What is the definition of 'fair value' used in the financial statements for Carls?
Carls Franchise · 2024 FDDAnswer from 2024 FDD Document
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Entities are required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value based on the following fair value hierarchy:
Level 1 - Quoted prices in active markets for identical assets or liabilities;
- Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
- Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Source: Item 21 — FINANCIAL STATEMENTS (FDD pages 79–80)
What This Means (2024 FDD)
According to Carls's 2024 Franchise Disclosure Document, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, also known as an exit price. This price is determined in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This definition is crucial for understanding how Carls assesses the value of its assets and liabilities in its financial statements.
The FDD specifies that Carls is required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This is based on a fair value hierarchy that includes three levels. Level 1 consists of quoted prices in active markets for identical assets or liabilities. Level 2 includes observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 consists of unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
For prospective franchisees, understanding this definition and hierarchy is important because it provides insight into how Carls values its assets, especially during impairment assessments. Although Carls's non-financial long-lived assets, such as intangible assets and property and equipment, are reported at carrying value and are not regularly measured at fair value, they are assessed for impairment periodically or when circumstances indicate that their carrying value may not be recoverable. When impairment is identified, these assets are written down to fair value. Franchisees should be aware of how these valuations can impact the financial health of Carls, as significant write-downs could indicate underlying issues with asset performance or market conditions.