Financial reporting and analysis

Question 1

Which account method to apply for ownership of less than 20% interest of company?

Balance sheet, income statement, difference for IFRS vs US GAAP.

Answer 1

Cost or fair value.

Question 2

Which account method to apply for ownership of 20% to 50% interest of company?

Balance sheet, income statement, difference for IFRS vs US GAAP.

Answer 2

Equity method

Balance sheet: - cost + % share of retained net income of investee

Income statement: % Share x investee’s net income

Cashflow: Dividends received not shown income statement, but rather are deducted from investment in associates in the balance sheet.

Question 3

Calculate the goodwill under the equity method?

Answer 3

Goodwill = (fair value * % interest) - cost

Goodwill is the difference between the fair value and cost.

Goodwill is included in the carry amount on the balance sheet.

Goodwill is not amortised but reviewed for impairment in the balance sheet.

Question 4

In the equity method how depreciation is shown in the balance sheet and income statement?

Answer 4

Balance sheet =
+ cost
+ (Net income - dividend) * x% interest
- (PPE Fair value - book value) / number of remaining life * x% interest

Income statement = % of net income - (Excess purchase price * % interest) / number of remaining life

Question 5

Impact of financial ratio under equity method, partial goodwill, and full goodwil.

Sales
Net income
Total assets
Total liabilities
Stockholder’s equity

Net profit margin
ROE
ROA
Leverage

Answer 5

Items - Equity / Partial Goodwill / Full Goodwill

Sales - Lower / Higher / Higher
Net income - Same / Same / Same
Total assets - Lowest / Middle / Highest
* assets contains goodwill
Total liabilities- Lower / Higher / Higher
Stockholder equity - Lowest / Middle / Highest
* Equity method has no minority interests

Net profit margin - Net income / revenue
- Higher / Lower / Lower
ROE - Net income / Equity
- Highest / Middle /Lowest
ROA - Net income / Assets
- Highest / Middle / Lowest
Leverage - Debt to Equity
- HIghest / Highest / Middle

Question 6

Which account method to apply for ownership over 50% interest of company?

Entry for
Balance sheet
Income statement

Answer 6

Consolidation method.

Balance sheet - Consolidate 100% of Investee asset and liability

Asset = Asset A + Asset B - Purchase price of B
Liability = Liability A + Liability B
Minority interest = (1 - % interest) * (Asset - Liability)
Common stock and retained earnings of B are not included.

Question 7

Calculate full goodwill under the consolidation method?

Is this allowed under US GAAP and IFRS?

Answer 7

Full Goodwill = Purchase cost - Fair net asset value
Minority interest = ( 1 - interest %) * cost

US GAAP and IFRS allowed

Under full goodwill. Non-controlling interests need to include a share of goodwill.

Non-controlling interests = fair value * (1 - purchased %)

Question 8

Calculate partial goodwill under the consolidation method?

Is this allowed under US GAAP and IFRS?

Answer 8

Partial Goodwill = Purchase cost - % interest * Fair value of net asset

Minority interest = (1 - interest %) * Fair value of net asset

Allowed under IFRS only.

Question 9

How to consolidate the following balance sheet items under full goodwill, partial goodwill and equity method? When Company A purchase x% of Company B.

Asset
Goodwill
Liability
Equity
Minority interest

Answer 9

Company A purchase x% of Company B.

Full goodwill:
Asset = A asset + B asset - cost to purchase B at x%
Goodwill = Fair value of B - fair value net asset of B
PPE = A + B PPE
Liability = A liability + B liability
Minority interest = ( 1 - interest %) * cost
Common stock and retained earnings = Company A only

Partial goodwill:
Asset = A asset + B asset - cost to purchase company B at x%

Goodwill = cost - (fair value net asset of B * interest x%)
PPE = A + B PPE
Liability = Company A liability + Company B liability
Minority interest = ( 1 - interest %) * fair value net asset of B
Common stock and retained earnings = Company A only

Equity method:
Asset = A asset - cost to purchase company B at x% + cost to purchase company B at x%
Goodwill = None
PPE = A PPE
Liability = A liability
Minority interest = None
Common stock and retained earnings = Company A only

Question 10

What is the difference between income statement under consolidated method and equity method?

Sales
Operating expense
Minority interest
Net income

Answer 10

Company A purchase x% of Company B.

Consolidated method:

Sales = A + B
Operating expense = A + B
Minority interest = - (1 - x% interest ) * (Sales - Operating expense)

Equity method:

Sales = A
Operating expenses = A
Equity income of B = (Operating income B) * x% interest

Question 11

Impact on the financial ratios under the Equity, Partial Goodwill and Full Goodwill method

Answer 11

TBC

Question 12

Held to maturity investments (Debt only) account entry under:

Balance sheet
Income statement
Difference between IFRS vs US GAAP?

Answer 12

Hold the debt to maturity.

Balance sheet:
Under IFRS:
asset = Initial at fair value - amortization cost + coupon
Show at amoritized cost thereafter.

Under US GAAP:
Initial price paid for US GAAP

Income statement:
Show realised gains / losses
Income = Interest income - amortization of premium (if any).

Question 13

Held for trading investments account entry under:

Balance sheet
Income statement
Difference between IFRS vs US GAAP?

Answer 13

Intent to sell in the short term.
Fair value through profit and loss. (FVPL)

Balance sheet:
Asset = fair market value + coupon

Income statement: (realised / unrealised gain / loss)
Income = interest income - premium cost
Net income = Income + Change in Fair value (FV)
Change in FV = Fair value + premium - Amortised cost

No difference between IFRS vs US GAAP

Question 14

Available for sale investments account entry under:

Balance sheet
Income statement
Difference between IFRS vs US GAAP?

Answer 14

Fair value through comprehensive income. (FVOCI)
Balance sheet = Fair value (Mark to market)

Unrealised gain / loss taken to equity OCI.

OCI (operation compensive income)
OCI shockholder’s equity = Fair value - Amortisated value (Unrealised gain/loss)

Income statement = Interest income
+ Realised gain and losses

Difference between IFRS vs US GAAP?
IFRS: Forex movement go to P&L
Carry value change to to OCI.
US GAAP: Total change and carry value change in OCI.

Question 15

If the debt is held and intent to sell, which accounting method should be used to avoid accounting mismatch?

Answer 15

Fair value through P&L (held for trading investments)

Question 16

Under IFRS 9, is reclassification of investment allowed under:

Equity
Debt

Answer 16

Recalssification of equity is not permitted.

Recalssification of debt is noly permitted if the business model for the asset has changed.
There is no restatement prior the reclassification date.

Question 17

What is the accounting method for loan and receivables?

Under IFRS and US GAAP.

Answer 17

Under IFRS:
Fair value through P&L (Held for trading)
Fair value through OCI
Upfront recognition of impairment using expected loss model
- performing assets 12 month expected loss
- Non-performing asset lifetime expected losses

Under US GAAP
Fair value through P&L (Held for trading)
Fair value through OCI
Held to maturity

Question 18

How would a company treat-in process R&D in balance sheet if it reports using US GAAP?

Answer 18

It is recognized at fair value as separate intangible asset. Both under IFRS and US GAAP.

Question 19

How derivatives held as investment measured on a company’s financial statements balance sheet or P&L under IFRS?

Answer 19

Fair value through profit and loss.

Question 20

Which account method would be used when accounting for joint ventures holding of 20 - 50% of the investee?

Answer 20

Equity method

Question 21

Under IFRS, can equity instrument can be reclassified as FVPL?

Answer 21

It can not be reclassified.

Question 22

Under IFRS and US GAAP which entities can be account for the investment at fair value?

Answer 22

IFRS - only allowed for venture capital, funds, unit trusts, and other collective investment fund.

US GAAP - all entities.

Question 23

Under IFRS and US GAAP does it allow impairments for the investment?

Answer 23

Both IFRS and US GAAP require periodic reviews for impairment.

IFRS - objective evidence of impairment.
US GAAP - decline if determined to be pemanent.

Both prohibit reversals of impairment losses.

Question 24

Downstream transition from Parent company A to an associate company B.

Yr1 A purchase 25% of B at $100
A sold $10 cost of good at $12 to B
B make a sale of 80% of good
B Net income $20
B extra PPE depreciation $5
Yr2 B sold the remaining 20% of good.
B Net income $20
B extra PPE depreciation $5
What is recorded in the income statement at Yr 1 and Yr 2 for company A?

Answer 24

Income Yr1:
Income = + net income B % share
Dep’n = - extra dep’n * % share
Inventory = - (sold price - cost of good sold) * remaining * % share

Income Yr2:
Income = + net income B % share
Dep’n = - extra dep’n * % share
Inventory = + (sold price - cost of good sold) * remaining * % share

Question 25

Upstream transition from an associate company B to Parent company A. Yr1 A purchase 30% of B at $100 B sold goods to A with recognized income $5. B net income $40, dividend paid $7 B fair value is $10 higher than book value with 10 years of remaining life What is recorded in the income statement? What is recorded in the balance sheet?

Answer 25

Balance sheet: Cost = + purchase price Dep'n = - (Fair value - book value) / remaing life * % share Income = + (B net income - B dividend) * % share Profit = - Recognized income * % share Income: Income = + B net income * % share Dep'n = - (Fair value - book value) * % share Profit = - Recognized income * % share

Question 26

Under business combinations ownership of over 50%, is full goodwill and partial goodwill is permitted under IFRS or US GAPP?

Answer 26

Full goodwill (IFRS and US GAPP) Partial goodwill (IFRS)

Question 27

What is the impact on ratios using full and partial goodwill accounting method? Asset Equity

Answer 27

Asset and Equity will be higher under full goodwill.

Question 28

Business combinations compare between IFRS and US GAAP. How the below are recorded in the account Contingent Asset / Liability / Equity. In process R&D

Answer 28

IFRS - Contingent recorded at fair value as liability and equity - In-process R&D, allow recongise as an intangible asset, and then amortized for both IFRS and US GAAP. US GAAP Also can be classify as asset.

Question 29

Company A buys 70% of company B. The fair value of B is $140K, and the net asset is $120K. What is the goodwill and minority interest under the full goodwill and partial goodwill method.

Answer 29

Full goodwill Asset: Current asset = A + B PPE = A+ B Goodwill = + B Fair value - B Net asset Equity: Minority interest = + Fair value * % interest Partial goodwill Asset: Current asset = A + B PPE = A+ B Goodwill = + Purchase price - (B Net asset * % interest) Equity: Minority interest = + Net asset * % interest

Question 30

What is the Profit margin ratio?

Answer 30

Net income / sales

Question 31

What is return on assets?

Answer 31

Net income / assets

Question 32

What is the return on equity?

Answer 32

Net income / equity

Question 33

What is goodwill impairment under IFR/S and US GAAP?

Answer 33

IFRS - if carry book value > recoverable amount, then impairment loss = Carry value - recoverable amount US GAPP Recoverability test - Impairment must be recognized when the carrying value of the assets exceeds the fair value or undiscounted cashflow on use and disposal. Loss measurement - The excess of the carry amount over the fair value Impairment loss = Book value - PV of future cashflow - Test that carry value > recoverable amount - if yes, apply account treatment: impairment loss = actual goodwill - justify goodwill where justify goodwill = recoverable amount - net asset https://analystnotes.com/cfa-study-notes-explain-the-impairment-of-property-plant-and-equipment-and-intangible-assets.html

Question 34

What is PBO Pension Benefit Obligation / DBO Defined Benefit Obligation?

Answer 34

PBO is the actuarial present value at the assumed discount rate of all future pension benefits, based on salary increase, and measures the obligation on a going concern assumptions. PBO end of year = + PBO start of year + Current services cost + Interest cost + Plan amendments + Past services cost + Actuarial losses (- gain) - Benefits paid

Question 35

What factors afftect the PBO in DB pension?

Answer 35

Income statement on Pension expense for US GAAP + service cost + Interest cost + Expect return on plan assets + Amortization of actuarial loss (-gains) (subject to corridor test) other income statement entry: + Employer contributions - Benefits paid Beginnign PBO + service cost (IS) + interest cost (IS) +- acturial loss/gain (life expectancy increase) IFRS: OCI (stay forever) US GAAP: OCI or IS (us corridor test, ammoztired loss/gain) + Past/future service cost (Plan amendments) IFRS: IS USGAAP: OCI or I/S +- Other factors (FX impacts) +- Benefits paid IFRS / US GAAP: No impact

Question 36

Calculate funded status.

Answer 36

Funded status = Fair value of assets - PV of the defined benefit obligation

Question 37

Calculate total periodic pension expense.

Answer 37

Total periodic pension expense = + Service cost + Interest cost + Actuarial loss + Prior service cost – Actual return

Question 38

Pension expense income statement for US GAAP Pension expense income statement for IFRS

Answer 38

US GAAP: pension expense = service cost + Interest cost (interest rate * opening PBO) - Expected return on assets - / + Amortization gain/ loss (US corridor test) IFRS: pension expense = Service cost + Past service cost - / + Net interest income /expense Net interest expense = opening net pension Liability * discount rate PBO = Pension benefit obligation Actuarial gains/losses are not recognized in the income statement but instead goes to OCI in the balance sheet, and are not part of pension expense. Past service cost are not amortized but are recognized in full in year of plan amendment.

Question 39

Multinational operations what is the definitions of the following currency? And what currency translation method should be used? Presentation currency Functional currency Local currency

Answer 39

Presentation currency - Currency in which the financial statements are presented Functional currency - Currecy of country where entity send and receives cash Local currency - Currency of the country in which the company operates Functional to presentation currency - use current rate year end method. Local to functionary currency - temporal method

Question 40

Pension remeasurement gain under IFRS and US GAAP.

Answer 40

Under IFRS, remeasurement gains and losses are recognized immediately in equity and not in the income statement. Under US GAAP they would be amortized through the income statement.

Question 41

Currency translation using the current rate (year end) method. -- Balance sheet -- Cash Inventories Non-current assets Liability Common stock Retained earnings -- Income statement -- Sales COGS Depreciation Forex gain/loss Net income

Answer 41

Asset and Liability - Current year end rate Common stock - historical rate Retained earnings - balancing item Income statement - average rate Forex gain/loss go to OCI Year 2 do income statement first. Asset Cash - year end rate Inventories - year end rate Non-current assets- year end rate Liability- year end rate Common stock - historical acquisition rate Retained earnings - Yr 1 retained earnings carry forward + Yr 2 Net income from income statement. OCI - rebalance item Income statement Sales - average rate COGS- average rate Depreciation- average rate Net income - sum total

Question 42

Currency translation using the temporal method. -- Balance sheet -- Cash Inventories Non-current assets Liability Common stock Retained earnings -- Income statement -- Sales COGS Depreciation Forex gain/loss Net income

Answer 42

Non monetary Asset and Liability - historic rate (current rate if measured at current value) (Property/Plant/Equipment/Inventory) Monetary Asset and Liability - Current rate Common stock - historical rate Retained earnings - balancing item Income statement - average rate, except for expenses related use historic rate. Forex gain/loss go to income statement. Year 2 do balance sheet first. Asset Cash - current y/end rate Inventories - historic purchase rate Non-current assets - historic purchase rate Liability - current yr end rate Common stock - historic acquisition rate Retained earnings - balancing figure Income statement Sales - average rate COGS - historical rate at purchase Depreciation - historical rate at purchase Forex gain/loss - balancing item Net income - (Yr2 retained earnings - Yr1 retained earnings)

Question 43

Current rate vs temporal method when the local currency is weakening. Current ratio Quick ratio Receivables turnover Fixed asset turnover Total asset turnover

Answer 43

Ratio | Current rate | Temporal Current ratio CA / CL : Lower | Higher Quick ratio (account receivable + cash) / (Current liability) : Same | Same Receivables turnover Sale turnover / receivables: Same | Same Asset turnover: Sales turnover / fixed assets: higher | lower

Question 44

Current rate vs temporal method when the local currency is weakening. Which is higher / lower? Gross profit margin Financial leverage Interest coverage Long term debt to total capital

Answer 44

Hints: Non-monetary asset and liability (PPE & Inventory), depreciation and COGS higher under the historic currency translation in the temporal method. Common stock is always historic Income statement: Mostly average Ratio | Current rate | Temporal Gross profit margin Gross profit / Sales: Higher | Lower Interest coverage EBIT / Interest: Higher | Lower Long term debt to total capital Debt / Asset: Higher | Lower

Question 45

Under Hyperinflation economies What is the translation curreny method for IFRS and US GAAP?

Answer 45

IFRS - Restate financial statement - Use current rate method US GAAP - Treat presentation currency as functional currency - Use temporal method.

Question 46

Calculate return on equity.

Answer 46

ROE = Net income / Equity = Net Income / Sales * Sales / Total Assets * Total assets / Equity = Net profit margin * asset turnover * leverage

Question 47

Calculate the impact on periodic pension cost under IFRS and US GAAP on change in plan assets over the year for Actual return on assets Employer contributions Benefits paid

Answer 47

Change in plan assets = + Actual return + contribution - Benefit paid Under IFRS Net actual return on assets = OCI as part of remeasurements = Actual return - opening plan assets * interest rate Under US GAAP Expected return on assets = P&L = Expected return on assets * opening plan assets Differences between actual and expected returns are treated the same as actuarial gains and losses. Usually recognised in OCI and then amortised to P&L using the corridor method. Employer contributions Benefits paid

Question 48

What is corridor test method?

Answer 48

Corridor test method compare the difference between actual vs expected return If the loss if bigger than 10% of total assets then P&L = Actuarial gains / loss - (assets * 10%) / services in years

Question 49

Change in PV of defined benefit obligation (PVDBO) impact on account under IFRS and US GAAP. Current service costs Past service costs Interest cost Actuarial gains and losses Actual return on assets Benefit paid Employer contributions

Answer 49

Under US GAAP Current service costs - P&L (Income statement) Past service costs - OCI then amortised to P&L over the average service life Interest cost - P&L = open gross pension liability * interest rate Actuarial gains and losses - OCI then amortised using the corridor method. Actual return on assets - P&L = Expected return on assets = Expected return on plan assets * openning plan assets Difference between actual and expected plan assets OCI then amortised using the corridor method. Under IFRS Current service costs - P&L (Income statement) Past service costs - P&L Interest cost - P&L = Opening net pension asset or liability * interest rate Actuarial gains and losses - OCI (remeasurements) Net return on plan assets - OCI (remeasurements) = Actual return - opening plan assets * interest rate Both Benefit paid - None Employer contributions - None

Question 50

If implements the share option scheme, the compensation expense would account for how long under US GAAP?

Answer 50

The expense should be recognized over the service period.

Question 51

Calculate the interest cost and service cost of PBO undedr US GAAP.

Answer 51

Interest cost = beging PBO * discount rate Service cost = PV of annual unit credit (addtional value of pension that has been accrued due to working an extra year)

Question 52

Change in PV of defined benefit obligation (PVDBO) impact on account under IFRS and US GAAP. Current service costs Past service costs Interest cost Actuarial gains and losses Actual return on assets Benefit paid Employer contributions

Answer 52

Under US GAAP Current service costs - P&L Past service costs - OCI then amortised to P&L over the average service life Interest cost - P&L = open gross pension liability * interest rate Actuarial gains and losses - OCI then amortised using the corridor method. Actual return on assets - P&L = Expected return on assets = Expected return on plan assets * openning plan assets Difference between actual and expected plan assets OCI then amortised using the corridor method. Under IFRS Current service costs - P&L Past service costs - P&L Interest cost - P&L = Opening net pension asset or liability * interest rate Actuarial gains and losses - OCI (remeasurements) Net return on plan assets - OCI (remeasurements) = Actual return - opening plan assets * interest rate Both Benefit paid - None Employer contributions - None

Question 53

What are the six factors in CAMELS approach to score a Bank.

Answer 53

Capital Adequacy - A capital adequacy ratio is a measurement of a bank's available capital as a percentage of bank's risk weighted credit exposures. = (Tier 1 + Tier 2 Capital) / Risk weighted assets Asset quality - How much credit risk does a bank's assets have. Management - Bank's compliance to policies and procedures, risk management, and steategic plan. The ratio of non-interest expenditures to total assets. Earnings - Assess bank's growth, stability, valuation allowances, net interest margin, and quaility of assets. Liquidity - How easy Bank can convert it's asset to cash Liquity Coverage ratio = Highly liquid assets / 1 month liquidity needs Net stable fudning ratio = available stable funding / required stable funding Target above 100% Sensitivity to Market Risk Risk management on how change in interest rate, FX rate, commodity price or equity price can affect Bank's earnings.

Question 54

Define the ROE equation using DuPont Analysis.

Answer 54

ROE = Net income / Equity = Net income / Sales * Sales / Asset * Asset / Equity = Net profit margin * Total asset turnover * Leverage = Net Income / EBT * EBT / EBIT * EBIT / Revenue * Revenue / Assets * Equity = Tax burden * Interest burden * EBIT margin * Asset turnover * Leverage

Question 55

Define the accruals ratio using balance sheet approach.

Answer 55

Accruals is the change in net operating assets assets over the period. Balance sheet accruals ratio for time t = NOA(t) - NOA(t - 1) / [(NOA(t) + NOA(t-1)) / 2] where NOA Net operating assets = operating assets - operating liabilities where Operating assets = Total assets - Cash - short term investment Operating liabilities = Total liability - Short and long term debt

Question 56

Define the accruals ratio using cashflow (CFO) approach.

Answer 56

accruals ratio = (Net Income - CFO - CFI) / Average NOA Average Net operating assets (NOA) = (NOA(t) + NOA(t+1))/2

Question 57

Formula for Cash conversion cycle (net operating cycle).

Answer 57

Net operating cycle = No of days inventory + No of day receivables - No of days payable No of days payable = Number of days in period / Payables turnover ratio

Question 58

Calculate return on common equity

Answer 58

Net income - Preferred dividends / Average common shareholders' equity

Question 59

The impact of raising debt and buy back the share on WACC Weighted average cost of capital?

Answer 59

WACC will decrease.

Question 60

What is pecking order theory?

Answer 60

Pecking order theory suggests that managers choose methods of financing internally generated funds are preferred to external, and preferred debt issues to equity issues. Manager will issue new equity if they believe the stock is overvalued.

Question 61

Calculate free cashflow to firm (FCFF) using CFO.

Answer 61

FCFF = CFO + Interest (1 -tax) - Investment in Working Capital

Question 62

Calculate free cashflow to firm (FCFF) using Net income.

Answer 62

FCFF = Net Income + Non-cash charge + Interest expense ( 1 - tax) - Fixed capital investment - Working capital investments

Question 63

Calculate free cashflow to equity (FCFE).

Answer 63

FCFE = Net Income+Non-Cash Charges−Fixed Capital Investments−Working Capital Investments+Net Borrowing

Question 64

What is the difference between accumulated benefit obligation (ABO) and projected benefit obligation (PBO)?

Answer 64

Accumulated benefit obligation (ABO) is the approximate amount of a company's pension plan liability at a single point in time. ABO is estimated based on the assumption that the pension plan is to be terminated immediately; it does not consider any future salary increases. This differs from the projected benefit obligation (PBO), which assumes that the pension plan is ongoing, and thus accounts for future salary increases.

Question 65

Calculate minority (non-controlling) interest be under the full goodwill and the partial goodwill methods

Answer 65

Under the full method (IFRS and US GAAP), minority interest is minority% x Fair value of acquiree. Under the partial method (only IFRS), minority interest is minority% x Fair value of net assets:

Question 66

Under equity method. Calculate the equity investment of x% in the balance sheet.

Answer 66

Balance sheet = + Cost of investment + x% * Earnings after tax - (x% * excess purchase price ) / number of remaining life

Question 67

Calculate minority interest in one year.

Answer 67

minority% * fair value of acquiree + minority% * retained earnings

Question 68

Ca