Fair Value Framework Flashcards
Define “Fair Value”
The price that would be received to sell an asset or paid to transfer a liability between market participants @ the date of measurement.
The price is determined by attributes such as, location, condition, restrictions on use & NOT the unique perspectives of buyer
ie what unbiased person would determine value as
What are some assumptions related to the “hypothetical situation” used to help determine for fair value?
Transaction is assumed to happen at the measurement date
Under current market conditions
NOT under duress (like in the case of a forced liquidation)
Assumed to occur in principal or most advantageous market
What is the “principal market” used to determine fair value?
Market available to entity w/ greatest volume & level of activity for item
What is the “advantageous market” used to determine fair value?
Market available to entity that maximizes selling prices or minimizes transfer prices.
The fair value measurement should NOT be adjusted for…..but SHOULD be adjusted for…..
Fair value should NOT be adjusted for transaction cost, as it does not measure a characteristic of the asset, liability or equity
Fair value SHOULD be adjusted for cost of transporting item to market as this falls under location characteristic
Fair value definition for NON-Financial Assets
Assumes HIGHEST & BEST USE by market participants Highest & Best Use = 1) Physically possible 2) Legally permissible 3) Financially Feasible
Fair Value definition Liabilities
Assumes liability is transferred and not settles
ie. it becomes a liability on the transferee’s book & still due to a third party
Fair Value=what would pay for transfer not what one would pay to settle
Fair Value definition for Shareholder’s Equity
Measurement is from perspective of market participant that holds the equity item as an asset
What is “Entry Price”?
Amount paid to buy an asset or paid to transfer a liability
What is “Exit Price”?
The price used to determine Fair Value
Amount received to sell an asset or paid to transfer a liability
What is the accounting price if Entry Price does not equal Exit Price?
A gain or loss is recognized in Income
What are the 3 approaches to determine Fair Value
1) Market Approach: uses prices generated by real markets transactions for identical or similar items
2) Income Approach: discounts future amounts to a current present value
3) Cost Approach: Uses current amount required to replace the asset
What is the “Fair Value Option?”
Mainly applies to financial assets
Entities can elect to measure the following @ Fair Value
1) Recognized financial assets & financial liabilities
2) Firm commitments not otherwise recognized & that involve only financial statements
3) Written loan commitments
4) Rights/obligations under warranties & insurance contracts that can be settled by a paying 3rd party
The “Fair Value Option” cannot be used…
Investments in entities to be consolidated
Obligations or assets related to pension or other employee oriented plans
Lease related financial assets or liabilities
Demand deposits of financial institutes
Instruments that are components of shareholder’s quity
Once applied the “Fair Value Option” is irrevocable except when…
A new election date for a specific item occurs
How to account for Fair Value on election date
1) Determine Carrying Value
2) Determine Fair Value
3) Determine difference between CV & FV
4) Recognize item by
a) writing up or down based on difference
b) recognize increase (gain) or decrease (loss) in current income
How to account for Fair Value after date of election
@ each subsequent reporting period you mark to market ie adjust to New FV
What is the input hierarchy used to determine fair value?
Level 1 = Unadjusted quoted prices @ measurement date in active markets for identical items.
Level 2 = Input observable, either directly or indirectly, that do not meet all conditions for level 1. ie. may not be identical but similar assets
Level 3 = lowest value. Based only on internal data, assumptions or inferences. Thus, susceptible to bias
What are the disclosure requirements for Fair Value items on a Recurring Basis?
Recurring basis = FV determined and applied to an item period after period
Must disclose:
a) FV @ reporting date
b) level of FV hierarchy used for each measurement
c) transfers into & out of each level of hierarchy
i) level 3 must include a reconciliation of beginning & ending balances including
A) recognized g/l
B) purchases, sales & settlements
C) transfers in/out of level 3
D) description of valuation process
E) quantitative info about unobservable inputs
What are the disclosure requirements for Fair Value items on a Non-Recurring Basis?
Non Recurring Basis = FV is determined & applied only when certain conditions or situations occur
Must disclose:
a) FV @ reporting date & reasons for measurement
b) level of FV hierarchy w/in each measurement falls
c) for measurement levels 2 & 3; a description of valuation techniques, inputs & any changes
d) if level 3:
i) valuation process
ii) quantitative info about unobservable inputs used
What is the required disclosure for the election of the FV Option?
Must disclose:
- items to which FV option is applied & reasons for electing
- Info to help users to understand how FV is applied to each item
- amount of g/l due to FV changes
