ASC 820: First Principles
How do you measure something that doesn’t come with a price tag?
At year-end, your company owns two investments.
The first consists of publicly traded securities purchased with excess cash. Your CFO asks, “what’s this investment worth?”
The answer takes only a few seconds, you open Yahoo or Google finance, type in the ticker, find today’s price, multiply by the number of shares, and move on.
The second investment is different.
Several years ago, your company acquired a 15% ownership interest in a privately held software company. The investment has performed well, but there isn’t an active market for its ownership interests.
Your CFO asks the same question, “what’s this investment worth?”
This time, there isn’t an obvious answer. The investment clearly has value and the company is growing, but how do you confidently put a dollar amount on that? Why is this answer so much harder to find?
That question lies at the heart of ASC 820.
Value exists whether we can observe it or not
It’s tempting to think that an asset has value only when someone can point to a market price, but that’s obviously not true.
A privately owned business has value, patents have value, and customer relationships have value. Their economic value doesn’t disappear simply because no active market exists to observe it.
The challenge isn’t whether value exists, it’s how to measure that value faithfully.
That distinction is fundamental.
The accounting isn’t trying to create value, it’s trying to measure value that already exists.
Markets provide evidence, not value
When an active market exists, measuring value is relatively straightforward. Thousands of willing buyers and sellers continuously exchange identical assets. The resulting market price becomes powerful evidence of value. Not because markets create value, but because they reveal it.
When that evidence exists, accounting has little reason to replace it with assumptions or valuation models. The problem is that markets don’t exist for every asset.
Sometimes observable evidence is limited, while other times it doesn’t exist at all.
That doesn’t mean the asset has no value, it means accounting must rely on different forms of evidence.
The fair value hierarchy is a hierarchy of evidence
This is where ASC 820 is often misunderstood. Many people think the fair value hierarchy ranks assets. It doesn’t.
A Level 3 investment isn’t less valuable than a Level 1 investment. A privately held company may be worth far more than a publicly traded security.
The hierarchy says nothing about the asset. It speaks only to the evidence supporting the measurement.
Level 1 measurements rely on directly observable market prices. Level 2 measurements rely on other observable market information. Level 3 measurements rely primarily on valuation techniques because objective market evidence is limited.
As the evidence becomes less objective, judgment necessarily increases.
That’s why ASC 820 requires additional disclosures for Level 3 measurements.
The purpose isn’t to apologize for the estimate. It’s to help users understand the evidence behind it.
Fair value is a market-based measurement
ASC 820 also answers another important question.
Whose opinion of value should matter, management’s, the company’s, or a valuation specialist’s?
The standard takes a different approach. It asks what knowledgeable market participants would pay or receive in an orderly transaction on the measurement date.
That objective keeps fair value grounded in the marketplace rather than in entity-specific assumptions.
The goal isn’t to discover a perfect number, it’s to arrive at the most objective measurement the available evidence can support.
Bringing It All Together
ASC 820 isn’t fundamentally about fair value. It’s about evidence.
Economic value exists whether or not we can directly observe it. Accounting’s responsibility is to measure that value using the most objective evidence available.
When markets provide clear evidence, accounting should use it. When they don’t, accounting should rely on the next best evidence available, while being transparent about the judgment involved.
Everything else in ASC 820 follows naturally from that principle.
Economic value exists independently of our ability to observe it. Accounting should use the most objective evidence available to measure that value.