Fair value is the estimated value of an asset, liability, or equity instrument that reflects 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 an objective measure of the value of an item, based on market data or other observable inputs, and it is used extensively in financial reporting to provide relevant and reliable information about the value of an entity's assets, liabilities, and equity instruments.

The concept of fair value is based on the idea that the value of an item should reflect its current market value, rather than historical cost or amortized cost, particularly for items that are subject to frequent market fluctuations or that have no observable market data. The use of fair value measurement is consistent with the objective of financial reporting to provide users of financial statements with information that is both relevant and reliable.

Fair value measurement can be complex and subjective, particularly for items that have no observable market data or that are subject to significant uncertainty. The measurement process requires careful consideration of the inputs and assumptions used in the valuation process to ensure that the resulting fair value is both accurate and reliable. However, despite its limitations, fair value measurement is an important tool for financial reporting that provides users with valuable information about the value of an entity's assets, liabilities, and equity instruments.

Here's an example of fair value measurement:

Let's say a company holds a building that it intends to sell in the near future. The company believes that the fair value of the building is currently $2 million, based on the prevailing real estate market in the area.

To measure the fair value of the building, the company could use a valuation model that takes into account the building's location, size, age, condition, and other relevant factors. Let's assume that the company determines that the building's fair value can be estimated using the following inputs:

• Comparable sales data for similar buildings in the area: $2.5 million
• Condition of the building: Average
• Age of the building: 10 years
• Estimated remaining useful life of the building: 20 years

Based on these inputs, the company estimates that the fair value of the building is $2.2 million.

This fair value measurement would fall under Level 2 of the fair value hierarchy, as it relies on observable market data (comparable sales data) and other inputs (condition, age, and estimated remaining useful life of the building) to estimate the building's fair value.

The journal entry to record the fair value measurement would be:

Building (asset) $200,000

Unrealized gain on building (income) $200,000

This entry would increase the asset balance for the building by $200,000 and create a corresponding increase in the unrealized gain on building income account.