What is fair value and how to calculate it

In simple terms, fair value is what something would sell for in a fair, well-informed deal today.

Accounting standards define it more precisely. Under IFRS 13, it’s:

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 key points:

• It’s based on current market conditions, not forecasts or wishful thinking.
• It’s a market-based measure, not specific to one company’s circumstances.
• It assumes knowledgeable, willing parties, not forced buyers or sellers.

FRS 102’s Section 2A mirrors this definition. Think of it as an “exit price” under normal market conditions – not a distressed sale, and not the number you hope for.

Fair value in share-based payment accounting

Under IFRS 2 and FRS 102 (UK GAAP) section 26, all share-based compensation must be recognised as an expense. The fair value of the equity instruments granted must be determined on the grant date.

This involves estimating the value of shares or options given to employees or suppliers, taking into account market conditions attached to those awards.

• IFRS 2 requires that market conditions, such as target share prices, are reflected in the fair value calculation.
  
  
• FRS 102 similarly requires initial grant-date valuation, but does not mandate subsequent adjustments. The accounting charge remains fixed unless the terms of the award change significantly.

These differences mean UK companies need to know which framework applies when accounting for equity compensation.

Fair value vs market value

Although related, fair value and market value are not the same: 

• Market value reflects the actual transaction price of an asset in an open market. It is driven by supply and demand and can fluctuate significantly. 
  
  For example, shares in a public company may trade at £20 today and £30 next month as market sentiment changes. 
  
  
• Fair value is an estimate based on ideal conditions: both buyer and seller are well‑informed and willing, and the sale is orderly. It is not a distressed or forced sale price.

Fair value may differ from market value when the market is illiquid or when the asset is not traded on an open market. A private company’s shares illustrate this distinction.

• The fair value of private shares represents the price a willing buyer and seller would agree upon; it must consider factors such as minority rights and restrictions.
  
  
• The market value of private shares would simply reflect whatever price the shares fetch on an open market, which doesn’t exist for many private companies.

How does fair value work for private companies?

Without active markets, private companies must rely on valuation techniques and professional judgment to estimate fair value. Independent third-party input is often required.

Typical scenarios include:

• Share‑based payment accounting (e.g. employee share schemes) under FRS 102 Section 26.
• Valuation of different share classes (such as growth shares or ordinary shares).
• Investment property valuations.
• Transaction due diligence, exits, or shareholder disputes.

These valuations typically use Level 3 inputs under IFRS 13 – *unobservable assumptions such as management forecasts and internal metrics.

*Unobservable assumptions, in the context of fair value measurement, refer to inputs used in valuation techniques that are not directly observable in the market.

How does fair value work for public companies 

Public companies benefit from active markets, making observable data more accessible.

IFRS 13 introduces a three-level fair value hierarchy:

• Level 1: Quoted prices in active markets for identical assets (e.g. LSE-listed shares).
• Level 2: Observable inputs such as interest rates, yield curves.
• Level 3: Unobservable inputs (e.g. management forecasts and assumptions).

Most listed companies rely on Level 1 and 2 inputs. However, level 3 models may still be necessary for unlisted subsidiaries, bespoke derivatives, or during *market dislocations. 

*Market dislocation refers to a situation where asset prices significantly deviate from their fair or intrinsic value due to abnormal market conditions.

Why fair value matters

Fair value isn’t just an accounting box-tick; it impacts:

• Financial statements: Fair value affects income statements and balance sheets. Gains or losses from fair value remeasurements may influence reported profit or equity.
  
  
• Equity compensation: Drives the accounting charge under IFRS 2 and FRS 102 Section 26. Accurate estimates improve transparency and stakeholder confidence.
  
  
• Fundraising and M&A: Investors scrutinise share valuations during funding rounds and acquisitions. Robust assessments support negotiation and governance.
  
  
• Taxation: HMRC uses fair value assessments to determine the taxable benefit of employee share schemes.
  
  
• Corporate governance: Accurate fair value measurement supports transparency and compliance with reporting frameworks (IFRS or UK GAAP).

Get it wrong, and you risk misstated accounts, audit challenges, or even employee disputes.

How to calculate fair value

There is no single formula. Fair value depends on the asset, data availability, and business maturity. 

Here are the main methods used: 

Market approach

The market approach estimates fair value based on prices and other relevant information from market transactions involving identical or comparable assets or businesses.

This method is most effective when you have reliable, recent, comparable data.

Example: A SaaS firm applies a 5x revenue multiple from similar AIM-listed peers to its £2m ARR, yielding a £10m estimated value, subject to adjustments. 

Common uses: 

• Minority share valuations.
• Share option pricing for EMI schemes.
• Transaction benchmarking.

Limitations: Not suitable where markets are illiquid or comparables lack relevance.

Income approach

The income approach estimates fair value based on the present value of expected future economic benefits, typically cash flows. The most common technique is the discounted cash flow (DCF) model. 

This involves forecasting future cash flows and discounting them back to their present value using a discount rate that reflects the risk associated with those cash flows (such as the company’s cost of capital).

Example: An early-stage business projects five years of EBITDA, adds a terminal value, and discounts all cash flows at 15% to arrive at today’s value.

This method is often applied where: 

• Business generates or expects to generate positive cash flow.
• Market comparables are limited or unreliable. 
• Share valuations are needed for internal management, financing, or HMRC purposes. 

This method depends on credible assumptions about growth, margins, and discount rates.

Cost approach 

The cost approach estimates fair value based on the cost to replace or reproduce the asset, minus depreciation and obsolescence. 

This method is most appropriate for tangible assets with limited earnings potential – for example, equipment, property, or infrastructure.

Example: An asset-heavy firm values its machinery at the current replacement cost of each asset today, then deducts depreciation based on age and condition. 

Although rarely used for valuing equity or intangibles, the cost approach may be relevant when: 

• Valuing asset-heavy businesses.
• Determining the fair value of fixed assets for financial reporting.
• Setting an entry price for new operations.

In practice, valuations – particularly for private company shares or share-based payments – often blend methods to mitigate the weaknesses of any single method. This combined approach helps ensure reasonableness, defensibility and compliance with accounting standards.

The Black-Scholes model: Valuing share options

Some assets, like employee share options, need a specialist approach. One of the most widely used for IFRS 2 reporting is the Black-Scholes model.

It calculates the fair value of an option at the grant date – the figure you’ll expense over the vesting period.

Black-Scholes takes into account:

• Current share price
• Exercise (strike) price
• Expected volatility
• Risk-free interest rate
• Time to expiry

It produces an estimate of what the option is worth today – i.e. its fair value under IFRS 2. For many UK companies, using Black-Scholes ensures the valuation is robust, defensible, and audit-ready.

This is the method used in Vestd’s IFRS 2-compliant share-based payment reports.

Try it yourself using our Black-Scholes calculator.

What factors affect fair value 

Valuations aren’t just about the numbers – they reflect judgment calls. Key influences include:

• Financial forecasts: Revenue growth, margin trends and cash‑flow projections.
• Discount rates: Cost of capital, market risk premiums and risk-free rates.
• Comparables: Valuation multiples from similar companies or transactions.
• Rights and restrictions:  Voting rights, dividend rights and protective provisions. Minority shares with limited rights may attract.
• Market conditions: supply and demand dynamics, macroeconomic factors and regulatory environments.
• Control and liquidity: Whether the buyer gains control and how easily the asset can be sold. 

For private companies, HMRC typically allows discounts for lack of control ot marketability, especially when valuing minority shareholdings or EMI options. 

Summary

Fair value is the estimated price in a fair deal between informed, willing parties. It’s not the same as market value, which is the actual price in a real-world trade.

For private companies, fair value often depends on Level 3 inputs and professional judgement. Market, income and cost-based approaches help determine a fair value range.

Share-based payment accounting under IFRS 2 and FRS 102 hinges on fair value at grant date.

And finally, correct fair value measurement supports accurate financial reporting, tax compliance and investor confidence.

When in doubt, seek out qualified valuation specialists.

What next?

Fair value isn’t just about compliance –  it’s about making decisions you can defend. Whether you’re issuing options, preparing for audit, or raising a round, knowing the fair value matters.

The right approach to valuation depends on your stage, structure, and reporting obligations.

Share schemes, investor expectations, and tax outcomes all intersect at the point of a valuation. Getting it wrong can be costly, but getting it right builds trust, clarity and long-term alignment.

We’ve made IFRS 2 reporting simpler, combining robust methods with reliable tech and expert support.

If you’re looking for support with your share-based payment accounting, book a free, no-obligation consultation.