Fair Value Measurement: Summary
Fair value measurement is a market-based concept: it estimates the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date (exit price), using market-participant assumptions rather than entity-specific intentions.
IFRS 13
IFRS 13 was designed to provide a single framework for measuring fair value and to enhance comparability through a fair value hierarchy and disclosure objectives.
Measurement mechanics and valuation techniques
What fair value is (and is not) under IFRS 13
IFRS 13 defines fair value as an exit-price concept at the measurement date, assuming an orderly transaction between market participants under current market conditions. It is not entity-specific and does not reflect management’s intent to hold an asset or settle a liability.
IFRS 13 applies when another IFRS requires or permits fair value measurement or fair value disclosures, but it does not decide when fair value is required; scope and unit of account are driven by the underlying standard (e.g., IFRS 9, IAS 40).
Core mechanics include identifying the relevant market (principal, or most advantageous if no principal market), using observable inputs where possible, and avoiding adjustments that contradict the exit-price objective (e.g., transaction costs are not part of fair value).
FRS 102’s Section 2A: similar structure, UK legal framing
FRS 102 Section 2A mirrors the conceptual flow: consider asset/liability characteristics, identify principal/most advantageous market, do not adjust for transaction costs (but adjust for transport costs where location is a characteristic), and apply highest and best use for non-financial assets.
It explicitly states that the fair value of a liability reflects non-performance risk and introduces a demand-feature constraint for financial liabilities due on demand.
It then sets out a methodology hierarchy for estimation, starting with unadjusted quoted prices and recent orderly transactions, and emphasises maximising inputs determined by reference to an active market price.
The three valuation approaches (market, income, cost) and UK-flavoured examples
IFRS 13 identifies three widely used approaches: market, income and cost, and requires techniques consistent with one or more of these, maximising observable inputs and minimising unobservable inputs.
A UK-facing way to describe typical applications:
Market approach: often used for listed shares (quoted prices) and for private company valuations via comparable listed peer multiples (e.g., UK-listed sector peers), adjusted for differences such as size, liquidity, and control.
Income approach: widely used for investment property cash flows, infrastructure/renewables portfolios, and unquoted equity - discounting expected cash flows using market-participant discount rates that reflect risk and current interest rate conditions.
Cost approach: used for specialised assets where replacement cost best reflects service capacity (for example, specialised plant or infrastructure assets with limited market comparables).
Hierarchy, disclosures, and what UK regulators actually challenge
Fair value hierarchy (Levels 1–3)
IFRS 13’s hierarchy prioritises inputs, not valuation techniques: Level 1 is quoted prices (unadjusted) in active markets for identical items; Level 2 is other observable inputs; Level 3 is unobservable inputs. The entire measurement is classified based on the lowest-level input that is significant to the measurement as a whole.
If a Level 1 input exists, IFRS 13 generally requires using it without adjustment; if an observable input requires a significant unobservable adjustment, the measurement can become Level 3.
UK-style examples that map naturally to the hierarchy:
Level 1: holdings of shares quoted on an active market (e.g., a UK listed equity investment).
Level 2: interest rate derivatives valued using observable interest rate curves; the FRC gives an example of a SONIA-based interest rate swap where observable SONIA swap rates are Level 2 inputs when available across commonly quoted intervals.
Level 3: contingent consideration liabilities where a probability of meeting performance targets is a significant unobservable input; or unquoted equity investments where liquidity adjustments and forecast cash flows are not directly observable.
IFRS 13 disclosure objective and minimum disclosures
IFRS 13 sets a disclosure objective: help users assess (i) valuation techniques and inputs for recurring and non-recurring fair value measurements, and (ii) for recurring Level 3, the effect on profit or loss/OCI. If minimum disclosures are insufficient, entities should add information to meet the objective.
Minimum disclosures are extensive and scale with complexity. Key recurring themes include: the fair value at period end, hierarchy level, transfers and transfer policies, valuation techniques and inputs, and for Level 3 a reconciliation, valuation processes, and sensitivity disclosures.
IFRS 13 requires (i) a narrative sensitivity description for all recurring Level 3 measurements, and (ii) for financial assets and financial liabilities, a quantified effect of reasonably possible alternative assumptions when such changes would significantly change fair value.
What the FRC expects in practice
The FRC’s IFRS 13 thematic review is explicit that most problems it sees are disclosure-driven, particularly for recurring Level 3 items: significant unobservable inputs should be quantified and sensitivities provided; disclosures should be class-based and appropriately disaggregated; boilerplate should be avoided; and consistency across the annual report is expected.
It also highlights that climate-related matters can become part of forward-looking assumptions and fair values; where material, companies are expected to explain how climate is incorporated and quantify significant uncertainty where relevant.
In the Annual Review of Corporate Reporting 2024/25, the FRC reiterates practical disclosure tips for Level 3 inputs (e.g., weighted averages when ranges are wide), and points out that sensitivity analysis may also be required under FRS 102 to meet estimation uncertainty disclosure requirements.
IFRS vs. UK GAAP comparison table (FRS 102 and FRS 105)
Topic | UK-adopted IFRS (IFRS 13 framework) | UK GAAP (FRS 102) | UK GAAP (FRS 105 micro-entities) |
|---|---|---|---|
Dedicated fair value measurement standard? | Yes: IFRS 13 provides the framework when other IFRS require/permit FV. | Yes: Section 2A “Fair Value Measurement” sets principles and methodology. | No FV accounting model; simplifications reflecting micro-entities legal regime. |
Core measurement concept | Exit price in orderly transaction, market participant assumptions, principal/most advantageous market. | Similar core concepts: principal/most advantageous market, no transaction cost adjustment, highest and best use, non-performance risk. | FV rules not applied in micro-entity accounts; generally cost-based. |
Valuation approaches explicitly referenced | Market / income / cost approaches; maximise observable inputs. | Methodology starts with quoted prices / recent transactions; Section 2A supports estimation framework. | Not designed around FV; limited measurement complexity. |
Level 1–3 hierarchy requirement | Full hierarchy for FV measurements; classification based on significant lowest-level input. | Section 2A does not impose a universal hierarchy for all entities; specific hierarchy disclosures apply in specialised areas (e.g., financial institutions). | Not applicable. |
Level 3 reconciliation + sensitivity disclosures | Required for recurring Level 3; quantified “reasonably possible alternatives” for financial assets/liabilities when significant. | Disclosure requirements are more dispersed by topic; FRC notes sensitivity may be needed to meet estimation uncertainty disclosures; specialised sectors have more explicit FV hierarchy disclosures. | Not applicable (no FV model). |
Regulatory scrutiny hotspot in UK practice | Level 3: unobservable inputs, sensitivities, aggregation, consistency across annual report. | Similar disclosure quality concerns reported by the FRC in Level 3 investment contexts; increased alignment focus via Periodic Review 2024. | Common pitfalls are more about inappropriate use of FV/revaluation rather than Level 3 modelling. |
Disclosure checklist table tailored to UK entities
This checklist is designed as a minimum viable note structure you can adapt for (a) IFRS reporters, and (b) UK GAAP reporters with material fair value exposure.
Disclosure area | UK-adopted IFRS: practical checklist prompts | UK GAAP: practical checklist prompts |
|---|---|---|
Scope and classes | Identify which items are measured at FV (recurring vs non-recurring) and define “classes” that reflect nature/risks (more disaggregation for Level 3). | Identify where FV is used (e.g., investment property, certain financial instruments) and ensure disclosures meet topic requirements and material estimation uncertainty requirements. |
Measurement basis | State measurement date, principal/most advantageous market, and market-participant assumption basis; avoid implying entity-intent drives FV. | Reference Section 2A approach: principal/most advantageous market and methodology starting from quoted prices / recent orderly transactions. |
Valuation techniques | For Level 2/3: explain technique(s) (market/income/cost), key inputs, and changes in technique + reasons. | Disclose technique(s) and inputs where required by relevant section; ensure explanations are entity-specific. |
Level classification | Present hierarchy level (1/2/3) by class; explain transfers and policy for timing of transfers. | Where a hierarchy disclosure is required (e.g., specialised activities), ensure level analysis is provided and consistent. |
Quantitative unobservable inputs | For Level 3: disclose quantitative significant unobservable inputs (ranges/weighted averages where helpful). | For material Level 3-style estimates, provide clear inputs/assumptions; the FRC encourages clarity on significant assumptions in Level 3 contexts. |
Level 3 roll-forward | Provide reconciliation from opening to closing for recurring Level 3 (gains/losses, purchases/sales, transfers). | If required by the applicable section, provide movement disclosures; otherwise ensure estimation uncertainty disclosures cover changes/uncertainties that matter. |
Sensitivity | Narrative sensitivity for Level 3; for financial assets/liabilities, quantify the effect of reasonably possible alternative assumptions where significant. | Consider whether sensitivity is needed to satisfy estimation uncertainty disclosures; include sensitivity where a reasonably possible change could materially affect carrying amounts. |
Process and governance | Describe valuation processes (policies, review, controls, use of external valuers). | Explain governance proportionately; consider disclosing use of external experts where material. |
Cross-report consistency | Ensure financial statements, accounting policies, audit report highlights, and narrative reporting tell a coherent story. | Same principle: avoid inconsistencies between notes and narrative reporting. |
Illustrative numerical examples and a worked Level 3 sensitivity analysis
The examples below are illustrative and simplified. In practice, fair value determinations should reflect the specific instrument terms, market data and facts-and-circumstances as required by the relevant framework.
Level 1 example: quoted UK equity investment (market approach)
Assume a UK entity holds 10,000 shares in a listed company. The quoted price (unadjusted) at the measurement date is £3.25.
Fair value = 10,000 × £3.25 = £32,500
Hierarchy: Level 1 (quoted price in an active market for an identical instrument, accessible at the measurement date).
Disclosure focus: the fair value amount and Level 1 classification by class; no Level 3 roll-forward or sensitivity is required for this instrument.
Level 2 example: fixed-rate bond valued using observable yield inputs (income approach)
Assume a 3-year bond with face value £1,000,000, annual coupon 5% paid annually, and an observable market yield of 6% at the measurement date.
Fair value (PV of cash flows at 6%):
Year 1: £50,000 / 1.06 = £47,170
Year 2: £50,000 / 1.06² = £44,500
Year 3: £1,050,000 / 1.06³ = £881,600
Total FV ≈ £973,270
This is typically Level 2 when the valuation uses observable yield inputs rather than a directly quoted price for the identical bond in an active market.
Market approach example that can become Level 3: unquoted operating company using EBITDA multiples
Assume a UK private company has sustainable EBITDA of £3.0m. Comparable listed peers imply an EV/EBITDA multiple of 7.0× (after adjusting for differences). Net debt is £6.0m. Market participants would apply a 20% discount for lack of marketability to the equity value.
Enterprise value = 3.0 × 7.0 = £21.0m
Equity value (pre-discount) = 21.0 − 6.0 = £15.0m
Equity value (post DLOM 20%) = 15.0 × (1 − 0.20) = £12.0m
Even though the base multiple is observable, if the discount is significant and unobservable (and material to the measurement), classification can move toward Level 3 because the lowest-level significant input drives the classification.
Cost approach example: replacement cost of specialised plant
Assume current replacement cost is £8.0m. Market participants would adjust for:
physical deterioration: 15% of replacement cost (= £1.2m)
functional obsolescence: 10% of the remaining amount (= 10% × £6.8m = £0.68m)
Fair value ≈ 8.0 − 1.2 − 0.68 = £6.12m
This aligns with IFRS 13’s cost approach concept (current replacement cost to replace service capacity), and is typically Level 3 if key obsolescence adjustments are unobservable.
Worked Level 3 example: turning unobservable assumptions into a quantified sensitivity analysis
This example is framed as a financial asset (an unquoted equity investment measured at fair value), so the IFRS 13 requirement to disclose the effect of reasonably possible alternative assumptions applies when changes would significantly change fair value.
Base valuation (income approach DCF)
Assume an investor holds a 10% non-controlling stake in a UK private company. Market participants would use a DCF (free cash flow to the firm) with:
Forecast free cash flows (years 1–5): £5.0m, £5.5m, £6.0m, £6.5m, £7.0m
Discount rate (WACC): 10.5%
Terminal growth rate: 2.5%
Net debt: £20.0m
Illiquidity discount on the stake: 12%
Calculation (summary):
Enterprise value from DCF ≈ £76.53m
Equity value ≈ £76.53m − £20.0m = £56.53m
10% stake value pre-illiquidity ≈ £5.65m
10% stake fair value post-illiquidity ≈ £5.65m × (1 − 0.12) = £4.97m
The critical Level 3 inputs here are the discount rate, terminal growth rate, and illiquidity discount (and the cash flow forecasts if not observable/market corroborated).
Sensitivity analysis (reasonably possible alternatives)
Assume management deems the following reasonably possible changes at the measurement date:
Discount rate: ±1.0% (9.5% and 11.5%)
Terminal growth: ±0.5% (2.0% and 3.0%)
Resulting 10% stake fair value outcomes:
Input changed | Base | Alternative | Stake FV (£m) | Change vs base (£m) |
|---|---|---|---|---|
Discount rate | 10.5% | 9.5% | 5.97 | +0.99 |
Discount rate | 10.5% | 11.5% | 4.20 | −0.77 |
Terminal growth | 2.5% | 2.0% | 4.67 | −0.30 |
Terminal growth | 2.5% | 3.0% | 5.32 | +0.34 |
This is the basic “IFRS 13 style” quantified sensitivity: it states the fact of sensitivity and discloses the effect of reasonably possible alternatives, and (in a real note) you would also describe how the effect was calculated and note interrelationships where relevant.
Sensitivity chart data (stake FV versus discount rate)
Discount rates from 9.0% to 13.0% (holding other assumptions constant) give:
9.0% → £6.58m
9.5% → £5.97m
10.0% → £5.44m
10.5% → £4.97m
11.0% → £4.57m
11.5% → £4.20m
12.0% → £3.88m
12.5% → £3.59m
13.0% → £3.32m