Analysis of Financial Statements Flashcards

Question

Units of Production - depreciation method

Answer 1

Annual Depreciation/ Unit= (Asset Cost – Salvage Value)/Number of Output Units

Answer 2

Annual Depreciation = Asset Remaining Cost*2* Straight Line Rate

Answer 3

Annual Depreciation = (Asset Cost – Salvage Value)*Years Remaining/Sum of all Years

Answer 4

Differently under US and International GAAP: – International --> change is applied prospectively. – US --> change is applied retroactively: * Go back and ‘redepreciate’ the asset under the new method * Depreciation for current & future years computed under new method, assuming that this method has been used throughout * Cumulative difference in depreciation b/w the two methods is charged to current years profits (Cumulative Effect of Accounting Change)

Answer 5

IFRS more detailed information about acquisitions, disposals, depreciation etc.

Answer 6

– This is NOT included in cost of sales, but rather is treated as an SG&A (Selling, General & Administrative) expense – Sometimes this is separately disclosed (or combined with Amortisation expense), but not always

Answer 7

* Use the concept of cost allocation as with other fixed assets. In this case, it is called depletion rather than depreciation. * Estimate the physical potential of the natural resource, i.e. the depletion base * Periodic depletion is based on the ratio of units extracted during the period to total estimated units available.

Answer 8

* Repairs include the cost of restoring an asset’s service potential after breakdowns or other damage. * Maintenance includes routine costs such as cleaning or adjusting. --> Both types of costs are an immediate expense

Answer 9

* Unlike repairs and maintenance costs: * The improvement cost is added to the original cost of the asset * And it should be depreciated over the remaining useful life of the asset because improvements change the asset’s service potential

Answer 10

* US GAAP: Increases in value CANNOT be recognised until the asset is sold - assets cannot be revalued upwards - substantial decreases in value (asset impairment) must be recognised immediately - conservatism * IFRS: Assets must written down if impaired - Upwards revaluations permitted (but not mandated)

Answer 11

Not allowed under US GAAP Allowed under International GAAP: * Revaluations must be done consistently across asset groups * Revaluations are need to be performed frequently – Because of this most companies stopped revaluing their assets

Answer 12

– Increase the cost of the asset to the revalued amount – Eliminate the accumulated depreciation – The increase in value (“gain”) is put in a special equity account called “revaluation reserve"

Answer 13

– Depreciate the asset based on the revalued amount (hence, depreciation expense increases) – Transfer an amount from the revaluation reserve directly to Retained Profits to offset the ‘extra’ depreciation expense – Do NOT recognise any gains or losses on the P&L

Answer 14

* Eliminate the fixed asset and accumulated depreciation. Record any cash received and calculate the amount of gain/loss (difference b/w cash and net book value) – Same as normal asset sales * Transfer the remaining balance in the revaluation reserve (for that asset) directly to Retained Profits – This does NOT go through the P&L – Eliminates revaluation reserve

Answer 15

- Eliminate Accumulated Depreciation - Decrease Fixed Asset ‘cost’ to Impaired amount - Loss goes to P&L - Permanent

Answer 16

* Impairment increases Accumulated Depreciation * Loss goes to P&L * Reversals are possible (but more difficult for goodwill) * Revalued Assets --> First revalue asset downwards & reduce the revaluation reserve (no P&L effect).

Answer 17

* Step 1 – Estimate the sum of undiscounted cash flows of operating units and compare it to the carrying amount of the operating unit. If the sum of undiscounted cash flows is lower than the carrying amount, an impairment loss must be recognized. * Step 2 - The impairment loss is equal to the difference between the carrying amount and the present value of cash flows (fair value). * After recognizing an impairment loss, the new carrying amount becomes the new cost basis (no reversal of losses).

Answer 18

* Impairment testing for each cash-generating unit, whenever there are specified indications for impairment (e.g., market-to-book below one). * Whenever there are indications for impairment, a recoverable amount must be measured – The larger between present value of cash flows (Value-in-Use) and net selling price (Exit Value). * An impairment loss is recognized in the Income Statement. * An impairment loss may be reversed. Impairments of goodwill may be reversed only when the circumstances that caused the impairment no longer exist.

Answer 19

* Interests similar to other costs * Better matching * Better comparability between own construction and purchases

Answer 20

* Arbitrary allocation of borrowing costs * Costs affected by source of financing

Answer 21

* UK GAAP - FRS 15: Option to companies, should apply policy consistently, only actual interest expense on separate borrowings for construction * US GAAP - SFAS 34: Mandatory capitalisation, interest expense on separate borrowings for construction. If no separate borrowing, weighted borrowing costs applied to expenditures incurred on construction * IAS GAAP – IAS 23: Mandatory capitalisation, should apply policy consistently; Interest expense on separate borrowings for construction. If no separate borrowing, weighted borrowing costs applied to expenditures incurred on construction

Answer 22

– Expenditures for the asset must have been made; and – Activities that are necessary to get the asset ready for its intended use are in progress; and – Interest cost is being incurred.

Answer 23

* Interest capitalized in a year cannot be more than the interest incurred in that year. * Interest capitalisation should cease when the asset is “substantially complete” and ready for use. * For financial analysis, better to treat borrowing costs as an expense as true interest expense may otherwise be understated.

Answer 24

1. Capitalised interest should be added to interest expense in P&L 2. Depreciation expense in P&L should be reduced by the amount that relates to depreciation of previously capitalised interest. 3. NBV of capitalised interest on assets sold during the year should be added to profit (loss) on disposal of fixed assets in P&L 4. NBV of capitalised interest (i.e. capitalised interest less accumulated depreciation of capitalised interest) should be excluded from NBV of assets. 5. Reduce deferred tax liability by NBV of capitalised interest * Marginal tax rate. 6. “NBV of capitalised interest *(1-Marginal tax rate)” should be deducted from Shareholder’s funds.

Answer 25

1. The value of the benefit is quantifiable, 2. The entity has acquired the right to use the resource as a result of past transactions

Answer 26

Definition: “identifiable non-monetary assets without physical substance” (IAS 38).

Answer 27

* Internally generated intangible assets are (generally) not able (or less able) to be recognized by firms (ie offbalance sheet). * Acquired intangible assets, including intangibles acquired in business combinations, are generally recognised (ie on-balance sheet).

Answer 28

* Generally not recognised (all costs expensed); Exceptions: * 1. Software – Capitalise (and amortise) expenditures once ‘technological feasibility’ is established (over three years, linear) – Stop when product is available for general release * 2. Website Development – Expense costs during planning stage – Capitalise (& amortise) costs during website’s application & and infrastructure development stages – Expense costs incurred during operation stage

Answer 29

* Research Costs are always expensed * Development Costs are capitalised (and amortised) – Intent to & technical feasibility of completing the asset – Ability to use/sell asset – How the asset will generate a future economic benefit * Software & Website Development – Similar to US

Answer 30

* Revaluation NOT allowed * Amortise asset over useful life * If intangible has an indefinite life do NOT amortise – Test annually for impairment (Goodwill)

Answer 31

* Revaluations allowed, but must be based on price in an active market (rare) – Revaluations must be regularly performed (annually in general) * Amortise asset over useful life (20 year max, rebuttable)

Answer 32

Can only revalue intangible assets if they are traded on an active market. Almost all intangibles fail to meet this requirement, but there are a few which qualify: Taxi licenses in major cities, carbon credits, and crypto currencies

Answer 33

* Financial asset -> only if it meets the definition of a financial asset (e.g. stablecoin like USD Coin) * Inventory -> only if the entity holding the crypto currency is a broker/dealer * Intangible asset -> if the crypto asset isn’t a financial asset or inventory, this is the only other option (most crypto assets end up here)

Answer 34

* Similar to IFRS, most crypto assets are treated as intangible assets. * HOWEVER under current US GAAP you can NOT revalue intangibles * --> historical cost – You must test for impairment – Any impairment can NOT be reversed

Answer 35

* Most crypto assets are treated as intangible assets – Account for the asset at its market value – Increases in value go to comprehensive income, decreases in value through the income statement

Answer 36

* Costs associated with patent applications, legal fees and document preparation are capitalized * All R&D costs associated with new ideas that will (hopefully) eventually be patented are expensed! * Shorter of useful life or legal life of patent is used in the amortization calculation (usually straight-line method) * In general, the patents you are likely to see recorded are those purchased from other entities. Why?

Answer 37

IFRS and US GAAP both allow firm’s to recognize and value acquired intangibles, including Brands.

Answer 38

* With great difficulty and subjectivity… * Cost-based approaches * Market-based approaches * Economic use or income-based approaches * Formulary approaches

Answer 39

* Intangible assets with finite useful live - capitalised and amortised * Intangibles assets with indefinite useful lives – capitalised and reviewed for impairment * Purchased goodwill – capitalised and reviewed annually for impairment

Answer 40

Goodwill is considered to have a uncertian life (i.e. indefiniteuseful life) and is not amortized; it is periodically tested for impairment -> this impairment testing is different than impairment testing of other intangibles

Answer 41

* Direct Method: presents cash flows as gross receipts minus gross payments  arrive at net cash flow from operations. * Indirect Method: starts with net income or EBIT (from income statement) and adjusts for non-cash items --> arrive at net cash flow from operations.

Answer 42

* Premature recognition of revenues * Undervaluation of liabilities * Overcapitalisation of costs * BUT, need to take into account a company’s life cycle (Growth vs. Maturity)

Answer 43

* For all annual periods beginning on or after 1 January 2005 * Provide guidance on events that happen after the end of the reporting period but before authorised for issue by directors * Examples given by IAS 10 are: Settlement of outstanding court case, finalization of bonuses, discovery of fraud or errors, information about recovery of an asset (e.g. NRV of inventory)

Answer 44

* occurring after the end of the reporting period * Disclosure may be necessary providing details of the nature of the event and estimate of financial effect * Examples: Major purchase or disposal of assets, destruction of assets caused by a fire, announcement of a major restructuring plan, significant fluctuation in exchange rates, changes in tax rates

Answer 45

* If declared after the end of the reporting period they do not meet definition of a liability * Should be disclosed in notes to financial statements

Answer 46

Classify a non-current asset, or disposal group, as held for sale when the entity no longer intends to use the asset as part of its ongoing business and instead intends to sell it.

Answer 47

* Available for immediate sale in present condition * Sale highly probable * Sale completed within one year of the date of classification * Does NOT apply if the entity decides to abandon, rather than sell, the asset * Does apply if the entity intends to distribute the asset to the owners – IFRIC 17 – Minor difference, assets are measured at fair value less costs to distribute (instead of costs to sell)

Answer 48

* Carry at lower of carrying amount and the fair value less costs to sell * May result in an impairment loss if fair value less costs to sell is below current carrying amount. * Do NOT depreciate the asset(s) * Present the asset(s) separately in the statement of financial position

Answer 49

As a loss or gain (under IAS 16 – PP&E) – NOT as an adjustment to any prior impairment

Answer 50

If measuring the asset using the revaluation model, assets classified as held for sale should be revalued immediately PRIOR to the reclassification. – Once reclassified, deduct the costs to sell and recognise an impairment loss.

Answer 51

* reclassify the assets as non-current assets * Measure assets as the lower of: * (1) the carrying amount that would have existed if the assets were never classified as held for sale * (2) The recoverable amount * If individual assets and/or liabilities within a disposal group no longer meet the specific requirements * (1) Remove the specific assets and/or liabilities * (2) Keep the group (as long as it still qualifies)

Answer 52

* first part profitability measure * second part activity measure * third part captures leverage (in the UK among older people called gearing)

Answer 53

* Mark-up policy * Cost efficiency

Answer 54

restructuring charges, impairments, legal expenses, gains/losses on asset sales

Answer 55

* Cost of Sales / Av. Inventory * For manufacturing companies, use finished goods inventory in the calculation of inventory turnover * Affected by: Relations with suppliers, Production process and type of business, Cost flow assumptions (e.g. FIFO and LIFO)

Answer 56

* Sales / Av. Trade Debtors * Measures and reflects on the ability of the firm to transform sales to cash * Affected by: Credit policy, Estimates of bad debt, VAT

Answer 57

* Purchases / Av. Trade Creditors * Measures the ability of the firm to extract credit from its suppliers * Purchases = C.O.S. + ∆Inventory (since C.O.S. = beginning inventory + purchases – ending inventory) * Alternatively (for manufacturing companies) use: C.O.S. / Av. Trade Creditors

Answer 58

* Fixed Assets T/O = Sales/ Av. Fixed Assets * Measures sales generation per one pound of fixed assets * Total Assets T/O = Sales/ Av. Total Assets * Affected by capital intensity of the production process, stage of the firm’s life cycle

Answer 59

– Business risks – Financial risks and is often summarized by using: – Credit ratings, or – Credit scores

Answer 60

* PBIT/ Interest expenses * CFO before interest payments and tax payments/Interest payments

Answer 61

Financial debt (bank loans, bonds, commercial paper etc) + All interest bearing instruments (though some financing arrangements (e.g. leasing) escape this simple rule) + preferred shares + leases on the balance sheet (i.e., financial leases)

Answer 62

Assets / Equity

Answer 63

* Express line items as a percentage of total assets e.g., [fixed assets / total assets] x 100 * This technique is useful for * looking at financial structure (industry variations) * Comparing across firms with different size * Comparing across firms in different countries

Answer 64

**Assets not broken up into current and long term** Instead categorized functionally – Cash – Investments, Government securities – Loans of different kinds – Property

Answer 65

**Not broken up into current and long term** Instead categorized functionally – Deposits (of different kinds) – Federal Funds Borrowed – Long Term Debt

Answer 66

* Instead of D/E ratio, banks analyzed in terms of capital adequacy, i.e. equity as a % of total assets * For this calculation, assets are “risk-adjusted” as some assets are safer and don’t need the backing of equity * Different calculations of capital: - Tier 1 Capital (sh. equity) has to be at least 4% - Tier 1 + Tier 2 Capital (reserves, hybrid instruments, some unsecured debt) has to be at least 8%, but Tier 2 cannot exceed Tier 1 (Basel II) * Basel III (currently scheduled for January 2022) will increase these requirements and add 2 additional capital requirements, e.g. Tier 1 increased to 6% * Focus on “Accumulated Other Comprehensive Income” - May include unrealized gains/losses on investments - Changes reflect unrealized or realized gains/losses in that year

Answer 67

* 4 categories: * Interest Income – income from loans, etc. * Interest Expense – interest paid to depositers - These 2 are usually netted to arrive at Net Interest Income - Lower rates are good, higher rates are bad, as borrowing rates are more sensitive than returns from assets lent out. * Non-Interest Income – fees, commissions, trading gains, etc. * Non-Interest Expense – salaries, pensions, admin costs, infrastructure costs, etc.

Answer 68

* Operations section is small * Investing and Financing sections highlight the real “operations” * - Generation of New Loans, Repayments` of Old Loans * - Changes in Borrowing, Deposits

Answer 69

* Interest Rate Risk * Credit Risk - Captured by the loan-loss provision

Answer 70

* Loan commitments – a promise to loan up to a certain amount to a customer under certain terms. Not an asset until the funds are actually provided. * Letters of credit and other guarantees * Loans sold with recourse * Derivative securities

Answer 71

* Earning Assets / Total Assets * Large number => more assets are being used productively. Number usually around 80-90% * Include all assets that generate income that would be classified as interest income – Loans – Deposits – Derivatives – Govt Securities * Exclude cash or at least some portion of cash

Answer 72

Non-Interest Expense / Total Revenues

Answer 73

* (Pre-Tax Income + Provision for Loan Losses) / Actual Charge-offs * Measures extent to which pre-tax income and provisions cover the actual losses * Charge-offs are net of actual recoveries from previously written off loans * One can also compare the provision to the actual charge-off

Answer 74

* Framework for analyzing the strength of a bank - Used extensively by regulators, bank rating agencies as well as in developmental banking * Capital adequacy * Asset quality * Management effectiveness * Earnings * Liquidity * Sensitivity to interest/market risk

Answer 75

* Standard-setters aim for financial statements to reflect the underlying economics of a business and so allow managerial discretion * Tax rules are the product of political and social objectives and attempt to minimize discretion

Answer 76

Tax expense divided by pre-tax income

Answer 77

* Certain revenue items on the income statement for ‘book’ purposes are never taxable; Example: Interest earned on municipal bonds (US) * Certain expense items on the ‘book’ income statement are never deductible for tax purposes; Example: Fines imposed by the government

Answer 78

* Compare the ‘book value’ of assets and liabilities on the financial accounting books to the tax books. Compute ‘deferred tax assets’ and ‘deferred tax liabilities’ based on differences in book values using future tax rates (shown shortly) * When tax rates change, this method can cause firms to revalue their deferred tax assets, and thus they might have a shock to their earnings stream

Answer 79

* Items that are deducted in calculating taxable income before they are recognized as a financial expense. (Usually generate deferred tax liabilities): Example: Insurance Prepayments. * Items that are recognized as a financial accounting expense before they are deducted in calculating taxable income. (Usually generate deferred tax assets); Example: Warranty Expense

Answer 80

* A transaction that is accounted for directly in other comprehensive income (e.g., due to pensions, revaluations) * A business combination

Answer 81

* When a company has loss for tax purposes, the firm can elect to do one of two things: * Carry back: Set off the tax-loss against profits in prior years (In US, companies can set off their tax loss against profits in prior 2 years. In UK, this is restricted to 1 year) * Carry forward: Set off the tax-loss against profits in future years (In US, companies can set off their tax loss against profits in next 20 years. In UK, there is no time limit for carry forwards)

Answer 82

* IFRS: Deferred tax assets are recognized only to the extent these benefits are likely to be realized in the future (i.e., here only $0.5m) * US GAAP: If DTAs are not likely to be realized in the future then a “valuation allowance” has to be created

Answer 83

* If it is “more likely than not” that a deferred tax assets will not be realized in the future, then a valuation allowance (a contra-asset account, similar to provisions for doubtful debt) has to be recorded * To a large extent, decision on timing and amount of valuation allowance is a management judgement (subject to approval by the company’s auditors) * The entry for valuation allowance would be to create a provision account called “valuation allowance” and charge this amount to the Income statement * Like any other provision, valuation allowance affects the net asset value and the net income, but does not affect the cash flows

Answer 84

In good years (when earnings are unusually high) increase the valuation allowance. This increases the income tax expense and so reduces current income. Increase: Income tax expense Decrease: DTA through increasing the valuation allowance (contra asset)

Answer 85

Then they are not an asset or liability and should be treated as part of equity for purposes of analysis. In this case, - Deferred tax assets should be seen as reducing shareholder equity – Deferred tax liabilities should be seen as increasing equity

Answer 86

* A segment must be reported if the following tests result in a percentage of 10% or more: (**) Segmental revenue as a percentage of all segment revenue (include internal sales) (**) Segment profit or loss as a percentage of the greater of: Total segment profit, excluding any segment that reported a loss; Total segment loss, excluding any segment that reported a profit * If a segment does not meet these tests then the company can still voluntarily report it as a segment * If a segment was separately reported in the prior period it should continue to be reported - Even if it fails to meet the 10% tests * If a segment is reportable for the first time that segment should also be separately reported for the previous period * Threshold test: – Separately identified segments must comprise AT LEAST 75% of the entity’s (or group’s) EXTERNAL revenue – If not, then additional segments need to be reported even if they fail to meet the 10% tests.

Answer 87

* Disclosure of general information required (type of products and services for each segment) * Measure of profit or loss, liabilities, and total assets should be disclosed for each reportable segment * Liabilities and total assets only required if this information is provided for internal reporting purposes. * Under US GAAP (SFAS 131), liabilities are not required to be disclosed even if provided for internal reporting purposes

Answer 88

* Disclosure is required about discontinued operations i.e. a component of an entity that either has been disposed of or is classified as held for sale. * The component should represent a separate major business line or geographical area of the entity's operations. * The effective closure of the component should be part of a single plan. * Should represent a separate major business line or geographical area of the entity’s operations * Prior periods: Should be restated to reflect all operations that have been discontinued * Discontinued Operations - no adjustments for events occurring after the end of the reporting period.

Answer 89

* Liability recognition tests mirror asset tests. * IAS 37, liability recognised if: – a present obligation exists as a result of a past event – a probable outflow of resources will be required to settle the obligation – a reliable estimate can be made of the amount of the obligation * Recognize at value of minimum obligation * In IFRS, liabilities are discounted * Mostly, liabilities are known, contractual, uncontroversial. * The challenge is when liability is large and uncertain in outcome. These liabilities require provision based on an estimate. Important cases: – pension liabilities – deferred tax liabilities

Answer 90

If the entity has no realistic alternative to settling the obligation created by the event ► Obligation may be legal or constructive ► Legal obligation derives from contract or law - the explicit or implicit terms of a contract, or from legislation or other law ► Constructive obligation: “by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.” ► Therefore, avoidable expenditures are not liabilities, for example: restructuring provisions recognized only if there’s an obligation

Answer 91

* a possible obligation (that arises from past events) whose existence depends on uncertain future events not wholly within the control of the entity; or an actual obligation but either not probable that an outflow of resources will be required or amount cannot be measured reliably. * Contingent liabilities should be disclosed, unless the possibility of an outflow of economic resources is remote. [IAS 37.86] * Similarly, the related party standard [IAS 24] requires disclosure of guarantees to associates. But again disclosure may be avoided on the grounds of economic insignificance. * For safety, need to approach the company directly to confirm the existence of equity pledges.

Answer 92

* IAS 37 regulates provisions for asset retirement obligations * ‘The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability.’

Answer 93

Two valuation approaches for firms’ issued debt securities: (1) Historical (Amortized) cost: use the original values and compute costs and benefits based on market rates at inception of the debt. (2) Mark-to-market: Adjust to fair or market value at each reporting date, i.e. FVO (IFRS 9)** (e.g. Netflix) Majority of firms tend to use amortized cost method, also referred to as effective interest rate method. (our focus)

Answer 94

* Increase cash by bond proceeds (i.e., bond price) * Increase “Bonds payable” (liability) by face value * The difference between (a) and (b) should (i) if positive, i.e. bond issued at premium, go to “Premium on bonds” (a liability account) (ii) if negative, i.e. bond issued at discount, go to “Discount on bonds” (a contra liability account)

Answer 95

* Decrease P&L a/c by interest expense = market interest rate at issuance (called effective interest rate) times net book value of the bond. * Decrease cash by interest paid = coupon rate multiplied by face value * Decrease “Premium” or “Discount” account by the difference between (a) and (b) * Cash flows are often at a different rate than the economic flows – accounting is based on economic flows * In the P&L, we actually want to show the “usage” of the bond (the interest expense) rather than the actual cash outflow (interest paid). * For example, if the bond is issued at a discount the actual expense of the year is the coupon PLUS part of the discount – i.e., we need to “amortize” the discount. * The accounting principle behind this: accrual/matching

Answer 96

* Cash Flow Impacts: * Coupon (interest) payments disclosed in CFO (US GAAP) or CFI (permitted under IFRS) * Proceeds from issuance of new debt and repayment of principal disclosed in CFI

Answer 97

* Foreign currency Bonds/Notes (presented in Fair Value) * Interest rate swaps (presented in Fair Value) * Payment-in-kind Bonds (interest “payments” added to principal) * Convertible debt (e.g. Tesla) - Bond / Note can be converted into predetermined amount of equity shares. Has both a liability and an equity component (IFRS requires separation of the elements in financials)

Answer 98

* Fundamental GAAP principle says that assets and liabilities cannot be offset, except where permitted by a standard * Financial assets and financial liabilities are netted where there is a legally enforceable right to offset. For example: – pensions assets and liabilities in same fund can be netted, but two funds, one in surplus, one in deficit cannot – deferred tax assets and liabilities cannot be netted

Answer 99

* In ‘asset financing’, borrowing is linked to a specific asset. If one can be offset or netted against the other, that gives off-balance sheet financing *Principal mechanisms of off-balance sheet financing have been – operating leasing – securitization – non-consolidation

Answer 100

* Items presented in “net” rather than “gross” * Items represent future commitments rather than present liabilities

Answer 101

1. Leases – Is it a genuine lease or a transaction that is equivalent to borrowing money and purchasing the asset? 2. Securitisation – Sell securities whose payoffs are tied to a specific future source of revenues? – Is it a form of financing or is it a genuine sale of future revenues? – If it is a form of financing, show transaction in balance sheet otherwise, off-balance-sheet 3. “Sale and Leaseback” – Is it a form of financing or a genuine sale of asset? – If former, show transaction in balance sheet.

Answer 102

* Leases * Securitisation * “Sale and Leaseback” * Associates * Sale with Repurchase agreement (Repo) * Special Purpose Vehicles and similar structures

Answer 103

Under an operating lease the lessee will only record an annual rent expense - rental expense should be recognized on a straight-line basis unless another basis is more representative of the time pattern of benefits from the leased property.

Answer 104

The lessee will record an asset and a liability at the inception of the lease. The asset will be depreciated over the lease term and the liability will be treated as any other loan. This implies that the P&L will include depreciation in the operating profit. It will also include the imputed interest cost as part of the interest expense

Answer 105

Current ratio and quick ratio will be lower under capital lease because of the inclusion of the current portion of the lease liability under “Current liabilities”

Answer 106

* For US companies, the implicit interest rate for leases can be estimated from disclosures relating to capital leases or from disclosures relating to debt. * For European Companies, the estimation of implicit interest rate is relatively easier. Since, for finance leases, IAS 17 requires the MLP in the following year as well as present value of the MLP in the following year to be disclosed, the implicit discount rate can be worked out directly from these figures.

Answer 107

* Consolidation of “Variable Interest Entities” (VIE) required if * investor is exposed, or has rights, to variable returns from its involvement with a VIE; ANDhas the ability to affect those returns through its power over the investee

Answer 108

An asset that is characterised by its ability to generate future economic benefits in the form of distributions and/or appreciation in value - Investments in common and preferred shares, bonds, or other securities

Answer 109

Available-for-sale-security, except classified as something else at time of buying - very difficult to reclassify afterwards

Answer 110

* Debt: Investment can be carried at fair value (with changes in value going to Other Comprehensive Income) or historical amortized cost * Debt and equity: investment is carried at fair value with changes in value going to P&L

Answer 111

Under IFRS (but not US GAAP): if the investment is not held for trading purposes, changes in the fair value of equity investments may be charged to OCI (need to designate the security as FVOCI at acquisition date and cannot reclassify)

Answer 112

* Available-for-sale and Held-to-maturity securities: include transaction costs * Trading securities: EXCLUDE transaction costs

Answer 113

An entity that has been designed so that voting or similar rights are NOT the dominant factor in deciding who controls the entity - IFRS 12. – Identify control by looking at the substance of the relationship, e.g. substance over legal form – Looking for situations where the structured entity acts as if on ‘autopilot’ or is ‘brain dead’ – Frequently control exists NOT through voting power but rather through the predetermination of the activities of the structured entity --> Look at corporate charter, etc

Answer 114

(*) IFRS 10 provides a definition of control that’s comprises three elements – Power over an investee; – Exposure or rights to variable returns from an investee; and – Ability to use power to affect the reporting entity’s returns (*) Explicitly states that an investor can control an investee with less than 50% of the voting rights and provides guidance on assessing control in such cases

Answer 115

IFRS includes the “potential voting rights” when determining control, whereas US GAAP does not.

Answer 116

* Sets out accounting requirements in relation to interests in joint ventures * Joint arrangement – An arrangement of which two or more parties have joint control – i.e a similar scope as for joint ventures under IAS 31 * Investor who does not share joint control – Account for as an investment or an associate * Contractual arrangement – Principal factor in determining whether a joint venture relationship exists * Does not apply where the venturer is a venture capital organisation * The joint venture interest is owned by a mutual fund or unit trust * Any company or division which is acquired but will be subsequently sold  IFRS 5 Non-current assets held for sale and discontinued operations

Answer 117

* Must be a separate entity * Joint venturers have rights to the NET assets of the arrangement * Equity method of accounting  same as Investment in Associates (next example)

Answer 118

* Show as an intangible asset * Do not amortise * Subject it to annual impairment reviews

Answer 119

* fair value (sometimes called the full goodwill method) * the NCI's proportionate share of net assets of the acquire (sometimes call the partial goodwill method)