This is a brief introduction to some of the key terms used in fair value measurement, as well as a diagram that shows the flow in relation to the process of measuring fair value and determining the appropriate disclosures.
The key term that drives this process is 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. Fair value is an exit price (e.g. the price to sell an asset rather than the price to buy that asset). An exit price embodies expectations about the future cash inflows and cash outflows associated with an asset or liability from the perspective of a market participant (i.e. based on buyers and sellers who have certain characteristics, such as being independent and knowledgeable about the asset or liability).
Fair value is a market-based measurement, rather than an entity-specific measurement, and is measured using assumptions that market participants would use in pricing the asset or liability, including assumptions about risk. As a result, an entity’s intention to hold an asset or to settle or otherwise fulfill a liability is not relevant in measuring fair value.
Fair value is measured assuming a transaction in the principal market for the asset or liability (i.e. the market with the highest volume and level of activity). In the absence of a principal market, it is assumed that the transaction would occur in the most advantageous market. This is the market that would maximize the amount that would be received to sell an asset or minimize the amount that would be paid to transfer a liability, taking into account transaction and transportation costs. In either case, the entity needs to have access to that market, although it does not necessarily have to be able to transact in that market on the measurement date.
A fair value measurement is made up of one or more inputs, which are the assumptions that market participants would make in valuing the asset or liability. The most reliable evidence of fair value is a quoted price in an active market. When this is not available, entities use a valuation approach to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.
These inputs also form the basis of the fair value hierarchy, which is used to categorize a fair value measurement (in its entirety) into one of three levels. This categorization is relevant for disclosure purposes. The disclosures about fair value measurements are extensive, with more disclosures being required for measurements in the lowest category (Level 3) of the hierarchy.
The key terms used in fair value measurement, as well as
The key terms used in fair value measurement, as well as The key terms used in fair value measurement, as well as