18.3 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.
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. 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). 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.
In Example 14.12 at 10.1.3 above, for the three-year option on exchange-traded shares,
the implied volatility derived through extrapolation has been categorised as a Level 2
input because the input was corroborated (through correlation) to an implied volatility
based on an observable option price of a comparable entity. In this example, the
determination of an appropriate proxy (i.e. a comparable entity) is a critical component
in supporting that the implied volatility of the actual option being measured is a market-
corroborated input.
In practice, identifying an appropriate benchmark or proxy requires judgement that
should appropriately incorporate both qualitative and quantitative factors. For example,
when valuing equity-based instruments (e.g. equity options), an entity should consider
the industry, nature of the business, size, leverage and other factors that would
qualitatively support the expectation that the benchmarks are sufficiently comparable
to the subject entity. Qualitative considerations may differ depending on the type of
input being analysed or the type of instrument being measured (e.g. a foreign exchange
option versus an equity option).
In addition to the qualitative considerations discussed above, quantitative measures are
used to validate a statistical analysis. For example, if a regression analysis is used as a
means of corroborating non-observable market data, the results of the analysis can be
assessed based on statistical measures.
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18.4 Making adjustments to a Level 2 input
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].
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 8 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.
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].
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].
18.5 Recently observed prices in an inactive market
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. 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 8 above).
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 18.4 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. Therefore, it is
important to understand the characteristics of the item being measured compared with
an item being used as a benchmark.
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). While this information may not be determinative for the particular
Fair value measurement 1063
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.
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. 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.
19 LEVEL
3
INPUTS
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 va
lue. 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].
19.1 Use of Level 3 inputs
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. 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].
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.
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].
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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. As discussed at 7.2 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].
19.2 Examples of Level 3 inputs
IFRS 13’s application guidance provides a number of examples of Level 3 inputs for
specific assets or liabilities, as outlined in Figure 14.10 below. [IFRS 13.B36].
Figure 14.10:
Examples of Level 3 inputs
Asset or Liability
Example of a Level 3 Input
Long-dated currency
An interest rate in a specified currency that is not observable and cannot be
swap
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.
Three-year option on
Historical volatility, i.e. the volatility for the shares derived from the
exchange-traded shares
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.
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.
Decommissioning
A current estimate using the entity’s own data about the future cash
liability assumed in a
outflows to be paid to fulfil the obligation (including market participants’
business combination
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. 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.
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.
Fair value measurement 1065
20 DISCLOSURES
The disclosure requirements in IFRS 13 apply to fair value measurements recognised in
the statement of financial position, after initial recognition, and disclosures of fair value
(i.e. those items that are not measured at fair value in the statement of financial position,
but whose fair value is required to be disclosed). However, as discussed at 2.2.4 above,
IFRS 13 provides a scope exception in relation to disclosures for:
• plan assets measured at fair value in accordance with IAS 19;
• retirement benefit plan investments measured at fair value in accordance with
IAS 26; and
• assets for which recoverable amount is fair value less costs of disposal in
accordance with IAS 36.
In addition to these scope exceptions, the IASB decided not to require the IFRS 13
disclosures for items that are recognised at fair value only at initial recognition.
Disclosure requirements in relation to fair value measurements at initial recognition are
covered by the standard that is applicable to that asset or liability. For example, IFRS 3
requires disclosure of the fair value measurement of assets acquired and liabilities
assumed in a business combination. [IFRS 13.BC184].
However, it should be noted that, unlike IAS 19, IAS 26 and IAS 36, there is no scope
exemption for IFRS 3 or other standards that require fair value measurements (or
measures based on fair value) at initial recognition. Therefore, if those standards require
fair value measurements (or measures based on fair value) after initial recognition,
IFRS 13’s disclosure requirements would apply.
From the IASB discussions of respondents input on the PIR, the IASB has decided to
feed the PIR findin
gs regarding the usefulness of disclosures into the work on Better
Communications in Financial Reporting, in particular, the projects on Principles of
Disclosure and Primary Financial Statements (See 1.1 above).24
20.1 Disclosure
objectives
IFRS 13 requires a number of disclosures designed to provide users of financial
statements with additional transparency regarding:
• the extent to which fair value is used to measure assets and liabilities;
• the valuation techniques, inputs and assumptions used in measuring fair value; and
• the effect of Level 3 fair value measurements on profit or loss (or other
comprehensive income).
The standard establishes a set of broad disclosure objectives and provides the minimum
disclosures an entity must make (see 20.2 to 20.5 below for discussion regarding the
minimum disclosure requirements in IFRS 13).
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The objectives of IFRS 13’s disclosure requirements are to:
(a) enable users of financial statements to understand the valuation techniques and
inputs used to develop fair value measurements; and
(b) help users to understand the effect of fair value measurements on profit or loss and
other comprehensive income for the period when fair value is based on
unobservable inputs (Level 3 inputs). [IFRS 13.91].
After providing the minimum disclosures required by IFRS 13 and other standards, such
as IAS 1 – Presentation of Financial Statements – or IAS 34 – Interim Financial
Reporting, an entity must assess whether its disclosures are sufficient to meet the
disclosure objectives in IFRS 13. If not, additional information must be disclosed in
order to meet those objectives. [IFRS 13.92]. This assessment requires judgement and will
depend on the specific facts and circumstances of the entity and the needs of the users
of its financial statements.
An entity must consider all the following:
• the level of detail needed to satisfy the disclosure requirements;
• how much emphasis to place on each of the various requirements;
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 210