Differences Which You Must Know between Par Value and Fair Value

Differences Which You Must Know between Par Value and Fair Value

Face value is another name for par value, which is the literal definition of the term. The par value of a financial instrument is established by the entity that issues it. When capital assets were printed on paper, the par values were printed on the faces of the shares.

The actual value of an asset - a product, stock, or security – that is agreed upon by both the seller and the buyer is known as fair value. A product's fair worth is determined when it is sold or traded in the market where it belongs or under normal conditions - not when it is liquidated. It is determined to arrive at a fair amount of value for the buyer without disadvantaging the seller.

Par value 

The lowest legal price for which a corporation may sell its shares is known as the par value, and it is normally fixed between a fraction of a cent (the lower range is known as a low par value) to a few dollars. This has very little to do with how much a corporation's stock is worth or can be sold for.

The par value of a bond issued by a company or government specifies how much income the asset will be valuable when it matures.

Suppose a bond with a par value of $100 is acquired with a one-year maturity date. In that case, the bondholder is entitled to receive $100 from the issuing business at the end of that year, in addition to any interest payments the bond generated.

The majority of private investors purchase bonds as a haven investment. The yield is paid in installments only until the bond matures, resulting in an income stream. The shareholder is then reimbursed for their initial investment. They want to keep the bond until it matures, to put it another way.

A bond's par value is quite significant to the average investor, whereas a stock's par value is somewhat of an oddity.

IMPORTANT POINTS 

  • The par value of a bond is the amount of money it will be worth when it matures.
  • The bond may sell for more or less than par value on the secondary market before its maturity date as the yield it pays becomes more or less appealing to buyers.
  • At the maturity date, whoever owns the bond will receive the par value, no more, no less.
  • A stock's par value is merely a nominal amount required for regulatory purposes.

Fair Value:

The buyer's real selling value of an item that is agreed to be paid and set by the seller is known as fair value. The sale benefits both parties. Profit margins, projected growth rates, and risk concerns are all considered when determining the fair value.

Company A, for example, sells its stock to Company B for $30 per share. The owner of Company B believes that once he has acquired the stock, he can sell it for $50 a share, so he chooses to buy a million shares at the original price. Despite Company B's enormous profit potential, the sale is considered fair because both parties agreed upon the price and gained from the transaction.

Fair Value Accounting's Benefits

Provides proof that the assessment is used to determine whether an asset's worth is actual or approximated. Because of the benefits it provides, it is one of the most widely utilized financial accounting procedures.

1. Valuation accuracy

Fair value accounting makes evaluations more thorough and allows them to analyze pricing fluctuations.

2. A true indicator of income

Fair value accounting uses total asset value to show a company's actual income. It does not rely on revenue and expenses but rather on the real value.

3. Adaptable to various asset types

This method can be used to value all types of assets, which is preferable to using historical cost value.

4. Aids in the survival of companies

Because it allows for asset reduction, fair value accounting aids businesses in surviving financially challenging times (or the act of declaring that the value of an asset that is included in a sale was overestimated).

Differences Which You Must Know

  • Valuation equals the number of rights issued multiplied by the share price at the time of granting (the share price may be a VWAP or same-day value). On the other hand, Fair value includes deductions for missed dividends and, in some cases, the likelihood of vesting. Only a few businesses now base the number of shares to be given on a fair valuation that includes the chance of vesting.
  • The par value of equity is used as a benchmark by proxy advisers. It's straightforward and transparent, and it's become the standard method for publicly traded firms when announcing how to calculate award size. If an executive's LTI entitlement is equal to half of their fixed salary, and the fixed pay is $1 million, the LTI entitlement is $500,000. If the share price is $1, you will be given 500,000 share rights. The issue is that face value isn't always an appropriate indicator of the grant's worth. When the LTI at other companies is calculated on the same basis and used as a benchmark, the problem is worsened. A share's par value contains the anticipation of a dividend, but most stocks do not.
  • When estimating the fair value of a share award, the present value of dividends expected to be paid during the vesting period should be deducted. Suppose that each of the Companies A and B CEOs is issued LTI share rights worth $500,000. Further:
  • The Business A CEO is not entitled to dividends or the equivalent, but they can be compensated in other ways.
  • The CEO of Company B is entitled to dividends with an 8 percent yield over a four-year performance term (provided as control and the ability rights only in respect of the share rights that expire).
  • The "par value" or "face value" of a company's stock is the lowest price at which it can be sold, while the value of shares on the market "Fair Value" refers to the price at the moment of selling.

Summary

  • Because of its simplicity, par value has been the most used approach for determining the number of LTI rights awarded. It doesn't require much explanation, which is better than a long description of a sophisticated process in the salary declarations. 
  • The most straightforward solution to address the discrepancy between par and fair value is eliminating it. This entails integrating the right to receive dividends (or a similar value) and may necessitate adjustments to the equity plan's terminology.
  • Incorporating a dividend right does not imply paying dividends on unvested shares or share rights. Most investors and proxy advisers would find unacceptable, only to the degree that the equity grant vests, dividends are accumulated.
  • Aside from harmonizing par value and fair value, there's another compelling reason to include dividends. The award is capital neutral if dividends are included. There is no financial motive to reduce dividend yield in favor of stock price growth. The risk is minor for low-yield companies, but there is the possibility of a conflict of interest for high-yield enterprises. Importantly, implementing dividend entitlements guarantees that the company's interests are better aligned with those of its shareholders. In this regard, the majority of share rights programs fail.
  • The introduction of dividends effectively improves the value of the grant for corporations that have traditionally calculated grant value and size based on par value. 

If you are looking for any Employee stock option plan (ESOP) services or consultants in Noida, Delhi, Gurgaon or anywhere in India, write to us at accounts@especia.co.in. Or Call On :(+91)-9711021268 +91-9310165114

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