Chapter 7 — Market-Participant Assumptions

7.1 Characteristics of Market Participants

ASC 820-10

Market Participants

35-9 A reporting entity shall measure the fair value of an asset or a liability using the assumptions that market participants would use in pricing the asset or liability, assuming that market participants act in their economic best interest. In developing those assumptions, a reporting entity need not identify specific market participants. Rather, the reporting entity shall identify characteristics that distinguish market participants generally, considering factors specific to all of the following:

The asset or liability
The principal (or most advantageous) market for the asset or liability
Market participants with whom the reporting entity would enter into a transaction in that market.

The Fair Value Measurement Approach

55-1 The objective of a fair value measurement is 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. A fair value measurement requires a reporting entity to determine all of the following:

The particular asset or liability that is the subject of the measurement (consistent with its unit of account)
For a nonfinancial asset, the valuation premise that is appropriate for the measurement (consistent with its highest and best use)
The principal (or most advantageous) market for the asset or liability
The valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorized.

To meet the fair value measurement objective in ASC 820, an entity must develop assumptions that market participants would use to determine the price of an asset, liability, or equity instrument in an orderly transaction as of the measurement date. ASC 820 defines the term “market participants” as follows:

Buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all of the following characteristics:

They are independent of each other, that is, they are not related parties, although the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms [see Section 7.1.1]
They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary [see Section 7.1.2]
They are able to enter into a transaction for the asset or liability [see Section 7.1.3]
They are willing to enter into a transaction for the asset or liability, that is, they are motivated but not forced or otherwise compelled to do so [see Section 7.1.4].

See Chapter 6 for discussion of the determination of the principal (or most advantageous) market.

7.1.1 Independence

As noted in the glossary definition above, market participants are considered independent when “they are not related parties.” However, the definition also indicates that “the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms.” The determination that an exit price is at market terms can be considered comparable to the determination that a transaction between two parties was at arm’s length.

Paragraph BC25 of ASU 2011-04 discusses the requirement for market participants to be independent and states, in part:

Before the amendments, Topic 820 described market participants as being independent of the reporting entity. Because fair value assumes an orderly transaction between market participants at the measurement date and not an orderly transaction between the reporting entity and another market participant, the Board decided to clarify that the term independence in the definition of market participant means that market participants are independent of each other (that is, they are not related parties).

7.1.2 Knowledgeability

Market participants must be knowledgeable about the transaction. That is, they must have a “reasonable understanding about” the asset, liability, or equity instrument subject to the fair value measurement and, accordingly, need sufficient information to make a reasoned economic decision. In making such a decision, a market participant would perform the usual and customary due diligence that is part of an orderly transaction. An entity should use judgment in determining whether a potential buyer or seller is knowledgeable and has the necessary information to make a reasoned economic decision.

7.1.3 Ability to Enter Into a Transaction

Market participants must be capable of entering into a transaction for the asset, liability, or equity instrument subject to the fair value measurement. An entity must consider all relevant facts and circumstances in determining whether a potential buyer or seller is able to enter into a transaction, including the financial capabilities related to acquiring the asset, any potential legal restrictions, and any operational issues that would prevent the transaction from occurring.

7.1.4 Willingness to Enter Into a Transaction

Market participants must be “willing to enter into a transaction for” the asset, liability, or equity instrument subject to the fair value measurement (i.e., they must be “motivated but not forced or otherwise compelled to do so”). An entity must ensure that the potential buyer or seller is willing to enter into the transaction by considering all relevant facts and circumstances.

In a speech at the 2008 AICPA Conference on Current SEC and PCAOB Developments, Muneera Carr, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, provided some of the SEC staff’s views on the willingness of market participants to enter into a transaction. Ms. Carr stated, in part:

The [ASC 820] definition of fair value contemplates a hypothetical transaction that is both orderly and conducted between willing market participants. An orderly transaction is one where the asset or liability is marketed to potential buyers for a period that is usual and customary. In any environment but especially in the current one, transactions may result in pricing that potential sellers may not view as “favorable”. Unfavorable pricing or reduced liquidity do not constitute, in and of themselves, a distressed sale or a forced liquidation under [ASC 820] if the asset can be sold in a period that is usual and customary. Reduced transaction volume and wide bid-ask spreads may be helpful indicators in understanding whether market participants are willing to transact for the asset. However, judgment should be exercised to determine whether buyers and sellers in orderly transactions are those who are motivated but not forced to transact and therefore can be considered ‘willing market participants’. Said differently, while [ASC 820’s] definition of fair value is based on an orderly transaction, it also states that such transactions should be between market participants and market participants are defined as both buyers and sellers willing to transact for an asset or liability because they are motivated rather than because they are forced to do so. [Footnotes omitted]

7.1.4.1 Unwillingness of a Seller to Transact at Current Prices

ASC 820-10

Measuring Fair Value When the Volume or Level of Activity for an Asset or a Liability Has Significantly Decreased

35-54H Estimating the price at which market participants would be willing to enter into a transaction at the measurement date under current market conditions if there has been a significant decrease in the volume or level of activity for the asset or liability depends on the facts and circumstances at the measurement date and requires judgment. A reporting entity’s intention to hold the asset or to settle or otherwise fulfill the liability is not relevant when measuring fair value because fair value is a market-based measurement, not an entity-specific measurement.

An entity’s unwillingness to transact at current prices for an asset it owns or a liability it owes is not a sufficient reason for such observable prices to be disregarded. ASC 820-10-35-54H states that “[a] reporting entity’s intention to hold the asset or to settle or otherwise fulfill the liability is not relevant when measuring fair value because fair value is a market-based measurement, not an entity-specific measurement.” However, an entity is responsible for determining fair value and must assess whether a price from an external source is representative of fair value as of the measurement date.

See Section 10.6.3.2 for further discussion of an entity’s unwillingness to transact at current prices.

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