FAR 1.04

Question 1

1.04 - An entity is required to recognize various items at Fair value including

Answer 1

• Investments in marketable debt securities (Trading securites -UNR-G/L I/S; or AFS- UNR-G/L OCI)
• Investments in equity securites (except those acct for under equity method, those that are req to be consolidates, and when an appropriate election is made, those for which the market value is not readily determinable.
• With very few exceptions, assets aquired and liability assumed (initially recognized at FV, but are not adj to FV in subsequent periods for presentation on the BS)
• Impairment losses-reduction in the carrying value of an asset to its fair value in the period of impairment. (Receivables, Goodwill, Depreciable assets & amortizable intangibles)
• All derivatives are always reported at fair value (minor ex. interest rate swaps that are hedges)

Question 2

1.04 Do not qualify for the Fair Value election

Answer 2

• Pension plan, post-retirement, and other post-employment benefits (ASC712 & 715)
• Leases (ASC 840)
• Financial Instruments that are components of equity (ASC505)
• Share based payments and stock options (ASC718)

Question 3

1.04 Fair Value Measurements (6)

Answer 3

1) Identify the asset/liability to be measured
2) Det. principle or most advantageous mkt. (highest + best use)
3) Det the valuation premise (In-use or in-exchange)
4) Det. appropriate valuation technique (mkt, income, cost approach)
5) Obtain inputs for valuation (Level 1, 2, 3) - FV hierarchy must be used to prioritize the inputs to valulation techniques.
6) Calculate the Fair Value of an asset

Question 4

1.04 3) Determine the appropriate valuation techniques (M.I.C)

Market Approach

Answer 4

• involves using information generated by market transactions that involve identical or comparable assets or liabilities.

Question 5

1.04 3) Determine the appropriate valuation techniques (M.I.C)

Income Approach

Answer 5

Involves analyzing future amounts in the form of revenues, cost, savings, earnings, or some other item.

-PV

Question 6

1.04 3) Determine the appropriate valuation techniques (M.I.C)

Cost Approach

Answer 6

• involves measuring the cost that would be incurred to replace the benefit derived from an asset.
• Replacement Cost

Question 7

1.04 5) Obtain inputs for Valuation (Levels 1,2,3)

Level 1

Answer 7

the most reliable, involves the use of observable data from actual market transactions, occurring in an active market, for identical assets or liabilities.

Question 8

1.04 5) Obtain inputs for Valuation (Levels 1,2,3)

Level 2

Answer 8

also involves the use of observable data from actual market transactions but either:

• The transactions did not occur in an active market, or
• The transactions relate to similar, but not identical, assets or liabilities.

Question 9

1.04 5) Obtain inputs for Valuation (Levels 1,2,3)

Level 3

Answer 9

involves the use of unobservable data and are largely based on management’s judgment

Question 10

1.04 SFAC7 introduces the expected cash flow approach which differs from traditional by focusing on explicit assumptions about the range of possible estimated cash flows and their respective probabilities. The factors that must be considered are:

Answer 10

• Risk, Timing, Interest, Amount
• Risk - the probability that the cash will actually be paid or received
• Timing-the periods in which the payments are expected to be received
• Interest-the interest rates that would be appropriate taking into consideration market rates and the credit standing of the parties involved.
• Amount of cash flows
• -Traditional approach (use most likely cash flow amounts)
• -Expected approach (Use weighted average of different possibilities ex: CF has 10%chance of being 100, 60% of being 200, 30% chance of 300) *Tradition: 200 (since most likely)
• Expected:220 (10%100+60%200+30%*300)

Question 11

1.04 Examples of financial assets and liabilities that would qualify for the fair value election

Answer 11

• Most investments - AFS securites reported at FV any G/L reported to I/S; Held to maturity securities reported at FV any adj from the amortized cost would be reported to income; Investments accounted for under equity method would be reported at FV with increases or decreases reported in income.
• Firm commitments involving financial instruments, such as forward exchange contracts to purchase or sell a foreign currency.

Question 12

1.04 Accounting literature defines Fair value for certain items for example:

FV of Cash, Mkt sec, AR, Inventory

Answer 12

• The FV of cash is its face amount
• The FV of an investment in marketable securities is its market value
• The FV of accounts receivable is its net realizable value (NRV)
• The fair value of inventory is its net realizable value (NRV)