1 Fair Value Framework

Question 1

FV

orderly transaction characteristics

market participants

Answer 1

Transaction

1. occurs at measurement date
2. occurs under current market conditions
3. not a forced liquidation or distressed sale
4. hypothetical transaction

Participants

1. independent of entity
2. acting in own economic best interest
3. knowledgeable
4. able and willing but not compelled

Question 2

What is Fair Value?

Answer 2

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. Fair value determination should consider the attributes (e.g., condition, location, restriction on asset use or sale, etc.) of the specific asset or liability being measured.

Question 3

Do transaction and transportation costs affect the fair value?

Answer 3

Only the transportation costs are used to calculate FV

But both are used in step 1 (determine which market to make valuation in)

Question 4

What is a transation price/entry price?

Answer 4

the price paid when an asset or liability is initially recognized, which may or may not be fair value

Question 5

What is an exit price?

Answer 5

Fair value of an asset or a liability is the price that would be received to sell an asset or paid to transfer a liability

Question 6

How are changes in fair value method accounted for?

Answer 6

As a Change in Accounting Estimate

Question 7

Which two type of inputs may be used to evaluate fair value?

Answer 7

Observable and Unobservable

Question 8

What is an observable input?

Answer 8

Inputs used in pricing an asset, liability, or equity item that are developed based on market data obtained from sources independent of the reporting entity.

Question 9

What is an unobservable input?

Answer 9

Inputs that reflect the reporting entity’s own assumptions used in pricing the asset, liability, or equity item that are developed based on the best information available in the circumstances.

Question 10

What are the three levels of inputs (hierarchy) used to determine/prioritize appropriate fair value measurement?

Answer 10

Level I - most reliable, involves use of observable active* market data from *IDENTICAL assets or liabilities

Level II - involves use of observable* market data from *SIMILAR assets or liabilities, or transactions that do not occur in an active market

Level III - mainly involves use of management’s judgement/forecasts

Question 11

What steps summarize fair value measurement?

Answer 11

1. Identify asset or liability to be measured
2. identify which market to use –> use most advantageous
   
   • highest net value = share price - costs
   • include:
     
     • transaction costs
     • transportation costs
   • markets:
     
     • principle: greatest volume and level of activity
     • most advantageous: can sell for max benefit (highest net value)
3. determine FV in chosen market
   
   • DO use transportation costs (is characteristic part of A that anyone would have to pay)
   • do NOT use transaction costs (characteristic of indiv sale)

Question 12

How is the fair value of an asset and liability determined? (Entry or Exit Price)

Answer 12

Asset: Exit Price, Liability: Exit Price

Question 13

What do you do if there is a difference between the entry and exit price?

Answer 13

Recognize a gain or loss for the difference between the entry price and the exit price

Question 14

3 valuation techniques utilized when measuring an item at fair value?

Answer 14

1) Market approach - information from market transactions involving identical or comparable assets or liabilities
2) Income approach - involves analyzing future amounts in the form of revenues, cost savings, earnings, etc.
3) Cost approach - involves measuring the cost that would be incurred to replace the benefit (service capacity) derived from an asset (“MIC”)

Question 15

FV is a ________ based measurement

Answer 15

Is a MARKET based measurement, not ENTITY specific

• HOW to measure, not WHEN to measure

Question 16

How is FV applied to A, L, SE

Answer 16

Asset:

• Best estimate of FV assumes the highest/best use of asset in market, even if is different form entities use

Liability

• Assumes L is transferred to mkt participant, NOT settled or canceled

Shareholders’ equity

• Measured from perspective of party that holds the item as an asset

Net Financial Assets and Financial Liabilities

• Requirement of separate estimate of FV is excepted when entity manages risk associated w/ a portfolio of financial interests on a NET exposure basis, rather than on a GROSS exposure basis
• Can measure these financial A/L at the price received to sell/paid to transfer a NET asset/liability position for a particular risk

Question 17

Entry (transaction) price

may NOT equal

exit price/FV at date of initial recog of A/L if:

Answer 17

• Bet related parties
• Seller under duress (liquidation)
• Differing units
• Market of transaction is different from principal/most advantageous market

Question 18

What is the Fair Value Option

Answer 18

can CHOOSE to use FV for measurement

• Must make election to use FV on the date if first recognizes the investment
• only on the date of specific events (an election date):
  • first recognized (ie: financial A/L, b/c have contractual (or claims) to future cash flows)
  • firm commitments not otherwise recog, only financial instruments
  • written loan commitments
  • rights/obligations under warranties/insurance contracts settled by paying 3^rd party
  • accounting treatment of investment in another entity changes, ie: change in % ownership

Question 19

Instruments NOT eligible for FV option

Answer 19

• Investment in entity to be consolidated
  
  • subsidiary
  • variable interest entity (VIE)
• Pension benefits/other employee oriented plans/benefits
• Lease-related financial A/L
• Demand deposit L of financial inst
• Fin instr classified by issuer as component of shareholders’ equity

Question 20

FV dislcosures for A/L

recurring vs non-recurring basis

Answer 20

recurring (period after period) basis

• In subsequent periods, for each interim and annual period for each major category of A/L
  
  • FV measurements at reporting date
  • Segregated in 3 FV hierarchy levels in table
  • any transfers into/out of each level, Level 1 to2 - reasons for/policy
  • Level 2 and 3: technique/input used and any changes in them during period
  • Level 3
    
    • reconcile beg/end balances, and what changes due to
    • describe valuation process

NON-recurring (only when situations occur, impairment) basis

• In subsequent periods, disclose for each major category A/L
  
  • FV measurements at reporting date
  • Why FV measurement is occurring
  • Segregated in 3 FV hierarchy levels
  • Levels 2/3: describe technique/inputs used

Question 21

FV disclosures

Balance Sheet

and

Income Statement

Answer 21

St of financial position (Balance sheet)

• Mgt reasons for election FV
• reason for any partial election of FV on items w/in a group
• Info to understand line items vs major categories of A/L
• Aggregate FV and aggregate unpaid principle differences for contractual principal amounts in
  
  • Loans and long-term rec
  • Long-term debt instruments

Income statements

• Amt of gain/loss from FV changes for each line item
• How interest/dividends measured
• Loans/rec, estimated G/L and how determined
• Significant changes FV - estimated G/L for that item, how G/L determined, qualitative reasons