Just came across this interesting article (link here) about Financial Accounting Standards Board (FASB) Statement No. 157. The FASB approved this statement in Sep 06 which introduced a three-level hierarchy for measuring the fair values of assets and liabilities:
- Level 1 means the values come from quoted prices in active markets. The balance-sheet changes then pass through the income statement each quarter as gains or losses. Call this mark-to-market.
- Level 2 values are measured using “observable inputs” such as recent transaction prices for similar items, where market quotes aren’t available. Call this mark-to-model.
- Level 3 means fair value is measured using “unobservable inputs”. While companies can’t actually see the changes in the fair values of their assets and liabilities, they’re allowed to book them through earnings anyway, based on their own subjective assumptions. Call this mark-to-make-believe.🙂