FAIR VALUE

In accounting and in most schools of economic thought, fair value is a rational and unbiased estimate of
the potential market price of a good, service, or asset.

Fair value is a term with several meanings in the financial world.

In investing, it refers to an asset's sale price agreed upon by a willing buyer and seller, assuming both
parties are knowledgable and enter the transaction freely. For example, securities have a fair value
that's determined by a market where they are traded.

In accounting, fair value represents the estimated worth of various assets and liabilities that must be
listed on a company's books.

The Basics of Fair Value

In its broadest economic sense, fair value represents the potential price, or the value assigned, to a good
or service, taking into account its utility, supply and demand for it, and the amount of competition for it.
Although it infers an open marketplace, it is not quite the same as market value, which simply refers to
the price of an asset in the marketplace (not intrinsic worth).

Fair Value and Financial Statements

The International Accounting Standards Board defines fair value as the price received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants on a certain date,
typically for use on financial statements over time. The fair value of all a company's assets and liabilities
must be listed on the books in a mark-to-market valuation. The original cost is used to value assets in
most cases.

In some cases, it may be difficult to determine a fair value for an asset if there is not an active market for
it. This is often an issue when accountants perform a company valuation. Say, for example, an
accountant cannot determine a fair value for an unusual piece of equipment. The accountant may use
the discounted cash flows generated by the asset to determine a fair value. In this case, the accountant
uses the cash outflow to purchase the equipment and the cash inflows generated by using the
equipment over its useful life. The value of the discounted cash flows is the fair value of the asset.