Principles of the fair value measurement project

The following principles were put to the Board as those forming the foundation of the fair value measurement project:

• The objective of a fair value measurement is to determine the price that would be received for an asset or paid to transfer a liability in a transaction between market participants at the measurement date.
• The definition of fair value and its measurement objective should be consistent for all fair value measurements required by IFRS.
• A fair value measurement should reflect market views of the attributes of the asset or liability being measured and should not include views of the reporting entity that differ from market expectations.
• A fair value measurement should consider the utility of the asset or liability being measured. As such, the fair value measurement should consider the location and the condition of the asset or liability at its measurement date.

The Board concurred with the staff that the above principles form the foundation of the fair value measurement project.

Revised definition of fair value

In the staff's view, the FASB's revised definition of fair value is substantively similar to the one tentatively approved by the IASB in December 2005. Based on that, the IASB agreed that the revised definition is consistent with the measurement objective.

However, some Board members expressed concern about the change to a 'price' rather than 'amount'. In addition, the revised definition is based on an exit price notion that does not consider prices that exist other than the exit price. As a consequence, other Board members noted that the current definition will require measurement based on a hypothetical market that, for some types of assets and liabilities, cannot be calibrated with reality and in most cases will result in day 1 gains or losses, which constituents are uncomfortable with.

Revised fair value hierarchy

The draft fair value measurement statement indicates that valuation techniques used to measure fair value shall maximise the use of observable inputs and minimize the use of unobservable inputs. The hierarchy prioritises the inputs to valuation techniques used to measure fair value based on their observable or unobservable nature.

The revised three-level hierarchy is summarised as follows:

• Level 1 inputs are observable inputs that reflect quoted prices for identical assets or liabilities in active markets the reporting entity has the ability to access at the measurement date.
• Level 2 inputs are observable inputs other than quoted prices for identical assets or liabilities in active markets at the measurement date.
• Level 3 inputs are unobservable inputs, for example, inputs derived through extrapolation or interpolation that cannot be corroborated by observable data. However, the fair value measurement objective remains the same. Therefore, unobservable inputs should be adjusted for entity information that is inconsistent with market expectations. Unobservable inputs should also consider the risk premium a market participant (buyer) would demand to assume the inherent uncertainty in the unobservable input.

IFRSs currently does not have a single hierarchy that applies to all fair value measures. Instead individual standards indicate preferences for certain inputs and measures of fair value over others, but this guidance is not consistent among all IFRSs.

The Board agreed with the staff's conclusion that the revised hierarchy in the draft fair value measurement statement is consistent with the principles discussed above and that the hierarchy in the draft fair value measurement statement represents an improvement over the disparate and inconsistent guidance currently in IFRSs.

Unit of account and fair value measurements

The Board agreed that it is not appropriate or practical to provide detailed guidance on the unit of account within the fair value measurement project. Determining the appropriate unit of account is a critical element of accounting and is not always consistent from one asset or liability to another or from one type of transaction to another.

Determination of which market

The Board agreed with the FASB's conclusion to adopt the 'principal market' view. While this will result in a change from the 'most advantageous' view currently in IFRS, the 'principal market' view more accurately reflects the fair value measurement objective and provides a more representative measure of fair value by giving preference to highly liquid markets over less liquid markets.

Transaction price presumption

At the December 2005 meeting, the IASB tentatively agreed the fair value measurement objective was an exit price. The December discussion highlighted the conceptual difference between transaction price (what an entity would pay to buy an asset or receive to assume a liability) and an exit price objective (what an entity would receive to sell an asset or pay to transfer a liability). The staff concluded that an entity cannot presume an entry price to be equal to an exit price without considering factors specific to the transaction and the asset or liability. As a consequence, the staff plans to bring a separate discussion of day 1 gains or losses to the Board at a future meeting.

The Board shared the concerns of the staff that if a transaction price were presumed to be fair value on initial measurement, entities might not sufficiently consider the differences between an entry transaction price and an exit fair value. As such, IFRSs should require an entity to consider factors specific to the transaction and the asset or liability in assessing if the transaction price represents fair value.

Fair value within the bid-ask spread

Entities often transact somewhere between the bid and ask pricing points, particularly if the entity is a market maker or an influential investor. However, application of the rule in IAS 39 results in consistency across entities without consideration of entity specific factors that may influence where within the bid-ask spread the entity is likely to transact. Further, the rule creates a bright-line in quoted markets, thus limiting the use of judgement and subjectivity in the fair value measurement.

The Board agreed to add a discussion to the invitation to comment that communicates agreement with the principle in the draft fair value measurement statement. The discussion would state that it is not appropriate to use a consistently applied pricing convention as a practical expedient to fair value. This recommendation would result in both a change to existing IFRSs as well as a departure from the FASB's draft fair value measurement statement.

Transaction and transportation costs in measuring fair value

The definitions of transaction type costs vary in IFRSs, though such costs are consistently excluded from fair value measurements. Currently, IFRSs are not clear (with the exception of IAS 41) whether transportation costs are an attribute of the asset or liability, and as such should be included in the fair value measurement.

The draft fair value measurement statement defines transaction costs as the incremental direct costs to transact in the principal or most advantageous market. Incremental direct costs are costs that result directly from, and are essential to, a transaction involving an asset (or liability). Incremental direct costs are costs that would not be incurred by the entity if the decision to sell or dispose of the asset (or transfer the liability) was not made.

In the draft fair value measurement statement, the FASB concluded the fair value measurement of the asset or liability shall include only those costs that are an attribute of the asset or liability. The FASB concluded transaction costs are an attribute of the transaction, not an attribute of the asset or liability. Therefore the fair value measurement of the asset or liability shall not include transaction costs.

The staff agreed with the conclusions in the draft FVM statement regarding transportation and transaction costs. However, the staff concluded that the discussion of what types of costs are attributes of the asset or liability could be more robust as it is difficult to decipher justification for different treatment of transaction costs and transportation costs in the current discussion in the draft FVM statement. As such, the staff recommended, and the Board agreed that the invitation to comment should include a question on the sufficiency of the discussion of costs that are attributes of an asset or liability, such as transportation costs.