Question

Domingo Entity entered into a contract to exchange a liability. However, this particular liability does not have a quoted price in Domingo’s principle market. Sabado Entity holds an asset similar to the liability to be exchanged at a price of $45,000. Domingo decided that their finance department could incorporate a complex valuation model using estimates that would generate a more accurate fair value of $60,000. What is the fair value of the liability? Explain.

Answer 1

Answer:

Fair value of Liability is $45,000

Explanation:

Based on faced hierarchy:

Level 1 inputs are quoted (unadjusted) price in active markets for identical liabilities that the entity can access at measurement date. However, this particular liability does not have a quoted price in Domingo’s principle market.

As such, Domingo need to evaluate if level 2 inputs are available.

Level 2 inputs are observable inputs other than quoted prices for identical liabilities. In this case level 2 inputs are available since Sabado Entity holds an asset similar to the liability to be exchanged at a price of $45,000.

As such fair value of liability is $45,000

In level 3 inputs (which is unobservable inputs for liability), companies use own estimates based on valuation models. In this case valuation of liability at $60,000 is based on complex valuation model using estimates and is level 3 inputs. However such inputs should be used only when level 1 or level 2 inputs are not available.