Chapter 2 Flashcards
What is FASB ASC 820?
It defines fair value for financial reporting and establishes a framework for measuring fair value on a consistent and comparable basis including required disclosures.
Is FASB ASC 820 based on the specific entity?
No, it is a market-based measurement and is not entity-specific
What is fair value under FASB ASC 820?
The price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions
(that is, an exit price at the measurement date from the perspective of a market participant that holds the
asset or owes the liability).
Under FASB ASC 820, what should a reporting entity do with respect to reliance on inputs?
Maximize observable inputs and minimize unobservable inputs
Under FASB ASC 820, is a reporting entity’s intent to hold an asset or to settle/fulfill a liability relevant to fair value?
No because it is measured from the market participants perspective
Does FASB ASC 820 fair value apply to shareholders’ equity?
Yes
What is the scope of FASB ASC 820?
applies to financial and non-financial assets and liabilities measured at fair value, except those relating to share-based payment transactions (FASB ASC 718, Compensation—Stock Compensation).
clarifies that it is not applicable for
– standards permitting practicability exceptions to fair value,
– vendor-specific objective evidence of fair value, and inventory pricing.
addresses how to measure fair value, not what or when to measure fair value.
Under FASB ASC, what is the definition of an orderly transaction?
A transaction that assumes exposure to the
market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities.
Under FASB ASC, what is the definition of market participants?
Buyers and sellers in the principal (or most advantageous) market for the asset or liability that are
independent of each other—that is, they are not related parties, although the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms;
knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary;
able to enter into a transaction for the asset or liability; and
willing to enter into transaction for the asset or liability, that is, they are motivated but not forced or otherwise compelled to do so.
What is the definition of principal market under FASB ASC?
The market with the greatest volume and level of activity for the asset or liability.
What is the definition of most advantageous market under FASB ASC?
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.
Under FASB ASC 820, if there is a principal market for an asset or liability, should the fair value reflect that price even if there is a different market that is potentially more advantageous?
Yes
Can the principal market for the same asset or liability be different for different entities under FASB ASC 820?
Yes depending on access to the principal market
Does the reporting entity have to be able to sell the asset or liability at the measurement date in the principal market assuming it has access under FASB ASC 820?
No
Under FASB ASC 820, fair value assumes that market participants do what?
Act in their economic best interests
Under FASB ASC 820, do specific market participants need to be identified?
No, but an analyst may identify attributes like strategic acquirers (with synergies) or financial buyers (no synergies)
Under FASB ASC 820, does the price adjust for transaction costs?
No
What is the definition of highest and best use under FASB ASC 820?
The highest and best use of a nonfinancial asset might provide maximum value to market participants through its use in combination with other assets as a group (as installed or otherwise configured for use) or in combination with other assets and liabilities (for example, a business) or on a standalone basis.
What does the highest and best use of a nonfinancial asset take into account?
What is physically possible, legally permissible, and financially feasible.
What if the reporting entity’s current use of a nonfinancial asset is different than the highest and best use?
Highest and best use is determined from the perspective of market participants and may not be the same as the current use by the reporting entity; however, the current use is presumed to be highest and best use unless market or other factors suggest a different highest and best use.
What is the entry price?
The transaction price paid to acquire the asset or received to assume a liability
What is the exit price?
The transaction price that would be received to sell the asset or paid to transfer the liability
Under what conditions would result in the transaction price not representing fair value of an asset/liability at initial recognition under FASB ASC 820?
- Related party transaction
- Transaction under duress
- Unit of account differs of the transaction differs from the unit of account when measured at fair value (e.g., during a business combination when you acquire a group of assets, includes unstated rights and privileges, or includes transaction costs)
- Different market from principal market or most advantageous market
What valuation approaches are widely used under FASB ASC 820?
Income approach, market approach, and cost approach
What is the appropriate risk-free interest rate for present value computations denominated in nominal U.S. dollars?
The yield curve for U.S. Treasury securities
What is the credit risk for a liability?
The nonperformance risk related to the liability (that is the obligor’s own risk)
What are common income approaches used under FASB ASC 820?
Present value techniques, option pricing models, and multi-period excess earnings models
Provide an example of double-counting the impact of risk factors through discount rates and cash flows
Using a discount rate that reflects the uncertainty in expectations about future defaults with a probability-weighted cash flow that include the risk of default
Do nominal cash flows include the effect of inflation?
Yes
What discount rate should be used for nominal cash flows that include the impact of inflation?
Nominal risk-free rate
Do real cash flows include the effect of inflation?
No
What discount rate should be used for real cash flows that does not include the impact of inflation?
Real risk-free rate
What discount rate should be used for after-tax cash flows?
After-tax discount rate
What discount rate should be used for asset cash flows?
WACC
What discount rate should be used for equity cash flows?
Equity cost of capital
What time period for future cash flows is utilized for a liability?
The contractual term of the liability unless early prepayment is considered highly probable and reflected in the pricing derived by the market participant
What economic principle is the market approach based on?
Efficient markets
What economic principle is the asset approach based on?
Substitution
What does the cost approach reflect under FASB ASC 820?
Current replacement cost or the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence
What does obsolescence encompass?
Physical deterioration, functional (technological) obsolescence, and economic (external) obsolescence
How does obsolescence compare to depreciation for financial reporting or tax purposes?
It is broader
What is the definition of inputs under FASB ASC?
Assumptions that market participants would use when pricing the asset or liability including assumptions about risk inherent to the methodology or inputs
What is the definition of observable inputs under FASB ASC?
Developed using market data, such as publicly available information about actual events or transactions, and that reflect the assumptions that market participants would use when pricing the asset or liability
What is the definition of unobservable inputs under FASB ASC?
Market data are not available and that are developed using the best information available about the assumptions market participants would use when pricing an asset or liability
What is the highest priority level number under FASB ASC 820?
Level 1
What is the lowest priority level number under FASB ASC 820?
Level 3
What are level 1 inputs under FASB ASC 820?
Quoted prices for identical assets or liabilities in active markets
Are level 1 inputs under FASB ASC 820 observable?
Yes
Are blockage factors or other valuation adjustments considered for level 1 inputs under FASB ASC 820?
No
What are level 2 inputs under FASB ASC 820?
Quoted, similar items in active markets or quoted, identical/similar items in not-active markets
What factors are considered for level 2 inputs under FASB ASC 820?
Condition or location of the assets
What are level 3 inputs under FASB ASC 820?
Unobservable inputs such as a company’s own data
When are significant disclosures required under FASB ASC 820?
Level 3 inputs or when leveling between periods for the same assets/liabilities changes
What are the steps of the acquisition method under FASB ASC 805?
- Determine if the transaction is a business combination
- Identify the acquirer.
- Determine the acquisition date.
- Recognize and measure identifiable acquired assets, liabilities assumed, non-controlling interests.
- Recognize and measure goodwill.
Does FASB ASC 805 apply to true mergers?
Yes
Does FASB ASC 805 apply to mergers of equals?
Yes
Does FASB ASC 805 apply to combinations without transfer of consideration (through contract or lapse of minority veto rights)?
Yes
Does FASB ASC 805 apply to the formation of a joint venture?
No
Does FASB ASC 805 apply to the acquisition of an asset or a group of asset that does not constitute a business?
No
Does FASB ASC 805 apply to a combination between entities/businesses under common control?
No
What does an election of FASB ASC 805 do?
Allows a private company to not recognize certain assets separately from goodwill including customer-related intangible assets unless they are capable of being sold/licensed separately and noncompetition agreements
If a private company elects FASB ASC 805, what must the company also adopt?
The private company alternative to amortize goodwill (FASB ASC 350)
What is the definition of acquiree under FASB ASC?
The business or businesses that the acquirer obtains control of in a business combination
What is the definition of acquirer under FASB ASC?
The entity that obtains control of the acquiree
In a business combination in which a variable interest entity (VIE) is acquired, what is the acquirer?
The primary beneficiary of the VIE
What is the definition of acquisition date under FASB ASC?
The date on which the acquirer obtains control of the acquiree
What is the definition of business under FASB ASC?
An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing returns in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants
What is the definition of business combination under FASB ASC?
Occurs when an entity (a) acquires net assets that constitute a business, or acquires entity interests in one or more entities that are businesses and obtains a controlling financial interest in those entities; or (b) obtains control of a business by contract alone.
What is the definition of business combination achieved in stages under FASB ASC?
When an acquirer obtains control of an acquiree in which it previously held an equity interest
What is the definition of consideration transferred under FASB ASC?
The sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquirer, and the equity interests issued by the acquirer
What is the definition of contingent consideration under FASB ASC?
Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners as part of the exchange for control if specified future events occur or conditions are met. Contingent consideration also may give the acquirer the right to return previously transferred consideration under specific conditions.
What is the definition of equity interests under FASB ASC?
Used broadly to mean ownership interests of investor-owned entities and owner, member, or participant interest of mutual entities
What is the definition of goodwill under FASB ASC?
An asset representing the future economic benefits arising from the other assets acquired in a business combination that are not individually identified and separately recognized.
What is the definition of an identifiable asset under FASB ASC?
An asset that is separable or arises from contractual or other legal rights regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
What is the definition of intangible asset under FASB ASC 805?
An asset that lacks physical substance other than a financial asset and goodwill (specifically under FASB ASC 805)
What is the definition of measurement period under FASB ASC?
The period that is required to identify and measure the fair value of the identifiable assets acquired, liabilities assumed, and any noncontrolling interests
When does the measurement period end under FASB ASC 805?
When the acquiring entity has all the information that it has arranged to obtain and that is known to be obtainable not to exceed one year from acquisition date
What is the definition of mutual entity under FASB ASC?
An entity other than an investor-owned entity that provides dividends, lower costs, or other economic benefits directly to its owners, members, or participants such as mutual insurance companies, credit unions, or cooperative entities
What is the definition of noncontrolling interest under FASB ASC?
The equity in a subsidiary not attributable directly to indirectly to the parent company
What are the three elements of a business under FASB ASC 805?
Input, process, and output
What is the definition of input under FASB ASC 805?
Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it (long-lived assets, IP, the ability to obtain access to materials or rights, employees)
What is the definition of process under FASB ASC 805?
Any system, standard, protocol, convention, or rule that when applied to inputs creates or has the ability to create outputs (strategic management processes, operational processes, resource management processes)
Are accounting, billing, payroll, and other administrative systems considered a process under FASB ASC 805?
No
What is the definition of output under FASB ASC 805?
The result of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants
How is goodwill measured under FASB ASC 805 at acquisition date?
The excess of the aggregate of:
- The consideration transferred at acquisition date fair value
- The fair value of any noncontrolling interest in the acquiree
- In a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree
Over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed
Under FASB ASC 805, when acquirer and the acquiree exchange only equity interests, which interest do you value?
Either
If no consideration is transferred, what do you value under FASB ASC 805?
The fair value of the acquirer’s interest in the acquiree
What is a bargain purchase under FASB ASC 805?
When the fair value of assets and liabilities acquired exceeds consideration paid
What is recorded when a bargain purchase is made under FASB ASC 805?
A gain for the difference between the purchase consideration and the fair value
To record a bargain purchase under FASB ASC 805, what should the acquirer review?
The identifiable assets acquired and liabilities assumed
The noncontrolling interest acquired
For a business combination achieved in stages, the previously held equity interest
The consideration transferred
How is consideration transferred in a business combination valued under FASB ASC 805?
At fair value, calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interests issued by the acquirer.
How is consideration transferred in a business combination achieved in stages valued under FASB ASC 805?
At fair value, calculated as the sum of (a) the fair value of the prior interest held; (b) the fair value of the consideration transferred, and; (c) the fair value of the noncontrolling interest.
Fair value of equity interests issued by the acquirer includes the impact of what?
All future cash flows including potential synergies
Is the fair value of contingent consideration included as part of the consideration recognized at acquisition date?
Yes
How are adjustments to contingent consideration liabilities and assets recorded?
Remeasured each period for changes and subsequent developments and is booked to current earnings
Business combination accounting is not revised for what?
Information obtained after acquisition date that is not about facts/circumstances that existed as of the acquisition date or after the measurement period ends except for error corrections
When are changes made when information is obtained about facts and circumstances that existed at acquisition date that require a retrospective adjustment?
The earlier of one year after acquisition or when the necessary information is received
What are marketing-related intangible assets?
Trademarks, trade names, service marks, collective marks, certification marks
Newspaper mastheads
Internet domain names
What are customer-related intangible assets?
Customer lists
Order or production backlog
Customer contracts and related customer relationships (contractual and non- contractual)
What are artistic related intangible assets?
Plays, operas, ballets
Books, magazines, newspapers, other literary works
Musical works such as composition song lyrics, advertising jingles
Pictures, photographs
Audiovisual material including motion pictures, music videos, television programs
What are contract-based intangible assets?
Licensing, royalty, standstill agreements
Advertising, contraction, management, service, or supply contracts
Lease agreements
Construction permits
Franchise agreements
Operating and broadcast rights
Servicing contract such as mortgage servicing contracts
Employment contracts
Non-Competition agreements
Use rights such as drilling, water, air, mineral, timber cutting, and route authorities
What are technology-based intangible assets?
Patented technology Computer software and mask works Unpatented technology Database, including title plants Trade secrets, such as secret formulas, know-how, processes, recipes
What are common errors when valuing identifiable assets?
Not including an IRC Section 197 tax amortization benefit
Inadequate analysis supporting useful life estimate
Inclusion of buyer-specific synergies in forecast
Use of buyer- or company-specific assumptions
Not identifying all of the identifiable intangible assets
Not properly valuing securities issued (debt and equity) as part of the business combination
Lack of IRR, WACC, and weighted average return on assets (WARA) reconciliation
Failure to reconcile prospective financial information used for individual assets to transaction
analysis
Improper estimation of contributory asset charges
Are transaction or direct acquisition costs included as part of the business combination accounting?
No, they are expensed when incurred
How are in-process research and development amounts handled?
Regardless of whether the assets have an alternative future use, they shall be considered as indefinite-lived
until the research and development (R&D) efforts are completed or abandoned. When the R&D
effort is complete, a useful life is assigned. Like other indefinite-lived assets, impairment testing is
required under FASB ASC 350.
How is goodwill treated if private company rules are adopted?
A private company to amortize its indefinite lived goodwill over a reasonable period not to exceed 10 years and cannot change accounting policy without restatement of prior periods.
How is goodwill handled under FASB ASC 350?
Goodwill is not amortized
The concept of a reporting unit is introduced
Two-step process is employed
What is a reporting unit under FASB ASC 350?
As an operating segment or component (one level below segment)
Lowest level at which discrete financial information is available and reviewed by management
Refers to segment reporting guidance under FASB ASC 280
Goodwill must be allocated to at least one reporting unit
Some reporting units may not have goodwill
What does FASB ASC 350 apply to?
Intangible assets acquired other than as part of a business combination
Intangible assets subject to amortization
Indefinite-lived intangible assets
Goodwill
What FASB ASC are finite-lived intangible assets subject to?
FASB ASC 360 (property, plant, and equipment)
What is step zero under FASB ASC 350 and the new ASU 2011-08?
An entity is permitted to make a qualitative assessment that the fair value of a reporting unit is less than the carrying amount. If the entity determines it is more likely than not (greater than 50 percent) that the fair value of the reporting unit is less than the carrying amount, the entity must perform step one of the goodwill impairment test.
What are examples of a general macroeconomic triggering event under FASB ASC 350 provided in ASU 2011-08?
Changes in accessing capital in general economic conditions
Limitations accessing capital
Fluctuations in foreign exchange rates
Changes in market multiples, cost of debt, and equity rates of return
What are examples of an industry and market triggering event under FASB ASC 350 provided in ASU 2011-08?
Deterioration in the operating environment Increased competition Decline in market-dependent multiples Change in market for products/services Regulatory/political development
What are examples of a cost factor triggering event under FASB ASC 350 provided in ASU 2011-08?
Raw materials, labor, and other cost increases
What are examples of a financial performance triggering event under FASB ASC 350 provided in ASU 2011-08?
Negative or declining cash flows compared to the PFI used when last step 1 was performed (not this years budget!)
A decline in actual or planned revenues/earnings
What are examples of an entity-specific triggering event under FASB ASC 350 provided in ASU 2011-08?
Changes in management/key personnel
Changes in strategy/customers
Bankruptcy/litigation
What are examples of a reporting unit triggering event under FASB ASC 350 provided in ASU 2011-08?
Write offs
Plans to sell or dispose of a portion of the reporting unit
Testing for recoverability of a significant asset group
Recognition of goodwill impairment in a component of the reporting unit
Sustained decrease in share price both absolutely and related to peers
What is the impairment testing hierarchy under FASB ASC 350?
Indefinite-lived intangible assets other than goodwill (trade names/FCC licenses)
Definite-lived intangible assets and long-lived assets (FASB ASC 360) if necessary due to triggering event
Goodwill (FASB ASC 350)
What is step one under FASB ASC 350?
Determine if a potential impairment exists by comparing the fair value of the reporting unit and the carrying value. If potentially impaired, move on to step 2.
What is step two under FASB ASC 350 similar to?
Similar to FASB ASC 805 acquisition method allocation.
What is the testing frequency under FASB ASC 350 and FASB ASC 360?
Immediately upon triggering event and at a minimum, annually
What are indications that an asset may be impaired under FASB ASC 360?
Significant decrease in market value of asset
Significant change in the extent or manner that the asset is used or physical change of asset
Legal factors/business climate that could affect value
Adverse action or assessment by a regulator
Accumulation of costs in excess of expectations to acquire or construct the asset
Current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an asset used for the purpose of producing revenue
What are additional indications that an asset may be impaired under FASB ASC 350?
A significant adverse change in legal factors/business climate
Adverse action/assessment by regulator
Unanticipated competition
Loss of key personnel
Expectation of sale/disposal of reporting unit or significant portion
Testing under FASB ASC 360 of a reporting unit/component
Recognition of goodwill impairment of a subsidiary that is component of reporting unit
How many steps are used in the impairment testing of indefinite-lived intangible assets other than goodwill?
One
How many steps are used in the impairment testing of goodwill?
Two
How is testing of impairment for indefinite-lived intangible assets other than goodwill performed?
Performed annually or sooner if there is a triggering event:
- Estimate the FV of the asset
- Compare to the carrying value of the asset (CV)
- If FV > CV, no impairment
- If FV < CV, record difference as impairment
How is testing of impairment for goodwill performed?
Step 0 - qualitative assessment to determine if impairment is more than likely to exist (greater than 50% likelihood) then proceed to step 1
Step 1 - Compare FV to CV of reporting unit using either invested capital or equity, if CV > FV move to step 2
Step 2 - Estimate the FV of goodwill as a residual, the same way it is done for business combinations
Is equity level or invested capital level utilized when comparing the FV and CV of goodwill when testing for impairment?
Either, although most use invested capital
What simplified accounting for goodwill is available to private companies under ASU No. 2014-02
Amortize goodwill over a period not to exceed 10 years
Choose to test goodwill impairment at either the entity or report unit level
Test goodwill only with triggering event
Test and measure goodwill impairment in a one-step process rather than two-step
Is goodwill amortized under FASB ASC 350?
No
Is goodwill amortized under ASU No. 2014-02?
Yes not to exceed 10 years
Is goodwill impairment testing tested annually under FASB ASC 350?
Yes, at least and more if triggering event
Is goodwill impairment testing tested annually under ASU No. 2014-02?
No, only at triggering event
What is the level of testing for goodwill impairment under FASB ASC 350?
Reporting unit
What is the level of testing for goodwill impairment under ASU No. 2014-02?
Entity level
What items need to be considered to determine whether CV is measured the same way as FV for impairment testing?
Deferred tax assets/liabilities
Intercompany accounts
Long-term, unfunded liabilities
Non-operating assets included in fair value estimates
