A business entity’s management is responsible for preparing the financial statements following the requirements of the administrative authorities. For example, in the State of Kuwait, the Ministry of Commerce and Industry mandates applying the International Financial Reporting Standards (IFRS) in preparing financial statements.
On the other hand, the auditor’s responsibility is to audit the financial statements, and they should observe the International Standards on Auditing (ISA) when performing audits per the Ministry of Commerce and Industry requirements.
In the course of the International Accounting Standards Board (IASB) efforts intended to ensure that the financial statements reflect the assets and liabilities at the most accurate estimate of fair value,
IFRS 13 “measurement of fair value” (“IFRS 13” or the “Standard”), was issued in 2011 and is effective for periods commencing on or after 1st January 2013.
IFRS 13 Objective
IFRS 13 aims to define the fair value of financial instruments, identify the measurement method, and request specific disclosures to be made regarding the measurement of fair value.
In addition, the Standard sets a general framework to be followed by business entities when measuring fair value. IFRS 13 is applicable when other IFRSs require or permit fair value measurements or disclosures, and the application must be within the limits required or allowed by such IFRSs.
Definition of fair value
IFRS 13 defines fair value as “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”.
Investments at FVPL or FVOCI, real estate investments, and equity instruments constitute the most common inputs for determining fair value.
Business entity’s responsibility for measuring fair value
A business entity’s management is responsible for measuring the fair value of assets and liabilities under evaluation. If the business entity does not have qualified staff to measure the fair value according to the requirements of international standards,
the management may engage the services of an external third party to conduct the valuation process to measure the fair value.
It is worth mentioning that the regulators in the State of Kuwait, i.e., the Central Bank of Kuwait and Capital Markets Authority, mandate the engagement of a licensed independent valuer for real estate investments located inside or outside Kuwait.
Value measurement approaches
IFRS 13 requires business entities to use suitable valuation approaches where sufficient data is available for measuring the fair value, maximize the use of observable data, and minimize the use of unobservable data.
The Standard indicates the widely used valuation approaches, which are:
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Market Approach
Uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities, such as using quoted prices of similar assets.
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Cost Approach
It reflects the amount that would currently be required to replace the service capacity of an asset (current replacement cost).
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Income Approach
This includes the net present value approach, which considers expected future cash flows to be received against holding the liability or the equity instrument as an asset.
When determining the valuation technique for measuring fair value, business entities shall take into account the following factors:
- The asset or liability is to be measured for fair value.
- For non-financial assets, determine the suitable valuation premise (consistently with its highest and best use).
- The principal market (most advantageous).
- The appropriate valuation approach takes into account the availability of data based on which pricing assumptions will be made and the level of the fair value hierarchy within which the inputs are categorized.
Fair value hierarchy
In order to achieve consistency and comparability in fair value measurements and related disclosures, IFRS 13 introduced the following fair value hierarchy:
- Level 1: Inputs are quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date.
- Level 2: Inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. For example, unquoted market prices, prices quoted in inactive markets, or assets and liabilities similar to assets and liabilities categorized in level 1 above.
- Level 3: Inputs are unobservable inputs for the asset or liability.
Auditor’s role in auditing the measurement of fair value
Concerning the measurement of fair value and its related disclosures, International Standard on Auditing 540 “Auditing Accounting Estimates,
Including Fair Value Accounting Estimates, and Related Disclosures” (ISA 540) states that the objective of the auditor is to obtain sufficient appropriate audit evidence to provide reasonable assurance that the measurement of fair value and its related disclosures are in compliance with IFRS requirements.
Should the auditor not have qualified personnel in the field of fair value measurement, he/she shall engage a specialist to examine the valuation process of fair value measurement.
Furthermore, SAS 101 of the Generally Accepted Auditing Standards (GAAS) states that “the auditor does not function as an appraiser and is not expected to substitute his or her judgment for that of the entity’s management. Rather, the auditor reviews the model and evaluates whether the assumptions used are reasonable and the model is appropriate considering the entity’s circumstances”.
In addition, the auditor shall apply the audit methodologies, which ensure verification of appropriateness and reliability of the fair value measurement, including:
- Understand the nature of the business entity, its internal controls, and previous accounting estimates.
- Understand the requirements of IFRS’s concerning fair value measurement and the management’s objective of the measurement.
- Understand the approach and procedures used for the measurement, and evaluate the material misstatement risk involved.
- Test the data, information, assumptions, and estimates used in the measurement.
- Review events and transactions subsequent to the reporting date up to the issue date of the auditor’s report, as they may provide audit evidence concerning fair value measurement as of the reporting date.
- Perform additional procedures, such as physical inspection of the tangible assets or inspection of security, which may reveal a restriction on its marketability that may affect its value.
- Test indications for management misapplication or bias.
Conclusion
We can state that the responsibility of the business entity relating to fair value measurement is to identify and implement the appropriate measurement approach if the entity has the technical capabilities,
or to engage an external third party to perform this assignment (Investment Advisor/Asset Valuator/Real Estate Valuator )
On the other hand, the responsibility of the auditor is to audit the extent of correctness and appropriateness of the valuation method and the reasonability of the assumptions employed to conclude the fair value measurement.