Fair value measurement and financial statement presentation

Lesson 1 described two families of measurement: historical cost and current value. Historical cost is easy to verify but can grow stale; current value is more relevant for some assets but depends on estimates. Fair value is the current value that standards use most often, for investments in shares and bonds, for impairment tests, for assets acquired in a business combination, for investment property and biological assets under IFRS, and for many disclosures. This lesson explains how fair value is measured and how its inputs are graded by reliability. It then turns to presentation: how the income statement and statement of comprehensive income are organized, including the new IFRS 18 categories and subtotals and the US disaggregated expense disclosures, and how discontinued operations are shown. Lesson 3 covers the statement of financial position and the statement of cash flows.

What fair value means

ASC 820, Fair Value Measurement, 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. IFRS 13 uses essentially the same definition; the two were developed together in 2011 and remain closely aligned.

Several words in the definition carry weight. It is an exit price, what the company would receive to sell, not what it would pay to buy (an entry price), although the two are often close. It is market-based, not entity-specific: it reflects the assumptions market participants would use, not management's own plans. It assumes an orderly transaction, not a forced sale or distressed liquidation. It is measured in the principal market for the asset (the market with the greatest volume and level of activity) or, if there is none, the most advantageous market. Transaction costs are not deducted from fair value, although transport costs to get the asset to market are.

For non-financial assets such as land, buildings or equipment, fair value assumes the asset's highest and best use: the use by market participants that would maximize its value, provided it is physically possible, legally permissible and financially feasible. If Northlake owns a vacant lot zoned for commercial development that it uses for parking service vans, its fair value reflects commercial development value if that is legally permitted and feasible, even though Northlake intends to keep parking vans there.

Valuation techniques

Standards recognize three valuation approaches, and an entity uses whichever are appropriate and for which enough data is available, maximizing the use of observable inputs. The market approach uses prices and other information from market transactions involving identical or comparable assets, such as quoted share prices or multiples of comparable companies. The income approach converts future amounts (cash flows or earnings) into a single current amount by discounting, as in a discounted cash flow model or option-pricing model. The cost approach reflects the amount that would be required currently to replace the service capacity of an asset (current replacement cost), adjusted for obsolescence; it is common for specialized equipment.

The fair value hierarchy

Because fair value can rely on more or fewer estimates, the standards classify the inputs used into three levels and require disclosure by level. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date, such as the closing price of a share on the TSX or NYSE. Level 2 inputs are observable inputs other than Level 1 prices: quoted prices for similar assets, prices in inactive markets, and observable inputs such as interest rates, yield curves and credit spreads. Level 3 inputs are unobservable, reflecting the entity's own assumptions about what market participants would use, such as projected cash flows for a private company or a discount rate built from judgment. The whole measurement is classified at the lowest level of any significant input.

The hierarchy is about inputs, not about which assets are safe. A share of a large listed company is Level 1 even if its price is volatile; a private company's shares are Level 3 even if the business is stable. For Level 3 measurements, both IFRS 13 and ASC 820 require a reconciliation of opening and closing balances, quantitative information about significant unobservable inputs and a description of valuation processes; IFRS also requires sensitivity information. Analysts pay close attention to Level 3 balances because they are where management judgment can most influence reported values.

# Classify fair value measurements by the lowest significant input (illustrative)
holdings = [
    # name, fair value, levels of significant inputs used
    ("Listed shares (exchange price)", 820_000, [1]),
    ("Corporate bond (priced from yield curve)", 410_000, [2]),
    ("Interest rate swap (observable curves)", 35_000, [2]),
    ("Shares of a private supplier (DCF)", 260_000, [2, 3]),
    ("Contingent consideration owed (probabilities)", -140_000, [3]),
]
totals = {1: 0, 2: 0, 3: 0}
for name, fv, levels in holdings:
    level = max(levels)          # lowest priority = highest level number
    totals[level] += fv
    print(f"Level {level}  {fv:>10,}  {name}")
print("Totals by level:", {k: f"{v:,}" for k, v in totals.items()})
assets = sum(fv for _, fv, _ in holdings if fv > 0)
print(f"Share of fair-valued assets in Level 3: {260_000 / assets:.1%}")

Level 1     820,000  Listed shares (exchange price)
Level 2     410,000  Corporate bond (priced from yield curve)
Level 2      35,000  Interest rate swap (observable curves)
Level 3     260,000  Shares of a private supplier (DCF)
Level 3    -140,000  Contingent consideration owed (probabilities)
Totals by level: {1: '820,000', 2: '445,000', 3: '120,000'}
Share of fair-valued assets in Level 3: 17.0%

The private supplier's shares use some observable inputs, but the cash flow forecast is a significant unobservable input, so the whole measurement drops to Level 3. The contingent consideration is a liability measured at fair value and is also Level 3. About 17 percent of Northlake's fair-valued assets rely on its own assumptions, which a reader of the notes would want to examine.

Presenting performance: the statement of profit or loss

US GAAP does not prescribe a full income statement format. Public companies follow SEC Regulation S-X (Rule 5-03), which lists captions such as net sales, cost of goods sold, selling, general and administrative expenses, interest expense, income tax expense and net income. Companies present either a single-step statement (all revenues less all expenses) or, more commonly, a multiple-step statement with subtotals such as gross profit and operating income, although 'operating income' is not defined in US GAAP. Expenses are usually presented by function (cost of sales, selling, general and administrative, research and development).

The FASB addressed the same need for detail differently. ASU 2024-03, Disaggregation of Income Statement Expenses (often called DISE), requires public business entities to disclose, in a tabular note, the amounts of purchases of inventory, employee compensation, depreciation, intangible asset amortization and, for oil and gas producers, depletion included in each relevant expense caption on the face of the income statement, together with selling expenses and a qualitative description of amounts not separately disaggregated. It is effective for annual periods beginning after 15 December 2026 and interim periods beginning after 15 December 2027 (as clarified by ASU 2025-01), with early adoption permitted. By contrast, IFRS 18, effective for annual periods beginning on or after 1 January 2027, changes the face of the IFRS income statement itself: operating, investing and financing categories, two defined subtotals (operating profit, and profit before financing and income taxes) and disclosure of management-defined performance measures. A US analyst comparing a US company with an IFRS reporter after 2027 will see different structures.

Other comprehensive income

Some gains and losses bypass net income and are reported in other comprehensive income (OCI) under ASC 220: unrealized gains and losses on available-for-sale debt securities, foreign currency translation adjustments, certain cash flow hedge results and pension remeasurements (ACCT-212). Unlike IFRS, US GAAP does not allow revaluation of property, plant and equipment, so there is no revaluation surplus, and equity investments are measured at fair value through net income rather than OCI. Accumulated OCI appears in equity, and amounts are generally reclassified ('recycled') into net income when realized. Comprehensive income is presented in one continuous statement or in two consecutive statements.

Discontinued operations

When an entity disposes of, or classifies as held for sale, a component whose disposal represents a strategic shift that has (or will have) a major effect on operations and results, ASC 205-20 requires its results to be presented separately, net of tax, after income from continuing operations, with prior periods restated. A long-lived asset or disposal group classified as held for sale under ASC 360 is measured at the lower of carrying amount and fair value less costs to sell and is no longer depreciated. Separating discontinued operations helps users predict future results from the operations that will continue.