The COVID-19 coronavirus pandemic has significantly affected financial markets in the first quarter of 2020. Stock markets have declined sharply and volatility has increased. Treasury bond yields have reached record lows and credit-default-swap indices have been surging, reflecting concerns of increased corporate defaults. For many assets and liabilities, fair values may have changed significantly, reflecting changes in cash flow forecasts, higher uncertainty and elevated risks.
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]
Performing a valuation that uses significant unobservable inputs is challenging, especially at times, as now, when markets are volatile and the economic outlook is highly uncertain and may change quickly.
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]
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 judgment may be needed to quantify risk premiums and other adjustments for these risks. Also, the number of fair value measurements classified as Level 3 in the fair value hierarchy may increase (e.g. due to unobservable inputs such as the credit risk becoming significant in the current environment).
What do you need to disclose?
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 Fair Value Measurement 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, including sensitivity disclosures. [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 entities may need to provide on accounting issues arising from the pandemic.
References to ‘Insights’ mean our publication Insights into IFRS
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