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Fair value through profit or loss is a valuation method used to determine the value of financial instruments on a balance sheet, taking into account market changes. It allows companies to track assets without selling them and is one of four ways to classify financial assets and two ways to classify liabilities. Assets and liabilities can be subcategorized as designated or held for trading.
Fair value through profit or loss is a way of establishing the value of assets and liabilities on a balance sheet. It is a valuation method that is used particularly to value financial instruments. These types of assets have a value that is constantly changing as a result of changes in the market. Using this method allows a company to take the fair value of the financial instrument at the time it was purchased or recognized and make changes to its book value each time a balance sheet is generated accounting for changes in the fair value of the profitability.
The concept of fair value is an accounting standard for valuing assets that do not have an established market value. The only way to definitively establish a market value is to sell the asset. Establishing a fair value allows a company to track the asset in the accounting system for tax purposes without having to sell it. It is an estimate that takes into account the types of factors that would affect the value if the asset were sold.
There is a particular procedure established by the national and international financial accounting standards boards to establish the fair value of financial instruments held by corporations as assets or liabilities. The problem with financial assets involves their changing value in the market. Stock markets, for example, can be volatile, and corporate shares can change in value multiple times in the course of a single day. Similarly, corporate liabilities, such as issued bonds, also change in value as government interest rates rise or fall.
Accounting standards allow corporations to value assets and liabilities by establishing fair value through profit or loss. This way of establishing value is one of the four ways a corporation generally uses to classify financial assets and one of two ways it classifies liabilities. Assets may be classified as carried at fair value through profit or loss or designated as available-for-sale, receivables or loans, or “held-to-maturity” investments. Liabilities can be classified as recorded at fair value through profit or loss or based on the amortized cost of the liability.
Assets and liabilities that are recorded in the books at fair value through profit or loss are subcategorized as designated or held for trading. A designated asset or liability is one that was selected for valuation in this way at the time it was acquired. An asset or liability that is held for trading is valued using this method, but it will only be held for the short term.
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