Measuring Equity Securities without Readily Determinable Fair Values
Equity securities may not always have a readily determinable fair value.How are equity securities measured if fair values are not readily determinable?Give real-world examples where appropriate.
Measuring Equity Securities without Readily Determinable Fair Values
Introduction
Equity securities are a vital component of investment portfolios, providing investors with ownership stakes in companies. While fair values of equity securities are typically determined through market prices, there are instances where these values are not readily ascertainable. In such cases, alternative methods must be employed to measure the value of equity securities, ensuring accurate financial reporting and decision-making.
Thesis Statement
When fair values of equity securities are not readily determinable, accounting standards provide guidelines for measuring these investments using methods such as cost, observable market prices of similar securities, or discounted cash flow models. Real-world examples further illustrate how companies navigate the valuation of equity securities in the absence of readily determinable fair values.
Methods for Measuring Equity Securities
1. Cost Method: Under the cost method, equity securities are initially recorded at their acquisition cost. Subsequent adjustments are made only if there are observable impairments in the value of the securities.
2. Market Price of Similar Securities: When market prices for specific equity securities are unavailable, companies may look to the prices of similar securities that are actively traded in the market as a reference point for valuation.
3. Discounted Cash Flow (DCF) Models: DCF models estimate the present value of expected future cash flows generated by the equity securities. This method requires projections of future cash flows and an appropriate discount rate.
Real-World Examples
1. Start-up Investments: Companies often invest in start-up ventures where there is limited market activity for similar securities. In such cases, they may use the cost method initially and reassess the valuation periodically based on the performance of the start-up.
2. Private Equity: Private equity investments may lack active markets for valuation. Private equity firms often use sophisticated valuation techniques like DCF models to estimate the fair value of their investments.
3. Illiquid Securities: Investments in illiquid securities, such as certain types of preferred stocks, may require unique valuation approaches. Companies may engage third-party valuation specialists to determine the fair value in such instances.
Conclusion
Measuring equity securities without readily determinable fair values necessitates the application of alternative valuation methods to ensure accurate financial reporting and decision-making. By utilizing approaches such as the cost method, market price comparisons, or DCF models, companies can navigate the complexities of valuing investments in various market conditions. Real-world examples demonstrate how organizations adapt these methods to assess the value of equity securities in diverse investment scenarios, highlighting the importance of robust valuation practices in financial management.