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ASC 820 establishes an overall framework for purposes of measuring fair value. This chapter describes the five steps of the framework.

3.1.1 Framework for application of the fair value standard

In accordance with the framework, a reporting entity should apply a structured approach when determining all fair value measurements that are within the scope of ASC 820.
Figure FV 3-1 illustrates key elements of the framework.
Figure FV 3-1
ASC 820-10-35-1 “provides a general framework, which applies to both initial and subsequent measurement”
* The election to value groups of financial assets and liabilities with offsetting market or credit risks on the basis of the net risk position is subject to the conditions in ASC 820-10-35-18E. See FV 6.6 for a discussion of this exception.
The concepts underlying the fair value standards are discussed in FV 4. Practical application considerations are provided in FV 6, FV 7, and FV 8.
Each step of the five-step application methodology is detailed below.

3.1.2 Step one: determine unit of account

The reporting entity must determine the unit of account (i.e., what is being measured). As discussed in ASC 820-10-35-2E, the unit of account is generally determined based on other applicable guidance, unless denoted otherwise within ASC 820. For example, ASC 815 specifies that the unit of account for a derivative is the contract, while under ASC 350-20, the unit of account for the first step of a goodwill impairment analysis is the reporting unit. See further discussion in FV 4.2.1.

3.1.3 Step two: determine valuation premise

After determining the unit of account, the reporting entity must assess the valuation premise based on the nature of the asset or liability being measured.

3.1.3.1 Nonfinancial assets

In accordance with ASC 820-10-35-10A, “A fair value measurement of a nonfinancial asset takes into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use”. The highest and best use for a nonfinancial asset must be determined based on the perspective of market participants, even if the reporting entity intends a different use. Consideration of the highest and best use for a nonfinancial asset is an integral part of the identification of potential markets in which the asset can be sold and establishes the valuation premise. The valuation premise may be either for the asset to be used in combination with other assets, other liabilities, or both. Alternatively, the valuation premise may be for the asset to be used on a standalone basis. See further discussion of the determination of the highest and best use in FV 4.2.5.

3.1.3.2 Financial assets

The concept of “highest and best use” does not apply to financial assets. The fair value of financial assets must be measured on a standalone basis. ASC 820-10-35-18D includes an exception in instances in which an entity manages its market risk(s) and/or counterparty credit risk exposure within a group (portfolio) of financial instruments on a net basis (the “portfolio exception”). If elected, the portfolio exception allows an entity to measure the fair value of those financial assets (and financial liabilities) based on the net position of the portfolio (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 positions within the portfolio (i.e., the gross positions).

3.1.3.3 Liabilities

Financial and nonfinancial liabilities are valued based on the transfer of the liability to a market participant on the measurement date. However, reporting entities must still consider market participant assumptions relative to the transfer of the liability. If the liability is held by another party as an asset, the liability should be valued using the assumptions of the market participants that hold the asset, assuming they have access to the same markets, whether or not the asset has a quoted market price.
The valuation premise for financial assets and liabilities (including the election of the portfolio exception) is discussed in FV 6.6.

3.1.4 Step three: determine markets for basis of valuation

Once a reporting entity has considered the unit of account, potential markets, market participants, and the valuation premise, it must assess whether it has access to any observable markets. If access is available, a reporting entity must consider the following:
  • Is there a principal market for the asset or liability?

    The principal market is the market with the greatest volume and level of activity for the asset or liability. If there is a principal market, the fair value measurement should be based on the price in that market, even if the price in another market is potentially more advantageous. The reporting entity cannot consider potentially more advantageous markets in its fair value measurements when it has a principal market. Unless there is contrary evidence, the market in which the reporting entity would normally sell the asset or transfer the liability is presumed to be the principal market (or, in the absence of a principal market, the most advantageous market).
  • What is the most advantageous observable market?

    If the reporting entity does not have a principal market, it should determine the most advantageous observable market for sale of the asset or transfer of the liability. As part of this determination, a reporting entity will need to consider all observable markets to which it has access and which inputs can be reasonably obtained. In some cases, a reporting entity will need to determine the value in multiple markets and may need to consider both valuation premises (for nonfinancial assets) in one or more markets, in order to determine the most advantageous market.

    The market that results in the highest value for the asset or the lowest amount that would be paid to transfer the liability (after transaction costs) will represent the most advantageous market.
In the application of the framework, it is important to note that the determination of highest and best use for nonfinancial assets, and development of the fair value measurement are based on market participant assumptions in markets to which the reporting entity has access.
If there are no observable markets for the asset or liability or the market is not active, the reporting entity must develop a hypothetical market based on the assumptions of potential market participants. See further discussion in FV 4.2.3.

3.1.5 Step four: apply the appropriate valuation approaches/technique

ASC 820-10-35-24A outlines three potential valuation approaches: the market approach, the cost approach, and the income approach. It requires that the reporting entity consider and apply each valuation approach and technique that is appropriate in the circumstances and for which market participant pricing inputs can be obtained without undue cost and effort. For example, a reporting entity should consider market conditions, nonperformance risk, risks and uncertainties, and other attributes and inputs that would bear on the fair value measurement. See FV 4.4.

3.1.6 Step five: determine fair value

The outcome of the market determination and the application of valuation approaches/techniques will be a fair value measurement. If a nonfinancial asset is valued in combination with other assets, the fair value is calculated based on the assumption that the market participant already owns the other assets. In certain circumstances, the total calculated value must be allocated to each unit of account in the asset grouping.
Finally, ASC 820-10-35-18D includes a portfolio exception for measuring a group of financial assets and liabilities at fair value on a net basis. The exception allows for the measurement of fair value based on the net risk position of a group of financial assets and liabilities. Refer to FV 6.6 for further details.
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