IFRS 13 Fair Value Measurement: Student Guide

IFRS 13 β€” Fair Value Measurement

Β Source: IFRS 13 (IASB May 2011; amended to IFRS 16 2016) Β |Β  DipIFR Scope: Full
IFRS 13 is the "how-to" guide for fair value. Other standards (IFRS 9, IAS 40, IAS 41) tell you when to use fair value; IFRS 13 tells you how to calculate it. The standard defines fair value as a single, consistent framework, establishes the Fair Value Hierarchy (Levels 1–3) to rank the reliability of inputs, and introduces the critical "Highest and Best Use" concept for non-financial assets. Every exam question on fair value expects you to begin with the definition, identify the hierarchy level, and β€” if property is involved β€” apply the three HBU hurdles.

Key Takeaways

  • Fair value is defined as "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." This is the exit price definition β€” memorise it word for word.
  • IFRS 13 does not create new fair value requirements. It only applies when another standard already requires or permits fair value measurement.
  • Fair value is a market-based measurement, not an entity-specific one. The entity's own intention to hold or use an asset is irrelevant; what matters is what a knowledgeable, willing market participant would pay or receive.
  • The standard assumes the transaction takes place in the principal market (greatest volume and level of activity). Only in its absence is the most advantageous market used.
  • Transaction costs are excluded from fair value (they are not a characteristic of the asset). Transport costs are included if location is a characteristic of the asset (e.g., a commodity).
  • For non-financial assets, fair value must reflect the asset's Highest and Best Use (HBU) β€” even if the entity currently uses it differently. HBU must be physically possible, legally permissible, and financially feasible.
  • The Fair Value Hierarchy ranks inputs β€” not techniques β€” from Level 1 (most reliable: quoted prices in active markets) through Level 3 (least reliable: unobservable inputs). When inputs from multiple levels are used, the measurement takes the lowest level that is significant to the whole measurement.
  • Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets. A share that is listed but not actively traded is no longer Level 1 β€” it drops to Level 2.
  • Level 2 inputs are observable but not Level 1: quoted prices for similar assets, interest rates/yield curves, implied volatilities, and market-corroborated data.
  • Level 3 inputs are unobservable β€” the entity's own internal data (DCF models, management forecasts). They must still reflect market participant assumptions, not just entity-specific data.
  • The Portfolio Exception (para 48): a group of financial assets and liabilities exposed to offsetting market/credit risks may be measured on a net basis, but only if management manages them on that basis with documented risk strategy and provides information to KMP on that basis.
  • The three valuation techniques are: Market Approach (comparable transactions/multiples), Cost Approach (current replacement cost), and Income Approach (discounted cash flows/present value). More than one can be used.
  • For liabilities, fair value reflects non-performance risk (including the entity's own credit risk) and assumes the liability is transferred to a market participant (not settled or extinguished).
  • At initial recognition, the transaction price (entry price) usually equals fair value (exit price), but not always β€” for example, when the transaction is between related parties or takes place under duress.
  • IFRS 13 does not apply to: share-based payments (IFRS 2), leases (IFRS 16), net realisable value (IAS 2), or value in use (IAS 36) β€” these are similar concepts but not fair value.

Table of Contents

  1. Objective, Scope & What IFRS 13 Does NOT Cover
  2. The Fair Value Definition (Exit Price)
  3. The Transaction & Market Selection
  4. Market Participants
  5. The Costs Rule: Transaction vs Transport
  6. Highest and Best Use β€” Non-Financial Assets
  7. Application to Liabilities & Equity Instruments
  8. The Fair Value Hierarchy
  9. Valuation Techniques
  10. The Portfolio Exception
  11. Fair Value at Initial Recognition
  12. Disclosure Requirements
  13. Worked Examples
  14. Examiner Themes & Pitfalls
  15. Knowledge Check
  16. Exam Tips
Objective, Scope & What IFRS 13 Does NOT Cover

IFRS 13 has three objectives: (i) define fair value; (ii) set out a single framework for measuring it; and (iii) specify the disclosures about fair value measurements. It is a measurement standard β€” it does not create any new requirements to use fair value where other standards do not already mandate or permit it.

IFRS 13 Para 5 β€” Scope Rule IFRS 13 applies when another IFRS requires or permits fair value measurements or disclosures about fair value measurements. Examples: IAS 40 Investment Property (fair value model), IFRS 9 Financial Instruments, IAS 41 Agriculture (biological assets), and business combinations under IFRS 3.

IFRS 13 does NOT apply to the following β€” a common exam trap:

  • IFRS 2 Share-based Payment β€” uses grant-date fair value but under its own rules
  • IFRS 16 Leases β€” has its own initial measurement basis
  • Net realisable value under IAS 2 Inventories β€” similar concept but not fair value
  • Value in use under IAS 36 Impairment β€” an entity-specific measure, not market-based
  • Plan assets under IAS 19 and IAS 26 β€” fair value is used but IFRS 13 disclosures are not required
The Fair Value Definition β€” Exit Price
β˜… The Definition β€” Write This Exactly in Your Exam Answer β˜… "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."
Exit Price (not Entry Price)
Fair value is the selling price β€” the price to exit the position, not the price paid to acquire it. An entity buys goods at an entry price; the fair value is the price it could sell them for. These may differ (e.g., a dealer buying at wholesale, selling at retail).
Orderly Transaction
A transaction with adequate exposure to the market before the measurement date β€” not a forced liquidation or distress sale. The assumption is the seller has had a normal marketing period.
Market Participants
Buyers and sellers who are: (i) independent of each other (not related parties); (ii) knowledgeable; (iii) able to transact; and (iv) willing but not forced. The entity's own intentions are irrelevant.
Measurement Date
Fair value is measured at a specific point in time β€” typically year-end. Current market conditions apply at that date. Fair value can and does change between reporting periods.
πŸ”΄ Entry Price vs Exit Price β€” Classic Exam Error The transaction price paid to acquire an asset is the entry price. The fair value is the exit price. In many cases they are equal at initial recognition, but not always β€” especially in related party transactions, distress sales, or business combinations where transaction costs are bundled into the purchase price.
The Transaction & Market Selection
β‘  Principal Market (Use First)
The market with the greatest volume and level of activity for the asset or liability. If a principal market exists, the fair value is the price in that market β€” even if a different market would give a higher price. The entity must have access to the principal market.
β‘‘ Most Advantageous Market (Only if No Principal Market)
Used only in the absence of a principal market. This is the market that maximises the amount received for an asset (or minimises the amount paid to transfer a liability), after taking into account transaction and transport costs. However, fair value itself is still not reduced by transaction costs.
No Exhaustive Search Required An entity does not need to search every possible market. The default presumption is that the market the entity would normally use is the principal market. Evidence to the contrary would be needed to rebut this presumption.

Because different entities have access to different markets, the principal market may be different for different entities selling the same asset. Fair value is assessed from the perspective of the reporting entity β€” it is not universal.

Market Participants

A market participant is a buyer or seller in the principal (or most advantageous) market who is: (i) independent of the other party (not a related party); (ii) knowledgeable about the asset using all reasonably available information; (iii) able to transact; and (iv) willing to transact but not forced or compelled to do so.

⚠️ The Entity's Own Intentions Are Irrelevant Because fair value reflects what market participants would do, an entity's decision to hold an asset, or to use it in a way that differs from highest and best use, does not change the fair value. The warehouse owner who plans to keep the building forever must still measure its fair value as if a market participant might demolish and redevelop it β€” if that is the highest and best use.
Related Party Transactions β€” Link to IAS 24 Market participants are defined as not related parties. However, a related-party transaction price can be used as a Level 2 input into a fair value measurement if the entity has evidence that the transaction was entered into at market terms.
The Costs Rule: Transaction Costs vs Transport Costs

This is one of the highest-tested technical distinctions in IFRS 13. The rule is precise and the examiner deducts marks for muddling these two types of costs.

❌ Transaction Costs β€” EXCLUDED from Fair Value
Transaction costs (broker fees, stamp duty, legal costs directly attributable to the disposal) are not a characteristic of the asset β€” they depend on how the entity enters into the transaction. They are excluded from the fair value measurement and accounted for separately under other IFRSs.
βœ“ Transport Costs β€” INCLUDED in Fair Value
If location is a characteristic of the asset (e.g., a commodity that must be delivered to a specific market), the price is adjusted for the transport costs to move the asset from its current location to the principal market. These are deducted from the fair value.
Most Advantageous Market β€” The Costs Trick When identifying the most advantageous market, transaction AND transport costs are both considered (to find the highest net proceeds). But when measuring the fair value itself, only transport costs are deducted β€” transaction costs are excluded. Candidates who forget this distinction lose marks.
Highest and Best Use β€” Non-Financial Assets
IFRS 13 Para 27 β€” The HBU Rule A fair value measurement of a non-financial asset (land, buildings, intangible assets, biological assets) takes into account a market participant's ability to generate economic benefits by using the asset in its highest and best use β€” even if the entity currently uses it differently.

The Three HBU Hurdles β€” All Three Must Be Met:

β‘ 
Physically Possible
Takes into account the physical characteristics of the asset that market participants would consider β€” location, size, topography, soil conditions, access, etc. A wetland cannot be physically built upon regardless of zoning.
β‘‘
Legally Permissible
Takes into account any legal restrictions on use β€” zoning regulations, planning laws, heritage listings, environmental restrictions. A warehouse rezoned for residential use clears this hurdle. A listed heritage building may not.
β‘’
Financially Feasible
Considers whether the physically possible and legally permissible use generates adequate income or cash flows (after conversion costs) to produce a return that market participants would require. Converting to residential must be NPV-positive.
The HBU Presumption (Para 29) An entity's current use of a non-financial asset is presumed to be its highest and best use β€” unless market or other factors suggest that a different use would maximise value. This presumption is rebuttable. In exam scenarios, the examiner usually gives a clear signal (e.g., rezoning, planning permission granted, nearby sales at higher values) that the current use is not the highest and best use.

Two Valuation Premises for Non-Financial Assets:

  • In-use premise: The HBU is to use the asset in combination with other assets (e.g., machinery installed in a factory). Value assumes complementary assets are available to the buyer.
  • In-exchange premise: The HBU is to use the asset on a stand-alone basis (e.g., land sold separately). Value is the stand-alone price without assuming complementary assets.
⚠️ Defensive Use of an Intangible Asset An entity may acquire an intangible asset and choose NOT to use it β€” for example, a patent acquired to prevent competitors from using it. IFRS 13 still requires the fair value to be measured at the asset's highest and best use (i.e., its value if deployed) regardless of the entity's defensive intent.
Application to Liabilities & Equity Instruments

Fair value for a liability is the price to transfer the liability to a market participant β€” not the price to settle or extinguish it. The liability is assumed to remain outstanding after the transfer; the market participant transferee must fulfil it.

Non-Performance Risk (Para 42) The fair value of a liability reflects non-performance risk β€” the risk that the entity will not fulfil the obligation. This includes the entity's own credit risk. Importantly, non-performance risk is assumed to be the same before and after the transfer, so a deterioration in credit quality increases the fair value of the liability (it becomes cheaper to transfer).

How to Measure Fair Value of a Liability:

  1. If the identical liability is held by another party as an asset (e.g., a corporate bond): use the quoted price for that asset in an active market (Level 1).
  2. If not available in an active market: use other observable inputs (Level 2).
  3. If no observable inputs: use a valuation technique (income approach β€” present value of expected future cash outflows) from the perspective of a market participant that owes the liability (Level 3).
Restriction on Transfer (Para 45) An entity shall NOT include a separate input or adjustment for a restriction preventing the transfer of a liability. The effect of the restriction is already implicitly included in the other inputs to the fair value measurement. Do not add a separate "restriction discount."
Financial Liability with a Demand Feature (Para 47) The fair value of a demand deposit or similar financial liability is never less than the amount payable on demand discounted from the first date the amount could be required to be paid.
The Fair Value Hierarchy

The fair value hierarchy prioritises the inputs used in a valuation technique β€” not the technique itself. A present value technique (an income approach) can produce a Level 2 or Level 3 measurement depending on the inputs used. The hierarchy is about reliability, not method.

L1
Level 1 β€” Highest Priority
Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. Use without adjustment whenever available. Example: a share price on the ASX or LSE.
L2
Level 2 β€” Medium Priority
Observable inputs other than Level 1: (a) quoted prices for similar assets in active markets; (b) quoted prices for identical/similar assets in inactive markets; (c) interest rates, yield curves, implied volatilities, credit spreads. Example: property price per square metre from comparable sales.
L3
Level 3 β€” Lowest Priority
Unobservable inputs β€” the entity's own data used where no observable market data is available. Must reflect market participant assumptions. Example: a DCF model using management's own revenue forecasts for an unlisted subsidiary.
⚠️ The "Lowest Level" Rule β€” Critical for Exams If inputs from more than one level are used, the entire measurement is classified at the lowest level of input that is significant to the measurement. If a Level 2 valuation requires a significant Level 3 adjustment (e.g., applying an entity-specific illiquidity discount to an observed market price), the whole measurement becomes Level 3.
Level Inputs Asset Examples Reliability
1 Quoted prices in active markets for identical assets Listed shares (actively traded), government bonds Highest β€” use first; no adjustment permitted (except in 3 limited circumstances)
2 Observable inputs not in Level 1: similar assets, inactive market prices, yield curves, volatilities Investment property (comparable sales), interest rate swap (LIBOR-based), unlisted bond Medium β€” use when Level 1 unavailable
3 Unobservable: entity's own forecasts/models that reflect assumed market participant views Unlisted shares (DCF), decommissioning liability (internal cost estimate), intangible assets from business combinations Lowest β€” use only when no observable data available; requires most disclosure
The Three Permitted Adjustments to Level 1 Inputs
  1. The entity holds a large number of similar (not identical) items and it is impractical to price each individually (use matrix pricing β€” drops to Level 2 or 3).
  2. The quoted price does not represent fair value at the measurement date (e.g., significant post-market event before year-end).
  3. Measuring a liability using a quoted price for the identical item held as an asset, where the asset price needs adjustment for factors specific to the liability.
πŸ”΄ Listed but Not Actively Traded β€” Drops from Level 1 A share is listed on a stock exchange but has not been traded for three months. The "quoted price" exists but the market is not "active" (insufficient frequency and volume). This moves the measurement from Level 1 to Level 2. The examiner tested this distinction in December 2021 and many candidates failed to apply it.
Valuation Techniques

An entity must use valuation techniques that are appropriate for the circumstances and for which sufficient data are available, maximising observable inputs and minimising unobservable inputs. Multiple techniques can be used simultaneously; if they produce a range, select the most representative point within that range.

Market Approach
Uses prices and information from market transactions involving identical or comparable assets/liabilities. Typical techniques: market multiples (P/E, EV/EBITDA), matrix pricing. Used for: listed shares, comparable company analysis, properties with active sales data.
Cost Approach
Reflects the current replacement cost β€” the amount to replace the asset's service capacity today, adjusted for obsolescence (physical, functional, economic). Used for: specialised tangible assets in combination with other assets, plant and equipment where no active market exists.
Income Approach
Converts future amounts (cash flows, income) to a single present value using a discount rate. Includes present value techniques (DCF), option pricing models (Black-Scholes), and multi-period excess earnings (intangibles). Used for: unlisted equity, investment property, customer lists.
Changing Valuation Techniques A change in valuation technique (e.g., from market to income approach) is permitted if it results in a measurement that is equally or more representative of fair value. The revision is accounted for as a change in accounting estimate under IAS 8 β€” but IAS 8's usual disclosure requirements do not apply.

Present Value Techniques β€” Key Principles:

  • Cash flows and discount rates must reflect market participant assumptions
  • Nominal cash flows must use a nominal discount rate; real cash flows use a real rate (internal consistency)
  • After-tax cash flows use an after-tax discount rate; pre-tax cash flows use a pre-tax rate
  • Include a risk premium for bearing the uncertainty in cash flows β€” difficulty in determining it is not an excuse to omit it
  • Avoid double-counting: if risk is in the cash flows, do not also adjust the discount rate for the same risk
The Portfolio Exception (Para 48)
IFRS 13 Para 48 β€” The Portfolio Exception An entity that manages a group of financial assets and financial liabilities on the basis of its net exposure to market risks or credit risk is permitted to measure the fair value of the group on a net basis (the price to sell a net long position or transfer a net short position), rather than measuring each instrument individually.

Three Conditions Must All Be Met to Use the Portfolio Exception:

  1. The entity manages the group on the basis of its net exposure to a particular market risk (or risks) or to the credit risk of a particular counterparty, in accordance with its documented risk management or investment strategy.
  2. The entity provides information to its Key Management Personnel (as defined in IAS 24) about the group on a net exposure basis.
  3. The financial assets and liabilities are required or elected to be measured at fair value in the statement of financial position at each reporting period end.
⚠️ Examiner Tip β€” December 2023 Finding Most candidates treated the financial assets individually and did not identify the portfolio exception. This is an accounting policy decision (IAS 8) and must be applied consistently from period to period for that portfolio. If you spot a director asking about a "net package" or "portfolio" of financial assets and liabilities, this is the paragraph to cite. State the three conditions explicitly to earn full marks.

Important: the exception relates only to measurement, not financial statement presentation. If IFRS does not permit net presentation, portfolio-level adjustments must be allocated back to individual instruments on a reasonable and consistent basis.

Fair Value at Initial Recognition

The transaction price (entry price) is the price paid to acquire an asset or received to assume a liability. The fair value (exit price) is the price to sell the asset or transfer the liability. In most cases these are equal at initial recognition β€” but not always.

Situations where transaction price β‰  fair value at initial recognition:

  • The transaction is between related parties (though it may still be used as a Level 2 input if at market terms)
  • The transaction takes place under duress (financially distressed seller)
  • The unit of account is different (e.g., a business combination where the price covers more than just the asset)
  • The market in which the transaction occurs is different from the principal market
Day 1 Gain or Loss If an IFRS requires initial measurement at fair value and the transaction price differs from fair value, the resulting gain or loss is recognised in profit or loss at initial recognition β€” unless the IFRS specifies otherwise. This is the "day 1 gain/loss" that arises in certain financial instrument transactions.
Disclosure Requirements

IFRS 13 requires disclosures to help users assess (a) the valuation techniques and inputs used for recurring and non-recurring fair value measurements, and (b) for Level 3 recurring measurements, the effect on profit or loss or OCI.

Minimum disclosures for each class of assets/liabilities measured at fair value:

  • The fair value measurement at period-end; for non-recurring measurements, the reason for it
  • The level of the hierarchy (Level 1, 2, or 3) for the entire measurement
  • Transfers between Level 1 and Level 2 β€” amounts, reasons, and timing policy
  • Description of valuation technique(s) and inputs used for Level 2 and Level 3; quantitative unobservable inputs for Level 3
  • For Level 3 recurring measurements: a reconciliation from opening to closing balance (gains/losses in P&L and OCI, purchases, sales, issues, settlements, transfers in/out of Level 3)
  • For Level 3: narrative description of sensitivity to changes in unobservable inputs
  • For Level 3 financial instruments: if changing one or more inputs to reasonably possible alternatives would change fair value significantly, disclose the effect
  • If HBU differs from current use: disclose the fact and the reason
Classes vs Line Items Disclosures are per class of assets and liabilities β€” which often requires more disaggregation than the line items in the statement of financial position. However, reconciliation back to the face of the financial statements must be possible. Level 3 classes may need to be more granular due to higher subjectivity.
Worked Examples

Example 1 β€” Investment Property & Highest and Best Use

HIGHEST & BEST USE

Scenario β€” June 2021 Style

Gamma plc owns a warehouse on the outskirts of a city. The site has recently been rezoned by the local authority from industrial to residential use. Comparable land transactions in the area for residential development achieve prices of $3,500/mΒ² but demolition and remediation costs would be $800/mΒ². The current warehouse generates rental income valued at $1,200/mΒ² using a capitalised income approach.

Gamma's management argues that the fair value should be $1,200/mΒ² because they intend to continue using the building as a warehouse indefinitely.

Requirement

Explain how the fair value of the property should be determined under IFRS 13.

Solution

Step 1 β€” Apply the HBU requirement:
Under IFRS 13 para 27, the fair value of a non-financial asset must reflect its highest and best use from a market participant's perspective. The entity's intention to continue using it as a warehouse is irrelevant. We must test whether the residential use qualifies as the HBU by applying the three hurdles:

βœ“ Physically Possible
The land is of adequate size and accessibility for residential development. No physical impediment mentioned.
βœ“ Legally Permissible
The site has been rezoned to residential use. This hurdle is met β€” legal permission for residential development exists.
βœ“ Financially Feasible
Net residential value = $3,500 βˆ’ $800 = $2,700/mΒ². This exceeds the warehouse value of $1,200/mΒ². The development generates an adequate return. Financially feasible.

Step 2 β€” Determine fair value:
All three conditions are met. The highest and best use is residential development. The fair value is $2,700/mΒ² (the residential land value net of demolition and remediation costs), not the warehouse income-capitalised value of $1,200/mΒ². Gamma's management argument based on their own intention is rejected by IFRS 13.

Step 3 β€” Hierarchy level:
The residential land sales are observable market transactions for comparable (similar but not identical) properties. This is a Level 2 input. The demolition cost estimate, if derived from contractor quotes or industry data, would also be Level 2. If significant entity-specific adjustments are made, it could fall to Level 3.

Examiner Note: Candidates who simply used the warehouse income value because "Gamma intends to keep the building" lost marks. Always check all three HBU hurdles explicitly by name and determine whether the alternative use clears them.

Example 2 β€” Classifying Inputs in the Fair Value Hierarchy

FAIR VALUE HIERARCHY

Scenario β€” December 2021 Style

Delta plc acquired a subsidiary. The subsidiary's assets include: (A) 50,000 listed shares in a FTSE 100 company β€” actively traded daily; (B) 100,000 shares in a company listed on a smaller exchange where the last recorded trade was 4 months ago; (C) a 30% stake in an unlisted private company, valued by management using a 5-year DCF model with internally projected revenues.

Classify each holding within the IFRS 13 fair value hierarchy and explain your reasoning.

Solution

Asset A β€” FTSE 100 shares:
Quoted price in an active market (sufficient frequency and volume) for identical assets. This is a Level 1 input. Use the quoted price without adjustment. Even if Delta holds a large block, no blockage discount is permitted at Level 1.

Asset B β€” Shares on an inactive exchange:
A quoted price exists but the market is not active (last trade was 4 months ago, suggesting insufficient frequency and volume). This is a Level 2 input β€” quoted price for an identical asset in a market that is not active. The price may need updating or adjustment to reflect current conditions. It does not qualify as Level 1.

Asset C β€” Unlisted private company stake:
No quoted price is available. Valuation relies entirely on management's internal revenue forecasts β€” unobservable inputs. This is a Level 3 input. Management must adjust its internal data if market participants would use different assumptions. The DCF model itself is acceptable (income approach) but is categorised at Level 3 due to unobservable inputs. Extensive disclosures required (sensitivity analysis, reconciliation of opening to closing balances).

Example 3 β€” The Portfolio Exception

PORTFOLIO EXCEPTION

Scenario β€” December 2023 Style

Epsilon plc holds a portfolio of interest rate swaps and bonds that create offsetting interest rate risk positions. The Finance Director asks the CFO whether the fair value of the portfolio can be determined on a net basis β€” i.e., measuring the net interest rate risk exposure rather than valuing each instrument individually. The portfolio is managed on a net basis according to Epsilon's documented risk management strategy, and reports are provided to the Board on a net exposure basis. All instruments are designated at fair value through profit or loss.

Requirement

Advise whether the portfolio exception can be applied.

Solution

Under IFRS 13 para 48, an entity may measure a group of financial assets and liabilities on a net basis where offsetting market or credit risk positions are managed together. However, three conditions (para 49) must all be satisfied:

  1. Documented net risk management strategy: βœ“ Epsilon manages the portfolio on a net basis per its documented risk strategy.
  2. Information provided to KMP on a net basis: βœ“ Board reports are prepared on a net exposure basis, satisfying this condition.
  3. Instruments measured at fair value in the SFP at period end: βœ“ All instruments are designated at FVTPL.

All three conditions are met. Epsilon may apply the portfolio exception and measure fair value on a net basis. This is an accounting policy decision under IAS 8 and must be applied consistently from period to period. The net measurement applies to valuation only β€” presentation in the SFP follows the applicable IFRSs (net presentation requires separate conditions under IAS 32). Epsilon must disclose the use of the exception.

Example 4 β€” Costs: Transaction vs Transport

COSTS DISTINCTION

Scenario

Zeta plc holds 10,000 tonnes of copper ore at its mine in Australia. The principal market for the ore is a metals exchange in London. To sell in London, Zeta would incur: (A) shipping and insurance costs of $12/tonne to transport the ore from Australia to London; and (B) exchange and broker commissions of $3/tonne. The quoted price in London is $250/tonne.

Calculate the fair value of the copper ore per tonne.

Solution

Location is a characteristic of copper ore β€” its current location (Australia) is different from the principal market (London). Under IFRS 13 para 26, transport costs are included in the fair value calculation.

Exchange/broker commissions are transaction costs β€” not a characteristic of the ore itself. Under IFRS 13 para 25, transaction costs are excluded from fair value.

Fair value per tonne:

  • London quoted price: $250
  • Less: Transport costs: ($12)
  • Less: Transaction costs: excluded β€” not deducted
  • Fair value = $238 per tonne

Total fair value of 10,000 tonnes = $2,380,000.

Examiner Themes & PitfallsΒ 
Theme What Candidates Often Do Wrong The Correct Approach
Exit Price Definition Use the purchase price or carrying amount as a proxy for fair value Always use the exit price definition; ask "what would a market participant pay to acquire this asset from the holder today?"
HBU β€” Missing the 3 Hurdles Identify the better use but fail to list all three HBU tests by name Explicitly name "physically possible, legally permissible, and financially feasible" β€” three separate sentences earn three separate marks
HBU β€” Entity Intention Accept the entity's stated intention to use the asset in its current form as the HBU Reject the entity's intention; apply market participant view; check if alternative use clears all three hurdles
Fair Value Hierarchy "Knowledge dump" all three levels but fail to apply them to the specific assets in the question Identify the specific inputs for the specific asset, then classify; note the "listed but not actively traded" downgrade from L1 to L2
Transaction vs Transport Costs Deduct both transaction AND transport costs from fair value Only transport costs are deducted (if location is a characteristic); transaction costs are excluded from FV but used to identify the most advantageous market
Lowest Level Rule Classify the measurement at the highest level of input used Always use the lowest level of input that is significant to the entire measurement
Portfolio Exception Ignore the exception and price each financial instrument individually Spot the net exposure scenario; cite para 48; state all three conditions; note it is an IAS 8 accounting policy decision
Liabilities β€” Non-Performance Risk Ignore the entity's own credit risk in liability fair value Include non-performance risk; a decline in credit quality raises the fair value of the liability

✎ Knowledge Check β€” Test Yourself

Q1. An entity holds 5,000 shares in a company listed on the NYSE. The shares are traded daily. What level in the fair value hierarchy applies, and can the entity adjust the quoted price?

Show Answer
Level 1 input β€” quoted price in an active market for identical assets. The price must be used without adjustment (subject only to the three limited exceptions in para 79). No blockage discount is permitted even if a large block would move the market.

Q2. A company owns land currently used as a car park ($200/mΒ²). A developer has obtained planning permission for residential housing on an adjacent plot, achieving $650/mΒ² after demolition costs. The land is physically buildable. Should fair value reflect $200 or $650/mΒ²?

Show Answer
$650/mΒ² β€” IFRS 13 requires HBU to be assessed from a market participant's perspective. Residential development is physically possible (buildable), legally permissible (adjacent plot received planning, suggesting rezoning is feasible), and financially feasible ($650 > $200). Current use as car park is the presumption only if no contrary evidence β€” here there is strong contrary evidence. Fair value = $650/mΒ².

Q3. What is the difference between the principal market and the most advantageous market? Which price does IFRS 13 use?

Show Answer
The principal market is the market with the greatest volume and level of activity for the asset β€” this is the default market. The most advantageous market maximises net proceeds after transaction and transport costs β€” used only in the absence of a principal market. IFRS 13 uses the price in the principal market even if the most advantageous market offers a higher price.

Q4. A financial asset is valued using a present value model (DCF). Management uses the entity's own budget forecasts as the main input. What hierarchy level applies and why?

Show Answer
Level 3 β€” the key input (management's own budget forecasts) is unobservable. The hierarchy classifies the entire measurement at the level of the lowest significant input. The DCF technique itself is neutral β€” it is the unobservable nature of the inputs that drives the Level 3 classification. Level 3 triggers the most extensive disclosure requirements.

Q5. Company X sells copper in Australia for $230/tonne (after $8 transport to Sydney port) or in London for $250/tonne (after $12 transport + $3 broker commission). Which is the most advantageous market, and what is the fair value if London is also the principal market?

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Most advantageous market identification: Australia net = $230 βˆ’ $8 βˆ’ nil transaction = $222. London net = $250 βˆ’ $12 βˆ’ $3 = $235. London is most advantageous. If London is also the principal market, fair value = $250 βˆ’ $12 transport = $238/tonne (transaction costs excluded from FV).
Exam Strategy β€” 4-Step Answer Framework

IFRS 13 β€” Exam Answer Protocol

1
Define Fair Value. Start every answer with: "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." Note: this is an exit price, not an entry price.
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2
Identify the Level. Ask: are the inputs observable or unobservable? Is there a quoted price for identical assets in an active market (L1)? Observable but not L1 (L2)? Unobservable (L3)? Remember: classify by the lowest significant input.
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3
Apply HBU for Property. If the asset is land or a building, always run the three tests: physically possible β€” legally permissible β€” financially feasible. Name them explicitly. Reject the entity's stated use if an alternative use clears all three hurdles.
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4
Handle Costs Correctly. State: "Transaction costs are excluded from fair value. Transport costs are included if location is a characteristic of the asset." Apply numerically if figures are given.
βœ“ Bonus Points β€” Mention These If Relevant
  • Portfolio Exception (para 48) if a net portfolio of financials is mentioned
  • Non-performance risk if a liability's fair value is being discussed
  • The "listed but inactive" downgrade from Level 1 to Level 2
  • The connection to IAS 24 β€” market participants are NOT related parties
  • Disclosure requirement: if HBU differs from current use, the entity must disclose the fact and the reason.

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