IFRS requires financial statements to be prepared on a modified historical cost basis, with a growing emphasis on fair value. ‘Fair value’ is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date – i.e. an exit price. [IFRS 13 9]
The carrying amounts of the following assets and liabilities are based on fair value measurements subsequent to initial recognition.
- Derivatives, financial assets, and financial liabilities classified as held-for-trading or designated as at fair value through profit or loss, and financial assets classified as available-for-sale are measured at fair value.
- Biological assets are measured at fair value less costs to sell.
- In general, an investment entity measures investments in subsidiaries at fair value.
- Whole classes of property, plant, and equipment may be revalued to fair value subject to certain conditions.
- Certain intangible assets may be revalued to fair value.
- Investment property may be measured at fair value.
- Inventories held by commodity broker-traders may be measured at fair value less costs to sell.
Additionally, discounting and value-based measurements are an integral part of financial reporting under IFRS in some areas, including impairment testing and provisions.
How is fair value accounting used in IFRS?
Three notions of fair value accounting enter the discussion, and one must be clear on what is being entertained:
1. Fair value variously applied as an alternative measurement in a “mixed attribute model”
This is the modified historical cost convention described in IFRS 13 as per above. In this treatment, fair value is used alternatively with historical cost for the same asset or liability but at different times; the accounting is primarily historical cost accounting, but fair values are applied under certain circumstances. Examples are fair values applied in fresh-start accounting and for initial measurement (that then proceeds under historical cost accounting), impairment from historical cost to fair value (really a form of fresh start accounting), and using fair values to establish historical cost (for barter transactions and donations, for example) or in the allocation of historical purchase price (between goodwill and tangible assets, for example).
2. Fair value continually applied as entry value
This is rejected by IFRS 13. Assets are revalued at their replacement cost, with current costs then recorded in the income statement and unrealized (holding) gains and losses also recognized in (comprehensive) income.
3. Fair value continually applied as exit value
This is the fair value measurement approach prescribed by IFRS 13. Assets and liabilities are remarked each period to current exit price, with unrealized gains and losses from the remarking recorded as part of ‘profit or loss’ or ‘other comprehensive income’.
The modified historical cost convention