1.2 Objective of a Fair Value Measurement

ASC 820-10

05-1 This Topic contains only the Overall Subtopic. This Topic does all of the following:

Defines fair value
Sets out in a single Topic a framework for measuring fair value
Requires disclosures about fair value measurements.

05-1A This Topic explains how to measure fair value for financial reporting. It does not require fair value measurements in addition to those already required or permitted by other Topics and is not intended to establish valuation standards or affect valuation practices outside of financial reporting.

05-1B Fair value is a market-based measurement, not an entity-specific measurement. For some assets and liabilities, observable market transactions or market information might be available. For other assets and liabilities, observable market transactions and market information might not be available. However, the objective of a fair value measurement in both cases is the same — to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability).

05-1C When a price for an identical asset or liability is not observable, a reporting entity measures fair value using another valuation technique that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. Because fair value is a market-based measurement, it is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. As a result, a reporting entity’s intention to hold an asset or to settle or otherwise fulfill a liability is not relevant when measuring fair value.

05-1D The definition of fair value focuses on assets and liabilities because they are a primary subject of accounting measurement. In addition, this Topic shall be applied to instruments measured at fair value that are classified in shareholders’ equity.

Before the issuance of FASB Statement 157 (the pre-Codification fair value standard that preceded ASC 820), various definitions of fair value existed in U.S. GAAP and the guidance on applying those definitions was limited. Statement 157 addressed the need for the consistency and comparability of fair value measurements and for expanded disclosures about those measurements. Specifically, Statement 157 (codified in ASC 820) contained a single definition of fair value, established a principles-based framework for measuring fair value that can be used by all entities, and required entities to provide relevant disclosures about fair value measurements. The definition of fair value and the measurement framework apply to assets, liabilities, and items classified in stockholders’ equity.

ASC 820 emphasizes that fair value is a market-based measurement based on an exit price notion and is not entity-specific. Therefore, a fair value measurement must be determined on the basis of the assumptions that market participants would use in pricing an asset or liability, whether those assumptions are observable or unobservable. The fair value hierarchy in ASC 820 serves as a basis for considering market-participant assumptions and distinguishes between (1) market-participant assumptions developed on the basis of market data that are independent of the entity (observable inputs) and (2) an entity’s own assumptions about market-participant assumptions developed on the basis of the best information available in the particular circumstances, including assumptions about risk inherent in inputs or valuation techniques (unobservable inputs). In accordance with the fair value hierarchy, entities are required to maximize the use of relevant observable inputs and minimize the use of unobservable inputs. This focus on the observability of inputs also often affects the valuation technique used to measure fair value.

The single definition of fair value, the fair value measurement framework, and the disclosure requirements in ASC 820 are intended to result in increased consistency and comparability of fair value measurements (as well as disclosures about fair value measurements). Such consistency and comparability should result in information that financial statement users (e.g., present and potential investors, creditors, regulators, and others) find useful in making investment, credit, and similar decisions. The fair value disclosure requirements are intended to increase the transparency of the inputs and valuation techniques used in fair value measurements; however, an entity will need to tailor its fair value disclosures to meet the needs of users of its financial statements, depending on whether it is a public business entity or a nonpublic entity.

1.2.1 Exit Price

ASC 820-10

30-2 When an asset is acquired or a liability is assumed in an exchange transaction for that asset or liability, the transaction price is the price paid to acquire the asset or received to assume the liability (an entry price). In contrast, the fair value of the asset or liability is the price that would be received to sell the asset or paid to transfer the liability (an exit price). Entities do not necessarily sell assets at the prices paid to acquire them. Similarly, entities do not necessarily transfer liabilities at the prices received to assume them.

Definition of Fair Value

35-2 This Topic defines fair value as 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.

ASC 820-10 — Glossary

Exit Price

The price that would be received to sell an asset or paid to transfer a liability.

The fundamental principle underlying the definition of fair value and the fair value measurement framework is that a fair value measurement represents an exit price, which ASC 820-10-35-2 describes as “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.” Thus, a fair value measurement is not entity-specific. Furthermore, a “mark-to-model” measurement that does not include an adjustment for risk does not represent a fair value measurement if market participants would include such an adjustment in pricing the related asset or liability (i.e., a fair value measurement must reflect all relevant factors that market participants would consider in determining a price for an asset or liability). ASC 820 also specifies that the fair value of an item classified in stockholders’ equity is similarly determined from the perspective of a market participant that holds the identical item as an asset as of the measurement date (i.e., also on the basis of an exit price determined from the perspective of the holder of the identical item as an asset).

Note that a transaction price (i.e., an entry price) differs from an exit price. As discussed in Chapter 9, when an item is initially measured at fair value, this measurement should represent an exit price in the principal market in which an entity would transact or, in the absence of a principal market, the most advantageous market. Accordingly, the exit price notion is applied consistently to both initial and subsequent measurements at fair value. Paragraph C52 in the Basis for Conclusions of FASB Statement 157 discusses the difference between an entry price and an exit price:

In this Statement, the Board clarified that in situations in which the reporting entity acquires an asset or assumes a liability in an exchange transaction, the transaction price represents the price paid to acquire the asset or received to assume the liability (an entry price). The fair value of the asset or liability represents the price that would be received to sell the asset or paid to transfer the liability (an exit price). Conceptually, entry and exit prices are different. Entities do not necessarily sell or otherwise dispose of assets at the prices paid to acquire them. Similarly, entities do not necessarily transfer liabilities at the prices paid to assume them. The Board agreed that in many cases the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition, but not presumptively (a change to Concepts Statement 7). This Statement includes examples of factors the reporting entity should consider in determining whether a transaction price represents the fair value of the asset or liability at initial recognition. The Board plans to consider those factors in assessing the appropriate measurement attribute at initial recognition in individual accounting pronouncements on a project-by-project basis.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.