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So, this time, the topic I have chosen is Fair Value or Fair Market Value – What’s the big deal? In fact, many of you might be thinking that they are similar terms.

Well, they are not. Let’s look at their definitions.

Starting with Fair Value, it is defined in Ind AS 113 (IFRS 13), Fair Value Measurement as:

“Fair value as 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”.

Fair value is further comprehensively defined in paragraph 24 of Ind AS 113 (IFRS 13), Fair Value Measurement as:

“Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (i.e. an exit price) regardless of whether that price is directly observable or estimated using another valuation technique”.

As I have explained in my previous blog “Fair Value Definitions in Accounting Standards”, certain other Indian Accounting Standards and Accounting Standards have differing definitions of fair value.

Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations) define fair value as:

“Fair value means the estimated realisable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion”.

As we can see the fair value definition in CIRP Regulations is quite similar to that in Ind AS 113 except for the fact that it does not cover liabilities and does not specify any market.

ICAI Valuation Standards (ICAI VS) has copied the definition of fair value from Ind AS 113. International Valuation Standards (IVS) do not define fair value.

There may be various statutes around the world that also define and use the term fair value.

Now coming to fair market value (FMV). FMV is not defined in any accounting standard or valuation standard. IVS refers to the definition of FMV in tax regulations in USA which (Regulation §20.2031-1) which states:

“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts”.

IVS also refers to the definition of FMV adopted by the Organisation for Economic Co-operation and Development (OECD) which is

“The price a willing buyer would pay a willing seller in a transaction on the open market”.

Like in the case of fair value, there may be various statutes around the world that also define and use the term fair market value.

Let’s now look at the differences between fair value and FMV.

A key difference between fair value and FMV is that fair value is computed at a unit of account level.

Unit of account refers to the level at which an asset or liability is aggregated or disaggregated in an Ind AS for recognition purposes. For example, in respect of shares, each share is a unit of account since each share can be transferred individually. Hence for fair valuation, the value per share is to be calculated without considering any premium or discount for an entity’s holding in a company. So, control premium cannot be considered, and neither can a discount that may be applicable on a bulk sale of shares on a stock exchange. However, discount for lack of marketability in respect of shares or an unlisted company or a private company can be considered since lack of marketability is a characteristic of each individual share of that company.

However, premiums or discounts can be considered for calculating FMV.

Secondly, fair value basically focuses on the principal market, and in its absence, the most advantageous market. FMV does not restrict itself to any market.

Thirdly, fair value is primarily used for accounting purposes. Accounting Standards, whether the old AS or the new Ind AS, both use the term fair value for accounting purposes. IBC 2016 also requires fair valuation of the corporate debtor for the purposes of insolvency resolution. However, FMV is not used anywhere either in the accounting standards or in IBC 2016.

Fourthly, both the IND AS 113/IFRS 13 specify that fair valuation should maximise the use of observable inputs and minimise the use of unobservable inputs. Observable inputs are those that are readily obtainable say, a stock market quotation of the redemption value of a mutual fund unit. Unobservable inputs are those that are developed by the entity such as cash flow projections. In fact, three levels of input hierarchy have been provided in Ind AS 113/ IFRS 13 with level 1 being unadjusted quoted prices and level 3 being unobservable inputs. The standards give highest priority to level 1 inputs.

There are no such levels of inputs in computation of FMV though both ICAI VS and IVS specify that the use of observable inputs should be maximised in all types of valuations.

Fifthly, in the Indian context, the term FMV is primarily used in the Income Tax law. There are a number of provisions which require FMV to be considered for computing taxable income. However, the definition of FMV differs in different rules.

For example, while the rule relating to issuance of equity shares by an unlisted company requires valuation to be carried out by a merchant banker on a discounted cash flows (DCF) basis, the rules relating to transfer or acquisition of movable property including shares prescribe different methods of valuation.

For computation of perquisite value in respect of shares issued by an unlisted company to employees as sweat equity or under ESOPs, the FMV is defined as a value computed by a merchant banker without specifying any method, while in the case of an  issue of shares by a listed company as sweat equity or under ESOPs, the rule specifies that the average of opening and closing price on the relevant date shall be the FMV.

The rule regarding acquisition or transfer of equity shares of an unlisted company specify an adjusted net asset value basis to arrive at FMV while in case of a an acquisition or transfer of shares or securities  of a listed company, the FMV shall be the transaction price, if the transaction is carried out on a stock exchange, or the lowest price of the share or security on any stock exchange on the valuation date, if the transaction is not carried out on a stock exchange.

In respect of unlisted shares or securities other than equity shares, the rules prescribe that the FMV shall be the price that such shares or securities would fetch in an open market as determined by a merchant banker or a chartered accountant.

For other types of movable assets such as jewelry or artworks, the rule prescribes open market value as FMV.

The income tax law does not refer to fair value at all. Neither the customs law nor the GST law uses the terms fair value or fair market value.