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How is fair value determined?

For fair value to be determined, there must be an orderly transaction between market participants. That means that there must be both a buyer and a seller that are independent of each other, acting in their own best interest, knowledgeable of what they are buying or selling, and able and willing to enter into a transaction (i.e. they have the funds).

Once it has been establish that there is an orderly transaction between market participants, you need to identify the market in which the transaction takes places. This can either be the principal market or the most advantageous market.

The principal market is the market with the greatest volume or level of activity for that particular asset or liability. The price in the market will be the fair value measurement, even if there is a more advantageous price in a separate market. In the event that no principal market exists, the market with the best price for the asset or liability is considered the most advantageous market.

Fair value can be based on a variety of valuation approaches. The market approach will be les subjective while the income or cost approach will be more subjective.

Lastly, there are a variety of inputs that can be used to determine fair value. Level 1 is going to be the most observable as they are typically based on market transactions in the stock market. Level 3 inputs will be the least observable as they are typically based on internal data or estimates from the company.

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