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Fair value: boon or curse - Essay Example

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Two terms used interchangeably in daily conversation: Value, and Price, one taken as a synonym for the other when spoken as layman's terms. But the connotations assume a sharp distinction when these terms are used in the context of finance. An asset may be valuable because it may have a potential to generate income, or it may have substantial intrinsic value; however, it may have a low market price because the buyer may be unaware of its true worth, or the seller was in dire need of money and was willing to sell at a huge discount…
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Fair value: boon or curse
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Fair value: boon or curse

A wise buyer will buy an asset at equal to or lower than its fair value, and a wise seller will sell at a price equal to or higher than fair value.
The distinctions become more pronounced if what came under consideration was accounting value, or the worth of an asset according to financial records and the workings of generally accepted accounting principles. Theoretically, price should equal value, but since market efficiency is seldom a reality, if ever, in a transaction, buyers and sellers can exploit price and value inconsistencies to their benefit.
The IASB definition of fair value has been described as "substantially similar" to the FASB revised definition, which are both consistent with the measurement objective. (IASB Fair Value Measurement). Under this definition, the fair value of an asset is the amount at which that asset could be bought or sold in a transaction between willing parties, other than in a liquidation. On the other hand, the fair value of a liability is that amount at which that liability could be incurred or settled in a current transaction between willing parties, other than in a liquidation. (Value-based Management)
Drews (2000) gives the IRS and legal definition of "fair market value" as that price at which an asset would change hands between a willing buyer and a willing seller, neither being under compulsion to act and both having reasonable knowledge of all relevant facts.
Representatives to the International Valuation Standards Committee (IVSC) made a presentation before the IASB. At that presentation the difference between 'price' and 'value' was articulated. 'Price' was defined at that mount agreed upon on in a transaction while 'value' is the outcome of a valuation process. In a majority of cases and for most common purposes, price and value result in almost the same number, the most recent transaction of a similar asset or liability being determinative of the fair value of the asset or liability subject of valuation. (IASB Fair Value Measurement)
Fair Value vs. Market Price
A quoted market price in an active market is considered the best evidence of what amount comprises the fair value, as a basis for measurement. In the absence of a quoted market price, the evaluators should be prepared to make an estimate of fair value, employing the best possible information which is available under the prevailing circumstances. (Value-based Management)
As the term is commonly used, "fair value" can be easily distinguished from "market value" or "market price". It necessitates the assessment of the price that is considered fair by two specific parties, while taking into account the respective advantages or disadvantages that each will gain or suffer from the transaction. Usually, market value meets these criteria since it is the price at which transaction actually takes place; however, this is not necessarily always the case. Fair value is often used when regulators or assayers conduct due diligence in corporate transactions. During such occasions, because of particular synergies that exist between the two contracting parties, a price is arrived at that is ... Read More
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