Flashcards in FAR - Framework/Overview - FASB, Fair Value Framework Deck (39):
FV measurement is elected; the firm must use the framework for determining (measuring) fair value
framework for determining (measuring) FV must be followed (limited exceptions) whenever FV measurement is used, either as required by GAAP or permitted by GAAP as an alternative that is elected by an entity.
A invests in B for 20% of stock, B makes dividend of $5, and A's investments at year end increases by $1. A uses FV measurement of investment. What's is A's net income for the year?
A's net income is 20% of B's dividend = $1 + $1 of A's increase of his investment totaling $2.
Net income = increase of investment at measurement date + percentage of dividends.
If there is no advantageous market available (principal market), how to compute the fair value?
If asset is quoted in several markets, take the quote price - transaction cost = net proceed, market with the highest net proceeds will be the market of which fair value will be reflected in order to maximize the most the firm can receive with the lowest costs = highest gross profit.
Fair value is measured at the exit price
By definition, the fair value for an asset or liability is measured as the price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants
Which costs can adjust FV of asset/liability?
Only transportation costs, not transaction costs.
Purpose of FV framework?
1) Definition of FV for GAAP
2) Framework to determine FV
3) Expanded Disclosures
Inventory reported at LCM is exempt from FV measurement
LCM use places upper ("ceiling") and lower ("floor") limits on the measurement of "market" that may not result in a true fair value measurement. measurement of inventory at "market" is one of the few exceptions
What elements must undergoe when determining asset at FV and is intended for highest and best use?
1) physically possible
2) legally permissible
3) financially feasible
ASC 820 exempts share-based payment transactions (and inventory valuing) from fair value framework.
Inventory and common stock transactions are exempt
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.
highest/best use of a nonfinancial asset (its max 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.
Define "exit price".
price received to sell asset/paid to transfer a liability.
Define "entry price".
price paid to acquire asset/price received to assume a liab
3 measurement techniques for recognition/measurement of FV
1) market - based on market transaction of assets/liab that are identical/similar
2) income - discount future amounts to present value
3) cost - consider replacement costs
When does entry price and exit price differ?
1) transaction between related parties
2) seller is under duress (liquidation sale)
3) unit of acct/measure is different from unit of acct used to measure asset/liab at FV
4) market in which transaction price takes place is different from principal market
Assets/liab entities cannot use FV to measure/report
1) investment in a subsidiary (consolidation)
2) interest in a Variable Interest Entity (consolidation)
3) pension benefits/employee-oriented plans
4) leased acct - financial assets/liab
5) bank demand deposit liab
6) instruments as a component of S/H equity
Dates when entity may elect FV option
1) item is recognized
2) firm commitment established
3) item's acct treatment ceases
4) investment subject to equity method acct OR to a VIE no longer consolidated
5) required item due to business combination or modification to debt instrument
Items allowed to measure and report at FV
1) recognized financial assets/liab
2) firm commitments
3) rights/obligations under insurance contracts/warranties
4) written loan commitments
5) financial instruments embedded in non-financial derivative instruments
Investments held-to-maturity can be measured via the valuation methods: 1) amortized cost and 2) fair value
Both amortized cost and fair value 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.
What is the FV of an asset/liab?
firm changes the valuation approach used to determine fair value, how would the amount of change in fair value resulting from the change in the valuation approach be reported?
Change in an accounting estimate -> reported under current income as income from continuing operations
Can a parent company elect to report its investments and subsidiaries' investments held-for-maturity at FV?
parent may elect to report all of the investments held-to-maturity at fair value in its consolidated statements (only)
principal market is active and available for an item, use the market price from this principal market even if it allows the entity other profitable options with a higher return.
Always use principal market, regardless of other options.
Parent reports any assets acquired from subsidiary on consolidated financials at historical cost -> NOT FV.
Consolidated financials -> show no profit/gains/losses -> historical cost
Parent reports any assets acquired from subsidiary on ITS financial statements at FV
Parent's financials -> allowed to report at FV (not consolidated financials)
Exit and entry price differ when transaction holds a related party
Majority S/H may sell asset to an entity; therefore exit price (FV) may be different from the entry price (acquisition/transaction cost)
Describe fair value measurement inputs.
assumptions/data used in valuation techniques:
observable: based on market data from independent sources
unobservable: entity's assumptions about factors that impact determination of fair value
What are the three levels of the fair value hierarchy and what does each consist of?
Level 1 - highest level, observable inputs, quoted market prices for assets/liab, identical to those being valued
Level 2 - observable inputs, directly/indirectly, other than those described in one, most likely based off quoted prices of similar assets/liab or identical prices in non-active markets
Level 3 - lowest level, unobservable inputs, based on entity's internal data and assumptions
What purpose does the fair value hierarchy serve?
prioritize/rank the inputs to valuation techniques used to measure FV
In level 1, input must be adjusted for the blockage factor
inputs may not be adjusted for the blockage factor (entity owns sizeable position int he asset/liab relative to trading volume in the market)
What significant fair value disclosures are required ONLY in ANNUAL statements?
Methods and significant assumptions used to estimate fair value.
Special disclosures required for fair value measurements (on a recurring basis) that are based on unobservable inputs (i.e., Level 3 inputs)?
1) reconcile beginning and ending balances
2) description of valuation process used
3) quantitative info about unobservable inputs used
4) narrative of FV sensitivity to changes in unobservable inputs used
5) unrealized gains/losses for period and where reported
What types of comparisons are fair value option disclosures intended to facilitate?
1) between companies that have different measurement methods for similar assets/liab
2) between asset/liab in financials subject to different measurement methods within a single company
difference between FV on a recurring basis and a non-recurring basis
recurring basis: asset/liab FV reflected after each period
nonrecurring basis: asset/liab FV reflected after a single special event/circumstance
Quantitative disclosures must be made in tabular format
Fair value measurement disclosures require both that fair value amounts be disclosed separately for each level of the fair value hierarchy
FV disclosure requirements differ when assets/liab are adjusted for FV on a recurring basis and a non-recurring basis
Disclosures on FV measurement are required on both the interim and annual financials
Level 1 - observable inputs, requires greatest amount of disclosures
Level 3 - requires greatest amount of disclosures because of the unobservable inputs