Fair value measurement is one of the most widely applied and frequently misunderstood concepts in financial reporting. Under IFRS 13 Fair Value Measurement, issued by the International Accounting Standards Board (IASB), entities are required to measure and disclose fair value using a consistent, market-based framework. Whether you are valuing financial instruments, investment properties, or acquired intangibles, understanding how IFRS 13 works is essential for accurate and compliant reporting.
This guide breaks down the core principles, the fair value hierarchy, valuation techniques, and the common mistakes practitioners must avoid.
What Is Fair Value Under IFRS 13?
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. Several elements of this definition deserve attention:
It is an exit price, not an entry price. Fair value reflects what you would receive selling an asset, not what you paid to acquire it.
It is market-based, not entity-specific. Your organisation’s intentions, internal forecasts, or strategic plans are irrelevant. Fair value is anchored to what a hypothetical market participant would assume, including their assumptions about risk.
It assumes an orderly transaction. The measurement excludes forced sales, distressed liquidations, or fire-sale scenarios. The transaction is assumed to occur under normal market conditions.
The Principal Market
IFRS 13 assumes the transaction takes place in the principal market. The market with the greatest volume and level of activity for the asset or liability. If no principal market exists, the standard defaults to the most advantageous market, which produces the highest net proceeds for an asset or the lowest net cost to transfer a liability.
Importantly, fair value is measured using the price in that market without adjustment for transaction costs. Transaction costs are specific to the deal, not a characteristic of the asset itself, so they are excluded from the measurement.
The Fair Value Hierarchy
One of IFRS 13’s most important contributions is the fair value hierarchy, which ranks the inputs used in valuation into three levels based on their observability and reliability.
Level 1: Quoted Prices in Active Markets
Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities. These are the most reliable inputs and must be used without modification where available.
Example: The closing price of a share listed on the London Stock Exchange is a Level 1 input. There is no need for judgment as the price is directly observable.
Level 2: Observable Inputs Other Than Quoted Prices
Level 2 inputs are observable either directly or indirectly, but are not quoted prices for identical instruments. They include quoted prices for similar assets, observable interest rates, yield curves, or implied volatilities.
Example: Valuing an interest rate swap using an observable LIBOR-based swap rate extrapolated across the full term of the instrument is a Level 2 measurement. The inputs are market-derived, even if not directly quoted for that specific instrument.
Level 3: Unobservable Inputs
Level 3 inputs rely on the entity’s own assumptions about what market participants would use when observable data is not available. These valuations carry the highest subjectivity and require the most robust disclosure.
Example: Valuing an early-stage biotech company’s pipeline using discounted cash flow projections based on internally developed assumptions about clinical success rates.
The hierarchy does not rank the techniques themselves; it ranks the inputs. An income approach using observable inputs may qualify as Level 2; the same technique using internal forecasts falls to Level 3.
Valuation Techniques
IFRS 13 permits three broad valuation approaches, and entities must select techniques that maximise the use of observable inputs and minimise unobservable ones.
Market approach: Uses prices and information from market transactions involving identical or comparable assets. Matrix pricing is a practical expedient under this approach, commonly used for large portfolios of similar debt securities where individual quoted prices are impractical to obtain. Note, however, that using matrix pricing typically results in a lower-level fair value categorisation.
Cost approach: Reflects the amount required to replace the service capacity of an asset (current replacement cost). Commonly used for specialised plant and equipment.
Income approach: Converts future cash flows or earnings into a single present value amount. Includes discounted cash flow models and option pricing models.
In practice, entities may use multiple techniques and weigh the results based on the circumstances. The chosen technique must be applied consistently from period to period.
Valuing Non-Financial Assets: Highest and Best Use
When measuring the fair value of a non-financial asset, IFRS 13 introduces the concept of highest and best use. The use of the asset that would maximise its value from the perspective of a market participant.
The assumed use must be:
- Physically possible
- Legally permissible
- Financially feasible
This concept has significant practical implications. Consider a company that acquires a competitor’s research and development patent with the sole intention of shelving it, preventing competitors from using it rather than commercialising it themselves. Under IFRS 13, the entity cannot value that patent at nil or a nominal amount based on its own defensive intent. It must measure fair value assuming market participants would put the patent to its highest and best use, which may be active commercialisation generating substantial royalty income.
The entity’s intention is entirely irrelevant to the measurement.
Valuing Liabilities and Own Equity
Fair value measurement of liabilities assumes the liability is transferred to a market participant not settled or extinguished. The transferee is assumed to have the same credit risk as the transferor.
When a liability or equity instrument is held by another party as an asset, the fair value is measured from the perspective of that asset holder where possible. If no observable market exists for the transfer, entities use valuation techniques from the perspective of a market participant that owes the liability.
Disclosure Requirements
IFRS 13 imposes extensive disclosure requirements designed to give financial statement users enough information to assess the valuation techniques used and the impact of fair value measurements on financial performance.
Key disclosures include:
- The fair value hierarchy level for each class of asset and liability
- Transfers between Level 1 and Level 2, and the reasons for those transfers
- For Level 3 measurements: a reconciliation of opening to closing balances, the valuation techniques and inputs used, and a sensitivity analysis showing the effect of changes in unobservable inputs
- The valuation processes used by the entity for Level 3 measurements
These disclosures are particularly scrutinised by auditors and regulators, especially in sectors with significant Level 3 exposures such as private equity, real estate, and financial services.
Recent Developments
The latest version of the fair value measurement standard effective for annual reporting periods beginning on or after 16 July 2025 supersedes earlier 2018 versions. It consolidates and unifies fair value measurement rules that were previously spread across multiple standards into a single coherent framework.
Common Mistakes to Avoid
Using entity intentions instead of market participant assumptions. This is the most frequent error. Your board’s view of what the asset is worth to your business is irrelevant. Ask what a market participant would assume.
Applying blockage factors. IFRS 13 strictly prohibits discounting a quoted price simply because the entity holds a position too large to liquidate in a single transaction without moving the market. The quoted price is used as-is.
Treating all low-volume markets as inactive. A decline in trading volume does not automatically make a market inactive or transactions disorderly. Practitioners must carefully assess whether reduced activity reflects an inactive market or simply lower liquidity; the distinction affects which inputs are prioritised.
FAQ
Does fair value include transaction costs? No. Transaction costs such as brokerage fees or legal costs are excluded from fair value measurement. They are deal-specific, not a characteristic of the asset or liability being measured.
How does fair value differ from value in use or net realisable value? Fair value is market-based and uses market participant assumptions. Value in use and net realisable value are entity-specific. They reflect how a particular company expects to benefit from the asset. IFRS 13 does not govern those measurements.
What happens when no active market exists? Entities move down the fair value hierarchy, using Level 2 or Level 3 inputs and applying appropriate valuation techniques. Forced or distressed sale prices must not be used as the primary basis for fair value.
When does highest and best use apply? It applies to non-financial assets only. For financial instruments, fair value is based on the transaction price in the principal market without a highest and best use assessment.
What are the disclosure requirements for Level 3 measurements? Entities must disclose the valuation techniques and unobservable inputs used, a reconciliation of opening and closing balances, and a quantitative sensitivity analysis showing how changes in key unobservable inputs would affect the fair value measurement.
Conclusion
IFRS 13 provides a robust, unified framework for fair value measurement that promotes consistency and comparability across financial statements globally. Understanding the fair value hierarchy, valuation techniques, and the market participant perspective is not just a compliance requirement. It directly affects how assets and liabilities are presented and how stakeholders interpret your financial position.
Need help applying IFRS 13 to your organisation’s financial statements? Speak to a qualified IFRS adviser or explore our other IFRS guides for practical, standard-specific guidance.
