F2:M6-Fair Value Measurements

Question 1

What is Fair Value?

Answer 1

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 (or most advantageous) market at the measurement date under current market conditions.

When you see “fair value,” think “exit price.”

Question 2

How is Fair Value different from Market Value?

Question 3

How is Fair Value defined?

Answer 3

Based on what market measures it as, not what the entity measures as.
Measures in:
* the principal market for the asset or liability; or
* most advantageous market (if there’s no principal market)
* Exit price (the price to sell an asser or transfer a liability), NOT an entrance price (the price to acquire an asset or assume a liablity.
* Measure reflects all assumptions that makret participants woudl use in pricing the asset or liability, including assumptions about risk
* Does NOT include transation cost, but might include transportation costs if location is an attribute of the asset/liability and it’s gotta be shipped.

Question 4

How is Fair Value determined for a non-financial asset?

Answer 4

By highest adn best use of asset

Question 5

How do you measure the Fair Value of a liability?

Answer 5

You should factor in:
* Liabilities nonperformance risk (default risk that borrower may not pay it)
* What equity is trading for on an exchange (open market) not what’s on the entity/company books (as an asset).

Question 6

What are some elements that must exist for asset/liability to be considered Fair Value.

Answer 6

• Asset/liability exposed to market for period of time before measurement date, long enough to allow for marketing activites usually and customary for transactions involving asset/liabilities.
• Not forced transaction (not a fire sale due to bankruptcy or foreclosure, etc.)

Question 7

What describes market participants?

Answer 7

Buyers and sellers who are:
* Unrelated (independent)
* Knowledgeable about the asset/liability
* Willing ot transact for the asset/liability
* Able to transact for the asset/liability

Considered to be acting in their economic best interest*

*No discounts or inflated prices to reduce taxable income (i.e., transfe

Question 8

What is a Principal Market?

Answer 8

• The place with the greatest volume or level of activity for the asset or liability.
• If there is a principal market for an asset/liability, the price in that market will be the fair value measurement, even if there’s a more advantageous price in a different market.
• Reporting entity/company must have access to the principal market at the measurement date.

Question 9

What can we do if there is no Principal Market?

Answer 9

Determine what is the most advantegous market.
* Best price for asset (maximize selling pric of asset) or liability (minimize payment to transfer liability)
* Note although transaction costs are used to determine most advantageous market, transaction cost are not included in final fair value measurement.
* Price will be the fair value measurement only if there’s no principal market.

Most Advantageous Market Maximizes Net Realizable Value*

*NRV: SP↑ - Transaction Cost↓ = NRV↑

Question 10

How is Fair Value for Non-Financial Assets/Liabilities determined?

Answer 10

Fair value is determined based on whicheverr use results in the highest value.

Question 11

What are some techniques for measuring fair value?

Answer 11

Market Approach
Income Approach
Cost Approach

Question 13

What is fair value hierarchy?

Answer 13

Inputs that are used in the valuation techniques where Level 1 inputs are the highest and Level 3 inputs are the lowest.

Question 14

What are Level 1 inputs?

Answer 14

Quoted prices in acrive markets for identical assets or liabilities that the reporting entity/company has access to on measurement date. Level 1 quoated prices may be obtained from exchange markets (NYSE), dealer markets adn principal-to-principal markets.

Most reliable measures of fair value and should be used when available.

Question 15

What are Level 2 inputs?

Answer 15

Quoted Market prices (other than Level 1) that are directly or indirectly observable for the asset or liability. Includes Level 2 inputs.

Question 16

What are Level 3 inputs?

Answer 16

Inputs that are unobsevable for the asset or liability. Reflects the entity/company’s assumptions and should be based on best available information.

Use only when there are no observable (Level 1 or Level 2) inputs or when undue cost and effort is required to obtain observable inupts.