Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CMA] CMA1: Fair Value Measurement: Applying the ASC 820 Framework
Transcript
- Hey, welcome to VoraPrep Audio. Glad you could join me. Let's talk about a scenario that comes up all the time. Imagine your company just bought a small startup. It's exciting. But with that startup came a bunch of weird assets—some securities that don't trade on any public exchange, a few patents, some unique software. Now it's year-end, and the auditors are asking, "Okay, what's the fair value of all this stuff?" You can't just look up a price on Google. And if you get it wrong, it could be a material misstatement. That's the kind of thing that gets regulators' attention and makes investors really nervous. This is exactly why we need a solid framework, and that framework is ASC 820. It’s not just theory; it’s a tool you will actually use. So, what exactly *is* fair value according to the rules? ASC 820 has a very specific definition. It's 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. I know, that’s a mouthful. Let’s break it down into plain English. First, notice it says "price that would be received to sell an asset." This is what we call an exit price. It's not what you paid for it. Think about your car. The price you paid for it new—the entry price—is totally different from its trade-in value today—the exit price. Fair value is focused on that trade-in value. What could you get for it *right now*? Next, the definition mentions an "orderly transaction." This is key. It assumes the asset has been on the market for a normal amount of time, with the usual marketing. It's not a fire sale. It’s not a forced liquidation where you have to sell something by Friday, no matter what. That’s a distressed sale, and that’s not fair value. Then we have "market participants." Who are they? The standard assumes these are buyers and sellers who are independent of each other. So, not your parent company or a subsidiary. They're also assumed to be knowledgeable, able to transact, and willing to transact. Basically, we're trying to figure out the value from the market's perspective, not just from your company's unique point of view. And finally, "at the measurement date." This just means the valuation is a snapshot in time. It's the value on the balance sheet date, not what it was last month or what you hope it will be next year. To make sense of how to find that value, ASC 820 gives us a hierarchy. A three-level system. The whole point is to use the most observable, market-based inputs you possibly can. You always have to start at the top and only move down if you have to. Think of it this way. Level 1 is "Look it up." These are quoted prices for identical assets in active markets. A share of Microsoft stock is the perfect example. There is no mystery. You can look up the price in a second. It's the most reliable data you can get. But what if you can't just look it up? Then you might move to Level 2, which I call "Figure it out." Here, you don't have a direct quote for your exact asset, but you can use other observable data to derive a value. For instance, valuing a building might involve looking at recent sale prices of similar buildings in the same area. Or valuing a bond that doesn't trade often might involve looking at interest rates and credit spreads for comparable companies. You’re using real market data, just indirectly. And then there's Level 3. This is "Model it out." You get here when there are no observable inputs. Zero. This is where you have to use your own internal data and assumptions. Think about projecting the future cash flows from that unique patent the startup owned. You're building a model from scratch. Level 3 is the most relevant for a unique asset, but it's also the least objective because it relies so heavily on your own judgment. Now, a huge part of this, and something the exam loves to test, is figuring out *which market* to get your price from. The rule is this: you must use the price from the principal market if one exists. The principal market is simply the one with the greatest volume and level of activity for that asset. If you can identify a principal market, your search is over. You use that price. Period. Even if you think you could get a slightly better price somewhere else. But what if there isn't one clear principal market? Only then do you look for the most advantageous market. This is the market that gives you the best net return. The one that maximizes what you'd receive for an asset after—and this is important—after you subtract transaction costs and transportation costs. Let's walk through an example, because this is where people get tripped up. Say Apex Corp. has a piece of equipment to sell. There's no principal market. They have offers from two different markets, A and B. In Market A, the quoted price is $100,000. Transaction costs would be $4,000, and getting it there would cost $1,000. In Market B, the quoted price is a little higher, $102,000. But the transaction costs are also higher, at $7,000. Transportation is the same, $1,000. So, which market do we choose? We have to find the most advantageous one by calculating the net proceeds for each. Let's start with Market A. We take the price of $100,000... subtract the $4,000 in transaction costs... and subtract the $1,000 in transportation costs. That leaves us with net proceeds of $95,000. Okay, hold that number. Now for Market B. The price is $102,000. We subtract the $7,000 in transaction costs... and the $1,000 for transport. That gives us net proceeds of $94,000. So, comparing the two, Market A gives us $95,000 net, while Market B gives us $94,000. Market A is clearly the winner. It's our most advantageous market. Now for the million-dollar question—the one that shows up on the exam. What is the fair value we record for the equipment? Is it the $95,000 net proceeds? No. And this is the most common trap. Transaction costs are only used to help you *decide which market to use*. Once you've picked the market—in this case, Market A—the fair value is the quoted price in *that* market. So, the fair value we record is $100,000. The transaction costs of $4,000 are treated as a separate expense for the period. They don't reduce the carrying value of the asset. Please, burn that into your memory. You use transaction costs to pick the market, but you don't subtract them from the final fair value number. So, when you see a question on this, your process is simple. First, does the question mention a principal market? If it says "Market X is the principal market," then you're done. Use the price from Market X and ignore everything else. If it says there's no principal market, then you do the calculation we just did. Find the net proceeds for each market to identify the most advantageous one. Then, grab the quoted price from that winning market. That's your answer. This whole framework can feel a bit abstract, but it's just a logical process for finding the most reliable value possible. If you need more practice with these kinds of problems, VoraPrep is a full exam-prep app. It’s got lessons, thousands of practice questions, and even an AI tutor to help you work through tricky spots like this one. You can get started for free at Vora Prep dot com. So to wrap it up: Fair value is an exit price. The hierarchy—Level 1, 2, and 3—is all about prioritizing the best, most observable data. Look it up, figure it out, or model it out. And for market selection, if there's a principal market, use it. If not, find the most advantageous market by calculating net proceeds, but remember that the final fair value is the price in that market *before* transaction costs. You've got this. Keep up the great work, and I'll catch you on the next one.