The fair value of assets is a necessary figure in accounting as companies need to properly value the assets listed on the balance sheet. Several different methods for valuing assets are typically available from standard accounting principles. These methods include valuation based on quoted prices in an active market for identical assets, valuation based on market observables, and an estimate for assets that have no identical counterparts or observables. The latter category for the fair value of assets is often the most subjective and under scrutiny. A company can typically select the valuation process that matches its situation the best.
Creating the fair value of assets based on market prices for identical items is the easiest of the three valuation methods. Nonphysical assets tend to have a rather robust market where many companies buy and sell the items freely. Physical assets, however, may not have an extremely active market in some cases due to their exclusivity in certain industries. Therefore, companies should determine the asset’s fair value based on a price quoted from a willing buyer for the very same asset. If absolutely no market value exists for the asset, accountants can determine a market price estimate from the gathered data.
When active markets do not exist for assets or the information in such a market is too unreliable, accountants can rely on market observables. The fair value of assets comes from market data about other assets sold between willing sellers and buyers. Identical assets may not exist in the market, though enough price information is readily available on other items. The fair value must be as close as possible between the company’s asset and gathered market data. If no gatherable data exists, accountants must simply estimate the item’s value from observed values taken from multiple points in the active market.
The worst situation for the fair value of assets process is when no active markets are available and no observable data exists. In this scenario, accountants must look at the asset’s cost and current value in order to present a fair value. The sole use of internal information here is acceptable only when gathering external data is too costly to obtain for determining the fair value of assets. Accountants must, however, create a fair value that is what a potential willing buyer would pay for the item. Therefore, estimates that are extremely low or extremely high are typically questionable.