ASC 820 or Accounting Standards Codification 820 – Fair Value Measurement

In 2006, the Financial Accounting Standards Board (FASB) introduced ASC 820 to provide a framework for fair value assessment. Back then, the US financial markets were still reeling from the aftermath of the Dot Com bubble wherein inconsistent valuation methods had distorted the market capitalizations of various internet companies and eventually caused misery for many investors.

By standardizing valuation methodologies, ASC 820 improves the transparency of investment values for investors. This accounting standard’s scope extends across a wide range comprising intangible assets, long-lived assets, financial instruments as well as investment values.

This article will cover ASC 820’s definition of fair value, valuation techniques, hierarchy of inputs, and disclosure requirements. These components ensure financial reporting provides reliable and comparable fair-value information for assets and liabilities across entities and periods.

What is ASC 820 fair value?

ASC 820 is an accounting standard that states that an investment must be reported at its fair value. Issued by the Financial Accounting Standards Board (FASB), this standard ensures that investments are accurately represented in financial statements. FASB, an independent private-sector organization in the United States, sets accounting standards in line with Generally Accepted Accounting Principles (GAAP).

Since ASC 820 applies to all kinds of different investments, to ensure the reporting of fair values, it classifies assets into three levels based on the observability of inputs used in fair value assessments. For the classification of inputs in the measurement of the fair value, the most important element of the ASC 820 fair value hierarchy is the utilization of the three-level hierarchy.

ASC 820 Fair Value Hierarchy

Level	Description	Liquidity	Examples
Level 1	Assets with quoted prices in active markets	High	Assets traded on stock exchanges like New York Stock Exchange (NYSE) and Nasdaq
Level 2	Assets that must be measured through observable inputs	Moderate	Corporate bonds, real estate in active markets, and derivatives of actively traded assets
Level 3	Assets that must be measured through unobservable inputs	Low	Private equity stocks, patents, and complex derivatives

When you are valuing an investment as per the ASC 820 accounting guideline, you must assess its fair value as per the exit price in the principal market. The hierarchy gives the lowest priority to the assets that are unobservable and the highest to the assets that are identical and active or are highly traded in the market.

Note: An asset’s price in a transaction on the measurement date, under normal market conditions, and between willing and knowledgeable parties is its fair value.

Who needs ASC 820 valuations?

All entities must follow ASC 820’s framework for fair value assessment when required by other US GAAP standards. Thus, investors, companies, investment companies as well as financial institutions may need ASC 820 valuations.

Companies need ASC 820 valuations for periodic financial reporting and in the event of mergers and acquisitions (M&As). Some financial instruments can also be valued through ASC 820 valuations.

Furthermore, investment companies like private equity funds must measure the value of their investments via ASC 820 valuations.

When Does ASC 820 Apply?

ASC 820 is applicable when other US GAAP accounting guidelines require a fair value assessment. Some examples of this are:

• Periodic financial reporting – Under ASC 350, in periodic financial reporting, a business must ensure that the carrying value of its intangible assets does not exceed its fair values. Similarly, ASC 360 requires businesses to ensure that the carrying value of long-lived assets does not exceed their fair values.
• Mergers and acquisitions (M&As) – Under ASC 805, the acquirer in an M&A transaction must recognize the acquired party’s assets, liabilities, and non-controlling interests at fair value.
• Financial assets – ASC 825 allows entities to recognize the fair value of certain financial instruments like written loan commitments and forward purchase contracts for loans that are not readily convertible to cash.
• Investment companies – Under ASC 946, investment companies must measure the value of investments, except investments into other investment companies, at fair value. Some entities that could meet the definition of investment companies include private equity funds, hedge funds, venture capital funds, and mutual funds.

ASC 820 Valuation Methods

ASC 820 provides a structured framework for measuring fair value, essential for various financial reporting purposes. The valuation methods are categorized primarily into three approaches. Each technique serves different types of assets and liabilities based on their characteristics and the availability of market data.

Income Approach

The Income approach is also known as capitalized cash flow analysis or discounted cash flow. In the income approach, you convert the potential future amount into the current amount. This method shows the current market value for future assets. By using this method, you might have to consider techniques such as option pricing model or present value technique.

Example of Income Approach for ASC 820

In this example, we shall try to find the value of Twin Shield, an accounting firm, via the income approach.

We will assume a discount rate of 8% and an operating income growth rate of 15% over the next 5 years. We will also assume that the terminal value at the end of 5 years would be thrice the total free cash flow accumulated from inception until now.

Below, we have the cash flows since inception.

Particulars	2021	2022	2023
Operating revenue	$2,500,000	$2,750,000	$3,025,000
Operating expenses	$1,625,000	$1,787,500	$1,966,250
Operating profit	$875,000	$962,500	$1,058,750
Tax	$183,750	$202,125	$222,338
Net operating profit after tax	$691,250	$760,375	$836,413
Capital expenditure	$100,000	$0	$200,000
Free cash flow	$591,250	$760,375	$636,413

Terminal value = Total free cash flow since inception × 3

= ($591,250 + $760,375 + $636,413) × 3

= $5,964,114

In the given data, we can observe a constant operating profit margin of 35%.

Particulars	2021	2022	2023
Operating revenue (A)	$2,500,000	$2,750,000	$3,025,000
Operating expenses (B)	$1,625,000	$1,787,500	$1,966,250
Operating profit (C=A-B)	$875,000	$962,500	$1,058,750
Operating profit margin (C/A)	35.00%	35.00%	35.00%

Hence, we shall assume an operating profit margin of 35% when we forecast Twin Shield’s cash flows for the next 5 years.

Particulars	2024	2025	2026	2027	2028
Operating revenue	$3,478,750	$4,000,563	$4,600,647	$5,290,744	$6,084,355
Operating expenses	$2,261,188	$2,600,366	$2,990,420	$3,438,984	$3,954,831
Operating profit	$1,217,563	$1,400,197	$1,610,226	$1,851,760	$2,129,524
Tax	$255,688	$294,041	$338,148	$388,870	$447,200
Net operating profit after tax	$961,874	$1,106,156	$1,272,079	$1,462,891	$1,682,324
Capital expenditure	$0	$0	$0	$0	$0
Free cash flow	$961,874	$1,106,156	$1,272,079	$1,462,891	$1,682,324

Now, we need to discount all future cash flows and the terminal value by the discount rate of 8%.

Year	Free cash flow	Discounted free cash flow
2024	$961,874	$890,624
2025	$1,106,156	$948,350
2026	$1,272,079	$1,009,817
2027	$1,462,891	$1,075,268
2028	$1,682,324	$1,144,962
Total discounted free cash flows		$5,069,022

Now, to find Twin Shield’s valuation, all we need to do is discount the terminal value of Twin Shield and add that to its total discounted free cash flows.

Particulars	Amount
Years (A)	5
Discount rate (B)	8%
Discounting factor (C=(1+B) A)	1.469328077
Terminal value (D)	$5,964,114
Discounted terminal value (E=D÷C)	$4,059,076
Total discounted free cash flows (F)	$5,069,022
Twin Shield's valuation (E+F)	$9,128,097

Market Approach

The market value approach utilizes all the information gathered from the market where similar transactions occur to determine the fair value. In this approach, there may be the use of market multiples from similar companies in the same industry and quotes for similar traded securities. Market approach relies on comparisons to similar assets, it is most useful when there is substantial data available regarding recent sales of comparable assets.

Example of Market Approach for ASC 820

In this example, we will try to find the valuation of DASHPAY, a payment aggregator, via the market approach. A payment aggregator’s valuation is most closely tied to its gross transaction value (GTV) and DASHPAY’s GTV is $3 billion.

We will try to find the market GTV and market valuation based on recent funding rounds and acquisitions to construct the market valuation multiple.

Following are some valuations of payment aggregators that recently had their funding rounds.

Payment aggregator name	Gross transaction value (GTV)	Valuation
PayStream	$5,200,000,000	$2,300,000,000
QuickPay Solutions	$1,800,000,000	$900,000,000
TransactHub	$12,400,000,000	$5,700,000,000
FlowPay Networks	$3,600,000,000	$1,500,000,000
PayFlex Systems	$7,100,000,000	$3,200,000,000
Total	$30,100,000,000	$13,600,000,000

Therefore, the market valuation multiple for payment aggregators = Market valuation ÷ Market GTV

= $13,600,000,000 ÷ $30,100,000,000

= 0.4518272

Therefore, DASHPAY’s valuation = Market valuation multiple × DASHPAY’s GTV

= 0.4518272 × $3 billion

= $1.36 billion

Thus, DASHPAY would be valued at $1.36 billion as per the market method.

Asset Approach

In the asset approach, the asset’s fair value is estimated by subtracting the total liabilities from the total asset value. This is the best approach for companies that are operating in asset-heavy industries or heading toward liquidation.

Example of Asset Approach for ASC 820

In this example, we will examine Bank of America’s value through the asset approach. Their balance sheet items are as follows.

Particulars	Amount (in million) (as of 30th September 2024)
Assets
Total Cash & Due from Banks	$24,847
Investments - Total	$1,896,963
Net Loans	$1,062,549
Investment in Unconsolidated Subs.	$17,254
Real Estate Other Than Bank Premises	$81
Net Property, Plant & Equipment	$20,647
Other Assets (Including Intangibles)	$301,952
Total assets	$3,324,293
Liabilities
Total Deposits	$1,930,352
Total Debt	$742,572
Provision for Risks & Charges	$3,300
Other Liabilities	$351,557
Total Liabilities	$3,027,781

As per the asset approach, Bank of America’s value = Total assets – Total liabilities

= $3,324,293 million – $3,027,781 million

= $296,512 million

= $296.51 billion

Disclosure requirements in ASC 820

ASC 820 disclosures help stakeholders understand the valuation processes and the assumptions underlying fair value measurements. When you report an investment’s value as per ASC 820, you must disclose the following information.

Information to be disclosed	Reasoning
Liquidity hierarchy level	Knowledge of the liquidity hierarchy level of the asset helps build context. It will help the reader understand why a certain valuation methodology and a certain discount for lack of marketability (DLOM) was applied.
Valuation techniques	The reader must be able to verify that you used an appropriate valuation technique accurately. If you modified an existing valuation technique, you must explain why you made changes and how these changes would improve the accuracy of the valuation.
Input data and assumptions	Forecasts of future market conditions, historical data, and assumptions are the final piece of the puzzle for the reader to verify the accuracy of the valuation.
Sensitivity analysis for level 3 assets	The value of level 3 assets may be heavily influenced by unobservable inputs. Hence, you must provide a sensitivity analysis that describes how changes in unobservable inputs would affect the valuation of the investment in question.

Role of valuation experts in estimating fair value as per ASC 820

Estimating fair value as per ASC 820 requires an exhaustive knowledge of accounting principles and familiarity with valuation techniques. The threshold for expertise keeps rising as you move higher up the liquidity hierarchy. 

To value level 3 assets like private equity stocks, you must possess exceptional research skills and financial acumen that enable you to decipher valuation-related trends in the most niche asset categories.

At the same time, you must methodically document the valuation exercise and ensure that you meet the disclosure requirements. Failure to do so can expose you in the event of an audit.

Thus, ASC 820 valuations are time-consuming exercises that require a high level of skill and experience. Hence, even seasoned investors and financial market professionals rely on valuation experts for ASC 820 valuations.

How Does Portfolio Valuation Work in the Real World?

The best way to ensure compliance with portfolio valuation reporting standards is focusing on communicating the true value of investments. Investors want to know how business-specific factors, market dynamics, and economic conditions impact their portfolio’s value and its future outlook.

Meeting these expectations requires not only extensive, data-driven financial modeling but also thoughtful integration of qualitative insights into the valuation process. Hence, portfolio valuation is as much an art guided by intuition as it is a science driven by metrics.

The intuition-driven aspect of portfolio valuations is magnified when the portfolio contains level 3 assets. For such assets, valuation often involves making informed judgments, akin to the precision of a skilled navigator charting a course through uncharted waters. Typically, the quality of conjectures improves with the extent of research, experience and in-depth knowledge.

Given the gravity of reporting requirements and the intricacies of portfolio valuation, one can only rely on reputed valuation experts like Eqvista. Our team combines robust methodologies with industry expertise to ensure your valuations are both compliant and insightful.

FAQs

Some of the most common queries regarding ASC 820 are as follows.

What does ASC 820 stand for?

ASC 820 stands for Accounting Standards Codification 820, an accounting principle that outlines how the fair value of investments must be calculated for accounting and reporting purposes.

Which IFRS is equivalent to ASC 820?

Methodologies for finding the fair value of investments are outlined in the accounting guidelines prescribed by the Financial Accounting Standards Board (FASB) in ASC 820 and by the International Accounting Standards Board (IASB) in IFRS 13.

Are there exceptions to ASC 820?

ASC 820 applies when other US GAAP standards require a fair value measurement. Hence, it excludes certain investments governed by other accounting guidelines, such as share-based compensations (ASC 718) and leasing transactions (ASC 842). ASC 820 also allows entities to report net asset values (NAVs) for certain alternative investments.

What is the difference between ASC 820 and 409A?

ASC 820 is an accounting guideline that outlines how the fair value of any investment must be derived for accounting and reporting purposes. On the other hand, Section 409A of the Internal Revenue Code (IRC) defines how a company must be valued when it issues equity compensation to determine the income and tax liability of the employee or service provider.

What is the principal market under ASC 820?

ASC 820 defines the principal market as the market with the greatest volume and level of activity for the investment being valued.

ASC 820: Ensure clarity and consistency in fair value measurement

Measuring the ASC 820 will remove the need for you to estimate a fair value for each liability and asset. Whether you have to determine the ownership interests held by your company or a private company, you will require a professional. 

Having the right professional who can help you out by using professional tools to smooth out the process is a must. 

You can evaluate your entity with compliance with the ASC 820 valuation through Eqvista. We at Eqvista provide you with a platform backed by our team of professionals who will help you throughout this process. Additionally, there are more features that can assist you in staying updated, keeping track of the shareholders, and maintaining a cap table.