Fair Value Measurements Flashcards
What is fair value?
it is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal (or most advantageous) market at the measurement date under current market conditions
Facts on fair value
it is a market based measure, not an entity based measure
it is measured in the principal market for the asset or liability or the most advantageous market in the absence of a principal market
it is an exit price (the price to sell an asset or transfer a liability), not an entrance price (the price to acquire an asset or assume a liability)
it does not include transaction costs, but may include transportation costs if location is an attribute of the asset or liability
for a nonfinancial asset, it assume the highest and best use of the asset
for a liability, it should include the liability’s nonperformance risk, which is the risk that the obligation will not be fulfilled
for an entity’s own equity instrument, it should be measured from the perspective of a market participant who holds that instrument as an asset
What is the principal market?
it is the market with the greatest volume or level of activity for the asset or liability; if there is a principal market for an asset or liability, the price in that market will be the fair value measurement, even if there is a more advantageous price in a different market; the reporting entity must have access to the principal market at the measurement date
What is the most advantageous market?
it is the market with the best price for the asset or liability after considering transaction costs; note that although transaction costs are used to determine the most advantageous market, they are not included in the final fair value measurement; the price in the most advantageous market will be the fair value measurement only if there is no principal market
T/F: the highest and best use of concept is not relevant when measuring the fair value of financial assets or the fair value of financial liabilities
True; this is because such items do not have alternative uses and their fair values do not depend on their use within a group of other assets or liabilities
What are the 3 valuation techniques?
market approach - uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value
income approach - converts future amounts, including cash flows or earnings, to a single discounted amount to measure fair value; it can be applied to assets or liabilities
cost approach - uses current replacement cost to measure the fair value of assets
How many levels are in the hierarchy of inputs?
three; this hierarchy prioritizes the inputs that can be used in the valuation techniques described above; level 1 has highest priority while level 3 has lowest priority; valuation techniques should maximize the use of observable inputs (level 1 and level 2) and minimize the use of unobservable inputs (level 3)
level 1 - these are quoted prices in active markets for identical assets or liabilities that the reporting entity has access to on the measurement date; these are the most reliable measures of fair value and should be used when available
level 2 - anything other than quoted market prices that are directly or indirectly observable for the asset or liability (quoted prices for similar assets/liabilities or for identical assets/liabilities in inactive markets)
level 3 - these are unobservable inputs for the asset/liability; they reflect the reporting entity’s assumptions and should be based on the best available information; these should be used only when there are no level 1 or level 2 inputs or when undue cost and effort is required to obtain observable inputs
What are some exceptions to fair value measurement?
it is not practicable to measure fair value, fair value cannot be reasonably determined, or fair value cannot be measured with sufficient reliability
