if this type of risk adjustment is included, it should be considered when categorising the
fair value measurement within the fair value hierarchy.
16.2 Categorisation within the fair value hierarchy
IFRS 13 distinguishes between where in the fair value hierarchy an individual input to a
valuation technique may fall and where the entire measurement is categorised for
disclosure purposes.
Fair value measurement 1051
Inputs used in a valuation technique may fall into different levels of the fair value
hierarchy. However, for disclosure purposes, the fair value measurement must be
categorised in its entirety (i.e. the fair value measure for the asset or liability or the group
of assets and/or liability, depending on the unit of account) within the hierarchy.
Categorising the entire measurement (and the required disclosure of this information,
see 20.3.3 below) provides users of financial statements with an indication of the overall
observability or subjectivity of a fair value measurement.
The appropriate categorisation may be obvious when only a single input is used, for
example, when measuring fair value using a quoted price in an active market,
without adjustment. However, an asset or liability that is not traded in an active
market with a quoted price will often require more than one input to determine its
fair value. For example, an over-the-counter option on a traded equity security
measured at fair value using an option pricing model requires the following market-
based inputs: (i) expected volatility; (ii) expected dividend yield; and (iii) the risk-
free rate of interest.
IFRS 13 clarifies that the hierarchy categorisation of a fair value measurement, in its
entirety, is determined based on the lowest level input that is significant to the entire
measurement. The standard also makes it clear that adjustments to arrive at
measurements based on fair value (e.g. ‘costs to sell’ when measuring fair value less costs
to sell) are not be taken into account in this determination. [IFRS 13.73]. In the over-the-
counter equity option example, assume that the risk-free interest rate and the dividend
yield were determined to be Level 2 inputs, but the expected volatility was determined
to be a Level 3 input. If expected volatility was determined to be significant to the
overall value of the option, the entire measurement would be categorised within Level 3
of the fair value hierarchy.
If an observable input requires an adjustment using an unobservable input and that
adjustment actually results in a significantly higher or lower fair value measurement,
the standard is clear that the resulting fair value measurement would be categorised
within Level 3 of the fair value hierarchy. [IFRS 13.75]. Consider our example of a
restricted security discussed at 15.1 above. While the quoted price for the
unrestricted security may be observable, if Level 3 inputs are needed to determine
the effect of the restriction on the instrument’s fair value, and this effect is significant
to the measurement, the asset would be categorised within Level 3 of the fair value
hierarchy. In addition, as discussed at 8 above, in certain situations adjustments to a
transaction price in an inactive market may be required. If these adjustments are
based on unobservable inputs and significant to the measurement, the item would
be categorised within Level 3 of the fair value hierarchy.
It is important to understand that the determination of the hierarchy level in which
the fair value measure falls (and, therefore, the category in which it will be disclosed
– see 20.3.3 below) is based on the fair value measurement for the specific item
being measured, which will be dependent on the unit of account for the asset or
liability. This may create practical challenges in relation to fair value measurements
for non-financial assets and financial assets and liabilities with offsetting risk
measured using the measurement exception discussed at 12 above. For example, in
situations where the unit of account for a non-financial asset is the individual item,
1052 Chapter 14
but the valuation premise is in combination with other assets (or other assets and
liabilities), the value of the asset group would need to be attributed to the individual
assets or liabilities or to the various instruments within each level of the fair value
hierarchy. For example, consider Example 14.13 at 10.2.2 above. The unit of account
for the vines and the land was that specified by IAS 41 and IAS 16 respectively.
However, their highest and best use was in combination, together and with other
assets. The value of that group would need to be attributed to each of the assets,
including both the vines and land, as the fair value of these individual assets should
be categorised within the fair value hierarchy.
16.2.1
Assessing the significance of inputs
Assessing the significance of a particular input to the entire measurement requires
judgement and consideration of factors specific to the asset or liability (or group of assets
and/or liabilities) being measured. [IFRS 13.73].
IFRS 13 does not provide specific guidance on how entities should evaluate the
significance of individual inputs. This determination will require judgement and
consideration of factors specific to the asset or liability (or group of assets and liabilities)
being measured.
The standard is clear that it considers significance in relation to ‘the entire
measurement’. In our view, this requires the assessment to consider the fair value
measure itself, rather than any resulting change in fair value, regardless of whether that
change is recognised (i.e. in profit or loss or other comprehensive income) or
unrecognised. For example, assume an investment property is measured at fair value at
the end of each reporting period. In the current reporting period the fair value of the
investment property reduces by CU 200,000 to CU 500,000. The significance of any
inputs to the fair value measurement would be assessed by reference to the CU 500,000,
even though CU 200,000 is the amount that will be recognised in profit or loss.
However a reporting entity may deem it appropriate to also consider significance in
relation to the change in fair value from prior periods, in addition to considering the
significance of an input in relation to the entire fair value measurement. Such an
approach may be helpful in relation to cash-based instruments (e.g. loans or structured
notes with embedded derivatives) whose carrying amounts, based on fair value, are
heavily affected by their principal or face amount.
As noted in 16.2 above, if an observable input requires an adjustment using an
unobservable input and that adjustment actually results in a significantly higher or lower
fair value measurement, the standard is clear that the resulting fair value measurement
would be categorised within Level 3 of the hierarchy. [IFRS 13.75]. What is not clear,
however, is the appropriate categorisation when an observable input requires an
adjustment using an unobservable input and: (a) that adjustment does not actually result
in a significantly higher or lower fair value in the current period; but (b) the potential
adj
ustment from using a different unobservable input would result in a significantly
higher or lower fair value measurement. As noted in 16.2 above, the categorisation of a
fair value measurement indicates the overall observability or subjectivity of a
measurement, in its entirety. To this end, in some cases, the use of sensitivity analysis
or stress testing (i.e. using a range of reasonably possible alternative input values as of
Fair value measurement 1053
the measurement date) might be appropriate to assess the effects of unobservable inputs
on a fair value measure. In situations where more than one unobservable input is used
in a fair value measure, the assessment of significance should be considered based on
the aggregate effect of all the unobservable inputs.
Entities should have a documented policy with respect to their approach to determining
the significance of unobservable inputs on its fair value measurements and apply that
policy consistently. This is important in light of the disclosure requirements in IFRS 13,
particularly for fair value measurements categorised within Level 3 of the fair value
hierarchy (see 20.3 below).
16.2.2
Transfers between levels within the fair value hierarchy
For assets or liabilities that are measured at fair value (or measurements based on
fair value) at the end of each reporting period, their categorisation within the fair
value hierarchy may change over time. This might be the case if the market for a
particular asset or liability that was previously considered active (Level 1) becomes
inactive (Level 2 or Level 3) or if significant inputs used in a valuation technique that
were previously unobservable (Level 3) become observable (Level 2) given
transactions that were observed around the measurement date. Such changes in
categorisation within the hierarchy are referred to in IFRS 13 as transfers between
levels within the fair value hierarchy.
An entity is required to select, and consistently apply, a policy for determining when
transfers between levels of the fair value hierarchy are deemed to have occurred,
that is, the timing of recognising transfers. This policy must be the same for transfers
into and out of the levels. Examples of policies for determining the timing of
transfers include:
• the date of the event or change in circumstances that caused the transfer;
• the beginning of the reporting period; or
• the end of the reporting period. [IFRS 13.95].
The standard requires an entity to disclose this policy (see 20.2 below). In addition, the
selected timing (i.e. when transfers are deemed to have occurred) has a direct impact on
the information an entity needs to collate in order to meet the disclosure requirements
in IFRS 13 – specifically those required by IFRS 13.93(c) and (e)(iv) – for both transfers
between Levels 1 and 2 and transfers into and out of Level 3 (these disclosure
requirements are discussed at 20.3.2 below). [IFRS 13.93(c), 93(e)(iv)].
16.2.3
Information provided by third-party pricing services or brokers
IFRS 13 does not preclude the use of quoted prices provided by third parties, such as
pricing services or brokers, provided those quoted prices are developed in accordance
with the standard. Quoted prices provided by third parties represent an important
source of information in estimating fair value for many entities. While not precluded,
the standard makes it clear that the use of broker quotes, third-party pricing services,
or a third-party valuation specialist does not alleviate management’s responsibility for
the fair value measurements (and the related disclosures) that will be included in its
financial statements. [IFRS 13.B45].
1054 Chapter 14
It is important for entities to understand the source of information received from
brokers and pricing services, particularly when there has been a significant decrease in
the volume or level of activity for the asset or liability, as management needs to assess
the relevance of these quotes. This is discussed further at 8.3 above.
As discussed at 15.5 above, an entity should evaluate whether quotes from brokers and
pricing services are based on current information that reflects orderly transactions or
were determined using valuation techniques that appropriately reflect market
participant assumptions regarding risk. Entities should place less weight on third-party
quotes that are not based on transactions compared to fair value indications that are
based on market transactions.
Determining the level in which assets and liabilities are categorised within the fair value
hierarchy for disclosure purposes often requires judgement. Information provided by
third-party pricing services or brokers could represent Level 1, Level 2, or Level 3 inputs
depending on the source of the information and the type of instrument being measured.
For example, pricing services may provide quoted market prices (e.g. closing price) for
financial instruments traded in active markets. These prices are Level 1 measurements.
Alternatively, a pricing service may provide an entity with consensus pricing
information (e.g. information obtained by polling dealers for indications of mid-market
prices for a particular asset class). The non-binding nature of consensus pricing would
generally result in its categorisation as Level 3 information, assuming no additional
corroborating evidence.
Pricing services may also use valuation models to estimate values for certain instruments.
For example, pricing services may use matrix pricing to determine the value of many
fixed-income securities. The hierarchy level in which these instruments would be
categorised depends on the observability of the valuation model’s inputs. Therefore,
entities that use pricing services should understand the data sources and valuation
methods used to derive those third-party quotes. This information will determine where
the entity’s instruments would be categorised within the fair value hierarchy.
Similarly, the level within the hierarchy in which a broker quote is categorised depends
on the nature of the quote. [IFRS 13.B47]. In certain brokered markets, firm quotes are
disclosed and an entity has the ability to ‘hit’ or execute a transaction at the quoted
price. Depending on the level of activity in these markets, those quotes may be
categorised as Level 1 or Level 2. However, when an entity has to solicit a quote from a
broker, the quotes are often non-binding and may include a disclaimer that releases the
broker from being held to that price in an actual transaction. On their own, non-binding
quotes would generally represent a Level 3 input. In addition, when the quote includes
explanatory language or a disclaimer, the entity should assess whether the quote
represents fair value (exit price) or whether an adjustment is needed.
Fair value measurement 1055
If an entity uses multiple quotes within a narrow range when measuring fair value,
it will likely provide stronger evidence of fair value than a single quote or quotes
that are widely dispersed. However, the number of quotes should not, in and of
itself, affect the categorisation within the fair value hierarchy. An entity would still
need to consider the nat
ure of those quotes. For example, multiple Level 3 inputs,
within a reasonable range, would not result in a Level 2 measurement without
additional observable corroborating evidence.
In August 2014, the IFRS Interpretations Committee received a request to clarify the
circumstances in which a fair value measurement, in its entirety, that uses prices that
are provided by third parties (e.g. consensus prices) could be categorised within
Level 1 of the fair value hierarchy, particularly in relation to debt securities that are
actively traded. The submitter highlighted that categorisation within the fair value
hierarchy for debt securities is not straightforward and that there were divergent
views on the appropriate level within the hierarchy such fair value measurements
should be categorised.
After considering the analyses and outreach performed by its staff, the Interpretations
Committee decided not to add this issue to its agenda, noting the following:23
• the guidance in IFRS 13 relating to the categorisation within the fair value
hierarchy was sufficient to draw an appropriate conclusion on this issue;
• the fair value hierarchy prioritises the inputs to valuation techniques, not the
valuation techniques used to measure fair value. When the fair value of assets or
liabilities is measured based on prices provided by third parties, the categorisation
of those measurements within the fair value hierarchy depends on the evaluation
of the inputs used by the third party to derive those prices; not on the pricing
methodology the third party has used; and
• only unadjusted quoted prices in active markets for identical assets or liabilities
that the entity can access at the measurement date qualify as Level 1 measurement.
Therefore, a fair value measurement that is based on prices provided by third
parties can only be categorised within Level 1 of the fair value hierarchy if that
measurement relies solely on unadjusted quoted prices in an active market for an
identical instrument that the entity can access at the measurement date (i.e. P×Q,
without adjustment).
16.2.4
Categorisation of over-the-counter derivative instruments
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 208
