Recent guidance from accounting rule makers requires the “fair value” reporting of specific items on the balance sheet. Here are some responses to frequently asked questions about this standard of value and its measurement methods.

What is fair value?

The U.S. Generally Accepted Accounting Principles (GAAP) define fair value as “the amount that would be obtained to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date.”

“Market participants” are purchasers and sellers in the item’s primary market. This market is entity-specific and might differ amongst businesses.

Fair value estimates report such assets as derivatives, nonpublic entity securities, certain long-lived assets, acquired goodwill, and other intangibles. These projections expressly do not include entity-specific factors like transaction costs and buyer-specific synergies.

Does fair value differ from fair market value?

Although fair value and fair market value are close, they are different. The IRS Revenue Ruling 59-60 definition of “fair market value” is the most common. The IRS describes fair market value as “[t]he price at which the property would change hands between a willing buyer and a willing seller, both parties having reasonable knowledge of relevant facts, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell.”

The Financial Accounting Standards Board (FASB) chose the phrase “fair value” to discourage businesses from using IRS regulations or guidelines and U.S. Tax Court precedent when evaluating assets and liabilities for financial reporting reasons. This term also shouldn’t be confused with its use in certain legal situations. For example, when appraising a company for divorce or shareholder buyouts. Statutory definitions of fair value typically differ from the definition provided under GAAP.

How do you measure fair value?

Three methods of valuation the FASB accept are cost, income, and market. Additionally, it offers the valuation input hierarchy below, from most to least important:

1. Quoted prices for equivalent assets and liabilities in active marketplaces
2. Observable inputs, such as quoted prices for identical or similar items in active markets, quoted prices for comparable items in active markets, and other market data
3. Unobservable inputs, like cash-flow estimates or other internal data

Fair value estimation frequently involves the involvement of valuation experts. But in the end, management cannot delegate control over fair value estimations. Management is responsible for comprehending the valuator’s models, techniques, and assumptions. Additionally, it must set up sufficient internal controls for disclosures, impairment charges, and fair value calculations.

How do auditors assess those measurements?

The primary audit techniques followed by external auditors include the evaluation of accounting estimates. They may inquire about the underlying assumptions (or inputs) utilized to produce estimates to ascertain whether the inputs are thorough, correct, and pertinent.

Auditors attempt to replicate management’s estimate wherever possible by using the same assumptions (or their own). An auditor will request an explanation from management if their estimate and the information provided in the financial statements disagree significantly. In today’s uncertain market, it should not shock you if auditors challenge your fair value estimations or ask for further evidence to support your assertions.

For more information 

Please contact our RRBB accountants and advisors if you have further inquiries about fair value measurements. Then, we can make sure you’re fulfilling your financial reporting obligations.

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