Fair value measurement: working as intended (if not as desired…)

The IASB has issued a project report and feedback statement on its post-implementation Review of IFRS 13 Fair Value Measurement.

This is how it summarizes the overall findings:

  • The Board concluded that IFRS 13 is working as intended. In particular:
    • the information required by IFRS 13 is useful to users of financial statements.
    • some areas of IFRS 13 present implementation challenges, largely in areas requiring judgement. However, evidence suggests that practice is developing to resolve these challenges.
    • no unexpected costs have arisen from application of IFRS 13.

The Board decided to feed its findings into the work on Better Communication in Financial Reporting, and more broadly to continue liaising with the valuation profession, monitor new developments in practice and promote knowledge development and sharing. It doesn’t intend any other specific follow-up. This obviously doesn’t mean that no issues or problems arise in implementing the standard, only that it’s unlikely that any amount of further amendment or guidance would significantly alleviate these.

From my perspective, the main recurring issues are the challenges of valuing “level 3” investments, and the somewhat overlapping one of determining whether an active market exists for a particular security, and thereby concluding that it isn’t a level 3 investment. It’s clear from the report that this isn’t an isolated perspective. On the first issue:

  • Most respondents to the (request for information) did not respond to the questions on unquoted equity instruments or said they had no experience in this area. Of those that did respond, most said they were familiar with the education material Unquoted equity instruments within the scope of IFRS 9 Financial Instruments (available on the IFRS Foundation website). Some of those respondents noted they were also using guidance prepared by industry groups, with most quoting the International Private Equity and Venture Capital Valuation Guidelines.
  • Many of those who responded to the questions said additional guidance was needed. Those respondents included several accounting firms, preparers, standardsetters and a user. Those respondents provided examples of the areas in which guidance was most sought, including valuation of early stage entities, and determining cost of capital and various premiums and discounts as well as more guidance on restrictions.
  • Some respondents, including several standard-setters and preparers, said additional guidance was not needed. Some respondents, including standard-setters and preparers, said that the valuation profession should develop any additional guidance, and not the Board.

At the time of writing, issues frequently arise in Canada relating to (say) recently-created entities in the marijuana industry, with big plans and prospects but little or no current revenue, entering into a market that by its nature is hazy with valuation uncertainties; these entities have often carried out recent financings, but at a price that seems questionable as an indicator of overall enterprise value. Such situations pose significant challenges in applying the concepts in the education material. Preparers often seek to default to the assumption that fair value isn’t materially different from recorded cost, but under IFRS 9 this will frequently be a stretch. Still, it’s probably true that no obvious way exists of alleviating these challenges. On the second issue:

  • Many respondents discussed application of judgement. Most of them found it challenging to assess whether a market is active and whether an unobservable input is significant. They asked the Board to provide further guidance on these assessments. The respondents mostly referred to assessments relating to financial instruments, with a few comments relating to property.
  • A few respondents said that, although the assessments are challenging, additional guidance would not be helpful and that the Standard should remain principle-based.
  • A large majority of those who said the assessments were not challenging stated this was because they either had developed internal guidance or used industry-level guidance.
  • Some respondents said preparers have an incentive to classify items within Level 2 of the hierarchy rather than Level 3, because disclosure requirements are more extensive for Level 3 measurements.

Again, the Board declined to go any further, noting among other things that “there will always be a need for exercise of judgement in making these assessments.” True enough, and yet it seems less than ideal that (say) the lower-tier Canadian markets will remain perpetually subject to the same recurring questions about how much activity it takes to be active.

Of course, the disclosures attaching to “level 3” items will likely provide an evergreen source of comments for regulators and others. As I’ve said before, I think the main point of those disclosures is to provide a big flashing red light, saying in effect: Don’t trust these values! They usually achieve that much at least, although I’ve seen examples that didn’t. The report observes that “many” respondents would like additional disclosure about “level 3” items (more explanation of assumptions; more disclosure about inputs and sensitivity), but this sounds like another illustration of how it’s easy to throw items onto a wish-list, regardless that if those gifts were actually received, they’d probably remain unopened under the tree…

The opinions expressed are solely those of the author

One thought on “Fair value measurement: working as intended (if not as desired…)

  1. The valuation of unquoted equity instrument is particularly challenging as the valuation practice is still evolving with no single international valuation standard exist. Having said that it is very difficult to value certain entities which are one of its kind and no comparable entities exist. Further in order to conclude whether the fair value can be reliably measure, more then one method to be used to derive fair value which is not practicable for entities which are conducting very specific operation and such entities are not having any comparable peer.

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