04. Financial Reporting & Analysis

Question 1

What is LIFO Reserve? What is it’s purpose?

Answer 1

• The difference in LIFO ending inventory and FIFO ending inventory.
• It is used to adjust the LIFO firm’s ending inventory and COGS back to FIFO for comparison purposes.

Question 2

What is LIFO Liquidation?

Answer 2

• When a firm sells more inventory than it replaces.
• The result is lower COGS and higher profit.
• However, the increase in profit is not sustainable once the current inventory is depleted.

Question 3

How do you adjust LIFO statements to FIFO?

Answer 3

• Add the LIFO reserve to current assets (ending inventory).
• Subtract the income taxes on the LIFO reserve from current assets (cash).
• Add the LIFO reserve, net of tax, to shareholders’ equity.
• Subtract the change in the LIFO reserve from COGS.
• Add the income taxes on the change in the LIFO reserve to income tax expense.

Question 4

What are the rules for inventory mark-downs and write-ups under IFRS?

Answer 4

• Inventories are valued at the lower of cost or net realizable value.
• Inventory “write-ups” are allowed, but only to the extent that a previous write-down to net realizable value was recorded.

Question 5

What are the rules for inventory mark-downs and write-ups under US GAAP?

Answer 5

• Inventories are valued at the lower of cost or market.
• Market is usually equal to replacement cost but cannot exceed net realizable value or be less than net realizable value minus a normal profit margin.
• No subsequent “write-up” is allowed.

Question 6

What are the differences between US GAAP and IFRS as it pertains to R&D?

Answer 6

• US GAAP: R&D costs are expensed as incurred.
• IFRS: research costs are expensed and development costs are capitalized.

Question 7

Describe IFRS’s rules for long-lived asset impairment:

Answer 7

• Impaired when its carrying value exceeds the recoverable amount.
• The recoverable amount is the greater of fair value less selling costs and the value in use (PV of expected cash flows).
• If impaired, the asset is written-down to the recoverable amount. Loss recoveries are permitted.

Question 8

Describe US GAAP’s rules for long-lived asset impairment:

Answer 8

• Impaired if its carrying value is greater than the asset’s undiscounted future cash flows.
• If impaired, the asset is written-down to fair value.
• Subsequent recoveries are not allowed for assets held for use.

Question 9

What is the average age(in years) calculation for long-lived assets?

Answer 9

Average age (in years) = accumulated depreciation / annual depreciation expense.

Question 10

What is the average depreciable life calculation for long-lived assets?

Answer 10

Average depreciable life = ending gross investment / annual depreciation expense.

Question 11

What is the remaining useful life calculation for long-lived assets?

Answer 11

Remaining useful life = ending net investment / annual depreciation expense.

Question 12

Describe a finance lease:

Answer 12

• A finance lease is, in substance, a purchase of an asset that is financed with debt.
• Expenses consists of depreciation of the asset and interest on the loan.
• Payments consist of an operating outflow of cash (interest expense) and a financing outflow of cash (principal reduction).

Question 13

Describe an operating lease:

Answer 13

• An operating lease is simply a rental arrangement.
• No asset or liability is reported by the lessee.
• The rental payment is reported as an expense and as an operating outflow of cash.

Question 14

Describe the influence and accounting for “less than 20% (Investments in financial assets)”

Answer 14

Influence: No Significant Influence

Accounting: Held-to-maturity, fair value through profit or loss, available-for-sale

Question 15

Describe the influence and accoutning for 20%-50%
ownership (Investments in associates)

Answer 15

Influence: Significant

Accounting: Equity Method

Question 16

Describe the influence and accounting for more than 50%
ownership (Business combinations)

Answer 16

Influence: Control

Accounting: Acquisition Method

Question 17

Describe the reporting for held-to-maturity securities:

Answer 17

• Reported on the balance sheet at amortized cost.
• Subsequent changes in fair value are ignored.

Question 18

Describe the reporting for Fair Value through Profit or Loss securities:

Answer 18

Reported at fair value, and the unrealized gains and losses are recognized in the income statement.

Question 19

Describe the reporting for available-for-sale securities:

Answer 19

Reported at fair value, but the unrealized gains and losses are reported in stockholders’ equity.

Question 20

Describe the equity method:

Answer 20

• The proportionate share of the investee’s earnings increase the investor’s investment account on the balance sheet and are recognized in the investor’s income statement.
• Dividends received reduce the investment account.
• Dividends received are not recognized in the investor’s income statement under the equity method.

Question 21

Differences between IFRS and U.S. GAAP treatment of intercorporate investments include:

Answer 21

• Unrealized FX gains(losses) on AFS securities are recognized on the I/S under IFRS and as OCI under U.S. GAAP.
• IFRS permits either the partial goodwill or full goodwill method to value goodwill and noncontrolling interest in business combinations. U.S. GAAP requires the full goodwill method.

Question 22

Describe the effects of the equity method versus the acquisition method:

Answer 22

• Both report the same net income.
• Acquisition method equity will be higher by the amount of minority interest.
• Assets and liabilities are higher under the acquisition method.
• Sales are higher under the acquisition method.

Question 23

Define PBO:

Answer 23

The projected benefit obligation is the actuarial present value of future pension benefits earned to date, based on expected future salary increases.

• Balance sheet asset (liability) = fair value of plan assets − PBO.

Question 24

Describe the current service cost portion of pension expense:

Answer 24

• The present value of benefits earned by the employees during the current period.
• Expensed in income statement.

Question 25

Describe the Interest cost portion of pension expense:

Answer 25

• The increase in the PBO due to the passage of time.
• Expensed in income statement.

Question 26

Describe the expected return on plan assets portion of pension expense:

Answer 26

• It reduces pension expense.
• Under GAAP, the expected rate of return is assumed. Under IFRS, the expected rate of return is the discount rate.
• Offsets pension cost in the income statement.

Question 27

Describe the amortization of actuarial gains(losses) portion of pension expense:

Answer 27

Under GAAP only, the losses (or gains) during the year due to changes in actuarial assumptions and due to differences between expected and actual return are recognized in OCI and amortized using the corridor method.

Under IFRS, the actuarial gains and losses during the year are recognized in OCI and are not amortized.

Question 28

Describe the amortization of past service cost portion of pension expense:

Answer 28

• Under U.S. GAAP only, an increase in PBO resulting from plan amendments granting a retroactive increase in benefits is amortized.
• Under IFRS, past service costs are immediately expensed in the income statement.

Question 29

What are the formulas for total periodic pension cost?

Answer 29

• = contributions – change in funded status
• = current service cost + interest cost – actual return on plan assets +/– actuarial losses/gains due to changes in assumptions affecting PBO + prior service cost

Question 30

Describe local, functional & presentation currencies:

Answer 30

Local: The currency of the country to which it refers.

Functional: Determined by management, is the currency of the primary economic environment in which the entity operates. The functional currency is usually the currency in which the entity generates and expends cash. It can be the local currency or some other currency.

Presentation(reporting): The currency in which the entity prepares its financial statements.

Question 31

What is the difference between the current rate method and the temporal method?

Answer 31

Current Rate: Used to translate the subsidiary’s F/S if the functional currency and the parent’s presentation currency differ.

Temporal Method: Used to remeasure the subsidiary’s F/S if the functional currency is the same as the parent’s presentation currency.