Fair Value

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

Fair value is used as a measurement base to measure intangible assets that either has no current historical accounting value, or has a value that is significantly different from its historical cost. For instance, my phone is worth $1,000. It's useful life is 5 years. I've used it for 1 year. This means it has depreciated by $200. So the carrying amount is $800. But when I take it to a dealer, he says its worth $750.

The dealer's appraisal of $750 is its fair value, where it is highly probable that anywhere in the market, the market would value it at $750 regardless.

This method is increasingly popular amongst most reporting entities as well as standard setters.

However, there are problems of fair value regarding intangible assets.

Intangible assets are assets that have no physical form. Intangible assets may be a reporting entity's goodwill, logo, brand name, masthead, research and development, so on and so forth. For instance, Coca Cola's brand name, is worth quite a lump sum. Coca Cola's bottle shape, their logo, is highly valued.

But here lies the problem : How do they measure the value of something intangible? How can Coca Cola perceive their brand name "Coca Cola" to be worth, lets say, $200 million and put that in their balance sheet? What is the basis for that measurement?

Fair value has certainly received a lot of attention, even from standard setters, such as the International Accounting Standards Board (IASB). But how can something intangible, be measured by fair value, if there is no liquid and competitive market for it?

Certainly, the hand phone could easily be appraised by any hand phone dealers anywhere in the world. But is there anybody in the world who has the expertise, the authority, the knowledge, or the right to suggest a value of a brand name? Goodwill of that company? The value of their logo? The value of research and development which might be successful or unsuccessful?

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Any business and economics students or accounting students/graduates that might want to share some thoughts? I feel this is a thought provocative issue for students and practitioners of financial accounting.

I will post up other bases of accounting such as Historical Cost, Current Costs (Exit and Entry prices), Value in Use, and Replacement Cost soon, for comparison.

I'm not well versed in any of the relevant fields, but I'll try to chip in anyway.

Could you perhaps get a rough figure based on the amount the company has spent on advertising (value perceived by company)? Then find the price that people are willing to pay for coca cola (value perceived by consumers), vs the average cola drink. The difference in price multipled by their production should give you a good idea on how much the brand alone makes.

Amateurish Reply: I believe that Fair Value is actually the value that is proposed by the market, or what the market is willing to offer in exchange for rights to the tangible / intangible asset.

If im not mistaken there was an in-depth discussion on the Fair Value basis with emphasis on intangible assets or else known as Goodwill. From what I last learnt, there are 2 methods to calculate the goodwill, Partial or Full which is with regards to Parent and Subsidiary. But thats a discussion altogether.

From what I deduce, Goodwill and its value is simply determined by the market price or price offered, deducting the company assets, and the balancing figure would be the Goodwill.

Anyways, anyone out there, please correct me and dont take my input at face value, this is just coming off the top of my head But thats my input. Hope to hear more substantiated arguments and explanations!

As you have said, intangible asset is in fact, intangible. To build up the value of intangible asset, we can't simply declare the value and assume the general public will take it.

It comes from years of effort, like marketing, commercial, sponsors, and they consume value. As to how they justify the value, I'll leave it to the real economic fella to explain, as I myself is not

That's just on goodwill alone, which is, I admit, a rather unique intangible asset. That method of goodwill calculation is very much simplified. And it only applies to goodwill calculated during a business combination phase. How do you measure the goodwill in consolidated financial statements? How will you amortise goodwill? Can goodwill only ever be amortised? Why can't goodwill grow?

There are several academic journals I've read that were discussing the current accounting culture. The framework emphasizes on reliability, relevance, and hence neutrality. But is financial reporting really neutral? Financial reporting is really biased towards risk averseness. Why can assets only depreciate or be amortised?? Can't certain assets appreciate over time? Why do we always assume capital of the business will always devalue?

Why is that an accountant's default setting. That's a very good question to discuss and, if anyone is writing a thesis, that would be a good topic to consider.

Thanks for the replies so far. Looking forward to more, before I post my thoughts on it ;D

PS : Doesn't look as if there are many gurus in this area of study O_O but there are so many engineers and science discussions in this PhD area :3

IIRC, goodwill balance would only arise if there is an acquisition. The goodwill figure would be the difference between the acquisition price and the target company's net assets.

Fair value, on the other hand, could be more complicated and controversial. Fair value generally refer to the value given to an asset or liability. This is easy if all assets are buildings and cars and all liabilities are creditors. The question is, how do you value an asset that is hard to value or an asset that has no open market for it.

May I ask howdid goodwill get into the picture? At basic level A=L+E. So the asset is either owner's money or borrowed money. When they operate a business it is about income and expenditure. How did goodwill get in the picture? Perhaps knowing how accountants injected goodwill into the balance sheet will be a starting point.

Is that rhetorical? Anyway, my attempt to answer it.

Goodwill is a kind of asset. It is intangible hence there is no physical form. Examples are like brand name and customer loyalty. Goodwill usually arises in the balance sheet when there is an acquisition of a company. For example A takes over B. A paid 10million. B's fair value is valued at 8million. The take over premium shall be treated as a goodwill and it would be entered in to the asset part of the balance sheet. I think both the IFRS and GAAP not does not allow amortisation. Not too sure about that. A quick google search would give you the answer.

Thanks monstar. So it is willing buyer and seller situation. Then why the interest to place a value for goodwill in the absense of buyers

Internally generated goodwill are not permitted to be recognised.
For goodwill arising from acquisition, you review it at least annually for impairment.

I don't deal with intangibles as part of business valuations, but I'm guessing some sort of DCF is often used (which really boils down to the basic).

Thanks Sesshoumaru. Then if there is no aqusition there is no need to think of putting value for goodwill. Grimm, I am lost. What are you trying to acheive here. I am geting to think of this as let put a value for goodwill since we dont have anything else to do.