How are Level 2 inputs observable for Chocolate Bash's assets or liabilities?
Chocolate_Bash 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 38)
What This Means (2024 FDD)
According to Chocolate Bash's 2024 Franchise Disclosure Document, Level 2 inputs are defined within a hierarchy of valuation techniques used to assess the fair value of financial instruments. This hierarchy prioritizes observable inputs, which are market data obtained from independent sources, over unobservable inputs, which reflect market assumptions. Level 2 inputs specifically refer to those other than quoted prices within Level 1, but are still observable for the asset or liability, either directly or indirectly.
Examples of Level 2 inputs include 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. This means that Chocolate Bash uses data from comparable items or markets to determine the value of its assets and liabilities, as long as that data is accessible and verifiable. This approach is more subjective than using direct, active market prices (Level 1) but more objective than relying on internal assumptions (Level 3).
For a prospective Chocolate Bash franchisee, understanding these valuation levels is important because it provides insight into how the franchisor assesses the value of its financial instruments. While the FDD does not provide specific examples of assets or liabilities valued using Level 2 inputs, it establishes the framework Chocolate Bash uses for financial reporting. Franchisees may want to inquire about specific examples to better understand how these valuations might affect the financial health and reporting of the franchise system.