Financial reporting and analysis Flashcards
Which account method to apply for ownership of less than 20% interest of company?
Balance sheet, income statement, difference for IFRS vs US GAAP.
Cost or fair value.
Which account method to apply for ownership of 20% to 50% interest of company?
Balance sheet, income statement, difference for IFRS vs US GAAP.
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.
Calculate the goodwill under the equity method?
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.
In the equity method how depreciation is shown in the balance sheet and income statement?
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
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
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
Which account method to apply for ownership over 50% interest of company?
Entry for
Balance sheet
Income statement
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.
Calculate full goodwill under the consolidation method?
Is this allowed under US GAAP and IFRS?
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 %)
Calculate partial goodwill under the consolidation method?
Is this allowed under US GAAP and IFRS?
Partial Goodwill = Purchase cost - % interest * Fair value of net asset
Minority interest = (1 - interest %) * Fair value of net asset
Allowed under IFRS only.
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
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
What is the difference between income statement under consolidated method and equity method?
Sales
Operating expense
Minority interest
Net income
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
Impact on the financial ratios under the Equity, Partial Goodwill and Full Goodwill method
TBC
Held to maturity investments (Debt only) account entry under:
Balance sheet
Income statement
Difference between IFRS vs US GAAP?
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).
Held for trading investments account entry under:
Balance sheet
Income statement
Difference between IFRS vs US GAAP?
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
Available for sale investments account entry under:
Balance sheet
Income statement
Difference between IFRS vs US GAAP?
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.
If the debt is held and intent to sell, which accounting method should be used to avoid accounting mismatch?
Fair value through P&L (held for trading investments)
Under IFRS 9, is reclassification of investment allowed under:
Equity
Debt
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.
What is the accounting method for loan and receivables?
Under IFRS and US GAAP.
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
How would a company treat-in process R&D in balance sheet if it reports using US GAAP?
It is recognized at fair value as separate intangible asset. Both under IFRS and US GAAP.
How derivatives held as investment measured on a company’s financial statements balance sheet or P&L under IFRS?
Fair value through profit and loss.
Which account method would be used when accounting for joint ventures holding of 20 - 50% of the investee?
Equity method
Under IFRS, can equity instrument can be reclassified as FVPL?
It can not be reclassified.
Under IFRS and US GAAP which entities can be account for the investment at fair value?
IFRS - only allowed for venture capital, funds, unit trusts, and other collective investment fund.
US GAAP - all entities.
Under IFRS and US GAAP does it allow impairments for the investment?
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.
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?
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
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?
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
Under business combinations ownership of over 50%, is full goodwill and partial goodwill is permitted under IFRS or US GAPP?
Full goodwill (IFRS and US GAPP)
Partial goodwill (IFRS)
What is the impact on ratios using full and partial goodwill accounting method?
Asset
Equity
Asset and Equity will be higher under full goodwill.
Business combinations compare between IFRS and US GAAP.
How the below are recorded in the account
Contingent Asset / Liability / Equity.
In process R&D
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.
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.
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
What is the Profit margin ratio?
Net income / sales
What is return on assets?
Net income / assets
What is the return on equity?
Net income / equity
What is goodwill impairment under IFR/S and US GAAP?
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
What is PBO Pension Benefit Obligation / DBO Defined Benefit Obligation?
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
What factors afftect the PBO in DB pension?
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
Calculate funded status.
Funded status = Fair value of assets - PV of the defined benefit obligation
Calculate total periodic pension expense.
Total periodic pension expense =
+ Service cost
+ Interest cost
+ Actuarial loss
+ Prior service cost
– Actual return
Pension expense income statement for US GAAP
Pension expense income statement for IFRS
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.
Multinational operations what is the definitions of the following currency? And what currency translation method should be used?
Presentation currency
Functional currency
Local currency
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
Pension remeasurement gain under IFRS and US GAAP.
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.
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
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
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
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)
Current rate vs temporal method when the local currency is weakening.
Current ratio
Quick ratio
Receivables turnover
Fixed asset turnover
Total asset turnover
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
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
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
Under Hyperinflation economies
What is the translation curreny method for IFRS and US GAAP?
IFRS
- Restate financial statement
- Use current rate method
US GAAP
- Treat presentation currency as functional currency
- Use temporal method.
Calculate return on equity.
ROE = Net income / Equity
= Net Income / Sales * Sales / Total Assets * Total assets / Equity
= Net profit margin * asset turnover * leverage
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
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
What is corridor test method?
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
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
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
If implements the share option scheme, the compensation expense would account for how long under US GAAP?
The expense should be recognized over the service period.
Calculate the interest cost and service cost of PBO undedr US GAAP.
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)
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
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
What are the six factors in CAMELS approach to score a Bank.
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.
Define the ROE equation using DuPont Analysis.
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
Define the accruals ratio using balance sheet approach.
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
Define the accruals ratio using cashflow (CFO) approach.
accruals ratio = (Net Income - CFO - CFI) / Average NOA
Average Net operating assets (NOA) = (NOA(t) + NOA(t+1))/2
Formula for Cash conversion cycle (net operating cycle).
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
Calculate return on common equity
Net income - Preferred dividends / Average common shareholders’ equity
The impact of raising debt and buy back the share on WACC Weighted average cost of capital?
WACC will decrease.
What is pecking order theory?
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.
Calculate free cashflow to firm (FCFF) using CFO.
FCFF = CFO + Interest (1 -tax) - Investment in Working Capital
Calculate free cashflow to firm (FCFF) using Net income.
FCFF = Net Income + Non-cash charge + Interest expense ( 1 - tax) - Fixed capital investment - Working capital investments
Calculate free cashflow to equity (FCFE).
FCFE = Net Income+Non-Cash Charges−Fixed Capital Investments−Working Capital Investments+Net Borrowing
What is the difference between accumulated benefit obligation (ABO) and projected benefit obligation (PBO)?
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.
Calculate minority (non-controlling) interest be under the full goodwill and the partial goodwill methods
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:
Under equity method. Calculate the equity investment of x% in the balance sheet.
Balance sheet =
+ Cost of investment
+ x% * Earnings after tax
- (x% * excess purchase price ) / number of remaining life
Calculate minority interest in one year.
minority% * fair value of acquiree + minority% * retained earnings
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