Fair Value Framework

Question 1

Define “fair value (for accounting purposes)”.

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 at the measurement date.

Question 2

For purposes of the fair value definition, what are the assumed characteristics of market participants?

Answer 2

Buyers and sellers that are:
Independent of the reporting entity;
Acting in their economic best interest;
Knowledgeable of the asset or liability and the transaction involved;
Able and willing, but not compelled, to transact for the asset or liability.

Question 3

What are the major purposes intended to be accomplished by the fair value framework?

Answer 3

To provide a framework for the use of fair value in GAAP so as to:
Achieve increased consistency and comparability in fair value measurements; and
Expand disclosure when fair value measurements are used.

Question 4

The fair value of a liability is based on the amount that would be paid to settle the liability. T/F

Answer 4

FALSE

Question 5

The price determined in the principal or most advantageous market should be adjusted for transportation cost in arriving at fair value in applying the fair value option. T/F

Answer 5

TRUE

Question 6

Fair value is based on an exit price. T/F

Answer 6

TRUE

Question 7

The fair value of a liability is based on the amount that would be paid to transfer the liability. T/F

Answer 7

TRUE

Question 8

The requirements of ASC 820, “Fair Value Measurement,” do not apply to inventory pricing. T/F

Answer 8

TRUE

Question 9

The fair value of a nonfinancial asset is based on its highest and best use by the reporting entity. T/F

Answer 9

FALSE

Question 10

The price determined in the principal or most advantageous market should be adjusted for transaction cost in arriving at fair value in applying the fair value option. T/F

Answer 10

FALSE

Question 11

Fair value determination must take into account the characteristics of the specific asset or liability being valued. T/F

Answer 11

TRUE

Question 12

The fair value of an asset is based on the price that would be paid to acquire the asset. T/F

Answer 12

FALSE

Question 13

In determining the highest and best use of an asset, it must be assumed that the asset will be used in combination with other assets as a group.

Answer 13

FALSE

Question 14

Fair value is based on a hypothetical transaction occurring in the principal or most advantageous market for the asset or liability being valued.

Answer 14

TRUE

Question 15

List the dates when an entity may elect to use fair value option for an eligible item.

Answer 15

When item is first recognized;
When firm commitment occurs;
When financial, an asset previously reported at fair value with unrealized gain/loss in earnings, no longer qualifies for that fair value treatment;
When accounting treatment for an investment changes because it becomes subject to the equity method or ceases to be eligible for consolidation;
When an item is measured at fair value at the time of an event, but does not require fair value measurement at subsequent reporting dates.

Question 16

List the financial assets and financial liabilities that entities may NOT use fair value to measure and report.

Answer 16

An investment in a subsidiary or variable interest to be consolidated;
Employers’ and plans’ obligations for pension benefits, other postretirement benefits, post-employment benefits;
Financial assets and liabilities under lease accounting;
Demand deposit liabilities of financial institutions;
Financial instruments classified by the issuer as a component of shareholders’ equity.

Question 17

List the items that entities may elect to measure and report at fair value.

Answer 17

Recognized financial assets or financial liabilities, (some exceptions);
Firm commitments;
Written loan commitments;
Rights and obligations under insurance contracts and warranties;
Other financial instruments embedded in non-financial derivative instruments.

Question 18

List the situations where the entry price may not be the exit price

Answer 18

The transaction is between related parties;
The transaction occurs when the seller is under duress;
The unit of account included in the transaction price is different from the unit of account that would be used to measure at fair value;
The market in which the transaction price occurred is different from the market in which the asset would be sold or the liability transferred.

Question 19

Define “exit price”.

Answer 19

The price that would be received to sell an asset or paid to transfer a liability.

Question 20

Define “entry price”.

Answer 20

The price paid to acquire an asset or the price received to assume a liability.

Question 21

Describe the cost approach for determining fair value for Generally Accepted Accounting Principles (GAAP) purposes.

Answer 21

This approach uses the amount currently required to replace the service capacity of an asset.

Question 22

Describe the income approach for determining fair value for Generally Accepted Accounting Principles (GAAP) purposes.

Answer 22

This approach converts future amounts to a single present amount.

Question 23

Describe the market approach for determining fair value for Generally Accepted Accounting Principles (GAAP) purposes.

Answer 23

This approach uses prices and other relevant information generated by market transactions involving assets or liabilities identical or comparable to those being valued.

Question 24

What are the three valuation techniques (or approaches) that should be used in determining fair value for Generally Accepted Accounting Principles purposes?

Answer 24

Market approach;
Income approach;
Cost approach.

Question 25

All financial assets and financial liabilities must be measured and reported at fair value. T/F

Answer 25

FALSE

Question 26

Property, plant, and equipment may be measured and reported using fair value. T/F

Answer 26

FALSE

Question 27

If, at acquisition of an asset or liability, the exit price of the item is different than the transaction price, a gain or loss should be recognized. T/F

Answer 27

TRUE

Question 28

Financial liabilities arising from a lease contract obligation can be measured and reported at fair value. T/F

Answer 28

FALSE

Question 29

A firm may elect to use the fair value option for an eligible firm commitment when it enters into the contract that establishes the firm commitment. T/F

Answer 29

TRUE

Question 30

The valuation technique(s) used to measure fair value can be changed every reporting period. T/F

Answer 30

FALSE

Question 31

A firm may not use the fair value option for investment in common stock which gives the investor significant influence over the investee. T/F

Answer 31

FALSE

Question 32

A firm may elect to use the fair value option for an eligible financial liability when it first recognizes the liability. T/F

Answer 32

TRUE

Question 33

A firm may elect at the beginning of each of its fiscal years to use the fair value option for eligible financial assets and financial liabilities. T/F

Answer 33

FALSE

Question 34

The price paid to acquire an asset or the price received to assume a liability is an exit price. T/F

Answer 34

FALSE

Question 35

Discounting a future stream of cash flows to its current value would be an example of the income approach to determining fair value. T/F

Answer 35

TRUE

Question 36

An employer’s prepaid pension asset account can be measured and reported at fair value. T/F

Answer 36

FALSE

Question 37

A subsidiary that is to be consolidated with its parent may elect the fair value option for eligible assets and liabilities on its books. T/F

Answer 37

TRUE

Question 38

A change in valuation technique(s) used to measure fair value would be treated as a change in accounting principle. T/F

Answer 38

FALSE

Question 39

Multiple valuation approaches will always be required to determine fair value. T/F

Answer 39

FALSE

Question 40

Describe fair value measurement inputs.

Answer 40

Inputs can be observable or unobservable. Observable inputs are based on market data from independent sources. Unobservable inputs are the entity’s assumptions about the factors that impact determination of fair value.

Question 41

What purpose does the fair value hierarchy serve?

Answer 41

To prioritize the inputs to valuation techniques used to measure fair value.

Question 42

What are the three levels of the fair value hierarchy and what does each consist of?

Answer 42

Level 1: highest level, are unadjusted quoted prices in active markets for assets and liabilities identical to those being valued.
Level 2: are observable for assets or liabilities, either directly or indirectly, other than quoted prices described in Level 1.
Level 3: lowest level, are unobservable and used to determine fair value only if observable inputs are not available.

Question 43

In the fair value hierarchy, level 3 inputs might include the reporting entity’s own data.

Answer 43

TRUE

Question 44

In the fair value hierarchy, level 3 inputs are unobservable for the asset or liability being valued.

Answer 44

TRUE

Question 45

In the fair value hierarchy, level 1 inputs may need to be adjusted for the blockage factor.

Answer 45

FALSE

Question 46

In the fair value hierarchy, level 2 inputs would include quoted prices for similar assets or liabilities in active markets.

Answer 46

TRUE

Question 47

Observable inputs used in determining fair value are developed based on market data obtained from sources independent of the reporting entity.

Answer 47

TRUE

Question 48

Level 3 in the fair value hierarchy is the lowest level and provides the least reliable evidence of fair value.

Answer 48

TRUE

Question 49

In the fair value hierarchy, level 1 inputs are the only acceptable inputs for fair value determination under GAAP.

Answer 49

FALSE

Question 50

In the fair value hierarchy, level 3 inputs should be developed based on what market participants would assume.

Answer 50

TRUE

Question 51

In the fair value hierarchy, level 1 inputs are derived from unadjusted quoted prices in active markets.

Answer 51

TRUE

Question 52

Level 1 in the fair value hierarchy is the highest level and provides the most reliable evidence of fair value.

Answer 52

TRUE

Question 53

Level 2 in the fair value hierarchy is based on observable inputs.

Answer 53

TRUE

Question 54

Valuation techniques used to determine fair value should use observable inputs to the greatest extent possible.

Answer 54

TRUE

Question 55

Unobservable inputs used in determining fair value are based on the reporting entity’s own assumptions using the best information available.

Answer 55

TRUE

Question 56

Inputs used in determining fair value include assumptions about the risk inherent in using a particular valuation technique.

Answer 56

TRUE

Question 57

What types of comparisons are fair value option disclosures intended to facilitate?

Answer 57

Between entities that choose different measurement methods for similar assets and liabilities;
Between assets and liabilities in the financial statements of an entity that selects different measurement for similar assets and liabilities.

Question 58

What significant fair value disclosures are required only in annual statements?

Answer 58

The methods and significant assumptions used to estimate fair value.

Question 59

Distinguish between assets and liabilities measured at fair value on a recurring basis and nonrecurring basis.

Answer 59

Assets and liabilities measured at fair value on recurring basis are adjusted to fair value period after a period. Assets and liabilities measured at fair value on a nonrecurring basis are adjusted to fair value only at the time of a particular event (e.g., significant modification of debt).

Question 60

What are the special disclosures required for fair value measurements (on a recurring basis) that are based on unobservable inputs (i.e., Level 3 inputs)?

Answer 60

Reconciliation of beginning and ending balances;
Description of the valuation process used;
Quantitative information about the unobservable inputs used;
Narrative description of the sensitivity of fair value to changes in unobservable inputs;
Unrealized gains/losses for the period and where reported.

Question 61

For each item measured under the fair value option that provides interest or dividend income, how those items of income are measured and where they are reported in the income statement must be disclosed.

Answer 61

TRUE

Question 62

Required fair value quantitative disclosures must be presented in a tabular format.

Answer 62

TRUE

Question 63

Management’s reasons for electing the fair value option must be disclosed for each elected eligible item.

Answer 63

TRUE

Question 64

For items measured at fair value on a nonrecurring basis, the reporting entity must disclose the fair value measurements at the reporting date and the reasons for the measurements.

Answer 64

TRUE

Question 65

Required disclosures about the use of the fair value option must be made for both the balance sheet and the income statement.

Answer 65

TRUE

Question 66

The methods and significant assumptions used to estimate fair value must be disclosed in both annual and interim reports.

Answer 66

FALSE

Question 67

Fair value measurements categorized as Level 1 of the fair value hierarchy require the greatest amount of disclosure.

Answer 67

FALSE

Question 68

A primary purpose of disclosures required under the fair value option is to facilitate comparisons by the user of financial statements.

Answer 68

TRUE

Question 69

Most fair value disclosures must be provided only in annual reports.

Answer 69

FALSE

Question 70

If other pronouncements require the use of fair value measurement and related disclosures, those disclosure requirements are superseded by fair value option disclosures.

Answer 70

FALSE

Question 71

Required disclosures under the fair value option must be made in both interim and annual financial statements.

Answer 71

TRUE

Question 72

The methods and significant assumptions used to estimate fair value must be disclosed only in annual reports.

Answer 72

TRUE

Question 73

Fair value disclosures required for items measured at fair value on a recurring basis are somewhat different than those measured at fair value on a nonrecurring basis.

Answer 73

TRUE

Question 74

Required disclosures under the fair value option must be made only in annual financial statements.

Answer 74

FALSE

Question 75

Most fair value disclosures must be provided in both interim and annual reports.

Answer 75

TRUE

Question 76

For each line item in the balance sheet which contains items measured under the fair value option, the amount of gains and losses from fair value changes included in the income statement must disclosed.

Answer 76

TRUE

Question 77

For fair value measurements that derive from level 3 inputs, the reporting entity must provide a reconciliation of the beginning and ending fair value balances for items so measured

Answer 77

TRUE

Question 78

For items measured at fair value on a recurring basis, the reporting entity must disclose the level within the fair value hierarchy in which the fair value measurements fall.

Answer 78

TRUE