What is the significance of unobservable inputs for Bombs Away's financial instruments?
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, the significance of unobservable inputs relates to how the company values its financial instruments. The document explains that the Financial Accounting Standards Board (FASB) has a hierarchy for valuation techniques. This hierarchy is based on whether the inputs used to determine the value are observable (based on market data) or unobservable (based on the company's own assumptions).
Level 3 measurements, which have the lowest priority, rely on unobservable inputs. This means that when Bombs Away uses its own pricing models, discounted cash flows, or similar techniques to determine the fair value of financial instruments, and at least one significant assumption or input is unobservable, those instruments are classified as Level 3.
For a prospective Bombs Away franchisee, this is important because it provides insight into how the company determines the value of its assets and liabilities. It also highlights the degree to which subjective assumptions, rather than objective market data, are used in these valuations. While the FDD states that the carrying amounts of Bombs Away's financial assets and liabilities approximate their fair value as of December 31, 2023, understanding the role of unobservable inputs is crucial for assessing the reliability and potential volatility of those valuations.