Full explanation
Overview
Two funds hold the exact same corporate bond. One reports it at ninety-eight. The other at ninety-four. Same instrument, same date, same definition of fair value. The four-point gap is entirely about which inputs each one was allowed to use.
IFRS thirteen doesn't tell you WHEN to measure something at fair value — other standards do that. It tells you HOW: one consistent definition, one measurement framework, and one disclosure package, applied every time fair value is required anywhere in the accounts.
Scope & carve-outs
IFRS thirteen applies whenever another standard requires or permits fair value — IFRS nine financial instruments, IAS forty investment property, business combinations, and more. It carves a few things OUT: share-based payments under IFRS two, leases under IFRS sixteen, and measurements that only resemble fair value, like net realisable value in IAS two and value in use in IAS thirty-six. Those have their own rules.
An exit price
The definition, word by word, because every word does work. Fair value is 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. It's an EXIT price, not what you paid to get in. It's hypothetical — an orderly transaction, not a forced sale. It's from the perspective of market participants, not your own intentions. And it's at today's date, using today's conditions.
Principal, or most advantageous
Which market's price? The PRINCIPAL market — the one with the greatest volume and level of activity for that asset or liability. If there's no principal market, the MOST ADVANTAGEOUS one — the market that maximises the amount received for an asset after transport costs. The price itself is not adjusted for transaction costs — those aren't a feature of the asset — but they do help identify which market is most advantageous. Transport costs, if location is a characteristic of the asset, DO adjust the price.
Market participants, not you
Market participants are buyers and sellers who are independent of each other, knowledgeable, and able and willing to transact. The measurement uses the assumptions THEY would use when pricing the asset — including assumptions about risk. It is explicitly NOT about what the reporting entity intends to do with the asset, or the price it would personally accept. Your intentions are irrelevant to fair value.
Highest and best use
For a non-financial asset — land, a building, a brand — fair value assumes its HIGHEST AND BEST USE by market participants. That use must be physically possible, legally permissible, and financially feasible. It may not be how YOU currently use it. A factory site worth more as residential land is measured at the residential value, even if you have no intention of selling. And 'defensive value' counts: if a market participant would pay to hold an asset idle to protect a competitive position, that's the fair value.
So the definition is fixed. The real question every preparer faces is where the number actually comes from — and how much judgement is baked into it.
Three approaches
Three valuation approaches, used alone or together. The MARKET approach uses prices from actual transactions in identical or comparable assets — trading multiples, recent deals. The INCOME approach converts future amounts to a single present value — discounted cash flow, option pricing models. The COST approach reflects the amount required to replace an asset's service capacity — current replacement cost less obsolescence. You choose the approach that's appropriate and for which sufficient data exists, maximising observable inputs and minimising unobservable ones.
Ranked by input quality
That last phrase drives the fair value hierarchy — three levels, ranked by input quality. LEVEL ONE: quoted prices in active markets for IDENTICAL assets, unadjusted. The gold standard — a listed share's closing price. LEVEL TWO: inputs other than quoted prices that are observable — quoted prices for SIMILAR assets, observable interest rates, credit spreads, yield curves. LEVEL THREE: unobservable inputs — the entity's own assumptions, internal models, forecasts where no market data exists. The level of the WHOLE measurement is set by the LOWEST-level input that is significant to it.
Three defensible numbers
The opener's bond, priced three ways. LEVEL ONE: it trades actively on an exchange and the quoted price is ninety-eight — use it, no adjustment. LEVEL TWO: it's thinly traded, so you price it off actively-quoted bonds of similar maturity and credit quality, landing at ninety-six. LEVEL THREE: no comparable trades at all, so you run a discounted cash flow using an internally-estimated credit spread — ninety-four. All three are defensible fair values under IFRS thirteen. The difference is entirely the observability of the inputs — and that is exactly what the hierarchy is designed to make visible.
Different asset, different toolkit
Practically, where does the number actually come from? It depends entirely on the asset. A listed security: the exchange close, done. A thinly-traded bond: a broker quote, or matrix pricing built off a benchmark yield curve plus a credit spread for that issuer. An unlisted equity stake: guideline public-company multiples, recent transactions in comparable businesses, or a discounted cash flow — then adjusted for a control premium or a discount for lack of marketability. Property: an independent professional valuer using comparable sales or an income capitalisation. A derivative: a standard pricing model fed with observable rates and volatilities. Same framework, very different toolkit.
The level moves
Before and after, on one holding. A company holds an unlisted equity stake it has always carried using a Level three discounted cash flow at nine million pounds. A funding round in a comparable company now gives an observable market multiple. AFTER: the measurement moves to Level two at eleven million. The two-million uplift runs through profit or loss or OCI per IFRS nine — but just as importantly, the DISCLOSURE changes: the Level three reconciliation and sensitivity analysis fall away, replaced by the Level two technique-and-inputs note. A reader watching the hierarchy sees the estimation risk drop, not just the number rise.
And because those three numbers can all be called fair value, the disclosure is where IFRS thirteen actually does its job.
The real job of IFRS 13
Disclosure, and it scales with judgement. For every class of asset and liability measured at fair value: the fair value, and the LEVEL of the hierarchy it sits in. Transfers between Level one and Level two, and the reasons for them. For Level two and Level three: a description of the valuation technique and the inputs used. And for Level three specifically, the heavy package — a RECONCILIATION of opening to closing balances showing gains, losses, purchases and sales; quantitative information about the significant unobservable inputs; and a SENSITIVITY analysis showing how the fair value would change if those inputs were reasonably different.
Practical challenges
Where this bites in practice. Illiquid or stressed markets push measurements down into Level three, right when reliability matters most. Day-one gains and losses appear when the transaction price differs from a model-derived Level three value — and IFRS nine restricts recognising that difference immediately. Auditors concentrate their effort on Level three assumptions because that's where the estimation risk lives. And the sheer volume of hierarchy disclosure can bury the one number that actually moves the needle.
Five traps
The mistakes that recur, and the fix for each. Stale comparables — refresh every measurement date and adjust for how the market has moved since. Cherry-picking the flattering multiple — set selection criteria in advance and carry a range, not a single point. A discount rate lifted from a generic cost of capital — build it up from the risk of THESE specific cash flows instead. Forgetting the marketability or control adjustment — apply it explicitly and disclose it. And model risk — always cross-check with a second technique; a wide gap between two methods is telling you an input is wrong, not that you should average them.
You manage the uncertainty
And when there is genuinely not enough information? You don't get to skip the measurement — you manage the uncertainty. Widen the range of reasonable inputs and select the point most representative within it. Use more than one technique and weight them. For an unlisted equity investment where more recent information is genuinely insufficient, IFRS nine allows COST to be an appropriate estimate of fair value — but only narrowly, and never once performance, a funding round, or market moves show cost is no longer representative. In a distressed or inactive market, a forced-sale quote is NOT fair value — adjust it, or move to a model. And whatever you do, disclose the uncertainty loudly: the range considered, the sensitivity, and why.
Behind everything
IFRS thirteen is plumbing for the whole framework. It's the fair value definition behind IFRS nine's financial instruments, IFRS two's share-option valuations, IAS nineteen's plan assets, IAS forty's investment property, IAS thirty-six's fair value less costs of disposal, and every fair value in a business combination. Its own recent changes are consequential only — minor amendments from IFRS eighteen and IFRS nineteen, both issued in twenty twenty-four. The core framework has been stable since twenty thirteen.
The hierarchy is a judgement map
From an investor's chair, the hierarchy is a judgement map. A balance sheet heavy in Level three fair values is concentrating estimation risk — small assumption changes swing reported equity. The sensitivity disclosure is where that risk is quantified; read it before you trust the headline fair value. And comparing two firms with very different Level mixes means comparing a marked-to-market number against a marked-to-model one — not the same quality of evidence, even when both are labelled fair value.
Three FAQs
Three questions that recur. First — if a quoted price exists but the market's gone quiet, is it still Level one? Only if the market is still ACTIVE; a stale or forced quote drops you to Level two or three, with the judgement that implies. Second — can fair value ever be below a recent purchase price? Yes — you paid entry price plus, sometimes, value you alone see; fair value is the exit price a market participant would pay, and day one that can be lower. Third — does 'highest and best use' mean I must revalue my whole factory as development land? For measurement under a standard that requires fair value, yes, that's the basis — but it doesn't force you to sell, change use, or adopt fair value where the standard lets you use cost.
Put the bond, its three levels, and the disclosure that follows onto one page.
Same asset, same rulebook
One bond, one measurement date. Actively traded: Level one, quoted price ninety-eight, no further disclosure needed beyond the level. Thinly traded: Level two, priced off similar bonds at ninety-six, disclose the technique and the observable inputs. No comparable market: Level three, discounted cash flow at ninety-four, disclose the technique, the unobservable credit spread, a full opening-to-closing reconciliation, and a sensitivity analysis. Same asset, same rulebook — and the disclosure tells the reader exactly how much to trust the number.