FInancial Reporting & Analysis 1: Investmetns In SPEs/VIEs

Question 1

SPE and VIE, IFRS vs GAAP

Answer 1

IFRS uses Special Purpose Entity

GAAP uses Variable Interest Entity

Question 2

IFRS vs GAAP: requirement of consolidated financial statements when using SPEs or VIEs

Answer 2

Both IFRS and GAAP require you to prepare consolidated financial statements

Question 3

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

Answer 3

The amount of equity interest doesnt matter. The primary beneficiary must consolidate the VIE as a subsidiary regardless of the amount of equity ownership

Question 4

How do we define a primary beneficiary under a VIE or SPE?

Answer 4

The primary beneficiary is the entity that is expected to absorb the majority of losses, gains, or both of the VIE.

Question 5

If one entity absorbs the VIEs losses, while another absorbs the gains, who has to consolidate the VIE?

Answer 5

Whoever absorbs the losses must consolidate

Question 6

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?

Answer 6

The VIE must show them on both the balance sheet and income statement

Question 7

Why does a company usually set up a SPE?

Answer 7

A company sets up an SPE typically to securitize accounts receivable

Question 8

How does a company securitize their accounts receivables using an SPE?

Answer 8

The sponsor basically sells their accounts receivable to the SPE, who in turn issues debt to fund the purchase of the receivables.

Question 9

What is the advantage of a sponsor selling their receivables to the SPE?

Answer 9

It speeds up their cash flow

Question 10

How does the SPE fund the purchase of accounts receivables from the sponsor?

Answer 10

The SPE issues debt. The debt is services by the cash flow from the accounts receivable.

Question 11

When the sponsor is on the hook for the cash flows from the receivables, what does this mean and what does it entail?

Answer 11

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.

Question 12

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?

Answer 12

If they aren’t on the hook, accounts receivable would decrease, the cash from the sale of the receivables would flow to CFO.

Question 13

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?

Answer 13

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

Question 14

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 -

Answer 14

CFO - Lower
CFF - Higher
Total Cash Flow - Same
Current Assets - Higher
Current Liabilities - Higher
Current Ratio (assuming greater than 1) - Lower

Question 15

Concerning contingent assets a liabilities, how does IFRS recognize?

Answer 15

Under IFRS, we recognize contingent liabilities, but we do not recognize contingent assets

Question 16

Concerning contingent assets and liabilities, how do we recognize under GAAP?

Answer 16

Under GAAP, contractual contingent liabilities and assets are recognized at fair value

Question 17

IFRS vs GAAP: recognition of contingent assets and liabilities

Answer 17

IFRS only recognizes contingent liabilities, not assets

GAAP recognized both assets and liabilities, at their fair value

Question 18

What is a contingent consideration?

Answer 18

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

Question 19

Under IFRS and GAAP, contingent considerations should initially be recognized at _____. How will they be classified?

Answer 19

Under IFRS and GAAP, contingent considerations should initially be recognized at Fair Value. They should be classified as a financial liability or equity

Question 20

Concerning subsequent changes in the fair value of contingent considerations, how are they recognized for assets, liabilities, and equities?

Answer 20

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.

Question 21

Under IFRS and GAAP, how do we recognize In Process R&D that is acquired as a result of a business combination?

Answer 21

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.

Question 22

Under IFRS and GAAP, how do we treat restructuring costs?

Answer 22

Under IFRS and GAAP, restructuring costs are expenses in the period they are incurred. They are not included in the acquisition price.

Question 23

If we choose the equity method, the investment appears ______ on the investors balance sheet.

Answer 23

Under the equity method, the investment will appear as a single line item on the investors balance sheet.

Question 24

Under the equity method, how do we report the investors share of the investees earnings?

Answer 24

Under the equity method, the investors share of the investees earnings are reported as a single line item on the income statement

Question 25

Under the Equity Method, we (recognize/don’t recognize) the investees debt. This results in (higher/lower) leverage ratios.

Answer 25

Under the equity method, we do not recognize the investees debt. Therefore, our leverage ratios will be lower.

Question 26

Under the equity method, we (recognize/don’t recognize) the investees revenue. This results in (higher/lower) profit margins.

Answer 26

Under the equity method we do not recognize the investees revenues. This results in higher profit margins.

Question 27

Under the acquisition method, what happens to the assets, liabilities, incomes, and expenses of the acquirer and acquired?

Answer 27

Under the acquisition method these are all combined, resulting in higher reporting values for each.

Question 28

When it comes to net income, it will be highest using (equity method vs acquisition method)

Answer 28

It will be the same under both methods.

Question 29

We use full and partial goodwill methods when using the (equity method or acquisition method)

Answer 29

We use the goodwill methods under the acquisition method

Question 30

Compare total assets and equity when using the full goodwill method vs the partial goodwill method

Answer 30

The full goodwill method results in higher total assets and equity.

Question 31

Compare ROA and ROE when using the partial vs full goodwill method

Answer 31

ROA and ROE will be lower when using the full goodwill method

Question 32

Compare net income and retained earning when using the partial vs full goodwill method

Answer 32

RE and Net Income will be the same under both methods

Question 33

Which method, equity or acquisition, usually provides more favorable results?

Answer 33

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.