What are Level 3 inputs, as defined by Monicals Pizza, for determining the fair value of an asset or liability?
Monicals_Pizza Franchise · 2025 FDDAnswer from 2025 FDD Document
[Item 23: RECEIPTS]
The Company follows current guidance related to fair value measurements, which, among other things, requires enhanced disclosures about assets and liabilities carried at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company is able to classify fair value balances based on the observability of those inputs. The guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. 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 Inputs Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
- Level 2 Inputs Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
- Level 3 Inputs Unobservable inputs for the asset or liability.
A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Source: Item 23 — RECEIPTS (FDD pages 46–257)
What This Means (2025 FDD)
According to Monicals Pizza's 2025 Franchise Disclosure Document, Level 3 inputs are defined as unobservable inputs for an asset or liability when determining fair value. Monicals Pizza uses a fair value hierarchy to prioritize the inputs used to measure fair value, with Level 1 having the highest priority (unadjusted quoted prices in active markets) and Level 3 having the lowest priority. The company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable.
For the business combination that occurred during 2023, the fair values of the assets and liabilities were determined by management and are based on significant inputs that are generally not observable in the market (Level 3). This means that Monicals Pizza relies on its own judgment and internal data when assessing the value of certain assets and liabilities, particularly in the context of acquisitions.
Specifically, in the acquisition of the Tolono, Illinois franchise, Monicals Pizza used Level 3 inputs to value inventory, property and equipment, and land. Food and supplies inventory were valued at retail price (Level 3). Property and equipment were valued using the cost approach and direct cost method to estimate replacement cost, which was then depreciated to arrive at fair value (Level 3). Land was also valued using the cost approach and direct cost method to estimate replacement cost (Level 3). Goodwill was the excess of the purchase price over the fair value of assets acquired.
For a prospective franchisee, this indicates that Monicals Pizza may use internal, less transparent methods for valuing assets in certain situations. While this is permitted under accounting standards, it's important to understand that these valuations are based on management's estimates and assumptions, which may not always align with market values. Franchisees may want to inquire about the specific methodologies used and the rationale behind these Level 3 valuations to gain a better understanding of the company's financial reporting practices.