In a recent memorandum, IASB Member Phillipe
Anjou noted that, while IFRS generally
require fair value accounting of financial instruments, IFRS do not require, nor does the IASB plan
that they will require, that all assets and liabilities be stated at fair
value. The IASB has clearly confirmed a preference for a mixed system of
measurements at fair value and measurements at depreciated historical cost,
based on the business model of the entity and on the probability of realizing
the asset and liability-related cash flows through operations or transfers. A
mixed model has been in use since 1989 under IAS 39, noted the Member, it will
be maintained under the new IFRS 9.
Fair value is defined as the price which would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants, at the measurement date. It is thus an exit price. The valuation technique to be used depends on each context, and three approaches are possible: income-based, market-based, or cost-based. For financial instruments, noted the IASB Member, fair value is thus a market price, either observed when trading activity is available, or estimated from economic data. IFRS 13 does not prescribe the models used for this purpose. When the market transaction volume decreases so significantly that the observed value no longer reflects the price which would result from a transaction concluded under normal terms and conditions, a more detailed review of this transaction is required, and the price may need to be adjusted.
IFRS 13 describes the fair value concept and how to implement it. Fair value is not always identical to market value, said Member
though priority must always be given to observable data when using a
mathematical model to estimate fair value. The fair value is stated either
directly in the financial statements, and affects the performance
measurement and the accounting net position, or in the notes, to improve the disclosure of risks and of value that may be realizable.
According to the IASB Member, structured or complex financial assets generating cash flows which do not depend only on capital and on contractual interest representing the time value of money and credit risk should definitely be recorded at fair value in the income statement. Embedding in these assets some derivative instruments or leverage clauses substantially alters future cash flows, he said, and historical cost would not reflect the resulting risks. The same applies to assets held in trading portfolios since these are held only with a view to being sold in a relatively short term.
Since derivative financial instruments, such as swaps and options, do not have a cost when signed, their historical cost is not relevant and obviously useless to measure the extent of the commitments undertaken. A market value measurement with matching changes in the income statement is therefore needed to reflect the risks. This certainly generates some volatility, acknowledged the IASB Member, but IFRS 9 contains hedge
accounting provisions which neutralize this volatility when the use of derivative instruments is part of a hedging strategy, provided its effectiveness can be demonstrated.