In accounting and in most schools of economic thought , fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset.
The derivation takes into account such objective factors as the costs associated with production or replacement, market conditions and matters of supply and demand. Subjective factors may also be considered such as the risk characteristics, the cost of and return on capital, and individually perceived utility.
There are two schools of thought about the relation between the market price and fair value in any form of market, but especially with regard to tradable assets:.
In accounting , fair value is used as a certainty of the market value of an asset or liability for which a market price cannot be determined usually because there is no established market for the asset. Under US GAAP FAS , fair value is 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 is used for assets whose carrying value is based on mark-to-market valuations; for assets carried at historical cost , the fair value of the asset is not used. FAS broadly applies to financial and nonfinancial assets and liabilities measured at fair value under other authoritative accounting pronouncements. However, application to nonfinancial assets and liabilities was deferred until Absence of one single consistent framework for applying fair value measurements and developing a reliable estimate of a fair value in the absence of quoted prices has created inconsistencies and incomparability.
The goal of this framework is to eliminate the inconsistencies between balance sheet historical cost numbers and income statement fair value numbers.
In the futures market, fair value is the equilibrium price for a futures contract. This is equal to the spot price after taking into account compounded interest and dividends lost because the investor owns the futures contract rather than the physical stocks over a certain period of time. 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. Topic emphasizes the use of market inputs in estimating the fair value for an asset or liability.
Quoted prices, credit data, yield curve , etc.
Fair Value Measurements [ASC Topic 820 (Formerly FAS 157) & IFRS 13 ]
Quoted prices are the most accurate measurement of fair value; however, many times an active market does not exist so other methods have to be used to estimate the fair value on an asset or liability. Topic emphasizes that assumptions used to estimate fair value should be from the perspective of an unrelated market participant.
This necessitates identification of the market in which the asset or liability trades. If more than one market is available, Topic requires the use of the "most advantageous market".
Both the price and costs to do the transaction must be considered in determining which market is the most advantageous market. The framework uses 3-level fair value hierarchy to reflect the level of judgment involved in estimating fair values.
Fair Value Hierarchy (Level 1, Level 2, Level 3)
The hierarchy is broken down into three levels:. The FASB, after extensive discussions, has concluded that fair value is the most relevant measure for financial instruments. In its deliberations of Statement , the FASB revisited that issue and again renewed its commitment to eventually measuring all financial instruments at fair value.
FASB published a staff position brief on October 10, , in order to clarify the provision in case of an illiquid market.
When measuring fair value, an entity uses the assumptions that market participants would use when pricing the asset or the liability under current market conditions, including assumptions about risk. From Wikipedia, the free encyclopedia.
Financial Accounting Standard 157 (FAS 157)
Redirected from IFRS Key concepts. Selected accounts.
Accounting standards. Financial statements. Financial Internal Firms Report. People and organizations.
Summary of Statement No. 157
Accountants Accounting organizations Luca Pacioli. Financial Accounting Standards Board. Retrieved Archived from the original PDF on International Accounting Standards Committee. List of standards requirements. Hidden categories: Webarchive template wayback links.
Historical cost Constant purchasing power Management Tax. Auditing Financial Internal Firms Report. People and organizations Accountants Accounting organizations Luca Pacioli.