What are some examples of Level 2 inputs that Bombs Away might use?
Bombs_Away Franchise · 2024 FDDAnswer from 2024 FDD Document
Financial Accounting Standards Board ("FASB") guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:
- Level 1 Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded instruments and listed equities.
- Level 2 Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly (e.g., quoted prices of similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active).
- Level 3 Unobservable inputs for the asset or liability. Financial instruments are considered Level 3 when their fair values are determined using pricing models, discounted cash flows or similar techniques and at least one significant model assumption or input is unobservable.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 35)
What This Means (2024 FDD)
According to Bombs Away's 2024 Franchise Disclosure Document, Level 2 inputs are defined within the context of fair value measurement for financial instruments. These inputs are observable, either directly or indirectly, but are not the same as quoted prices in active markets for identical assets (Level 1). Instead, Level 2 inputs might include quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not considered active.
For a Bombs Away franchisee, understanding these definitions is important because they relate to how the franchisor values its financial assets and liabilities. While the FDD does not provide specific examples of what Level 2 inputs Bombs Away actually uses, it clarifies that these inputs are based on observable market data, albeit not from the most liquid or identical markets. This suggests that Bombs Away uses valuation techniques that incorporate market-based information to determine the fair value of its financial instruments.
The distinction between Level 1, Level 2, and Level 3 inputs is a standard accounting practice to provide transparency in financial reporting. Level 1 inputs are the most reliable because they are based on actual market transactions for identical items. Level 2 provides slightly less direct market data, while Level 3 relies on unobservable inputs and management's own assumptions, making them the least transparent. Bombs Away states that as of December 31, 2023, the carrying amounts of the Company's financial assets and liabilities reported in the balance sheets approximate their fair value.
Prospective franchisees might want to inquire about the specific types of financial instruments Bombs Away holds and the valuation techniques used, particularly if they have a significant impact on the franchisor's financial statements. Understanding the valuation methods can provide additional insight into the franchisor's financial health and risk management practices.