International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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(b) On the basis of its analysis of the nature, characteristics and risks of the investments, the entity has
determined that presenting them as a single class is appropriate.
Fair value measurement 1077
(c) In accordance with IFRS 5, assets held for sale with a carrying amount of CU 35 million were written
down to their fair value of CU 26 million, less costs to sell of CU 6 million (or CU 20 million),
resulting in a loss of CU 15 million, which was included in profit or loss for the period.
(Note: A similar table would be presented for liabilities unless another format is deemed more appropriate
by the entity.)
In the above example, the gain or loss recognised during the period for assets and
liabilities measured at fair value on a non-recurring basis is separately disclosed and
discussed in the notes to the financial statements.
20.3.4
Transfers between hierarchy levels for recurring fair value
measurements
IFRS 13 requires entities to disclose information regarding all transfers between fair
value hierarchy levels (i.e. situations where an asset or liability was categorised within a
different level in the fair value hierarchy in the previous reporting period).
[IFRS 13.93(c), 93(e)(iv)]. However, this disclosure requirement only applies to assets and
liabilities held at the end of the reporting period which are measured at fair value on a
recurring basis. Information regarding transfers into or out of Level 3 is captured in the
Level 3 reconciliation (discussed at 20.3.6 below) as these amounts are needed to roll
forward Level 3 balances from the beginning to the end of the period being disclosed.
The amounts of any transfers between Level 1 and Level 2 of the fair value hierarchy
are also required to be disclosed. Regardless of the hierarchy levels involved, transfers
into each level of the hierarchy are disclosed separately from transfers out of each level.
That is, all transfers are required to be presented on a gross basis by hierarchy level,
whether included in the Level 3 reconciliation or disclosed separately.
For all transfer amounts disclosed, an entity is required to discuss the reasons why the
categorisation within the fair value hierarchy has changed (i.e. transferred between
hierarchy levels). [IFRS 13.93(c), 93(e)(iv)]. Reasons might include the market for a particular
asset or liability previously considered active (Level 1) becoming inactive (Level 2 or
Level 3), or significant inputs used in a valuation technique that were previously
unobservable (Level 3) becoming observable (Level 2) given transactions that were
observed around the measurement date.
As discussed at 16.2.2 and 20.2 above, IFRS 13 also requires that entities disclose and
consistently follow their policy for determining when transfers between fair value
hierarchy levels are deemed to have occurred. That is, an entity’s policy about the
timing of recognising transfers into the hierarchy levels should be the same as the policy
for recognising transfers out, and this policy should be used consistently from period to
period. Paragraph 95 of IFRS 13 includes the following examples of potential policies:
the actual 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. In practice, some
variation of these approaches may also be used by entities. For example, some entities
may use an intra-period approach using a transfer amount based on the fair value as at
the month-end in which the transfer occurred, as opposed to the actual date within the
month. [IFRS 13.95]. The following illustrative example demonstrates the differences
between the three methods noted above.
1078 Chapter 14
Example 14.26: Comparison of policies for recognising transfers
Assume an entity acquires an asset at 31 December 20X8 for CU 1,000 that was categorised within Level 2
of the fair value hierarchy at year end 20X8 and throughout Q1 20X9. At the end of Q1 20X9, the fair value
of the asset based on market observable information was CU 950, and, as such, the asset was excluded from
the Level 3 reconciliation. During Q2 20X9, observable market information was no longer available, so the
entity categorised the asset in Level 3 at the end of Q2 20X9. During Q2 20X9, the fair value of the asset
decreased from CU 950 to CU 750, with CU 50 of the change in fair value arising subsequent to the time
when market observable information was no longer available.
Under the three approaches described above, the Level 3 reconciliation for Q2 20X9 would be as follows.
Transferred to Level 3 at:
Beginning of the
period
Actual date
End of the period
Beginning fair value
–
–
–
Purchases, issuances and
–
–
–
settlements
Transfers in
CU 950
CU 800
CU 750
Total losses
CU (200)
CU (50)
–
Ending fair value
CU 750
CU 750
CU 750
As previously noted, the disclosures under IFRS 13 are intended to provide information
that enables users to identify the effects of fair value measurements that are more
subjective in nature on reported earnings, and, thereby, enhance financial statement
users’ ability to make their own assessment regarding earnings quality. We believe that
this objective is best met by considering the level of observability associated with the
fair value measurement made at the end of the reporting period (i.e. the observability of
the inputs used to determine fair value on the last day in the period). As such, while no
specific approach is required under IFRS, we believe a beginning-of-period approach
for recognising transfers provides greater transparency on the effect that unobservable
inputs have on fair value measurements and reported earnings. Under this view, all
changes in fair value that arise during the reporting period of the transfer are disclosed
as a component of the Level 3 reconciliation.
While the ‘actual date’ approach more precisely captures the date on which a change in
the observability of inputs occurred, its application can be more operationally complex.
In addition, in our view, it does not necessarily provide more decision-useful
information than the beginning-of-period approach. This is because, for a given period,
the intra-period approach results in an allocation of the fair value changes between
hierarchy levels that is inconsistent with the actual categorisation of the item as at the
end of the reporting period. As such, the intra-period approach implies that a portion
of the earnings recognised during the period is of a higher (or lower) quality solely
because there was observable information regarding the value of the instrument at some
point during the period.
To further illustrate this point, assume an entity acquires an investment in a private
company in Q1 for CU 1,000. In the middle of Q2, the company completes an initial
public offering that values the investment at CU 1,500. At the end of Q2, the fair value
of the
investment is CU 2,200 based on a quoted market price. Under the intra-period
approach for the six-month period ended Q2, CU 500 would be included as an
unrealised gain in the Level 3 reconciliation, despite the fact that the entire CU 1,200
Fair value measurement 1079
unrealised gain recognised during the six-month period is supported by observable
market information (i.e. a quoted price less cash paid).
Of the three alternatives, we believe the end-of-period approach is the least effective
in achieving IFRS 13’s disclosure objectives. Under this approach, the Level 3
reconciliation would not reflect any unrealised gains or losses for items that move from
Level 2 to Level 3 during the reporting period.
20.3.5
Disclosure of valuation techniques and inputs
Entities are required to describe the valuation techniques and inputs used to measure
the fair value of items categorised within Level 2 or Level 3 of the fair value hierarchy.
In addition, entities are required to disclose instances where there has been a change in
the valuation technique(s) used during the period, and the reason for making the change.
As discussed at 20.3.5.A below, the standard also requires quantitative information
about the significant unobservable inputs to be disclosed for Level 3 fair value
measurements. [IFRS 13.93(d)].
Importantly, the disclosures related to valuation techniques and inputs (including the
requirement to disclose quantitative information about unobservable inputs) apply to
both recurring and non-recurring fair value measurements. [IFRS 13.93(d)].
20.3.5.A
Significant unobservable inputs for Level 3 fair value measurements
For Level 3 measurements, IFRS 13 specifically requires that entities provide
quantitative information about the significant unobservable inputs used in the fair value
measurement. [IFRS 13.93(d)]. For example, an entity with asset-backed securities
categorised within Level 3 would be required to quantitatively disclose the inputs used
in its valuation models related to prepayment speed, probability of default, loss given
default and discount rate (assuming these inputs were all unobservable and deemed to
be significant to the valuation).
Consistent with all of the disclosures in IFRS 13, entities are required to present this
information separately for each class of assets or liabilities based on the nature,
characteristics and risks of their Level 3 measurements. [IFRS 13.93]. As such, we expect
that entities will likely disclose both the range and weighted average of the unobservable
inputs used across a particular class of Level 3 assets or liabilities. In addition, entities
should assess whether the level of disaggregation at which this information is provided
results in meaningful information to users, consistent with the objectives of IFRS 13.
In some situations significant unobservable inputs may not be developed by the
reporting entity itself, such as when an entity uses third-party pricing information
without adjustment. In these instances, IFRS 13 states that an entity is not required to
create quantitative information to comply with its disclosure requirements. However,
when making these disclosures, entities cannot ignore information about significant
unobservable inputs that is ‘reasonably available’.
Determining whether information is ‘reasonably available’ will require judgement, and
there may be some diversity in practice stemming from differences in entities’ access to
information and information vendors may be willing or able to provide. If the valuation
has been developed, either by the entity or an external valuation expert at the direction
of the entity, quantitative information about the significant unobservable inputs would
1080 Chapter 14
be expected to be reasonably available and therefore should be disclosed. As a result,
entities need to ensure any valuers they use provide them with sufficient information to
make the required disclosures.
In contrast, when an entity receives price quotes or other valuation information from a
third-party pricing service or broker, the specific unobservable inputs underlying this
information may not always be reasonably available to the entity. While determining
whether information is reasonably available in these instances will require judgement,
we would expect entities to make good-faith efforts to obtain the information needed
to meet the disclosure requirements in IFRS 13. In addition, some diversity in practice
may stem from differences in entities’ access to information and the nature of
information that various vendors may be willing or able to provide. However, in all
cases, any adjustments made by an entity to the pricing data received from a third party
should be disclosed if these adjustments are not based on observable market data and
are deemed to be significant to the overall measurement.
The following example from IFRS 13 illustrates the type of information an entity might
provide to comply with the requirement to disclose quantitative information about
Level 3 fair value measurements. [IFRS 13.IE63]. Extract 14.3 from BP p.l.c. and Extract 14.4
from Rio Tinto plc at 20.3.8.A below also illustrates this disclosure in relation to
derivatives categorised within Level 3.
Example 14.27: Significant unobservable inputs (Level 3)
Quantitative information about fair value measurements using significant unobservable inputs
(Level 3)
(CU in millions)
Range
Fair value
Valuation
(weighted
Description
at 31/12/X9
technique(s)
Unobservable input
average)
Other equity securities:
Healthcare
53 Discounted
weighted average cost of capital
7%-16% (12.1%)
industry
cash flow
long-term revenue growth rate
2%-5% (4.2%)
long-term pre-tax operating margin
3%-20% (10.3%)
discount for lack of marketability(a)
5%-20% (17%)
control premium(a)
10%-30% (20%)
Market
EBITDA multiple(b)
10-13 (11.3)
comparable
revenue multiple(b)
1.5-2.0 (1.7)
companies
discount for lack of marketability(a)
5%-20% (17%)
control premium(a)
10%-30% (20%)
Energy
industry
32 Discounted
weighted average cost of capital
8%-12% (11.1%)
cash flow
long-term revenue growth rate
3%-5.5% (4.2%)
long-term pre-tax operating margin
7.5%-13% (9.2%)
discount for lack of marketability(a)
5%-20% (10%)
control premium(a)
10%-20% (12%)
Market
EBITDA multiple(b)
6.5-12 (9.5)
comparable
revenue multiple(b)
1.0-3.0 (2.0)
companies
discount for lack of marketability(a)
5%-20% (10%)
control premium(a)
10%-20% (12%)
Private
/>
equity
25 Net
asset
n/a n/a
fund
value(c)
investments(b)
Fair value measurement 1081
(CU in millions)
Range
Fair value
Valuation
(weighted
Description
at 31/12/X9
technique(s)
Unobservable input
average)
Debt securities:
Residential
125
Discounted
constant prepayment rate
3.5%-5.5%
mortgage-
cash flow
(4.5%)
backed
probability of default
5%-50% (10%)
securities
loss severity
40%-100%
(60%)
Commercial
50 Discounted
constant prepayment rate
3%-5% (4.1%)
mortgage-
cash flow
probability of default
2%-25% (5%)
backed
loss severity
10%-50% (20%)
securities
Collateralised
35
Consensus
offered quotes
20-45
debt obligations
pricing
comparability adjustments (%)
–10%-+15%
(+5%)
Hedge fund investments:
High-yield
debt
90 Net
asset
n/a n/a
securities
value(c)
(CU in millions)
Range
Fair value
Valuation
(weighted
Description
at 31/12/X9
technique(s)
Unobservable input
average)
Derivatives:
Credit contracts
38
Option
annualised volatility of credit(d)
10%-20%
model
counterparty credit risk(e)
0.5%-3.5%
own credit risk(e)