Fair value is the price you would receive to sell an asset, or pay to transfer a liability, in an orderly transaction between market participants at the measurement date.
IFRS establishes a fair value hierarchy that categorises into three levels the inputs to valuation techniques used to measure fair value. The hierarchy decides how reliable your inputs are and how much you have to disclose.
The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).
Step 1: Measurement
Identify the specific asset or liability, its unit of account and its characteristics, and measure it from the perspective of market participants.
Step 2: Market identification
Use the principal market for the item. If not, use the most advantageous market. Do not adjust the price for transaction costs.
Step 3: Valuation technique
Choose the market, cost or income approach, whichever suits the item. Maximise relevant observable inputs and minimise unobservable ones.
Step 4: Hierarchy
| Level | Inputs | Key point |
|---|---|---|
| Level 1 | Quoted prices (unadjusted) in active markets for identical items the entity can access at the measurement date. | Most reliable evidence. Use without adjustment, except in limited cases. |
| Level 2 | Inputs other than Level 1 prices that are observable for the item, directly or indirectly. | Examples include prices for similar items, interest rates, yield curves and credit spreads. Adjustments may be needed. |
| Level 3 | Unobservable inputs. | Used only where relevant observable inputs are not available. Build them from the best information available, reflecting what market participants would assume. |
Step 5: Classification
The entire fair value measurement sits at the lowest level of any input that is significant to it. If a Level 2 input needs a significant unobservable adjustment, the measurement can fall to Level 3.
Step 6: Disclosure
Disclose the level of each measurement, any transfers between levels, and the valuation techniques and inputs used. For Level 3 recurring measurements, disclosure also includes a reconciliation and a sensitivity analysis.