A reading of various accounting standards revealed that the definition of fair value is different under various standards. This could have implications on the carrying amount of an asset or a liability recognised under different accounting standards.

Indian Accounting Standards included in the Companies (Indian Accounting Standards) Rules, 2015 (Ind AS) have a very different definition from those included in accounting standards issued by The Institute of Chartered Accountants of India (ICAI) and those included in The Companies (Accounting Standards) Rules, 2006 (together “AS”). Further, the definitions of fair value also differ amongst different ASs.  

Starting with AS,  unlike Ind ASs,  there is no AS which deals exclusively with fair value measurement.

Accounting standards namely

AS 10, Property, Plant and Equipment

AS 11, The Effects of Changes in Foreign Exchange Rates

AS 15, Employee Benefits

AS 19, Leases

AS 20, Earnings Per Share

AS 26, Intangible Assets

define Fair Value as “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.”

AS 13, Accounting for Investments, defines Fair Value as “the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction. Under appropriate circumstances, market value or net realisable value provides an evidence of fair value.”

AS 14, Accounting for Amalgamations, defines Fair Value as“the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.”

As can be noted from above, there are some differences in all the three definitions.

The first definition does not mention buyers or sellers. While the term “willing parties” includes buyers and sellers, it could include other parties too such as shareholders of an amalgamating or a demerging company even though this definition is not applicable to amalgamations.

Secondly, all definitions mention willing parties or a willing seller. A person in the course of a distress sale or desperate to sell may also be a willing seller. However, we all know that distress sales or desperate sales do not realise fair values.

Thirdly, all definitions mention exchange of an asset rather that buying or selling of an asset. An exchange may take place in situations other than in the course of a sale e.g. receipt of shares of the transferee company by the shareholders of the transferor company in lieu of their shares in the transferor company upon amalgamation of the transferor company into transferee company is an exchange but not a sale.

Fourthly, the definitions do not mention where the exchange of the asset would take place. It may be a market or a private transaction or a transaction between related parties. We all know that transactions between related parties may not neccesarily be at arms length.

Fifthly, the first definition mentions of settling a liability and not transfer of a liability. Most liabilities are settled at their face value and, where applicable, include interest accrued. Hence, the definition does not really cover the fair value of liabilities. For example, in case of corporate bonds/ debentures which are traded on a stock exchange, the quoted price could be different from the face value of the bond plus accrued interest on account of interest rate variations on change in financial standing of the issuer. However, according to the terms of the bond, the bond may only be redeemed (settled) at its face value plus accrued interest. 

Sixthly, none of the definitions specify from whose perspective the definition of fair value is to be considered – whether it is the buyers, acquirers, sellers, or transferors.

Seventhly, none of the definitions mention the date on which the fair value has to be considered. We can only infer that the definition will need to be applied on the transaction date or the balance sheet date, as the case may be.

Eigthly, fair value definitions under AS 13 and AS 14 do not include liabilities. While it is understandable that there is no need to include liabilities in the definition of fair value in AS 13 since it deals only with assets viz. investments, however, AS 14 covers both assets and liabilities and the absence of liabilities in the definition of fair value is inexplicable.

Lastly, the fair value definition in AS 13 also provides an option between the market value and net realisable value. As we know, the difference between the market value and net realisable value is primarily selling costs such as brokerage and securities transaction tax. The reason for having an option of net realisable value is not clear.

Under Ind ASs, Ind AS 113, Fair Value Measurements is the main standard dealing with fair values.

Ind AS 113 and various other Ind ASs namely

Ind AS 101, First Time Adoption

Ind AS 103, Business Combinations

Ind AS 104, Insurance Contracts

Ind AS 105, Non-current Assets Held for Sale and Discontinued Operations

Ind AS 107, Financial Instruments: Disclosures

Ind AS 109, Financial Instruments

define 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.” 

Ind AS 113 further expands the definition of Fair Value as “The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (ie an exit price) regardless of whether that price is directly observable or estimated using another valuation technique”.

Standards other than Ind AS 113 as mentioned above all refer to Ind AS 113 for fair value measurements.

Ind AS 113 provides that it applies to all standards that require or permit fair value measurements or disclosures about fair value measurements (and measurements such as fair values less costs to sell, based on fair value or disclosure about those measurements) except Ind AS 102, Share Based Payment, and Ind AS 116, Leases.

Ind AS 113 also mentions that while the definition of fair value deals with assets and liabilitities, the standard is also applicable for the measurement of entity’s own equity at fair value.

However, two standards Ind AS 102, Share Based Payment, and Ind AS 116, Leases define fair value differently.

A key feature of the fair value definition in Ind AS 113 is that it is a market-based measurement and not an entity-specific measurement. Because fair value is a market-based measurement, it is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. As a result, an entity’s intention to hold an asset or to settle or otherwise fulfil a liability is not relevant when measuring fair value. Hence, entity-specific factors are not to be considered while measuring fair value.

Secondly, the standard provides that where the market price of an asset/ liability or of an identical asset/ liability is not observable, fair value is measured using another valuation technique that maximises the use of relevant observable inputs (such as quote price or interest yield or market multiples) and minimises the use of unobservable inputs (such as cash flow projections).  Hence, there is greater focus on observable inputs than unobservable inputs.

Thirdly, the definition focuses on an exit price i.e. the price to be received to sell an asset or to be paid to transfer a liability. The fair value would be the price before transaction costs i.e. transaction costs are not to be considered. However, in case of movable assets, the standard allows for deduction of transport costs of taking the goods to the market, from the selling price to arrive at the fair value.

Fourthly, the definition provides for an orderly transaction between market participants. This means that it is assumed that the asset or the liability has been marketed properly (marketing activities that are usual and customary for transactions involving concerned assets or liabilities) and for a sufficient period of time, as may be required to sell that asset or a liability. These activities are assumed to take place prior to the measurement date. The standard also provides that the transaction is not a forced sale e.g. a forced liquidation or a distress sale.

Fifthly, market participants are assumed to be independent of the reporting entity, knowledgeable, able to enter into a transaction and willing to enter into a transaction i.e. they are not forced or otherwise compelled to enter into such transaction.

Sixthly, it is mentioned that the transaction shall be in the principal market, or in the absence of principal market, in the most advantageous market. Principal market is defined as the market with the greatest volume and level of activity for the asset or liability. For example, in case of shares listed on more than one stock exchange, the principal market would be the stock exchange which has the greatest trading volume. Most advantageous market is defined as the market that maximises the amount that would be received to sell an asset  or minimises the amount that would be paid to transfer a liability, after taking into account transaction costs and transport costs.

Lastly, the definition clearly mentions that the price to be received or paid is on the measurement date i.e. the transaction date or the financial reporting date as may be applicable.

Ind AS 102 defines Fair value as “The amount for which an asset could be exchanged, a liability settled, or an equity instrument granted between knowledgeable, willing parties in an arm’s length transaction.” The standard further specifies that fair value in respect of equity shares granted to employees would be the market price of the entity’s shares (or an estimated market price, if the entity’s shares are not publicly traded) adjusted for terms and conditions at which the shares are granted. The standard also specifies that share options granted to employees should be valued using an option pricing model after considering various factors as specified in the standard.

Ind AS 116 defines Fair value as “For the purposes of applying lessor accounting requirements is this standard, the amount for which an asset could be exchanged, a liability settled between knowledgeable, willing parties in an arm’s length transaction.” This definition has been carried forward from the old Ind AS 17, Leases since lessor accounting principles as specified in Ind AS 17 have substantiaally been retained in Ind AS 116.

However, the definitions of fair value in Ind AS 102 and Ind AS 116 suffer from the same limitations as mentioned in respect of fair value definitions in AS.