Fair Value Framework - Wiley

Question 1

Define “fair value” (for accounting purposes).

Answer 1

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

Question 2

For purposes of the fair value definition, what are the assumed characteristics of market participants?

Answer 2

Buyers and sellers that are:

1. Independent of the reporting entity.
2. Acting in their economic best interest.
3. Knowledgeable of the asset or liability and the transaction involved.
4. Able and willing, but not compelled, to transact for the asset or liability.

Question 3

What is the major purposes of the fair value framework?

Answer 3

To provide a framework for the use of fair value in generally accepted accounting principles (GAAP) so as to:

1. Achieve increased consistency and comparability in fair value measurements; and
2. Expand disclosure when fair value measurements are used.

Question 4

List the items that entities may elect to measure and report at fair value.

Answer 4

1. Recognized financial assets or financial liabilities (some exceptions)
2. Firm commitments
3. Written loan commitments
4. Rights and obligations under insurance contracts and warranties
5. Other financial instruments embedded in nonfinancial derivative instruments

Question 5

List the financial assets and financial liabilities that entities may NOT use fair value to measure and report.

Answer 5

1. An investment in a subsidiary or variable interest to be consolidated
2. Employers’ and plans’ obligations for pension benefits, other postretirement benefits, postemployment benefits
3. Financial assets and liabilities under lease accounting
4. Demand deposit liabilities of financial institutions
5. Financial instruments classified by the issuer as a component of shareholders’ equity

Question 6

Define “entry price.”

Answer 6

The price paid to acquire an asset or the price received to assume a liability

Question 7

Define “exit price.”

Answer 7

The price that would be received to sell an asset or paid to transfer a liability

Question 8

List the situations where the entry price may not be the exit price.

Answer 8

1. The transaction is between related parties.
2. The transaction occurs when the seller is under duress.
3. The unit of account included in the transaction price is different from the unit of account that would be used to measure at fair value.
4. The market in which the transaction price occurred is different from the market in which the asset would be sold or the liability transferred

Question 9

What are the three valuation techniques (or approaches) that should be used in determining fair value for the purposes of generally accepted accounting principles?

Answer 9

Market approach
Income approach
Cost approach

Question 10

Describe the market approach for determining fair value for the purposes of generally accepted accounting principles (GAAP).

Answer 10

This approach uses prices and other relevant information generated by market transactions involving assets or liabilities identical or comparable to those being valued.

Question 11

Describe the income approach for determining fair value for the purposes of generally accepted accounting principles (GAAP).

Answer 11

This approach converts future amounts to a single present amount.

Question 12

Describe the cost approach for determining fair value for the purposes of generally accepted accounting principles (GAAP).

Answer 12

This approach uses the amount currently required to replace the service capacity of an asset.

Question 13

List the dates when an entity may elect to use fair value option for an eligible item.

Answer 13

1. When the item is first recognized
2. When firm commitment occurs
3. When financial, an asset previously reported at fair value with unrealized gain/loss in earnings no longer qualifies for that fair value treatment
4. When accounting treatment for an investment changes because it becomes subject to the equity method or ceases to be eligible for consolidation
5. When an item is measured at fair value at the time of an event but does not require fair value measurement at subsequent reporting dates

Question 14

Describe fair value measurement inputs.

Answer 14

Inputs can be observable or unobservable. Observable inputs are based on market data from independent sources. Unobservable inputs are the entity’s assumptions about the factors that impact determination of fair value.

Question 15

What purpose does the fair value hierarchy serve?

Answer 15

To prioritize the inputs to valuation techniques used to measure fair value

Question 16

What are the three levels of the fair value hierarchy and what does each consist of?

Answer 16

Level 1: highest level, are unadjusted quoted prices in active markets for assets and liabilities identical to those being valued

Level 2: are observable for assets or liabilities, either directly or indirectly, other than quoted prices described in Level 1

Level 3: lowest level, are unobservable and used to determine fair value only if observable inputs are not available

Question 17

What types of comparisons are fair value option disclosures intended to facilitate?

Answer 17

1. Between entities that choose different measurement methods for similar assets and liabilities
2. Between assets and liabilities in the financial statements of an entity that selects different measurement for similar assets and liabilities

Question 18

Distinguish between assets and liabilities measured at fair value on a recurring basis and nonrecurring basis.

Answer 18

Assets and liabilities measured at fair value on recurring basis are adjusted to fair value period after a period. Assets and liabilities measured at fair value on a nonrecurring basis are adjusted to fair value only at the time of a particular event (e.g., significant modification of debt).

Question 19

What are the special disclosures required for fair value measurements (on a recurring basis) that are based on unobservable inputs (i.e., Level 3 inputs)?

Answer 19

1. Reconciliation of beginning and ending balances
2. Description of the valuation process used
3. Quantitative information about the unobservable inputs used
4. Narrative description of the sensitivity of fair value to changes in unobservable inputs
5. Unrealized gains/losses for the period and where reported

Question 20

What significant fair value disclosures are required only in annual statements?

Answer 20

The methods and significant assumptions used to estimate fair value