Fair Value Measurements Flashcards
Fair Value
Defined as the price that would be received if you sell an asset in an active market
Assumptions Fair Value
Transaction takes place in the most advantageous market available to the entity that maximizes the selling price
Buyer/Seller are willing and able to do business, and are each acting in their own best interest
Not compelled to enter the transaction- they both act independently
Highest and best use considers what is:
Physically possible
Legally permissible
Financially feasible
Approaches for determining fair value
Market approach
Income approach
Cost approach
Market approach
Prices generated by real market transactions for identical or similar items
Income approach
Discounts future amounts to current value
Cost approach
Uses current amount required to replace the service value of an existing asset
Fair value option is not available for
Investments in entities that will be consolidated
Obligations of assets related to pension or other employee-oriented plans
Lease-related financial assets or liabilities
Demand deposits of financial institutions
Instruments that are components of shareholders’ equity
Fair value can be elected only when:
The item is first recognized (when the company acquired it)
When an eligible firm commitment occurs
When the accounting treatment of an investment in another entity changes
Fair value can be applied on an instrument by instrument basis
Does not have to be applied to all instruments issued or acquired in a single transaction
Must be applied to an entire instrument- not just to specific elements of an instrument
Fair value accounting at eligible election date
Determine carrying value (CV) Determine fair value (FV) Determine difference between CV and FV Recognize difference as A write up or write down Recognize increase (gain) or decrease (loss) in current income
Fair value inputs
Observable and unobservable
Observable inputs
Derived from market data independent of the entity- example is stock exchange which gives real-time market prices for stocks.
Unobservable inputs
Value is based on the entity’s assumptions based on the best information they have (essentially their best guess)
Level 1
Quoted market prices in an active market for identical items
Highest level and involves observable inputs, which are the most desirable
Example is stocks listed on a major exchange, you know at any second what the exact value is for one share, all shares are identical.
Level 2
Observable inputs that don’t meet all requirements for level 1
Quoted prices in active markets for similar items
Quoted prices in markets that are not active
Example is comparing recently sold homes that are similar to your house to come up with a value.
Level 3
Unobservable inputs for the item being valued
Lowest level with the least desirable inputs
Usually based on the reporting firm’s internal data
This basically means an entity’s best guess based on their own internal numbers
Disclosure requirements
You must disclose the fair value at the reporting date
You must disclose the transfers in and out of level 3 assets and liabilities
You must disclose the significant unobservable inputs used in the level 3 valuators
Disclose the amounts of unrealized gains and losses associated with the fair value changes for level 3 assets and liabilities
GAAP vs IFRS differences- Statement of Cash Flows
GAAP: Dividends paid are in the financing section. Dividends received, and interest paid and received are all included in the operating section.
IFRS: Dividends and interest paid can be classified as either operating or financing activities. Dividends and interest received can be classified as either operating or investing activities.
GAAP vs IFRS- Inventory
LIFO is not allowed at all under IFRS but is allowed by GAAP.
Write downs: If inventory value is written down, no reversals are allowed under GAAP, but a subsequent reversal is allowed under IFRS, but never above the original cost.
Measurement: For IFRS, inventory is the power of cost or NRV, with NRV being the selling price less completion costs. Under GAAP, inventory using LIFO or the retail inventory method is the lower of cost or market, otherwise it’s the lower of cost or NRV.
GAAP vs IFRS- Equity Method
When an investment is between 20% to 50% ownership but the investor does NOT have significant influence.
GAAP: either the fair value method or the equity method can be used.
IFRS: the equity method must be used.
PPE Carrying Value and Depreciation GAAP vs IFRS
Under GAAP, PPE is carried at historical cost less accumulated depreciation and any impairment losses
Under IFRS, the revaluation model is allowed as well as historical cost. The revaluation model is basically the fair value option for PPE: whenever there is a difference in the carrying amount and the fair value of any PPE, then the value is written up or down to whatever the fair value is. If the value is written up, then the increase goes to other comprehensive income. If the value is written down, it is recognized in income.
Investment property under IFRS can also be carried at historical cost or use its fair value, except that any gain or loss in value under the fair value is recognized in income instead of gains going through OCI like for PPE.
Remember that IFRS uses component depreciation, meaning that if major components of one piece of equipment has different useful lives, the similar components will be depreciated separately.
Impairment of Assets: GAAP vs IFRS
IFRS: it’s a one step test that compares the carrying amount to the recoverable amount. The impairment loss would the difference in carrying amount and its recoverable amount. Also, under IFRS an impairment loss can be reversed. These same one step rule reversal of impairments apply to intangible assets.
GAAP: Two-step year for impairment. Step 1: is the carrying amount greater than the sum of future cash flows from the asset? Step 2: the impairment loss is equal to the difference between the carrying amount and the asset’s fair value. An impairment loss under GAAP can’t be reversed. Same rules for the tests and no reversal of impairment applies to intangible assets.
Intangible Assets: GAAP vs IFRS
Intangible Assets are carried at cost less amortization under GAAP.
IFRS allows for either historical cost or revaluation model
