Fair Value Framework

Question 1

What types of comparisons are fair value option disclosures intended to facilitate?

Answer 1

(1) Between entities that choose different measurement methods for similar assets and liabilities
(2) Between assets and liabilities in the financial statements of an entity that selects different measurement for similar assets and liabilities

Question 2

What significant fair value disclosures are required only in annual statements?

Answer 2

The methods and significant assumptions used to estimate fair value.

Question 3

What are the special disclosures required for fair value measurements (on a recurring basis) that are based on unobservable inputs (i.e., Level 3 inputs)?

Answer 3

(1) Reconciliation of beginning and ending balances
(2) Description of the valuation process used
(3) Quantitative information about the unobservable inputs used
(4) Narrative description of the sensitivity of fair value to changes in unobservable inputs
(5) Unrealized gains/losses for the period and where reported

Question 4

Distinguish between assets and liabilities measured at fair value on a recurring basis and nonrecurring basis.

Answer 4

Assets and liabilities measured at fair value on recurring basis are adjusted to fair value period after period. Assets and liabilities measured at fair value on a nonrecurring basis are adjusted to fair value only at the time of a particular event (e.g., significant modification of debt).

Question 5

For the purposes of the fair value definition, what are the assumed characteristics of market participants?

Answer 5

Buyers and sellers that are:

(1) Independent of the reporting entity
(2) Acting in their economic best interest
(3) Knowledgeable of the asset or liability and the transaction involved
(4) Able and willing, but not compelled, to transact for the asset or liability.

Question 6

Define “fair value (for accounting purposes)”

Answer 6

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.

Question 7

What are the major purposes intended to be accomplished by the fair value framework?

Answer 7

To provide a framework for the use of fair value in GAAP so as to:

(1) Achieve increased consistency and comparability in fair value measurements, and
(2) Expand disclosure when fair value measurements are used

Question 8

Define “exit price”

Answer 8

The price that would be received to sell and asset or paid to transfer a liability.

Question 9

List the items that entities may elect to measure and report at fair value.

Answer 9

(1) Recognized financial assets or financial liabilities (some exceptions)
(2) Firm commitments
(3) Written loan commitments
(4) Rights and obligations under insurance contracts and warrants
(5) Other financial instruments embedded in non-financial derivative instruments

Question 10

List the situations where the entry price may not be the exit price.

Answer 10

(1) The transaction is between related parties
(2) The transaction occurs when the seller is under duress
(3) The unit of account included in the transaction price is different from the unit of account that would be used to measure at fair value
(4) The market in which the transaction price occurred is different from the market in which the asset would be sold or the liability transferred

Question 11

Describe the market approach for determining fair value for GAAP purposes.

Answer 11

This approach uses prices and other relevant information generated by market transactions involving assets or liabilities identical or comparable to those being valued.

Question 12

List the dates when an entity may elect to use fair value option for an eligible item.

Answer 12

(1) When the item is first recognized
(2) when firm commitment occurs
(3) When financial, an asset previously reported at fair value when unrealized gain/loss in earnings, no longer qualifies for that fair value treatment
(4) When accounting treatment for an investment changes because it becomes subject to the equity method or ceases to be eligible for consolidation
(5) When an item is measured at fair value at the time of an event, but does not require fair value measurement at subsequent reporting dates

Question 13

Define “entry price”

Answer 13

The price paid to acquire an asset or the price received to assume a liability.

Question 14

Describe the cost approach for determining fair value for GAAP purposes.

Answer 14

This approach uses the amount currently required to replace the service capacity of an asset.

Question 15

List the financial assets and financial liabilities that entities may NOT use fair value to measure and report.

Answer 15

(1) An investment in a subsidiary or variable interest to be consolidated
(2) Employers’ and plans’ obligations for pension benefits, other post-retirement benefits, post-employment benefits
(3) Financial assets and liabilities under lease accounting
(4) Demand deposit liabilities of financial institutions
(5) Financial instruments classified by the issuer as a component of shareholders’ equity

Question 16

Describe the income approach for determining fair value for GAAP purposes.

Answer 16

This approach converts future amounts to a single present amount.

Question 17

What are the three valuation techniques (or approaches) that should be used in determining fair value for GAAP purposes?

Answer 17

(1) Market approach
(2) Income approach
(3) Cost approach

Question 18

What purpose does the fair value hierarchy serve?

Answer 18

To prioritize the inputs to valuation techniques used to measure fair value.

Question 19

What are the three levels of the fair value hierarchy and what does each consist of?

Answer 19

Level 1: highest level, are unadjusted quoted prices in active markets for assets and liabilities identical to those being valued
Level 2: are observable for assets or liabilities, either directly or indirectly, other than quoted prices described in Level 1
Level 3: lowest level, are unobservable and used to determine fair value only if observable inputs are not available

Question 20

Describe fair value measurement inputs.

Answer 20

The various assumptions market participants use in determining fair value, including:

(1) Assumptions about the risk inherent in using a particular valuation technique
(2) Risk inherent in using various inputs (data, assumptions, etc.) with each valuation technique