Ind AS 113 Fair Value Measurement: A Comprehensive Guide to Valuation in Financial Reporting
The introduction of Indian Accounting Standards (Ind AS), converged with International Financial Reporting Standards (IFRS), has fundamentally transformed the reporting dynamics of the Indian corporate environment. A cornerstone of this new regime is Ind AS 113, Fair Value Measurement, which provides a unified framework for determining value across various financial and non-financial assets.
1. Objectives and Scope of Ind AS 113
The primary goal of Ind AS 113 is to standardise how fair value is calculated and reported in financial statements. Its core objectives include:
- Defining Fair Value: Establishing a clear, consistent definition.
- Measurement Framework: Setting out a single standard for measuring fair value.
- Disclosure Requirements: Ensuring transparency by requiring specific disclosures regarding measurement methods.
When Does Ind AS 113 Apply?
Ind AS 113 is applied whenever another Ind AS requires or permits fair value measurements or disclosures. Common standards that rely on Ind AS 113 include:
- Ind AS 109: Financial Instruments.
- Ind AS 16: Property, Plant, and Equipment.
- Ind AS 40: Investment Property.
- Ind AS 103: Business Combinations.
2. The Core Definition of Fair Value
Under Ind AS 113, Fair Value is defined 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.
Key Aspects of the Definition:
- Asset or Liability Specific: Fair value is measured for a particular asset or liability. The measurement must account for specific characteristics (e.g., condition, location, or restrictions) if market participants would consider them when pricing.
- The Exit Price: Fair value represents an exit price (the price to sell/transfer) rather than an entry price (the price paid to acquire/assume).
- Orderly Transaction: It assumes the asset has been exposed to the market for a usual and customary period to allow for marketing activities. It specifically excludes forced transactions, such as distressed sales or forced liquidations.
3. Market and Market Participants
Ind AS 113 assumes that the transaction occurs in a specific market context involving knowledgeable and independent actors.
Principal and Most Advantageous Markets
- Principal Market: The market with the greatest volume and level of activity for the asset or liability.
- Most Advantageous Market: In the absence of a principal market, this is the market that maximises the amount received to sell the asset or minimises the amount paid to transfer the liability, after considering transaction and transport costs.
Note on Costs: While the price in these markets should not be adjusted for transaction costs (as they are not characteristics of the asset), it should be adjusted for transport costs if location is a characteristic of the asset.
Characteristics of Market Participants
Market participants are buyers and sellers in the principal (or most advantageous) market who are:
- Independent: They are not related parties (unless there is evidence the transaction was at market terms).
- Knowledgeable: They have a reasonable understanding of the asset/liability based on all available information, including due diligence.
- Able and Willing: They have the capacity and desire to enter into the transaction.
4. Highest and Best Use (Non-Financial Assets)
For non-financial assets, fair value measurement considers the "highest and best use" by market participants. This use must be:
- Physically Possible: Considering size, shape, or location.
- Legally Permissible: Accounting for zoning or legal regulations.
- Financially Feasible: The use must generate adequate income or cash flows to produce a required investment return.
5. Valuation Techniques and Approaches
Entities must use valuation techniques that are appropriate for the circumstances and for which sufficient data is available. The goal is to maximise the use of relevant observable inputs and minimise the use of unobservable inputs.
The Three Valuation Approaches
Ind AS 113 outlines three widely used approaches:
| Approach | Description | Key Examples |
|---|---|---|
| Market Approach | Uses prices and relevant information from market transactions involving identical or comparable assets/liabilities. | EBITDA multiples, revenue multiples. |
| Cost Approach | Reflects the amount currently required to replace the service capacity of an asset (often called current replacement cost). | Substitute assets adjusted for obsolescence. |
| Income Approach | Converts future amounts (cash flows or income/expenses) into a single discounted current amount. | Option pricing models, discounted cash flows (DCF). |
Consistency in Techniques
Valuation techniques should be applied consistently. However, a change is appropriate if it results in a more representative fair value due to new markets, new information, or improved techniques.
6. The Fair Value Hierarchy
To increase consistency and comparability, Ind AS 113 establishes a three-level hierarchy that prioritises the inputs used in valuation.
| Level | Input Description | Examples |
|---|---|---|
| Level 1 | Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. | Listed equities, G-Secs, Treasury bills, Gold bullion. |
| Level 2 | Inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly. | Quoted prices for similar assets, prices in inactive markets, interest rates, yield curves. |
| Level 3 | Unobservable inputs for the asset or liability, reflecting the entity's own assumptions about market participant assumptions. | Financial forecasts, historical volatility, private equity shares, complex derivatives. |
7. Disclosure Requirements
Transparency is a critical component of Ind AS 113. Entities must disclose information that helps users assess:
- Valuation Methods: For assets/liabilities measured at fair value on a recurring or non-recurring basis, the techniques and inputs used.
- Level 3 Impact: For recurring measurements using significant unobservable inputs (Level 3), the effect of the measurements on profit or loss or other comprehensive income for the period.
Important Terms to Remember
- Unit of Account: The level at which an asset or liability is aggregated or disaggregated for recognition purposes.
- Observable Inputs: Inputs developed using market data reflecting assumptions market participants would use.
- Unobservable Inputs: Inputs for which market data is unavailable, developed using the best information about market participant assumptions.
- Exit Price: The price received to sell an asset or paid to transfer a liability.
Key Takeaways for Valuers
- Standardisation: Ind AS 113 eliminates diversity in valuation practices by providing a single framework.
- Maximise Observability: Always prioritise Level 1 and Level 2 inputs over Level 3 to ensure higher reliability and less disclosure scrutiny.
- Context Matters: Fair value is not absolute; it depends on the principal market and the specific characteristics of the asset or liability at the measurement date.
- Documentation: Given the disclosure requirements, valuers must maintain robust records of their chosen techniques and the rationale behind the inputs used.