Fair Value Framework Flashcards
GAAP vs IFRS
No big differences for FV Meaning, Measurement or disclosures
Fair Value is
Based on hypothetical transaction and exit price.
- Market Based
- Subject to Condition, Location, Restriction
- Not based on unique attributes of Buyer
- Adjusted for Transportation but NOT Transaction costs
Highest and Best Use
- Physically, Legally, Financially permissable
2. In Use (non Financial) or in Exchange (Financial Asset)
FV applied to Liabilities
- Liability continues but is obligation of another party.
- Nonperformace Risk is assumed unchanged
- Adjustment should not be made for transfer restrictions.
FV Techniques
MIC
Market
Income
Cost
When fair value is determined as the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), the cost approach has been used.
The fair value for an asset or liability is measured as
The fair value of an asset or liability is not measured as the price that would be paid to acquire the asset or received to assume the liability in an orderly transaction between market participants, which would be entry price. By definition, fair value is based on an exit price, which is the price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
Use and Application of the Framework
The framework for determining (measuring) fair value provided in ASC 820, “Fair Value Measurement,” must be followed (with very limited exceptions) whenever fair value measurement is used, either as required by GAAP or permitted by GAAP as an alternative that is elected by an entity.
Purpose of the FV Framework
- Provide definition, framework and expanded disclosures.
2. Increase Consistency and Comparability.
Highest and Best Use of nonfinancial Asset
The highest and best use of a nonfinancial asset (i.e., its maximum value) to market participants may occur either principally through its use with other assets or principally on the price that would be received to sell (exchange) the asset.
Exempted Items from the FV Framework
ASC 820 specifically exempts:
- share-based payment transactions
- Inventory valuing and other minor items
Most Advantageous Market
IF no Principle Market, then use Market that provides the MOST Value net of Transaction Costs, but use the PRICE ignoring Transaction Costs for the FV from that Mkt
FV Option of Investment
- UNLIKE the Equity Method, Recognize the Dividend Income (% Share) AND the MTM increase (Change in Investment Value)
- Must make the Election when first recognize.
- Parent can make the FV Election even if Subs are not.
HTM Investments
Both amortized cost and fair value may be used to measure and report investments classified as held-to-maturity. Amortized cost is the traditional measurement method for investments held-to-maturity and would be used unless an entity elects to use fair value, which is permitted by the fair value option.
An exit price and an entry price are conceptually different
An exit price and an entry price are conceptually different (Statement I) and in practice an entry price and an exit price may be different amounts at the date an asset or liability is initially recognized (Statement II).
Such a difference may come about, for example, because the entry price is based on a transaction between related parties or because the selling entity was under financial duress at the time of the sale.
Which one of the following financial items may not be measured and reported at fair value at the election of an entity?
A firm may not use fair value to measure and report an investment in a subsidiary that is to be consolidated. The financial asset “Investment in subsidiary” will be eliminated in the consolidating process and be replaced by the subsidiary’s assets and liabilities (and possibly goodwill) on the consolidated balance sheet.
Appropriate basis for determining the fair value of an asset or a liability is
EXIT Price for Both
Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny’s carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa’s consolidated statements prepared immediately after the transaction?
Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be “eliminated” so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)
Excluded from FV Option
- Leases
- Pensions
- Held for Trading MUST use FV (no option)
A. An investment in a subsidiary that is to be consolidated;
B. An interest in a variable interest entity that is to be consolidated;
C. Employers’ and plans’ obligations (or assets) for pension benefits, other postretirement benefits, post-employment benefits, and other employee- oriented plans;
D. Financial assets and liabilities recognized under lease accounting;
E. Demand deposit liabilities of financial institutions;
F. Financial instruments that are classified by the issuer as a component of shareholders’ equity.
An entity may not elect to measure and report financial assets and liabilities recognized under a pension plan (or other postretirement and post-employment plans) at fair value.
Parent vs Subs and FV Option
As the parent, Alphaco may elect to report all of the investments held-to-maturity at fair value in its consolidated statements (only), whether or not the fair value option was elected by its subsidiaries for their separate books and any separate reporting purposes.
FV Hierarchy
Level 1 – Inputs in this, the highest level, are unadjusted quoted prices in active markets for assets or liabilities (or equity items) identical to those being valued that the entity can obtain at the measurement date.
**NOT adjusted for Blockage Factor (large holding)
Level 2 – Inputs in this level are observable for assets or liabilities (or equity items), either directly or indirectly, other than quoted prices described in Level 1, above.
Level 3 – Inputs in this, the lowest level, are unobservable for the assets or liabilities (or equity items) being valued and should be used to determine fair value only to the extent observable inputs are not available.
FV Disclosures
- Differentiate Recurring vs Non-Recurring
- FV Level (I,II,II) must be disclosed and in Tabular format.
- In B/S and I/S
- Combined disclosures about fair value measurements required by all pronouncements are not required, but are encouraged.
- Interim AND Annual Statements
- Facilitate comparisons both across firms and for differently measured financial assets and liabilities of a single firm.
- Disclosures must be provided that show information for each major category of assets and/or liabilities (e.g., investments held-for-trading, investments available-for-sale, derivatives, etc.)
