Although the terms fair value and market value are often used interchangeably, there is a difference between the two. The International Valuation Standards requires fair-value prices be assessed by the advantages or disadvantages that two individuals encounter when making a transaction. While market value can encompass the same requirements, fair-value assessment also takes into account any special value for the individuals involved in the transaction.
Fair-value assessment requires that the individuals consider gains or losses in the value of an asset when it changes hands. For example, if a corporation wants to sell an asset, that asset may gain or lose value depending on who purchases it. When considering a purchase, fair value allows the buyer to calculate the difference in the value of an asset when determining what they are willing to pay.
Market value does not allow consideration of what the sale of an asset will do to its value. The individuals involved in the transaction assess its value based on what it is worth at the moment of sale. Investors often determine market value by considering the value of similar assets and the demand for the asset. While an asset's market value should be close to an asset's fair value, it can vary depending on the individuals involved in a transaction.
Determining the Difference
The difference between market value and fair value can be large if there is an individual with an asset that someone else wants to buy. For example, if a painting is appraised at $20 million, its market value is $20 million. However, if the same painting goes on the auction block and two bidders get in a bidding war for it, the fair value of the painting is the amount that both bidders were willing to pay. This does not mean that the winning bid is the fair value of the painting; it is the last bid before the winning bid because the other bidder was not willing to pay the final bid amount. So if one bidder placed a bid of $25 million, and the other bidder placed the winning bid of $26 million, the fair value of the painting is $25 million.
Companies must disclose the market value of liquid assets in their financial statements. Because fair-value assessment can vary depending on the purchaser, the company and the purchaser must determine the fair value when considering an asset's value. Just because the market value of an asset is one amount, an individual purchasing the asset may be willing to pay more or less for it depending on its value to him.