Fair Value Accounting

Understanding of Fair Value Accounting?

Fair Value Accounting is the practice of measuring assets and liabilities at their current
market value. Fair value is the actual selling value of an asset that is agreed to be paid by the
buyer as set by the seller. In a simpler sentence it is an approach that company use to report
their assets and liabilities at the estimated amount of money they would receive if they were
to sell the assets or to be alleviated of their liabilities in the market today. By using
contemporary and market-based measurement, mark-to-market (Fair value) accounting aims
to make financial accounting information more updated and reflective of current real market
values.
For Example, ABC company bought multiple properties in New York 100 years ago
for $50,000. They are now appraised at a market value $50 million. If the company
uses Fair value accounting principles then the cost of the properties recorded on the
balance sheet rises to $50 million to more accurately their value in today’s market.
The following concepts are a natural part of proper market value calculation:

Current market conditions

Fair value is based on market conditions on the date of the estimate, rather than on historical
performance.

Owner's Purpose
The owner's intention may change the estimated value. For example, if the owner wants to
sell the property immediately, it can lead to a quick sale and a lower sale price.

Formal transaction
The fair value is due to a formal transaction which means that there is no unnecessary
pressure to sell as a business termination.

Third party
Fair value is based on the sale of a third party. A related party that enters the company or
anyone who is related to the seller may change the price paid for that asset.
Major Benefits of Fair Value Accounting
1. It is very beneficial to the companies to report the amount of assets and liabilities
more
2. accurately, timely and comparable than the amounts that would be reported under the
3. traditional accounting system.
4. It’s very helpful to report updated market value of assets and liabilities on a regular
5. basis.
6. It limits company’s ability to manipulate their net income.
7. Gains and losses resulting from changes in fair value estimate indicated economic
events
8. that companies and investors may find worthy of additional disclosures.
9. It is very helpful for the overall growth of the organization and avoids confusions in
10. maintaining books of accounts.

To determine the fair value there are three levels of input information to determine the fair
value of an asset or liability. Sovereignty is defined by IFRS 13 Measure Value
Measurement.

Level 1
Level 1 quoted prices of similar assets and liabilities in active markets. An active market is a
market in which transactions for assets and liabilities are made more frequently and in
volume to provide continuous price information, such as stock exchanges.

Level 2
Level 2 input refers to the visual information of similar items in active or inactive markets,
such as two buildings in the same location.

Level 3
Where class 1 and level 2 values are not available, the estimated value is measured using
measurement techniques. Level 3 unseen inputs to be used in situations where markets are
not available or do not appear to be in a time of debt crisis. At this point, the correct market
rating becomes excessive and businesses can include their own data organized by other
available data.