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Fair Market Value Definition
The price at which the property is sold on the open market is called fair market value (FMV). The Fair market value is different from appraised value or market value. It is based on economic principles of open and free market activity. The term market value only shows asset’s price in the market. The appraised value depicts the value of asset as per a single appraiser’s valuation; therefore, it does not necessarily represent the value of the product in a free and open market.
A Little More on Fair Market Value
As an example, FMV is usually used in real estate scenarios. It presents the property’s price with certain conditions understood. These conditions might include: the potential sellers and buyers are well-aware of the property; behave in their best interest; are committing a certain time period for the completion of transaction; and are not subject to undue pressure or influence. Under these conditions, one is most able to accurately determine the property’s fair market value.
Fair market value is also used in legal settings such as the taking of property pursuant to eminent domain. Insurance companies also use FMV as a basis to compensate the vehicle’s damages in accidents. It is also used in taxation when the fair market value of the property is used for tax calculation. For example, the FMV of the property is used to assess municipal property taxes. The global tax authorities prefer transactions to be executed at FMV for tax purposes. FMV is also relevant for tax deductible donations. The donor gets a tax credit or deduction for the donation’s value.
References For Fair Market Value
Academic Research on Fair Market Value
Be careful what you ask for: Is fair value accounting really fair?, King, A. M. (2008). International Journal of Disclosure and Governance, 5(4), 301-311. This paper explores the general concept and processes of ‘Fair Value’ accounting. The author of this paper aims to show that Fair Value reporting is likely to be neither relevant nor reliable, two of the requirements for financial reporting.
Fair value accounting: Evidence from investment securities and the market valuation of banks, Barth, M. E. (1994). Accounting Review, 1-25. This study investigates how disclosed fair value estimates of banks’ investment securities and securities gains and losses based on those estimates are reflected in share prices in comparison with historical costs. This study examines disclosed fair values of investment securities that can be considered more reliable than previously-studied fair value disclosures. This study also investigates the Barth et al. (1990) suggestion that fair value securities gains and losses are value-relevant.
Just Compensation and the Condemnation of Future Interests: Empirical Evidence of the Failure of Fair Market Value, Burney, L. H. (1989). BYU L. Rev., 789. The purpose of this article is to demonstrate the general inappropriateness of strictly adhering to any one predetermined standard in compensating owners whose property has been taken. It urges that just compensation be equated with the fifth amendment’s dictate of fairness and indemnity rather than with any one objective standard. It also presents the condemnation of fee simple determinables as representative of the objective standards’ failure in determining just compensation in all takings cases and proposes restructuring this approach by dethroning objective standards and emphasizing the equities of each case.
Financial reporting quality: is fair value a plus or a minus?, Penman, S. H. (2007). Accounting and business research, 37(sup1), 33-44. This paper focuses on the measurement of fair value of assets and liabilities, and when fair value measurement should be applied. It also analyses the circumstances under which fair value might be a plus or a minus. To achieve this, a survey of public statements made for and against fair value accounting by a variety of standard setters, regulators, analysts, and preparers is used. Findings are discussed, and recommendations highlighted in the text.
Fair valuation of life insurance liabilities: the impact of interest rate guarantees, surrender options, and bonus policies, Grosen, A., & Jørgensen, P. L. (2000). Insurance: Mathematics and Economics, 26(1), 37-57. The paper analyzes one of the most common life insurance products — the so-called participating (or with profits) policy. The paper shows that the typical participating policy can be decomposed into a risk free bond element, a bonus option, and a surrender option. Findings show that values of participating policies are highly sensitive to the bonus policy, that surrender options can be quite valuable, and that LIC solvency can be quickly jeopardized if earning opportunities deteriorate in a situation where bonus reserves are low and promised returns are high.
Fair–value accounting: A cautionary tale from Enron, Benston, G. J. (2006). Journal of Accounting and Public Policy, 25(4), 465-484. This paper explores Enron’s use of fair-value accounting, ad how it affected its demise.
Inco Ltd.: Market value, fair value, and management discretion, Hilton, A. S., & O’brien, P. C. (2009). Journal of Accounting Research, 47(1), 179-211. In this paper, the authors examine management discretion to decide when and how much to write down an asset, in a unique case where a tracking stock provides an observable market value for the asset. Findings show that, despite market evidence that Inco Ltd.’s financial statements substantially overvalued the Voisey’s Bay nickel mine throughout 1997 to 2000, management chose not to write down the mine until 2002. The management discretion exercised in this case provides a concrete example of the subjectivity inherent in fair valuation.
The relationship between fair value, market value, and efficient markets, Milburn, J. A. (2008). Accounting Perspectives, 7(4), 293-316. This paper proposes that an assumption of reasonable market efficiency is at the essence of the relevance of fair value for financial reporting purposes. The paper’s examination of this proposal begins with a review of recent academic literature on market efficiency, and on evidence of inefficiencies and their implications for the ability of the efficient market hypothesis to explain what market prices represent. The paper also examines the essential attributes of a reasonably efficient market for fair value measurement purposes, and some basic implications for its reliable estimation.