Fair Value Accounting Explained in Simple Terms
A company needs to properly value assets, liabilities, revenues and expenses when recording transactions and reporting operating data. Senior executives usually make sure the firm records such transactions in accordance with accounting rules.
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Definition
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Fair value is either the market value of an economic resource or the price at which a potential investor is willing to buy the resource. For example, the fair value of a stock is its value on securities exchanges.
Significance
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Fair value is an important concept, especially in situations in which there is no readily available price for an item. For instance, an owner of classic cars may need an appraiser to provide the fair value of an old automobile.
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Misconceptions
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Fair value is distinct from book value. In accounting parlance, the book value of an asset is the asset cost minus financial adjustments, such as depreciation entries. Depreciating an asset means spreading its cost over several years.
Asset Fair Value
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The fair value of an asset is either its market price or appraised value. For instance, an investor wants to buy the equity shares of a privately-held company. The investor must use fair value accounting to estimate the shares' value.
Liability Fair Value
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The fair value of a liability, such as a loan, equals its principal amount plus the unpaid interest at a given point in time. A liability is a debt that a firm must repay.
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References
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