Appendix: Fair value measurement

Fair value has been used for very many years as a means of fixing an accounting value where there is none. As we saw in this chapter, the acquisition of another company requires the integration of a bundle of assets and liabilities into the consolidated accounts. You don’t have individual values for these, only a figure for the whole bundle. Fair value is then used as an allocation device to break down the total price into the components. Similarly, if you do a barter transaction, referring to market price enables you to find an accounting value. If you exchange your car and pay €5,000 for another car, the market value of the car you exchanged will enable you to derive an accounting value for the car acquired.

The use of fair value is, of itself, not necessarily controversial. It causes problems with financial instruments because their market value fluctuates and people do not like importing volatility into their balance sheets. At a theoretical level you could measure all assets and liabilities at fair value. If you did this, every company’s balance sheet would be directly comparable, and the data would give you the market’s estimate of the cash generating potential of the company (if you subscribe to the view strongly held by the finance community that the market price of anything – in a perfect and efficient market – reflects the market’s valuation of the expected future benefits of owning that asset). If the objective of financial reporting, ...

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