FAR2 M4 - Fair Value Measurements

Question 1

What is fair value?

Answer 1

Fair value 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 market or the most advantageous market market at the measurement date under current market conditions.

Question 2

Attributes of Fair Value

Answer 2

1. Market based, not entity based measure
2. Principal market or the most advantageous market in the absence of a principal market
3. Exit price to sell an asset or transfer a liability, not an entrance price to acquire an asset or assume a liability
4. Reflects all of the assumption that market participants would use in pricing the asset or liability.
5. Fair value does NOT include transaction costs, but may include transportation cost. The only exception is in the absence of a principal market. In advantageous market, transaction costs are used to calculate the fair value.
6. FV of a non-financial asset (PP&E) assumes the highest and best use
7. FV of a liability should include the liability’s non-performance risk (risk the obligation will not be fulfilled)
8. FV of an entity’s equity instrument should be measured from the perspective of a market participant holding the instrument as an asset.
9. FV assumes the liability or equity instrument is transferred to a market participant as of the date of measurement and assumes the liability/equity will remain o/s and not be settled, cancelled or extinguished as of the measurement date.

Question 3

Orderly Transaction

Answer 3

An orderly transaction is one that is exposed to the market for a period of time before the measurement date. It cannot be a forced transaction.

Question 4

Market Participants

Answer 4

Buyers/sellers are independent and unrelated. They are knowledgeable about the asset/liability, able and willing to transact.

Question 5

Principal Market

Answer 5

The market with the greatest volume or level of activity for the asset or liability.

Question 6

Most Advantageous Market

Answer 6

If there is no principal market, the market with the best price for the asset (max selling price) or liability (min payment to transfer liability), after considering transaction costs. Although transaction costs are used to determine the most advantageous market, they are not included in the final FV measurement.

Question 7

Non-Financial Assets (PP&E)

Answer 7

FV of a non-financial asset considers the market participants ability to generate economic benefits by using the asset for the highest and best use or by selling it to another market participant that would use it for the highest and best use.

Question 8

Liabilities and Financial Assets (Stocks & Bonds)

Answer 8

The highest and best use concept is not relevant in this case because these instruments do not have alternative uses.

Question 9

Fair Value Measurement Framework

Answer 9

Uses valuations techniques and hierarchy of the inputs .

Question 10

Valuation Techniques

Answer 10

1. Market Approach - uses prices and other relevant info from market transactions (exchange)
2. Income Approach - PVFCF (DCF); conversts future cash flows to a singe discounted amount to measure FV
3. Cost Approach - uses current replacement cost to measure FV

Question 11

Hierarchy of Inputs

Answer 11

The FV hierarchy “prioritizes” the inputs that can be used in valuation techniques. Level 1 have the highest priority and level 3, the lowest.

Question 12

Level 1 Inputs

Answer 12

Quoted prices based on active markets for identical assets, which the entity has access to as of the date of measurement. The most reliable measure.

Question 13

Level 2 Inputs

Answer 13

Inputs other than the quoted market prices (level 1) that are directly or indirectly observable for the asset/liability.
Level 2 involves:
- Quoted prices for similar assets/liabilities in active markets
- Quoted prices for identical or similar assets in non-active markets.

Question 14

Level 3 Inputs

Answer 14

DCF approach. Un-observable inputs for the asset/liability. They reflect the reporting entity’s assumptions and should be based on the best available info. Only used if no level 1 or 2, or when there is undue cost and effort required to obtain observable inputs.

Question 15

FV Disclosures

Answer 15

1. Valuation techniques and inputs used

2. Estimate the effect on earnings is level 3 inputs are used

Question 16

Exceptions to FV

Answer 16

Process is exempted when:

1. Not practicable to sue FV
2. FV cannot be reasonably determined or
3. FV cannot be measured with sufficient reliability.