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Amortized fair value

What Is Amortized Fair Value?

Amortized Fair Value refers to the broader concept in financial accounting that encompasses two primary methods for valuing assets and liabilities on a company's balance sheet: amortized cost and fair value. These distinct measurement bases are fundamental to how financial instruments are reported, impacting insights into a company's financial position and performance. While "Amortized Fair Value" isn't a singular accounting term, understanding the principles behind both amortized cost and fair value is crucial for accurate financial reporting.

Amortized cost generally reflects the original cost of an asset or liability, adjusted over time for elements like discounts, premiums, and the recognition of interest, aiming to spread the cost over the instrument's life57, 58. In contrast, fair value represents 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 date55, 56. The application of either amortized cost or fair value depends heavily on the nature of the financial instrument and the business model under which it is held.

History and Origin

The concepts of amortized cost and fair value have evolved significantly within accounting standards over decades. Historically, historical cost was the predominant method for valuing assets. However, as financial markets became more complex and the need for more relevant, real-time financial information grew, the push for fair value accounting increased.

Major international accounting standards, such as IFRS 9 Financial Instruments and IFRS 13 Fair Value Measurement, significantly shaped the application of these measurement models. IFRS 9, for instance, revised the classification and measurement of financial assets, stipulating conditions under which an instrument should be measured at amortized cost, fair value through other comprehensive income, or fair value through profit or loss53, 54.

The debate surrounding the appropriate use of fair value accounting intensified during the 2007-2009 financial crisis. Critics argued that mark-to-market accounting, a form of fair value accounting, exacerbated the crisis by forcing write-downs of assets in illiquid markets, leading to a downward spiral of asset values51, 52. This period highlighted the inherent tensions between providing timely market-based information and maintaining stable, historical cost-based financial statements, prompting various studies and discussions, including a report to Congress by the U.S. House Financial Services Committee50.

Key Takeaways

  • "Amortized Fair Value" is a conceptual term referring to the distinct accounting measurement approaches of amortized cost and fair value.
  • Amortized cost values assets and liabilities based on their initial acquisition cost, adjusted over time for various factors, typically used for instruments held to collect contractual cash flows.
  • Fair value reflects the current market price at which an asset could be sold or a liability transferred, providing a more up-to-date valuation.
  • The choice between amortized cost and fair value has significant implications for a company's financial statements, particularly earnings volatility and the portrayal of financial health.
  • International accounting standards, notably IFRS 9 and IFRS 13, provide the framework for when each method is applied to financial assets and financial liabilities.

Formula and Calculation

The calculation of amortized cost involves adjusting the initial recognized amount of a financial instrument for the cumulative amortization of any difference between that initial amount and the maturity amount, typically using the effective interest method. It also accounts for principal repayments and any impairment losses49.

The formula for amortized cost is generally expressed as:

\text{Amortized Cost} = \text{Initial Acquisition Amount} - \text{Principal Repayments} \pm \text{Amortization of Discount/Premium} \pm \text{Foreign Exchange Differences} - \text{Impairment Losses} $$[^48^](https://www.stern.nyu.edu/sites/default/files/assets/documents/khan%20ryan%20varma%20tar%20november%202019.pdf) Fair value, on the other hand, does not typically involve a formula in the same way, as it is a market-based measurement. It is determined by 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[^46^](https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2022/issued/part-a/ifrs-13-fair-value-measurement.pdf?bypass=on), [^47^](https://www.ifrs.org/issued-standards/list-of-standards/ifrs-13-fair-value-measurement/). When observable market prices are not available, valuation techniques are used, maximizing observable inputs and minimizing unobservable inputs, often following a fair value hierarchy[^45^](https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2022/issued/part-a/ifrs-13-fair-value-measurement.pdf?bypass=on). ## Interpreting the Amortized Fair Value Interpreting "Amortized Fair Value" means understanding the implications of applying either amortized cost or fair value to a company's [financial instruments](https://diversification.com/term/financial-instruments). When assets or liabilities are measured at amortized cost, their value on the [balance sheet](https://diversification.com/term/balance-sheet) is relatively stable and reflects the long-term cash flow expectations[^44^](https://www.researchgate.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry). This method is often preferred for instruments where the intention is to hold them to maturity and collect contractual cash flows, such as many loans or "held-to-maturity" [debt instruments](https://diversification.com/term/debt-instruments). It provides a clearer view of the expected return over the life of the instrument without immediate market volatility. Conversely, when items are measured at fair value, their reported value can fluctuate significantly with market conditions[^43^](https://www.stern.nyu.edu/sites/default/files/assets/documents/khan%20ryan%20varma%20tar%20november%202019.pdf). This provides investors and analysts with a more current snapshot of the instrument's worth, reflecting changes in market [interest rates](https://diversification.com/term/interest-rates), credit risk, and other observable factors. While fair value accounting offers greater transparency regarding current market exposures, it can introduce volatility into earnings, which some argue may not always reflect the true economic performance[^1^](https://cirano.qc.ca[^41^](https://www.researchgate.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry), [^42^](https://pages.stern.nyu.edu/~adamodar/pdfiles/country/fairvalueaccounting.pdf)/files/publications/2009s-27.pdf)[^2^](https://www.cahill.com/publications/client-alerts/000138/_res/id=Attachments/index=0/SEC%20Delivers%20Report%20to%20Congress%20Regarding%20Results%20of%20Study%20on%20Fair%20Value%20Accounting%20Standards.pdf), 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[^18^](https://www.iasplus.com/en/standards/ifrs/ifrs9)[^19^](https://www.iasplus.com/en/standards/ifrs/ifrs9)[^20^](https://www.researchgate.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry)[^21^](https://www.researchgate.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry)[^22^](https://www.ifrs.org/conten[^40^](https://www.iasplus.com/en/standards/ifrs/ifrs9)t/dam/ifrs/publications/pdf-standards/english/2022/issued/part-a/ifrs-13-fair-value-measurement.pdf?bypass=on)[^23^](https://www.researchgate.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry)[^24^](https://www.ifrs.org/content/dam/ifrs/publications/pdf-standards/english/2022/issued/part-a/ifrs-13-fair-value-measurement.pdf?bypass=on)[^25^](https://www.stern.nyu.edu/sites/default/files/assets/documents/khan%20ryan%20varma%20tar%20november%202019.pdf)[^26^](https://pages.stern.nyu.edu/~adamodar/pdfiles/country/fairvalueaccounting.pdf)[^27^](https://www.cahill.com/publications/client-alerts/000138/_res/id=Attachments/index=0/SEC%20Delivers%20Report%20to%20Congress%20Regarding%20Results%20of%20Study%20on%20Fair%20Value%20Accounting%20Standards.pdf)[^28^](https://www.aei.org/wp-content/uploads/2011/10/20080728_2333[^39^](https://www.cahill.com/publications/client-alerts/000138/_res/id=Attachments/index=0/SEC%20Delivers%20Report%20to%20Congress%20Regarding%20Results%20of%20Study%20on%20Fair%20Value%20Accounting%20Standards.pdf)6JulyFSOg.pdf), [^29^](https://cirano.qc.ca/files/publications/2009s-27.pdf)[^30^](https://www.cahill.com/publications/client-alerts/000138/_res/id=Attachments/index=0/SEC%20Delivers%20Report%20to%20Congress%20Regarding%20Results%20of%20Study%20on%20Fair%20Value%20Accounting%20Standards.pdf), [^31^](https://www.willkie.com/-/media/files/publications/2008/05/the-role-of-fair-value-accounting-in-the-subprim__/files/the-role-of-fair-value-accountingpdf/fileattachment/the-role-of-fair-value-accounting.pdf)[^32^](https://www.accaglobal.com/gb/en/student/exam-support-resources/dipifr-study-resources/technical-articles/ifrs13.html), [^3[^37^](https://www.stern.nyu.edu/sites/default/files/assets/documents/khan%20ryan%20varma%20tar%20november%202019.pdf), [^38^](https://www.ifrs.org/issued-standards/list-of-standards/ifrs-13-fair-value-measurement/)3^](https://www.cahill.com/publications/client-alerts/000138/_res/id=Attachments/index=0/SEC%20Delivers%20Report%20to%20Congress%20Regarding%20Results%20of%20Study%20on%20Fair%20Value%20Accounting%20Standards.pdf)[^34^](https://www.researchgat[^36^](https://www.stern.nyu.edu/sites/default/files/assets/documents/khan%20ryan%20varma%20tar%20november%202019.pdf)e.net/publication/332822302_Fair_Value_versus_Amortized_Cost_Measurement_and_the_Timeliness_of_Other-Than-Temporary_Impairments_Evidence_from_the_Insurance_Industry), [^35^](https://pages.stern.nyu.edu/~adamodar/pdfiles/country/fairvalueaccounting.pdf)