What is Fair Value?

Fair value is the price that two parties are willing to pay for an asset or liability, preferably in an active market. In this situation, the effects of supply and demand will likely impact the value associated with the asset under examination. A less accurate measure of fair value is when there is an active market for a similar item, while the least accurate measurement method is to use the discounted cash flows associated with the future performance of an item. The accounting rules related to fair value are noted in detail in Topic 820 (Fair Value Measurement) of the Accounting Standards Codification.

A liquidation sale is not considered to result in prices that adequately reflect fair value, since the transaction is too rushed to attract an adequate number of bidders.

Fair Value vs. Market Value

The fair value concept differs somewhat from market value. Market value is the actual price at which a transaction is settled in the marketplace, and can change rapidly in accordance with the dictates of supply and demand. Fair value tends to change at a reduced speed, since it is based on the intrinsic worth of the asset or liability in question. Intrinsic worth is derived from the cost required to replace an asset, or the extent to which its value can potentially grow in the future. These concepts give rise to the following differences between fair value and market value:

Calculation method. Fair value is based on intrinsic factors, while market value is based on current market conditions.
Usage. Fair value is used for long-term assessments and accounting purposes, while market value is used in actual buying and selling transactions.
Volatility. Market value is often more volatile, while fair value is a more stable reflection of long-term worth.

In summary, fair value is what an asset should be worth based on its fundamentals, while market value is what it’s actually worth at a given point in time, based on the open market.