Fair Value Framework

Question 1

Define “Fair Value”

Answer 1

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

Question 2

What are some assumptions related to the “hypothetical situation” used to help determine for fair value?

Answer 2

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

Question 3

What is the “principal market” used to determine fair value?

Answer 3

Market available to entity w/ greatest volume & level of activity for item

Question 4

What is the “advantageous market” used to determine fair value?

Answer 4

Market available to entity that maximizes selling prices or minimizes transfer prices.

Question 5

The fair value measurement should NOT be adjusted for…..but SHOULD be adjusted for…..

Answer 5

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

Question 6

Fair value definition for NON-Financial Assets

Answer 6

Assumes HIGHEST & BEST USE by market participants
Highest & Best Use = 
   1) Physically possible
   2) Legally permissible
   3) Financially Feasible

Question 7

Fair Value definition Liabilities

Answer 7

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

Question 8

Fair Value definition for Shareholder’s Equity

Answer 8

Measurement is from perspective of market participant that holds the equity item as an asset

Question 9

What is “Entry Price”?

Answer 9

Amount paid to buy an asset or paid to transfer a liability

Question 10

What is “Exit Price”?

Answer 10

The price used to determine Fair Value

Amount received to sell an asset or paid to transfer a liability

Question 11

What is the accounting price if Entry Price does not equal Exit Price?

Answer 11

A gain or loss is recognized in Income

Question 12

What are the 3 approaches to determine Fair Value

Answer 12

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

Question 13

What is the “Fair Value Option?”

Answer 13

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

Question 14

The “Fair Value Option” cannot be used…

Answer 14

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

Question 15

Once applied the “Fair Value Option” is irrevocable except when…

Answer 15

A new election date for a specific item occurs

Question 16

How to account for Fair Value on election date

Answer 16

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

Question 17

How to account for Fair Value after date of election

Answer 17

@ each subsequent reporting period you mark to market ie adjust to New FV

Question 18

What is the input hierarchy used to determine fair value?

Answer 18

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

Question 19

What are the disclosure requirements for Fair Value items on a Recurring Basis?

Answer 19

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

Question 20

What are the disclosure requirements for Fair Value items on a Non-Recurring Basis?

Answer 20

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

Question 21

What is the required disclosure for the election of the FV Option?

Answer 21

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