Item Identification and Unit of Account

In general, the same unit of account at which the asset or liability is aggregated or disaggregated by applying other applicable IFRS pronouncements is to be used for fair value measurement purposes. The asset or liability measured at fair value might be either a stand-alone asset or liability (e.g., a financial instrument or a non-financial asset) or a group of assets, a group of liabilities or a group of assets and liabilities (e.g., a cash-generating unit or a business). No adjustment may be made to the valuation for a “blockage factor.” A blockage factor is an adjustment made to a valuation that takes into account the fact that the investor holds a large quantity (block) of shares relative to the market trading volume in those shares. The prohibition applies even if the quantity held by the reporting entity exceeds the market's normal trading volume—and that, if the reporting entity were, hypothetically, to place an order to sell its entire position in a single transaction, that transaction could affect the quoted price.

The Principal or Most Advantageous Market

The IFRS requires the entity performing the valuation to maximise the use of relevant assumptions (inputs) that are observable from market data obtained from sources independent of the reporting entity. In making a fair value measurement, management is to assume that the asset or liability is exchanged in a hypothetical, orderly transaction between market participants at the measurement date.

To characterise the exchange as orderly, it is assumed that the asset or liability will have been exposed to the market for a sufficient period of time prior to the measurement date to enable marketing activities to occur that are usual and customary with respect to transactions involving such assets or liabilities. It is also to be assumed that the transaction is not a forced transaction (e.g., a forced liquidation or distress sale).

The fair value is to be measured by reference to the principal market, or in the absence of a principal market, the most advantageous market. Unless otherwise apparent it is assumed that the principal market is the market in which the entity would normally transact to sell the asset or transfer the liability. An entity, therefore, need not engage in elaborate efforts to identify the principal market. This approach is deemed appropriate and broadly consistent with the concept of the most advantageous market, as it is reasonable that an entity would normally transact in the most advantageous market to which it is has access, taking into consideration transaction and transport costs.

Note that the determination of the most advantageous market is made from the perspective of the reporting entity, as the reporting entity needs to have access to the principal market. Thus, different reporting entities engaging in different specialised industries, or with access to different markets, might not have the same most advantageous market for an identical asset or liability. The IFRS provides a typology of markets that potentially exist for assets or liabilities.

1. Exchange markets. A market in which closing prices are readily available and generally representative of fair value. Examples of such markets include NYSE, Euronext, Toronto Stock Exchange, London Stock Exchange, Hong Kong Stock Exchange and Johannesburg Securities Exchange among others.
2. Dealer markets. A market in which parties (dealers referred to as market makers) stand ready to buy or sell a particular investment for their own account at bid and ask prices that they quote. The bid price is the price the dealer is willing to pay to purchase the investment and the ask price is the price at which the dealer is willing to sell the investment. In these markets, these bid and ask prices are typically more readily available than are closing prices characteristic of active exchange markets. By using their own capital to finance and hold an inventory of the items for which they “make a market,” these dealers provide the market with liquidity. Dealer markets include over-the-counter markets for which the prices at which transactions have been concluded could be publicly available. Dealer markets exist for financial instruments and non-financial assets such as commodities, equipment and such items.
3. Brokered market. These markets use “brokers” or intermediaries to match buyers with sellers. Brokers do not trade for their own account and do not hold an inventory in the security. The broker knows the bid and asked prices of the potential counterparties to the transaction but the counterparties are unaware of each other's price requirements. Prices of consummated transactions are sometimes available privately or as a matter of public record. Brokered markets include electronic communication networks that match buy and sell orders, as well as commercial and residential real estate markets. In some cases, each of the counterparties is aware of the other's identity, while in other cases, their identities are not disclosed by the broker.
4. Principal-to-principal market. A market in which the counterparties negotiate directly and independently without an intermediary. Because no intermediary or exchange is involved, little if any information about these transactions is released to the public.

Market Participants

Fair value will be measured using the assumptions that a market participant would take into consideration assuming that the market participant would behave in his best economic interests. It is not necessary for an entity to identify an actual market participant for this purpose as this is a hypothetical construct. Instead the entity will develop a “picture” of the market participant by taking into consideration factors such as the nature of the asset or liability, the principal (or most advantageous) market and the market participants with whom the entity would enter into a transaction in that market. In light of the market-oriented alignment, company-specific assumptions are therefore irrelevant, and the valuation must be based on premises that typical market participants would assume when defining a price in their own commercial interests. As such, the consideration of factors whose impacts would be assessed differently by a typical market participant is crucial, and therefore the company-specific circumstances and assumptions of the reporting company are not decisive.

The hypothetical market participants can be summarised as:

1. Independent of each other (i.e., are unrelated third parties).
2. Knowledgeable (i.e., are sufficiently informed to make an investment decision and are presumed to be as knowledgeable as the reporting entity about the asset or liability).
3. Able to enter into a transaction for the asset or liability.
4. Willing to enter into a transaction for the asset or liability (i.e., they are motivated but not forced or otherwise compelled to do so).

Measurement considerations when transactions are not orderly. In recent years, there have been heightened concerns about the effects of tumultuous or illiquid credit markets in the US and abroad. The previously active markets for certain types of securities have become illiquid or less liquid. Questions have arisen regarding whether transactions occurring in less liquid markets with less frequent trades might cause those market transactions to be considered forced or distress sales, thus rendering valuations made using those prices not indicative of the actual fair value of the securities.

The presence of the following factors may indicate that a quoted price is not obtained from a transaction that could be considered orderly and therefore may not be indicative of fair value:

1. There has been a significant decrease in the volume and level of activity for the asset or liability when compared with normal market activity for the asset or liability (or for similar assets or liabilities).
2. There have been few recent transactions.
3. Price quotations are not based on current information about the fair value of an asset or liability.
4. Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value of that asset or liability.
5. There has been a significant increase in implied liquidity risk premiums, yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the entity's estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability.
6. There has been a wide bid-ask spread or significant increase in the bid-ask spread.
7. There has been a significant decline or absence of a market for new issues (i.e., in the primary market) for the asset or liability (or similar assets or liabilities).
8. Little information has been released publicly (e.g., as occurs in a principal-to-principal market).

An entity should evaluate the significance and relevance of the foregoing indicators (together with other pertinent factors) to determine whether, on the basis of the evidence available, a market is not active. If it concludes that a market is not active, it may then also deduce that transactions or quoted prices in that market are not determinative of fair value (e.g., because there may be transactions that are not orderly). Further analysis of the transactions or quoted prices may therefore be needed, and a significant adjustment to the transactions or quoted prices may be necessary to measure fair value.

The IFRS does not prescribe a methodology for making significant adjustments to transactions or quoted prices in such circumstances; however, the typology of valuation techniques—the market, income and cost approaches, respectively—applies to these situations equally. Regardless of the valuation technique used, an entity must include any appropriate risk adjustments, including a risk premium reflecting the amount market participants would demand because of the risk (uncertainty) inherent in the cash flows of an asset or liability. Absent this, the measurement would not faithfully represent fair value. The risk premium should be reflective of an orderly transaction between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume or level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. When weighting indications of fair value resulting from the use of multiple valuation techniques (market, income or cost approach), an entity shall consider the reasonableness of the range of fair value measurements. The objective is to determine the point within the range that is most representative of fair value under current market conditions.

Of most importance, even when a market is not active, the objective of a fair value measurement remains the same—to identify the price that would be received to sell an asset or paid to transfer a liability in a transaction that is orderly and not a forced liquidation or distress sale, between market participants at the measurement date under current market conditions. Therefore, is an entity's intention to hold the asset or to settle, or otherwise fulfil, the liability not relevant when measuring fair value, because fair value is a market-based measurement and not an entity-specific measurement?

Even if a market is not active, it would be inappropriate to conclude that all transactions in that market are not orderly (i.e., that they are forced or distress sales). Circumstances that may suggest that a transaction is not orderly, however, include, inter alia, the following:

1. There was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions.
2. There was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant.
3. The seller is in or near bankruptcy or receivership (i.e., distressed) or the seller was required to sell to meet regulatory or legal requirements (i.e., forced).
4. The transaction price is an outlier when compared with other recent transactions for the same or similar asset or liability.

The reporting entity is required to evaluate the circumstances to determine, based on the weight of the evidence then available, whether the transaction is orderly. If it indicates that a transaction is indeed not orderly, the reporting entity places little, if any, weight (in comparison with other indications of fair value) on that transaction price when measuring fair value or estimating market risk premiums.

On the other hand, if the evidence indicates that a transaction is in fact orderly, the reporting entity is to consider that transaction price when measuring fair value or estimating market risk premiums. The weight to be placed on that transaction price when compared with other indications of fair value will depend on the facts and circumstances—such as the volume of the transaction, the comparability of the transaction to the asset or liability being measured, and the proximity of the transaction to the measurement date.

The IFRS does not preclude the use of quoted prices provided by third parties—such as pricing services or brokers—when the entity has determined that the quoted prices provided by those parties are determined in accordance with the standard. If a market is not active, however, the entity must evaluate whether the quoted prices are based on current information that reflects orderly transactions or a valuation technique that reflects market participant assumptions (including assumptions about risks). In weighting a quoted price as an input to a fair value measurement, however, the entity should place less weight on quotes that do not reflect the result of transactions.

Selection of the Valuation Premise for Asset Measurements

The measurement of the fair value of a non-financial asset is to assume the highest and best use of that asset by market participants. Generally, the highest and best use is the way that market participants would be expected to deploy the asset (or a group of assets and liabilities within which they would use the asset) that would maximise the value of the asset (or group). This highest and best use assumption might differ from the way that the reporting entity is currently using the asset or group of assets or its future plans for using it (them).

At the measurement date, the highest and best use must be physically possible, legally permissible and financially feasible. In this context, physically possible takes into account the physical characteristics of the asset that market participants would consider when pricing the asset (e.g., the location or size of a property). Legally permissible takes into account any legal restrictions on the use of the asset that market participants would consider when pricing the asset (e.g., the zoning regulations applicable to a property). Financially feasible takes into account whether a use of the asset that is physically possible and legally permissible generates adequate income or cash flows (taking into consideration the costs of converting the asset to that use) to produce an investment return that market participants would require from an investment in that asset put to that use.

In all cases, the highest and best use is determined from the perspective of market participants, even if the reporting entity intends a different use. The highest and best use of an asset acquired in a business combination might differ from the intended use of the asset by the acquirer. The highest and best use is normally the use for which an asset is currently engaged unless market or other factors indicate otherwise. For example, for competitive or other reasons, the acquirer may intend not to use an acquired asset actively or it may not intend to use the asset in the same way as other market participants. This may particularly be the case for certain acquired intangible assets, for example, an acquired trademark that competes with an entity's own trademark. Nevertheless, the reporting entity is to measure the fair value of the asset assuming its highest and best use by market participants.

Where the highest and best use of an asset is determined by its use in conjunction with other assets and liabilities, fair value should be determined on that basis, thereby assuming that the asset would be used with other assets and liabilities and that those assets and liabilities (i.e., its complementary assets and the associated liabilities) would be available to market participants. Consequently the fair value of all other assets in that group of associated assets and liabilities should be determined on the same basis.

Risk Assumptions when Valuing a Liability

Many accountants, analysts and others find the concept of computing fair value of liabilities and recognising changes in the fair value thereof to be counterintuitive. Consider the case when a reporting entity's own credit standing declines (universally acknowledged as a “bad thing”). A fair value measurement that incorporates the effect of this decline in credit rating would result in a decline in the fair value of the liability and a resultant increase in stockholders' equity (which would be seen as a “good thing”). Nonetheless, the logic of measuring the fair value of liabilities is as valid, and as useful, as it is for assets. The IFRS does not expand the applicability of fair value measures from what currently exists, however.

Based on the market value concept and the associated sale price, IFRS 13 focuses on the transaction approach when measuring the fair value of liabilities. Applying the transfer approach involves recognising the amount that would be payable in the marketplace for the hypothetical transfer of a liability. This includes the cash flows that are still probably due and may need to be discounted. Accordingly, IFRS 13.34 assumes that the debt relationship continues in a modified form, and that therefore the liability continues to exist at the time of transfer, with only the identity of the debtor changing. No distinction is made between financial and non-financial assets. Fair value measurements of liabilities assume that a hypothetical transfer to a market participant occurs on the measurement date. In measuring the fair value of a liability, the evaluator is to assume that the reporting entity's obligation to its creditor (i.e., the counterparty to the obligation) will continue at and after the measurement date (i.e., the obligation will not be repaid or settled prior to its contractual maturity). This being the case, this hypothetical transfer price would most likely represent the price that the current creditor (holder of the debt instrument) could obtain from a marketplace participant willing to purchase the debt instrument in a transaction involving the original creditor assigning its rights to the purchaser. In effect, the hypothetical market participant that purchased the instrument would be in the same position as the current creditor with respect to expected future cash flows (or expected future performance, if the liability is not able to be settled in cash) from the reporting entity.

The evaluator is to further assume that the non-performance risk related to the obligation would be the same before and after the hypothetical transfer occurs. Non-performance risk is the risk that the obligation will not be fulfilled. It is an all-encompassing concept that includes the reporting entity's own credit standing but also includes other risks associated with the non-fulfilment of the obligation. For example, a liability to deliver goods and/or perform services may bear non-performance risk associated with the ability of the debtor to fulfil the obligation in accordance with the timing and specifications of the contract. Further, nonperformance risk increases or decreases as a result of changes in the fair value of credit enhancements associated with the liability (e.g., collateral, credit insurance and/or guarantees).

As with the valuation of assets, company-specific elements are also ignored when measuring liabilities. Accordingly, valuations do not consider more favourable cost structures, for example, for non-financial liabilities, nor credit terms and conditions that may be more or less favourable than the market norm. To meet the objective of a fair value measurement in accordance with IFRS 13, an entity shall maximise the use of relevant observable inputs and minimise the use of unobservable inputs. In order to meet this requirement even if there is no observable market to provide pricing information about the transfer of a liability, there might be an observable market for such items if they are held by other parties as assets (e.g., a corporate bond).

Liabilities and Equity Instruments Held by Other (Third) Parties as Asset

When a quoted price for the transfer of an identical or a similar liability or entity's own equity instrument is not available and the identical item is held by another party as an asset, an entity shall measure the fair value of the liability or equity instrument from the perspective of a market participant that holds the identical item as an asset at the measurement date. The IASB is convinced that the fair value from the viewpoint of investor and issuer should be the same in an efficient market.

In the case where a third party held the liability or equity instrument, an entity shall measure the fair value as follows:

1. Using the quoted price in an active market for the identical item held by another party as an asset, if that price is available.
2. If that price is not available, using other observable inputs, such as the quoted price in a market that is not active for the identical item held by another party as an asset.
3. If the observable prices in (a) and (b) are not available, using another valuation technique, such as:
   1. An income approach (e.g., a present value technique that takes into account the future cash flows that a market participant would expect to receive from holding the liability or equity instrument as an asset);
   2. A market approach (e.g., using quoted prices for similar liabilities or equity instruments held by other parties as assets).

An entity shall adjust the price of a liability or an entity's own equity instrument held by another party as an asset only if there are factors specific to the asset that are not applicable to the fair value measurement of the liability or equity instrument. According to the IASB, adjustments are made such as:

1. The quoted price for the asset relates to a similar (but not identical) liability or equity instrument held by another party as an asset. For example, the liability or equity instrument may have a particular characteristic (e.g., the credit quality of the issuer) that is different from that reflected in the fair value of the similar liability or equity instrument held as an asset.
2. The unit of account for the asset is not the same as for the liability or equity instrument. For example, for liabilities, in some cases the price for an asset reflects a combined price for a package comprising both the amounts due from the issuer and a third-party credit enhancement. If the unit of account for the liability is not for the combined package, the objective is to measure the fair value of the issuer's liability, not the fair value of the combined package. Thus, in such cases, the entity would adjust the observed price for the asset to exclude the effect of the third-party credit enhancement.

Liabilities and Equity Instruments not Held by Other (Third) Parties as Asset

There are certain liabilities that are not held by a third party as an asset. An example is a decommissioning liability assumed in a business combination, warranty obligations and many other performance commitments.

In this respect, the accounting entity must determine the fair value of the liabilities or of the equity instrument by applying valuation methods from the perspective of a market participant who must honour the claims to payment from the liability or from the equity instrument.

These valuation techniques can include a present value technique that considers either:

1. Future cash outflows that a market participant would expect to incur in fulfilling the obligation, including the compensation that a market participant would require for taking on the obligation; or
2. The amount that a market participant would receive to enter into or issue an identical liability or equity instrument, using the assumptions that market participants would use when pricing the identical item (e.g., having the same credit characteristics) in the principal (or most advantageous) market for issuing a liability or an equity instrument with the same contractual terms.

When using a present value technique to measure the fair value of a liability that is not held by another party as an asset, an entity shall, among other things, estimate the future cash outflows that market participants would expect to incur in fulfilling the obligation. Those future cash outflows shall include market participants' expectations about the costs of fulfilling the obligation and the compensation that a market participant would require for taking on the obligation. Such compensation includes the return that a market participant would require for the following:

1. Undertaking the activity (i.e., the value of fulfilling the obligation; e.g., by using resources that could be used for other activities); and
2. Assuming the risk associated with the obligation (i.e., a risk premium that reflects the risk that the actual cash outflows might differ from the expected cash outflows).

For example, a non-financial liability does not contain a contractual rate of return and there is no observable market yield for that liability. In some cases the components of the return that market participants would require will be indistinguishable from one another (e.g., when using the price a third-party contractor would charge on a fixed-fee basis). In other cases an entity needs to estimate those components separately (e.g., when using the price a third-party contractor would charge on a cost-plus basis because the contractor in that case would not bear the risk of future changes in costs).

Non-performance risk in valuing liabilities. The fair value of a liability reflects the effect of non-performance risk, which is the risk that an entity will not fulfil an obligation. For valuation purposes, non-performance risk is assumed to be the same before and after the transfer of the liability. This assumption is rational, because market participants would not enter into a transaction that changes the non-performance risk associated with the liability without reflecting that change in the price.

Non-performance risk includes credit risk, the effect of which may differ depending on the nature of the liability. For example, an obligation to deliver cash (a financial liability) is distinct from an obligation to deliver goods or services (a non-financial liability). Also, the terms of credit enhancements related to the liability, if any, would impact valuation.

Liabilities with inseparable third-party credit enhancements. Creditors often impose a requirement, in connection with granting credit to a debtor, that the debtor obtain a guarantee of the indebtedness from a creditworthy third party. Under such an arrangement, should the debtor default on its obligation, the third-party guarantor would become obligated to repay the obligation on behalf of the defaulting debtor and, of course, the debtor would be obligated to repay the guarantor for having satisfied the debt on its behalf.

The issuer of a liability issued with an inseparable third-party credit enhancement that is accounted for separately from the liability shall not include the effect of the credit enhancement in the fair value measurement of the liability. If the credit enhanced is accounted for separately from the liability, the issuer should take into account its own credit standing and not that of the third-party guarantor.

Restriction Preventing the Transfer of a Liability or an Entity's Own Equity Instrument

If there are restrictions on the transfer of a liability or equity instrument, which is not an uncommon feature in certain circumstances, that should not be a consideration when measuring the fair value of such an instrument. The IFRS takes the view that the effect of such a feature is already included in other inputs to the fair value measurement of such instruments.

Financial Liability with a Demand Feature

The fair value of financial liability with a demand feature is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.

Shareholders' Equity

IFRS 13 is equally applicable to the entity's equity instruments. These include the entity's own equity instruments, and how these are issued as consideration in the course of a business combination, for example. The valuation procedure adheres to the same regulations that govern the valuation of liabilities. Accordingly, own equity instruments are valued from the perspective of a market participant who holds the instrument as an asset. If such an instrument is not held as an asset by a third party, it is measured using a valuation procedure that reflects the assumptions of the market participant, in line with the regulations governing the valuation of liabilities. One such typical valuation method might be the income approach.

Fair Value for Net Exposures

Where an entity manages a portfolio of financial assets and liabilities with a view to managing net exposures to counterparty risk including credit and market risks, the standard permits that fair value may be determined for the net long (asset) or short (liability) position. This exception is available only if the entity qualifies for that exception by demonstrating that the net exposure is consistent with how it manages risk and it has elected to measure the financial assets and liabilities at fair value. Fair value would therefore be determined on the basis of what market participants would take into consideration when considering a transaction on the net exposure risks.

The exception does not, however, extend to the presentation of such net exposures in the financial statements, unless otherwise permitted by another IFRS.

IFRS 13 and the new IFRS 9 have not resulted in the abolition of the option of measuring short-term receivables and payables with no stated interest rate at invoice amount, without discounting them, as long as the effects of not discounting them were not material.

The portfolio exception in section 52 of IFRS 13 applies to all contract accounting within the scope of IAS 39, Financial Instruments: Recognition and Measurement, or IFRS 9, Financial Instruments, regardless of whether the contracts meet the definitions of financial assets or financial liabilities as defined in IAS 32, Financial Instruments: Presentation.

Inputs

For the purpose of fair value measurements, inputs are the assumptions that market participants would use in pricing an asset or liability, including assumptions regarding risk. An input is either observable or unobservable. Observable inputs are either directly observable or indirectly observable. The IFRS requires the entity to maximise the use of relevant observable inputs and minimise the use of unobservable inputs.

An entity shall select inputs that are consistent with the characteristics of the asset or liability that market participants would take into account in a transaction for the asset or liability. In some cases those characteristics result in the application of an adjustment, but adjustments are solely applicable for characteristics of the asset or liability which are consistent with the unit of account in the IFRS that requires or permits the fair value measurement.

An observable input is based on market data obtainable from sources independent of the reporting entity. For an input to be considered relevant, it must be considered determinative of fair value. Examples of markets in which inputs might be observable for some assets and liabilities include exchange markets, dealer markets, broker markets and principal-to-principal markets.

An unobservable input reflects assumptions made by management of the reporting entity with respect to assumptions it believes market participants would use to price an asset or liability based on the best information available under the circumstances.

The standard provides a fair value input hierarchy (see diagram below) to serve as a framework for classifying inputs based on the extent to which they are based on observable data. In some instances inputs used in a valuation technique may be categorised at different levels across the hierarchy; in such instances the fair value measurement is categorised in the same level as the lowest level of input significant to the measurement of fair value. Determining significance in this context requires the use of judgement. Adjustments to arrive at measurements based on fair value, such as costs to sell when measuring fair value less costs to sell, shall not be taken into account when determining the level of the fair value hierarchy within which a fair value measurement is categorised.

The fair value hierarchy is determined by the predominant input factor with the aim of maximising the use of observable input parameters and keeping non-observable input parameters to the lowest possible minimum. The measurement method (measurement technique) that is applied is dictated by the available data, since the adopted measurement method constitutes the appropriate procedure for the given circumstances, and sufficient data is available to measure the fair value using that method.

Level 1 inputs. Level 1 inputs are considered the most reliable evidence of fair value and are to be used whenever they are available. These inputs consist of quoted prices in active markets for identical assets or liabilities. The active market must be the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability in which the reporting entity has the ability to enter into a transaction for the asset or liability at the price in that market at the measurement date. A quoted price in an active market is the most reliable evidence of fair value and should be used without adjustment except in the following circumstances:

1. As a practical expedient where an entity holds a large number of similar but non-identical assets and liabilities that are measured at fair value and a quoted price in an active market is available but not readily accessible for each of those assets or liabilities without difficulty. The entity may use a pricing alternative (e.g., pricing matrix) but the resultant fair value will be categorised as lower than Level 1.
2. When a quoted price in an active market does not reflect fair value at measurement date, for example when there is a significant after-market transaction which takes place after the close of a market but before the measurement date. If an adjustment is made in this regard the resultant fair value will be categorised as lower than Level 1.
3. Where the fair value of a liability or an entity's own equity instrument is determined using the quoted price for the identical asset adjusted for features present in the asset but not the liability. The resultant fair value is categorised as lower than Level 1.

Under no circumstances, however, is management to adjust the quoted price for blockage factors. Blockage adjustments arise when an entity holds a position in a single financial instrument that is traded on an active market that is relatively large in relation to the market's daily trading volume. That is the case even if a market's normal daily trading volume is not sufficient to absorb the quantity held and placing orders to sell the position in a single transaction might affect the quoted price.

Level 2 inputs. Level 2 inputs are inputs for the asset or liability (other than quoted prices within Level 1) that are either directly or indirectly observable. Level 2 inputs are to be considered when quoted prices for the identical asset or liability are not available. If the asset or liability being measured has a contractual term, a Level 2 input must be observable for substantially the entire term. These inputs include:

1. Quoted prices for similar assets or liabilities in active markets.
2. Quoted prices for identical or similar assets or liabilities in markets that are not active.
3. Inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves observable at commonly quoted intervals; implied volatilities; prepayment speeds; loss severities; credit risks; and default rates).
4. Inputs that are derived principally from or corroborated by observable market data that, through correlation or other means, are determined to be relevant to the asset or liability being measured (market-corroborated inputs).

Adjustments made to Level 2 inputs necessary to reflect fair value, if any, will vary depending on an analysis of specific factors associated with the asset or liability being measured. These factors include:

1. Condition;
2. Location;
3. Extent to which the inputs relate to items comparable to the asset or liability;
4. Volume and level of activity in the markets in which the inputs are observed.

Depending on the level of the fair value input hierarchy in which the inputs used to measure the adjustment are classified, an adjustment that is significant to the fair value measurement in its entirety could render the measurement a Level 3 measurement.

During the turmoil experienced in credit markets beginning in early 2008, a holder of collateralised mortgage obligations (CMOs) backed by a pool of subprime mortgages might determine that no active market exists for the CMOs. Management might use an appropriate ABX credit default swap index for subprime mortgage bonds to provide a Level 2 fair value measurement input in measuring the fair value of the CMOs.

Level 3 inputs. Level 3 inputs are unobservable inputs. These are necessary when little, if any, market activity occurs for the asset or liability. Level 3 inputs are to reflect management's own assumptions about the assumptions regarding an exit price that a market participant holding the asset or owing the liability would make including assumptions about risk. The best information available in the circumstances is to be used to develop the Level 3 inputs. This information might include internal data of the reporting entity. Cost-benefit considerations apply in that management is not required to “undertake all possible efforts” to obtain information about the assumptions that would be made by market participants. Attention is to be paid, however, to information available to management without undue cost and effort and, consequently, management's internal assumptions used to develop unobservable inputs are to be adjusted if such information contradicts those assumptions.

Inputs based on bid and ask prices. Quoted bid prices represent the maximum price at which market participants are willing to buy an asset; quoted ask prices represent the minimum price at which market participants are willing to sell an asset. If available market prices are expressed in terms of bid and ask prices, management is to use the price within the bid-ask spread (the range of values between bid and ask prices) that is most representative of fair value irrespective of where in the fair value hierarchy the input would be classified. The standard permits the use of pricing conventions such as midmarket pricing as a practical alternative for determining fair value measurements within a bid-ask spread.

Valuation Techniques

In measuring fair value, management may employ one or more valuation techniques consistent with the market approach, the income approach and/or the cost approach. As previously discussed, the selection of a particular technique (or techniques) to measure fair value is to be based on its appropriateness to the asset or liability being measured and in particular the sufficiency and observability of inputs available.

In certain situations, such as when using Level 1 inputs, use of a single valuation technique will be sufficient. In other situations, such as when valuing a reporting unit, management may need to use multiple valuation techniques. When doing so, the results yielded by applying the various techniques are to be evaluated and appropriately weighted based on judgement as to the reasonableness of the range of results. The objective of the weighting is to determine the point within the range that is most representative of fair value.

If the transaction price is fair value at initial recognition and a valuation technique that uses unobservable inputs will be used to measure fair value in subsequent periods, the valuation technique shall be calibrated so that at initial recognition the result of the valuation technique equals the transaction price. Calibration ensures that the valuation technique reflects current market conditions, and it helps an entity to determine whether an adjustment to the valuation technique is necessary (e.g., there might be a characteristic of the asset or liability that is not captured by the valuation technique).

Management is required to consistently apply the valuation techniques it elects to use to measure fair value. It would be appropriate to change valuation techniques or how they are applied if the change results in fair value measurements that are equally or more representative of fair value. Situations that might give rise to such a change would be when new markets develop, new information becomes available, previously available information ceases to be available or improved techniques are developed. Revisions that result from either a change in valuation technique or a change in the application of a valuation technique are to be accounted for as changes in accounting estimate under IAS 8.

Market approaches. Market approaches to valuation use information generated by actual market transactions for identical or comparable assets or liabilities (including a business in its entirety). Market approach techniques often will use market multiples derived from a set of comparable transactions for the asset or liability or similar items. The entity will need to consider both qualitative and quantitative factors in determining the point within the range that is most representative of fair value. An example of a market approach is matrix pricing. This is a mathematical technique used primarily for the purpose of valuing debt securities without relying solely on quoted prices for the specific securities. Matrix pricing uses factors such as the stated interest rate, maturity, credit rating and quoted prices of similar issues to develop the issue's current market yield.

Income approaches. Techniques classified as income approaches measure fair value based on current market expectations about future amounts (such as cash flows or net income) and discount them to an amount in measurement date dollars. Valuation techniques that follow an income approach include present value techniques, option pricing models, such as the Black-Scholes-Merton model (a closed-form model) and binomial, i.e., a lattice model (an open-form model), which incorporate present value techniques, as well as the multi-period excess earnings method that is used in fair value measurements of certain intangible assets such as in-process research and development.

Cost approaches. Cost approaches are based on quantifying the amount required to replace an asset's remaining service capacity (i.e., the asset's current replacement cost) from the perspective of a market participant buyer. A valuation technique classified as a cost approach would measure the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. Obsolescence adjustments include factors for physical wear and tear, improvements to technology and economic (external) obsolescence. Thus, obsolescence is a broader concept than financial statement depreciation, which simply represents a cost allocation convention and is not intended to be a valuation technique.