Fair Value Disclosures
Case 11-2(b) is an extension of Case 11-2(a). For this case, assume that the Case 11-2(a) facts remain, with the exception of the additional assumptions listed below for each security. As stated in Case 11-2(a), Family Finance Co. (FFC) accounts for its investments at fair value, with changes in fair value reflected either in earnings (for trading securities) or other comprehensive income (OCI) (for available-for-sale (AFS) securities). 1 Because FFC uses the interest rate swap in a cash-flow hedge, FFC measures the derivative at fair value, presenting the portion of the fair value change that effectively offsets cash flow variability on its corporate debt in OCI and the remainder in earnings. Additional facts related to specific securities and derivatives owned by FFC are described below. Also refer to the data table at the end of this section for the fair value amounts for each instrument needed to complete the case.
S tudents should assume that all amounts discussed below and those included in the data tables are U.S. dollars in thousands.
Instrument 1 — Collateralized Debt Obligation
FFC classifies its collateralized debt obligation (CDO) within Level 3 of the ASC 820, Fair Value Measurement, fair value hierarchy as of December 31, 2012.
FFC identified October 1, 2012, as the date on which the CDO’s fair value measurement changed in classification from Level 2 to Level 3.
FFC determined the broker quotes were not significant to the fair value measurement in its entirety because those quotes resulted in a management adjustment to the income-approach discount rate of just 1 percent. On the basis of sensitivity analysis performed by adjusting the discount rate, management determined percentage changes of 2 percent result in a significantly higher or lower fair value. Further, management performed a qualitative assessment of the significance of these inputs to its fair value measurement and concluded that it did not place much weight on these measurements because they were based on proprietary models using unobservable inputs. That is, management could not, without unreasonable effort, conclude with sufficient assurance whether the quotes were prepared in accordance with ASC 820 and reflected current market conditions and market participant assumptions.
FFC accounts for the CDO as a trading security.
Note that as discussed in Case 11-2(a), Instrument 4 is an equity security that does not have a readily determinable fair value and thus is not within the scope of ASC 320, Investments — Debt and Equity Securities. However, FFC has elected the fair value option for the security in accordance with ASC 82510, Financial Instruments: Overall, and thus accounts for the investment at fair value with changes in fair value recorded through earnings.
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Case 11-2(b): Fair Value Disc losures
Instrument 2 — Mortgage-Backed Security
FFC classifies its mortgage-backed security (MBS) within Level 2 of the fair value hierarchy as of December 31, 2012.
FFC accounts for the MBS as a trading security.
Instrument 3 — Auction-Rate Security
FFC classifies its auction-rate securities (ARSs) within Level 3 of the fair value hierarchy as of December 31, 2012.
FFC identified November 1, 2012, as the date on which the fair value measurement of the ARSs changed in classification from Level 2 to Level 3.
FFC accounts for the ARSs as AFS securities.
Instrument 4 — Equity Security of a Nonpublic Company
FFC classifies its investment in Company X within Level 3 of the fair value hierarchy during 2012.
FFC sold the equity security in October 2012 for $120.
Instrument 5 — Interest Rate Swap
The interest rate (IR) swap is part of a portfolio of IR swaps. FFC individually assessed the IR swaps and classified them within Level 2 of the fair value...