10.7 Identifying Transactions That Are Not Orderly

In an orderly transaction, there is a sufficient period of exposure to the market before the measurement date to allow for usual and customary marketing activities involving similar assets or liabilities. The length of the exposure period depends on the amount of time it takes market participants in typical transactions to agree on a transaction price for the type of asset or liability being measured.

For some assets (such as many financial instruments), the required period may elapse instantaneously or be measured in hours. For instance, no exposure may be required for an asset quoted in an active market (such as stock quoted on the NYSE) if current transaction prices are immediately available and no additional marketing activities are required for a transaction to occur. Accordingly, ASC 820-10-35-41 generally requires that an entity use a quoted price in an active market to measure fair value whenever such a price is available, with limited exceptions. In addition, even if an active market does not exist for an identical instrument, the period of market exposure required for many types of financial instruments is often relatively short (e.g., when standard documentation exists and relevant observable market data are available to price the financial instrument). However, the period of market exposure for some types of financial instruments could be somewhat longer (e.g., a large portfolio of commercial loans that are measured by using significant unobservable inputs). In addition, a longer period of market exposure may be required for certain assets (e.g., servicing rights, real estate, or intangibles). In some markets, it is usual and customary for information dissemination, promotion, selling, and due diligence activities to take some time before a typical transaction can close.

While a period of exposure to the market is assumed in an orderly transaction, this does not mean that an entity can disregard changes in market conditions during that period or take a “longer view” of the market. Even when there is no observable market to provide pricing information about the sale of an asset or the transfer of a liability on the measurement date, in accordance with ASC 820-10-35-3, “[a] fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date under current market conditions” (i.e., the fair value measurement objective). For instance, if the volume or level of activity in a market decreases because of a decline in investor demand, transaction prices in orderly transactions may also decrease. However, because those transaction prices are orderly, they are still relevant.13 In addition, if an entity uses a valuation technique to determine fair value, a decline in market liquidity might justify a higher risk premium or discount rate to reflect the increased risk inherent in the valuation technique or in the inputs to the valuation technique.

A transaction that is forced (e.g., a forced liquidation or distress sale) is not orderly. ASC 820-10-35-54J discusses the considerations an entity should take into account when the evidence indicates that a transaction is either (1) not orderly (in which case the entity should place little, if any, weight on the transaction price) or (2) orderly (in which case the entity must take the transaction price into account). ASC 820-10-35-54J also discusses the considerations related to situations in which an entity cannot conclude whether a transaction is orderly, in which case the entity must take the transaction price into account but place less weight on it than on other indications of fair value. In these situations, the transaction price cannot be the sole or primary basis for estimating fair value. Because the transaction price might not reflect the assumptions that market participants would use, it may be appropriate for the entity to use multiple valuation techniques and weigh different indications of fair value to determine the amount that is most representative of fair value under current market conditions.

An entity evaluates whether a transaction is orderly on the basis of factors specific to the parties entering into the transaction (e.g., the seller’s financial difficulties). This evaluation is not based on general market conditions. For instance, it would not be appropriate to assume that a decline in an asset’s or liability’s volume or level of activity indicates that all sales or transfers of those assets or liabilities are not orderly. In other words, an entity cannot assume that an entire market is in “distress” (see Section 10.6.2.2). Thus, the entity should evaluate whether each transaction is orderly on the basis of the weight of the evidence available, as discussed in ASC 820-10-35-54I. In performing this evaluation, an entity will need to consider its specific facts and circumstances and may need to use significant judgment.

An entity must overcome a high hurdle to conclude that an observable transaction is not an orderly transaction. Although ASC 820-10-35-54I includes a list of factors that may indicate a transaction is not orderly, there is an implicit presumption that observable transactions between unrelated parties are orderly. This presumption generally is not overcome in practice. To overcome such a presumption, an entity needs to have compelling evidence to support its conclusion that the transaction was not orderly. However, it is never appropriate to conclude that observable transactions in active markets (i.e., Level 1 fair value measurements) do not represent orderly transactions. This is the case even in times of significantly market volatility.