This assignment will be identifying and analysing the issues faced by accountants when valuing a company’s assets and liabilities in the Statement of Financial Position. Valuation of assets and liabilities is important because it can affect various stakeholders such as investors, shareholders and suppliers.
Hierarchy Valuation Methods Specified within IFRS 13
An International Financial Reporting Standard (IFRS) has been developed for accountants to allow them to value assets and liabilities fairly. The standard IFRS 13: Fair Value Measurement came into effect 1st January 2013 and its objectives are to define fair value, set out a framework to measure fair value and also requires accountants to disclose the level of the fair value measurement. It is important to understand that IFRS 13 does not tell you when to use fair value but how to use fair value. This standard creates consistency for businesses when valuing assets and allows accounts to be compared to previous years or competitors.
IFRS 13 applies to standards that permits or requires fair value measurements except for the following that sit outside the scope of the standard:
1. Share based payments (IFRS2)
2. Leases (IAS 17)
3. Net realisable value (IAS 2)
4. Value in use (IAS 36)
IFRS 13 provides accountants with three valuation techniques to help value their company’s assets or liabilities. The three techniques aim to maximize the observable inputs and minimize the unobservable inputs. The valuation techniques are as follows;
Market approach – This technique uses information from transactions of identical or comparable assets/liabilities that are taking place in a liquid market. For example if a company has a fleet of delivery vans they can value these vans as there is a market where delivery vans are openly traded.
Income approach – This valuation technique takes into account the future cash flows and discounts them to value an asset/liability. For example, owning an office building which is rented out to another company. The present value of the building is based on the discounted cash flow amounts.
Cost approach – The cost approach is used when you have an asset that has no market value but still needs to be valued. This technique uses current replacement cost which means how much it would cost a business to replace the asset if the asset ever needed to be replaced.
IFRS does not favour any of these valuation techniques but each technique will be more applicable to some assets. Any valuation of assets or liabilities will need to be backed up by the valuation hierarchy so stakeholders can identify the most reliable information.
There are three levels to the disclosure of the valuation hierarchy in IFRS 13. The first two levels, Level 1 and Level 2, are based on a mark to market approach which means there has to be an active market for there to be a valuation. Level 3 is mark to model and do not have an active markets and the valuation are based on risk-adjusted...