CPA Fair Value Notes: Measurement, Hierarchy Levels and Worked Examples [ASC 820]

Fair value under FASB ASC 820 is the exit price that a market participant would receive to sell an asset or would pay to transfer a liability in an orderly transaction between market participants at the measurement date. In contrast, it is not the entry price. These CPA fair value notes explain the definition, the three level hierarchy, the three valuation techniques, and the disclosures that FAR tests. Fair value measurement sits in FAR Area III, Select Transactions, under the AICPA 2026 Blueprint. See the CPA notes hub at https://www.studyfromnotes.com/cpa-notes/ for companion notes, and review the related bonds payable note at https://www.studyfromnotes.com/bonds-payable-cpa-notes-effective-interest/ before the bond example below.

CPA Fair Value Notes: The ASC 820 Definition

CPA fair value notes define fair value as the ASC 820 exit price to sell an asset or transfer a liability at the measurement date. The hierarchy ranks inputs, not assets, from Level 1 quoted prices to Level 3 unobservable inputs, and the lowest significant input sets the level.

ASC 820 supplies the measurement framework only. However, it does not decide when fair value applies. Another Topic requires or permits fair value, and ASC 820 then tells the preparer how to measure it: ASC 820 answers how, not when.

The price is an exit price, not the entry price paid to acquire the item. In contrast to a forced sale, the transaction is orderly. Market participants are independent buyers and sellers who act in their economic best interest, and preparers measure the price at the measurement date.

Preparers measure fair value in the principal market. If there is no principal market, use the most advantageous market. In practice, the entity must have access to that market at the measurement date. Transaction costs do not change fair value. For a liability, assume the liability transfers and remains outstanding, not settled.

CPA Fair Value Notes: Level 1, Level 2 and Level 3

The hierarchy classifies inputs, not assets. The lowest level of any input significant to the measurement sets the level of the whole measurement. As a result, maximize observable inputs and minimize unobservable inputs.

Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date. For example, a listed share at its closing price is the classic example.

In contrast, Level 2 inputs are observable inputs other than Level 1 quoted prices, including quoted prices for similar assets in active markets, quoted prices for identical or similar assets in inactive markets, interest rates, yield curves, and credit spreads. For example, the bond in Example 1 is Level 2 because its 6 percent market yield is observable, while no quoted price exists for the identical bond in an active market.

Finally, Level 3 inputs are unobservable inputs significant to the measurement. They reflect the entity’s own assumptions about the assumptions market participants would use, when market data are scarce. In practice, a private company valuation that uses management forecasts is Level 3, and it needs fuller disclosure.

Level	Inputs	Example	Reliability
Level 1	Unadjusted quoted price for an identical item in an active market	Listed share at its closing price	Highest
Level 2	Observable inputs other than Level 1 prices	Bond valued with an observable market yield	Middle
Level 3	Unobservable inputs significant to the measurement	Private asset valued on management forecasts	Lowest

CPA Fair Value Notes: Valuation Techniques

ASC 820 recognizes three valuation techniques. In practice, a preparer selects the technique that fits the item and the data available and uses it consistently, changing it only when the change gives a more representative measure.

First, the market approach uses prices from market transactions for identical or comparable assets and liabilities, such as a multiple from comparable companies.

Next, the income approach converts future amounts to a single present amount. Discounted cash flow is the main method: forecast the cash flows, choose a discount rate that reflects risk and time value, and discount each flow to the measurement date. Both worked examples below use this approach.

Finally, the cost approach measures current replacement cost, the amount required today to replace the service capacity of an asset. Preparers use it most often for tangible assets and for assets where market and income data are thin.

CPA Fair Value Notes: Worked Example 1, Level 2 Bond at $97,327

All figures are illustrations. A three year bond has a face value of $100,000 and a 5 percent coupon, so it pays $5,000 each year. The observable market yield for similar bonds is 6 percent, and there is no quoted price for this identical bond in an active market, so the measurement is Level 2.

First, Year 1: $5,000 divided by 1.06 equals $4,716.98. Next, Year 2: $5,000 divided by 1.06 squared, or 1.1236, equals $4,449.98. Finally, Year 3: $105,000, the final coupon plus principal, divided by 1.06 cubed, or 1.191016, equals $88,160.02. Then, add the unrounded present values and the total is $97,326.99. The three rounded figures shown here add to $97,326.98; the one cent difference is rounding, so keep the unrounded total. Rounded, fair value is $97,327.

Because the 6 percent market yield is higher than the 5 percent coupon rate, the bond sells below par. Subtracting fair value from par gives a discount of $100,000 minus $97,327, or $2,673. The 6 percent yield is an observable market input, not a quoted price for the identical bond, so the measurement is Level 2, not Level 1.

CPA Fair Value Notes: Worked Example 2, Level 3 Expected Cash Flow

All figures are illustrations. An asset has a single expected cash flow in one year: $120,000 at 40 percent, $90,000 at 40 percent, and $60,000 at 20 percent. Because the probabilities and the discount rate are unobservable assumptions, the measurement is Level 3.

First, weight each scenario: $120,000 times 40 percent equals $48,000; $90,000 times 40 percent equals $36,000; $60,000 times 20 percent equals $12,000. Next, add them: $48,000 plus $36,000 plus $12,000 equals an expected cash flow of $96,000. Then, discount at 10 percent: $96,000 divided by 1.10 equals $87,272.73. Finally, rounded fair value is $87,273.

For sensitivity, at a 12 percent rate fair value is $96,000 divided by 1.12, or $85,714.29, about $1,559 below $87,273. Therefore, that sensitivity belongs in the disclosures described next.

CPA Fair Value Notes: Disclosures and ASU 2018-13

Preparers repeat a recurring measurement each reporting period, such as a trading security that preparers measure at fair value every quarter. In contrast, a nonrecurring measurement happens only when a trigger occurs, such as an impairment write down, and preparers disclose it in that period.

For each class, the entity discloses the fair value at the reporting date, the level, the valuation techniques, and the inputs. In addition, for Level 3, the disclosures go further: a rollforward from the opening balance to the closing balance, showing gains and losses, purchases, sales, issues, settlements, and transfers, plus the valuation process and the sensitivity to unobservable inputs.

ASU 2018-13 updated the ASC 820 disclosure requirements, effective for fiscal years beginning after December 15, 2019. Furthermore, it added the range and weighted average of significant unobservable inputs for Level 3 measurements.

CPA Fair Value Notes: Exam Traps to Avoid

1. Fair value is an exit price, not an entry price.

2. ASC 820 does not decide when fair value applies; another Topic does.

3. The hierarchy ranks inputs, not assets.

4. One significant Level 3 input pulls the whole measurement to Level 3.

5. A quoted price for a similar asset is Level 2, not Level 1.

6. Transaction costs do not change fair value.

7. Treat a liability as transferred, not settled.

8. The principal market comes first.

One-Page Revision Box: CPA Fair Value Notes

Fair value is the ASC 820 exit price at the measurement date. ASC 820 is the how, not the when. Hierarchy ranks inputs, lowest significant input sets the level. Level 1 is an unadjusted quoted price for an identical item in an active market. In contrast, Level 2 is observable inputs other than Level 1 prices. Finally, Level 3 is unobservable inputs significant to the measurement. Principal market first, most advantageous market if none, transaction costs do not change fair value, liability assumed transferred and still outstanding.

Example 1: bond $5,000 a year for 3 years at 6 percent, present values $4,716.98, $4,449.98, $88,160.02, fair value $97,327, discount $2,673, Level 2. Next, Example 2: expected cash flow $96,000, at 10 percent $87,273, at 12 percent $85,714, Level 3. Disclosures: recurring versus nonrecurring, Level 3 rollforward and sensitivity, ASU 2018-13 effective after December 15, 2019. FAR: 4 hours, 50 MCQs, 7 TBSs, pass 75, Area III 25 to 35 percent.

Finally, for more FAR foundations, see our CPA notes hub.

Frequently Asked Questions: CPA Fair Value Notes

Is fair value the same as market value?

Not exactly. Fair value is the ASC 820 exit price in an orderly transaction between market participants. In practice, a market price is only fair value when it meets those conditions.

Can a Level 1 price ever be adjusted?

No. Level 1 inputs are unadjusted quoted prices for identical items in active markets. However, once a preparer needs an adjustment, it is no longer Level 1.

Why is a probability weighted cash flow a Level 3 measurement?

Because the scenario probabilities and the discount rate are unobservable assumptions. In Example 2, changing the rate from 10 percent to 12 percent moves fair value from $87,273 to $85,714.

Where does fair value sit in the 2026 FAR Blueprint?

In summary, fair value measurement sits in FAR Area III, Select Transactions, at 25 to 35 percent of FAR.

Sources

AICPA, Learn what is tested on the CPA Exam, https://www.aicpa.org/resources/article/learn-what-is-tested-on-the-cpa-exam . Deloitte DART, ASC 820-10, Principal or Most Advantageous Market, https://dart.deloitte.com/USDART/home/codification/broad-transactions/asc820-10/roadmap-fair-value-measurements-disclosures/chapter-6-principal-or-most-advantageous/6-1-general . Becker, CPA Exam Blueprint: What is on the CPA Exam, https://www.becker.com/blog/cpa/new-cpa-exam-exposure-draft .