Fair value measurement – mostly looking good

Some European observations on compliance with IFRS 13

We’ve already covered some of the material in the ESMA Report on Enforcement and Regulatory Activities of Accounting Enforcers in 2014, issued a while ago by the European Securities and Markets Authority. Here’s another extract:

  • “Considering the date of the first application of IFRS 13 Fair Value Measurement, ESMA decided to include specific elements in its 2013 European Common Enforcement Priorities.
  • This assessment was performed by European enforcers on a sample of 100 issuers (both financial and non-financial institutions) from 20 EEA countries for which fair value measurement related to the application of IFRS 13 was deemed to be material. More than 90% of this sample included material items classified as level 2 or level 3 of the fair value hierarchy.
  • These issuers included both corporates as well as financial institutions. ESMA highlighted the following issues:
  • Accounting policy
  • Almost 90% of issuers in the sample properly disclosed the accounting policy in accordance with the definition of fair value in IFRS 13 and disclosed all elements relevant for the issuer in the description of the accounting policy. For the issuers in the sample with items classified as level 2 and/or level 3 of the fair value hierarchy, more than three quarters provided appropriate disclosure of the valuation techniques in the fair value measurement. For the remaining issuers, disclosure of the valuation technique was incomplete or generic, mainly repeating the wording of the standard.
  • Aggregation
  • Almost all issuers provided disclosures based on appropriate classes of assets and liabilities, higher level of disaggregation for level 3 fair value measurements and adequately disclosed fair value measurements at the end of the reporting period.
  • Adjustments for credit risk
  • Issues related to adjustments for credit risk in fair value measurement, such as credit valuation adjustment (CVA), were considered significant for approximately half of issuers in the sample.
  • Those affected were mainly financial institutions. More than 90% of the affected issuers accounted for credit risk (CVA) when determining the fair value of derivative financial assets, and for own credit risk (debit valuation adjustment (DVA)) when determining the fair value of derivative financial liabilities. While only one third of issuers specifically disclosed quantitative effects of these adjustments, the impact of CVA or DVA was not significant in most of the cases. However, even when material, disappointingly, less than a half of the issuers provided an appropriate description of the methods of calculation of CVA or DVA.
  • Furthermore, almost a third of issuers applying the fair value option for financial liabilities did not disclose or in some cases even account for the effects of own credit risk adjustments on these financial liabilities.
  • Fair Value Hierarchy
  • Almost all issuers in the sample provided adequate disclosures on the fair value hierarchy for all significant fair value measurements. While almost 85% of issuers in the sample disclosed separately the transfers into each level of the fair value hierarchy, three quarters of them explained the reasons for the transfers.
  • Almost 90% of issuers in the sample provided adequate fair value disclosures for non-recurring fair value measurements (e.g. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations), even though only three quarters of them provided adequate disclosures for assets and liabilities not measured at fair value but for which disclosures about fair value measurement are required according to IFRS 13.
  • More than three quarters of issuers in the sample reported significant recurring level 3 fair value measurements calculated using significant unobservable inputs. More than 90% of these issuers disclosed the effect of the measurements on profit or loss or other comprehensive income for the period for all significant fair value measurements.
  • Almost all issuers in the sample for whom level 3 fair value measurements were significant provided a reconciliation from the opening balances to the closing balances of level 3 assets and liabilities, disclosing the amount of the total gains or losses included in profit or loss that is attributable to the change in unrealized gains or losses relating to those assets and liabilities held at the end of the reporting period, and the line item(s) in which those unrealized gains or losses are recognized. However, more than a quarter of the issuers provided only a generic description of the valuation policy for level 3 fair value measurements. Furthermore, almost a third of the issuers failed to disclose a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs including a description of the interrelationships between the inputs and their effects on the fair value.”

Nineteen enforcement actions came out of this, mostly relating to level 3 disclosures – three to require “public corrective notes” (it’s not clear whether that necessarily means refiling and restatement) and sixteen to require corrections in future financial statements. Which doesn’t sound too damning. One assumes that in many of the cases where 75% of the sample didn’t do this or 10% didn’t do that, it was simply because the information wasn’t material. This should surely apply to many of the cases of missing “level 3” disclosures – after all, such disclosures merely expand, with an inevitable degree of subjectivity, on what’s already inherent in the level 3 classification: that these values should be handled with a high degree of caution and skepticism.

This may be an increasingly reaction to such regulatory reports as we move into applying the “disclosure overload” amendments to IAS 1 – that is, why bother telling us how many issuers didn’t do something, unless you can also very specifically tell us why it mattered…?

The opinions expressed are solely those of the author

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