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Flashcards in FAR 3 - Fair Value Framework Deck (36):
1

Which of the following statements concerning the determination of fair value is/are correct?
I. The determination of fair value is based on a hypothetical transaction.
II. The determination of fair value is based on an exit price.
III. The determination of fair value of a nonfinancial asset should be based on the intended use of the asset by the reporting entity.

Both Statements I and II are correct. The determination of fair value is based on a hypothetical transaction and on the use of a (hypothetical) exit price.
Statement III is not correct. The determination of fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants, not based on the intended use by the reporting entity.

2

A company owns a financial asset that is actively traded on two different exchanges (market A and market B). There is no principal market for the financial asset. The information on the two exchanges is as follows

Market A: Price $1,000; Transaction cost $ 75
Market B: Price $1,050; Transaction cost $150

What is the fair value of the financial asset?

The fair value of the financial asset is $1,000, the quoted price in the most advantageous market, but without adjusting that price for transaction costs. Since there is no principal market for the financial asset, the most advantageous market must be used to determine fair value. The most advantageous market is the market that maximizes the amount that would be received to sell the asset (or minimizes the amount that would be paid to transfer a liability), after taking into account transaction costs and transportation costs. Thus, the most advantageous market is Market A, determined as:

Market A Market B
Quoted price of asset $1,000 $1,050
Transaction cost ( 75) ( 150)
Net Proceeds $ 925 $ 900

Even though transaction costs are considered in determining the most advantageous market, the price in the most advantageous (or principal) market used to measure the fair value of the asset (or liability) is not adjusted for transaction costs [ASC 820-10-35-9B]. Therefore, the quoted price of the asset in the most advantage market, unadjusted for the transaction costs, is fair value.

3

In determining the fair value of an asset in the most advantageous market, the market based exit price should be adjusted for:
A. Transaction Cost
B. Transportation Cost

B. only
In determining the fair value of an asset in the most advantageous market, the market based exit price would not be adjusted for transaction cost associated with executing the (hypothetical) transaction, but would be adjusted for transportation cost to get the asset to the principal or most advantageous market.

4

T/F: In the determination of fair value of a nonfinancial asset, the highest and best use of the asset may be determined as occurring through use and/or through exchange.

True. Both. The highest and best use of a nonfinancial asset (i.e., its maximum value) to market participants may occur either principally through its use with other assets or principally on the price that would be received to sell (exchange) the asset.

5

For which of the following circumstances is the guidance for determining fair value as provided in the fair value framework presented in ASC 820, "Fair Value Measurement," least likely to apply?
A. Determination of the fair value to be assigned to land acquired in a business combination.
B. Determination of the fair value of a bond liability for applying the fair value option.
C. Determination of the fair value of legal services received in exchange for an entity's common stock.
D. Determination of the fair value of a production facility when assessing whether or not an impairment loss has occurred.

C. The guidance for determining fair value provided in the fair value framework is not appropriate for determining the fair value of legal services received in exchange for an entity's common stock. ASC 820 specifically exempts share-based payment transactions (and inventory valuing and other minor items) from the purview of the fair value framework.

6

On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.'s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody's investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?

Since Peabody has elected to report the investment in Newman using the fair value option, it should recognize its share of cash dividends received during the period (.30 x $20,000 = $6,000) and the increase in the fair value of the investment ($400,000 > $410,000 = $10,000), or $6,000 + $10,000 = $16,000.

7

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

True

8

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

False

Fair value of an asset is based on the price that would be received to sell the asset.

9

Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?
A. Market.
B. Income.
C. Cost.
D. Observable inputs.

B. The income approach to fair value measurement of an asset measures fair value by converting future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.

10

Which one of the following financial items may not be measured and reported at fair value at the election of an entity?
A. Accounts receivable.
B. Investment in debt securities to be held to maturity.
C. Investment in a subsidiary that is to be consolidated.
D. Accounts payable

D. A firm may not use fair value to measure and report an investment in a subsidiary that is to be consolidated. The financial asset "Investment in subsidiary" will be eliminated in the consolidating process and be replaced by the subsidiary's assets and liabilities (and possibly goodwill) on the consolidated balance sheet.

11

In determining the fair value of an asset or liability, would the fair value of the asset or the fair value of the liability be determined using an entry price or an exit price?

The appropriate basis for determining the fair value of an asset or a liability is an exit price.

12

When the fair value of an asset is determined as the amount that currently would be required to replace the service capacity of the asset, which one of the following valuation techniques has been used?
A. Income approach.
B. Cost approach.
C. Expense approach.
D. Market approach.

B. When fair value is determined as the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), the cost approach has been used.

13

Which of the following valuation methods may be used to measure investments classified as held-to-maturity?
A. Amortized Cost
B. Fair Value

Both A and B may be used to measure and report investments classified as held-to-maturity.
Amortized cost is the traditional measurement method for investments held-to-maturity and would be used unless an entity elects to use fair value, which is permitted by the fair value option.

14

Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny's carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000. At what amount should the land and building be reported on Papa's consolidated statements prepared immediately after the transaction?

Land = $60,000
Building = $50,000
Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be "eliminated" so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)

15

T/F: 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.

True

16

T/F: 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.

True
The entity cannot apply the fair value option prior to the firm commitment being established.

17

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

True

18

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

False
Entities may NOT use fair value measurement for Financial assets and liabilities recognized under lease accounting

19

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

False
Entities may NOT use fair value measurement for Financial assets and liabilities recognized under lease accounting

20

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

False
It's a change in accounting estimates.

21

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

False
When the investor has significant influence over the investee, the fair value option can be used.

22

Which of the following statements concerning the fair value hierarchy used in ascertaining fair value is/are correct?

I. Quoted market prices should be adjusted for a "blockage factor" when a firm holds a sizable portion of the asset being valued.

II. Quoted market prices in markets that are not active because there are few relevant transactions cannot be used.

Neither Statement I nor Statement II is correct.
Quoted market prices should not be adjusted for a "blockage factor" when a firm holds a sizable portion of the asset being valued (Statement I). A "blockage factor" occurs when an entity holds a sizable portion of an asset (or liability) relative to the trading volume of the asset or liability in the market. Using a "blockage factor" would adjust the market value for the impact of such a large block of securities being sold, but is not permitted in determining fair value. Additionally, quoted market prices in markets that are not active because there are few relevant transactions can be used in determining fair value (Statement II). Such prices would be considered level 2 factors, observable inputs but not in active markets.

23

Observable inputs, other than quoted prices in active markets for identical items, would constitute what level in the fair value hierarchy?

Level 2 inputs are observable for assets or liabilities, either directly or indirectly, other than quoted prices in level 1. For example, quoted prices for similar items in an active market would be level 2 inputs.

24

Each of the following would be considered a Level 2 observable input that could be used to determine an asset or liability's fair value, except
A. Quoted prices for identical assets and liabilities in markets that are not active.
B. Quoted prices for similar assets and liabilities in markets that are active.
C. Internally generated cash flow projections for a related asset or liability.
D. Interest rates that are observable at commonly quoted intervals.

C. This response is a false statement—internally generated cash flow projections are not an observable input.

25

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

True

26

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

True

27

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

True

28

Which of the following statements, if any, concerning disclosures about fair value measurements in periods subsequent to initial recognition is/are correct?
I. The fair value hierarchy level within which fair value measurements fall must be disclosed.
II. Quantitative fair value measurement disclosures must be in tabular format.

Both I and II are correct. Fair value measurement disclosures require both that fair value amounts be disclosed separately for each level of the fair value hierarchy and that quantitative disclosures be provided in tabular format.

29

When an entity uses the fair value option for eligible financial assets and liabilities, which one of the following is not an expected outcome of the disclosures required of that entity?
A. Users being able to understand management's reasons for using the fair value option.
B. Users being able to understand how changes in fair value affect net income.
C. Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value.
D. Users being able to understand the difference between fair value and cash flows.

C. The disclosures required when the fair value option is used are not intended to replace the kind and amount of information that would have been provided if the fair value option had not been used. Rather, the intent is to provide the same kind and amount of information that would have been provided if the fair value option had not been elected.

30

Under U.S. GAAP the disclosure requirements when fair value measurement is used are differentiated by which of the following classifications?
A. Between assets measured at fair value and liabilities measured at fair value.
B. Between fair value measurements that result in gains and fair value measurements that result in losses.
C. Between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis.
D. Between items for which fair value measurement is required and items for which fair value measurement is elected.

C. Disclosure requirements when fair value measurement is used are differentiated between items measured at fair value on a recurring basis and items measured at fair value on a non-recurring basis. Items measured at fair value on a recurring basis are adjusted to (measured at) fair value period after period; an example would be investments held-for-trading. Items measured at fair value on a non-recurring basis are adjusted to (measured at) fair value only when certain conditions are met; an example would be the impairment of an asset.

31

Which level of the fair value hierarchy, if any, requires the greatest amount of disclosures?

Level 3 is the lowest level in the fair value hierarchy. It consists of unobservable inputs and requires the greatest amount of disclosures.

32

For a firm that elects to measure certain of its financial assets and financial liabilities at fair value, required financial statement disclosures are intended to facilitate which of the following comparisons?
I. Comparisons between entities that use different measurement methods for similar assets and liabilities.
II. Comparisons between assets and liabilities of a single entity that uses different measurement methods for similar assets and liabilities.

Both Statements I and II are correct. The intended purposes of financial statement disclosures required of a firm that elects to use fair value measurement are to facilitate comparisons both across firms and for differently measured financial assets and liabilities of a single firm.

33

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

False
Only a MUST for annual reports.

34

T/F: Transfers in and transfers out of each level of the fair value hierarchy must be disclosed.

True

35

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

True

36

T/F: Management's reasons for electing the fair value option must be disclosed for each elected eligible item.

True

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