In September 2006, the Financial Accounting Standards Board (FASB) issued ‘Statement of Financial Accounting Standards 157: Fair Value Measurement’ (SFAS 157). SFAS 157 defines fair value, it establishes a framework for measuring fair value in generally accepted accounting principles and defines disclosures about fair value measurements.
Paragraph 5 of SFAS 157, which is also known as ASC 820 in the updated FASB codification, defines fair value as ‘the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date’.
- ASC 820 requires the consideration of an exit price paid (if liability) or received (if asset) in a hypothetical transaction in an orderly market.
- It assumes the hypothetical transaction occurs in a principal market, ‘the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability’.
- ASC 820 emphasizes that fair value is a market-based instrument, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.
ASC 820 therefore requires the application of valuation techniques that place greater reliance on observable inputs and less reliance on unobservable inputs.