Definition
ASC 820 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 hierarchy classifies inputs: Level 1 are quoted prices in active markets for identical assets or liabilities that the entity can access; Level 2 are inputs other than Level 1 that are observable, directly or indirectly; Level 3 are unobservable inputs. A measurement is categorized in its entirety based on the lowest-level input significant to the measurement.
Why it matters in an audit or review
Higher levels need more audit evidence about management's assumptions and models. Auditors vouch Level 1 prices to independent sources, evaluate Level 2 vendor pricing, and often use a specialist for Level 3. Nonpublic entities have scaled-back disclosure requirements under ASC 820-10-50.
Example
(Illustrative) A company holds a publicly traded mutual fund (Level 1), a corporate bond priced from observable quotes of similar bonds (Level 2), and an interest in a private company valued with a discounted cash flow (Level 3).
Common mistakes
- Classifying vendor-supplied prices as Level 1 without checking activity.
- Omitting the valuation technique disclosures.
Sources
- FASB ASC 820-10-20, Fair Value Measurement, definition of fair value
- FASB ASC 820-10-35, Fair Value Measurement, the fair value hierarchy
- FASB ASC 820-10-50, Fair Value Measurement, disclosures
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error