6.5 Examples | DART – Deloitte Accounting Research Tool

Example 4 in ASC 820-10-55-42 through 55-45A illustrates a scenario in which two entities may measure the same instrument differently because each entity identifies a different principal (or most advantageous) market.

ASC 820-10

Example 4: Level 1 Principal (or Most Advantageous) Market

55-42 Example 4 illustrates the use of Level 1 inputs to measure the fair value of an asset that trades in different active markets at different prices.

55-43 An asset is sold in two different active markets at different prices. A reporting entity enters into transactions in both markets and can access the price in those markets for the asset at the measurement date. In Market A, the price that would be received is $26, transaction costs in that market are $3, and the costs to transport the asset to that market are $2 (that is, the net amount that would be received is $21). In Market B, the price that would be received is $25, transaction costs in that market are $1, and the costs to transport the asset to that market are $2 (that is, the net amount that would be received in Market B is $22).

55-44 If Market A is the principal market for the asset (that is, the market with the greatest volume and level of activity for the asset), the fair value of the asset would be measured using the price that would be received in that market, after taking into account transportation costs ($24).

55-45 If neither market is the principal market for the asset, the fair value of the asset would be measured using the price in the most advantageous market. The most advantageous market is the market that maximizes the amount that would be received to sell the asset after taking into account transaction costs and transportation costs (that is, the net amount that would be received in the respective markets).

55-45A Because the reporting entity would maximize the net amount that would be received for the asset in Market B ($22), the fair value of the asset would be measured using the price in that market ($25), less transportation costs ($2), resulting in a fair value measurement of $23. Although transaction costs are taken into account when determining which market is the most advantageous market, the price used to measure the fair value of the asset is not adjusted for those costs (although it is adjusted for transportation costs).

Further, Example 5 in ASC 820-10-55-46 through 55-49 illustrates a scenario in which an entity’s principal entry markets differ from its principal exit markets.

ASC 820-10

Example 5: Transaction Prices and Fair Value at Initial Recognition — Interest Rate Swap at Initial Recognition

55-46 This Topic (see paragraphs 820-10-30-3 through 30-3A) clarifies that in many cases the transaction price, that is, the price paid (received) for a particular asset (liability), will represent the fair value of that asset (liability) at initial recognition, but not presumptively. This Example illustrates when the price in a transaction involving a derivative instrument might (and might not) equal the fair value of the instrument at initial recognition.

55-47 Entity A (a retail counterparty) enters into an interest rate swap in a retail market with Entity B (a dealer) for no initial consideration (that is, the transaction price is zero). Entity A can access only the retail market. Entity B can access both the retail market (that is, with retail counterparties) and the dealer market (that is, with dealer counterparties).

55-48 From the perspective of Entity A, the retail market in which it initially entered into the swap is the principal market for the swap. If Entity A were to transfer its rights and obligations under the swap, it would do so with a dealer counterparty in that retail market. In that case, the transaction price (zero) would represent the fair value of the swap to Entity A at initial recognition, that is, the price that Entity A would receive to sell or pay to transfer the swap in a transaction with a dealer counterparty in the retail market (that is, an exit price). That price would not be adjusted for any incremental (transaction) costs that would be charged by that dealer counterparty.

55-49 From the perspective of Entity B, the dealer market (not the retail market) is the principal market for the swap. If Entity B were to transfer its rights and obligations under the swap, it would do so with a dealer in that market. Because the market in which Entity B initially entered into the swap is different from the principal market for the swap, the transaction price (zero) would not necessarily represent the fair value of the swap to Entity B at initial recognition.

Below are four additional examples illustrating the determination of the principal (or most advantageous) market.

Example 6-1

Multiple Markets in Different Countries

Entity A, a global commodity company that connects commodity buyers around the world, has a commodity sourcing strategy for customers located in Country Z. The commodities are recognized at fair value by A.

As part of A’s commodity sourcing strategy, a wholly owned subsidiary of A that is domiciled in Country Y buys the commodities in Country Y and executes intercompany sales of the commodities to a wholly owned subsidiary in Country Z. Country Z faces certain heightened economic risks stemming from uncertainty in its access to foreign currency in the amounts necessary to satisfy large-scale contracts as well as other limitations that have resulted from economic sanctions placed on it by other countries.

Commodities are delivered to Country Z through Country Y, which is adjacent to Country Z. There is an active market in Country Y that can rapidly absorb significant amounts of a particular commodity. Because A readily has access to, and the ability to transact in, the active market in Country Y, it can sell the commodity to buyers in Country Z after incurring insignificant transportation costs. Entity A may also purchase the commodity in Country Z; however, the market in Country Z is not active. As a result, the commodities sold to customers in Country Z are purchased in Country Y.

Entity A should assess its principal market for the commodity from its own perspective. Only in the absence of a principal market may A look to prices in the most advantageous market. Two entities may measure the same commodity differently because each entity identifies a different principal market on the basis of its own activities.

Entity A purchases and stores in Country Y the commodities that it sells to Country Z. Although A may purchase quantities of the commodity in Country Z to sell to customers in that country, A should look to Country Y when determining the fair value of the commodities sold to customers in Country Z, given the presence of an active market in Country Y (i.e., the market with the greatest level of activity and volume exists for the commodity). Although there is a market for the commodity in Country Z, it could not represent the market in the determination of the fair value of the commodity, since there is a principal market for the commodity in Country Y.

Example 6-2

Purchases in Multiple Markets

Entity B is a global commodity company that holds commodities in several different storage facilities in different geographic regions. These commodities are carried at fair value.

Entity B holds a certain quantity of commodities in Country W that it expects to sell to customers in that country. Country W has an active market for the commodities that can rapidly absorb significant amounts of them, and B readily has access to, as well as the ability to transact in, that market. While the market for the commodity in Country W is considered active and is the market in which B sells the commodity, in certain instances, B will sell the commodities held in storage in Country W on the F Exchange, which is in a neighboring country and is an active market for the commodity that can rapidly absorb significant amounts of it. The F Exchange is the commodities exchange that is closest to Country W and is the primary exchange for the commodity in the broader geographic area. Entity B incurs transportation costs to deliver commodities to the F Exchange, and those costs typically result in a lower margin than when the commodities are sold in the active market in Country W. However, B sells the commodities on the F Exchange in certain instances, primarily when its transaction volume is seasonally abnormal or it is balancing its sales activities.

Typically, Country W would be considered the principal market for the commodity. However, identification of the principal market should be reassessed in each reporting period. If, in response to larger macroeconomic or other relevant factors, B were to temporarily cease transacting in Country W, the F Exchange could be viewed as the principal market.

Country W would generally be considered the principal market for the commodity on the basis of the following:

There is a rebuttable presumption that, in the absence of evidence to the contrary, the market in which an entity normally would transact (i.e., the market in Country W) is the principal market.
Country W has an active market that can rapidly absorb significant amounts of the commodity, and B has ready access to, as well as the ability to transact in, that market.
Although the F Exchange constitutes an active market that B transacts in and has the ability to access, the F Exchange would not constitute B’s principal market because:
- Entity B normally transacts in the active market in Country W.
- Transactions that B enters into on the F Exchange are executed primarily when B’s transaction volumes are seasonally abnormal or it wants to balance its sales activities.
- Given the transportation costs that it would incur to sell the commodity on the F Exchange, B concludes that the value is maximized when the sales occur on the active market in Country W.
- Entity B typically has access to the market in Country W; from time to time, however, B may choose to sell the commodity on the F Exchange. Periodic ebbs and flows of activity are not an indication that B must change the identification of its principal market.

If, however, there was a significant economic event, which caused a significant change in market conditions, including a lack of liquidity in the market in Country W, B may temporarily cease transacting in the market in Country W and may transact on the F Exchange. As a result, B may conclude that its principal market for the commodity has changed even if the change is temporary. However, in reaching such a conclusion, B should consider how long it expects to primarily transact on the F Exchange.

Example 6-3

Reassessment of Principal Market

Entity C buys and sells credit default swaps. The credit default swap market for some exposures is primarily a principal-to-principal or over-the-counter (OTC) market. The volume and level of activity for credit default swaps in the exchange market increase and decrease over time. In such cases, C may need to reassess the principal market and would not necessarily be limited by past volume or level of transactions in determining its principal market. In performing this assessment, C should consider the current activity level and expectations about how market participants will transact in the future as well as its ability to access the exchange market.

Example 6-4

Multiple Principal Markets in Consolidated Financial Statements

Parent D owns Subsidiary A, based in the United States, and Subsidiary B, based in Hong Kong. Both A and B own shares of XYZ, which is publicly traded on the NYSE and the Hong Kong Exchange (HKEx), and each market in shares of XYZ is considered active. Subsidiary A purchased its shares of XYZ on the NYSE, and B purchased its shares of XYZ on the HKEx. Both A and B are legally prohibited from transferring their investments in shares of XYZ to D or other subsidiaries of D. Both A and B recognize their XYZ shares at fair value through earnings. As of the end of the reporting period, A and B both measure the fair value of XYZ by using the price in the principal market, which they have determined to be their respective local stock exchanges because of differences in the ability to access the respective exchanges. ASC 820 specifies that if there is a principal market for the asset, the fair value measurement should represent the price in that market, even if the price in a different market is potentially more advantageous on the measurement date. Therefore, A would use the quoted price from the NYSE, which may be greater or less than the quoted price from the HKEx. Subsidiary B should use the quoted price from the HKEx, which may be greater or less than the quoted price from the NYSE.

If A and B were not legally prohibited from transferring their investments in shares of XYZ to D or related subsidiaries, both A and B would consider access to the HKEx and NYSE exchanges, respectively, through transfers. As a result, the reporting entity might have a single principal (or most advantageous) market for all subsidiaries (businesses) within the consolidated group that have invested in XYZ.