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Flashcards in FAR - Fair Value Measurements & Changing Prices Deck (25):
1

IFRS and GAAP have worked standardized the fair value disclosure and measurements for all areas that requires Fair value measurement, except:

(1) ___-___ compensation

(2) Measurements based on or using ____-specific objective evidence of fair value, and

(3) Fair value measurement used for ____ classification or measurement.

IFRS and GAAP have worked standardized the fair value disclosure and measurements for all areas that requires Fair value measurement, except:

(1) SHARE-BASED compensation

(2) Measurements based on or using VENDOR-specific objective evidence of fair value, and

(3) Fair value measurement used for LEASE classification or measurement.

2

Fair value is the price that would be ____ to ___ an asset or paid to transfer a_____ in an orderly transaction between market participants in the ___ (or the most _____) market at the ____ date under current market conditions.

Fair value is 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 the most ADVANTAGEOUS) market at the MEASUREMENT date under current market conditions.

3

1. Fair value is measured for a ____ asset or liability, a ____ of assets and/or liabilities, or an entity's own ___ instrument (e.g. an ____ interest issued as consideration in a business combination).

2. Fair value is a ____-based measure, not an entity-based measure.

3. Fair value is measured in the _____ market for the asset or liability, or the most _____ market in the absence of a ____ market (other words: when there is no ____ market for it).

1. Fair value is measured for a SPECIFIC asset or liability, a GROUP of assets and/or liabilities, or an entity's own EQUITY instrument (e.g. an EQUITY interest issued as consideration in a business combination).

2. Fair value is a MARKET-based measure, not an entity-based measure.

3. Fair value is measured in the PRINCIPAL market for the asset or liability, or the most ADVANTAGEOUS market in the absence of a PRINCIPAL market. (other words: when there is no PRINCIPAL market for it).

4

4. Fair value is an ____ price (the price to sell an asset or transfer a liability), not an ___ price (the price to acquire an asset or assume a liability).

5. A fair value measure should reflect all of the assumptions that ____ ____ would use in pricing the asset or liability, including assumptions about __.

6. Fair value does not include ___ costs, but may include ___ costs if location is an attribute of the asset or liability, in other words the __ costs that involve getting the asset or liability to be ____ to the company's location.

4. Fair value is an EXIT price (the price to sell an asset or transfer a liability), not an ENTRANCE price (the price to acquire an asset or assume a liability).

5. A fair value measure should reflect all of the assumptions that MARKET PARTICIPANTS would use in pricing the asset or liability, including assumptions about RISK.

6. Fair value does not include TRANSACTION costs, but may include TRANSPORTATION costs if location is an attribute of the asset or liability in other words the TRANSPORTATION costs that involve getting the asset or liability to be TRANSPORTED to the company's location.

5

7. The fair value of a ____ asset assumes the ___ and best use of the asset. In other words, the buyer or the seller generates the most Economic Benefit that can utilize it at its ____ and best use.

8. The fair value of a liability should include the liability's ____ risk, which is the risk that the obligation will __ be ___.

9. The fair value of an entity's own equity instrument should be measured from the perspective of a ____ participant who ___ that instrument as an asset.

10. Fair value measurement assumes that a liability or an entity's own equity instrument is transferred to a market participant at the _____ date and assumes that the
liability or equity interest would remain _____ and would ___ be settled, cancelled, or extinguished on the measurement date.

7. The fair value of a NONFINANCIAL asset assumes the HIGHEST and BEST use of the asset. In other words, the buyer or the seller generates the most economic benefit that can utilize it at its HIGHEST and BEST use.

8. The fair value of a liability should include the liability's NONPERFORMANCE risk, which is the risk that the obligation will NOT be FULFILLED.

9. The fair value of an entity's own equity instrument should be measured from the perspective of a MARKET participant who HOLDS that instrument as an asset. (FYI - other words: in the buyer/seller's perspective who hold the equity instrument as an asset (like investment in a company's stock).

10. Fair value measurement assumes that a liability or an entity's own equity instrument is transferred to a market participant at the MEASUREMENT date and assumes that the liability or equity interest would remain OUTSTANDING and would NOT be settled, cancelled, or extinguished on the measurement date.

6

Define the following terms:

Orderly transaction

Market participants

Principal market

Most Advantageous market

Orderly transaction: It's not a forced transaction. It's where an asset and liability is out there in the market for sometime before measurement date for the market participants (buyers/sellers) to handle it in an usual and customary way (buyer transfer payment; seller transfers over asset)

Market participants: unrelated, independent buyers and sellers that have knowledge of the asset or liability and are able and are willing to transfer over asset or liability.

Principal market: the market with the GREATEST volume or GREATEST activity level for asset or liability. Fair value is used most in the principal market even the same asset or liability is also being sold in a different, advantageous market.

Most advantageous market: Market with the best price for asset or liability after analyzing/calculating the transaction costs. Note: transaction costs are not included in the fair value of asset / liability when analyzing the advantageous market's price. Also - Use advantageous market fair value price when principal market does not exist for asset or liability.

7

Example - most advantageous market

Exchange Quote Price Transaction cost
NY $1000 $55
LN $1050 $75

What is the price of stock in its most advantageous market?

Solution:

NY: $1000 - $55 = $945
LN: $1050 - $75 = 975

So, Answer: $1050 in LN.

(Note: it's not $975 because transaction costs actually not used to determine the actual fair value, but used to determine which fair value is the best).

8

Highest and best use analysis is used in

Non-financial assets

Liabilities

Or Finanncial assets

Or all of them.

Highest and best use only for Non-financial assets.

This involves the buyers/sellers that can generate the economic benefits when they have a highest and best use of a non-financial asset

Highest and best use analysis for measure fair value is not used in Liabilities and Financial assets because it's irrelevant and liabilities and financial assets do not have alternate uses and their use not rely on their use within a group or other assets or liabilities.

9

There are 3 techniques/methods for Fair value measurement as follows:

(1) Market approach

(2) income approach

(3) cost approach

What do each one mean?

(1) Market approach: Uses prices and other relevant information Market Transactions involving identical or comparable assets or liabilities to measure fair value.

(2) Income approach: Utilize discounted future cash flows or utilize future earnings to measure fair value of assets or liabilities.

(3) Cost approach: uses replacement cost to measure fair value. Even for calculating the gain / loss

(Example: Holding gain / loss on asset with

Purchase price = $8
Replacement price = $10
Holding gain = $10 − $8 = $2 gain)

10

Hierarchy of inputs -

Which one has the highest priority to determine fair value?

Level 1
Level 2
Or Level 3

Level 1 - because it's more reliable and used more when level 1 input info are available.

11

Hierarchy of inputs:

Level 1 inputs are ___________.

Level 2 inputs are ___________.

Level 3 inputs are ___________.

Level 1 = Quoted prices in ACTIVE markets for IDENTICAL assets or liabilities can be access on MEASUREMENT DATE.

Level 2 =
a. Quoted prices for similar assets or liabilities in active markets.
b. Quoted prices for identical or similar assets in markets that are not active.
c. Quoted prices for identical liabilities when traded as assets, if adjustments to the quoted market price of the assets are required.
d. Quoted prices for similar liabilities when traded as assets.
e. Inputs other than quoted prices that are observable for the asset or liability.
f. Inputs that are derived from or corroborated by observable market data.

c. Inputs other than quoted prices that are observable for the asset or liability, for example:

1. Interest rates and yield curves observable at commonly quoted intervals

2. Implied volatilities

3. Subparagraph superseded by Accounting Standards Update No. 2011-04

4. Subparagraph superseded by Accounting Standards Update No. 2011-04

5. Credit spreads

6. Subparagraph superseded by Accounting Standards Update No. 2011-04

d. Market-corroborated inputs.

FASB ASC 820-10-35-48

Level 3 inputs = unobservable inputs on asset or liability. Utilize company's assumption on best available data available to determine fair value on asset or liability.

12

What are 3 exceptions to the fair value measurement?

(1) Not practical to measure fair value

(2) Cannot reasonably determine fair value

(3) Not have sufficient reliability to measure fair value.

13

Define the following:

Historic cost

Current cot

Nominal dollars

Constant dollars

Historic cost = Actual purchase cost at time asset was purchased or liability assumed.

Current cost = Current replacement cost (incurred at present time). Use recoverable amount if lower.

Nominal dollars = Current dollars (not adjusted) for changes in purchasing power.

Constant dollars = Dollar amounts that always change / restated using Consumer Price Index (CPI)

14

Define the following:

Historic cost / nominal dollars (HCND)

Historic Cost / Constant Dollars (HCCD)

Current cost / nominal dollars (CCND)

Current cost / constant dollars (CCCD)

Historic cost / nominal dollars (HCND): Historic prices without changing/restating the dollar amount.

Historic Cost / Constant Dollars (HCCD): Historic prices adjusted for changes in generalpruchase power of the dollar using the Bureau Labor Statistics - Consumer Price Index (BLS-CPI)

Current cost / nominal dollars (CCND): Current cost without restatement/changes in dollar amount (dollar's purchasing power)

Current cost / constant dollars (CCCD): Current cost adjusted for changes in dollar amounts (dollar's purchasing power).

15

Define the following:

Monetary assets / liabilities


Non-monetary assets / liabilities:

Monetary assets: The FASB defines monetary assets as "money or a claim to receive a sum of money the amount of which is fixed or determinable without reference to future prices of specific goods or services."

Monetary liabilities: money or claim to pay sum of money that is fixed or determinable without reference to future price.

Non-monetary assets: prices on assets / liabilities that fluctuate with inflation and deflation.

16

Holding monetary assets >> will have Purchasing power gains during a period of _____

Holding monetary assets >> will have Purchasing power loss during a period of _____

Holding Non-monetary liabilities >> will have a Purchasing power gain during a period ____

Holding Non-monetary liabilities >> will have a Purchasing power loss during a period ____

Holding monetary assets >> will have Purchasing power gains during a period of DEFLATION

Holding monetary assets >> will have Purchasing power loss during a period of INFLATION

Holding Non-monetary liabilities >> will have a Purchasing power gain during a period INFLATION

Holding Non-monetary liabilities >> will have a Purchasing power loss during a period DEFLATION

17

(a) Historic cost / nominal dollars deal with:

Monetary Purchasing Power Gain / loss (INFLATION) - Yes or No??

(b) Historic cost / Constant dollars deal with:

Monetary Purchasing Power Gain / loss (INFLATION) - Yes or No??

(c) Current cost / Nominal dollars deal with:

Monetary Purchasing Power Gain / loss (INFLATION) - Yes or No??

(d) Current cost / constant dollars deal with:

Monetary Purchasing Power Gain / loss (INFLATION) - Yes or No??






Monetary Purchase Power Gain / Loss (inflation):

Historic cost / nominal dollars - No
(this because nominal dollars mean $$ amount not change)

Historic cost / Constant dollars - Yes
(this because constant dollars means $$ amounts change)

Current cost / nominal dollars - No
(this because nominal dollars mean $$ amount not change)

Current cost / constant dollars - Yes
(this because constant dollars means $$ amounts change)

18

(a) Historic cost / nominal dollars deal with:

Non-Monetary Holding Power Gain / loss (APPRECIATION) - Yes or No??

(b) Historic cost / Constant dollars deal with:

Non-Monetary Holding Power Gain / loss (APPRECIATION) - Yes or No??

(c) Current cost / Nominal dollars deal with:

Non-Monetary Holding Power Gain / loss (APPRECIATION) - Yes or No??

(d) Current cost / constant dollars deal with:

Non-Monetary Holding Power Gain / loss (APPRECIATION) - Yes or No??





Non-Monetary Holding Power Gain / loss (APPRECIATION)

Historic cost / nominal dollars - No
(this because Historic cost is the first purchase cost that does not change when dealing with appreciation. Historic cost does not need to be changed/altered since it's needed to compare historic cost to current/replacement cost to determine the fair value or current $ price of asset / liability)

Historic cost / Constant dollars - No
(this because Historic cost is the first purchase cost that does not change when dealing with appreciation. Historic cost does not need to be changed/altered since it's needed to compare historic cost to current/replacement cost to determine the fair value or current $ price of asset / liability)

Current cost / nominal dollars - Yes
(Yes - because current cost means what is the value of asset or liability at a future point in time when it's appreciated)

Current cost / constant dollars - Yes
(Yes - because current cost means what is the value of asset or liability at a future point in time when it's appreciated)

19

Monetary or Non-monetary

Assets
-------
* Cash
* Marketable common stock
* Bonds-non-convertible
* Accounts/notes receivable (and allowance)
* Inventory
* Long-term receivables
* Investment in subsidiary (equity)
* Plan, property, and equipment (and accum. depr.)
* Intangible assets-patents and trademarks

Liabilities
----
* Accounts and notes payable
* Accrued expenses
* Bonds/notes payable
* Deferred charges and credits

Equity
---
* Preferred stock
* Common stock
* Retained earnings is neither. Use as a residual
(plug).

Assets
-------
Monetary items:
* Cash
* Bonds-non-convertible
* Accounts/notes receivable (and allowance)
* Long-term receivables

(FYI - these are monetary because above have fixed price / determinable to be received at a later date and not altered due to future price info)

Non-monetary items:
* Marketable common stock
* Inventory
* Investment in subsidiary (equity)
* Plan, property, and equipment (and Accum. Depr.)
* Intangible assets-patents and trademarks

(FYI - above are non-monetary because these items have $$ amounts that will change over time)

Liabilities
----
Monetary items:
* Accounts and notes payable
* Accrued expenses
* Bonds/notes payable

(FYI - above are Monetary because these items have fixed $$ amounts to paid at later time without alterations due to future prices)

Non-monetary items:
* Deferred charges and credits

(FYI - above are non-monetary because these items have $$ amounts that will change over time)

Equity
--
Preferred Stock - Non-monetary
Common Stock - Non-monetary

(FYI - above are non-monetary because these items have $$ amounts that will change over time)

Retained Earnings - Neither monetary or non-monetary

20

Constant dollars are dollars of equal purchasing power. To convert historical cost dollars to constant dollars, the

following formula is ??

    

Historical         Current Year's

      Cost                 Index              Constant

     to Be       x    ---------------    =     Dollar

    Restated          Base Year's Index       Index

21

Define the following:

General price-level accounting

Current value accounting

General price-level accounting: A method of financial reporting whereby financial statement items are restated so that each item is reported in terms of monetary units with the same purchasing power. Generally accepted accounting principles are maintained in general price-level accounting, and restatement is made only to adjust for changes in the general purchasing power of the monetary unit. (This method is identified as “constant purchasing power accounting” by the FASB.)

Current value accounting: A method of financial reporting whereby financial statement items are measured
and reported at their current value, as determined by one of several valuation approaches. GAAP, including
historical cost, are not maintained in current value accounting, and financial statement items are restated to
reflect changes in value, even though the changes have not been evidenced by an exchange transaction.
(The FASB's version of this method is called “current cost accounting.”)

22

FASB ASC 825-10-15-5 lists the following items that are not eligible for the fair value election:

a. An investment in a subsidiary that the entity is required to ____

b. An interest in a ____ interest entity that the entity is required to consolidate

c. Employers' and plans' obligations (or assets representing net overfunded positions) for ___ benefits, other ___ benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred
compensation arrangements, as defined in [FASB ASC] Topics 420; 710; 712; 715; 718; and 960.

d. Financial assets and financial liabilities recognized under ____ as defined in [FASB ASC] Subtopic 840-10 (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)

e. Deposit ____, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions

f. Financial instruments that are, in whole or in part, classified by the issuer as a component of ___ ____ (including “____ equity”). An example is a convertible debt security with a noncontingent beneficial conversion feature.

FASB ASC 825-10-15-5 lists the following items that are not eligible for the fair value election:

a. An investment in a subsidiary that the entity is required to CONSOLIDATE

b. An interest in a VARIABLE interest entity that the entity is required to consolidate

c. Employers' and plans' obligations (or assets representing net over-funded positions) for PENSION benefits, other POST-RETIREMENT benefits (including health care and life insurance benefits), post-employment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in [FASB ASC] Topics 420; 710; 712; 715; 718; and 960.

d. Financial assets and financial liabilities recognized under LEASES as defined in [FASB ASC] Subtopic 840-10 (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)

e. Deposit LIABILITIES, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions

f. Financial instruments that are, in whole or in part, classified by the issuer as a component of SHAREHOLDERS' EQUITY (including “TEMPORARY equity”). An example is a convertible debt security with a non-contingent beneficial conversion feature.

23

FASB ASC 825-10-15-4 lists the following items that are eligible for the fair value election:

a. A recognized financial asset and financial liability, except any listed in the following paragraph

b. A firm commitment that would otherwise not be recognized at ___ and that involves only ___ instruments (An example is a forward purchase contract for a loan that is not readily convertible to cash. That commitment involves only financial instruments—a loan and cash—and would not otherwise be recognized because it is not a derivative instrument.)

c. A written ___ commitment

d. The rights and obligations under an ___ contract that is not a ___ instrument (because it requires or permits the insurer to provide goods or services rather than a ___ settlement) but whose terms permit the insurer to settle by paying a ___ party to provide those goods or services

e. The rights and obligations under a ___ that is not a financial instrument (because it requires or permits the ____ to provide goods or services rather than a ___ settlement) but whose terms permit the ____ to settle by paying a ___ party to provide those goods or services

f. A host financial instrument resulting from the separation of an embedded ____ derivative instrument from a ___ hybrid instrument under [FASB ASC] 815-15-25-1, subject to the scope exceptions in paragraph 8. (An example of such a ___ hybrid instrument is an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash.)

FASB ASC 825-10-15-4 lists the following items that are eligible for the fair value election:

a. A recognized financial asset and financial liability, except any listed in the following paragraph

b. A firm commitment that would otherwise not be recognized at INCEPTION and that involves only FINANCIAL instruments (An example is a forward purchase contract for a loan that is not readily convertible to cash. That commitment involves only financial instruments—a loan and cash—and would not otherwise be recognized because it is not a derivative instrument.)

c. A written LOAN commitment

d. The rights and obligations under an INSURANCE contract that is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a CASH settlement) but whose terms permit the insurer to settle by paying a THIRD party to provide those goods or services

e. The rights and obligations under a WARRANTY that is not a financial instrument (because it requires or permits the WARRANTOR to provide goods or services rather than a CASH settlement) but whose terms permit the WARANTOR to settle by paying a THIRD party to provide those goods or services

f. A host financial instrument resulting from the separation of an embedded NONFINANCIAL derivative instrument from a NONFINANCIAL hybrid instrument under [FASB ASC] 815-15-25-1, subject to the scope exceptions in paragraph 8. (An example of such a NONFINANCIAL hybrid instrument is an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash.)

24

Fair value option method:

What is the net income with Company A's investment in company B?

Info:
Purchase investment at $400,000
This is 30% control of Company B's voting stock.

Company B's net income in year 1 = $60,000
Company B paid dividends in year 1 = $20,000
Investment in Company B fair value = $410,000

$400,000 purchase / investment
+ 18,000 income ($60,000 x 0.30 control)
-------
= $418,000
- $6,000 Dividends ($20,000 x 0.30)
------
= $412,000 balance equity method

Then: Fair value adjustment towards Net income

$412,000 balance - $410,000 fair value in Company B investment
= $2,000

Then:

$18,000 net income (from 0.30 control x $60,000)
- $2,000
-------
$16,000 net income via fair value method

25

Fair value method - what is the income loss attribute to investment to be reflected in earnings for parent company?

Info:

Parent company bought 5000 shares of 500,000 outstanding shares in Company B.
Purchase $$ amount is $35,000

Parent company received $1,800 dividends
Fair value investment at year end is 32,000

Solution:

Here Parent company has 0.01 ownership of Company B.
Therefore, dividends received is income. Not reduction in investment in company B.

Therefore: calculation:

$1,800 dividend
- $3000 (change in value: $35,000 purchase - $32,000 FV)
-----
= $(1,200) net loss

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