How does Aplus define Level 3 inputs, and what is the key characteristic that distinguishes them from Level 1 and Level 2 inputs?
Aplus Franchise · 2024 FDDAnswer from 2024 FDD Document
ASC 820 "Fair Value Measurements and Disclosures" prioritizes the inputs used in measuring fair value into the following hierarchy:
Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities;
- Level 2 Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable;
- Level 3 Unobservable inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.
Source: Item 22 — CONTRACTS (FDD page 68)
What This Means (2024 FDD)
According to Aplus's 2024 Franchise Disclosure Document, Level 3 inputs are defined as unobservable inputs where little to no market activity exists. This requires the entity to develop its own assumptions about what market participants would use for pricing. These inputs are used in fair value measurements when observable prices are not available, often relying on internal valuation models.
The key distinction of Level 3 inputs is their unobservable nature and the absence of market activity. Unlike Level 1 inputs, which are quoted prices in active markets for identical assets or liabilities, and Level 2 inputs, which are observable either directly or indirectly, Level 3 inputs require Aplus to create its own assumptions about market participant pricing. This introduces a higher degree of subjectivity and management judgment in determining fair value.
For a prospective Aplus franchisee, understanding these distinctions is important because it highlights the areas where financial reporting relies on internal estimates rather than concrete market data. This is particularly relevant when assessing the value of acquired assets, investments, or potential impairments. Franchisees should be aware that these Level 3 valuations can be more susceptible to changes based on the assumptions used, potentially impacting the financial performance and reported value of certain assets.