What is a fair value gap?

A fair value gap is a concept that refers to the difference between the fair value of an asset or liability and its carrying amount in the financial statements. Fair value is 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.

The fair value gap can be positive or negative, depending on whether the fair value of the asset or liability is higher or lower than its carrying amount. A positive fair value gap indicates that the asset or liability is undervalued on the balance sheet, while a negative fair value gap indicates that it is overvalued.

It is important for companies to identify and understand fair value gaps in their financial statements, as they can impact key financial metrics and ratios, such as profitability, liquidity, and solvency. Large fair value gaps may also indicate potential risks or opportunities for the company.

In order to address fair value gaps, companies may need to reassess the valuation of their assets and liabilities, update their accounting policies and procedures, or seek guidance from external experts. Regular monitoring and disclosure of fair value gaps can help investors and stakeholders make informed decisions about the company's financial health and performance.