In the world of financial accounting, there is fair value. This can be calculated using CPC-46. This fair value is the process of determining a PV (Present Value) of a specific asset.
Fair value assessments can be made on an asset, such as stocks, investments, companies, brands, patents and others, and can also be assessed on liabilities.
It is important that fair value be assessed for a number of reasons. This includes analysis of capital budgeting, investment, acquisition, merger transactions, taxable events and financial reporting.
In the case of fair value, the cash that would be obtained for a sale of an asset or paid for a transfer of a liability, through a transaction that was not forced between the parties.
In this content you will see what fair value is, how it is calculated, what affects the fair value of an asset and much more. Keep reading to check it out!
What this article covers:
What is fair value?
Fair value is the total amount that would be received by the seller or service provider (asset). This is also true for money that was paid to transfer a liability.
It is important to clarify that these are transactions that were not forced. However, this means that it is not the type of emergency sale that, in this case, aims to settle a debt.
As a rule, in cases of sales that are emergencies, it is normal for the owner of the asset to reduce its value, so that the transaction or sale is made faster. The fair value is linked to the act of the transaction. This is due to the fact that the value can change over time.
How is fair value calculated?
It is critical to understand that fair value is done for a specific asset or liability. This is due to the process that took into account each characteristic of the product, such as location, use restrictions, condition and conservation.
In order to define the fair value of the asset, some asset data or liabilities. It is crucial that the way in which fair value was determined is made absolutely clear.
There are three main methods to determine this value which are: revenue approach, cost approach and market approach. The first mode can also be known as “discounted cash flow” and calculates the present value increase according to the discount rate.
The cost approach is used to measure the fair value or replacement cost of the asset. While the third mode, the market approach calculates fair value through prices and other information relevant to the product, such as quotes and pricing.
According to CPC 46, it is important that the entity uses the most appropriate valuation techniques at the time, taking into account the circumstances so that there are sufficient ways to arrive at the fair value. In this way, the use of relevant observable data is maximized and so is the use of data that are not observable.
Why is fair value important?
There are several ways that can lead to fair value. Each asset valuation method has its importance for the calculation to be made. In this way, it is possible to bring both parties to an agreement that is valid.
What affects the fair value of an asset?
When the fair value of an asset is determined, the product or item needs to be analyzed based on the value of like products. It is important to carry out a professional valuation or determine the value that is normally given in the market for similar items.
As you can see, fair value is very important for both a seller and a buyer. It is widely used in the market and it is very important to understand about it.