ASC 820-10: Level 1 Inputs in Fair Value Measurement & Journal Entries Explained

ASC 820-10: Level 1 Inputs in Fair Value Measurement & Journal Entries Explained

Posted In | ASC Education | Gridlex Academy

Accounting Standards Codification (ASC) 820-10, part of the larger ASC 820 Fair Value Measurement topic, establishes a framework for measuring fair value and provides guidance on the application of fair value measurement in financial reporting. This article will provide an overview of the ASC 820-10 guidance, explain Level 1 inputs in the fair value hierarchy, and demonstrate the application of Level 1 inputs through an example using journal entries.

 

1. ASC 820-10: Fair Value Measurement - Overall

ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels.
 

2. Level 1 Inputs

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date. These inputs provide the most reliable evidence of fair value and are prioritized over Level 2 and Level 3 inputs in the fair value hierarchy.
 

3. Journal Entries: Level 1 Inputs Transaction Example

Suppose a company, XYZ Corp, purchases 1,000 shares of publicly traded Company ABC at $50 per share as a long-term investment. The shares of Company ABC are actively traded in a public stock exchange, and their market price is easily accessible.

 

Journal entries for the Level 1 inputs transaction
 

1. Record the purchase of Company ABC shares:

Dr. Investment in Company ABC $50,000

Cr. Cash $50,000
 

At the end of the reporting period, the market price of Company ABC shares has increased to $55 per share.

 

2. Record the fair value adjustment for the investment in Company ABC shares:

Dr. Investment in Company ABC $5,000

Cr. Unrealized Gain on Investment in Company ABC $5,000
 

(Note: The unrealized gain account may be reported as part of other comprehensive income or net income, depending on the classification of the investment under the applicable accounting standards.)
 

At a later date, XYZ Corp decides to sell all 1,000 shares of Company ABC at the current market price of $60 per share.
 

3. Record the sale of Company ABC shares:

Dr. Cash $60,000

Cr. Investment in Company ABC $55,000

Cr. Realized Gain on Sale of Investment in Company ABC $5,000
 

ASC 820-10 provides guidelines for measuring fair value in financial reporting and establishes a fair value hierarchy that prioritizes the inputs used in valuation techniques. Level 1 inputs are the most reliable and represent quoted prices in active markets for identical assets or liabilities. By accurately applying the guidance, companies can ensure transparent and reliable financial reporting that is consistent across organizations.