A fair value measurement is performed for a particular asset or liability. The characteristics of the asset or liability should be taken into account when determining fair value if market participants would consider these characteristics when pricing the asset or liability. Such characteristics include (1) the condition and/or location of the asset or liability and (2) any restrictions on sale, transferability, or use of the asset.

When applying ASC 820, it is important to determine the appropriate unit of account (i.e., the level at which an asset or liability is aggregated or disaggregated for recognition purposes under the applicable guidance). An asset or liability measured at fair value may be (1) a standalone asset or liability (e.g., a financial instrument, an investment property, or a warranty liability) or (2) a group of assets, a group of liabilities, or a group of assets and liabilities (e.g., a reporting unit or a business).

The level at which fair value is measured is generally consistent with the unit of account specified in other guidance. However, as discussed under the “Application to nonfinancial assets” section below, for non-financial assets, fair value measurements may be determined assuming that the asset is used in combination with other assets and liabilities as a group.

Also, for financial assets and liabilities that qualify, as discussed in ASC 820-10-35-18D, fair value may be measured at a group or portfolio level. Even when fair value is measured for a group of assets or liabilities, if fair value is a required measurement or disclosure in the financial statements, it should be attributed to the unit of account specified in other guidance on a systematic and rational basis.

ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. As such, management's intended use of an asset, or planned method of settling a liability, are not relevant when measuring fair value. Instead, the fair value of an asset or liability should be determined based on a hypothetical transaction at the measurement date, considered from the perspective of a market participant. For instance, if a market participant were to assign value to an asset acquired in a business combination, the market participant assumptions should be incorporated in determining its fair value, even if the acquiring company does not intend to use the asset.

A key principle in ASC 820 is the concept of valuation based on the principal market or, in the absence of a principal market, the most advantageous market. The principal market is the market with the greatest volume and level of activity for the asset or liability being measured at fair value. The market where the reporting entity, or a business unit within the overall reporting entity, would normally enter into a transaction to sell the asset or transfer the liability is presumed to be the principal market, unless there is evidence to the contrary.

The principal market must be available to and accessible by the reporting entity. If there is a principal market, fair value should be determined using prices in that market. If there is no principal market, or the reporting entity doesn't have access to the principal market, fair value should be based on the price in the most advantageous market (the market in which the entity would maximize the amount received to sell an asset or minimize the amount that would be paid to transfer a liability).

The determination of the most advantageous market may require the reporting entity to consider multiple potential markets and the appropriate valuation premise(s) in each market (for nonfinancial assets). Once the potential markets are identified, the reporting entity should value the asset in each market to determine which one is the most advantageous. If there are no accessible markets, the reporting entity should value the asset in a hypothetical market based on assumptions of potential market participants.

The highest and best use concept is applicable to fair value measurements of nonfinancial assets. It takes into account a market participant's ability to generate economic benefits by using an asset in a way that is physically possible, legally permissible, and financially feasible.

The highest and best use of a nonfinancial asset is determined from the perspective of a market participant, even if the reporting entity intends to use the asset differently. In determining the highest and best use, the reporting entity should consider whether the nonfinancial asset would provide maximum value to a market participant on its own or when used in combination with a group of other assets or other assets and liabilities.

Although the concept of highest and best use does not apply to financial assets and liabilities, there is an exception to the valuation premise when an entity manages its market risk(s) and/or counterparty credit risk exposure within a portfolio of financial instruments (including derivatives that meet the definition of a financial instrument), on a net basis.

The "portfolio exception" allows for the fair value of those financial assets and financial liabilities to be measured based on the net positions of the portfolios (i.e., the price that would be received to sell a net long position or transfer a net short position for a particular market or credit risk exposure), rather than the individual values of financial instruments within the portfolio. This represents an exception to how financial assets and financial liabilities are measured outside of a portfolio, where each unit of account would be measured on an individual basis.

ASC 820-10-35-24A requires consideration of three broad valuation approaches: the market approach, the income approach, and the cost approach. It also provides examples of valuation techniques that are consistent with each valuation approach.

The guidance requires that entities consider all valuation approaches applicable to what is being measured and the availability of sufficient data. In some cases, one valuation approach may be sufficient, while in other cases, the reporting entity may need to incorporate multiple approaches, depending on the specific fact pattern.

Under ASC 820, reporting entities are required to consider the risk of error inherent in a particular valuation technique (such as an option pricing model) and/or the risk associated with the inputs to the valuation technique. Accordingly, a fair value measurement should include an adjustment for risk if market participants would include such an adjustment in pricing a specific asset or liability.

See further discussion in FV 4.4.

ASC 820-10-35-37 establishes a three-level hierarchy of fair value measurements to provide greater transparency and comparability of fair value measurements and disclosures among reporting entities. The guidance prioritizes observable data from active markets, placing measurements using only those inputs in the highest level of the fair value hierarchy (Level 1). The lowest level in the hierarchy (Level 3) includes inputs that are unobservable, which may include an entity's own assumptions about cash flows or other inputs. In addition, in response to some constituents' concerns about the reliability of fair value measurements based on unobservable data, additional disclosure is required for Level 3 measurements.

See further discussion in FV 4.5.

Other concepts and requirements of ASC 820 include the following:

While excluded from the determination of fair value, transaction costs should be considered in determining the most advantageous market. In making that determination, a reporting entity should calculate the net amount that would be received from the sale of an asset or paid to transfer a liability. The price received or amount paid is adjusted by the transaction costs. See further discussion in FV 4.2.4.1 and FV 4.2.4.2.