Carrying Value vs. Fair Value: An Overview
Carrying value and fair value are two different accounting measures used to determine the value of a company's assets.
The carrying value, or book value, is an asset value based on the company's balance sheet, which takes the cost of the asset and subtracts its depreciation over time. The fair value of an asset is usually determined by the market and agreed upon by a willing buyer and seller and it can fluctuate often. In other words, the carrying value generally reflects equity, while the fair value reflects the current market price.
Because the fair value of an asset can be more volatile than its carrying value or book value, it's possible for big discrepancies to occur between the two measures. The market value can be higher or lower than the carrying value at any time. These differences usually aren't examined until assets are appraised or sold to help determine if they're undervalued or overvalued.
The carrying value of an asset is based on the figures from a company's balance sheet. When a company initially acquires an asset, its carrying value is the same as its original cost. However, this changes over time. To calculate the carrying value or book value of an asset at any point in time, you must subtract any accumulated depreciation, amortization, or impairment expenses from its original cost.
For example, say company ABC bought a 3D printing machine to design prototypes of its product. The 3D printing machine costs $50,000 and has a depreciation expense of $3,000 per year over its useful life of 15 years under the straight-line basis. Therefore, the book value after 15 years is $5,000, or $50,000 - ($3000 x 15).
Different from the carrying value, the fair value of assets and liabilities is calculated on a mark-to-market accounting basis. In other words, the fair value of an asset is the amount paid in a transaction between participants if it's sold in the open market. A willing buyer and seller have agreed upon this value. Due to the changing nature of open markets, however, the fair value of an asset can fluctuate greatly over time.
For example, let's say an investment company has long positions in stocks in its portfolio during an economic downturn. The investment company's original cost of the asset was $6 million. However, after two negative gross domestic product rates, the company's portfolio falls 40% in value, to $3.6 million. Therefore, the fair value of the asset is $3.6 million, or $6 million - ($6 million x 0.40).
Determining the fair value of an asset can be difficult if a competitive, open market for it doesn't exist—an unusual piece of equipment in a manufacturing plant, for example.
- Carrying value and fair value are two different accounting measures used to determine the value of a company's assets.
- The carrying value of an asset is based on the figures from a company's balance sheet.
- the fair value of an asset is the amount paid in a transaction between participants if it's sold in the open market.