FAR (Section 1.5) Fair Value Measurement

Items required to be recognized at fair value
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Terms in this set (19)
Items required to be recognized at fair value
1. Investments in marketable debt securities that are classified as trading or available for sale (AFS)
2. Investments in equity securities (except those required to be accounted for under the
equity method, those that are required to be consolidated, and, when an appropriate
election is made, those for which the market value is
not readily determinable)
3. Assets acquired & Liabilities assumed in a business combination (initially recognized at fair value, not adj in subsequent periods usually)
4. Impairment losses--result in the reduction of as asset's carrying value to its fair value in the period of the impairment
5. All derivatives (except interest rate swaps that are hedges
when the alternative accounting approach available to nonpublic entities is elected)
Fair Value Definition
*EXIT PRICE* 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
Market Participants
Independent of the entity.
•
Reasonably knowledgeable about the asset or liability.
•
In a position to acquire the asset or assume the liability.
•
Voluntarily willing to
acquire the asset or assume the liability.
Fair value financial assets are measured on the basis of their
"highest and best use"

-Some assets are
more valuable
in exchange
and are measured at what would be received upon
their
sale
-Others
are more valuable
in use
and are measured at the value represented in the form of some
combination
of potential revenues earned and cost sav
ings
that result from their use
Principal Market
Where it is assumed a fair market transaction will occur. It is the market in which the asset or liability would most frequently be traded
Most Advantageous Market
Where a transaction would occur When there is no principal market
If an asset needs to be transported to its principal market
The cost of doing so is taken into account when measuring the assets fair value
Three Fair Value Valuation Techniques
1. Market approach
2. Income approach
3. Cost approach
Market approach
involves using information generated by market transactions that
involve identical or comparable assets or liabilities
Income Approach
involves analyzing future amounts in the form of revenues, cost
savings, earnings, or some other item.
Cost approachinvolves measuring the cost that would be incurred to replace the benefit derived from an assetThree Levels of Inputs1. Level 1: the most reliable, involves the use of observable data from actual market transactions, occurring in an active market, for identical assets or liabilities 2. Level 2: also involves the use of observable data from actual market transactions but either: -The transactions did not occur in an active market -The transactions relate to similar, but not identical, assets or liabilities 3. Level 3: involves the use of unobservable data and are largely based on management's judgmentSteps to Fair Value Measurement1. Identify the asset or liability to be measured. 2. Determine the principal or most advantageous market (highest and best use) 3. Determine the valuation premise (in use or in exchange) 4. Determine the appropriate valuation technique (market, income, or cost approach) 5. Obtain inputs for valuation (Level 1, Level 2, or Level 3) **Fair value hierarchy must be used to prioritize the inputs to valuation techniques.** 6. Calculate the fair value of the asset. .Disclosures about the use of fair value to measure assets and liabilities should provide F/S users with better information about:1. The valuation techniques and inputs that the entity uses to arrive at its measures of fair value, including judgments and assumptions made 2. The uncertainty in the fair value measurements as of the reporting date 3. The effect of changes in fair value measurements on entity performance (ie, earnings or changes in net assets) and cash flowsFair Value OptionIn addition to those items that are required to be measured at fair value, ASC 825 allows an entity to elect to report some or all of its financial instruments (aka, financial assets and liabilities) at their fair values.Financial Instrumentdefined as cash , evidence of an ownership interest in an entity, or a contract that both: 1. Imposes on one entity a contractual obligation either: -To deliver cash or another financial instrument to a second entity -To exchange other financial instruments on potentially unfavorable terms with the second entity 2. Conveys to that second entity a contractual right either: -To receive cash or another financial instrument from the first entity -To exchange other financial instruments on potentially favorable terms with the first entityExamples of financial assets and liabilities that would qualify for the fair value option1. Most investments that do not already require FV measurement, such as investments accounted for under the equity method 2. Firm commitments involving financial instruments, such as forward exchange contracts to purchase or sell a foreign currency .Do NOT qualify for the "fair Value option"1. Pension plan, post - retirement, and other post - employment benefits (ASC 712 and 715) 2. Leases 3. Financial instruments that are components of equity (ASC 505) 4. Share-based payments and stock options (ASC 718)When the fair value option is electedUnrealized gains and losses are reported in income.