What is the philosophy behind fair value? A key concept in accounting
Posted: Sat Dec 21, 2024 5:11 am
We explain the basic principles on which the concept of fair value is based, its main applications and the foreseeable regulatory changes that are approaching.
The ideal approach to the concept of fair value is through a reliable market value.
Fair value is a reference for the practice of valuation corrections
Valuation is one of the most important processes that the accounting process requires. For each element, the accounting regulations determine how to carry it out both at the time of incorporation into our accounts and at any subsequent time.
There are various valuation criteria for greece email list this , such as historical cost, net realizable value, current value, value in use, amortized cost, accounting or book value, or residual value.
In this post we will analyze one of the most relevant: fair value .
The concept of fair value
The General Accounting Plan (PGC) defines it as "the amount for which an asset can be exchanged or a liability settled, between interested and duly informed parties , who carry out a transaction under conditions of mutual independence ."
Therefore, the philosophy that pursues fair value is that of a market value , taking into account all the limitations that this entails. Ideally, the reference is sought for an active market , in which:
The goods or services exchanged on the market are homogeneous . For example, the average price per square metre of business premises cannot serve as a reference, since there are many types of premises with different characteristics. On the contrary, the prices of a very specific and limited variety of raw materials traded on a raw materials market could be used to calculate their fair value.
Buyers or sellers for a particular good or service can be found at virtually any time . This lends reliability to known values, prevents their value from being determined by circumstances that force them, and makes it more realistic to be able to settle the item for that amount between independent parties.
Prices are known and easily accessible to the public . They also reflect real, current and regularly occurring market transactions. This achieves transparency and objectivity that facilitates subsequent verification processes such as an accounting audit or a tax inspection .
In the absence of an active market to refer to, valuation models and techniques are used .
The General Accounting Plan mentions:
References to recent arm's length transactions between interested and duly informed parties.
The fair value of other assets that are substantially the same.
Methods for discounting estimated future cash flows .
Models generally used to value options .
Reforms in the concept of fair value
There is a draft royal decree that aims to address, among other aspects, the revision of the concept of fair value . It is part of a reform that aims to respond to various regulatory changes at an international level.
In principle, it is expected that, once approved and published in the Official State Gazette, it will come into force the day after its publication and will be applied from January 1, 2020 with certain specific rules for its first application.
As regards the concept of fair value itself, it does not modify the definition, but it does modify some aspects related to the methods and circumstances that must be taken into account for its calculation.
For example, it introduces the precision that it must be estimated for a certain date and that, therefore, it should include the considerations that market participants would take into account when setting the price and that may change over time, such as the state of conservation, location or possible restrictions on its use.
The ideal approach to the concept of fair value is through a reliable market value.
Fair value is a reference for the practice of valuation corrections
Valuation is one of the most important processes that the accounting process requires. For each element, the accounting regulations determine how to carry it out both at the time of incorporation into our accounts and at any subsequent time.
There are various valuation criteria for greece email list this , such as historical cost, net realizable value, current value, value in use, amortized cost, accounting or book value, or residual value.
In this post we will analyze one of the most relevant: fair value .
The concept of fair value
The General Accounting Plan (PGC) defines it as "the amount for which an asset can be exchanged or a liability settled, between interested and duly informed parties , who carry out a transaction under conditions of mutual independence ."
Therefore, the philosophy that pursues fair value is that of a market value , taking into account all the limitations that this entails. Ideally, the reference is sought for an active market , in which:
The goods or services exchanged on the market are homogeneous . For example, the average price per square metre of business premises cannot serve as a reference, since there are many types of premises with different characteristics. On the contrary, the prices of a very specific and limited variety of raw materials traded on a raw materials market could be used to calculate their fair value.
Buyers or sellers for a particular good or service can be found at virtually any time . This lends reliability to known values, prevents their value from being determined by circumstances that force them, and makes it more realistic to be able to settle the item for that amount between independent parties.
Prices are known and easily accessible to the public . They also reflect real, current and regularly occurring market transactions. This achieves transparency and objectivity that facilitates subsequent verification processes such as an accounting audit or a tax inspection .
In the absence of an active market to refer to, valuation models and techniques are used .
The General Accounting Plan mentions:
References to recent arm's length transactions between interested and duly informed parties.
The fair value of other assets that are substantially the same.
Methods for discounting estimated future cash flows .
Models generally used to value options .
Reforms in the concept of fair value
There is a draft royal decree that aims to address, among other aspects, the revision of the concept of fair value . It is part of a reform that aims to respond to various regulatory changes at an international level.
In principle, it is expected that, once approved and published in the Official State Gazette, it will come into force the day after its publication and will be applied from January 1, 2020 with certain specific rules for its first application.
As regards the concept of fair value itself, it does not modify the definition, but it does modify some aspects related to the methods and circumstances that must be taken into account for its calculation.
For example, it introduces the precision that it must be estimated for a certain date and that, therefore, it should include the considerations that market participants would take into account when setting the price and that may change over time, such as the state of conservation, location or possible restrictions on its use.