Chasing Myths: Common Misapplications of IFRS and Their Implications Myth 9 – Cost as a Measurement Basis for Investments in Equity Instruments
The subsequent measurement bases for financial assets provided in #IFRS 9 (paragraph 5.2.1) do not include cost. Nevertheless, it is relatively common for entities reporting under IFRS to measure investments in #unquoted equity instruments of other entities at cost, claiming that this results from the inability to reliably determine fair value.
This possibility is actually contemplated in paragraph B5.2.3 of IFRS 9, which acknowledges situations where cost may be an appropriate approximation of fair value. However, as explicitly stated in that paragraph, this is only possible in limited (i.e., rare) circumstances. Considering the examples of indicators that cost is not representative of fair value, listed in paragraph B5.2.4 of the same standard, it can be concluded that the aforementioned “limited circumstances” are restricted to cases where the following conditions both apply: (i) the acquisition of the asset is relatively recent; and (ii) the asset does not exhibit high volatility. In all other circumstances, using cost as an approximation of fair value is not appropriate.
It is important to note that the solution adopted by IFRS 9 for dealing with cost-based measurement is based on a strong presumption: in most cases, fair value can be reliably measured. Therefore, any claimed inability to reliably measure fair value must first be thoroughly assessed.
So, how should entities deal with situations where equity instruments held are unquoted, their fair value is allegedly not reliably determinable, and the “rare circumstances” referred to in paragraph B5.2.3 of IFRS 9 do not apply?
The solution to this issue follows the approach advocated by IFRS/IAS whenever there is a deadlock in applying the standards. That is, the hierarchy of sources set out in IAS 8, paragraphs 8 to 12, should be followed for the definition of accounting policies. In this specific case, the applicable level in the hierarchy is the one derived from paragraph 11(b) – provisions of the IASB’s Conceptual Framework. According to paragraph 5.22 of the IASB’s Conceptual Framework, when there is significant measurement uncertainty associated with an asset or liability, that asset or liability should not be recognized, as doing so would result in information that is not useful for financial statement users.
Thus, recognition of the asset corresponding to the investment in unquoted equity instruments of other entities is not permitted if its fair value cannot be reliably determined (rare situations) and cost is not an appropriate approximation of fair value.