1. Fair Value Measurements
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Fair Value Measurements
ASC 820 (FAS 157) Fair Value Disclosures
Acct 414

3. ASC 820 (FAS 157): Definition of Fair Value
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ASC 820 (FAS 157): Definition of Fair Value
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
An exit price notion for a hypothetical transaction; may or may not equal actual entry price
Not adjusted for transaction costs
Not based on value to current owner or company-specific assumptions

4. Entry price vs. Exit price
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Materials & Labor Markets
Manu-facturer
Wholesale Market
Dealer
Retail Market
Consumer
2nd Hand Market
Based on From: Refining Fair Value Measurement, Miller, Paul B. W.; Bahnson, Paul R.. Journal of Accountancy, Nov2007, Vol. 204 Issue 5, p30-36,
FASB’s Solution: “highest and best use”

5. Statement 157: Approach to Measuring Fair Value
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Statement 157: Approach to Measuring Fair Value
Unit of
Valuation
Unit of
Account
THE ASSET OR LIABILITY
Valuation
Premise
Highest and
Best Use
Exit Market
Market Participant
Assumptions
Inputs to
Valuation Techniques
Attribute Value to Asset or Liability
at Unit of Account Level
Fair Value
Measurement
Indicated Value
Unit of Valuation
F/S Presentation and Disclosure

6. 4/1/2017
FAS Exit Market
The market in which the ENTITY would sell the asset or transfer the liability
First Choice: Principal market is the market with the greatest volume and level of activity for asset or liability
If there is no principal market : Most advantageous market maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs
Valuation
Premise
Highest and
Best Use
Exit Market
Step 2 – Determine the exit market
Market Participant
Assumptions

7. FAS 157 - Market Participant Assumptions
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FAS Market Participant Assumptions
A fair value measurement should be determined based on the assumptions market participants would use in pricing the asset or liability, including assumptions about (measurement) risk, highest and best use (if asset), and nonperformance risk (if liability)
Valuation
Premise
Highest and
Best Use
Step 3 – determine the market participants
Market participants are buyers and sellers in the exit market (other entities with whom the entity would transact)
Exit Market
Market Participant
Assumptions

8. 4/1/2017
Unit of Valuation
The unit of valuation depends on the highest and best use of the asset, which establishes the valuation premise used to measure the fair value of the asset
In-use or
in-exchange
Valuation
Premise
Highest and
Best Use
Use by market participants that maximizes value of asset (or asset group)
Step 4a – determine highest and best use
Step 4b – determine valuation premise (in use or in exchange)
Step 4c – determine unit of valuation (group of assets, stand-alone asset, etc.)
Exit Market
Market Participant
Assumptions

9. Statement 157: Approach to Measuring Fair Value
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Statement 157: Approach to Measuring Fair Value
Unit of
Valuation
Unit of
Account
THE ASSET OR LIABILITY
Valuation
Premise
Highest and
Best Use
Exit Market
Market Participant
Assumptions
Inputs to
Valuation Techniques
Attribute Value to Asset or Liability
at Unit of Account Level
Fair Value
Measurement
Indicated Value
Unit of Valuation
F/S Presentation and Disclosure

10. FAS 157 - Inputs to Valuation Techniques
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FAS Inputs to Valuation Techniques
Market participant assumptions are incorporated in the fair value measurement through the inputs to valuation techniques
Observable inputs
Developed based on market data obtained from sources independent of the reporting entity
Unobservable inputs
Developed based on the best information available in the circumstances, subject to cost-benefit constraint
We are to use observable inputs in preference to unobservable inputs.
The next slide is a FLOWCHART on deciding which inputs to use – there isn’t always an observable input available.

11. A fair value measurement should maximize the use of observable inputs
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A fair value measurement should maximize the use of observable inputs
From: Refining Fair Value Measurement, Miller, Paul B. W.; Bahnson, Paul R.. Journal of Accountancy, Nov2007, Vol. 204 Issue 5, p30-36,
The next slide give the FASB definitions of the three levels of inputs

12. Statement 157 - Fair Value Hierarchy
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Statement Fair Value Hierarchy
Level 1
Quoted prices in active markets for identical assets/ liabilities (unadjusted); no blockage factors (Price x Quantity)
Level 2
Other observable inputs—include quoted prices for similar assets/ liabilities (adjusted) and market-corroborated inputs
Level 3
Unobservable inputs—entity’s own assumptions about market participant assumptions, including assumptions about risk, developed based on the best information available in the circumstances (subject to cost-benefit constraint); might include the entity’s own data

13. Last Step - Disclosures
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Last Step - Disclosures
F/S Presentation and Disclosure
THE ASSET OR LIABILITY
Indicated Value
Unit of Valuation
Market Participant
Assumptions
Inputs to
Valuation Techniques
Attribute Value to Asset or Liability
at Unit of Account Level
Highest and
Best Use
Exit Market
Valuation
Premise
Unit of
Account
Fair Value
Measurement

14. 4/1/2017
FAS Disclosures
Extensive disclosures to indicate the “quality” of fair value measurements by the 3 categories of inputs
For regularly re-valued assets & liabilities:

15. 4/1/2017
FAS Disclosures
For regularly re-valued assets & liabilities that use a lot of Level 3 unobservable inputs – there is more:

16. FAS 157 - Disclosures For assets & liabilities not regularly revalued:
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FAS Disclosures
For assets & liabilities not regularly revalued:

17. The steps to FV measurement
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The steps to FV measurement
1. Identify asset or liability being measured (unit of account)
2. Determine the exit market
3. Identify the market participants in the exit market
4a. Determine the highest and best use for an asset or nonperformance risk for a liability being valued
4b. Determine the valuation premise (in-use vs. in-exchange) based on highest and best use for an asset group of assets, reporting unit, or business being valued.
4c. Determine the unit of valuation based on the highest and best use and the valuation premise
Remember that step 2 assumes that the PRINCIPAL market should be used unless there is no principal market. In that case, use the most advantageous market

18. The steps to FV measurement
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The steps to FV measurement
5. Determine a value for the unit of valuation based on market participant assumptions and other market-based inputs, and apply one or more appropriate valuation techniques
5a. If applicable, impute value determined in Step 5 to the unit of account
6. Classify inputs used in Step 5 as Level 1, 2, or 3 and then classify the fair value measurement in its entirety to prepare SFAS No. 157 disclosures

19. 4/1/2017
Let’s look at HW#3
Problem 3 – using level 1 & 2 inputs to determine fair value of bonds
Let’s look at Bond 2:
Term = 6 years, rating = BBB
Note: this is probably “level 2” since we don’t have an EXACT quotation for a market price for the exact bonds the company is holding

20. Bond 2: Term = 6 years, rating = BBB
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Bond 2: Term = 6 years, rating = BBB
Bond 2
Look at the BBB bond rating column.
Term of 6 is how far between years 5 & 10? (Diff = 5 years, therefore 1/5 or 20%)
Based on the term of the bond, Bond 2 is 20% of the way from to
Estimated price of Bond 2 = × $1,000 = $
Difference between the two rates = – = 1.630
20% * = .326 =
$1,000 face value * (approximation) = $ fair value

21. Let’s try another one, $1000 Bond: Term = 8 years, rating = A
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Let’s try another one, $1000 Bond: Term = 8 years, rating = A

22. HW #3 (small groups okay)
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HW #3 (small groups okay)
The first two problems are related to understanding the “fair value option”
You will also practice fair value disclosures
Problems 4 and 5 will let you try your hand at creating the disclosure tables required under ASC Topic 820
Use the “handout” files to get examples from FASB or find them in the FASB codification
There are also examples are in Appendix 17C in textbook
To this assignment, you will attach the FAIR VALUE part of the HW#2 serial bond problem