Fair Value Disclosures & Reconciliation. CPA Exam

In this session, I cover fair value disclosures and reconciliation.

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Fair value measurement of non-financial assets can be more complex than that of financial assets, primarily because these assets often don't have active markets to derive direct valuations. "Non-financial assets" encompasses a broad range of items, such as property, plant, equipment, intangible assets (like trademarks, patents, or copyrights), and commodities, among others.

Here are some key points to consider when determining the fair value of non-financial assets:

Highest and Best Use: The fair value of a non-financial asset should be determined based on its "highest and best use." This represents the use of the asset by market participants that would maximize the value of the asset or the group of assets within which the asset would be used.

Physical and Economic Factors: The "highest and best use" should consider the asset's physical characteristics (like location and size) and any functional or economic limitations.

Use in Combination or Standalone: Some non-financial assets may generate maximum value when used in combination with other assets or liabilities, rather than on a standalone basis. For instance, machinery in a production line might have its highest value when used with other complementary machinery.

Principal (or Most Advantageous) Market: Similar to financial assets, the fair value should be based on the principal market, or in its absence, the most advantageous market. The principal market is the market with the highest volume and activity for the asset.

Valuation Techniques: Given the absence of active markets for many non-financial assets, various valuation techniques are employed, which include:

Market Approach: This method uses prices and relevant information from market transactions involving identical or comparable (i.e., similar) assets or liability groupings.
Cost Approach: Reflects the amount that would be required to replace the service capacity of an asset (often referred to as current replacement cost).
Income Approach: Converts future amounts (e.g., cash flows or income and expenses) to a single current (i.e., discounted) amount. The fair value measurement reflects current market expectations about those future amounts.
Depreciation and Impairment: For tangible assets, considerations related to wear and tear, functional obsolescence, and economic factors can reduce the asset's fair value. Similarly, for intangible assets, factors like technological changes or market changes can lead to impairments that reduce fair value.

Restrictions: If the non-financial asset has any restrictions on its sale or use, this can impact its fair value. For instance, land that can't be developed due to zoning restrictions might have a reduced fair value compared to similar land without such restrictions.

Liquidity Considerations: For some non-financial assets, especially those that are unique or specialized, there might be limited market participants or longer periods required to find a buyer. These liquidity considerations can impact the fair value determination.

Disclosures: In financial statements, entities often have to provide disclosures about the methodologies, assumptions, and inputs used in their fair value measurements of non-financial assets, especially if significant judgment is involved.

It's worth noting that while the overarching principles of fair value measurement are consistent across assets, the application and complexity can differ significantly when dealing with non-financial assets. As always, specific accounting standards and guidance, like the FASB's ASC Topic 820 in the U.S., provide more detailed direction on these valuations.