remains the same – i.e. an
exit price under current market conditions from the perspective of market participants.

Selection, application, and evaluation of the valuation techniques can be complex. As such, reporting entities may need assistance from valuation professionals.

Question 8

Selecting appropriate valuation techniques -
Single versus multiple valuation techniques 1

The standard does not contain a hierarchy of valuation techniques because particular valuation techniques might be more appropriate in some circumstances than in others.

Selecting a single valuation technique may be appropriate in some circumstances, for example, when measuring a financial asset or liability using a quoted price in an active market.

Answer 8

However, in other situations, more than one valuation technique may be deemed appropriate and multiple approaches should be applied. For example, it may
be appropriate to use multiple valuation techniques when measuring fair value less costs of disposal for a cash-generating unit to test for impairment.

Question 9

Selecting appropriate valuation techniques -
Single versus multiple valuation techniques 2

The nature of the characteristics of the asset or liability being measured and the availability of observable market prices may contribute to the number of valuation
techniques used in a fair value analysis.

Answer 9

For example, the fair value of a business is often
estimated by giving consideration to multiple valuation approaches; such as an income approach that derives value from the present value of the expected future cash flows specific to the business and a market approach that derives value from market data (such
as EBITDA or revenue multiples) based on observed transactions for comparable assets. On the other hand, financial assets that frequently trade in active markets are often valued using only a market approach given the availability and relevance of observable data.

Question 10

Selecting appropriate valuation techniques -
Single versus multiple valuation techniques 3

Even when the use of a single approach is deemed appropriate, entities should be aware of changing circumstances that could indicate using multiple approaches may be more appropriate. For example, this might be the case if there is a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity.

Answer 10

Observable transactions that once formed the basis for the fair value estimate may cease to exist altogether or may not be determinative of fair value and, therefore, require an adjustment to the fair value measurement (this is discussed further at Estimating fair value when there has been a significant decrease in the volume and level of activity above). As such, the use of multiple valuation techniques may be more appropriate.

Question 11

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 1

When the use of multiple valuation techniques is considered appropriate, their application is likely to result in a range of possible values. IFRS 13 requires that management evaluate the reasonableness of the range and select the point within the range that is
most representative of fair value in the circumstances.
[IFRS 13.63].

Answer 11

As with the selection of the valuation techniques, the evaluation of the results of multiple techniques requires significant judgement. The merits of each valuation technique applied, and the underlying assumptions embedded in each of the techniques, will need to be considered. Evaluation of the range does not necessarily require the approaches to be calibrated to one another (i.e. the results from different approaches do not have to be equal). The objective is to find the point in the range that most reflects the price to sell an asset or transfer a liability between market participants.

Question 12

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 2

If the results from different valuation techniques are similar, the issue of weighting multiple value indications becomes less important since the assigned weights will not significantly alter the fair value estimate. However, when indications of value are disparate, entities should seek to understand why significant differences exist and what assumptions might contribute to the variance.

Answer 12

Paragraph B40 of IFRS 13 indicates that when evaluating results from multiple valuation approaches, a wide range of fair value measurements may be an indication that further analysis is needed. [IFRS 13.B40]. For example, divergent results between a market approach and income approach may indicate a misapplication of one or
both of the techniques and would likely necessitate additional analysis.

Question 13

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 3

The standard gives two examples that illustrate situations where the use of multiple valuation techniques is appropriate and, when used, how different indications of value are assessed.

Answer 13

Firstly, an entity might determine that a technique uses assumptions that are not consistent with market participant assumptions (and, therefore, is not representative of fair value). This is illustrated in Example 14.22 below, where the entity eliminates use of the cost approach because it determines a market participant would not be able to construct the asset itself. [IFRS 13.IE15-17].

Example 14.22: Multiple valuation techniques – software asset

Question 14

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 4

Secondly, as is illustrated in Example 14.23 below, [IFRS 13.IE11-14], an entity considers the possible range of fair value measures and considers what is most representative of fair value by taking into consideration that:
• one valuation technique may be more representative of fair value than others;
• inputs used in one valuation technique may be more readily observable in the marketplace or require fewer adjustments (inputs are discussed further at INPUTS TO VALUATION TECHNIQUES below);

Answer 14

• the resulting range in estimates using one valuation technique may be narrower than the resulting range from other valuation techniques; and

• divergent results from the application of the market and income approaches would indicate that additional analysis is required, as one technique may have been
misapplied, or the quality of inputs used in one technique may be less reliable.

Example 14.23: Multiple valuation techniques – machine held and used

Question 15

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 5

Both Examples 14.22 and 14.23 highlight situations where it was appropriate to use more than one valuation approach to estimate fair value. Although the indication of value from the cost approach was ultimately not given much weight in either example,
performing this valuation technique was an important part of the estimation process.

Answer 15

Even when a particular valuation technique is given little weight, its application can highlight specific characteristics of the item being measured and may help in assessing the value indications from other techniques.

Question 16

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 6

Determining the point in a range of values that is ‘most representative of fair value’ can be subjective and requires the use of judgement by management. In addition, although Example 14.23 refers to ‘weighting’ the results of the valuation techniques used, in our
view, this is not meant to imply that an entity must explicitly apply a percentage weighting to the results of each technique to determine fair value. However, this may be appropriate in certain circumstances.

Answer 16

The standard does not prescribe a specific weighting methodology (e.g. explicit assignment of percentages versus qualitative assessment of value indications). As such, evaluating the techniques applied in an analysis will require judgement based on the merits of each methodology and their respective assumptions.

Question 17

Selecting appropriate valuation techniques -
Using multiple valuation techniques to measure
fair value 7

Identifying a single point within a range is not the same as finding the point within the range that is most representative of fair value. As such, simply assigning arbitrary weights to different indications of value is not appropriate. The weighting of multiple value
indications is a process that requires significant judgement and a working knowledge of the different valuation techniques and inputs. Such knowledge is necessary to properly assess the relevance of these methodologies and inputs to the asset or liability being
measured.

Answer 17

For example, in certain instances it may be more appropriate to rely primarily on the fair value indicated by the technique that maximises the use of observable inputs and minimises the use of unobservable inputs. In all cases, entities should document how they considered the various indications of value, including how they evaluated qualitative and quantitative factors, in determining fair value.

Question 18

Selecting appropriate valuation techniques -
Valuation adjustments 1

In certain instances, adjustments to the output from a valuation technique may be required to appropriately determine a fair value measurement in accordance with IFRS 13. An entity makes valuation adjustments if market participants would make those adjustments when pricing an asset or liability (under the market conditions at the measurement date).

Answer 18

This includes any adjustments for measurement uncertainty (e.g. a risk premium).

Question 19

Selecting appropriate valuation techniques -
Valuation adjustments 2

Valuation adjustments may include the following:

(a) an adjustment to a valuation technique to take into account a characteristic of an asset or a liability that is not captured by the valuation technique (the need for such an adjustment is typically identified during calibration of the value calculated using the valuation technique with observable market information – see Adjustments to valuation techniques that use
unobservable inputs below);

(b) applying the point within the bid-ask spread that is most representative of fair value in the circumstances (see Pricing within the bid-ask spread below);

Answer 19

(c) an adjustment to take into account credit risk (e.g. an entity’s non-performance risk (risk not fulfill obligation) or the credit risk of the counterparty to a transaction); and
(d) an adjustment to take into account measurement uncertainty (e.g. when there has been a significant decrease in the volume or level of activity when compared with normal market activity for the asset or liability, or similar assets or liabilities, and the entity has determined that the transaction price or quoted price does not represent fair value). [IFRS 13.BC145].

Question 20

Selecting appropriate valuation techniques -
Valuation adjustments : Adjustments to valuation techniques that use unobservable inputs 1

Regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same – i.e. an exit price under current market conditions from the perspective of market
participants.

Answer 20

As such, if the transaction price is determined to
represent fair value at initial recognition (see FAIR VALUE AT INITIAL RECOGNITION above) AND a valuation technique that uses unobservable inputs will be used to measure the fair value of an item in subsequent periods, the valuation technique must be calibrated to ensure the valuation technique reflects current market conditions. [IFRS 13.64].

Question 21

Selecting appropriate valuation techniques -
Valuation adjustments : Adjustments to valuation techniques that use unobservable inputs 2

Calibration ensures that a valuation technique incorporates current market conditions. The calibration also helps an entity to determine whether an adjustment to the valuation technique is necessary by identifying potential deficiencies in the valuation model. For example, there might be a characteristic
of the asset or liability that is not captured by the valuation technique.

Answer 21

If an entity measures fair value after initial recognition using a valuation technique (or techniques) that uses unobservable inputs, an entity must ensure the valuation
technique(s) reflect observable market data (e.g. the price for a similar asset or liability) at the measurement date. [IFRS 13.64]. That is, it should be calibrated to observable market data, when available.

Question 22

Selecting appropriate valuation techniques -
Making changes to valuation techniques 1

The standard requires that valuation techniques used to measure fair value be applied on a consistent basis among similar assets or liabilities and across reporting periods. [IFRS 13.65]. This is not meant to preclude subsequent changes, such as a change in its
weighting when multiple valuation techniques are used or a change in an adjustment applied to a valuation technique.

Answer 22

An entity can make a change to a valuation technique or its application (or a change in the relative importance of one technique over another), provided that change results in a measurement that is equally representative (or more representative) of fair value in the circumstances.

Question 23

Selecting appropriate valuation techniques -
Making changes to valuation techniques 2

IFRS 13 provides the following examples of circumstances that may trigger a change in
valuation technique or relative weights assigned to valuation techniques:
(a) new markets develop;
(b) new information becomes available;

Answer 23

(c) information previously used is no longer available;
(d) valuation techniques improve; or
(e) market conditions change. [IFRS 13.65].

Question 24

Selecting appropriate valuation techniques -
Making changes to valuation techniques 3

In addition, a change in the exit market (i.e. the principal (or most advantageous) market), characteristics of market participants that would transact for the asset or liability, or the highest and best use of an asset by market participants could also warrant a change in valuation techniques in certain circumstances.

Answer 24

Changes to fair value resulting from a change in the valuation technique or its application are accounted for as a change in accounting estimate in accordance with IAS 8. However, IFRS 13 states that the disclosures in IAS 8 for a change in accounting
estimate are not required for such changes. [IFRS 13.65, 66]. Instead, information would be disclosed in accordance with IFRS 13 (see Disclosure of valuation techniques and inputs below for further discussion). If a valuation technique is applied in error, the correction of the technique would be accounted as a correction of an error in accordance with IAS 8.

Question 25

Market approach 1

IFRS 13 describes the market approach as a widely used valuation technique. As defined in the standard, the market approach ‘uses prices and other relevant information generated by market transactions involving identical or comparable (i.e. similar) assets,
liabilities or a group of assets and liabilities, such as a business’. [IFRS 13.B5].

Answer 25

Hence, the market approach uses prices that market participants would pay or receive for the transaction, for example, a quoted market price. The market price may be adjusted to reflect the characteristics of the item being measured, such as its current condition and location, and could result in a range of possible fair values.

Question 26

Market approach 2

Valuation techniques consistent with the market approach use prices and other market data derived from observed transactions for the same or similar assets, for example, revenue, or EBITDA multiples. Multiples might be in ranges with a different multiple
for each comparable asset or liability. The selection of the appropriate multiple within the range requires judgement, considering qualitative and quantitative factors specific to the measurement. [IFRS 13.B6].

Answer 26

Another example of a market approach is matrix pricing. Matrix pricing is a mathematical technique used principally to value certain types of financial instruments, such as debt securities, where specific instruments (e.g. cusips) may not trade frequently. The method derives an estimated price of an instrument using transaction prices and other relevant market information for benchmark instruments with similar features (e.g. coupon, maturity or credit rating). [IFRS 13.B7].

Question 27

Cost approach 1

‘The cost approach reflects the amount that would be required currently to replace the service capacity of an asset’. This approach is often referred to as current replacement cost. [IFRS 13.B8]. The cost approach (or current replacement cost) is typically used to
measure the fair value of tangible assets, such as plant or equipment.

Answer 27

From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.

Question 28

Cost approach 2

Obsolescence is broader than depreciation, whether for financial reporting or tax purposes. According to the standard, obsolescence encompasses:

• physical deterioration;

Answer 28

• functional (technological) obsolescence; and

* economic (external) obsolescence. [IFRS 13.B9].

Question 29

Cost approach 3

Physical deterioration and functional obsolescence are factors specific to the asset. Physical deterioration refers to wear, tear or abuse. For example, machines in a factory might deteriorate physically due to high production volumes or a lack of maintenance. Something is functionally obsolete when it does not function in the manner originally intended (excluding any physical deterioration).

Answer 29

For example, layout of the machines in the factory may make their use, in combination, more labour intensive, increasing the cost of those machines to the entity. Functional obsolescence also includes the impact of technological change, for example, if newer, more efficient and less labour-intensive models were available, demand for the existing machines might decline, along with the price for the existing machines in the market.

Question 30

Cost approach 4

Economic obsolescence arises from factors external to the asset. An asset may be less desirable or its economic life may reduce due to factors such as regulatory changes or excess supply. Consider the machines in the factory; assume that, after
the entity had purchased its machines, the supplier had flooded the market with identical machines.

Answer 30

If demand was not as high as the supplier had anticipated, it could result in an oversupply and the supplier would be likely to reduce the price in order to clear the excess stock.

Question 31

Cost approach - Use of depreciated replacement cost to measure fair value 1

As discussed at Cost approach above, IFRS 13 permits the use of a cost approach for measuring fair value. However, care is needed in using depreciated replacement cost to ensure the resulting measurement is consistent with the requirements of IFRS 13 for measuring fair value.

Answer 31

Before using depreciated replacement cost as a method to measure fair value, an entity should ensure that both:

• the highest and best use of the asset is its current use (see 10 above); and
• the exit market for the asset (i.e. the principal market or in its absence, the most advantageous market, see 6 above) is the same as the entry market (i.e. the market in which the asset was/will be purchased).

Question 32

Cost approach - Use of depreciated replacement cost to measure fair value 2

In addition, an entity should ensure that both:

• the inputs used to determine replacement cost are consistent with what market participant buyers would pay to acquire or construct a substitute asset of
comparable utility; and

Answer 32

• the replacement cost has been adjusted for obsolescence that market participant buyers would consider – i.e. that the depreciation adjustment reflects all forms of obsolescence (i.e. physical deterioration, technological (functional) and economic obsolescence), which is broader than depreciation calculated in
accordance with IAS 16.

Question 33

Cost approach - Use of depreciated replacement cost to measure fair value 3

Even after considering these factors, the resulting depreciated replacement cost must be assessed to ensure market participants would actually transact for the asset, in its current condition and location, at this price. The Illustrative Examples to IFRS 13 reflect
this stating that ‘the price received for the sale of the machine (i.e. an exit price) would not be more than either of the following:

Answer 33

(a) the cost that a market participant buyer would incur to acquire or construct a substitute machine of comparable utility; or
(b) the economic benefit that a market participant buyer would derive from the use of the machine.’ [IFRS 13.IE11-IE14].

Question 34

Income approach 1

The income approach converts future cash flows or income and expenses to a single current (i.e. discounted) amount. A fair value measurement using the income approach will reflect current market expectations about those future cash flows or income and expenses. [IFRS 13.B10].

Answer 34

no note

Question 35

Income approach 2

The income approach includes valuation techniques such as:

(a) present value techniques (see 21 below);
(b) option pricing models – examples include the Black-Scholes-Merton formula or a binomial model (i.e. a lattice model) – that incorporate present value techniques and reflect both the time value and the intrinsic value of an option; and
(c) the multi-period excess earnings method. This method is used to measure the fair value of some intangible assets. [IFRS 13.B11]

Answer 35

The standard does not limit the valuation techniques that are consistent with the income approach to these examples; an entity may consider other valuation techniques. The standard provides some application guidance, but only in relation to present value
techniques (see 21 below for further discussion regarding this application guidance).

Question 36

INPUTS TO VALUATION TECHNIQUES

Answer 36

INPUTS TO VALUATION TECHNIQUES

Question 37

General principles 1

When selecting the inputs to use in a valuation technique, IFRS 13 requires that they:

• be consistent with the characteristics of the asset or liability that market participants would take into account (see 5.2 above);

Answer 37

• exclude premiums or discounts that reflect size as a characteristic of the entity’s holding, rather than a characteristic of the item being measured (for example, blockage factors); and
• exclude other premiums or discounts if they are inconsistent with the unit of account (see 5.1 above for discussions regarding unit of account). [IFRS 13.69].

Question 38

General principles 2

In all cases, if there is a quoted price in an active market (i.e. a Level 1 input) for the identical asset or a liability, an entity shall use that price without adjustment when measuring fair value. Adjustments to this price are only permitted in certain circumstances, which are discussed at 17.1 below.

Answer 38

Regardless of the valuation techniques used to estimate fair value, IFRS 13 requires that these techniques maximise the use of relevant observable inputs and minimise the use of unobservable inputs. [IFRS 13.67]. This requirement is consistent with the idea that fair value is a market-based measurement and, therefore, is determined using market-based
observable data, to the extent available and
relevant.

Question 39

General principles 3

The standard provides some examples of markets in which inputs might be observable.
(a) Exchange markets – where closing prices are both readily available and generally representative of fair value, e.g. the Hong Kong Stock Exchange;

(b) Dealer markets – where dealers stand ready to trade for their own account. Typically, in these markets, bid and ask prices (see 15.3 below) are more readily
available than closing prices. Dealer markets include over-the-counter markets, for which prices are publicly reported;

Answer 39

(c) Brokered markets – where brokers attempt to match buyers with sellers but do not stand ready to trade for their own account. The broker knows the prices bid and asked by the respective parties, but each party is typically unaware of another party’s price requirements. In such markets, prices for completed transactions may be available. Examples of brokered markets include electronic communication
networks in which buy and sell orders are matched, and commercial and residential real estate markets;

(d) Principal-to-principal markets – where transactions, both new and re-sales, are negotiated independently with no intermediary. Little, if any, information about
these transactions in these markets may be publicly available. [IFRS 13.68, B34].

Question 40

General principles 4

The standard clarifies that the relevance of market data must be considered when assessing the priority of inputs in the fair value hierarchy.

Answer 40

When evaluating the relevance of market data,
the number and range of data points should be considered, as well as whether this data is directionally consistent with pricing trends and indications
from other more general market information.

Question 41

General principles 5

Relevant market data reflects the assumptions that market participants would use in pricing the asset or liability being measured. Recent transaction prices for the reference asset or liability (or similar assets and liabilities) are typically considered to represent relevant market data, unless the transaction is determined not to be orderly (see 8 above for a discussion of factors to consider when determining if a transaction is orderly).

Answer 41

However, even in situations where a transaction is considered to be orderly, observable transaction prices from inactive markets may require adjustment to address factors, such as timing differences between the transaction date and the measurement date or
differences between the asset being measured and a similar asset that was the subject of the transaction. In those instances where the adjustments to observable data are significant and are determined using unobservable data, the resulting measurement
would be considered a Level 3 measurement.

Question 42

General principles 6

Whether observable or unobservable, all inputs used in determining fair value should be consistent with a market-based measurement. As such, the use of unobservable inputs is not intended to allow for the inclusion of entity-specific assumptions in a fair
value measurement. While IFRS 13 acknowledges that unobservable inputs may sometimes be developed using an entity’s own data, the guidance is clear that these inputs should reflect market participant assumptions.

Answer 42

When valuing an intangible asset using unobservable inputs, for example, an entity should take into account the intended use of the asset by market participants, even though this may differ from the entity’s intended use. The entity may use its own data, without adjustment, if it determines that market participant assumptions are consistent with its own assumptions (see Use of Level 3 inputs below for additional discussion on how an entity’s own assumptions may be applied in a fair value measurement).

Question 43

General principles 7

The term ‘input’ is used in IFRS 13 to refer broadly to the assumptions that market participants would use when pricing an asset or liability, rather than to the data entered into a pricing model. This important distinction implies that an adjustment to a pricing
model’s value (e.g. an adjustment for the risk that a pricing model might not replicate a market price due to the complexity of the instrument being measured) represents an input, which should be evaluated when determining the measurement’s category in the
fair value hierarchy.

Answer 43

For example, when measuring a financial instrument, an adjustment for model risk would be considered an input (most likely a Level 3 input) that, if deemed significant (see Assessing the significance of inputs below for further discussion on assessing the significance of inputs) may provide the entire fair value estimate a Level 3 measurement.

Question 44

General principles 8

It is also important to note that an input is distinct from a characteristic. IFRS 13 requires an entity to consider the characteristics of the asset or liability (if market participants would take those characteristics into account when pricing the asset or liability at the
measurement date). [IFRS 13.11]. As discussed at The unit of account above, examples of such
characteristics could include:

• the condition and location of an asset; and
• restrictions, if any, on the sale or use of an asset or transfer of a liability.

Answer 44

To draw out the distinction between an input and a characteristic, consider the example of a restricted security that has the following characteristics, which would be considered by a market participant :

• the issuer is a listed entity; and
• the fact that the security is restricted.

Question 45

General principles 9

An entity is required to select inputs in pricing the asset or liability that are consistent with its characteristics. In some cases those characteristics result in the application of an adjustment, such as a premium or discount. In our example, the inputs could be:

• a quoted price for an unrestricted security; and
• a discount adjustment (to reflect the restriction).

Answer 45

The quoted price for the unrestricted security may be an observable and a Level 1 input. However, given the restriction and the standard’s requirement that inputs be consistent with the characteristics of the asset or liability being measured, the second input in
measuring fair value is an adjustment to the quoted price to reflect the restriction. If this input is unobservable, it would be a Level 3 input and, if it is considered to be significant to the entire measurement, the fair value measurement of the asset would also be categorised within Level 3 of the
fair value hierarchy.

Question 46

THE FAIR VALUE HIERARCHY

Answer 46

THE FAIR VALUE HIERARCHY

Question 47

The fair value hierarchy is intended to increase consistency and comparability in fair value measurements and the related disclosures.
[IFRS 13.72]. Application of the hierarchy requires an entity to prioritise observable inputs over those that are unobservable when measuring fair value.

Answer 47

In addition, for disclosures, it provides a framework for users to consider the relative subjectivity of the fair value
measurements made by the reporting entity.

Question 48

The fair value hierarchy 1

Level 1 : Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date

Example : The price for a financial asset or financial liability for the identical asset is traded on an active market (e.g. Tokyo Stock Exchange).

Answer 48

Level 2 : Inputs other than quoted prices included within
level 1 that are observable for the asset or liability,
either directly or indirectly.

Example : Interest rates and yield curves observable at
commonly quoted intervals, implied volatilities, and credit spreads.

Question 49

The fair value hierarchy 2

Level 3 : Unobservable inputs for the asset or liability.

Example : Projected cash flows used in a discounted
cash flow calculation.

Answer 49

Valuation techniques used to measure fair value must maximise the use of relevant observable inputs and minimise the use of unobservable inputs. The best indication of fair value is a quoted price in an active market (i.e. ‘a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis’ [IFRS 13 Appendix A] ).

Question 50

The fair value hierarchy 3

The fair value hierarchy focuses on prioritising the inputs used in valuation techniques, not the techniques themselves. [IFRS 13.74]. While the availability of inputs might affect the valuation technique(s) selected to measure fair value, as discussed at VALUATION TECHNIQUES above,
IFRS 13 does not prioritise the use of one technique over another (with the exception of the requirement to measure identical financial instruments that trade in active markets at P×Q).

Answer 50

The determination of the valuation technique(s) to be used requires significant judgement and will be dependent on the specific characteristics of the asset
or liability being measured and the principal (or most advantageous) market in which market participants would transact for the asset or liability.

Question 51

The fair value hierarchy 4

Although the valuation techniques themselves are not subject to the fair value hierarchy, a risk adjustment that market participants would demand to compensate for a risk inherent in a particular valuation technique (e.g. a model adjustment) is considered an input that must be assessed within the fair value hierarchy.

Answer 51

As discussed at Categorisation within the fair value hierarchy below, if this type of risk adjustment is included, it should be considered when categorising the
fair value measurement within the fair value hierarchy.

Question 52

Categorisation within the fair value hierarchy 1

IFRS 13 distinguishes between where in the fair value hierarchy an individual input to a valuation technique may fall and where the entire measurement is categorised for disclosure purposes. Inputs used in a valuation technique may fall into different levels of the fair value hierarchy.

Answer 52

However, for disclosure purposes, the fair value measurement must be categorised in its entirety (i.e. the fair value measure for the asset or liability or the group of assets and/or liability, depending on the unit of account) within the hierarchy. Categorising the entire measurement (and the required disclosure of this information, see 20.3.3 below) provides users of financial statements with an indication of the overall
observability or subjectivity of a fair value measurement.

Question 53

Categorisation within the fair value hierarchy 2

The appropriate categorisation may be obvious when only a single input is used, for example, when measuring fair value using a quoted price in an active market, without adjustment. However, an asset or liability that is not traded in an active market with a quoted price will often require more than one input to determine its fair value.

Answer 53

For example, an over-the-counter option on a traded equity security measured at fair value using an option pricing model requires the following market based inputs: (i) expected volatility; (ii) expected dividend yield; and (iii) the risk-free rate of interest.

Question 54

Categorisation within the fair value hierarchy 3

IFRS 13 clarifies that the hierarchy categorisation of a fair value measurement, in its entirety, is determined based on the lowest level input that is significant to the entire measurement. The standard also makes it clear that adjustments to arrive at measurements based on fair value (e.g. ‘costs to sell’ when measuring fair value less costs to sell) are not be taken into account in this determination. [IFRS 13.73] see diagram Kpmg

Answer 54

In the over-the counter equity option example, assume that the risk-free interest rate and the dividend yield were determined to be Level 2 inputs, but the expected volatility was determined to be a Level 3 input. If expected volatility was determined to be significant to the overall value of the option, the entire measurement would be categorised within Level 3 of the fair value hierarchy

Question 55

Categorisation within the fair value hierarchy 3

If an observable input requires an adjustment using an unobservable input and that adjustment actually results in a significantly higher or lower fair value measurement, the standard is clear that the resulting fair value measurement would be categorised within Level 3 of the fair value hierarchy. [IFRS 13.75]. Consider our example of a restricted security discussed at General principles above. While the quoted price for the unrestricted security may be observable, if Level 3 inputs are needed to determine the effect of the restriction on the instrument’s fair value, and this effect is significant to the measurement, the asset would be categorised within Level 3 of
the fair value hierarchy.

Answer 55

In addition, as discussed at THE TRANSACTION above, in certain situations adjustments to a transaction price in an inactive market may be required. If these adjustments are based on unobservable inputs and significant to the measurement, the item would be categorised within Level 3 of the fair value hierarchy.

Question 56

Categorisation within the fair value hierarchy 4

It is important to understand that the determination of the hierarchy level in which the fair value measure falls (and, therefore, the category in which it will be disclosed
– see 20.3.3 below) is based on the fair value measurement for the specific item being measured, which will be dependent on the unit of account for the asset or liability. This may create practical challenges in relation to fair value measurements for non-financial assets and financial assets and liabilities with offsetting risk measured using the measurement exception discussed at 12 above.

Answer 56

For example, in situations where the unit of account for a non-financial asset is the individual item, but the valuation premise is in combination with other assets (or other assets and liabilities), the value of the asset group would need to be attributed to the individual
assets or liabilities or to the various instruments within each level of the fair value hierarchy. For example, consider Example 14.13 at 10.2.2 above. The unit of account for the vines and the land was that specified by IAS 41 and IAS 16 respectively. However, their highest and best use was in combination, together and with other assets. The value of that group would need to be attributed to each of the assets, including both the vines and land, as the fair value of these individual assets should be categorised within the
fair value hierarchy.

Question 57

Categorisation within the fair value hierarchy -
Assessing the significance of inputs 1

Assessing the significance of a particular input to the entire measurement requires judgement and consideration of factors specific to the asset or liability (or group of assets and/or liabilities) being measured. [IFRS 13.73].

Answer 57

IFRS 13 does not provide specific guidance on how entities should evaluate the significance of individual inputs. This determination will require judgement and
consideration of factors specific to the asset or liability (or group of assets and liabilities) being measured.

Question 58

Categorisation within the fair value hierarchy -
Assessing the significance of inputs 2

The standard is clear that it considers significance in relation to ‘the entire measurement’. In our view, this requires the assessment to consider the fair value
measure itself, rather than any resulting change in fair value, regardless of whether that change is recognised (i.e. in profit or loss or other comprehensive income) or
unrecognised. For example, assume an investment property is measured at fair value at the end of each reporting period. In the current reporting period the fair value of the investment property reduces by CU 200,000 to CU 500,000. The significance of any
inputs to the fair value measurement would be assessed by reference to the CU 500,000, even though CU 200,000 is the amount that will be recognised in profit or loss.

Answer 58

However a reporting entity may deem it appropriate to also consider significance in relation to the change in fair value from prior periods, in addition to considering the
significance of an input in relation to the entire fair value measurement. Such an approach may be helpful in relation to cash-based instruments (e.g. loans or structured notes with embedded derivatives) whose carrying amounts, based on fair value, are heavily affected by their principal or face amount.

Question 59

Categorisation within the fair value hierarchy -
Assessing the significance of inputs 3

As noted in 16.2 above, if an observable input requires an adjustment using an unobservable input and that adjustment actually results in a significantly higher or lower fair value measurement, the standard is clear that the resulting fair value measurement
would be categorised within Level 3 of the hierarchy. [IFRS 13.75]. What is not clear, however, is the appropriate categorisation when an observable input requires an adjustment using an unobservable input and: (a) that adjustment does not actually result
in a significantly higher or lower fair value in the current period; but (b) the potential adjustment from using a different unobservable input would result in a significantly higher or lower fair value measurement.

Answer 59

As noted in Categorisation within the fair value hierarchy above, the categorisation of a fair value measurement indicates the overall observability or subjectivity of a measurement, in its entirety. To this end, in some cases, the use of sensitivity analysis or stress testing (i.e. using a range of reasonably possible alternative input values as of the measurement date) might be appropriate to assess the effects of unobservable inputs on a fair value measure. In situations where more than one unobservable input is used in a fair value measure, the assessment of significance should be considered based on the aggregate effect of all the unobservable inputs.

Question 60

Categorisation within the fair value hierarchy -
Assessing the significance of inputs 4

Entities should have a documented policy with respect to their approach to determining the significance of unobservable inputs on its fair value measurements and apply that policy consistently.

Answer 60

This is important in light of the disclosure requirements in IFRS 13, particularly for fair value measurements categorised within Level 3 of the fair value
hierarchy (see Disclosures for recognised fair value measurements below).

Question 61

Categorisation within the fair value hierarchy -
Transfers between levels within the fair value
hierarchy 1

For assets or liabilities that are measured at fair value (or measurements based on fair value) at the end of each reporting period, their categorisation within the fair value hierarchy may change over time. This might be the case if the market for a particular asset or liability that was previously considered active (Level 1) becomes inactive (Level 2 or Level 3) or if significant inputs used in a valuation technique that were previously unobservable (Level 3) become observable (Level 2) given transactions that were observed
around the measurement date.

Answer 61

Such changes in categorisation within the hierarchy are referred to in IFRS 13 as transfers between levels within the fair value hierarchy.

Question 62

Categorisation within the fair value hierarchy -
Transfers between levels within the fair value
hierarchy 2

An entity is required to select, and consistently apply, a policy for determining when transfers between levels of the fair value hierarchy are deemed to have occurred, that is, the timing of recognising transfers. This policy must be the same for transfers into and out of the levels. Examples of policies for determining the timing of transfers include:

• the date of the event or change in circumstances that caused the transfer;
• the beginning of the reporting period; or
• the end of the reporting period. [IFRS 13.95].

Answer 62

The standard requires an entity to disclose this policy (see 20.2 below). In addition, the selected timing (i.e. when transfers are deemed to have occurred) has a direct impact on the information an entity needs to collect in order to meet the disclosure requirements
in IFRS 13 – specifically those required by IFRS 13.93(c) and (e)(iv) – for both transfers between Levels 1 and 2 and transfers into and out of Level 3 (these disclosure
requirements are discussed at 20.3.2 below).
[IFRS 13.93(c), 93(e)(iv)].

Question 63

LEVEL 1 INPUTS

Answer 63

LEVEL 1 INPUTS

Question 64

‘Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date’. [IFRS 13.76]. According to IFRS 13, this price represents the most reliable evidence of fair value.

Answer 64

If a quoted price in an active market is available, an entity must use this price to measure fair value without adjustment; although adjustments are permitted in limited circumstances (see Quoted prices in active markets that are not representative of fair value below). [IFRS 13.77].

Question 65

Use of Level 1 inputs 1

As a general principle, IFRS 13 mandates the use of quoted prices in active markets for identical assets and liabilities whenever available. With limited exceptions, quoted prices in active markets should not be adjusted when determining the fair value of identical assets and liabilities, as the IASB believes these prices provide the most reliable evidence of fair value.

Answer 65

Adjustments can only be made to a quoted price in an active market (a Level 1 input) in the following circumstances:

(a) when an entity holds a large number of similar (but not identical) assets or liabilities (e.g. debt securities) that are measured at fair value and a quoted price in an active market is available but is not readily accessible for each of those assets or liabilities
individually. That is, since the assets or liabilities are not identical and given the large number of similar assets or liabilities held by the entity, it would be difficult to obtain pricing information for each individual asset or liability at the measurement date.

In this situation, IFRS 13 provides a practical expedient; an entity may measure fair value using an alternative pricing method that does not rely exclusively on quoted prices (e.g. matrix pricing);

Question 66

Use of Level 1 inputs 2

(b) when a quoted price in an active market does not represent fair value at the measurement date.

This may be the case, for example, if significant events, such as transactions in a principal-to-principal market, trades in a brokered market or announcements, take place after the close of a market but before the measurement date. An entity must establish and consistently apply a policy for identifying those events that might affect fair value measurements; or

Answer 66

(c) when measuring the fair value of a liability or an entity’s own equity instrument using the quoted price for the identical item traded as an asset in an active market and that price needs to be adjusted for factors specific to the item or the asset. [IFRS 13.79].

Question 67

Use of Level 1 inputs 3

These exceptions are discussed further at 17.1.1, 17.2 and 17.3 below. Level 1 inputs are most commonly associated with financial instruments, for example, shares that are actively traded on a stock exchange. It may be that an asset or liability is traded in multiple active markets, for example, shares that are listed on more than one stock exchange. In light of this, the standard emphasises the need within Level 1 to determine both, the principal (or most advantageous) market (see THE PRINCIPAL (OR MOST ADVANTAGEOUS) MARKET above) and whether the entity can enter into a transaction for the asset or liability at the price in that market at the measurement date (see THE TRANSACTION above). [IFRS 13.78].

Answer 67

As discussed at Categorisation within the fair value hierarchy above, if no adjustment is made to a Level 1 input, the result is the entire fair value measurement being categorised within Level 1 of the fair value hierarchy. However, any adjustment made to a Level 1 input or use of the practical expedient in (a) above would result in categorisation within a lower level of the fair value hierarchy. If the adjustment uses significant unobservable inputs, it would need to be categorised within Level 3. [IFRS 13.75].

Question 68

Alternative pricing methods

When an entity holds a large number of similar assets and liabilities for which quoted prices exist, but are not easily accessible, IFRS 13 allows for the use of alternative pricing methods (e.g. matrix pricing) as a practical expedient. [IFRS 13.79(a)

Answer 68

The IASB provided this practical expedient to ease the administrative burden associated with obtaining quoted
prices for each individual instrument. However, if the practical expedient is used, the resulting fair value measurement would not be considered a Level 1 measurement.

Question 69

Quoted prices in active markets that are not representative of fair value

IFRS 13 recognises that in certain situations a quoted price in an active market might not represent the fair value of an asset or liability, such as when significant events occur on the measurement date, but after the close of trading. In these situations, entities would adjust the quoted price to incorporate this new information into the fair value measurement.
[IFRS 13.79(b)].

Answer 69

However, if the quoted price is adjusted, the resulting fair value measurement would no longer be considered a Level 1 measurement.

Question 70

LEVEL 2 INPUTS

Answer 70

LEVEL 2 INPUTS

Question 71

Level 2 inputs .1

Level 2 inputs include quoted prices (in non-active markets or in active markets for similar assets or liabilities), observable inputs other than quoted prices and inputs that are not directly observable, but are corroborated by observable market data. [IFRS 13.82].

Answer 71

The inclusion of market-corroborated inputs is significant because it expands the scope of Level 2 inputs beyond those directly observable for the asset or liability. Inputs determined through mathematical or statistical techniques, such as correlation or
regression, may be categorised as Level 2 if the inputs into, and/(or) the results from, these techniques can be corroborated with observable market data.

Question 72

Level 2 inputs .2

IFRS 13 requires that a Level 2 input be observable (either directly or indirectly through corroboration with market data) for substantially the full contractual term of the asset or liability being measured. [IFRS 13.81].

Answer 72

Therefore, a long-term input extrapolated from
short-term observable market data (e.g. a 30-year yield extrapolated from the observable 5-, 10- and 15-year points on the yield curve) would generally not be
considered a Level 2 input.

Question 73

Examples of Level 2 inputs (Asset or Liability/Example of a Level 2 Input) 3

Licensing arrangement
- For a licensing arrangement that is acquired in a business combination and was recently negotiated with an unrelated party by the acquired entity (the party to the licensing arrangement), a Level 2 input would be the royalty rate in the contract with the unrelated party at inception of the arrangement

Answer 73

Cash-generating unit
- A valuation multiple (e.g. a multiple of earnings or revenue or a similar performance measure) derived from observable market data, e.g. multiples derived from prices in observed transactions involving comparable (i.e. similar) businesses, taking into account operational, market, financial and non-financial factors.

Question 74

Examples of Level 2 inputs (Asset or Liability/Example of a Level 2 Input) 2

Receive-fixed, pay variable interest rate swap based on a specific bank’s prime rate

• The bank’s prime rate derived through extrapolation if the extrapolated values are corroborated by observable market data, for example, by correlation with an interest rate that is observable over substantially the full term of the swap.

Answer 74

Three-year option on exchange-traded shares

• The implied volatility for the shares derived through extrapolation to year 3 if both of the following conditions exist:
  (i) Prices for one-year and two-year options on the shares are observable.
  (ii) The extrapolated implied volatility of a three-year option is corroborated by observable market data for substantially the full term of the option.

In this situation, the implied volatility could be derived by extrapolating from the implied volatility of the one-year and two-year options on the shares and corroborated by the implied volatility for three-year options on comparable entities’ shares, provided that correlation with the one-year and two-year implied volatilities is established.

Question 75

Market corroborated inputs

Level 2 inputs, as discussed at 18.1 above, include market-corroborated inputs. That is, inputs that are not directly observable for the asset or liability, but, instead, are corroborated by observable market data through correlation or other statistical techniques.

Answer 75

IFRS 13 does not provide any detailed guidance regarding to the application of statistical techniques, such as regression or correlation, when attempting to corroborate inputs to observable market data (Level 2) inputs.

Question 76

Examples of Level 2 inputs (Asset or Liability/Example of a Level 2 Input) 4

Finished goods inventory at a retail outlet
- For finished goods inventory that is acquired in a business combination, a Level 2 input would be either a price to customers in a retail market or a price to retailers in a wholesale market, adjusted for differences between the condition and location of the inventory item and the comparable (i.e. similar) inventory items so that the fair value measurement reflects the price that would be received in a transaction to sell the inventory to another retailer that would complete the requisite selling efforts.
Conceptually, the fair value measurement will be the same, whether adjustments are made to a retail price (downward) or to a wholesale price (upward). Generally, the price that requires the least amount of subjective adjustments should be used for the fair value measurement.

Answer 76

Building held and used
- The price per square metre for the building (a valuation multiple) derived from observable market data, e.g. multiples derived from prices in observed transactions involving comparable (i.e. similar) buildings in similar locations.

Question 77

Market corroborated inputs 1

Level 2 inputs, as discussed at 18.1 above, include market-corroborated inputs. That is, inputs that are not directly observable for the asset or liability, but, instead, are corroborated by observable market data through correlation or other statistical techniques.

Answer 77

IFRS 13 does not provide any detailed guidance regarding to the application of statistical techniques, such as regression or correlation, when attempting to corroborate inputs to observable market data (Level 2) inputs.

Question 78

Market corroborated inputs 2

However, the lack of any specific guidance or
‘bright lines’ for evaluating the validity of a statistical inference by the IASB should not be construed to imply that the mere use of a statistical analysis (such as linear regression) would be deemed valid and appropriate to support Level 2 categorisation (or a fair value measurement for that matter).

Answer 78

Any statistical analysis that is relied on for financial
reporting purposes should be evaluated for its predictive validity. That is, the statistical technique should support the hypothesis that the observable input has predictive value with respect to the unobservable input.

Question 79

Making adjustments to a Level 2 input 1

The standard acknowledges that, unlike a Level 1 input, adjustments to Level 2 inputs may be more common, but will vary depending on the factors specific to the asset or liability. [IFRS 13.83].

Answer 79

There are a number of reasons why an entity may need to make adjustments to Level 2 inputs. Adjustments to observable data from inactive markets (see THE TRANSACTION above), for example, might be required for timing differences between the transaction date and the measurement date, or differences between the asset being measured and a similar asset that was the subject of the transaction. In addition, factors such as the condition or location of an asset should also be considered when determining if adjustments to Level 2 inputs are warranted.

Question 80

Making adjustments to a Level 2 input 2

If the Level 2 input relates to an asset or liability that is similar, but not identical to the asset or liability being measured, the entity would need to consider what adjustments may be required to capture differences between the item being measured and the reference asset or liability. For example, do they have different characteristics, such as credit quality of the issuer in the case of a bond? Adjustments may be needed for differences between the two. [IFRS 13.83]

Answer 80

If an adjustment to a Level 2 input is significant to the entire fair value measurement, it may affect the fair value measurement’s categorisation within the fair value hierarchy for disclosure purposes. If the adjustment uses significant unobservable inputs, it would need to be categorised within Level 3 of the hierarchy. [IFRS 13.84].

Question 81

Recently observed prices in an inactive market 1

Valuation technique(s) used to measure fair value must maximise the use of relevant observable inputs and minimise the use of unobservable inputs. While recently observed transactions for the same (or similar) items often provide useful information for measuring
fair value, transactions or quoted prices in inactive markets are not necessarily indicative of fair value.

Answer 81

A significant decrease in the volume or level of activity for the asset or liability may increase the chances of this. However, transaction data should not be ignored, unless the transaction is determined to be disorderly (see THE TRANSACTION above).

Question 82

Recently observed prices in an inactive market 2

The relevance of observable data, including last transaction prices, must be considered when assessing the weight this information should be given when estimating fair value and whether adjustments are needed (as discussed at Making adjustments to a Level 2 input above). Adjustments to observed transaction prices may be warranted in some situations, particularly when the observed transaction is for a similar, but not identical, instrument.

Answer 82

Therefore, it is important to understand the characteristics of the item being measured compared with an item being used as a benchmark.

Question 83

Recently observed prices in an inactive market 3

When few, if any, transactions can be observed for an asset or liability, an index may provide relevant pricing information if the underlying risks of the index are similar to the item being measured. While the index price may provide general information about market participant assumptions regarding certain risk features of the asset or liability, adjustments are often required to account for specific characteristics of the instrument being measured or the market in which the instrument would trade (e.g. liquidity considerations).

Answer 83

While this information may not be determinative for the particular instrument being measured, it can serve to either support or contest an entity’s determination regarding the relevance of observable data in markets that are not active.

Question 84

Recently observed prices in an inactive market 4

IFRS 13 does not prescribe a methodology for applying adjustments to observable transactions or quoted prices when estimating fair value. Judgement is needed when evaluating the relevance of observable market data and determining what (if any)
adjustments should be made to this information. However, the application of this judgement must be within the confines of the stated objective of a fair value measurement within the IFRS 13 framework.

Answer 84

Since fair value is intended to represent the exit price in a transaction between market participants in the current market, an entity’s intent to hold the asset due to current market conditions, or any entity-specific needs, is not relevant to a fair value measurement and is not a valid reason to adjust observable market data.

Question 85

LEVEL 3 INPUTS

Answer 85

All unobservable inputs for an asset or liability are Level 3 inputs. The standard requires an entity to minimise the use of Level 3 inputs when measuring fair value. As such, they should only be used to the extent that relevant observable inputs are not available, for example, in situations where there is limited market activity for an asset or liability. [IFRS 13.86, 87].

Question 86

Use of Level 3 inputs 1

A number of IFRSs permit or require the use of fair value measurements regardless of the level of market activity for the asset or liability as at the measurement date (e.g. the initial measurement of intangible assets acquired in a business combination). As such, IFRS 13 allows for the use of unobservable inputs to measure fair value in situations where observable inputs are not available. In these cases, the IASB recognises that the best information available with which to develop unobservable inputs may be an entity’s own data.

Answer 86

However, IFRS 13 is clear that while an entity may begin with its own data, this data should be adjusted if :

• reasonably available information indicates that other market participants would use different data; or
• there is something particular to the entity that is not available to other market participants (e.g. an entity-specific synergy). [IFRS 13.89].

Question 87

Use of Level 3 inputs 2

For example, when measuring the fair value of an investment property, we would expect that a reporting entity with a unique tax position would consider the typical market participant tax rate in its analysis. While this example is simplistic and is meant only to illustrate a concept, in practice significant judgement will be required when evaluating what information about unobservable inputs or market data may be
reasonably available.

Answer 87

It is important to note that an entity is not required to undertake exhaustive efforts to obtain information about market participant assumptions when pricing an asset or
liability. Nor is an entity required to establish the absence of contrary data. As a result, in those situations where information about market participant assumptions does not exist or is not reasonably available, a fair value measurement may be based primarily on the reporting entity’s own data. [IFRS 13.89].

Question 88

Use of Level 3 inputs 3

Even in situations where an entity’s own data is used, the objective of the fair value measurement remains the same – i.e. an exit price from the perspective of a market participant that holds the asset or owes the liability. As such, unobservable inputs should reflect the assumptions that market participants would use, which includes the risk inherent in a particular valuation technique (such as a pricing model) and
the risk inherent in the inputs.

Answer 88

As discussed at Market participant assumptions above, if a market participant would consider those risks in pricing an asset or liability, an entity must include that risk adjustment; otherwise the result would not be a fair value measurement. When categorising the entire fair value measurement within the fair value hierarchy, an entity would need to consider the significance of the model adjustment as well as the observability of the data
supporting the adjustment. [IFRS 13.87, 88]

Question 89

Examples of Level 3 inputs (Asset or Liability / Example of a Level 3 Input ) 1

Long-dated currency swap
- An interest rate in a specified currency that is not observable and cannot be corroborated by observable market data at commonly quoted intervals or
otherwise for substantially the full term of the currency swap. The interest rates in a currency swap are the swap rates calculated from the respective countries’ yield curves.

Answer 89

Three-year option on exchange-traded shares
- Historical volatility, i.e. the volatility for the shares derived from the shares’ historical prices. Historical volatility typically does not represent current market participants’ expectations about future volatility, even if it is the only information available to price an option.

Question 90

Examples of Level 3 inputs (Asset or Liability / Example of a Level 3 Input ) 2

Cash-generating unit
- A financial forecast (e.g. of cash flows or profit or loss) developed using the entity’s own data if there is no reasonably available information that indicates that market participants would use different
assumptions.

Answer 90

Interest rate swap
- An adjustment to a mid-market consensus (non-binding) price for the swap developed using data that are not directly observable and cannot otherwise
be corroborated by observable market data.

Question 91

Examples of Level 3 inputs (Asset or Liability / Example of a Level 3 Input ) 3

Decommissioning liability assumed in a business combination
- A current estimate using the entity’s own data about the future cash outflows to be paid to fulfil the obligation (including market participants’ expectations about the costs of fulfilling the obligation and the compensation that a market participant would require for taking on the obligation to dismantle the asset) if there is no reasonably available information that indicates that market participants would use different
assumptions.

Answer 91

cont’ : That Level 3 input would be used in a present value technique together with other inputs, e.g. a current risk-free interest rate or a credit-adjusted risk-free rate if the effect of the entity’s credit standing on the fair value of the liability is reflected in the discount rate rather than in the estimate of future cash outflows.