Strategic Business Reporting (International) · Other reporting issues

IFRS 13 Fair Value Measurement: Hierarchy and Highest and Best Use

Updated 11 October 2026 · Fact-checked

Under IFRS 13, fair value is the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. You identify the asset, market and participants, choose a valuation technique, and rank inputs using the three-level hierarchy. Non-financial assets use highest and best use.

Understand IFRS 13 Fair Value Measurement

IFRS 13 does not tell you when to use fair value. Other standards do that, for example IFRS 3, IAS 40, IFRS 9 and IAS 16 (revaluation model). IFRS 13 tells you how to measure it, so you have one consistent definition.

Fair value is an exit price. It is the price you would receive to sell an asset, or pay to transfer a liability, in an orderly transaction between market participants at the measurement date. It is a market-based measure, not an entity-specific one. What the entity intends to do with the asset does not change fair value.

You measure it from the viewpoint of market participants who are knowledgeable, independent, able and willing to transact. You assume the transaction takes place in the principal market, which is the market with the greatest volume and activity for the asset and which the entity can access at the measurement date. The principal market is presumed to be the market the entity would normally sell in. If there is no principal market, use the most advantageous market. Transaction costs are not part of fair value, but you do consider transport costs if location is a characteristic of the asset.

Valuation techniques are the market approach, the cost approach (current replacement cost) and the income approach (discounted cash flows or other present value methods). You must use techniques that maximise observable inputs. Inputs are ranked in the fair value hierarchy. Level 1 is quoted prices in active markets for identical items that you can access at the measurement date. Level 2 is observable inputs other than Level 1, such as quoted prices for similar items or observable interest rates. Level 3 is unobservable inputs, such as your own cash flow forecasts adjusted for market participant assumptions. The whole measurement is categorised at the lowest level input that is significant to it.

For non-financial assets, fair value uses highest and best use. This is the use by market participants that maximises the asset's value. It must be physically possible, legally permissible and financially feasible. Highest and best use is assumed to be the current use unless market or other factors suggest a different use would maximise value.

Key rules to remember

Definition of fair value: Fair value = price received to sell an asset (or paid to transfer a liability) in an orderly transaction between market participants at the measurement date; It is an exit price. It is not entity-specific and it excludes transaction costs.
Fair value hierarchy: Level 1: quoted prices, active market, identical items | Level 2: other observable inputs | Level 3: unobservable inputs; Categorise the whole measurement at the lowest level input that is significant to it.
Market selection: Principal market (which the entity can access); if none, most advantageous market; Fair value is the price in the principal market, or in the most advantageous market if there is no principal market. Adjust that price for transport costs if location is a characteristic of the asset. Do not deduct transaction costs. The net-proceeds test, which uses both transaction and transport costs, is used only to identify the most advantageous market.
Highest and best use tests: Physically possible + legally permissible + financially feasible; Applies to non-financial assets only. Valuation premise is either in combination with other assets or on a stand-alone basis.
Valuation approaches: Market approach | Cost approach (current replacement cost) | Income approach (present value); Use techniques that maximise relevant observable inputs and minimise unobservable inputs.
Transaction price vs fair value: Initial fair value may differ from transaction price; For example, when the transaction is between related parties or under duress. Do not assume the price paid equals fair value.

How to solve IFRS 13 Fair Value Measurement questions

Use this order for any IFRS 13 requirement, whether it is a calculation, a discussion or a disclosure point.

1Identify exactly what is being measured: the asset or liability, its condition, its location and any restrictions that market participants would consider.
2State the principal market, or the most advantageous market if no principal market exists. Use the entity's access to the market at the measurement date.
3Define the market participants and their assumptions. Use their view, not the entity's intentions.
4For a non-financial asset, apply highest and best use. Test each alternative use for physical possibility, legal permissibility and financial feasibility, then pick the one giving the highest value.
5Choose the valuation technique (market, cost or income) and prioritise observable inputs.
6Classify each significant input as Level 1, 2 or 3 and conclude on the level of the whole measurement.
7Calculate the figure, excluding transaction costs, and apply any adjustments such as transport costs.
8Finish with the accounting effect or disclosure and tie it to the scenario, for example the gain in OCI or profit or loss, and comment on reliability.

Quickest way: Four-line fair value check

When to use it: Use this when time is short and you need to score the core marks for a short discussion or a part-calculation.

Write the definition: exit price, market participants, orderly transaction, measurement date.
Name the market: principal first, then most advantageous. Show the price used.
Name the technique and the input level. Say why it is Level 1, 2 or 3.
For property or other non-financial assets, state the highest and best use and apply it to the numbers. Then give the accounting entry or the effect on profit.

Common mistakes in IFRS 13 Fair Value Measurement

Deducting transaction costs from fair value.
Students confuse fair value with fair value less costs of disposal in IAS 36 or IFRS 5.
Fix: Under IFRS 13, fair value excludes transaction costs. Deduct them only where another standard asks for fair value less costs to sell or dispose.
Using the entity's own intended use or own assumptions.
The scenario describes what management plans to do, so it feels relevant.
Fix: Use market participant assumptions. Management's intention does not change fair value, though it may be a clue to what a participant would do.
Choosing the most advantageous market first.
Students think fair value should maximise proceeds.
Fix: Use the principal market if one exists and the entity can access it. Use the most advantageous market only when there is no principal market.
Saying the hierarchy level depends on the technique used.
Techniques and inputs are learned together and blur.
Fix: The level depends on the inputs. A discounted cash flow can be Level 2 if all significant inputs are observable, or Level 3 if a significant input is not.
Applying highest and best use to financial assets or ignoring the three tests.
Students remember the phrase but not its scope or conditions.
Fix: It applies to non-financial assets. Check physical, legal and financial tests in turn. Zoning restrictions often rule out an otherwise attractive use.
Treating the last observed transaction price as always equal to fair value.
A price paid looks like hard evidence.
Fix: Check whether the transaction was orderly and between unrelated parties at the measurement date. A forced sale or a related-party deal may not be fair value.

Worked examples

Example 1

Kavya Ltd holds an asset traded in two markets. Market A is the principal market. Market B is the most advantageous market. The asset has a quoted price in each: Market A $100, Market B $110. Transaction costs are $3 in Market A and $6 in Market B. Transport costs to Market A are $2 and to Market B are $4. Kavya can access both markets. Determine the fair value and explain the level in the hierarchy.

Show the solution

Kavya can access the principal market, Market A, so IFRS 13 requires you to use it. You do not choose the market that gives the highest net proceeds.
Take the Market A price of $100.
Deduct transport costs of $2, because location is a characteristic of the asset. Fair value = $100 − $2 = $98.
Do not deduct the $3 transaction costs. They are not a characteristic of the asset.
The price is a quoted price in an active market for an identical item, so the input is Level 1.

Answer: Fair value is $98, using the principal market. It is a Level 1 measurement. For comparison, the most advantageous market is chosen by net proceeds: Market B gives 110 − 4 − 6 = $100 versus 100 − 2 − 3 = $95 in Market A. So Market B is more advantageous, but this does not matter because the principal market must be used.

Example 2

Arjun plc owns a plot of land used as a car park. Its current use value is $5m. Market participants would pay $9m for the land on the basis of residential development. This $9m is the price they would pay after allowing for the $2m development cost and for the risk and cost of obtaining planning permission. Planning permission has not been applied for, but similar plots nearby have recently received it. A buyer could alternatively use the land for offices at $7m, which the local zoning law prohibits. All figures in this question are assumed for illustration. Advise on fair value under IFRS 13.

Show the solution

Start with highest and best use. Test each use for physical possibility, legal permissibility and financial feasibility.
Car park: physically possible and legal. Value $5m.
Offices at $7m: the zoning law prohibits it, so it fails the legal test. Ignore it.
Residential flats: physically possible. The use must be legally permissible, and permission has not been granted. It is not ruled out if market participants would reasonably expect permission. Similar plots nearby have recently received it, so on the facts given, permission is reasonably expected. If there were no such evidence, this use would fail the legal test and fair value would be $5m. Financial feasibility is shown because $9m is above $5m.
Highest and best use is therefore residential development. Once you have decided this, you measure fair value on that use. You do not blend in the $5m car park value as a refusal scenario.
The risk that permission is not granted, and the cost of obtaining it, are reflected in the inputs market participants would use, such as the cash flows and discount rate. Here that is already built into the $9m price. The $2m development cost is also inside the $9m, so you do not deduct it again, and you do not deduct any transaction costs. Fair value = $9m.
The permission risk is an unobservable input and it is significant, so the measurement is Level 3.

Answer: On these assumed figures, fair value is $9m. It reflects residential development as the highest and best use, not the $5m car park use or the prohibited office use. The permission risk is reflected in the Level 3 inputs, not by blending the car park value into the measurement. Disclose the valuation technique, the significant unobservable inputs and the highest and best use assumption.

Exam tips

Write the definition in your own words in the first sentence. It is an exit price between market participants, not an entry price and not entity-specific.
In scenario questions, link the hierarchy level to the specific input in the scenario, such as a quoted price or a management forecast. Do not just list the three levels.
For highest and best use, show the three tests one by one. Marks are given for rejecting uses on the legal or financial test, not just for the answer.
Apply the standard to the other standards that invoke it, such as IFRS 3 acquisition values, IAS 40 and IAS 16 revaluation, and mention professional scepticism over Level 3 inputs and management bias.
In SBR, always conclude with the reporting effect and a comment on reliability and disclosure. This earns professional skills marks for commercial acumen and analysis.

Practice questions from Other reporting issues

IFRS 13 Fair Value Measurement in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

IFRS 13 Fair Value Measurement: frequently asked questions

What is the difference between fair value and value in use?

Fair value is a market-based exit price from the viewpoint of market participants. Value in use under IAS 36 is the present value of cash flows the entity expects from the asset, which is entity-specific. The two can differ because the entity may use the asset in a different way from other participants.

Can a discounted cash flow valuation be Level 2?

Yes. The level is set by the inputs, not by the technique. If all significant inputs, such as the discount rate and cash flows, are observable or corroborated by market data, it can be Level 2. If a significant input is unobservable, the whole measurement is Level 3.

Does IFRS 13 apply to all fair value measurements?

No. The measurement and disclosure requirements do not apply to share-based payment transactions within IFRS 2 or to leasing transactions within IFRS 16. This does not stop IFRS 13 applying to fair values used in other contexts, such as the fair value of an underlying asset in lessor accounting. It also does not apply to measures that are similar to fair value but are not fair value, such as net realisable value in IAS 2 and value in use in IAS 36. The disclosure requirements are also excluded for some items, such as plan assets under IAS 19 and assets whose recoverable amount is fair value less costs of disposal under IAS 36. Check the scenario to see whether fair value is actually the required basis.

What is highest and best use in IFRS 13?

It is the use of a non-financial asset by market participants that would maximise its value. The use must be physically possible, legally permissible and financially feasible. It is assumed to be the current use unless market factors suggest another use would give a higher value.