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What is Fair Value? - Definition, Principle, Measurement & Examples

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  • 0:02 What Is Fair Value?
  • 1:11 Measuring Fair Value
  • 2:13 Examples
  • 3:17 Lesson Summary
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Lesson Transcript
Instructor: Tara Schofield

Tara has a PhD in Marketing & Management

Determining the value of an item, asset, stock, and even a company can be a difficult task. This lesson reviews the importance of understanding fair value and how to arrive at the fair value of items.

What Is Fair Value?

Fair value is the current price or value of an item. More specifically, it is the amount that the item could be sold for that is fair for both the buyer and the seller. Fair value does not relate to products being sold in liquidation; rather it refers to products that are being sold under normal, reasonable conditions.

Fair value becomes increasingly important when assets are sold or a company is acquired. Using fair value allows a fair and appropriate sales price to be determined for individual items or an entire business. When a company is purchased, the fair value helps determine the value of the assets and arrive at a reasonable sales price for the business.

Fair value is also important when valuing assets on financial statements. If a product falls in value, it may affect the depreciation costs of the business and lower the value of the assets. On the other hand, if a product increases in value, it will cause the value of the asset and company to increase. Fair value can also apply to the value of a stock or security in the open market.

Measuring Fair Value

Two common ways to measure fair value are market value and cost.

The market approach is an easy way to measure the value of a product if it is readily available for sale. For instance, if you have a car that you want to sell, there are likely other similar cars available for sale. Determining the price of the car is easy because there are many other cars of the same make and model for sale. A reasonable price can be determined by referring to the price of similar cars.

Cost is a common method for determining the value of a product by how much it would cost to replace the item. Cost is often used for items that hold their value and have little depreciation. Insurance companies often use cost as a fair value when covering the loss of an item. As an example, if your home burns down, the insurance company may use the cost method to determine the fair value of your home. What will it cost to replace your house? Using the cost method, a value can be determined for an item based on what it will cost to build or re-purchase that item.

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