Introduction to Financial Valuation

Question 1

Identify and briefly describe the three approaches to determining fair value as specified by U.S. generally accepted accounting principles (GAAP).

Answer 1

1. Market approach: Information generated by market transactions for identical or similar items.
2. Income approach: Converts future amounts of benefits or sacrifice to determine current value.
3. Cost approach: Determines the amount required to acquire or construct a comparable item.

Question 2

How is “fair value” defined and determined for U.S. generally accepted accounting principles (GAAP) purposes?

Answer 2

Fair value for the purposes of U.S. generally accepted accounting principles (GAAP) is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Question 3

Identify and briefly describe the three component levels of the U.S. generally accepted accounting principles (GAAP) hierarchy of inputs used for determining fair value.

Answer 3

Level 1: Quoted prices in active markets for identical items.

Level 2: Quoted prices in inactive markets or for items similar (but not identical) to those being valued; observable inputs other than quoted prices relevant to the item being valued.

Level 3: Unobservable inputs relevant to valuing an item (e.g., assumptions, estimates, etc.).

Question 4

Identify ways in which professional judgment must be used in carrying out a valuation.

Answer 4

Professional judgment is used in valuation to develop an understanding of the purpose and context of valuation, the selection of appropriate quantitative techniques and data, and, ultimately, the assignment of a value.

Question 5

What are some of the factors that must be considered in assigning value?

Answer 5

These factors must be considered in assigning value:

• The specific item or items (asset, liability, equity etc.) being valued;
• The condition of the item(s);
• The location of the item(s);
• The time at which the valuation is occurring;
• The economic environment in which the valuation is occurring.