Fair Value

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Explanation of Fair Value accounting. Definition, relevance and measurement.



What is Fair Value? Definition

Fair Value is an accounting expression, originally defined by the SEC. It should be regarded as a basis of accounting. The major alternative accounting basis being historical cost.


Under GAAP, the Fair Value of an asset is the amount at which that asset could be bought or sold in a current transaction between willing parties, other than in a liquidation. On the other side of the balance sheet, the Fair Value of a liability is the amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in a liquidation.

If available, a quoted market price in an active market is the best evidence of Fair Value and should be used as the basis for the measurement. If a quoted market price is not available, preparers should make an estimate of Fair Value using the best information available in the circumstances. In many circumstances, quoted market prices are unavailable. As a result, making estimates of Fair Value is often difficult.

Why Fair Value accounting? Relevance.

The basis of accounting - whether FV or historical cost - affects the choices investors take, and the decisions managers make. Today's markets are dynamic and volatile. Whether it is for buying or selling, what people want to know is what an asset is worth today.

Accounting Research is supporting that assertion. The FASB, after extensive discussions, has concluded that Fair Value is the most relevant measure for financial instruments. In its deliberations of Statement 133, the FASB revisited that issue and again renewed its commitment to eventually measuring all financial instruments at Fair Value.

Fair Value accounting provides more transparency than historical cost based measurements. Maybe, if companies in the United States and Asia had measured all financial instruments at Fair Value, regulators, depositors, and investors could have achieved greater regulatory and market discipline and avoided some of the losses that investors and taxpayers have had to pay during previous downturns in the economy.

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