Under United States generally accepted accounting principles (U.S. GAAP), fair value represents a current exit price for an asset or liability. It measures asset-sale proceeds or a liability-transfer payment in an orderly transaction between market participants at the measurement date.
Market participant assumptions determine this measurement even when management intends to retain the asset or fulfill the obligation itself. Historical acquisition cost, a desired selling price, and an entity's financing needs cannot independently establish the current exit price.
- The measurement framework explains how fair value is determined; other accounting requirements establish when fair value must or may be used.
- An acquisition price can equal fair value, but differences in the transaction, market, or unit of account can prevent equality.
- A reporting-date measurement reflects conditions existing on that date, including current prices and risk expectations.
Market participants are independent, knowledgeable buyers and sellers who can transact and willingly pursue their economic interests without compulsion.
Market participant assumptions have these consequences:
- Forecasts incorporate information reasonably available to participants, including customary investigation of the asset or liability.
- Management's own information can support an estimate, but known differences from market participants' assumptions require adjustment.
Common mistakes
- Selecting the highest quotation. South's $112 quote produces only $100 net proceeds; it loses the no-principal-market comparison to Central's $105.
- Deducting commissions from fair value. Central's $105 net proceeds are $2 below its $107 per-unit fair value.
- Classifying the model name. Example 2's same $20,000 income calculation is Level 2 or Level 3 according to the significant spread's observability.
Bottom line
- Fair value is a measurement-date exit price in an orderly transaction using market participant assumptions.
- An accessible principal market governs; only its absence permits selection of the most advantageous accessible market.
- Transaction costs affect the most advantageous market comparison but are excluded from fair value; applicable transportation costs reduce the destination-market quote.
- Market, income, and cost approaches use prices, future benefits, and replacement service capacity, respectively.
Exam shortcut
The requested output identifies the calculation needed: market, fair value, hierarchy level, or journal entry. A correct market-selection calculation can still be the wrong reported amount. Separate columns distinguish net proceeds from fair value. The preparer identifies any principal market before comparing net proceeds. An income calculation measures each payment's distance from the measurement date, discounts each receipt separately, and retains unrounded factors.
The full lesson (about 5,750 words, 38 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- III.E1
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