Glossary term
Fair Value Measurement
Subject: Legal, Tax and Reporting, Financial Reporting and Audit
Also known as: Fair value accounting, Mark-to-market, Mark-to-model
Fair value measurement values an asset or liability at the price it could be sold for, or a liability transferred at, in an ordinary transaction between willing market participants on the reporting date, rather than at historical cost.
Explanation
Accounting standards rank the inputs used to reach a fair value. Level 1 uses quoted prices in active markets for identical items, such as listed shares. Level 2 uses inputs that can be observed indirectly, such as prices of similar assets or interest rate curves. Level 3 relies on unobservable inputs, meaning the company’s own assumptions, and the value comes from a model; this is mark-to-model. Unlisted equity stakes, complex derivatives and illiquid loans often sit at Level 3. Fair value is a market view, not what the owner hopes to receive or paid originally. It is used for trading securities, derivatives and some investment property, and for impairment tests. Because Level 3 values depend on judgment, they invite bias, and they attract extra disclosure, audit effort and regulatory attention. Disclosure notes show how much of each balance sits at each level.
Example
A fund holds a stake in an unlisted company with no recent trades. It values the stake with a model based on projected cash flows and a chosen discount rate. In the model, raising the growth assumption by one percentage point lifts the value by about a tenth. The valuation committee records the inputs, compares them with similar listed firms, and the auditor tests whether the assumptions are reasonable and applied consistently.
Not to be confused with
- Historical cost
- Historical cost keeps an asset at what was paid, less depreciation. Fair value moves with market conditions at each reporting date.