The COVID-19 coronavirus pandemic significantly affected economic activity and financial markets in 2020. For many assets and liabilities, fair values may have changed significantly, reflecting changes in cash flow forecasts, higher uncertainty and elevated risks. Performing a valuation in these market conditions is more challenging, in particular when significant unobservable inputs are used.
Fair value is a market-based measurement – it is measured using assumptions that market participants would use, reflecting market conditions at the measurement date. According to IFRS 13 Fair Value Measurement, a quoted price in an active market provides the most reliable evidence of fair value and if one is available then it has to be used to measure fair value. Use of hindsight or adjusting for what may be viewed as depressed pricing at the measurement date in light of subsequent changes in market prices is not permitted. [IFRS 13.77, 79]
The fair value of an asset (or liability) should reflect market conditions at the measurement date. This has become more challenging due to the uncertainty of the economic impact of COVID-19.
‘Unobservable inputs’ are inputs for which market data is not available and that are developed using the best information available about the assumptions that market participants would make in pricing the asset or liability, including assumptions about risk. Unobservable inputs used in valuations may require significant adjustment to reflect the risks and uncertain market conditions at the measurement date. [IFRS 13.A]
Greater estimation uncertainty and less observable market data may require companies to change valuation techniques and use more judgements and assumptions. This may lead to a higher number of fair value measurements classified as Level 3 in the fair value hierarchy – e.g. due to unobservable inputs becoming significant in the current environment.
Reflecting risks and market conditions at the measurement date
Some of the key factors and risks to consider when measuring fair value using a valuation technique include the following.
Significant judgement may be needed to quantify risk premiums and other adjustments for these risks. Incorporating other specific effects of the pandemic – e.g. support measures from the state or international organisations, including the potential effects of the withdrawal thereof, may require significant judgement as well.
This increases the importance of providing disclosures around the key assumptions and judgements used, to help users of financial statements understand the impact of COVID-19 on a company’s fair value measurements.
The number of significant unobservable inputs may have increased – this may lead to a higher number of Level 3 measurements and with it to more disclosures that are required by IFRS 13.
What do you need to disclose?
Disclosures related to fair value measurement are likely to be a focus area for regulators. Preparers are expected to explain how COVID-19 has affected significant judgements and estimation uncertainty – e.g. the assumptions underlying fair value measurement. In a recent statement ESMA1, the European regulator, strongly recommends that companies provide information about the sensitivity of carrying amounts to the methods, assumptions and estimates underlying their calculations. For more information, see our article on ESMA’s enforcement priorities for 2020.
Given the impact of the increase in economic uncertainty on forecasting cash flows and other unobservable inputs used in valuation techniques (e.g. certain risk-adjusted discount rates), companies may need to provide sensitivity disclosures – together with disclosure of the key assumptions and judgements made by management – to enable users to understand how fair value has been determined. These disclosures are required under both IFRS 13 and IAS 1 Presentation of Financial Statements. IFRS 13 also contains specific disclosure requirements when amounts are transferred into Level 3 of the fair value hierarchy. [IFRS 13.93(e)(iv), 93(h), IAS 1.125, 129]
IAS 34 Interim Financial Reporting requires companies to provide many of the IFRS 13 disclosures on fair value measurement of financial instruments, including the sensitivity disclosures and significant transfers between levels in the fair value hierarchy. Additionally, IAS 34 requires companies to explain events and transactions that are significant to an understanding of the changes in a company’s financial position and performance since the last annual reporting date. Therefore, fair value disclosures related to non-financial assets and non-financial liabilities are required if they are material to an understanding of the current interim period. This may be the case when fair values change significantly. [IAS 34.15, 16A(j)]
Our annual Guides to financial statements, which help you to prepare financial statements in accordance with IFRS® Standards, this year include a COVID-19 supplement illustrating additional disclosures that companies may need to provide on accounting issues arising from the pandemic.
References to ‘Insights’ mean our publication Insights into IFRS
1 European Securities and Markets Authority
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