IFRS 13 Fair Value Measurement: Definition, Scope and the Three Approaches

IFRS 13 Fair Value Measurement: Definition, Scope and the Three Approaches

By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)

Lead Instructor, Global Fin X | www.globalfinx.in/manikanta

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Before IFRS 13, fair value appeared in at least a dozen IFRS standards with no consistent definition. IAS 16's revaluation model used it. IFRS 9 built an entire classification system around it. IAS 40 allowed it for investment property. IAS 41 required it for biological assets. Each standard had its own guidance on how to measure it, and the guidance was not always consistent.

The problem was not academic. When two entities use different approaches to measure the fair value of similar assets, their financial statements become incomparable even though both claim IFRS compliance. IFRS 13, issued in 2011 and effective from 2013, fixed this by providing one definition, one measurement framework, and one disclosure requirement that applies wherever fair value is used across IFRS.

This post covers the IFRS 13 definition, the six key measurement concepts, the three valuation approaches, and where the standard does and does not apply. Post 26 covers the fair value hierarchy in detail with Indian market applications.

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What IFRS 13 Does and Does Not Do

IFRS 13 is a measurement standard. It tells you how to measure fair value. It does not tell you when to use fair value. That decision sits with the individual standards: IAS 16 gives you the option to revalue; IAS 40 gives you the option of fair value or cost; IFRS 9 mandates fair value for certain financial instruments. IFRS 13 applies wherever any of those standards require or permit a fair value measurement.

Three things IFRS 13 does not govern:

Share-based payment transactions within the scope of IFRS 2: these have their own measurement guidance.

Leasing transactions within the scope of IFRS 16: lease liability measurement follows IFRS 16, not IFRS 13.

Measurements that are similar to fair value but are not fair value: value in use under IAS 36 and net realisable value under IAS 2 are not fair value measurements. IFRS 13 does not apply.

Everything else that requires or permits fair value is within scope.

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The Definition: Exit Price, Not Entry Price

IFRS 13 defines fair value as 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.

Six words matter most: received to sell. Fair value is an exit price. It is not what the entity paid for the asset (entry price). It is not what the asset is worth to the entity specifically (entity-specific value). It is the price a market participant would pay to acquire the asset in an orderly transaction.

The distinction between exit and entry price has real consequences. An entity may have purchased a machine for Rs. 10 crore. The machine is purpose-built for the entity's production line. A market participant with a different production process would pay Rs. 4 crore for it on the open market. The fair value is Rs. 4 crore, not Rs. 10 crore, regardless of what the entity spent or what it would cost to replace the machine with new.

Orderly Transaction

Fair value assumes an orderly transaction: not a forced sale, not a liquidation. The hypothetical seller has adequate time to market the asset, attract buyers, and negotiate at arm's length. If markets are distressed and recent transactions reflect forced sales, those prices are not necessarily fair value under IFRS 13. They may be evidence, but they require adjustment.

This mattered during the COVID-19 pandemic when some real estate and equity markets saw transactions that reflected distress rather than orderly conditions. IFRS 13 explicitly permits entities to assess whether recent transactions were orderly and, if they were not, to give them less weight in the valuation.

Market Participants

Fair value is measured from the perspective of a hypothetical market participant, not the entity itself. Market participants are buyers and sellers in the principal market who are independent, knowledgeable, able to enter into a transaction, and willing to do so.

This is why entity-specific synergies are excluded from fair value. If Tata Steel acquires a small steel plant and expects to generate Rs. 50 crore of synergies from integrating it into its distribution network, those synergies are Tata-specific. A generic market participant cannot be assumed to have the same network. Fair value is measured without those synergies. IFRS 3 purchase price allocation deals with this distinction explicitly: synergies go into goodwill, not into the fair value of identifiable assets.

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The Six Key Measurement Concepts

1. The Asset or Liability Being Measured

Fair value is asset-specific or liability-specific. The characteristics of the asset being measured must be taken into account if market participants would take them into account. Location, condition, restrictions on use: all relevant.

A plot of agricultural land in rural Maharashtra has different fair value characteristics from a commercial plot in suburban Mumbai, even if both are the same size. The physical location is a characteristic of the asset, not of the entity holding it.

Restrictions on sale are characteristics of the asset itself (such as lock-in periods on listed shares held by promoters) or may be characteristics of the entity's holding. IFRS 13 distinguishes: restrictions that are a characteristic of the asset affect fair value; restrictions that arise from the entity's specific ownership position do not.

2. The Principal Market

Fair value is measured using the price in the principal market for the asset or liability. The principal market is the market with the greatest volume and level of activity for that asset.

Where the entity normally transacts is presumed to be the principal market, unless evidence exists to the contrary. An entity does not need to continuously scan every market to check whether a better price exists somewhere. It starts with the market it uses.

If no principal market exists, the most advantageous market is used. The most advantageous market is the one that maximises the net amount received after transaction and transport costs. Note: fair value itself does not deduct transaction costs, but transaction costs are used to identify the most advantageous market.

Indian context: the NSE is the principal market for most listed Indian equity securities due to its higher trading volumes compared to the BSE for the same securities. For a Sensex or Nifty component, the NSE quoted price is the principal market price.

3. Orderly Transaction Assumption

Already covered in the definition section, but it is worth stating separately: fair value always assumes the transaction is orderly. Recent transaction prices in illiquid or distressed markets require assessment of whether they were orderly before using them as evidence of fair value.

4. Market Participant Assumptions

The entity must take the perspective of market participants, not its own perspective. What assumptions would a knowledgeable, willing buyer use when pricing this asset? Internal projections are relevant only to the extent they would also be used by market participants.

An Indian pharmaceutical company valuing a drug patent must ask: what assumptions would an arms-length buyer use to project the commercial life, the royalty rates, and the risk-adjusted revenue potential of this patent? The company's own optimistic projections for its in-house development pipeline are not the same as market participant assumptions.

5. The Transaction Price vs Fair Value at Initial Recognition

In most cases, the transaction price paid for an asset equals its fair value at initial recognition. But they can differ. When an entity buys an asset at a price that differs from fair value (for example, a below-market interest rate loan, a related-party transaction, or a transaction with non-market terms), the asset is recognised at fair value and the difference is accounted for based on the nature of the transaction.

For financial instruments measured at FVTPL, a Day 1 gain or loss arises when the transaction price differs from fair value. Under IFRS 9, this gain is recognised in profit or loss immediately only if the fair value is supported by Level 1 inputs (a quoted price) or a valuation technique using only observable inputs. If the fair value uses unobservable (Level 3) inputs, the Day 1 difference is deferred and recognised only as those inputs become observable over time.

This prevents entities from engineering P&L gains by transacting at off-market prices and immediately recognising the difference as income based on an internally generated valuation.

6. Transaction Costs vs Transport Costs

Transaction costs (brokerage, stamp duty, legal fees) are not part of fair value. Fair value is the price itself, before deducting what it costs to transact. Transaction costs are accounted for separately under the applicable standard.

Transport costs are different. If an asset's value depends on its location (a commodity that would have to be transported to the principal market), the cost of getting the asset to that market reduces the amount the seller nets. Transport costs are relevant to identifying the most advantageous market but are not deducted from the fair value itself in most cases.

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Non-Financial Assets: Highest and Best Use

For non-financial assets only, IFRS 13 introduces the highest and best use concept. Fair value must reflect the maximum value a market participant could extract from the asset, considering all feasible alternative uses.

Highest and best use must be physically possible (the asset's physical characteristics allow the use), legally permissible (zoning laws, regulations, and other legal constraints permit the use), and financially feasible (the use generates adequate returns to a market participant).

In Use vs In Exchange

An asset can be valued in use or in exchange.

In use: the asset's value is maximised when used in combination with other assets and liabilities. A specialist piece of machinery that is worth Rs. 2 crore as a standalone machine but Rs. 8 crore when integrated into a specific production process is valued at Rs. 8 crore if market participants would buy it in combination with complementary assets.

In exchange: the asset's value is maximised when used on a standalone basis. A generic office building is valued as a standalone asset.

The distinction matters for purchase price allocation under IFRS 3. A customer relationship intangible may be worth Rs. 500 crore only in combination with the brand and distribution network. Its highest and best use is "in use." The fair value reflects the value it contributes as part of that combination, not as a standalone isolated asset.

Current Use Presumption

IFRS 13 presumes that the current use of a non-financial asset is its highest and best use, unless market or other factors suggest otherwise. An entity does not need to exhaustively analyse every possible alternative use every reporting period. If the asset is currently used in a manner that appears reasonable and market participants would not obviously divert it to another use, the current use presumption holds.

An Indian manufacturing company that holds a factory on the outskirts of a major city need not assume the land has been rezoned for residential development unless there is actual evidence that market participants are valuing similar land on that basis.

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The Three Valuation Approaches

IFRS 13 does not mandate a specific valuation technique. It identifies three broad approaches and requires the entity to select techniques that are appropriate in the circumstances and for which sufficient data are available, maximising observable inputs and minimising unobservable inputs.

Multiple approaches can and often should be used. Where different approaches produce different results, the entity must assess which approach is most representative of fair value in the circumstances, and reconcile the differences.

Approach 1: The Market Approach

The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities.

Techniques within the market approach:

Quoted prices for identical assets: If an identical asset is traded in an active market, the quoted price is direct evidence of fair value. NSE-listed equity is the cleanest example. The closing price on the NSE on the measurement date is Level 1 fair value.

Comparable transaction multiples: For businesses and business units, market participants use revenue multiples or EBITDA multiples derived from comparable listed companies or recent transactions. If a mid-sized Indian IT services company is being valued, EBITDA multiples from comparable listed IT companies (Wipro, HCL Technologies, Mphasis) provide market-based benchmarks.

Matrix pricing: Used for debt instruments. If a bond is not actively traded, its fair value can be interpolated from prices of similar bonds traded in the market, using factors like credit rating, maturity, and coupon structure. Indian corporate bond pricing often relies on matrix pricing because the corporate bond secondary market has lower liquidity than the government securities market.

The market approach is most reliable when genuinely comparable transactions or instruments exist. Comparability requires adjustments for differences in size, risk profile, capital structure, and market conditions. A quoted EBITDA multiple for a listed company includes a liquidity premium. An unlisted company valued using the same multiple typically warrants a discount for lack of marketability.

Approach 2: The Income Approach

The income approach converts expected future economic benefits into a single present amount using a discount rate that reflects the risk in those cash flows.

Techniques within the income approach:

Discounted cash flow (DCF): Project future cash flows over an explicit forecast period, estimate a terminal value, and discount everything at a risk-adjusted rate. DCF is the most widely used technique for valuing businesses, investment properties, intangible assets, and illiquid financial instruments.

For an Indian NBFC valuing its loan portfolio at fair value for disclosure under Ind AS 107, a DCF approach discounts expected contractual cash flows at a market rate that reflects current credit spreads for similar instruments.

Multi-period excess earnings method (MEEM): Used to value intangible assets like customer relationships, proprietary technology, and trade names. Projects earnings attributable to the asset over its remaining useful life, after deducting charges for all other assets contributing to those earnings (contributory asset charges), and discounts the residuals.

Option pricing models: For instruments with optionality, such as warrants, convertible notes, and equity in leveraged capital structures, Black-Scholes and binomial lattice models fall within the income approach.

The income approach is highly sensitive to assumptions about discount rates, growth rates, and terminal values. Small changes in the discount rate can move a DCF valuation significantly. This makes Level 3 DCF valuations the most judgment-intensive and the most vulnerable to challenge.

Indian example: DLF valuing its investment properties under IAS 40 uses a DCF approach for properties where direct comparable transactions are limited. Key assumptions: rental growth rates (typically 3-5% in Tier 1 markets), capitalisation rates (7-10% depending on location and tenant quality), and vacancy rates. Each assumption involves significant judgment.

Approach 3: The Cost Approach

The cost approach reflects the amount that would be required currently to replace the service capacity of an asset. It is current replacement cost, adjusted for physical deterioration, functional obsolescence, and economic obsolescence.

The cost approach is most commonly used for:

Specialised assets with no active market and no income stream that can be attributed specifically to the asset. A bespoke piece of industrial equipment, a purpose-built infrastructure asset, or a specialised IT system.

Assets under construction where the income approach is premature (no revenue yet) and the market approach produces no comparable data.

Contributory asset charges within a MEEM valuation. The charge for using an assembled workforce, for example, is typically calculated using the cost approach: what would it cost to recreate this workforce if it were lost today?

The cost approach is the weakest approach for most financial reporting purposes because it ignores the income-generating potential of the asset and may produce values that differ significantly from what a market participant would pay. A building with cost of Rs. 50 crore may generate rental income worth Rs. 90 crore in present value terms. The cost approach values it at Rs. 50 crore (adjusted for depreciation); the income approach values it at Rs. 90 crore. The income approach is the better indicator of fair value for income-producing assets.

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Selecting and Applying Valuation Techniques

IFRS 13 requires consistency in valuation techniques across periods. Changing techniques is permitted only if the change produces a measurement that is equally or more representative of fair value. Changes in valuation technique are changes in accounting estimate, not changes in accounting policy, meaning no retrospective restatement.

Where multiple approaches produce different values, the entity must determine which is most representative. If a DCF produces Rs. 100 crore and a market multiples approach produces Rs. 80 crore for the same asset, the entity must explain and document why it has weighted one over the other.

The calibration requirement: if a valuation technique uses unobservable inputs and the asset will continue to be measured at fair value going forward, the technique must be calibrated at the transaction date to ensure consistency with the transaction price. This is operationally demanding but necessary to prevent entities from using a transaction price to justify an initial recognition value and then applying a fundamentally different technique in subsequent periods.

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Scope: What IFRS 13 Does Not Apply To

Understanding the exclusions matters for the Dip IFRS exam.

The most important exclusion to remember is value in use (IAS 36). VIU is calculated using the entity's own cash flow projections and the entity's own discount rate. IFRS 13 fair value uses market participant assumptions. These are not the same, and the Dip IFRS exam tests whether candidates understand the distinction.

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Ind AS 113 vs IFRS 13

Ind AS 113 mirrors IFRS 13 in all material respects. The definition of fair value, the three valuation approaches, the hierarchy, and the disclosure requirements are identical.

The practical difference is in market conditions. India's capital markets, while deep for Nifty 50 constituents, are thinner for mid-cap and small-cap securities. Corporate bond secondary markets are less liquid than in developed economies. Unlisted equity valuations, which are common for NBFC investment portfolios and PE fund investments, rely more heavily on Level 3 techniques in India than in markets with more active M&A and secondary transaction data. This makes Level 3 disclosure particularly important in Indian financial statements.

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What Big 4 Auditors Focus On

Technique selection and consistency. Auditors assess whether the chosen valuation technique is appropriate for the asset and whether it has been applied consistently from the prior period. A change from DCF to market multiples mid-way through an audit without a documented rationale is a red flag.

Observable vs unobservable input classification. The hierarchy level assigned to each fair value measurement drives the disclosure requirements. Auditors test whether inputs classified as Level 2 (observable) are genuinely derived from market data, or whether they involve significant management adjustment that makes them effectively Level 3. Reclassifying Level 3 measurements to Level 2 to reduce disclosure is a known audit risk.

Highest and best use assessment for non-financial assets. For entities with real estate holdings, land banks (particularly DLF, Godrej Properties, Prestige), or investment properties, auditors challenge whether the highest and best use assessment is current, documented, and considers alternative uses that market participants would realistically consider.

Day 1 gain deferral for Level 3 instruments. Where a financial instrument is initially recognised using a Level 3 technique and the transaction price differs from the calculated fair value, auditors test whether the Day 1 difference has been correctly deferred rather than immediately recognised in P&L.

Valuation specialist independence. For material Level 3 measurements, auditors engage their own valuation specialists to independently assess the appropriateness of the model and the reasonableness of key assumptions. This is standard practice for Big 4 engagements involving investment property valuations, intangible asset purchase price allocations, and unlisted equity portfolios.

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Dip IFRS Exam Angle

IFRS 13 questions in Dip IFRS test both conceptual understanding and application to scenarios.

Most tested areas:

The definition and its components: exit price, orderly transaction, market participants, measurement date. Know each element and what it rules out (entry price, entity-specific value, forced sales, internal synergies).

Highest and best use for non-financial assets: given a scenario where an asset has multiple possible uses, determine which use represents highest and best use and whether it is in use or in exchange. Know the three criteria: physically possible, legally permissible, financially feasible.

Principal market vs most advantageous market: know the distinction and the hierarchy. Principal market is the one with the greatest volume and activity. Most advantageous market is the fallback. Fair value is measured at the principal market price, transaction costs excluded.

Scope exclusions: value in use and net realisable value are not fair value. IFRS 2 and IFRS 16 measurements are excluded. Know why VIU and fair value differ: VIU is entity-specific; fair value is market-based.

Common traps:

Deducting transaction costs from fair value. Transaction costs are not part of fair value. They are accounted for separately. The fair value is the price itself.

Applying highest and best use to financial assets. Highest and best use applies only to non-financial assets. It does not apply to bonds, derivatives, or equity instruments.

Using entry price as fair value. The price paid for an asset is not automatically its fair value. These coincide in most arm's-length transactions but differ in related-party transactions, below-market loans, and transactions with non-market terms.

Assuming VIU and fair value are the same. They are measured differently, from different perspectives, and produce different numbers. IFRS 36 uses VIU to test impairment; IFRS 13 provides fair value for measurement and disclosure.

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FAQ

Does IFRS 13 require entities to measure assets at fair value?

No. IFRS 13 tells you how to measure fair value when another standard requires or permits it. The decision to use fair value sits with the individual standards. IFRS 13 provides the measurement framework.

Is fair value always the same as market price?

Not always. Where a quoted price exists in an active market for an identical instrument, the quoted price is fair value (Level 1). For illiquid or unique assets, fair value requires a valuation technique that estimates what a market price would be in an orderly transaction.

Can an entity use an approach that is not one of the three specified?

IFRS 13 does not prohibit other techniques but requires that they be consistent with one or more of the three approaches. In practice, any valuation technique can be traced back to market, income, or cost logic.

What is the difference between fair value and value in use?

Fair value is market-based: what a market participant would pay in an orderly transaction. Value in use is entity-specific: the present value of the entity's own expected cash flows from using the asset, using the entity's own discount rate. VIU can be higher than fair value (if the entity has superior capabilities) or lower. They are different measurements serving different purposes.

Does IFRS 13 apply to the measurement of goodwill?

Goodwill is not measured at fair value after initial recognition. It is tested for impairment under IAS 36. IFRS 13 applies to the initial measurement of goodwill at acquisition in an IFRS 3 business combination, where the identifiable net assets are measured at fair value and goodwill is the residual.

Is the transaction price always Level 1 fair value?

No. The transaction price may be Level 1 (if the asset is an exchange-traded security where the price is directly observable), Level 2 (if the price is observable but requires minor adjustment), or Level 3 (if it requires significant unobservable inputs). Transaction price and fair value level classification are separate questions.

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Enroll with Global Fin X

IFRS 13 underpins fair value measurements across IFRS 9, IAS 16, IAS 40, IAS 41, and IFRS 3. Understanding the definition, the three approaches, and the hierarchy is foundational for the Dip IFRS exam and essential for anyone working in valuation, audit, or corporate finance at Indian listed entities. Our programme covers IFRS 13 across two posts with detailed lectures, worked examples, exam-style MCQs, and a dedicated LMS for working professionals.

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Faculty profile: www.globalfinx.in/manikanta

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This is Post 25 of the Global Fin X IFRS Series. Previous: IAS 32: Compound Instruments, Treasury Shares and Puttable Instruments. Next: Post 26: IFRS 13 Fair Value Hierarchy: Level 1, Level 2, Level 3 and Indian Market Applications.