CFM21160 - Accounting for corporate finance: key concepts: fair value

Measurement of Fair value

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. It is not the amount an entity would receive or pay in a forced transaction, involving liquidation or distress sale. However, fair value reflects the credit quality of the instrument. So, for example, a bond issued by a company with an AAA credit rating would normally be expected to have a higher value than an identical bond issued by a lower-rated company.

The best evidence of the fair value of a financial asset at initial recognition is usually the transaction price. Where the price is not paid in cash, it will be the fair value of the consideration given.

Ascertaining fair value

IFRS 13’s application guidance gives extensive detail and consideration to the various factors governing the interpretation of what constitutes fair value. It provides a hierarchy to be used:

• Quoted marked prices in an active market are the best evidence of fair value and should be used, where they exist, to measure the financial asset:
• If a market for a financial asset is not active, an entity establishes fair value by using other observable inputs, such as the quoted price in a market that is not active for the identical item held by another party as an asset
• If the observable prices in the above two examples are not available another valuation technique should be used such as an income approach (e.g. a present value technique that takes into account the future cash flows that a market participant would expect), or a market approach (e.g. using quoted prices for similar instruments held by other parties).