FInancial Reporting & Analysis 1: Investmetns In SPEs/VIEs Flashcards
SPE and VIE, IFRS vs GAAP
IFRS uses Special Purpose Entity
GAAP uses Variable Interest Entity
IFRS vs GAAP: requirement of consolidated financial statements when using SPEs or VIEs
Both IFRS and GAAP require you to prepare consolidated financial statements
The primary beneficiary of a VIE (does/does not) have to consolidate the VIE as a subsidiary if they do not hold a majority equity interst
The amount of equity interest doesnt matter. The primary beneficiary must consolidate the VIE as a subsidiary regardless of the amount of equity ownership
How do we define a primary beneficiary under a VIE or SPE?
The primary beneficiary is the entity that is expected to absorb the majority of losses, gains, or both of the VIE.
If one entity absorbs the VIEs losses, while another absorbs the gains, who has to consolidate the VIE?
Whoever absorbs the losses must consolidate
When there are minority shareholders in the VIE, does the sponsor have to show them in their consolidated balance sheet? What about on the consolidated income statement?
The VIE must show them on both the balance sheet and income statement
Why does a company usually set up a SPE?
A company sets up an SPE typically to securitize accounts receivable
How does a company securitize their accounts receivables using an SPE?
The sponsor basically sells their accounts receivable to the SPE, who in turn issues debt to fund the purchase of the receivables.
What is the advantage of a sponsor selling their receivables to the SPE?
It speeds up their cash flow
How does the SPE fund the purchase of accounts receivables from the sponsor?
The SPE issues debt. The debt is services by the cash flow from the accounts receivable.
When the sponsor is on the hook for the cash flows from the receivables, what does this mean and what does it entail?
If the sponsor is on the hook they are responsible for the cash flow from the accounts receivable that they sold to the SPE generating enough flow to service the debt holders. If they are responsible, there will need to be work done by the analyst to reclassify some of the cash flows.
If the sponsor is not on the hook for the cash flows from the receivables that were sold to the SPE, how would we record the transaction?
If they aren’t on the hook, accounts receivable would decrease, the cash from the sale of the receivables would flow to CFO.
If the sponsor is on the hook for the cash flows from the receivables they sold to the SPE, what does the analyst need to do to the cash flows?
If they aren’t on the hook, the cash would flow to CFO and receivables would decrease. Since they are on the hook for the cash flows being enough to cover the debt service, the analyst needs to decrease CFO, increase CFO, increase receivables, increase liabilities
Effects on the below for a sponsor being responsible for the cash flow of receivables sold to an SPE: lower or higher
CFO - CFF - Total Cash Flow - Current Assets - Current Liabilities - Current Ratio -
CFO - Lower CFF - Higher Total Cash Flow - Same Current Assets - Higher Current Liabilities - Higher Current Ratio (assuming greater than 1) - Lower
Concerning contingent assets a liabilities, how does IFRS recognize?
Under IFRS, we recognize contingent liabilities, but we do not recognize contingent assets
Concerning contingent assets and liabilities, how do we recognize under GAAP?
Under GAAP, contractual contingent liabilities and assets are recognized at fair value
IFRS vs GAAP: recognition of contingent assets and liabilities
IFRS only recognizes contingent liabilities, not assets
GAAP recognized both assets and liabilities, at their fair value
What is a contingent consideration?
A contingent consideration is when a parent enters an agreement to pay additional amounts to the subsidiary’s shareholders based on performance achievements by the combined entity
Under IFRS and GAAP, contingent considerations should initially be recognized at _____. How will they be classified?
Under IFRS and GAAP, contingent considerations should initially be recognized at Fair Value. They should be classified as a financial liability or equity
Concerning subsequent changes in the fair value of contingent considerations, how are they recognized for assets, liabilities, and equities?
Subsequent changes in fair value are recognized in the consolidated income statement for assets and liabilities.
Subsequent changes in fair value of equities are ignored.
Under IFRS and GAAP, how do we recognize In Process R&D that is acquired as a result of a business combination?
Under IFRS and GAAP, In Process R&D that is acquired is to be recognized as a separate intangible asset that is recognized at fair value. It will then be amortized.
Under IFRS and GAAP, how do we treat restructuring costs?
Under IFRS and GAAP, restructuring costs are expenses in the period they are incurred. They are not included in the acquisition price.
If we choose the equity method, the investment appears ______ on the investors balance sheet.
Under the equity method, the investment will appear as a single line item on the investors balance sheet.
Under the equity method, how do we report the investors share of the investees earnings?
Under the equity method, the investors share of the investees earnings are reported as a single line item on the income statement
Under the Equity Method, we (recognize/don’t recognize) the investees debt. This results in (higher/lower) leverage ratios.
Under the equity method, we do not recognize the investees debt. Therefore, our leverage ratios will be lower.
Under the equity method, we (recognize/don’t recognize) the investees revenue. This results in (higher/lower) profit margins.
Under the equity method we do not recognize the investees revenues. This results in higher profit margins.
Under the acquisition method, what happens to the assets, liabilities, incomes, and expenses of the acquirer and acquired?
Under the acquisition method these are all combined, resulting in higher reporting values for each.
When it comes to net income, it will be highest using (equity method vs acquisition method)
It will be the same under both methods.
We use full and partial goodwill methods when using the (equity method or acquisition method)
We use the goodwill methods under the acquisition method
Compare total assets and equity when using the full goodwill method vs the partial goodwill method
The full goodwill method results in higher total assets and equity.
Compare ROA and ROE when using the partial vs full goodwill method
ROA and ROE will be lower when using the full goodwill method
Compare net income and retained earning when using the partial vs full goodwill method
RE and Net Income will be the same under both methods
Which method, equity or acquisition, usually provides more favorable results?
The Equity method usually provides more favorable results. It results in lower leverage ratios because it ignores the investees debt, and higher profit margins because it ignores the investees revenue.
The acquisition method combines the assets, liabilities, incomes, and expenses.
