Fair Value Framework Section Flashcards
Which of the following is a benefit of the fair value framework with respect to fair value measurement and fair value reporting?
Increased Consistency Increased Comparability
Yes Yes
Yes No
No Yes
No No
The framework for the use of fair value in GAAP is intended to achieve not only increased comparability, but also increased consistency in fair value measurement and reporting. A
For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, “Fair Value Measurement,” least likely to apply?
Determination of the fair value to be assigned to land acquired in a business combination
Determination of the fair value of a bond liability for applying the fair value option
Determination of the fair value of legal services received in exchange for an entity’s common stock
Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred
The guidance for determining fair value provided in the fair value framework is appropriate for determining the fair value of a production facility when assessing whether or not an impairment loss has occurred. C
In determining the fair value of an asset in the most advantageous market, the market-based exit price should be adjusted for
Transaction Cost Transportation Cost
Yes Yes
Yes No
No Yes
No No
In determining the fair value of an asset in the most advantageous market, the market-based exit price would be adjusted for transportation cost (to get the asset to the principal or most advantageous market), but would not be adjusted for transaction cost associated with executing the (hypothetical) transaction. Fair Value DEF.
In determining the fair value of a nonfinancial asset, assessing the highest and best use of the asset must take into account all but which one of the following?
What is physically possible
What is financially feasible
How the reporting entity would use the asset
What is legally permissible
In determining the fair value of a nonfinancial asset, what is physically possible (and what is financially feasible and legally permissible) should be taken into account in assessing the highest and best use of the asset.
Crossroads Co. chooses to report a financial asset at its fair value. The asset trades in two different markets; however, neither market is the principal market for the financial asset. In the first market, sales proceeds are $76, which is net of transaction costs of $6. In the second market, sales proceeds are $80, which is net of transaction costs of $1. What amount should Crossroads report as the fair value of the asset?
$76
Incorrect. When there are multiple markets for an asset, the fair value of an asset is determined based on prices in the principal or most advantageous market. The second market is more advantageous because it has the higher selling price. In addition, fair value excludes transaction cost; therefore, the valuation of the asset would be $81. The response of $80 is incorrect because it includes transaction costs.
Principal market: the one with the greatest volume and level of activity for the asset or liability within which the reporting entity could sell the asset or transfer the liability.
Most advantageous market: the one in which the reporting entity could sell the asset at a price that maximizes the amount that would be received for the asset or that minimizes the amount that would be paid to transfer the liability.
Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?
Market
Income
Cost
Observable inputs
The market approach to fair value measurement of an asset does not measure fair value by discounting future cash flows of the asset. The market approach to fair value measurement uses prices and other relevant information generated by market transactions involving assets or liabilities that are identical or comparable to those being valued. Discounting future cash flows would be an income approach to determining fair value.
A
On January 15, 2008, Able Co. made a significant investment in the debt securities of Baker Co., which it intends to hold until the debt matures. Able’s fiscal year-end is December 31. If Able Co. intends to measure and report its investment in Baker Co. debt securities at fair value as permitted by ASC 820 on which one of the following dates must Able elect to implement the fair value option?
January 15, 2008
January 31, 2008
March 31, 2008
December 31, 2008
If Able Co. intends to elect to implement the fair value option for its investment in Baker’s debt, it must make its election on the date it first recognizes the investment, which is January 15, 2008, not December 31, 2008, the end of the firm’s fiscal year. On December 31, 2008, the fair value of the investment at that date would be determined, and any gain or loss since January 15, 2008, would be recognized in 2008 net income.
A
Which one of the following can be measured at fair value at the option of the reporting entity?
A liability under a lease contract
A debt investment classified as held-for-trading with readily determinable fair value
A debt investment classified as held-to-maturity
A liability under a pension plan
An entity may elect to measure and report a debt investment classified as held-to-maturity at fair value. Traditionally, debt investments classified as held-to-maturity would be measured and reported at amortized cost, but the provisions of the fair value option permit such investments to be measured and reported at fair value at the option of the reporting entity.
C
In which one of the following circumstances is the entry price to acquire an asset least likely to represent fair value of the asset?
Since the raw material inventory was acquired from a supplier in bankruptcy, it is likely that the transaction occurred when the seller was under duress. Therefore, it is likely that the price paid (an entry price) does not represent fair value. Exit price is not representative of fair value when the item is sold under duress.
C
When the fair value of an asset is determined as the amount that currently would be required to replace the service capacity of the asset, which one of the following valuation techniques has been used?
Income approach
Cost approach
Expense approach
Market approach
When fair value is determined as the amount that currently would be required to replace the service capacity of an asset, the cost approach, not the income approach, has been used. The income approach converts future amounts (e.g., of cash flows) to a current present value to determine fair value.
B
In determining the fair value of an asset or liability, would the fair value of the asset or the fair value of the liability be determined using an entry price or an exit price?
Asset Fair Value Liability Fair Value
Entry price Entry price
Entry price Exit price
Exit price Entry price
Exit price Exit price
Not only is an exit price the appropriate basis for determining the fair value of an asset, an exit price is also the appropriate basis for determining the fair value of a liability.
D
Which of the following is a level three input to valuation techniques used to measure the fair value of an asset?
Quoted prices in active markets for identical assets.
Quoted prices for similar assets in active markets.
Unobservable inputs for the asset.
Inputs other than quoted prices that are observable for the asset.
Correct! Level three inputs are unobservable.
C
Which of the following statements concerning inputs used in ascertaining fair value is/are correct?
I. Only observable inputs can be used.
II. Inputs that incorporate the entity’s assumptions may be used.
I only.
II only.
Both I and II.
Neither I nor II.
An entity’s assumptions may be used as inputs in determining fair value. Those assumptions would be level 3, unobservable inputs, but would be used when adequate observable inputs were not available to make fair value determinations.
B
Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?
I. Quoted market prices should be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued.
II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.
I only.
II only.
Both I and II.
Neither I nor II.
Neither Statement I nor Statement II is correct. Quoted market prices should not be adjusted for a “blockage factor” when a firm holds a sizable portion of the asset being valued (Statement I). A “blockage factor” occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a “blockage factor” would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value. Additionally, quoted market prices in markets that are not active because there are few relevant transactions can be used in determining fair value (Statement II). Such prices would be considered level 2 factors, observable inputs but not in active markets.
D
Which of the following levels of the fair value hierarchy is the highest and which is the lowest in terms of desirability for use in determining fair value?
Highest Level Lowest Level
Level 3 Level 1
Level 1 Level 4
Level 1 Level 3
Level 4 Level 1
In the fair value hierarchy, level 1 is the highest or most desirable level, and level 3 is the lowest or least desirable level.
C
Which of the following items would best enable Driver Co. to determine whether the fair value of its investment in Favre Corp. is properly stated in the balance sheet?
Quoted market prices on a stock exchange for identical assets would be level 1 inputs, the highest level in the hierarchy of inputs for valuation purposes, and the most reliable evidence of fair value.
C
Each of the following would be considered a Level 2 observable input that could be used to determine an asset or liability’s fair value, except
Quoted prices for identical assets and liabilities in markets that are not active.
Quoted prices for similar assets and liabilities in markets that are active.
Internally generated cash flow projections for a related asset or liability.
Interest rates that are observable at commonly quoted intervals
This response is a false statement—internally generated cash flow projections are not an observable input.
C
2 Inputs and what they mean
Observable—Inputs used in pricing an asset, liability, or equity item that are developed based on market data obtained from sources independent of the reporting entity (maximize)
Unobservable—Inputs that reflect the reporting entity’s own assumptions used in pricing the asset, liability, or equity item that are developed based on the best information available in the circumstances. (minimize)
NAV
Not part of the hierarchy
For a firm that elects to use fair value to measure eligible financial assets and financial liabilities, specific disclosures are required for which of the following financial statements?
Quarterly Financial Statements
Annual Financial Statements
No No
No Yes
Yes No
Yes Yes
Firms which elect to measure financial assets and financial liabilities at fair value are required to make significant additional disclosures in both interim (quarterly, etc.) and annual financial statements.
D
Which of the following statements, if any, concerning disclosures about fair value measurements in periods subsequent to initial recognition is/are correct?
I. The fair value hierarchy level within which fair value measurements fall must be disclosed.
II. Quantitative fair value measurement disclosures must be in tabular format.
Both I and II are correct.
I only.
II only.
Neither I nor II are correct.
Fair value measurement disclosures require both that fair value amounts be disclosed separately for each level of the fair value hierarchy and that quantitative disclosures be provided in tabular format.
A
Under U.S. GAAP the disclosure requirements when fair value measurement is used are differentiated by which of the following classifications?
Between assets measured at fair value and liabilities measured at fair value
Between fair value measurements that result in gains and fair value measurements that result in losses
Between items measured at fair value on a recurring basis and items measured at fair value on a nonrecurring basis
Between items for which fair value measurement is required and items for which fair value measurement is elected
Disclosure requirements when fair value measurement is used are differentiated between items measured at fair value on a recurring basis and items measured at fair value on a nonrecurring basis. Items measured at fair value on a recurring basis are adjusted to (measured at) fair value period after period; an example would be investments held-for-trading. Items measured at fair value on a non-recurring basis are adjusted to (measured at) fair value only when certain conditions are met; an example would be the impairment of an asset.
C
Which one of the following is not a required disclosure in annual financial reports for an entity that uses fair value measurement?
The level of the fair value hierarchy within which fair value measurements fall
The valuation techniques used to measure fair value
Combined disclosures about fair value measurements required by all pronouncements
A discussion of any change from the prior period in valuation techniques used to measure fair value
Combined disclosures about fair value measurements required by all pronouncements are not required, but are encouraged.
Balance sheet and Income Statement
Both require disclosures to use fair value
