Fair Value

Question 1

The framework for the use of fair value in GAAP is intended to achieve increased _____________ and ___________ in fair value measurement and reporting.

Answer 1

comparability, consistency

Question 2

In the fair value framework the principal market is…

Answer 2

…the one with the greatest volume and level of activity for the asset or liability that the reporting entity is selling or transferring.

Note that the proceeds from selling an asset in the principal market are net of transaction costs, but the fair value of the asset is gross of transaction costs. Similarly, the total cost to transfer a liability in its principal market includes transaction costs, but the fair value of the liability is net of transaction costs.

Example 1: The proceeds from selling an asset in its principal market is $76, which is net of transactions costs of $6. Therefore, the fair value of the asset is $76 + $6 = $82.

Example 2: The total cost to transfer a liability in its principal market is $82, which includes transaction costs of $6. Therefore, the fair value of the liability is $82 - $6 = $76.

Question 3

In the fair value framework, the most advantageous market is…

Answer 3

…the one that maximizes the amount received from selling an asset or minimizes the amount paid to transfer a liability.

Note that the amount used to determine the most advantageous market is net of transaction costs for an asset and gross of transaction costs for a liability. But to determine fair value, transaction costs are added back to an asset and deducted from a liability.

Example 1: An asset trades in two markets. In market A, sales proceeds are $76, which is net of transaction costs of $6. In market B, sales proceeds are $80, which is net of transaction costs of $1. Market B is the most advantageous market because it maximizes proceeds ($80 > $76). But fair value of the asset is $80 + $1 = $81.

Example 2: A liability trades in two markets. In market A, the total cost to transfer the liability is $82, which includes transaction costs of $6. In market B, the total cost to transfer the liability is $81, which includes transaction costs of $1. Market B is the most advantageous market because it minimizes the total cost ($81 < $82). But the fair value of the liability is $81 - $1 = $80.

Question 4

In the fair value framework, should the price determined in the principal or most advantageous market be adjusted* for transaction costs?

* added back to assets, subtracted from liabilities

Answer 4

No, because transaction costs do not measure a characteristic of the asset or liability.

That is, when determining price in the principal or most advantageous market, transaction costs should not be added back to the proceeds received from selling an asset or deducted from the total cost of transferring a liability. But when determining fair value, the opposite is true: transaction costs should be added back to the proceeds received from selling an asset and deducted from the total cost of transferring a liability.

Question 5

Should fair value be adjusted for the cost of transporting an asset or liability to its principal or most advantageous market?

Answer 5

Yes, because the principal or most advantageous market is a location characteristic of an asset and its associated liability.

Example 1: An asset sells for $500 in market A and $600 in market B, and it costs $50 to transport the asset to market B. Market B is the most advantageous market because it maximizes proceeds from selling the asset ($550 > $500). Therefore, the fair value of the asset is $550, which is the selling price minus transportation cost.

Example 2: A liability can be transferred for $500 in market A and $400 in market B, and it costs $50 to transport the liability to market B. Market B is the most advantageous market because it minimizes the total cost of transferring the liability ($450 < $500). Therefore, the fair value of the liability is $450, which is the amount paid to transfer the liability plus transportation cost.

Question 6

In determining the fair value of a nonfinancial asset, assessing the highest and best use of the asset must take into account what is __________ ________, ___________ ________, and _______ ___________.

Answer 6

physically possible, financially feasible, legally permissible

Question 7

The fair value hierarchy appears in ASC ___

Answer 7

820

Question 8

Describe Level 1 inputs in the fair value hierarchy.

Answer 8

Unadjusted quoted prices in active markets for assets or liabilities (or equity items) identical to those being valued and obtainable at the measurement date

Question 9

Describe Level 2 inputs in the fair value hierarchy.

Answer 9

Directly or indirectly observable inputs for assets or liabilities (or equity items) other than the quoted prices described in Level 1.

Examples:

• Quoted prices for similar assets or liabilities in active markets
• Quoted prices for identical or similar assets or liabilities in inactive markets
• Observable inputs other than quoted prices, such as interest rates and yield curves
• Inputs corroborated by observable market data by correlation or other means

Question 10

Describe Level 3 inputs in the fair value hierarchy.

Answer 10

Unobservable inputs that should be used only to the extent observable inputs are not available.

• should reflect the entity’s assumptions about what market participants would assume
• should apply any premium or discount that market participants would apply (e.g., a control premium)

Question 11

The fair value of a nonfinancial asset assumes the _______ ___ ____ ___ of the asset by market participants, even if the intended use of the asset by the reporting entity is different.

Answer 11

highest and best use

Question 12

Which one of the following financial items may not be measured and reported at fair value at the election of an entity?

• Accounts receivable
• Investment in debt securities to be held to maturity
• Investment in a subsidiary that is to be consolidated
• Accounts payable

Answer 12

Investment in a subsidiary that is to be consolidated

Question 13

In a parent company’s consolidated financial statements, may the parent choose to report its subsidiary’s held-to-maturity debt investments at fair value even if the subsidiary uses amortized cost to report the HTM debt investments on its separate financial statements?

Answer 13

Yes, the parent may choose the valuation method for all HTM debt investments in its consolidated financial statements.