Fair Value Measurements and Disclosures (Including the Fair Value Option)

Step 1: Identify the unit of account — The unit of account represents the level of aggregation or disaggregation of individual assets, liabilities, or equity instruments for recognition in the financial statements and, with the exception of items for which there are quoted prices in an active market, is determined on the basis of other U.S. GAAP.

Step 2: Identify the unit of valuation — The unit of valuation is often consistent with the unit of account, but there are exceptions. The unit of valuation for nonfinancial assets (other than nonfinancial derivative assets) is the asset’s highest and best use. In addition, the unit of valuation for certain groups of financial assets, financial liabilities, and nonfinancial items accounted for as derivatives may represent a portfolio of items with offsetting risk positions.

Step 3: Identify the principal or most advantageous market — Under ASC 820, it is assumed that an entity will transact in its principal market or, in the absence of a principal market, the most advantageous market. This determination is important because exit prices are not the same in different markets. In most situations, there will be a principal market, which represents the market with the greatest volume and level of activity for the item. The market in which the entity normally transacts is generally the principal (or most advantageous) market.

Step 4: Develop assumptions that market participants would use to measure fair value — To meet the “exit price” measurement objective, 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, even if those assumptions are based on unobservable information. An entity may not substitute the assumptions of market participants with its own assumptions that differ from those of market participants.

Step 5: Measure fair value on the basis of available inputs and appropriate valuation techniques — The initial fair value measurement of an item will often be equal to its transaction price. However, in certain situations, the transaction price does not equal an exit price on initial recognition. In subsequently measuring items at fair value, an entity must maximize the use of observable inputs and minimize the use of unobservable inputs. Entities must use valuation techniques that are consistent with the techniques that market participants would use to determine an exit price. Since a quoted market price for an identical item in an active market (i.e., a Level 1 input) constitutes the most reliable evidence of fair value, this price must be used to measure fair value when available. Although a significant decrease in the volume and level of activity in relation to normal market activity may affect the entity’s selection of techniques or inputs, it does not change the fair value measurement objective. Entities cannot incorporate measurements that are inconsistent with fair value on the basis that (1) an entire market is functioning in a disorderly manner or (2) an entity would not enter into a transaction to sell an asset or transfer a liability at the current market price.

Step 6: Allocate fair value measurement to individual units of account (if necessary) — An entity may be required to allocate a fair value measurement when the unit of account for the item measured at fair value differs from the unit of valuation. In some cases, an allocation will be required even when the unit of account and unit of valuation are the same. Such allocations are performed in accordance with other U.S. GAAP.

Step 7: Classify the fair value measurement within the fair value hierarchy and prepare disclosures — Under ASC 820, inputs used in fair value measurements are categorized into a three-level fair value hierarchy. In addition to requiring the disclosure of items measured at fair value within this hierarchy (i.e., Level 1, Level 2, or Level 3), ASC 820 requires entities to provide numerous quantitative and qualitative disclosures about fair value measurements.