Fair Value: Definition, Calculation, and Importance in Corporate Accounting and Reporting

Corporate accounting and
reporting

Fair value
Recoverable amount is the value in use of an asset or the greater of its fair value fewer
costs incurred in its sale. The value in use simply means the money value in present of
future cash flows expected to be generated from an asset. Thus, the concept records the
highest value of cash flows that can be extracted from an asset either by selling it or by
using it. The recoverable amount concept is used in the international financial reporting
standards framework (IFRS). The concept of recoverable amounts is oftentimes used in
the context of determining the impairment of fixed assets.
A company is as per the accounting principles, needed to record on its balance sheet
instances where the recoverable amount of an asset is exceeded by its carrying amount.
This approach is somewhat on similar lines of the concept of lower of cost or market
value, which applies to inventory (Shoaf & Zaldivar, 2005). International Accounting
Standards (IAS) 36 provides accountants with guidance on this topic, stating:
• “If the asset's fair value less the cost of disposal cannot be determined, the
recoverable amount is equal to its value in use.
• If the company intends to sell the asset, the recoverable amount is equal to its fair
value less the cost of disposal.”
It is to be noted that if the fair value of an asset less its cost of disposal, or the asset's
value in use is greater than its carrying amount, then calculating a recoverable amount is
not necessary since the asset is not impaired (Kieso et. al, 2010). In simple terms, the
recoverable amount is the highest value that can be obtained from an asset. We can think
of two general ways we can obtain value from an asset: (a) from using that asset in the
business or (b) by selling it to someone else. The value of (a) is the present value of
expected future cash flows from using the asset. The value of (b) is the fair value of the
asset fewer costs to sell the asset. The higher amount of these two alternatives is the
recoverable amount.
The present value of future cash flows derived from the use of an asset is termed as a
value in use of that particular asset. Companies determine an asset's value-in-use as part
of a process that evaluates if an asset's value is impaired.
Value-in-Use = Present Value of the Asset's Benefits
A formal estimate of the recoverable amount of the asset has to be taken into account in
case a company believes that the asset’s value may be impaired. This approach is
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