Let’s discuss the concept of Fair Value Accounting.

What is the definition of Fair Value Accounting?

Fair Value Accounting can be described as a specific kind of financial reporting approach. Accountants use this approach for measuring general financial instruments (i.e. assets and liabilities).  Therefore, if a financial transaction is being made, the individual or organization will receive an estimated price of the asset or liability.

When an individual or an organization sells their assets today, they must adhere to certain, rules, guidelines and laws that govern their transactions.  Since the economy has been struggling over the years, the fair market value for the property or item that an individual sells can be significantly different from its original purchase price.  Which means, though an individual may have purchased a specific asset for $250,000 or more a few years ago, the actual fair market value may have dropped significantly within the last year.  So, people cannot go by the original price that the person has noted on their books, especially because the item will need to be reassessed by the fair value calculator prior to its sale.  This said, there are some standards that people will need to follow, and they are found in fair value accounting and in FAS 157.

What is fasb 157?

FAS 157 can be described as a financial Accounting Standard.  This standard was established by the Financial Accounting Standards board in September 2006, and it covers all publicly-traded companies within the United States.  The purpose of this statement is to classify an organization’s assets based on a fair value concept.  This fair value can be calculated in one of 3 ways, and they are divided into at least 3 categories, Level 1, Level 2 and Level 3.  With Level 1 assets being the easiest to calculate accurately, while level 3 is known as the most difficult in the industry.

Level 1 - values are based on a quoted price in an active market place, applies to assets and liabilities.

Level 2 - values are based on observable input (i.e. quoted prices for similar assets and liabilities in an active market).

Level 3 - values are based on unobservable input (i.e. based on a company’s own pricing models and estimates, considered to be the most risky and subject to expansive disclosure requirements).

Though this standard was meant to protect investors from buying assets that were well below the original assets pricing, it is still said to have problems that could use a second look at for possible corrections.  One of which is it allows certain assets to be left out of these equations. Which means, the rules will only apply to some of the seller’s assets and not all of them. Therefore, there are some inconsistencies in the standards that if  re-addressed could add more uniformity and accuracy in attaining the true valuation of assets.  It is better than nothing and is considered a strong foundation to asses value.  This is why some organizations are pushing to modify standards instead of completely discarding fasb 157 and the associated fair value pricing guidelines.

Clarifications of FAS 157

When accountants are preparing their client’s books, they are bound by certain principles that they must follow.  These accounting principles are used to make sure there is consistency across the board from one company or corporation to another.  This consistency will keep an organization from comparing apples to oranges so the numbers that a third party sees is equivalent to other financial sheets as well, and everyone knows what they mean.  For example, an investor should know what the stock market fair value is before they buy stock from any company.  Without a fair value measurement, the buyer will not know if they are actually making money or losing money on a deal.  So, it is important for accountants to know how to calculate fair value measurement when they are working with their client’s assets.  For assistance in this area, some companies are utilizing crunch accounting services.  Crunch accounting services is becoming increasingly popular today, especially since it is an online accountancy firm that provides their software and services to small businesses, contractors and freelancers.

The same is true for clarifications that have been made for FAS 157.  Since the wording and some of the language was unclear and not beneficial to protect the investor, these are some of the clarifications that have been made.

Fair value is the representation of an exit price.  It can be described as the price that a firm sells its assets for or transfer their liability.

Fair value cannot be described as an entity specific measurement.  Instead, it is considered to be a market-based measurement.

Transaction costs is not a reason to adjust Fair value measures.

When an individual or organization sells their assets, there are some guidelines that they will need to follow.  Some of the more recent involves assessing assets based on fair value measurement accounting principles.  The guidelines for this statement can be found in FAS 157, and should be reviewed prior to selling and buying assets from an individual or a firm. These guidelines are designed to protect investors from buying assets that have been overvalued as well as to supply specific measurement industry standards that’s consistent across the board.