What Is Fair Value?
In fair value, a company presents certain assets and liabilities on the balance sheet at a price received or given in an orderly transaction between market participants. Goodness, what a mouthful! Need an example to make this a bit clearer?
Basically, a company reports securities it owns on the balance sheet at the current market rate, or the amount of money the company would be able to sell them for if it wanted to.
This value is also known as the security’s exit price. The exit price assumes that no duress is involved in the sale and that it applies regardless of whether the company wanted to or was able to sell the security at the date of fair value measurement.
For example, the company isn’t forced to sell the security to have the funds to make payroll. In fact, some sort of contract may prohibit the company from selling the security for a certain period of time after purchase. Such a situation doesn’t preclude fair value measurement.
Fair value assessment assumes a hypothetical transaction to sell the asset or get rid of a liability at the measurement date, which is the date of the balance sheet.
Here’s a bit of history, for the interested: After the failure of 747 savings and loans in the 1980s, FASB issued Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” in 1991. Since Codification, it is now a part of Accounting Standards Codification (ASC) 825 “Financial Instruments,” which requires entities to supplement their historical cost financial statements with disclosures about the fair values of financial instruments that those statements report.
Some items for which fair value is never used are investments in subsidiaries, lease financial assets, and liabilities.