Fair Value Framework Flashcards
Fair Value
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
Market-based measurement; single or group
Should consider specific item being measured
NOT based on buyers unique perspective
Hypothetical Transaction “orderly transaction”
- Assumed to occur at the measurement date
- Assumed to occur under current market conditions
- Not assumed to occur in a forced liquidation or distressed sale
- Assumed in principal market or most advantageous market for the item to which the entity has access
- DO NOT add in transactions costs e.g. incremental direct cost to execute transfer/sale but some TRANSPORTATION costs are
Non-financial Asset
highest/best use by market participants, even if it will be used in some other capacity.
So, base it off how the market would use it
Entry Price
Amount paid to acquire an asset or received to assume a liability ; the price when initially recognized;
may or may not be fair value
Exit Price (FV)
Price that would be received to sell an asset or paid to transfer a liability
Accounting Treatment
If the transaction price (entry) is different from the fair value (exit) then a GAIN/LOSS is recognized
Determine CV and FV and the difference between the 2; what is on your books vs the fair value; WRITE the item up or down in current earnings
IF a GAIN: Dr: asset Cr: unrealized gain fv option
Market Approach (FV determination)
Uses prices generated by real market transactions for identical or similar items
Income Approach (FV determination)
Discounts future amounts to a current present value
Taking future cash flows and discounting them back to a current value
Cost Approach (FV determination)
Uses current amount required to replace the service value of an existing asset
replacement cost
more likely for a non-financial asset
Single Approach
Sometimes this is appropriate and adequate - e.g. share of Apple stock
Multiple approaches
This may also be appropriate in some cases - e.g. valuing an entire business
Fair Value Option
An entity can elect to measuring the following at FV:
- Recognized financial assets & liabilities e.g. equity method investment (20-50%)
- Firm commitments not otherwise recognized that involve only financial instruments
- Written loan commitments
- Rights/obligations under warranties & insurance contracts that can be settled by paying a 3rd party
Can NOT use FV Option for
- Investments in entities to be consolidated
- Obligations or assets related to pension or other employee-oriented plans
- Lease-related financial assets/liabilities
- Demand deposits of financial institutions
- Instruments that are components of SE
CAN use FV Option for
- When he item is first recognized
- When an eligible firm commitments occurs
- When the accounting treatment of an investment in another entity changes
- Investment becomes subject to equity method acct.
- An event that requires the item to be measured at FV - business combination/significant modifications to debt instruments
Observable Inputs
Used in pricing an asset, liability, or equity item that is developed based on market data obtained from sources independent of the reporting entities
Unobservable Inputs
Reflect the reporting entities own assumptions used in procong the asset, liability, or equity item that are developed based on the best information available in the circumstances
Level 1:
Unadjusted quoted prices in active markets for a/l identical to those being valued that the entity can obtain at the measurement date
**most reliable, should always be used when available; only liquidity discount adjustment permitted
Level 2:
Observable for a/l/ or e either directly or indirectly, other than L1 quoted prices
- QP in active market similar items
- QP markets that are not active
- observable other than QP that are relevant to the item being valued
Level 3:
Unobservable inputs
lowest level, least desireable
May use reporting firm’s internal data
- Based on assumtions or inferenced that market participants would make
e.g. closely held share of stock - mom n pop
Disclosure Requirements - RECURRING
In interim/annual stmnts for each major category of a/l measured at FV must disclose:
- Level of fv hierarchy
- Transfers in and out of each level of hierarchy
- anything in level 3 reconciliation of begend balances
- Description of level 3 valuation process, info on unbservbale iputs, g/l, sensitivity to changes
Disclosure Requirements - NON-RECURRING
In interim/annual stmnts for each major category of a/l measured at FV must disclose:
- Reasons for FV measurement
- Level
- Anything in 2 or 3 a description of any techniques
- Level 3 effect of measurement on earnings, quantitative info/inputs
- if other than highest and best use explain why
Disclosure for FV Option
Identify which items apply to the FV option and the reasons for electing it
Provide info so users understand how evaluation is being applied; must disclose gains/losses and where they are being recognized
