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Fair value, what is it?
Fair value is a concept used in accounting, finance and asset valuation that It refers to the price at which an asset can be sold or a debt can be transferred between interested and knowledgeable parties of the market, in a free and pressure-free transaction.
Fair value is determined using valuation methods that may include the use of current market information, mathematical models, comparative valuation techniques and other approaches, it is important to note that fair value may differ from the original cost of an asset on a company's balance sheet, as it reflects the current market value rather than the historical value.
In practice, fair value is used to value a wide range of assets and liabilities, including stocks, bonds, real estate, financial derivatives and other financial instruments, in addition to accounting standards such as International Financial Reporting Standards (IFRS). and Generally Accepted Accounting Principles (GAAP), typically require that certain assets and liabilities be measured at fair value in the financial statements, especially when these are subject to a fair value measurement.
Importance of calculating fair value
Calculating fair value is important for several reasons:
| Reason | |
|---|---|
| Informed decision making | Knowing the fair value of assets and liabilities allows managers and investors to make informed financial decisions, including investment decisions, financing, mergers and acquisitions, among others. |
| Financial transparency | The use of fair value in financial statements provides transparency about the financial position of a company, it is especially important for investors and other stakeholders, as it allows them to better understand the valuation of the company's assets and liabilities. |
| Normative compliance | Many accounting standards require that certain assets and liabilities be valued at fair value; compliance with these standards is critical to maintaining the integrity and credibility of a company's financial statements. |
| Performance evaluation | Fair value is also used to evaluate the performance of investments and the company in general, comparing the fair value of assets with their historical cost or with their book value can help determine whether profits or losses are being generated. |
| Risk management | Understanding the fair value of assets and liabilities is also crucial for managing financial risk, it allows companies to identify and mitigate potential risks related to the overvaluation or undervaluation of their assets and liabilities. |
Calculating fair value is essential for effective financial management, transparency in financial reporting and regulatory compliance, as well as for evaluating the performance and managing risk of a company.
Fair Value Measurement Hierarchy (GAAP)
In the context of Generally Accepted Accounting Principles (GAAP for its acronym in English), the measurement of fair value follows a hierarchy established by the Financial Accounting Standards Board (FASB) used in accounting in US industries
This hierarchy, which is used to determine the most reliable and relevant source of information for measuring fair value, is composed of three levels:
Level 1
Fair value based on quoted market prices: This level includes fair values that can be determined using identical active quoted prices in active markets. For example, publicly traded stocks have a fair value based on the current market price.
Level 2
Fair value based on observable data: When identical asset quoted prices are not available, fair value is determined using observable data such as recent transaction prices for comparable assets, market information or other relevant market data.
Level 3
Fair value based on unobservable data: At this level, fair value is determined using valuation techniques that rely heavily on unobservable data, such as financial valuation models, these models may include discounted cash flow valuations, valuations of real options or other similar approaches.
The fair value hierarchy establishes that preference should be given to the most objective and reliable sources of information available. In general, it seeks to use the highest level available to measure the fair value of an asset or liability. However, in practice , multiple levels of the hierarchy may need to be reached to arrive at a reasonable estimate of fair value.
Methods for measuring fair value
There are three common methods for assessing fair value: the market approach, the income approach and the cost approach.
The market approach It relies on market transactions of comparable assets or liabilities to determine their fair value. For example, if a company seeks to establish the fair value of its building, it may examine recent sales of similar buildings in the same area.
The income approach Calculates the fair value of an asset or liability using the present value of the anticipated future cash flows. For example, if a company wants to determine the fair value of a patent, it can project the expected future cash flows it generates and discount them to value. present.
The cost approach It is based on the replacement or reproduction cost of an asset to determine its fair value. For example, if a company wants to calculate the fair value of its machinery, it may consider the cost of replacing it with a similar machine.
NIFBdM B-17, Determination of fair value
The accounting framework outlined in this Financial Reporting Standard for Public Companies should be used to calculate and disclose fair value, if such value is required or permitted by other Financial Reporting Standards for Public Companies. In other words, this criterion specifies how fair value should be determined and reported, but does not indicate when it should be recognized or disclosed, as this is determined by other Financial Reporting Standards for Listed Companies.
This Financial Reporting Standard for Publicly Traded Companies should be used where fair value measurements and/or related disclosures (as well as fair value-based determinations, such as net fair value) are required or permitted. of disposal costs).
Importance of NIFBdM B-17, Determination of fair value
NIFBdM B-17, Determination of Fair Value, is important for several reasons:
Clear standards: Provides clear and specific guidelines on how to determine the fair value of assets, liabilities and other financial instruments, helping to ensure consistency and transparency in the measurement of fair value in financial statements.
Normative compliance: Helping companies comply with the disclosure requirements established by accounting standards, compliance with NIFBdM B-17 ensures that companies provide the necessary fair value information in their financial statements, contributing to transparency and reliability. Reliability of the financial information.
Informed decision making: By providing guidance on how to determine fair value, the standard makes it easier for users of financial statements to make informed decisions, investors, creditors and other interested parties can rely on fair value information to evaluate the financial health and performance of a company.
International standardization: NIFBdM B-17 is aligned with international accounting standards, which facilitates the comparability of financial statements between companies and countries. This is especially important in a globalized business environment where consistency in the application of accounting standards is essential.
Risk management: A clear understanding of the fair value of assets and liabilities allows companies to better manage their financial risk, properly identifying and evaluating the fair value of assets and liabilities helps companies make more informed decisions about the management of their portfolio and the financial planning.
NIFBdM B-17 plays a crucial role in standardization, transparency and informed decision making in the field of financial valuation, contributing to the integrity and confidence in a company's financial statements.
