ASC 820 is the FASB standard that governs fair value measurement across US GAAP. It does not decide which assets or liabilities have to be reported at fair value; other codification topics do that. What ASC 820 does is set the definition, the measurement mechanics, and the disclosure rules that apply whenever fair value is called for. At its core sits a single idea: fair value is an exit price, measured from the perspective of market participants on a specific date.
Fair Value as an Exit Price
ASC 820-10-20 defines fair value as 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. The phrase “exit price” carries the definition. Fair value is not historical cost, not replacement cost, and not the price of a forced sale. It is what you would walk away with if you sold the asset today under normal conditions, or what a willing counterparty would accept to assume your liability.
An orderly transaction assumes the asset has been exposed to the market long enough for customary marketing activity to occur before the measurement date. Buyers have had time to conduct due diligence, and neither side is acting under compulsion. For a widely traded stock, that exposure may last minutes. For niche industrial real estate, it may take months. Even in disrupted markets, the reporting entity estimates the price under normal conditions rather than taking whatever a distressed buyer would pay.
The measurement date matters because fair value is a point-in-time concept. The hypothetical sale is considered from the standpoint of a market participant standing on that date, using information available at that moment.
When ASC 820 Applies
ASC 820 kicks in whenever another codification topic requires or permits a fair value measurement or a fair value disclosure. If another standard says “measure at fair value,” ASC 820 tells you how. If no other standard calls for fair value, ASC 820 stays on the shelf.
Several areas sit outside its scope. Share-based compensation under ASC 718 follows its own measurement rules. Inventory measured at the lower of cost or net realizable value under ASC 330 uses a related concept but is not governed by ASC 820. Revenue recognition under ASC 606 and the derecognition of nonfinancial assets under ASC 610-20 are also excluded. Fair value measurements for lease classification under the former ASC 840 were carved out; that exclusion was superseded when ASC 842 took effect, though certain lease-related measurements retain their own rules.
The Principal Market and Market Participants
The hypothetical sale is assumed to occur in the principal market for the asset or liability, meaning the market with the greatest volume and level of activity. If a principal market exists, the entity uses that market’s price even if a different venue would produce a better number. Only when a principal market cannot be identified or is not accessible does the entity fall back on the most advantageous market, which is the one that maximizes the amount received for an asset or minimizes the amount paid for a liability after accounting for transaction and transportation costs.
Transaction costs and transportation costs identify which market is most advantageous, but they play different roles in the actual measurement. Transaction costs are never included in the fair value figure. Brokerage fees, transfer taxes, and similar charges are costs of the deal, not characteristics of the asset. ASC 820-10-35-9B requires them to be accounted for under whatever other topic applies. Transportation costs get the opposite treatment when location is a characteristic of the asset. A commodity stored in a specific warehouse has a value partly determined by where it sits, so the price is adjusted for the cost of moving the asset to or from the market.
Market participants are the theoretical buyers and sellers used in the measurement. They must be independent of the reporting entity, knowledgeable about the asset and the transaction, able to transact, and willing to do so without being forced. The entity does not have to name specific participants. It identifies their characteristics and builds assumptions that reflect how they would price the item.
Valuation Techniques
ASC 820 permits three broad approaches. The entity picks whichever one, or combination, best captures how market participants would price the item, with the overriding aim of maximizing observable inputs and minimizing unobservable ones.
- The market approach uses prices and other data from actual transactions in identical or comparable assets. Valuation multiples drawn from comparable public companies are a common tool. It works best when an active market generates transparent data.
- The income approach converts future cash flows or earnings into a single present value through discounting. Net present value models and option pricing models such as Black-Scholes fall here. It is the usual choice for intangibles and business units where future income drives value.
- The cost approach estimates the amount currently required to replace the asset’s service capacity, adjusted downward for physical deterioration and both functional and economic obsolescence. Specialized manufacturing equipment with no active secondary market is a typical candidate.
An entity is not locked into one technique. If circumstances change or better data becomes available, switching approaches is allowed. The change and the reason for it must be disclosed.
Calibration at Initial Recognition
When an entity plans to use a valuation technique that relies on unobservable inputs for later measurements, ASC 820-10-35-24C requires calibrating that model to the transaction price at initial recognition, assuming the transaction price represents fair value. The model must produce the same number as the price actually paid on day one. This blocks entities from booking an immediate gain or loss simply because their model disagrees with the price they just agreed to. After initial recognition, the model can and should reflect updated observable data, but the starting point must match the transaction.
The Fair Value Hierarchy
ASC 820-10-35-37 sorts the inputs used in valuation techniques into three tiers. The hierarchy is about inputs, not techniques. A single technique may use inputs from different levels, and the overall measurement is categorized by the lowest-level input that is significant to the result. A Level 2 input buried inside a model full of Level 1 data makes the whole measurement Level 2.
Level 1
Level 1 inputs are unadjusted quoted prices for identical assets or liabilities in active markets. The closing price of a widely traded stock on the New York Stock Exchange is the textbook example. Because these prices are directly observable and require no adjustment, they provide the most objective evidence of fair value, and when a Level 1 input is available, the entity must use it. Blockage factors, which would discount the quoted price because the entity holds more than the market’s normal daily trading volume, are prohibited. The size of your holding is a characteristic of you, not of the asset.
Level 2
Level 2 covers observable data that does not qualify as Level 1. Examples include quoted prices for similar but not identical assets in active markets, quoted prices for identical assets in markets that are not active, and market-corroborated inputs such as interest rates, yield curves, and credit spreads. A corporate bond valued using the interest rate on a similar bond with a comparable credit rating is a classic Level 2 measurement. Adjustments to Level 2 inputs are permitted, but significant adjustments based on unobservable data can push the measurement into Level 3.
Level 3
Level 3 applies when observable inputs simply do not exist. A private equity stake, an early-stage biotech patent, or a bespoke derivative may land here. The entity uses its own assumptions about how market participants would price the item, drawing on the best information available, which might include internal forecasts, proprietary models, or management estimates. Even so, the assumptions must reflect a market-participant perspective rather than the entity’s own plans for the asset. Level 3 measurements carry the heaviest disclosure load because investors have the least ability to verify them independently.
Unit of Account
Before slotting an item into the hierarchy, the entity must determine the unit of account, which is the level at which an asset or liability is aggregated or disaggregated for recognition. ASC 820 generally does not specify the unit of account. The topic that requires the fair value measurement makes that call. The unit of account for a debt security might be the individual security, while for a group of assets in a business combination it might be a reporting unit. Getting this wrong can change the hierarchy classification.
The Portfolio Exception
Entities that manage market risk or counterparty credit risk on a net basis within a portfolio of financial instruments may measure the fair value of the portfolio based on the net risk position rather than pricing each instrument individually. This portfolio exception was introduced by ASU 2011-04 and reflects how dealers and financial institutions actually hedge their exposure.
Highest and Best Use for Nonfinancial Assets
Financial instruments do not need a highest-and-best-use analysis: a bond is a bond regardless of who holds it. Nonfinancial assets like land, buildings, and equipment are different. A factory may be worth more as a warehouse. A parcel may be worth more as a development site than as a parking lot. ASC 820 requires the entity to identify the use that would maximize the asset’s value from a market participant’s perspective, subject to three constraints. The use must be physically possible, legally permissible, and financially feasible.
Physically possible means the asset’s characteristics support the use; a building with load-bearing limits cannot be valued as a heavy-manufacturing facility. Legally permissible means zoning, environmental rules, and other restrictions allow it. Financially feasible means the use generates enough income to justify the required investment and deliver a competitive return. The entity’s own intended use is irrelevant. What matters is what a market participant would do with the asset.
In-Use Versus In-Exchange Premises
The highest and best use dictates the valuation premise. If value is maximized by using the asset in combination with other assets or with other assets and liabilities, the in-use premise applies, and fair value is measured assuming those complementary assets and associated liabilities would be available to market participants. A specialized machine that only has value installed alongside other equipment on a production line falls here. If value is maximized on a standalone basis, the in-exchange premise applies, and fair value reflects what a buyer would pay for the asset by itself. Vacant land in a desirable location often fits this category. The premise chosen for one asset in a group must be consistent with the premise used for the other assets in that group.
Measuring Liabilities and Nonperformance Risk
The framework applies equally to liabilities. The exit price for a liability is the amount that would be paid to transfer it to another party with the same credit standing, not the amount needed to settle it. The liability is assumed to continue after the hypothetical transfer rather than being extinguished.
Fair value must also reflect nonperformance risk, including the entity’s own credit risk. If a company’s creditworthiness deteriorates, the fair value of its liabilities can decrease because a market participant would demand a discount to take on debt from a riskier counterparty. The result feels counterintuitive but follows directly from the exit-price framework: the transfer price incorporates every risk a buyer would consider, and the seller’s credit quality is one of them.
Disclosure Requirements
ASC 820 draws a hard line between recurring and nonrecurring fair value measurements, and the disclosure obligations differ accordingly.
Recurring Measurements
Recurring measurements are those that other topics require at the end of each reporting period. Trading securities carried at fair value on every balance sheet date are the classic case. For each class of recurring assets and liabilities, the entity discloses the fair value at period end, the hierarchy level, and, for Level 2 and Level 3 measurements, the valuation techniques and inputs used.
Level 3 recurring measurements carry the heaviest load. The entity must provide a rollforward from the opening balance to the closing balance, separately identifying total gains and losses recognized in earnings, total gains and losses in other comprehensive income, purchases, sales, issues, settlements, and transfers into and out of Level 3. The entity also reports the portion of unrealized gains or losses attributable to instruments still held at period end, identifies where those amounts hit the income statement, provides quantitative information about significant unobservable inputs (including ranges and weighted averages for public companies), and includes a narrative description of the uncertainty around the measurement and how interrelated inputs could amplify or dampen changes in fair value.
Nonrecurring Measurements
Nonrecurring measurements happen only in particular circumstances. A long-lived asset written down to fair value less costs to sell under ASC 360 is a common example. For these, the entity discloses the fair value at the relevant measurement date, the reason for the measurement, and the hierarchy level. Level 2 and Level 3 nonrecurring measurements also require a description of valuation techniques and inputs. The rollforward and the sensitivity narrative required for recurring Level 3 measurements do not apply.
Items Disclosed but Not Measured at Fair Value
Some assets and liabilities are carried at amortized cost on the balance sheet but require fair value disclosure in the footnotes. For these, the entity discloses the hierarchy level and, where applicable, the highest-and-best-use determination for nonfinancial assets. The more granular quantitative disclosures required for Level 3 recurring measurements do not apply. Nonpublic entities have reduced requirements across several categories, including exemptions from the range-and-weighted-average disclosure and the narrative uncertainty discussion for Level 3 inputs.