Fair value measurement sits at the core of modern financial reporting. It aims to reflect what an asset or liability is worth today rather than what it cost in the past. However, in periods of market volatility, determining that “fair value” becomes significantly more complex.

For both preparers and auditors, unstable market conditions test professional judgment, valuation methodologies, and the robustness of financial reporting.

1. What Is Fair Value?

Under IFRS 13 – Fair Value Measurement, fair value is defined 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.”

This definition assumes an orderly transaction in a functioning market environment. When markets become unstable or illiquid, applying this principle becomes more challenging.

2. The Core Challenge: Market Instability

In stable markets, fair value measurement is often supported by readily available market data such as quoted prices, recent transactions, or comparable market inputs.

In volatile markets, however:

• Prices may fluctuate rapidly, making valuation timing critical.
• Bid–ask spreads may widen, reducing the reliability of quoted prices.
• Some markets may experience reduced activity or temporary illiquidity.

When observable market inputs become limited, entities must rely more heavily on valuation models and assumptions, increasing the level of estimation uncertainty.

3. The Fair Value Hierarchy

To improve transparency and consistency, IFRS 13 establishes a three-level fair value hierarchy based on the quality of inputs used in valuation:

• Level 1: Quoted prices in active markets for identical assets or liabilities (most reliable).
• Level 2: Observable inputs other than quoted prices, such as market comparables, interest rate curves, or credit spreads.
• Level 3: Unobservable inputs, typically based on internal assumptions and valuation models.

During periods of significant market disruption, valuations may increasingly rely on Level 3 inputs, where greater judgment and disclosure are required.

4. Common Challenges in Volatile Markets

a) Lack of Market Activity

When trading volumes decline, market prices may reflect distressed or forced transactions rather than orderly market conditions. IFRS 13 requires entities to assess whether observed prices truly represent fair value.

b) Model Risk

In the absence of observable inputs, organizations often rely on valuation models such as discounted cash flow (DCF) analyses. These models are sensitive to assumptions such as discount rates, expected growth, and credit risk. Even small changes in assumptions can significantly affect valuations.

c) Disclosure Complexity

IFRS 13 requires extensive disclosures, particularly for Level 3 measurements. Entities must disclose valuation techniques, significant inputs, and sensitivity analyses. Ensuring these disclosures are transparent and understandable can be challenging.

d) Auditor–Management Judgment Differences

Valuations involving significant estimates often lead to detailed discussions between management and auditors. Auditors must exercise professional skepticism while recognizing the inherent uncertainty in volatile markets.

5. The Audit Perspective

During periods of market volatility, auditors typically apply increased scrutiny to fair value measurements. Key areas of focus include:

• Assessing the reasonableness of assumptions against available market data
• Evaluating consistency of valuation methodologies across reporting periods
• Considering post–balance sheet events that may affect valuation conclusions
• Reviewing the adequacy of disclosures required under IFRS 13

Where valuation complexity is significant, independent valuation specialists may be engaged to support the audit process.

6. Strengthening Fair Value Practices

Organizations can strengthen their approach to fair value measurement by:

• Establishing clear valuation policies and governance frameworks
• Performing sensitivity analyses to understand the impact of key assumptions
• Maintaining robust documentation supporting valuation judgments
• Engaging external valuation experts early for complex or illiquid assets

Conclusion

Fair value measurement inherently involves judgment. In volatile markets, that judgment becomes even more critical.

Organizations that emphasize transparency, consistency, and strong governance are better positioned to produce reliable valuations that withstand scrutiny from auditors, regulators, and stakeholders.

At SKM Africa LLP, we support clients in applying fair value principles responsibly and transparently, helping ensure that financial statements remain reliable even in uncertain market conditions.