Fair Value Hierarchy

Lesson Exercise Solution

Sometimes it isn't obvious how an asset or liability should be valued.

In such cases, someone must come up with a value.

Depending upon the item, a firm can use one of three methods. The higher the method number, the more risky and unreliable the valuation:

Level 1 (aka Marked to Market) - Quoted prices for identical items in active markets
Level 2 - Quoted prices for similar items or quoted prices for identical items in non-active markets
Level 3 (aka Marked to Model) - Items with one or more unobservable inputs to price

Items in level 3 can be a bit dangerous, due to the number of assumptions being made.

The details for the value hierarchy are laid out in ASC 820-10-35-37.

Frank inc., the ever-maligned pencil designer, just purchased some distressed debt, but has no idea how to value them.

Where in the fair value hierarchy do distressed debt belong?

Items at level 3 - Items with one or more unobservable inputs to price