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What is Fair Value Accounting?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 07 September 2016
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Fair value accounting is an approach to the accounting process that focuses on the prices that assets should be purchased or sold at between willing parties, excluding the incidence of a liquidation of assets. The idea behind this accounting approach is to create an equitable balance between the benefits and the liabilities that would occur when assets are bought or sold at specific prices. This particular approach is sometimes touted at being particularly relevant in the marketplace today, given the sometimes volatile nature of the various markets.

Arriving at the fair value to use in the process of fair value accounting often involves looking closely at the current market price associated with a given asset. That market price can serve as the basis for the calculation, with the outcome also taking into consideration other factors that may have some impact on the sale or purchase of the asset, such as the condition of the asset itself, or just how much the investor wants to either buy or sell that asset. When a market price is not readily available, fair value accounting often involves reviewing historical data as well as taking into consideration subjective factors related to the buyer and seller to arrive at a value that is considered equitable and fair.

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One of the benefits of fair value accounting is that it is often viewed as being more transparent than other valuation approaches. This means that the process for arriving at the value is relatively straightforward while still allowing for some amount of subjective input. This is in contrast to relying solely on historical data, which may or may not be sufficient to arrive at a value that is indicative of the current demand for the asset. It is not unusual for businesses to go with a fair value accounting process when considering the sale of different assets, often relying on this type of pricing approach to determine whether to move forward with the transaction now or wait until key factors have changed and the chances for gaining additional benefits are improved.

Some proponents of the use of fair value accounting note that this approach, which takes into account current supply and demand as well as other key factors, has the potential to minimize the possibility of triggering undesirable trends within a national or even the global economy. The theory is that if all businesses and governments would make use of this approach, rather than relying more on historical information as the primary basis for arriving at the value of different assets and liabilities, greater control of the economy is maintained and the chances of entering into a downturn are kept within a reasonable range.

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