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Relevance of Level 3 fair value disclosures and IFRS 13: a case study

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Abstract

This paper studies the relevance of Level 3 fair value disclosures in financial statements for equity analysts. The research also examines the impact that implementation of IFRS 13 Fair Value measurement had on the relevance of disclosures and disclosure practice. Semi-structured interviews with equity analysts and fair value disclosures of three listed real estate companies are used to analyse relevance of fair value disclosures. Equity analysts focus on cash flow and do not incorporate Level 3 fair values as an input in their valuation. These results indicate that Level 3 fair value measurements or fair value disclosures have little relevance or information value for analysts. However, the fair value disclosures appear to have to some extent confirmative value as they provide the analysts with comfort over their own fair valuation measurements and verify the credibility of management. The additional disclosure requirements implemented with IFRS 13 have scant relevance for equity analysts. The results provide evidence that standard setters, auditors and preparers of financial statements with significant Level 3 estimates should focus on predictive and forward-looking disclosures to evaluate future cash flows. Detailed disclosures about management valuation process and sensitivity analysis have limited relevance for the analysts. This study links together the analysts and disclosures literature and provides insights into relevance of fair value disclosures and understanding how analysts process and use fair value disclosures.

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Notes

  1. IFRS 13 defines a fair value hierarchy which gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1 inputs) and lowest priority to fair value inputs that consist of entity’s own data and unobservable inputs (Level 3).

  2. IFRS Practice Statement 2 Making Material Judgements provides a guidance on how to make materiality judgements.

  3. The qualitative characteristics of useful accounting information are: Relevance and faithful representation (fundamental characteristics) and comparability, verifiability, timeliness and understandability (enhancing characteristics).

  4. Based on information in the 2018 financial statements.

  5. IFRS Standards Project Summary https://www.ifrs.org/investor-centre/project-summaries/

  6. Level 2 inputs are observable inputs other than quoted price which are included within Level 1 such as quotes price for similar assets.

  7. Revenue information is taken as an example in IFRS 13 for information that can have both confirmatory and predictive value. The revenue can be used as the basis for predicting revenues in future years but also be compared with revenue predictions for the current year that were made in past years (CF 2.10).

  8. Example of fair value disclosure for one of the case companies (Reginn hf.) is included in “Online Appendix 3”.

  9. The disclosure checklists for the case companies are included in “Online Appendix 2”.

  10. IFRS 13 was implemented in 2013 and the financial statements for the 2012 were therefore used to analyse the fair value disclosure before the implementation of IFRS 13.

  11. See “Online Appendix 1” for the interview guide.

  12. Receivables accounts for 0.2–0.4% of total assets of the case companies.

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  1. Reykjavik University, Reykjavik, Iceland

    Árni Claessen

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  1. Árni Claessen
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Correspondence to Árni Claessen.

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Claessen, Á. Relevance of Level 3 fair value disclosures and IFRS 13: a case study. Int J Discl Gov 18, 378–390 (2021). https://doi.org/10.1057/s41310-021-00119-z

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