What is ASC 820 and how does it define fair value hierarchy?

Full Explanation

ASC 820 (Fair Value Measurement) — the US GAAP equivalent of IFRS 13 — establishes a consistent framework for measuring fair value and a hierarchy that prioritises the inputs used in valuation. The fair value hierarchy has three levels. Level 1: quoted prices in active markets for identical assets or liabilities. For intangible assets, Level 1 inputs are extremely rare — only assets like carbon emission allowances or taxi medallions traded on exchanges qualify. Level 2: observable inputs other than Level 1 prices, including quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets, and other observable market data (interest rates, yield curves, credit spreads). For intangible assets, Level 2 inputs include comparable royalty rates from licensing databases and comparable transaction multiples from recent M&A deals. Level 3: unobservable inputs based on the reporting entity's own assumptions about market participant expectations. The vast majority of intangible asset valuations use Level 3 inputs because the assets are unique, rarely traded, and lack directly comparable market data. Level 3 fair value measurements require the most extensive disclosure, including: a description of the valuation techniques used, the key inputs and assumptions, the sensitivity of fair value to changes in assumptions, and a reconciliation of beginning-to-ending balances. ASC 820 also introduced the concept of highest and best use — fair value should reflect how market participants would use the asset to generate maximum value, which may differ from the entity's current use. For intangible assets in a PPA, this means valuing assets based on their highest-value application, not necessarily how the acquirer plans to use them.

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