In this article we will look at some further challenges in the implementation of the IFRS 13 Fair Value standard. This article considers challenges in the area of market definition.
IFRS 13 identifies 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. The market used for this assessment is referred to as the Principle Market.
However, many organisations trade in many different markets. Furthermore many organisations trade in many different segments of many markets. So, which market is the Principle Market that will be used to assess Fair Value?
IFRS 13 recommends that the Principle Market be the market with the greatest volume and level of activity for the asset or liability. This is assumed to be the market where the entity normally transacts. But what if the entity normally transacts in many different markets? In this case, should the entity consider the market where the entity has the greatest volume of activity, or the market which has the greatest volume of activity, even though the entity may only have a small percentage of the activity of this market.
Alternatively there is another argument that says that the entity should consider the market in which it is growing fastest.
IFRS 13 states that, if there is no principal market for an asset, then the most advantageous market is used. Again, this clarification raises as many questions as it provides answers. Preparers and users of Financial Statements need to understand how to determine which market is the most advantageous market. IFRS 13 states that the most advantageous market is the one that maximises the amount that would be received for the asset or paid to extinguish the liability after transport and transaction costs. This suggests that market in which we can obtain the highest price with respect to the cost of the asset, that is, achieve the highest margin.
But, as proponents of management Accounting will readily tell us, the cost of an asset is not always an absolute number. The cost of any asset is very much influenced by how an organisation allocates the costs to this asset. A minor adjustment on the basis of allocating costs to a product can have a significant impact on the reported margin on sale of that product.
So, in summary, even though Fair Value is a desirable measurement basis to improve understandability, reliability and comparability of Financial information, the range of criteria that can influence the market in which Fair Value is determined can often undermine some of these advantages.