What Is Fair Value According to IFRS 13?

Fair value is one of the most important concepts in modern accounting. 

Whether you’re preparing financial statements, valuing stock options, or complying with IFRS 13, understanding fair value ensures that assets and liabilities are reported at an amount that reflects current market conditions rather than outdated historical costs.

In the case of stock options, fair value is central to every key decision, from setting strike prices to expensing option-based compensation. 

What is fair value under IFRS 13?

IFRS 13 fair value measurement is the standard that provides a single, consistent framework for determining fair value. Before IFRS 13, different standards defined and measured fair value in slightly different ways; IFRS 13 replaced those inconsistencies with one authoritative definition.

Under IFRS 13, fair value is “the price you would receive to sell an asset or pay to transfer a liability in a normal transaction with market participants on the specific date it is measured.”

The standard also clarifies how to identify the market you’re using for your measurement:

• Principal market: the market with the greatest volume and level of activity that the entity can access.
  
• Most advantageous market: the market that would maximise the amount received for the asset (or minimise the amount paid for the liability) after considering transaction and transport costs.

Although IFRS 13 itself doesn’t apply to certain areas such as share-based payments (those fall under IFRS 2) or leases (IFRS 16), it underpins the way you estimate the value of inputs to those standards. 

For example, when valuing employee stock options under IFRS 2, the fair value of the underlying shares is determined using IFRS 13 principles and fed into an option-pricing model.

Fair value vs market value

Although people often use “fair value” and “market value” interchangeably, they’re not the same thing. 

Market value is simply the observable price in an active market at a given moment. For example, the quoted share price of a publicly traded company. 

Fair value, by contrast, is an estimate of the exit price under IFRS 13. It uses market data where available but also allows for adjustments and assumptions when reliable data isn’t observable, which is frequently the case with private company shares or employee stock options.

Fair value hierarchy: Levels 1, 2 and 3

IFRS 13 introduces a three-level hierarchy to rank the quality of the inputs you use when measuring fair value. 

The hierarchy doesn’t dictate the valuation method itself; it prioritises the data that feeds your method. 

• Level 1 inputs are the gold standard: unadjusted quoted prices in active markets for identical assets or liabilities.

Example: The closing price of a publicly listed share on a stock exchange on the grant date. If your company’s shares are publicly traded, this Level 1 input feeds directly into the option-pricing model.

• Level 2 inputs are other observable inputs for similar (but not identical) assets or liabilities.

Example: Quoted prices for comparable bonds, interest rates or yield curves. In stock-option contexts, a late-stage private company might use the volatility of similar public companies or industry-specific multiples as Level 2 inputs to its model.

• Level 3 inputs are unobservable inputs developed by the entity itself when market data isn’t available.

Example: Discounted cash-flow projections, internally estimated volatility or expected option life for an early-stage company. Because these assumptions are entity-specific, they require more disclosure and sensitivity analysis.

Tip: Always maximise the use of Level 1 and Level 2 inputs and minimise Level 3 inputs to increase reliability and reduce auditor or regulator challenge. 

Valuation approaches to measure fair value

IFRS 13 recognises three broad approaches for estimating fair value. 

These aren’t mutually exclusive, many companies blend them to cross-check results, but each one has a distinct logic.

1. Market approach

Uses actual transaction prices for identical or comparable assets or liabilities. For publicly traded shares this can be as simple as the quoted price on the grant date. For private companies issuing options, it may involve looking at recent independent transactions in your own equity, secondary sales, or applying valuation multiples (like revenue or EBITDA multiples) from comparable public companies to your own financials.

2. Income approach

Converts expected future cash flows into a present value by applying a discount rate that reflects the risk of those cash flows. This discounted cash-flow (DCF) method is common when valuing early-stage or cash-generating private businesses whose shares aren’t traded. Those DCF results then inform the price per share used in your option-pricing model.

3. Cost approach

Estimates what it would cost to replace the service capacity of an asset today, adjusted for depreciation or obsolescence. While less common for equity itself, this approach can be relevant when valuing certain intangible assets or when a company’s primary assets are hard to price directly from market or income data.

Because no single approach fits every situation, a combination is often used to triangulate the most reasonable fair value. 

Is fair value a good indicator?

Fair value is widely regarded as the best available measure for options and other equity-based awards because it aligns reported numbers with economic reality rather than historical cost.

Advantages:

• Reflects current market conditions. This is especially important for stock options, where strike prices and compensation expense should be based on what the underlying shares are actually worth at the grant date.
• Enhances comparability across entities. Using a market-based framework makes it easier for investors, auditors and regulators to compare the true cost of equity compensation between companies.
• Limits earnings manipulation. Because fair value relies on observable data and established models, it’s harder for companies to “manage” reported compensation expense by choosing favourable historical numbers.
  

Limitations:

• Greater volatility. If markets swing, the fair value of the underlying shares can change quickly, affecting option strike prices and compensation expense from one grant to the next.
  
• More judgement for illiquid assets. Early-stage private companies often rely on Level 3 inputs (internal projections, estimated volatilities) to value shares and options, which introduces subjectivity and requires robust documentation.
  
• Potential confusion. Employees and even some investors may not understand why the option value reported in the financials differs from the strike price or perceived “worth” of the company.
  

The key to making fair value a reliable indicator is consistent methodology and transparent disclosure. For stock options, that means using the same valuation models and assumptions consistently over time, documenting your approach in the financial statement notes, and explaining it clearly to employees and stakeholders.

How do you record fair value in accounting?

Fair value accounting is designed to make financial statements mirror economic reality rather than simply historical cost. When it comes to equity-based compensation, that principle is crucial.

• Financial reporting: Under IFRS 2, companies must recognise an expense for stock options equal to their grant-date fair value. This gives investors a truer picture of what it costs to attract and retain talent than simply showing the cash outlay.
  
• Taxes and audits: In the U.S., IRC Section 409A requires that option strike prices be at least equal to the fair market value of the underlying stock on the grant date. Tax authorities and auditors can challenge, or even penalise, companies whose valuations appear unreasonable or inconsistent with market data.
  
• Compensation planning: Setting option exercise prices at or above fair value protects employees from adverse tax treatment and ensures the award is compliant. For private companies, it also provides a defendable basis for pricing future grants and communicating equity value to employees.

Without fair value accounting, a balance sheet can significantly misstate the real cost of equity awards and the current worth of the underlying shares. That in turn can distort key metrics such as earnings per share, and hide the dilution cost of equity incentives.

Fair value vs historical cost accounting

Fair value accounting bases its numbers on a current market-based estimate, an exit price, while historical cost accounting records the original purchase price of an asset or liability. Because fair value is tied to present conditions, the reported figure can fluctuate as markets change; historical cost stays largely fixed until the asset is disposed of, adjusted only for depreciation or amortisation.

Fair value also enhances comparability across companies because it reflects what each asset would fetch in today’s market rather than the unique price each company paid in the past. Historical cost, by contrast, can obscure economic reality because two firms may own identical assets purchased at very different prices.

Fair value for private vs public companies

How you determine fair value depends heavily on whether your company’s shares trade on a public exchange or are privately held.

Public companies‍

For listed companies, establishing fair value is straightforward: you simply use the quoted market price of the shares on the grant date. This Level 1 input feeds directly into your option-pricing model. Because the share price is observable and updated in real time, both the fair value of the underlying shares and the fair value of employee stock options can be calculated with relatively little subjectivity.

Private companies‍

With no quoted share price, private companies must estimate fair value using IFRS 13 principles or, in the U.S., a 409A valuation. An independent third-party appraiser typically applies one or more of the recognised approaches—market (comparable company multiples), income (discounted cash flows), or cost—to arrive at a per-share value. That value then becomes a key input in the Black-Scholes or binomial model used to calculate the grant-date fair value of options under IFRS 2.

When to revalue‍

Private companies should update their valuations at least annually and also upon any material event that could change the company’s value, such as a new funding round, acquisition, merger, secondary sale or major change in business prospects. These events can significantly alter the fair value of the underlying shares, which in turn affects the strike price you set for new stock options and the compensation expense you recognise.

This distinction matters because regulators expect you to base your option grants on a current, defensible fair value. Public companies achieve this with transparent market data; private companies must show a clear methodology and documentation for each valuation.

Frequently asked questions about fair value

1. What is the meaning of fair value?

Fair value is the estimated exit price between willing market participants on a given date. It reflects what the market would actually pay for an asset. For stock options, fair value is used to determine both the strike price (based on the underlying share FMV) and the compensation expense recorded in the company’s financials (using an option-pricing model).

2. What is fair value vs market value?

Market value is the observable current price of an asset in an active, liquid market. For example, the share price of a publicly traded company. 

Fair value is broader: it uses market data where available but also allows adjustments and assumptions when no direct price exists. This distinction is critical for private companies issuing options, because their shares don’t have a quoted market value. In those cases, appraisers use valuation approaches (market comps, discounted cash flows) to estimate fair value.

3. What is a Level 3 fair value?

Level 3 fair value refers to a measurement based primarily on unobservable inputs like assumptions or models created by the company when no reliable market data is available. An example is using discounted cash flow projections to value the shares of a private early-stage company. 

4. Is fair value a good indicator?

Fair value ensures that financial statements reflect what assets and liabilities are actually worth in today’s market. For stock options, this means employees’ equity grants are priced fairly and consistently. However, fair value can also introduce volatility (as values move with the market) and requires more judgement for illiquid or private securities, which can create uncertainty for employees and investors who are less familiar with valuation methods.