FAR 3E Fair Value Flashcards
(25 cards)
How is fair value for an asset determined under ASC 820?
✅ Price received in an orderly transaction between market participants
✅ Measured in the principal market, or if none, the most advantageous market
✅ Excludes transaction costs
✅ May include transportation costs if location is relevant
❌ Does not use internal cost structures or internal markets unless accessible to other market participants
How does ASC 820 treat transaction and transportation costs in fair value measurement?
✅ Transaction costs (incremental direct costs to sell or transfer) are excluded from fair value
✅ Transportation costs are included only if location is a characteristic of the asset or liability
✅ Per ASC 820-10-35-8, fair value must reflect the cost to transport the asset/liability to or from its principal (or most advantageous) market if applicable
❌ Transportation costs are not considered transaction costs
How is fair value determined when a quoted price in an active market for an identical asset is available?
✅ Use the quoted price for the identical asset in the active market
✅ Do not adjust this price for transaction costs or internal estimates
❌ Do not use prices for similar assets or internal valuation models if a quoted price is available
✅ This represents the exit price at the measurement date
Can a company elect the fair value option for an investment that qualifies for the equity method due to significant influence?
✅ Yes — a company may elect the fair value option even if it has significant influence
✅ The election is made at initial recognition and is irrevocable
✅ Once elected, the investment is not accounted for using the equity method
✅ All changes in fair value are recognized in net income
🔒 Based on guidance from ASC 825-10-15-4 and 15-5
Is fair value considered at year-end when applying the equity method of accounting?
❌ No — year-end fair value is ignored under the equity method
✅ Income recognized = investor’s share of investee’s net income
✅ Dividends received = reduction of investment, not income
✅ The investment is carried at cost + share of income – dividends received
✅ Changes in market value are not recognized unless there’s impairment
How is fair value determined when there is no principal market but multiple accessible markets?
✅ Use the most advantageous market — the one that maximizes the asset’s exit price
✅ The entity must have access to the market at the measurement date
✅ Quoted price in that market determines fair value (excluding transaction costs)
❌ Do not average prices or use an internal model if active market prices are available
What is the market approach to fair value measurement?
📊 Uses prices and observable data from identical or comparable market transactions
🧮 Includes techniques like matrix pricing based on current spreads and yields
🧠 Appropriate when direct quotes are unavailable but similar market data exists
❌ Does not rely on internal forecasts or unobservable assumptions like in the income approach
🛠️ Typically used for fixed income securities such as private placements
How are transaction costs treated when determining fair value in the absence of a principal market?
🧭 Use the most advantageous market — the one that yields the highest net proceeds (price minus transaction costs)
💲 Transaction costs are used only to identify the most advantageous market
🏷️ Fair value is the quoted price in that market — do not subtract transaction costs from the recognized fair value
❌ Do not adjust the fair value measurement for transaction costs after identifying the market
How are principal and most advantageous markets used in fair value measurement?
🏛️ Principal market: The market with the greatest volume and level of activity for the asset or liability
🧭 Most advantageous market: Used only if no principal market exists; it’s the market that maximizes the selling price (or minimizes the transfer price) after considering transaction costs
💡 Once the market is identified, the fair value is the quoted price in that market — do not subtract transaction costs from it
❌ Do not use internal estimates or average prices across markets
What are the three levels of the fair value hierarchy?
📈 Level 1 inputs — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date
📊 Level 2 inputs — Inputs other than Level 1 that are observable, such as:
- Quoted prices for similar assets/liabilities in active markets
- Quoted prices for identical/similar assets in inactive markets
- Other observable market data (e.g., interest rates, yield curves)
🔒 Level 3 inputs — Unobservable inputs that rely on the entity’s own assumptions and require significant judgment or estimation
What types of items are eligible for the fair value option election under the guidance?
💼 Recognized financial assets and liabilities (unless specifically excluded)
🤝 Firm commitments involving only financial instruments (e.g., forward loan contracts)
📝 Written loan commitments
🛡️ Insurance contracts (not financial instruments) that allow settlement via third party
🧰 Warranties (not financial instruments) that allow settlement via third party
🔀 Host financial instruments separated from embedded nonfinancial derivatives in hybrid contracts
❗ Election must be made at initial recognition and is irrevocable
What items are not eligible for the fair value option election?
❌ Investments in consolidated subsidiaries
❌ Pension or postretirement benefit plan assets/liabilities
❌ Financial assets or liabilities classified as lease contracts under lease accounting guidance
❌ Deposit liabilities of depository institutions
❌ Financial instruments classified as equity
❌ Financial instruments required to be classified as a component of other comprehensive income (OCI)
❌ Written loan commitments for loans held for sale, measured at lower of cost or fair value
📌 These exclusions are listed in ASC 825-10-15-5
Can the fair value option be applied to only part of a financial instrument (e.g., a specific risk or cash flow)?
❌ No — the fair value option must be applied to the entire financial instrument
🧩 An entity cannot apply it selectively to individual risks, cash flows, or features
📌 Example: If an entity holds a callable bond, it cannot elect the fair value option for just the callable feature — the entire bond must be measured at fair value
🧾 The election is made instrument by instrument, but covers the whole instrument, unless a specific exception applies (e.g., bifurcation under derivative accounting)
🔒 Once elected, the fair value option is irrevocable unless a new election date arises
What are examples of Level 2 inputs in fair value measurement?
📈 Quoted prices for similar assets or liabilities in active markets
🧾 Quoted prices for identical or similar assets or liabilities in inactive markets
📊 Observable market data, including:
- Interest rates and yield curves at commonly quoted intervals
- Implied volatilities
- Credit spreads
- Market-corroborated inputs
🔁 Level 2 inputs are indirectly observable and must cover substantially the full term of the asset or liability if it has a contractual life
❌ Do not include unobservable inputs or entity-specific assumptions — those are Level 3
How is fair value measured for a building?
🏢 Use the principal market with the highest volume and activity
❌ Transaction and internal costs are excluded from fair value
🚚 Transportation costs are not included, since location is not a relevant characteristic for a building
Are leases eligible for the fair value option?
❌ No — financial assets or liabilities classified as leases are not eligible for the fair value option
What other items are not eligible for the fair value option?
❌ Investments in entities required to be consolidated (e.g., variable interest entities)
❌ Pension and postretirement benefit obligations
❌ Equity instruments classified as equity, including convertible debt
❌ Lease contracts
When is fair value adjusted for transportation costs?
🚚 If location is a characteristic of the asset (e.g., commodities), fair value includes transportation costs to the relevant market
🏢 If location is not relevant (e.g., buildings, financial assets), no transportation adjustment is made
❌ Do not include general transaction or internal costs in fair value
What are the key disclosure requirements for fair value measurements?
📊 Disclose the fair value hierarchy level (Level 1, 2, or 3) for each class of assets and liabilities measured at fair value
📆 Separate disclosures for recurring (e.g., trading securities) and nonrecurring (e.g., impaired assets) fair value measurements
🛠️ For each class, disclose the valuation techniques and inputs used
❗ Required for both items measured on a recurring basis and on a nonrecurring basis
What additional disclosures are required for Level 3 fair value measurements?
🧠 Reconciliation of beginning and ending balances, showing:
- Total gains/losses (in earnings or OCI)
- Purchases, sales, issuances, and settlements
📉 Disclosure of valuation processes and sensitivity to changes in unobservable inputs
🔍 Narrative description of how fair value was determined
❗ Level 3 disclosures help users understand the subjectivity and risk in valuation estimates
What is the difference between recurring and nonrecurring fair value measurements?
🔁 Recurring: Fair value is measured at every reporting period (e.g., trading securities, derivatives)
🧯 Nonrecurring: Fair value is measured only when required by triggering events (e.g., asset impairment, business combinations)
📆 Recurring is ongoing by nature; nonrecurring is event-driven
🔍 Disclosures must separately identify which measurements are recurring vs. nonrecurring
What are examples of recurring and nonrecurring fair value measurements?
✅ Recurring examples:
- 📈 Trading securities
- 🔁 Derivatives measured at fair value
- 💵 Available-for-sale debt securities (if FV is used in reporting)
✅ Nonrecurring examples:
- 🏢 Asset impairments (e.g., PPE or goodwill write-downs)
- 📦 Inventory write-downs to NRV
- 🧩 Allocation of purchase price in business combinations
What is the income approach to fair value measurement?
💰 Uses present value techniques to estimate fair value
🧮 Converts future cash flows or earnings into a single discounted amount
🔑 Key inputs: estimated cash flows, discount rates, timing of payments
📘 Common methods: discounted cash flow (DCF), option pricing models
❗ Requires careful judgment — often used when observable market data is limited
What is the cost approach to fair value measurement?
🛠️ Based on the cost to replace or reproduce an asset with one of comparable utility
🔧 Reflects current replacement cost, adjusted for depreciation and obsolescence
🏢 Commonly used for specialized tangible assets (e.g., machinery, custom buildings)
❗ Focuses on the economic benefit the asset provides, not market pricing
