Fair value measurements

Area 3: Select Transactions (25-35%)

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Topics

ASC 820 fair value hierarchy
Valuation techniques and inputs

Lessons

Fair Value MeasurementsFree

Study Frameworks

Fair Value Measurement Framework (ASC 820)

Fair Value Measurement

Definition

Exit price in an orderly transaction

Between market participants

At the measurement date

Hierarchy (Inputs)

Level 1: Quoted prices in active markets (identical assets)

Level 2: Observable inputs (similar assets, inactive markets)

Level 3: Unobservable inputs (entity's own assumptions)

Valuation Approaches

Market approach — comparable transactions

Income approach — DCF or option pricing

Cost approach — replacement cost less obsolescence

Key Principles

Highest and best use (nonfinancial assets)

Principal or most advantageous market

Maximize observable inputs, minimize unobservable

Fair Value Hierarchy: Which Level?

Are there quoted prices in active markets for identical assets or liabilities?

Yes

Level 1 — use the quoted price (unadjusted). Most reliable

Are there observable inputs other than Level 1 prices (quoted prices for similar assets, yield curves, interest rates, credit spreads)?

Yes

Level 2 — use observable inputs, with adjustments if needed

Level 3 — use unobservable inputs (entity's own assumptions about market participant assumptions). Least reliable; requires most disclosure

ASC 820 Fair Value Hierarchy

Level	Input Type	Examples	Reliability
Level 1	Quoted prices (unadjusted) in active markets for identical assets/liabilities	Exchange-traded stocks, U.S. Treasury bonds, commodity futures	Highest — most reliable
Level 2	Observable inputs other than Level 1 (similar assets, inactive markets, derived from observable data)	Corporate bonds with comparable trade data, interest rate swaps using yield curves, real estate with comparable sales	Moderate — observable but adjusted
Level 3	Unobservable inputs based on entity's own assumptions about market participant assumptions	DCF models with projected revenues, internal pricing models for complex derivatives, customer relationship valuations	Lowest — most estimation uncertainty

MICMarket approach, Income approach, Cost approach

The three valuation techniques under ASC 820 for measuring fair value. Market uses comparable transactions, Income converts future cash flows to present value, and Cost uses replacement cost adjusted for obsolescence.

HBUMHighest and Best Use for nonfinancial assets, Market participant assumptions

Two key ASC 820 principles: (1) Fair value of nonfinancial assets is based on highest and best use — the use that maximizes value to market participants, which may differ from current use. (2) All fair value measurements use market participant assumptions, not entity-specific assumptions, even for Level 3 inputs.

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