The core difference between fair value and value in use lies in their perspectives: fair value focuses on the market price (what someone would pay), while value in use focuses on the asset's specific economic benefits to the company (what the asset is worth to the company).
Diving Deeper: Fair Value vs. Value in Use
To better understand the distinction, let's explore each concept:
Fair Value
Fair value represents 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 essentially an exit price from the perspective of the seller.
- Focus: Market-based. What would an independent buyer pay in the current market?
- Perspective: External. Considers the views of hypothetical market participants.
- Examples: Quoted market prices, discounted cash flows reflecting market assumptions, or valuations based on comparable transactions.
- Adjustments: Fair value less costs to sell considers the expenses directly attributable to the disposal of the asset (e.g., commissions, legal fees).
Value in Use
Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit. It reflects the economic benefits the asset will provide to the entity using it.
- Focus: Entity-specific. What economic benefits will this asset provide to this company?
- Perspective: Internal. Considers the entity's specific circumstances and plans for the asset.
- Examples: Cash flows from production, cost savings from using the asset, or terminal value at the end of the asset's useful life.
- Discounting: Future cash flows are discounted using a rate that reflects the time value of money and the risks specific to the asset.
Key Differences Summarized
| Feature | Fair Value | Value in Use |
|---|---|---|
| Perspective | Market Participant | Entity-Specific |
| Basis | Exit Price | Present Value of Future Cash Flows |
| Focus | Price in an orderly market transaction | Economic benefits to the specific company |
| Assumptions | Market assumptions | Company's plans and strategies |
Practical Implications
The choice between fair value and value in use often arises in impairment testing. If an asset's carrying amount (book value) exceeds its recoverable amount, the asset is considered impaired, and its carrying amount must be written down. The recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.
Example:
Imagine a specialized piece of equipment.
- Fair Value: A potential buyer is willing to pay \$50,000 for it, but selling costs would be \$5,000. So, fair value less costs to sell is \$45,000.
- Value in Use: The company expects the equipment to generate \$60,000 in discounted future cash flows.
In this case, the recoverable amount is \$60,000 (the higher of the two).
Conclusion
Fair value aims to represent what an asset could be sold for in the marketplace, reflecting external market conditions. Value in use, on the other hand, reflects the economic value an asset contributes to a specific entity based on its unique utilization and future cash flow expectations. The accounting standards require careful consideration of both measures, particularly in impairment scenarios.
