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CFA > Financial Reporting and Analysis > Flashcards

Financial Reporting and Analysis Flashcards

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CFA flashcards
1
Q

What are the characteristics of investments in financial assets? How can they be measured and reported?

A

1) Investor has no significant influence (usually less than 20% of voting rights)
2) Measured and reported as:
- Fair value through profit and loss
- Fair value through other comprehensive income
- Amortized cost
3) Interest/Dividend income: reported in the income statement
4) IFRS and GAAP treat investments in financial assets in a similar manner

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2
Q

What is the IFRS approach to determine and measure the impairment loss of goodwill?

A

One-step approach: compare recoverable amount vs carrying amount. If recoverable amount is smaller than carrying amount, the difference is impaired.

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3
Q

What is the US GAAP approach to determine and measure the impairment loss of goodwill?

A

Two-step approach.

1) Identification by comparing recoverable amount and carrying amount
2) Measurement; Recoverable amount less net assets

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4
Q

What is a defined contribution pension plan?

A

Only the amount of contribution to the plan is defined. The eventual amount of the pension benefit to the employee will depend on the value of an employee’s plan assets at the time of retirement.

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5
Q

What is a defined benefit pension plan?

A

The amount of the pension benefit is defined, often determined by a plan formula.

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6
Q

What both IFRS and US GAAP require companies to report on their balance sheet regarding pension plan?`

A

Pension liability or asset (net)
= Projected Benefit Obligation - Fair Value of Plan Assets
(Also called minimum liability)

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7
Q

Under IFRS, what are the components of periodic pension cost recognised in P&L?

A

1) Service cost

2) Net interest income/expense

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8
Q

Under IFRS, what are the components of periodic pension cost recognised in OCI?

A

1) Remeasurement (Actuarial G/L)

2) Difference between actual return & amount included in net interest

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9
Q

Under US GAAP, what are the components of periodic pension cost recognised in P&L?

A

1) Current service cost
2) Interest expense on the pension obligation
3) Expected returns on plan assets (reduce the cost)
4) Actuarial G/L amortized via corridor

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10
Q

Under US GAAP, what are the components of periodic pension cost recognised in OCI?

A

1) Past service cost
2) Actuarial G/L (not amortized)
3) Difference between expected and actual returns on plan assets

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11
Q

What is the corridor method?

A

Corridor = 10% of Defined Benefit Obligation

If balance of unrecognized actuarial losses > Corridor, the difference is amortized

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12
Q

An increase in which variables increase the value of the option, thus the remuneration expense?

A

1) Risk-free rate
2) Expected life
3) Volatility

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13
Q

What is the effect of dividend-yield on option value?

A

Decrease value of option

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14
Q

What is the formula for periodic pension costs?

A

PPC = Ending funded status - Employer Contribution - Beginning funded status

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15
Q

When is a pension plan underfunded?

A

When Accumulated Benefit Obligation (ABO) > Value of pension plan assets

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16
Q

How can we calculate cash from operations from an economic perspective for pension plans?

A

Employer Contribution - Total pension expense = Excess payment over expense, which should be reclassified from CFO to CFF

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17
Q

What are the effects of foreign currency appreciation/depreciation for a company with export sale/import purchase?

A 
Export sale (Asset exposure; A/R): Strengthens = Gain ; Weakens = Loss
Import purchase (Liability exposure; A/P): Strenghtens = Loss ; Weakens = Gain
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18
Q

How companies must report foreign currency translation gain or loss, even when unrealized?

A

In net income ; can choose between operating or non-operating

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19
Q

If foreign currency is the functional currency, which method must be used?

A

Current rate method

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20
Q

If parent’s presentation currency is functional currency, which method must be used?

A

Temporal method

21
Q

How do we translate each financial statement component under the current rate method?

A

Assets/Liabilities: Current FX
Stockholders’ equity: Historical FX
Revenues/Expenses: Average rate (or rate when transaction happened)

22
Q

How do we translate each financial statement component under the temporal method?

A

Monetary assets/liabilities: Current FX
Non-monerary assets/liabilities: Historical FX
Stockholders’ equity: Historical FX
Revenues/Expenses: Average rate (or rate when transaction happened)
Expenses related to non-monetary assets (COGS, depreciation): Same rate than related assets

23
Q

How do we report the translation gain/loss under the current rate method?

A

Separate component of stockholders’ equity: Cumulative Transaction Adjustment (CTA)
If foreign currency decreases: Negative CTA
If foreign currency increases: Positive CTA

24
Q

How do we report the translation gain/loss under the temporal method?

A

Translation gain/loss in net income

25
Q

What are the balance sheet exposures and their effects if foreign currency appreciates/depreciates?

A

Net asset: Strengthens = Gain ; Weakens = Loss

Net Liability: Strengthens = Loss ; Weakens = Gain

26
Q

What is the balance sheet exposure under the current rate method?

A

Net assets (Total Assets - Total Liabilities)

27
Q

What is the balance sheet exposure under the temporal method?

A

Net monetary assets (Monetary assets - Monetary liabilities)

28
Q

According to IFRS, how should we deal with foreign operations in a highly inflationary country?

A

1) Nonmonetary assets/liabilities are restated for local inflation
2) Translated using the current exchange rate

Monetary assets/liabilities are not restated for inflation and may have resultant gains or losses (erosion in value due to inflation).

The net gain or loss in purchasing power due to holding monetary assets and liabilities is recognized in the income statement.

29
Q

According to US GAAP, how should we deal with foreign operations in a highly inflationary country?

A

1) Translated using the temporal method ; no restatement for inflation

30
Q

What is the quality spectrum?

A

1 - GAAP, decision-useful, sustainable, adequate returns
2 - GAAP, decision-useful, but low earnings quality
3 - Within GAAP, biased choices
4 - Within GAAP, but earnings management
5 - Non-compliant accounting
6 - Fictitious transactions

31
Q

Related to accruals, which component is under scrutiny?

A

Discretionary accruals

32
Q

What is the formula for cash-flow based accruals ratio?

A

( (NI - (CFO + CFI) ) / Average Net Operating Assets

Lower is ratio, higher is earnings quality

33
Q

What is the formula to assess segment analysis and capital allocation?

A

Capital expenditure % / Total assets %

Lower = Segment that will decline in the future

34
Q

What are the rules to impair an investment?

A

If the fair value of the investment is below its carrying value and this decline is deemed to be other than temporary, an impairment loss must be recognized.

Under IFRS, there must be objective evidence of impairment as a result of one or more (loss) events that occurred after the initial recognition of the investment, and that loss event has an impact on the investment’s future cash flows, which can be reliably estimated.

If dividends have been maintained, we should not consider impairment for this reason.

35
Q

For stock grants, what is the compensation expense based on?

A

Based on the fair market value of the stock on the day of the grant (BSM model) and is not affected by the stock’s volatility.

36
Q

What high-quality earnings allow investors to?

A

Identify a company’s core or recurring earnings from non-operating or non-recurring earnings.

37
Q

Under US GAAP, how should we account joint ventures?

A

Using the equity method

38
Q

What is the formula to determine compensation expense arising from executive stock options?

A

(Number of options * Price of option at inception) / Vesting period

39
Q

How can we determine the benefits paid during the year (asset perspective)?

A

Assets (start of year) + Actual return on assets + Employer contributions + Employee contributions - Assets (end of year)

40
Q

How can we determine the benefits paid during the year (liability perspective)?

A

Benefit obligation (start of year) + Current service cost - Plan amendments + Interest cost + Employee contributions - Actuarial gain - Benefit obligation (end of year)

41
Q

How can we interpret Altman’s Z score?

A

Altman scores in excess of 3.0 indicate low probability of bankruptcy, while those below 1.81 indicate a high probability of bankruptcy. Scores within the 1.81 to 3.0 do not provide a clear indication of bankruptcy.

42
Q

If a company owns more than 20% of the shares of another entity, but does not have influence, how should it classify its investment?

A

Available-for-sale

43
Q

What is the total shareholders’ equity in a business combination with payment involving acquirer’s stocks?

A

Capital stock (Original + Issued in acquisition) + Retained earnings + Non-controlling interest

44
Q

If Plan Assets > Defined Obligation Benefit, what amount must be reported as net asset?

A

Subject to a ceiling: present value of available refunds and reductions in future contributions

45
Q

Under US GAAP, how are past service costs reported?

A

Reported in OCI and amortized in NI over the average service lives of employees.

46
Q

How do we determine the defined obligation benefit for an employee?

A

Step 1: Determination of annual credit benefit
1A: Estimate final salary
1B: Estimate annual payment in retirement based on defined formula
1C: Calculate PV of future payments at start of retirement
1D: Annual unit credit at time of retirement: PV/service years
Step 2: Determination of build-up pension obligation
2A: Current service cost: PV of unit credit
2B: Opening obligation + Interest cost + Current service cost = Closing obligation

47
Q

Which discount rate should be used to calculate the PV of future benefits?

A

Yield on high quality corporate bonds

48
Q

What happens to current service cost if discount rate increases?

A

Current service cost will decrease as unit credit will decrease.

49
Q

What are the effects of inflation on purchasing power?

A

Net monetary asset position: Loss

Net monetary liability position: Gain

CFA (10 decks)

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