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.

Tango ltd., the infamous mask importer, just purchased some illiquid shares of stock, but has no idea how to value them.

Where in the fair value hierarchy do illiquid shares of stock belong?

Items at level 2 - Quoted prices for similar items or quoted prices for identical items in non-active markets