Carrying Value vs. Fair Value: An Overview
The carrying value and the fair value are two different accounting measures used to determine the value of a company's assets.
The carrying value, or book value, is an asset value based on the company's balance sheet, which takes the cost of the asset and subtracts its depreciation over time. The fair value of an asset is usually determined by the market and agreed upon by a willing buyer and seller, and it can fluctuate often. In other words, the carrying value generally reflects equity, while the fair value reflects the current market price.
Because the fair value of an asset can be more volatile than its carrying value or book value, it's possible for big discrepancies to occur between the two measures. The market value can be higher or lower than the carrying value at any time. These differences usually aren't examined until assets are appraised or sold to help determine if they're undervalued or overvalued.
Key Takeaways
- The carrying value and the fair value are two different accounting measures used to determine the value of a company's assets.
- The carrying value of an asset is based on the figures from a company's balance sheet.
- Carrying value is often used for bookkeeping and tax purposes.
- The fair value of an asset is the amount paid in a transaction between participants if it's sold in the open market.
- Fair market value is most often used by market participants.
Carrying Value
The carrying value of an asset is based on the figures from a company's balance sheet. When a company initially acquires an asset, its carrying value is the same as its original cost. However, this changes over time. To calculate the carrying value or book value of an asset at any point in time, you must subtract any accumulated depreciation, amortization, or impairment expenses from its original cost.
Example of Carrying Value
Let's say company ABC bought a 3D printing machine to design prototypes of its product. The 3D printing machine costs $50,000 and has a depreciation expense of $3,000 per year over its useful life of 15 years under the straight-line basis of calculating depreciation and amortization.
Straight-line depreciation is a simple way to calculate the loss of an asset's carrying value over time. This calculation is particularly useful for physical assets—such as a piece of equipment—that a company might sell in whole or in parts at the end of its useful life. Therefore, the book value of the 3D printing machine after 15 years is $5,000, or $50,000 - ($3,000 x 15).
Carrying Value
Fair Value
Different from the carrying value, the fair value of assets and liabilities is calculated on a mark-to-market accounting basis. In other words, the fair value of an asset is the amount paid in a transaction between participants if it's sold in the open market. A willing buyer and seller have agreed upon this value. Due to the changing nature of open markets, however, the fair value of an asset can fluctuate greatly over time.
Example of Fair Value
Let's say an investment company has long positions in stocks in its portfolio. By having long positions, the company anticipates favorable market conditions, also known as a "bull market." The company is holding onto these stocks with the expectation they will rise in price over time.
The investment company's original cost of these assets was $6 million. However, after two negative gross domestic product (GDP) rates, the market experiences a significant downturn. The company's portfolio falls 40% in value, to $3.6 million. Therefore, the fair value of the asset is $3.6 million, or $6 million - ($6 million x 0.40).
Determining the fair value of an asset can be difficult if a competitive, open market for it doesn't exist—an unusual piece of equipment in a manufacturing plant, for example.
Fair Value
Is Carrying Value the Same as Book Value?
Both book value and carrying value refer to the accounting value of assets held on a balance sheet, and they are often used interchangeably. "Carrying" here refers to carrying assets on the firm's books (i.e., the balance sheet).
How Do You Determine Fair Value?
The fair value of an asset or security is often determined by the market, at a price agreed upon by a willing buyer and seller. This can be determined by the forces of supply and demand, by a valuation model, or several other methods, depending on the particular asset or security involved.
How Do You Determine Carrying Value?
Carrying value is typically determined by taking the original cost of the asset, less depreciation.
FAQs
The carrying value, or book value, is an asset value based on the company's balance sheet, which takes the cost of the asset and subtracts its depreciation over time. The fair value of an asset is usually determined by the market and agreed upon by a willing buyer and seller, and it can fluctuate often.
What is the difference between value and fair value? ›
Fair value is most often used to gauge the true worth of an asset by looking at factors like its potential for growth or the cost to replace it. Market value is the observed and actual value for which an asset or liability is exchanged.
What if carrying amount is greater than fair value? ›
What happens if the carrying amount exceeds the fair value? The difference between an asset's carrying value and its recoverable value is known as an impairment loss. The higher an asset's fair value fewer costs of disposal, and its value in use is the recoverable amount for that asset or cash-generating unit.
What does "carrying value" mean? ›
Carrying value is an accounting measure of value in which the value of an asset or company is based on the figures in the respective company's balance sheet. For physical assets, such as machinery or computer hardware, carrying cost is calculated as (original cost - accumulated depreciation).
What is the difference between value in use and fair value? ›
Fair value less costs to sell is the arm's length sale price between knowledgeable willing parties less costs of disposal. The value in use of an asset is the expected future cash flows that the asset in its current condition will produce, discounted to present value using an appropriate discount rate.
What is the difference between carrying value and fair value? ›
The carrying value, or book value, is an asset value based on the company's balance sheet, which takes the cost of the asset and subtracts its depreciation over time. The fair value of an asset is usually determined by the market and agreed upon by a willing buyer and seller, and it can fluctuate often.
What is fair value in simple words? ›
Fair value refers to the actual value of an asset – a product, stock, or security – that is agreed upon by both the seller and the buyer. Fair value is applicable to a product that is sold or traded in the market where it belongs or under normal conditions – and not to one that is being liquidated.
What is the best evidence of fair value? ›
Quoted market prices in an active market are the best evidence of fair value and should be used, where they exist, to measure the financial instrument.
What is an example of a carrying amount? ›
Example of Carrying Amount
Let's say a company owns a tractor worth $80,000 to be used for developing its newest land property. The said tractor's annual depreciation is $3,000 and is expected to still be of use for 20 years, at which time the salvage value is expected to be $20,000.
Can cash be measured at fair value? ›
Fair value estimate
The Company's cash and cash equivalents include cash on hand, deposits in banks, certificates of deposit and money market funds. Due to their short-term nature, the carrying amounts reported in the consolidated balance sheets approximate the fair value of cash and cash equivalents.
Carrying value, also known as carrying amount, is an accounting concept used to measure the current value of an asset.
What are the disadvantages of fair value accounting? ›
Other issues with fair value accounting include the fact that it can lead to investor dissatisfaction, while it's also possible that the observed value of the asset in the market isn't indicative of its fundamental value.
How to determine fair value? ›
DCF is the most widely accepted method to calculate the fair value of a company. It is based on the premise that the fair value of a company is the total value of its future free cash flows (FCF) discounted back to today's prices. FCF is the company's incoming cash flows less its cash expenses.
What happens if recoverable amount is higher than carrying amount? ›
An impairment loss is the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount. The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs of disposal and its value in use.
At what point is an asset considered to be impaired? ›
An impaired asset is an asset valued at less than book value or net carrying value. In other words, an impaired asset has a current market value that is less than the value listed on the balance sheet. To account for the loss, the company's balance sheet must be updated to reflect the asset's new diminished value.
How do you calculate the carrying amount? ›
To calculate the carrying amount, here's a list of steps you can take:
- Determine the original cost of the asset and deduct the salvage value, which is the amount you expect to receive for it at the end of its useful life.
- Divide the difference between the asset's cost and its salvage value by its useful life.
No. A home's appraised value is the opinion of a licensed, objective appraiser. This professional assessment is typically used by the buyer's mortgage lender as a kind of safety precaution, to make sure that the home is worth the loan amount. Appraised values are often lower than fair market values.
What is true value and fair value? ›
In summary, the "true and fair value of property in money" is its market value or the amount of money a buyer willing, but not obligated to buy would pay for it to a seller willing, but not obligated to sell.
What is the difference between book value and fair market value? ›
Book value indicates an asset's value that is recognized on the balance sheet. Essentially, book value is the original cost of an asset minus any depreciation, amortization, or impairment costs. On the other hand, fair value is referred to as an estimate of the potential value of an asset.
What is the difference between settlement value and fair value? ›
The primary difference between settlement value and fair value is that nonperformance risk (the risk that an entity will not fulfill an obligation) is not considered in the measurement of settlement value. ASC 815-10-35-1B provides guidance on determining the settlement value of a swap.
