Fair value is a value for an asset or liability that is deemed reasonable after considering all of the factors that can play a role in determining value. There are a number of ways that fair value can be applied in accounting and business. Organizations that set standards for accounting practices periodically review the methodology they endorse for arriving at fair value to confirm that it is accurate, and revise it if necessary to reflect changing trends and attitudes so that accounting practices will keep pace with real world events.
In fair value accounting, assets and liabilities are recorded at this value to provide a complete and accurate picture of financial health. This value can also be a concern when planning a sale or acquisition, as all parties involved want to confirm that the price is fair and advantageous to their interests. Since selling at a loss or discount can be associated with penalties or benefits, depending on the type of transaction involved, determining fair value is critical for the reporting of certain types of transactions.
One way to determine fair value is to use quoted market prices. Market prices can be used as a guideline for valuing many types of assets and liabilities under the assumption that people trading on the open market are reaching prices that are agreeable to them. Since the foundation of a fair value is the price that an asset or liability would fetch if it were sold in a willing transaction by parties who are not coerced and open market transactions are usually willing, these values can be accurate.
Other means can include using the services of an assessment professional or pricing on the basis of comparable items on the market. Something like a piece of real estate, for example, can be challenging to value because it is unique. Looking at prices for comparable properties can provide a frame of reference for valuation that can be used to record the asset’s value as accurately as possible.
If there is a dispute about the fair value of an item, the parties involved can present information to support their position. The information can include demonstrating the methods used to arrive at a given value along with the credentials of the person handling the value estimate. Such disputes can be stumbling blocks to deals such as sales and mergers as the parties may be reluctant to move forward until they can agree on the value of the item in question.