8.2 Level 1 Inputs
8.2.1 General
ASC 820-10
Level 1 Inputs
35-40 Level 1 inputs are
quoted prices (unadjusted) in active markets for
identical assets or liabilities that the reporting
entity can access at the measurement date.
35-41 A quoted price in an
active market provides the most reliable evidence of
fair value and shall be used without adjustment to
measure fair value whenever available, except as
specified in paragraph 820-10-35-41C.
35-41C A reporting entity
shall not make an adjustment to a Level 1 input except
in the following circumstances:
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When a reporting entity holds a large number of similar (but not identical) assets or liabilities (for example, debt securities) that are measured at fair value and a quoted price in an active market is available but not readily accessible for each of those assets or liabilities individually (that is, given the large number of similar assets or liabilities held by the reporting entity, it would be difficult to obtain pricing information for each individual asset or liability at the measurement date). In that case, as a practical expedient, a reporting entity may measure fair value using an alternative pricing method that does not rely exclusively on quoted prices (for example, matrix pricing). However, the use of an alternative pricing method results in a fair value measurement categorized within a lower level of the fair value hierarchy.
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When a quoted price in an active market does not represent fair value at the measurement date. That might be the case if, for example, significant events (such as transactions in a principal-to-principal market, trades in a brokered market, or announcements) take place after the close of a market but before the measurement date. A reporting entity shall establish and consistently apply a policy for identifying those events that might affect fair value measurements. However, if the quoted price is adjusted for new information, the adjustment results in a fair value measurement categorized within a lower level of the fair value hierarchy.
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When measuring the fair value of a liability or an instrument classified in a reporting entity’s shareholders’ equity using the quoted price for the identical item traded as an asset in an active market and that price needs to be adjusted for factors specific to the item or the asset (see paragraph 820-10-35-16D). If no adjustment to the quoted price of the asset is required, the result is a fair value measurement categorized within Level 1 of the fair value hierarchy. However, any adjustment to the quoted price of the asset results in a fair value measurement categorized within a lower level of the fair value hierarchy.
For a fair value measurement to qualify as a Level 1 measurement, or for an input
into a fair value measurement to qualify as a Level 1 input, the price (input)
must be a quoted price (unadjusted) in an active market for an identical asset
or liability that the reporting entity can access as of the measurement date.
Additional criteria for a Level 1 input are as follows:
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Quoted price in an active market — See Section 8.2.2 for more information about what constitutes an active market.
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Unadjusted — ASC 820-10-35-41C indicates that any adjustment (regardless of significance) to a fair value measurement (input) that would otherwise meet the Level 1 criteria results in a fair value measurement (input) that must be “categorized within a lower level of the fair value hierarchy.” See Section 8.2.3 for more information about adjustments to Level 1 inputs.
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Identical asset or liability — For a fair value measurement (input) to qualify as a Level 1 measurement (input), the price used in the fair value measurement must be for an identical asset or liability held by the reporting entity. See Examples 8-4 through 8-7 for more information.
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Access to the price as of the measurement date — The reporting entity must have access to the price as of the measurement date. For example, an entity has access to the price if it has the ability to transact at the price in an exchange market. An entity also has access if there are dealers that stand ready to transact with the entity at the price. Broker quotes alone are not sufficient evidence that the entity has access to the price if those brokers do not stand ready to transact at the price. Any adjustment made to a quoted price in an active market, because of limited or no market access, would result in a Level 2 or Level 3 measurement (input) depending on the nature of the adjustment. In addition, even if a quoted price in an active market is available, such pricing may not be readily accessible for each item being measured given the volume of instruments held by the reporting entity. As a result, a reporting entity may use alternative pricing (e.g., matrix pricing) as a practical expedient to measure fair value, but such a valuation would constitute a lower measurement within the fair value hierarchy. See Section 8.2.3 for more information.
Connecting the Dots
There is a presumption that a Level 1 input should be used when it is
available and the entity can access the market in which such a quote is
available. However, this may not always be the case. For example, if an
entity purchases an equity security in the United States that is not
traded on a U.S. exchange but is traded on the Cyprus Stock Exchange,
the entity would not use a Level 1 quote from the Cyprus Stock Exchange
if its principal (or most advantageous) market is not the Cyprus Stock
Exchange.
See Section 10.4.4 for discussion of Level
1 fair value measurements on the basis of bid-and-ask inputs.
The example below illustrates the fair value measurement of a
debt security that is traded in a dealer market, which represents a Level 1
measurement.
Example 8-4
Debt Security That Is Traded in a Dealer
Market
Entity A holds a debt security that is traded in a dealer
market in which bid and ask prices are available. Assume
that the market is active for the debt security, no
adjustments have been made to the price, and the price
is accessible by A.
If the price used to measure the fair
value of the debt security is for the identical debt
security held by A (i.e., the identical Committee on
Uniform Securities Identification Procedures [CUSIP]),
the debt security should be classified in Level 1 of the
fair value hierarchy. The fact that the debt security is
traded in a dealer market, as opposed to an exchange
market, does not preclude the measurement of the debt
security from being classified as a Level 1
measurement.
The ASC master glossary indicates that
“[o]ver-the-counter markets (for which prices are
publicly reported by the National Association of
Securities Dealers Automated Quotations systems or by
OTC Markets Group Inc.) [and] the market for U.S.
Treasury securities” are dealer markets. Prices in
dealer markets may be Level 1 measurements if all of the
above criteria are met and the dealer market is
active.
The example below illustrates the fair value measurement of an
exchange-traded debt security, which represents a Level 1 measurement.
Example 8-5
Exchange-Traded Debt
Security Recognized as a Liability
Entity B has issued an exchange-traded
debt security and has elected to account for the
liability for such issuance at fair value in accordance
with the FVO. The identical instrument is currently
trading as an asset in an active market. Entity B uses
the quoted price for the asset as its initial input into
the fair value measurement of its liability for the debt
security. Entity B also evaluates whether the quoted
price for the asset must be adjusted for factors such as
third-party credit enhancements, which would not apply
to the fair value measurement of the liability. Entity B
determines that no adjustments need to be made to the
quoted price of the asset.
Since the price used to measure the fair
value of the debt security is for the identical debt
security issued by B (i.e., the identical CUSIP) that
actively is traded as an asset in an exchange market,
and no adjustments to the quoted price of the instrument
are required, the measurement of the debt security
should be classified as a Level 1 measurement.
The example below illustrates an OTC forward contract that is
classified as a Level 2 measurement because quoted prices in active markets are
available only for similar securities.
Example 8-6
OTC Forward Contract
Entity C holds an OTC “look-alike” forward contract. The
counterparty to this contract is contractually obligated
to settle it on the basis of the quoted price for a
similar futures contract traded on an active futures
exchange. The forward contract meets the definition of a
derivative and is therefore recorded at fair value.
While the look-alike forward contract mirrors — and its
value is intended to approximate the quoted price for —
the exchange-traded futures contract, the forward and
futures contracts are not identical. Even if the
counterparties to the forward contract both have the
highest credit quality (resulting in the same level of
credit risk as the exchange-traded futures contract),
the forward contract is not considered identical because
(1) the counterparties are different and (2) C cannot
sell the forward contract on the futures exchange (i.e.,
the counterparty and liquidity risk related to the
forward contract are greater than those related to the
futures contract). While the measurement of a futures
contract may be classified as a Level 1 measurement (in
an active market), the measurement of the look-alike
forward contract can only be classified as Level 2 or
below.
The example below illustrates an interest rate swap for which
observable inputs are used to determine fair value. Because the interest rate
swap itself is not traded on an OTC market, the measurement of the swap cannot
be classified as a Level 1 measurement.
Example 8-7
OTC Interest Rate
Swap
Entity D is a party to an interest rate
swap transacted on an OTC market. The OTC market does
not quote prices for interest rate swaps. Entity D
measures the fair value of the swap by using either (1)
a discounted cash flow approach on the basis of
observable market-based yield curves or (2) the price at
which a similar swap was exchanged on the OTC market.
While similar swaps may have been exchanged on the OTC
market, these swaps would have different counterparties
and would therefore not be identical to D’s swap.
The price at which D would be able to
transfer the swap would result from a negotiated
transaction in which the credit standings of the two
parties to the swap, as well as the terms of the
specific swap, are contemplated. Because the swap is not
identical to the similar swap for which there are
transactions on the OTC market, the fair value
measurement of the swap would be classified as a Level 2
measurement (or a Level 3 measurement if any of the
inputs that are significant to the measurement are
unobservable inputs).
8.2.2 Active Markets
8.2.2.1 Active Versus Inactive Markets
ASC 820-10 — Glossary
Active Market
A market in which transactions for the asset or
liability take place with sufficient frequency and
volume to provide pricing information on an ongoing
basis.
ASC 820-10
Measuring Fair Value When the Volume or Level of
Activity for an Asset or a Liability Has
Significantly Decreased
35-54C The
fair value of an asset or a liability might be
affected when there has been a significant decrease
in the volume or level of activity for that asset or
liability in relation to normal market activity for
the asset or liability (or similar assets or
liabilities). To determine whether, on the basis of
the evidence available, there has been a significant
decrease in the volume or level of activity for the
asset or liability, a reporting entity shall
evaluate the significance and relevance of factors
such as the following:
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There are few recent transactions.
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Price quotations are not developed using current information.
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Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
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Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
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There is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, taking into account all available market data about credit and other nonperformance risk for the asset or liability.
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There is a wide bid-ask spread or significant increase in the bid-ask spread.
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There is a significant decline in the activity of, or there is an absence of, a market for new issues (that is, a primary market) for the asset or liability or similar assets or liabilities.
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Little information is publicly available (for example, for transactions that take place in a principal-to-principal market).
ASC 820-10-20 defines “active market,” and ASC 820-10-35-54C
lists factors that may indicate that a market is not active because of a
significant decrease in the volume or level of activity relative to normal
market activity for the asset or liability (or similar assets or
liabilities). In determining whether a market is active, an entity would
focus on the trading activity of the individual asset or liability being
measured rather than on the market in which it is traded. Therefore, a
security that is traded infrequently on the Nasdaq could represent an asset
that is not traded in an active market. In determining whether an active
market exists for an asset or liability (or similar assets or liabilities),
an entity should consider the factors discussed in ASC 820-10-35-54C only
when the frequency and volume of the transactions for the asset or liability
are not sufficient to provide ongoing relevant pricing information.
The presence of one or more of the factors in ASC 820-10-35-54C does not in
itself mean that a market is not active. An entity should evaluate the
relevance and significance of these factors to the individual asset,
liability, or equity instrument measured at fair value to determine whether
the market for the asset, liability, or equity instrument is not active. A
market is not deemed inactive simply because of insufficient trading volume
relative to the size of an entity’s position.
The characterization of a market as “active” or “inactive” may change as
market conditions change. However, a decline in the volume of transactions
for a particular asset or liability does not automatically make a market
inactive. A market is considered active as long as the frequency and volume
of transactions are sufficient to provide reliable ongoing pricing
information.
Connecting the Dots
The level of market activity does not change the objective of a fair
value measurement under ASC 820. ASC 820-10-35-54H states:
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.
A measurement that does not meet these objectives (e.g., a holder’s
estimate of economic or fundamental value) is not a fair value
measurement. An entity must consider market-participant assumptions
when measuring fair value. If an entity determines that a market is
inactive, it cannot use entity-specific assumptions instead of
relevant observable market information in measuring fair value. See
Section 10.6 for more
information about measuring fair value when the volume or level of
activity for an asset or liability has significantly decreased.
8.2.2.2 Multiple Active Markets
ASC 820-10
Level 1
Inputs
35-41B A Level 1 input will
be available for many financial assets and financial
liabilities, some of which might be exchanged in
multiple active markets (for example, on different
exchanges). Therefore, the emphasis within Level 1
is on determining both of the following:
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The principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability
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Whether the reporting entity can enter into a transaction for the asset or liability at the price in that market for the asset or liability at the measurement date.
35-46 Paragraph 820-10-55-42
illustrates the use of Level 1 inputs to measure the
fair value of a financial asset that trades in
multiple active markets with different prices.
An asset or liability may be exchanged in multiple active markets. For
example, a security may be traded on several different exchanges. In these
circumstances, fair value is measured on the basis of the entity’s principal
market, or if a principal market does not exist, the most advantageous
market for the asset or liability. An entity must be able to access a market
as of the measurement date for this market to be the principal or most
advantageous market.
Example 4 in ASC 820-10-55-42 through 55-45A illustrates how
an entity would measure fair value for an asset that is sold in two
different active markets. That example states that if one of the two markets
is the entity’s principal market, that market must be used to measure the
fair value of the asset. If neither market is considered the entity’s
principal market, the fair value measurement is based on the most
advantageous market. The example shows that the entity, in making this
determination, must consider the transaction costs and transportation costs
that would be incurred in each market. However, the fair value measurement
in the most advantageous market is reduced only for transportation costs.
See Chapter 6 for more information about the
determination of the principal or most advantageous market. See Sections 10.2.5.3
and 10.2.5.4
for discussion of transaction costs and transportation costs.
8.2.2.3 Active Market That Is Not a Secondary Market
A fair value measurement could be a Level 1 measurement even
if there is no secondary market (e.g., an exchange market for the asset does
not exist). This situation commonly applies to investments in registered
open-ended mutual funds, which are illustrated in the example below.
Example 8-8
Investment in Registered Open-Ended Mutual
Fund
Entity E has an investment in an open-ended mutual
fund, Fund B, that is registered under the
Investment Company Act of 1940. Fund B is not listed
on an exchange but publishes daily quotations of its
NAV. Units are redeemed and purchased at the
published NAV without any adjustment (i.e., Fund B’s
price is readily determinable since the published
NAV is the basis for current transactions). There is
no secondary market for the units because they are
not transferable (i.e., the sole transactions are
redemptions and purchases of the units by Fund
B).
The fact that there is no secondary market for the
units in Fund B (i.e., all transactions are between
the fund and the unit holders) does not prevent E
from classifying the fair value of its investment in
Fund B within Level 1 of the fair value hierarchy if
the conditions for Level 1 classification are met.
In this example, E must evaluate whether the quoted
price (i.e., the published NAV) is in an active
market. For Fund B, pricing information is provided
on an ongoing basis (and thus the active-market
criteria are met), since the fund itself is a
registered investment company, is obligated to stand
ready to transact in either purchases or redemptions
at the published NAV, and settles within seven days
of investor redemption. In the absence of any
evidence to the contrary (e.g., the fund is not able
to settle an investor redemption in accordance with
normal conventions because of underlying fund
investment liquidity constraints), the investment in
the registered open-ended investment company would
meet the “active” criteria.
The assumption that the active-market criteria have
been met is only related to determining the level of
investments in open-ended mutual funds that are
registered under the Investment Company Act of 1940.
It should also be noted that in this example, NAV is
not being used as a practical expedient; rather, it
represents fair value since the published NAV
amounts reflect readily determinable fair
values.
8.2.3 Adjustments to Level 1 Inputs
Generally, an entity should not adjust a Level 1 input in measuring the fair
value of an asset or liability. However, ASC 820-10-35-41C notes the following
three circumstances in which an adjustment may be made to a Level 1 input:
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A reporting entity holds a large number of similar (but not identical) assets or liabilities (e.g., debt securities) that are measured at fair value and, while a quoted price in an active market is available for each asset or liability, such quoted prices are not readily accessible for each of those assets or liabilities individually given the large number of similar assets or liabilities held by the entity as of the measurement date. Therefore, the entity uses an alternative pricing method such as matrix pricing.
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A quoted price in an active market does not represent fair value as of the measurement date because a significant event takes place after the close of a market but before the measurement date.
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The fair value measurement pertains to a liability or equity instrument, and the quoted price for the identical item traded as an asset in an active market must be adjusted for factors specific to the item or asset (see ASC 820-10-35-16D).
Further, the FASB stated the following in paragraph C68 of the Basis for Conclusions of Statement 157:
The Exposure Draft emphasized that a quoted price
(unadjusted) in an active market should be used to measure fair value
whenever it is available. Some respondents interpreted the related
guidance as requiring the use of a quoted price in an active market
without regard to whether that price is readily available or
representative of fair value. Those respondents referred to possible
conflicts with ASR 118, which requires adjustments to a quoted price in
those situations (fair value pricing). In its redeliberations, the Board
affirmed that its intent was not to preclude adjustments to a quoted
price if that price is not readily available or representative of fair
value, noting that in those situations, the market for the particular
asset or liability might not be active. To convey its intent more
clearly, the Board clarified that in those situations, the fair value of
the asset or liability should be measured using the quoted price, as
adjusted, but within a lower level of the fair value hierarchy.
In any of the above three situations, any adjustment to the quoted price renders
the fair value measurement a Level 2 or Level 3 measurement.
8.2.4 Requirement to Use Level 1 Inputs
ASC 820-10
Level 1
Inputs
35-44 If a reporting entity
holds a position in a single asset or liability
(including a position comprising a large number of
identical assets or liabilities, such as a holding of
financial instruments) and the asset or liability is
traded in an active market, the fair value of the asset
or liability shall be measured within Level 1 as the
product of the quoted price for the individual asset or
liability and the quantity held by the reporting entity.
That is the case, even if a market’s normal daily
trading volume is not sufficient to absorb the quantity
held and placing orders to sell the position in a single
transaction might affect the quoted price.
The size of a position held by an entity does not affect the categorization of
the asset or liability within the fair value hierarchy, even if the normal daily
trading or transaction volume would not be sufficient to absorb the entity’s
position. Fair value is not an entity-specific measurement; therefore, even if
an entity expects to be unable to exit the position in a single transaction
without adjusting the observable price, it would be inappropriate to use an
input other than the quoted price in an active market. That is, a quoted market
price (i.e., a Level 1 input) must be used to measure the fair value of an asset
or liability that is traded in an active market on the basis of the product of
the quoted price for the individual asset or liability and the quantity held by
the entity.