Let’s say you need to come up with a value for something – a company, a hard asset, intellectual property, shares of stock. The measure is often Fair Market Value or Fair Value – two terms that get treated as if they are identical. Except Fair Market Value and Fair Value are not identical and their differences matters. So, let’s answer the question:
What is the difference between Fair Market Value and Fair Value?
Let’s start with the definitions.
| FAIR MARKET VALUE | FAIR VALUE |
| The search for the price at which the property would change hands between a willing buyer and a willing seller under no compulsion to buy. | The search for the price to sell an asset or paid to transfer a liability in an orderly transaction between market participants. |
To my eye, these definitions look identical. But, they are different. And the reason they are different is because of where they come from and how they get used. Fair Market Value is the Internal Revenue Service’s (“IRS”) measure. The IRS has actually defined Fair Market Value in an IRS Revenue Ruling (59-60). Since Fair Market Value is the tax man’s measure, there is an enormous amount of case law analyzing and defining Fair Market Value. Case law and history beget comfort, so appraisers and accountants rely on Fair Market Value as a standard measure for assets and enterprises and real estate.
In contrast, Fair Value is the standard of valuation under Generally Accepted Accounting Principles, which is the sort of official set of accounting rules put out by the Financial Accounting Standards Board (“FASB”) FASB gets its authority from the Securities Exchange Commission, the regulator of stocks and bonds. FASB’s job is to set standards for financial reporting under US GAAP. So, Fair Value is the sort of the publicly-traded stock valuation measure. Fair Value is used in Black Scholes, Lattice Model and other valuation strategies for options. Sometimes, Fair Market Value valuations conducted for tax purposes don’t comply with Fair Value and have to be revalued.
The difference goes beyond source – it also includes inputs. Fair Market Value gets to an objective estimate of what fictional, fungible, fully-informed reasonable and willing buyers and sellers would pay and accept for something. Fair Value aims to show what “two specific parties taking into account the respective advantages or disadvantages that each will gain from the transaction.[i]” Fair Value tries to pull in the idiosyncrasies of the parties while Fair Market Value approaches valuation from a slightly more theoretical position.
There is actually a horse race between Fair Market Value and Fair Value. Though Fair Market Value started in the lead, Fair Value is coming up on the outside, propelled by globalization. If Fair Market Value represents the old economy, market oriented approach, Fair Value has developed into a set of three tiers that starts off by using lofty variables from the market and drills down to take into account hard-to-get information as well as grass roots facts.
Fair Value is picking up steam. In 2009, FASB got its arms around GAAP and reogrnized it into a single collection of rules called the FASB Accounting Standards Codification (“ASC”). FASB claims it didn’t kill GAAP, but it did seem to start to sedate it. GAAP were American rules for accounting – now that America’s financial statements get shared increasingly around the world, our methods of accounting are out of step, sometimes requiring restatement to match International Financial Reporting Standards (“IFRS”). The IFRS are established and maintained by the International Accounting Standards Board (“IASB”). IASB and FASB are right now working together to converge the international and US accounting standards – their report is due during the second half of 2012. Here is the Profit and Laws prediction: the IRS will switch to Fair Value by 2015. You heard it here first. Disagreements welcome.
[i] International Valuation Standards 2007.
June 6, 2013
michael bloom
Excellent. Thanks
December 14, 2016
roman
why is there a diffference between the followong article definition of “fair Market Value”
http://www.lawpipe.com/california/Fair_Market_Value_Legal_Definition.html
and the article you wrote above ?
August 15, 2017
Martin
Just came across this post (belatedly). The explanation is incorrect and even the accounting profession and the valuation profession cannot highlight the difference, and until recently both definitions were exactly the same. .
Fair value (Accounting Standards) is not an entity specific value, therefore is not to reflect the idiosyncrasies of the parties. This is the same underlying principle as market value.
With respect to fair value, value inputs is the accounting professions way of explaining that market evidence should be used to define market outcomes. To their credit, they have segregated what all valuers/appraisers learn in valuation 101, use the most reliable data first (Level 1), followed by less directly related data (Level 2) with non-market data (level 3) the last option to be used (if ever) in determiing your opinion of value
All valuations are conceptual and only those entities that deal in the specialist field should attempt to provide advice on such matters.
August 15, 2017
Coco Soodek
Martin, thanks for your comment. To be honest, I have not looked at this article in a few years. It is probably time for me to update it. That said, I respectfully disagree with your assessment. First, the goal of my post was not to differentiate the terms for the use and purpose of seasoned, expert appraisers. I’m not an appraiser and I wouldn’t. But, Second, the purpose of this post was to ferret out the legal applications of these standards. Third, just as you said, until a few years ago, there were few agreements on the definition of these terms of art – so this was an argument attempting to synthesize where the meanings were moving. This analysis was written a few years ago, specifically when the professions of law, accounting and finance were grappling with segregating these definitions to smooth out their use. But, I sure take your point. It is time for me to revisit this analysis and see how it can be updated for the stunningly rapid evolution of seemingly standard, settled accounting terms. Thanks for reading and for your comments. They are much appreciated.
Coco