As market turbulence and uncertainty continue, estimating fair value will continue to be a significant challenge for many companies. In this memorandum, we provide key reminders about the fair value requirements of IAS 39, Financial Instruments: Recognition and Measurement and IFRS 7, Financial Instruments: Disclosures.
Don't forget that fair value of assets and traded liabilities is a current market price! More properly, it's the price at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Many non-accountants confuse an asset's fair value with its so-called "fundamental value" – the value of the future cash flows that management expects to derive from the asset. This value will be very different than fair value when management's expectations about future cash flows differ from those of market participants.
Consider the sources of fair value guidance. IAS 39, Appendix A, paragraphs 43 65 establishes basic requirements for making fair value estimates. Another very useful source of guidance is the IASB Expert Advisory Panel's publication, "Measuring and disclosing the fair value of financial instruments in markets that are no longer active".
Use market prices as a basis for estimating fair value whenever possible. IAS 39.48A distinguishes betweenprices quoted in an active market and thosein an inactive market. If a market is active,the entity must use the quoted marketprice, unadjusted, as its best estimate of fairvalue. If the market is inactive, the entitymust estimate fair value using a valuationtechnique. A market is considered to beactive when prices are "readily and regularlyavailable", meaning that price informationis accessible and trades are occurringregularly. An absence of transactions for ashort period, or a lower than normal volumeof transactions, doesn't necessarily mean amarket is inactive.
In an August letter regarding the valuation of Greek bonds, the Chair of the IASB, Hans Hoogervorst, commented:
"A company cannot ignore observable transaction prices when it is clear that market participants are regularly entering into transactions for the same or similar financial assets, even if they are doing so less frequently than they have in the past. Although the level of trading activity in Greek government bonds has decreased, transactions are still taking place. IAS 39 is clear that unless there is evidence that the prices in those transactions...