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Fair value through profit or loss is a way of establishing the value of assets and liabilities on a balance sheet. It is a valuation method that is particularly used to value financial instruments. These types of assets have a value that is constantly in flux as a result of changes in the market. Using this method allows a company to take the fair value of the financial instrument at the time it was purchased or recognized and to make changes to its value on the books whenever a balance sheet is generated by accounting for fair value changes in profitability.
The concept of fair value is an accounting standard for valuing assets that do not have an established market value. The only way to definitively establish a market value is to sell the asset. Establishing a fair value allows a business to track the asset in the accounting system for tax purposes without having to sell it. It is an estimate that takes into account the types of factors that would affect the value if the asset was sold.
There is a particular procedure set by national and international financial accounting standards boards for establishing the fair value of financial instruments that are held by corporations as assets or liabilities. The issue with financial assets involves their changing value on the market. Stock markets, for example, can be volatile, and stocks held by corporations can change in value multiple times over the course of a single daily. Likewise, corporate liabilities, such as bonds issued, also change in value as government interest rates rise or fall.
Accounting standards allow corporations to value assets and liabilities by establishing fair value through profit or loss. This way of establishing value is one of four ways a corporation typically uses to categorize financial assets and one of two ways it categorizes liabilities. Assets can be categorized as carried at fair value through profit or loss or designated as available for sale, receivables or loans, or "held to maturity" investments. Liabilities can be classified as carried at fair value through profit or loss or as carried at the liability's amortized cost.
Assets and liabilities that are carried on the books at fair value through profit or loss are subcategorized as designated or held for trading. A designated asset or liability is one that was selected for valuation this way at the time it was acquired. An asset or liability that is held for trading is valued using this method, but will only be held for the short term.
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