Fair Value Framework- Introduction and Definitions

I.

II.

Introduction- the use of fair value to measure and report financial

statement items is required or permitted by a number of GAAP
pronouncements (ASCs). Some of those pronouncements, however,
provide somewhat different definitions of fair value and provide
only limited guidance in determination of fair value for GAAP
purposes. As a consequence, in the past, inconsistencies have
occurred in how fair value is measured in practice. ASC 820
provides a framework for how to measure fair value to achieve
increased consistency and comparability in fair value
measurements and expanded disclosure when fair value
measurements are used.
a. Objectives- in order to accomplish the objectives of ASC 820, it
provides the following
i. A definition of fair value for GAAP purposes
ii. A framework for measuring fair value for accounting
purposes
iii. A set of required disclosures about fair value measurement
when it is used
Fair value defined
a. Fair value- the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between
market participants at the measurement date
b. In order to fully understand and apply this definition, several
components of the definition need to be described further:
i. Fair value is a market based measurement, not an entity
specific measurement
ii. The determination of fair value is for a particular asset or
liability (or equity item), which may be either a standalone
asset or liability (e.g. a financial instrument or a
nonfinancial operating asset) or a group of assets/liabilities
(e.g. a reporting unit or business). Fair value determination
should consider the attributes (e.g. condition, location,
restriction on asset use or sale, etc.) of the specific asset or
liability being measured.
iii. The transaction to sell the asset or transfer the liability is a
hypothetical transaction at the measurement date that
would occur under current market conditions; it is not a
transaction that would occur in a forced liquidation or
distress sale

iv. Even when there is no observable market to provide pricing

information about the sale of an asset or the transfer of a
liability at the measurement date, a fair value
measurement assumes that a transaction takes place at
that date
v. The assumed transaction establishes a basis for
estimating the price to sell the asset or transfer the
liability.
vi. The hypothetical transaction to sell the asset or transfer
the liability is assumed to occur in the principal market or,
alternatively, in the absence of a principal market, the
most advantageous market for the asset or liability, to
which the entity has access, after taking into account
transaction costs and transportation costs
1. The principal market is the one with the greatest
volume and level of activity for the asset or liability
within which the reporting entity could sell the asset
or transfer the liability
2. The most advantageous market is the one in which
the reporting entity could sell the asset at a price
that maximizes the amount that would be received
for the asset or that minimizes the amount that
would be paid to transfer the liability.
vii. The price determined in the principal or most
advantageous market should not be adjusted for
transaction costs- incremental direct cost to sell the asset
or transfer the liability- which do not measure a
characteristic of the asset or liability. However, cost
incurred to transport the asset or liability to its principal or
most advantageous market (the location characteristic of
an asset) would be used to adjust fair value for
measurement purposes.
viii. Market participants, as used in the definition, are buyers
and sellers of the asset or liability that are:
1. Independent of the reporting entity
2. Acting in their economic best interest
3. Knowledgeable of the asset or liability and the
transaction involved
4. Able and willing, but not compelled, to transact for
the asset or liability

III.

Application of Definition to assets, liabilities, and shareholders

equity
a. Application to assets
i. The determination of fair value of a nonfinancial asset
assumes the highest and best use of the asset by market
participants, even if the intended use of the asset by the
reporting entity is different; the concept of highest and
best use does not apply to measuring the fair value of
financial assets (or liabilities)
ii. The highest and best use must take into account what is
physically possible, legally permissible, and financially
feasible at the measurement date
iii. The highest and best use of an asset may be:
1. In use: maximum value to market participants would
occur through its use in combination with other
assets as a group
2. In exchange: maximum value to market participants
would occur principally on a standalone basis, that is,
the price that would be received in a current
transaction to sell the (single) asset
b. Application to liabilities
i. The determination of fair value of a liability assumes that
the liability is transferred to a market participant at the
measurement date; it is not settled or canceled
1. The liability to the counterparty (i.e. the party to
whom the obligation is due) is assumed to continue
after the hypothetical transaction
2. Nonperformance risk relating to the liability is
assumed to be the same after the hypothetical
transaction as before the transaction.
ii. The determination of fair value of a liability should consider
the effects of the reporting entitys credit risk (or credit
standing) on the fair value of the liability in each period for
which the liability is measured at fair value; a third party
credit enhancement should not be considered.
iii. A separate input or an adjustment to other inputs to
account for a restriction that prevents the transfer of
liabilities should not be made in measuring fair value
iv. When a quoted price for the transfer of an identical or
similar liability is not available, and the identical liability is
held by another party as an asset, the liability should be

IV.

measured from the perspective of the party that holds the

item as an asset
c. Application to shareholders equity
i. The requirements for the determination of fair value apply
to instruments classified in shareholders equity that are
measured at fair value (e.g. equity interest issued as
consideration in a business combination).
ii. The measurement assumes the instrument is transferred to
a market participant at the measurement date and is
measured from the perspective of a market participant
that holds the instrument as an asset.
iii. A separate input or an adjustment to other inputs to
account for a restriction that prevents the transfer of a
shareholder equity instrument should not be made in
measuring the fair value
iv. When a quoted price for the transfer of an identical or
similar shareholders equity instrument is not available,
and the identical instrument is held by another part as an
asset, the instrument should be measured from the
perspective of the party that holds the item as an asset.
d. Application to net financial assets and financial liabilities
i. An exception to the requirement that fair value of qualified
financial assets and financial liabilities be measured
separately is permitted when a reporting entity manages
risk associated with a portfolio of financial instruments on a
net exposure basis, rather than on a gross exposure basis
ii. An entity that holds financial assets and financial liabilities
and manages those instruments on the basis of their net
risk exposure may measure the fair value of those financial
assets and financial liabilities at
1. The price that would be received to sell a NET asset
position for a particular risk, or
2. The price that would be paid to transfer a NET
liability position for a particular risk
Applicability- the content of ASC 820 is for items that uses fair value
measurement either as required or as permitted by GAAP, except in
very limited situations. Specifically, the guidance of ASC 820 does
NOT apply to:
a. Accounting principles that address share based payment
transactions
b. ACSs that require or permit measurements that are similar to fair
value but that are not intended to measure fair value, including

i. Accounting principles that permit measurements that are

determined using vendor-specific objective evidence of fair
value
ii. Accounting principles that address fair value measurement
for purposes of inventory pricing
c. Accounting principles that address fair value measurements for
purposes of lease classification or measurement
d. ASCs that permit practicability exceptions to fair value
measurement
e. Pervasive applicability
i. Other than the exceptions noted above, the content of ASC
820 must be followed when fair value measurement is
used, either as required or permitted by other
pronouncements.