F2 - M6 - Fair Value Measurements Flashcards
(17 cards)
For the fair value, how is this measured?
This is like an exit price if the item was sold today, and normally these items are valued based upon the market.
For example, principle market for the asset or liability. So, you have stock, what is the value of that stock on the market today? That is fair value.
If there is no principle market, than you want to use the most advantageous market available.
Does the fair value include transaction costs?
No, but it might include transportation costs if that is an important measure of the asset or liability.
You do use transaction costs to determine the most advantageous market, but use the fair value in finding fair value.
How would the fair value be measured for a non financial asset or liability?
Non financial asset - Is measured by the highest and best use of the asset. An example of this would be land.
Liability - Should include nonperformance risk, which is the risk that the obligation will not be fulfilled.
What is an orderly transaction for fair value?
The asset or liability is exposed to the market for a while to allow other people to purchase.
It is not a fire sale, or a forced transaction. This might be due to bankruptcy, foreclosure, etc.
What are the requirements of market participants in order to measured at fair value?
Buyers and sellers need to be unrelated,
knowledgeable about the asset or liability
Willing and able to transact.
Acting in your own economic best interest.
What determines which principle market you use?
The market with the greatest volume or level of activity for that asset and liability, and the reporting entity must have access to that market.
So if you have a stock, the market you will use is the market that holds most of that stock.
What determines the most advantageous market?
The market with the best price for an asset, or the lowest cost for a liability after considering transaction costs.
So for example, you want to maximize selling price and minimize transaction cost for an asset in this method. So NRV = SP - Transaction cost.
So for example, lets say you have to determine the most advantageous market since they do not give you the principle market. So here are your choices. which one is the most advantageous and what is the fair value?
New York: $52 (Quoted stock price), $6 (Transaction Cost); $46 (NRV)
London: $50 (Quoted stock price), $2 (Transaction Cost); $48 (NRV)
Answer: London is because the NRV is greater than New York’s. The FV is only $50, remember that you use transaction cost to help determine FV, but not used in the FV.
How is the fair value determined for non financial assets (think of land for a non-financial asset)?
It takes into account the market participant’s ability to generate economic benefits: (higher of the two)
- By using the asset in its highest and best use; or
- By selling it to another market participant that would use the asset in its highest and best use.
Just note for the exam: The reporting entity we assume is using the non financial asset at its highest and best use, unless market or other factors suggest that other participants would maximize it’s value.
Does the highest and best use apply to to financial assets?
No, just non-financial assets.
What are the key takeaways from this lecture?
Financial assets use the principle market to determine its fair value, and if that is not available, then they use the most advantageous market to determine the value.
Non financial assets use the highest and best use method.
If you change the valuation method, is that change retrospective or prospective?
This would be a prospective change since it is considered a change in estimate.
What are the valuation techniques? (MIC is the acronym).
M - Market Approach; this is when companies use other markets whether that is similar transactions or information to value their assets or liabilities.
I - Income Approach; this is when you discount future cash flows to get a measure of the current fair value. Think of time value of money of a stock or bond. Has to make income. Can be assets or liabilities.
C - Cost Approach; the replacement cost of the item to measure the fair value of the assets.
What is a level 1 input? (This is an observable input)
These are things that are observable, active, and identical. The best example of this is the stock market. Comparing what you stock price value is, is what the market says it is that day.
What is a level 2 input? (This is an observable input)
These are items that are observable and quoted, and you can get prices for similar assets or liabilities in active markets.
What is a level 3 input?
Unobservable, based on entities assumptions. No comparable assets,
bias and least reliable. Should be used when o other choice, no level 1 or 2.
Do you have to disclose the valuation method in the footnotes?
Yes you do. You have to say which method you used (MIC) and what input you used.
For level 3, you have to give quantitative information about unobservable inputs and a sensitivity analysis.
What are some exceptions to when you cannot use fair value measurements?
It is not practical to use the fair value
Fair value cannot be determined
Fair value cannot be measured with sufficient reliability.
