Financial 2 - Fair Value Measurements

Question 1

Fair Value Basics

Answer 1

• Fair Value includes transportation costs, but NOT Transaction costs
• The price in the principal market for an asset or liability will be the fair value measurement
• Fair value is a market-specific measure, NOT entity-specific
• 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 at the measurement date, a market-based measure, NOT entity-based
• A change in the valuation technique used to measure fair value is a change in accounting estimate (implement PROSPECTIVELY)
• Fair value is measured for a specific asset/liability or a group of assets/liabilities

Question 2

Fair Value Inputs

Answer 2

• Level I inputs are the most reliable fair value measurements and Level III inputs are the least reliable
• Level I measurements are quoted prices in active markets for IDENTICAL assets or liabilities only, when no adjustments are required. Ex: Quoted stock market prices in an active stock market
• Level II inputs are quoted prices in active markets for similar assets or liabilities. Ex: Prices from observed transaction involving similar assets or liabilities
• Level III input is an unobservable input which reflects the entity’s or management’s assumptions. This is acceptable only when there are no Level I or II inputs OR when undue cost or effort is required to obtain Level I or II inputs. Ex: Projected cash flows; this is unobservable and based on an entity’s assumptions
• The level in the fair value measurement hierarchy is determined by the level of the lowest level significant input

Question 3

No Principal Market??

Answer 3

• The price in the most advantageous market is the Fair value measurement
• ** Although transaction costs are NOT included in the fair value measurement, they are used to determine the most advantageous market

Net Price = Quoted Price - Transaction Costs

What ever market produces the higher FV measurement, that quoted price will be the fair value of the asset

Question 4

Determining the “Principal” Market and “Most-Advantageous” Market

Answer 4

• The “principal” market is the market with the greatest volume of activity for the particular asset for which the fair value is being determined

Example: Michigan had the greatest volume of corn purchases in total; therefore, Michigan exchange is the principal market

• The “most-advantageous” market is the market offering the best price, net of transaction costs

Question 5

Fair Value of Non-Financial Assets

Answer 5

• The fair value of non-financial assets is the value at its highest and best use.
• **In the example, the highest and best use of the farmland is as a shopping plaza. Therefore, the fair value is its value as a shopping plaza

Question 6

Appropriate Valuation Techniques for Measuring Fair Value

Answer 6

Valid Techniques

• The Market approach
• The Cost approach
• The Income Approach

Invalid Techniques
- Net Realizable Value