Fair Value Measurement Flashcards
What is the definition of fair value?
The definition of fair value is the price that would be received or paid in an orderly transaction between market participants at the measurement date.
Speedco sells widgets in two separate markets - their principal market prices their product at $12 per widget and most of their transactions over the course of the year take place in this market. However, there is a secondary market where they can sell widgets for $15 per widget, but they sell far fewer widgets in this market. Should they use the $12 or $15 price in determining the fair value of their widgets when considering a writedown?
If there is both a principal market (i.e. the market with the greatest volume and level of activity - in this case the $12 market) and a more advantageous market (in this case the $15 market price), they must use the principal market (in this case $12 per widget).
Are transaction costs considered in determining the fair value of an asset?
No - fair value of assets or liabilities are not adjusted for transaction costs.
Should fair value of a product be based on the entity’s specific circumstances or based on the market?
Fair value measurements are market based, <u>not entity specific measurements</u> (i.e. based on assumptions that market participants would use when pricing the item being measured, including assumptions about risk).
What are 3 common valuation techniques?
Three common valuation techniques are:\n\n(1) Market approach ? Look at comparable assets/liabilities;\n\n(2) Cost approach ? Amount required to replace the service capacity of the asset (i.e. replacement cost);\n\n(3) Income approach ? Take cash flows or income and convert to a single current (or discounted) amount. Could use present value techniques or option pricing models.
How would one treat a change in the valuation technique (i.e. change in accounting policy, estimate or an error)?
If there is a change in the valuation technique, it is considered a change in estimate.
What are the 3 levels in the fair value hierarchy?
The 3 levels to use in a valuation technique are:\n\n(1) Level 1 Inputs ? Quoted prices in active markets for identical assets/liabilities (usually this is the most reliable evidence of fair value).\n\n(2) Level 2 Inputs ? Inputs other than quoted prices included in level 1, that are observable, directly or indirectly (i.e. quoted prices for similar items in active markets or identical assets in non-active markets or inputs that are not quoted prices like observable interest rates at commonly quoted intervals etc.)\n\n– Examples are interest rate swaps (observable), licensing arrangements, a valuation multiple (i.e. a multiplier)\n\n(3) Level 3 Inputs ? Unobservable inputs. Use when observable inputs not available (i.e. little market activity). This includes assumptions about risk.\n\n– Examples are interest rate swaps or financial forecasting using company’s assumptions.
