business valuation fair value of accounting concept

1. FAIR VALUE OF
ACCOUNTING CONCEPT
Under the guidance :-Prof.Jayraj Javheri sir
NAME:-Mayuri Hemant bhole
Subject:- business valuation
MBA 2Year 4sem (FINANCE)
PRN NO:-180102031014

2.  Fair value accounting uses current market values as the basis for recognizing certain assets and
liabilities . Fair value is the estimated price at which an asset can be sold or a liability settled in an
orderly transaction to a third party under current market conditions.
 Current market conditions. The derivation of fair value should be based on market conditions on the
measurement date, rather than a transaction that occurred at some earlier date.
 Intent. The intention of the holder of an asset or liability to continue to hold it is irrelevant to the
measurement of fair value. Such intent might otherwise alter the measured fair value. For example, if
the intent is to immediately sell an asset, this could be inferred to trigger a rushed sale, which may
result in a lower sale price.
 Orderly transaction. Fair value is to be derived based on an orderly transaction, which infers a
transaction where there is no undue pressure to sell, as may be the case in a corporate liquidation .
 Third party. Fair value is to be derived based on a presumed sale to an entity that is not a corporate
insider or related in any way to the seller. Otherwise, a related-party transaction might skew the price
paid
Fair Value of Accounting

3.  Market approach. Uses the prices associated with actual market transactions for similar or identical
assets and liabilities to derive a fair value. For example, the prices of securities held can be obtained
from a national exchange on which these securities are routinely bought and sold.
 Income approach. Uses estimated future cash flows or earnings , adjusted by a discount rate that
represents the time value of money and the risk of cash flows not being achieved, to derive a
discounted present value. An alternative way to incorporate risk into this approach is to develop a
probability-weighted-average set of possible future cash flows.
 Cost approach. Uses the estimated cost to replace an asset, adjusted for the obsolescence of the
existing asset.
general approaches permitted for deriving fair values

4. ?
 Huge losses reported by financial firms on subprime assets have led to a debate over the
implementation of SFAS 157 in circumstances where markets collapse and price inputs arent
readily available
 In the current crisis, banks and investment banks have had to reduce the value of the mortgages and
mortgage-backed securities to reflect current prices. Those prices declined severely with the
collapse of credit markets as mortgage defaults escalated
WHY FAIR VALUE ACCOUNTING IS IMPORTANT?

5.  Advantage: Accurate Valuation
 A primary advantage of fair value accounting is that it provides accurate asset and liability valuation on
an ongoing basis to users of the company's reported financial information. When the price of an asset or
liability has increased or is expected to increase, the company marks up the value of the asset or liability
to its current market price to reflect what it would receive if it sold the asset or would have to pay to
relieve itself from the liability. Conversely, the company marks down the value of an asset or liability to
reflect any decrease in the market price.
 Advantage: True Income
 Fair value accounting limits a company’s ability to potentially manipulate its reported net income.
Sometimes management may purposely arrange certain asset sales, for example, to use gains or losses
from the sales to increase or decrease net income as reported at its desired time. Using fair value
accounting, gains or losses from any price change for an asset or liability are reported in the period in
which they occur. While an increase in asset value or a decrease in liability value adds to net income, a
decrease in asset value or an increase in liability value reduces net income
Advantage or Disadvantage

6.  Disadvantage: Value Reversal
 Fair value accounting can also present challenges to companies and users of reported financial information.
Conditions of the markets in which certain assets and liabilities are traded may fluctuate often and even
become volatile at times. Applying fair value accounting, companies reevaluate the current value of certain
assets and liabilities even in volatile market conditions, potentially creating large swings in the value of those
assets and liabilities. However, as markets stabilize, such value changes likely reverse back to previous normal
levels, making any reported losses or gains temporary, which means fair value accounting may have provided
misleading information at the time.
 Disadvantage: Market Effects
 The use of fair value accounting may further affect a down market adversely. For example, after an asset has
been revalued downward because of drops in the current market trading prices, the lower value of the asset
could trigger greater selling of the asset at a potentially even more depressed price. Without valuation
markdown as required by fair value accounting, companies may not feel the need to sell an asset in a down
market to prevent potentially further downward valuation of the asset. Absent additional selling pressures, the
market may stabilize over time, which would help preserve the value of the asset.
Disadvantage

7.  How Do You Determine Fair Value?
Level 1
Level 1 is quoted prices for identical assets and liabilities in active markets. An active market is a
market where the transactions for assets and liabilities are done frequently and at a volume to provide
ongoing pricing information, such as stock exchanges.
Level 2
Level 2 inputs refer to observable information for similar items in active or inactive markets, such as
two buildings in a similar location.
Level 3
When values for level 1 and level 2 are unavailable, fair value is estimated using valuation
techniques. Level 3 are unobservable inputs to be used in situations where markets are non-existent or are
illiquid such as during a credit crisis. At this point, fair market valuation becomes extremely subjective and
businesses may include their own data adjusted for other reasonably available information.
Please note that the levels of fair value hierarchy are not used to create fair values for assets or liabilities.
Fair value accounting requires that the fair market value or an estimation of a market price be used as the
present value of expected cash flows.
How Do You Determine Fair Value?

8. REFERANCE:-
 www.bing.com/search?q=fair+value+of+accounting+concept+&form=EDGHPT&
qs=HS&cvid=7ece1922a6914826a2f1adddbcf8db6a&refig=6e21
 https://www.accountingtools.com/articles/fair-value-accounting.htm
 https://www.freshbooks.com/hub/accounting/fair-value-accounting