Fair Value

Question 1

Purposes of fair value framework as set forth in ASC 820

Answer 1

Provide a uniform definition of fair value for GAAP purposes. Provide a framework for determining fair value for GAAP purposes. Establish expanded disclosures about fair value when it is used.

Question 2

What is the determination of fair value based on?

Answer 2

The determination of fair value is based on a hypothetical transaction and a hypothetical exit price. The determination if fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants.

Question 3

What does the guidance of ASC 820 not apply to?

Answer 3

1. Accounting principles that address share-based payment transactions.
2. ASCs that require or permit measurements similar to fair value but that are not intended to measure fair value, including
   a) Accounting principles that permit measurements determined using vendor-specific objective evidence of fair value
   b) Accounting principles that address fair value measurement for the purposes of inventory pricing.
3. Accounting principles that address fair value measurement for purposes of lease classification or measurement.

Question 4

How can highest and best use of a nonfinancial asset be determined?

Answer 4

Highest and best use of a nonfinancial asset may be determined as occurring through its use (using it with other assets) or through exchange (the price that would be received to sell (exchange) the asset).

Question 5

The three approaches to determining fair value are the market approach, income approach, and cost approach. Define wach.

Answer 5

Market approach uses price and other relevant information generated by market transactions involving assets or liabilities that are identical or comparable to those being valued.

Income approach converts future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.

Cost approach uses the amount that currently would be required to replace the service capacity of an asset (e.g. Current replacement cost), adjusting for obsolescence.

Question 6

An entity can apply the fair value option to an eligible item only on the date when one of the following events occur (an election date). When are the election dates?

Answer 6

1. When the item is first recognized.
2. When an eligible firm commitment is established.
3. Specialized accounting for an item ceases to exist.
4. An investment becomes subject to equity method accounting (but is not consolidated) or to a VIE that is no longer consolidated.
5. An event that requires the item to be measured at fair value, such as business combination or significant modification to debt instruments.

Question 7

The fair value option CAN be applied on an instrument by instrument basis, EXCEPT

Answer 7

1. If multiple advances are made to one borrower as part of a single contract and the individual advances lose their identity, the fair value option must be applied to all advances under the contract.
2. If the fair value option is applied to an investment that would otherwise be accounted for under the equity method of accounting, it must be applied to all of the investor’s financial interests, both equity and debt, in that entity.
3. If the fair value option is applied to a single insurance/reinsurance contract, it must be applied to all claims/obligations and features/coverage under the contract.

Question 8

If the fair value option is elected for held to maturity securities, those securities will be treated and reported as trading securities. How will their gains and losses from change in fair value be treated?

Answer 8

Gains and losses resulting from a change in fair value will be reported in current income, not other comprehensive income.

Question 9

What instruments are NOT eligible for fair value option?

Answer 9

1. An investment in a subsidiary that is to be consolidated.
2. An investment in a variable interest entity that is to be consolidated.
3. Employers’ and plans’ obligations or assets for pension benefits, other post-retirement benefits, post-employment benefits, and other employee-oriented plans
4. Financial assets and liabilities recognized under lease accounting.
5. Demand deposit liabilities of financial institutions
6. Financial instruments that are classified by the issuer as a component of shareholder’s equity.

Question 10

Inputs (assumptions, data, etc.) used to determine fair value may be either observable (eg market data) or unobservable (eg probability, assumptions). There are three levels in the fair value hierarchy, what are they?

Answer 10

Level 1: Highest level: Quoted market prices on a stock exchange for identical assets. Quoted prices for identical items in an active market are Level 1 inputs.

Level 2: Observable for assets or liabilities, either directly or indirectly, other than quoted prices in Level 1. Quoted prices for similar items in an active market are Level 2 inputs.

Level 3: Lowest level: Unobservable for the assets or liabilities being valued and should be used to determine fair value only to the extent that observable inputs are unavailable.