3K - Fair Value Measurements Flashcards
When valuing certain financial instruments, a company that has elected the fair value measurement option must apply the accounting measurement based on which of the following criteria?
Type-by-type basis
A portion of an asset or liability
At the entity level
Instrument-by-instrument basis
Instrument-by-instrument basis
An entity may choose to elect the fair value option on an instrument-by-instrument basis for an eligible item only on the date that one of the following occurs:
The entity first recognizes the eligible item.
The entity enters into an eligible firm commitment.
Financial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles cease to qualify for that specialized accounting.
The accounting treatment for an investment in another entity changes because the investment becomes subject to the equity method of accounting.
An event occurs that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment under lower-of-cost-or-market accounting or other-than-temporary impairment of equity securities.
FASB ASC 820 defines fair value as “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.” Fair value measurement assumes that the transaction occurs in the principal market for the asset or liability.
If there is no principal market for that type of asset or liability, the entity should use the most advantageous market for that asset or liability; therefore, the fair value of the financial asset is $35,000.
Monetary assets are cash or items whose amounts are fixed in terms of numbers of dollars. Demand deposits and receivables are monetary assets; patents and trademarks are not.
Demand bank deposits $ 650,000
Net long-term receivables 400,000
Total $1,050,000
Which of the following phrases best describes a Level 2 input for measuring the fair value of an asset or liability?
Quoted prices for similar assets or liabilities in active markets
Unobservable inputs for the asset or liability
Unadjusted quoted prices for identical assets or liabilities in active markets
None of the answer choices are correct.
Quoted prices for similar assets or liabilities in active markets
The FASB’s fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
Level 1 inputs—quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date
Level 2 inputs—inputs other than quoted prices included within Level 1 that are observable for similar assets or liabilities, either directly or indirectly
Level 3 inputs—unobservable inputs for the asset or liabilit
A company owns land and a building that houses its manufacturing operations. When the company purchased the manufacturing facility 10 years ago, the purchase price allocated to the land account was $120,000. The manufacturing facility is located in an area that was once the site of many factories. The owners of many of the neighboring factories have recently sold their facilities to residential real estate developers. The company’s land is also suitable for residential development. The estimated current value of the land as part of the manufacturing facility is $150,000. The estimated current value of the land as an undeveloped investment is $130,000, and the current value of the land as part of a residential development would be $180,000. What is the fair value of the land?
$180,000
$150,000
$130,000
$120,000
FASB ASC 820 defines fair value as “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.” Fair value measurement assumes that the transaction occurs in the principal market for the asset or liability.
If there is no principal market for that type of asset or liability, the entity should use the most advantageous market for that asset or liability; therefore, the fair value of the land should be determined using the residential market, which is $180,000.
Giaconda, Inc., acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?
Observable inputs
Market
Income
Cost
Income
The valuation techniques discussed in FASB ASC 820-10-35-24A include the:
market approach,
income approach, and
cost approach.
The income approach uses valuation techniques to determine a discounted present value. This is the approach described in this problem.
When computing purchasing power gain or loss on net monetary items, which of the following accounts is classified as nonmonetary?
Advances to unconsolidated subsidiaries
Accumulated depreciation of equipment
Unamortized premium on bonds payable
Allowance for uncollectible accounts
Accumulated depreciation of equipment
Monetary assets are cash or items whose amounts are fixed in terms of numbers of dollars. All of the assets are monetary assets except for accumulated depreciation.
Which of the following is not an eligible item for the fair value measurement option under FASB ASC 825-10-15-4?
An interest in a variable interest entity that the entity is required to consolidate
A firm commitment that would otherwise not be recognized at commencement and that involves only financial instruments (An example is a forward purchase contract for a loan that is not readily convertible to cash. That commitment involves only financial instruments—a loan and cash—and would not otherwise be recognized because it is not a derivative instrument.)
A written loan commitment
A recognized financial asset and financial liability, except any listed below in exceptions
An interest in a variable interest entity that the entity is required to consolidate
Incorrect
FASB ASC 825-10-15-5 lists the following items that are not eligible for the fair value election:
“An investment in a subsidiary that the entity is required to consolidate
“An interest in a variable interest entity that the entity is required to consolidate
“Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in [FASB ASC] Topics 420; 710; 712; 715; 718; and 960.
“Financial assets and financial liabilities recognized under leases as defined in [FASB ASC] Subtopic 842-10 (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)
“Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions
“Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholder’s equity (including “temporary equity”). An example is a convertible debt security with a noncontingent beneficial conversion feature.”
Which of the following phrases best describes a Level 1 input for measuring the fair value of an asset or liability?
Quoted prices for similar assets or liabilities in active markets
Unadjusted quoted prices for identical assets or liabilities in active markets
Inputs for the asset or liability based on the reporting entity’s internal data
Inputs that are principally derived from or corroborated by observable market data
Unadjusted quoted prices for identical assets or liabilities in active markets
The FASB’s fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
Level 1 inputs—quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date
Level 2 inputs—inputs other than quoted prices included within Level 1 that are observable for similar assets or liabilities, either directly or indirectly
Level 3 inputs—unobservable inputs for the asset or liability
During Year 1, Wistrand Corporation purchased 12,000 shares of the 800,000 outstanding shares of Cherry Corporation’s common stock for $84000. At the end of Year 1, Wistrand received $1280 of dividends from its investment in Cherry’s stock. The fair value of Wistrand’s investment on December 31, Year 1, is $95960. What amount of income or loss that is attributable to the Cherry stock investment should be reflected in Wistrand’s earnings for Year 1?
$13240
$3730
$11960
$1280
Equity securities representing less than 20% of the investee’s outstanding common stock are marked to fair value at each reporting period, with gains and losses reported in earnings. Dividends are treated as dividend income. Therefore, there is both an increase from the dividend and from the increase in fair value that must be recognized:
Dividend of $1280 + Increase in fair value ($95960 − $84000) of $11960 = Increase in income of $13240
During Year 3, Gilman Co. purchased 5,000 shares of the 500,000 outstanding shares of Meteor Corp.’s common stock for $35,000. During Year 3, Gilman received $1,800 of dividends from its investment in Meteor’s stock. The fair value of Gilman’s investment on December 31, Year 3, is $32,000. Gilman has elected the fair value option for this investment. What amount of income or loss that is attributable to the Meteor stock investment should be reflected in Gilman’s earnings for Year 3?
Loss of $1,200
Loss of $3,000
Income of $1,800
Income of $4,800
There is both a gain and a loss that must be recognized:
Dividend $ 1,800
Decline in value ($35,000 - $32,000) (3,000)
Net loss $(1,200)
A company performing its long-lived asset impairment testing is reviewing the fair value of equipment. Each of the following valuation techniques may be appropriate for measuring the fair value of the equipment, except the:
income approach.
net realizable value approach.
cost approach.
market approach.
net realizable value approach.
The net realizable value approach is not an acceptable fair valuation method. The determination of fair value may require the use of one or more valuation techniques. The valuation technique used should be consistent with the market approach, income approach, and/or cost approach, as appropriate.
The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach converts future amounts (e.g., cash flows) to a single present amount (discounted) using methods such as present value techniques and option-pricing models. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost).
In a period of rising general price levels, Pollard Corp. discloses income on a current cost basis. Which of the following contributes to Pollard’s purchasing power loss on net monetary items?
Warranty obligations
Refundable deposits with suppliers
Wages payable
Equity investment in unconsolidated subsidiaries
Refundable deposits with suppliers.
Purchasing power gain or loss is computed by restating monetary assets and liabilities in units of constant purchasing power. Rising prices would cause liabilities to be paid with less valuable dollars, so equity investment in unconsolidated subsidiaries, warranty obligations, and wages payable would result in a purchasing power gain. Receipt of less valuable dollars from refundable deposits would result in a purchasing power loss.
A company holds a financial asset that is actively traded in two different markets. The company transacts in both markets equally. The price of the asset in market A is $50. If the company sells the asset in market A, it incurs a transaction cost of $4. The price of the asset in market B is $48. If the company sells the asset in market B, it incurs a transaction cost of $1. What is the fair value of the financial asset?
$46
$48
$50
$47
48
Fair value measurement requires the company to measure the asset in its most advantageous market if no principal market exists. The most advantageous market is the market where the company could extract the highest value. Market A would return a value of $46 ($50 − $4) and market B would return a value of $47 ($48 − $1). Therefore, market B is the most advantageous market and the asset will be reported at $48.
Transaction costs are relevant to determining the most advantageous market. They do not impact the recognition of the asset at fair value. Fair value is the selling price of the asset in the most advantageous market.
A company has an equity investment with a historical cost of $500,000 that is traded in an active market. At December 31, year 1, the quoted price for an identical investment was $400,000 and the quoted price for a similar investment was $430,000. Using the company’s internal present value of cash flows model, the company arrived at a value of $410,000. What amount is the value of the investment on December 31, year 1?
$430,000
$500,000
$400,000
$410,000
A fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value into levels. A Level 1 input consists of quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date, and a Level 2 input is an input other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 1 valuations are of higher order and represent the most appropriate measurement if a Level 1 price is available. Level 2 prices are used if a Level 1 input is not available.
The equity investment should be valued at the Level 1 value of $400,000.
Which of the following is a Level 3 input to valuation techniques used to measure the fair value of an asset?
Inputs other than quoted prices that are observable for the asset
Quoted prices in active markets for identical assets
Quoted prices for similar assets in active markets
Unobservable inputs for the asset
Unobservable inputs for the asset
A fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value into three broad levels, as follows: (1) Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date; (2) Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and (3) Level 3 inputs are unobservable inputs for the asset or liability.
An investment company’s portfolio of private placement securities is recorded at fair value and valued using a matrix pricing model. The matrix pricing model uses current pricing spreads on similar securities to determine the fair value of the private placement securities. Which of the following valuation techniques is being used?
The exchange approach
The income approach
The market approach
The cost approach
The market approach
The matrix pricing model is a type of market approach. A matrix pricing model prices securities based on their relationship to other transactions involving benchmark securities. The market approach to valuation uses prices and other relevant information from transactions involving identical or comparable assets and liabilities.
Which of the following is a true statement regarding FASB ASC 825-10-25-1?
A business entity shall report unrealized gains and losses on items for which the fair value option has been elected as an adjustment to retained earnings.
The statement permits election of fair value measurement on a contract-by-contract basis.
The fair value option established by FASB ASC 825-10 requires all entities to measure eligible items at fair value at specified dates.
None of the answer choices are true statements regarding FASB ASC 825-10-25-1.
The statement permits election of fair value measurement on a contract-by-contract basis.
FASB ASC 825-10-25-1 permits the fair value election but does not require it. Unrealized gains and losses on these items are reported in earnings, not directly to retained earnings: “This Subtopic permits all entities to choose, at specified election dates, to measure eligible items at fair value (the ‘fair value option’).”
FASB ASC 825-10-25-2 requires that the fair value option be applied contract by contract: “The decision about whether to elect the fair value option:
“Shall be applied instrument by instrument, except as discussed in [FASB ASC] 825-10-25-7
“Shall be irrevocable (unless a new election date occurs, as discussed in [FASB ASC] 825-10-25-4)
“Shall be applied only to an entire instrument and not to only specified risks, specific cash flows, or portions of that instrument.”
The fair value for an asset or liability is measured as the:
price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
appraised value of the asset or liability.
cost of the asset less any accumulated depreciation or the carrying value of the liability on the date of the sale.
price that would be paid to acquire the asset or received to assume the liability in an orderly transaction between market participants.
price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
The correct answer is the definition of fair value as it appears in the glossary of the FASB Accounting Standards Codification: “Fair Value: 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.” (FASB ASC 820-10-20)
When the recoverability of a building’s carrying amount is determined to be impaired, the building’s fair value is best measured as:
the price that would be received for this type of building based on observable inputs in its principal market.
the selling price less transaction costs to complete the sale for this type of building in its principal market.
the price the building can be sold for in an advantageous market.
the price determined using internal cost estimates to construct a similar building.
the price that would be received for this type of building based on observable inputs in its principal market.
Fair value for an asset is the price at which the asset could be sold between willing parties in its principal (not best) market. The fair value does not consider transaction costs and does not consider internal cost factors as internal markets are not the principal market. The market is to be priced in its principal, not most advantageous, market.
A company leases trucks and properly classifies the leases as finance leases. The leases have a 10-year term, and the lease calculations were done 3 years ago when interest rates were lower. Which of the following is the appropriate accounting treatment, if any, for the application of the fair value option to lease transactions?
Recognize the change to fair value accounting with an unrealized loss in accumulated other comprehensive income.
Recognize the change to fair value accounting with a cumulative adjustment to beginning retained earnings.
Recognize the change to fair value accounting with an unrealized loss in the income statement.
Leases are not eligible for the fair value option.
Leases are not eligible for the fair value option.
Companies may choose to measure a wide range of financial assets and liabilities at fair value. Even though leases are considered financial in nature, the FASB specifically excludes “financial assets and financial liabilities recognized under leases” from the fair value option of accounting (FASB ASC 825-10-15-5).
The remaining answer choices are not correct as there is no option to recognize the change in fair value.
Crossroads Co. chooses to report a financial asset at its fair value. The asset trades in two different markets; however, neither market is the principal market for the financial asset. In the first market, sales proceeds are $76, which is net of transaction costs of $6. In the second market, the sales proceeds are $80, which is net of transaction costs of $1. What amount should Crossroads report as the fair value of the asset?
$80
$81
$76
$82
$81
Fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability. If there is no principal market, the entity should use the most advantageous market for that asset or liability. The FASB defines the most advantageous market as “the market that maximizes the amount that would be received to sell the asset or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and transportation costs” (FASB ASC 820-10-20). The price used to measure fair value should not be adjusted for transaction costs, which are the incremental direct costs to sell the asset or transfer the liability.
In other words, in determining the most advantageous market, adjust for transaction costs. But to compute the actual fair value amount, ignore the transaction costs. The first market yields $76 and the second market yields $80, so the second market is the most advantageous. The fair value in the second market is $81 ($80 with the $1 added back).
McClave Enterprises used quoted prices for similar assets as the basis for determining the fair value of its investments. McClave’s inputs for determining the fair values of the investments would be classified as which level in the fair value hierarchy?
Level 1
Level 3
Level 4
Level 2
Level 2
The fair value hierarchy uses three levels to measure fair value. Level 1 inputs are based on quoted prices in active markets for identical assets or liabilities. Level 2 inputs are those inputs other than quoted prices that are observable. Level 3 inputs are unobservable.
The quoted prices for McClave are level 2 inputs because the quoted prices are for similar assets and not the identical assets.
There is no such thing as a level 4 input.
A company that wishes to disclose information about the effect of changing prices should report this information in:
the notes to the financial statements.
management’s report to shareholders.
supplementary information to the financial statements.
the body of the financial statements.
supplementary information to the financial statements.
FASB ASC 255-10-50-1 provides that “a business entity that prepares its financial statements in U.S. dollars and in accordance with U.S. generally accepted accounting principles is encouraged, but not required, to disclose supplementary information on the effects of changing prices.”
This information would be supplementary information to the financial statements.
