fair value

Suppose you own a share of stock you bought for 10 dollars, and today the market price is 25. What is it 'worth'? Most people would answer 25 — what you could sell it for now, not what you once paid. Fair value captures that intuition: it is the price an item would change hands for today, between willing parties, in an orderly market.

Formally, fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. It is an exit price (what you would get on the way out), not necessarily your cost. Because not everything has a quoted market price, the standards rank the inputs into a hierarchy: Level 1 uses quoted prices for identical items in active markets (most reliable), Level 2 uses observable prices for similar items, and Level 3 uses unobservable inputs and a company's own models (least reliable). Items commonly measured at fair value include marketable securities and certain derivatives; many other assets, like buildings under US GAAP, stay at historical cost.

Fair value matters because it can make the balance sheet more relevant — it tells you what things are worth now, not just what they once cost. But there is a real trade-off with faithful representation: when a market is thin or absent, 'fair value' becomes a model-driven estimate that can be soft, and in a crisis it can swing violently and even feed panic. Critics during the 2008 financial crisis argued that 'mark-to-market' accounting amplified losses. The honest view: fair value gains relevance but can lose verifiability, especially at Level 3.