F2M6 Flashcards
Fair Value
Definition of fair value
the price that would be received if you sold an asset or transferred a liability in a regular transaction between regular market participants in the principal (or most advantageous) market at the measurement date under current market conditions.
fair value is an exit price.
reflect all assumptions a market participant would make.
does not include transaction costs, but maybe transportation if location is key.
non financial asset: assumes highest and best use.
fair value of a liability should include nonperformance risk.
FV of an equitys own instrument should be measures from the perspective of a market participant who holds the instrument as an asset.
Fair value measurement assumes that a liability or an entity’s own equity instrument is transferred to a market participant at the measurement date and assumes:
the liability/equity interest would remain outstanding and not be settled, canceled, or extinguished on the measurement date.
Orderly transaction definition
a transaction in which the asset or liability is exposed to the market, for a period before the measurement date, for long enough to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities.
Cannot be a forced transaction
Market Participant definition
buyers and sellers who are independent, knowledgeable about the asset/liability, able to transact for the asset/liability, and willing to transact for the asset/liability. They are also considered to be acting in their economic best interest.
Principal Market definition
market with the greatest volume or level of activity for the asset/liability. The reporting entity must have access to the principal market at measurement date. The price in the principal market will be the fair value measurement.
Most advantageous market definition
market with the best price for an asset (maximized selling price of the asset) or liability (minimized payment to transfer liability), after considering transaction costs even though they are not included in the final fair value measurement. Only use the price in the most advantageous market if there is no principal market.
if a reporting entity acquires land that currently has a factory on it, but other similar sites were developed or residential and retail purposes, how do you determine the highest and best use of the land?
1: consider value of land as it currently is. value of land + value of assets/liabilities associated with land (building costs and debt on the land/building)
2. consider value of land if it was vacant for residential use. cost of tearing down factory and related costs are considered as well as uncertainty in converting the land to a vacant site for residential and retail space.
3: fair value is then the highest of either of these values.
Highest and best of nonfinancial assets:
fair value measurement takes into account the market participants ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use
A reporting entitys current use of a nonfinancial asset is presumed to be its highest and best use, unless factors suggest that a different use by market participants would maximize the value of the asset.
Highest and best use could be that its used in a combination or stand alone
Market approach
uses price and other relevant market transactions involving identical or comparable assets/liabilities to measure fair value
Income approach
converts future amounts, including cash flows or earnings, to a single discounted amount to measure fair value. Can be applied to assets or liabilities.
Cost approach
only assets. Uses replacement cost to measure fair value.
Hierarchy of inputs
level 1 is the best.
the level in which the fair value falls is determined by the lowest level input that is significant that is used in the measurement.
minimize use of level 3
Change in value of fair value is treated as:
a change in accounting estimate and applied prospectively
level 1 inputs
quoted prices in active markets for identical assets/liabilities that reporting entity has access to at measurement date. Quoted prices may be obtained from exchange, dealer, brokered, and principal-to-principal markets. Level 1 is the most reliable measure.
Level 2 inputs
inputs other than quoted market prices that are directly or indirectly observable for the asset or liability. Includes:
* Quoted prices for similar items in active markets
* Quoted prices for identical or similar assets in non active markets.
* Quoted prices for identical liabilities when traded as assets, if adjustments to the quoted market price of the assets are required.
* Quoted prices for similar liabilities when traded as assets
* Inputs other than quoted prices that are observable for the asset or liability
* Inputs that are derived from or corroborated by observable market data.
