Financial Statement Analysis Flashcards
Describe the classification, measurement, and disclosure under IFRS for investments in financial assets.
Dividends and interest income are recognized in the investor’s income statement.
Amortized cost securities are reported on the balance sheet at amortized cost.
Subsequent changes in fair value are ignored.
Fair value through profit or loss securities (FVPL): are reported at fair value, and the unrealized gains and losses are recognized in the income statement.
Fair value through OCI securities (FVOCI): are reported at fair value, but the unrealized gains and losses are reported in stockholders’ equity.
Describe the classification, measurement, and disclosure under IFRS for investments in associates and joint ventures.
Equity method of Accounting
The proportionate share of the investee’s earnings increase the investor’s investment account on the balance sheet and are recognized in the investor’s income statement.
Dividends received reduce the investment account and are not recognized in the investor’s income statement.
For Joint venture’s only: In rare cases, proportionate consolidation may be allowed (only includes the proportionate share of the assets, liabilities, revenues, and expenses). No minority owners’ interest is required.
Describe the classification, measurement, and disclosure under IFRS for business combinations.
Consolidated method of accounting
All of the assets, liabilities, revenues, and expenses of the subsidiary are combined with the parent.
Intercompany transactions are excluded.
Noncontrolling interest account (when the parent owns less than 100% of the subsidiary) for the proportionate share of the subsidiary’s net assets and net income that is not owned by the parent.
Describe the classification, measurement, and disclosure under IFRS and GAAP for special purpose and variable interest entities.
IFRS, the sponsor of a special purpose entity (SPE) must consolidate the SPE if their economic relationship indicates that the sponsor controls the SPE.
GAAP requires that a variable interest entity (VIE) must be consolidated by its primary beneficiary.
What are the differences between IFRS and GAAP treatment of intercorporate investments?
IFRS and U.S. GAAP differ between contingent asset and liability recognition under the acquisition method.
IFRS permits either the partial goodwill or full goodwill method to value goodwill and noncontrolling interest in business combinations.
GAAP requires the full goodwill method.
Analyze how different methods used to account for intercorporate investments affect financial statements and ratios.
The effects of the equity method versus the acquisition method:
- Both report the same net income.
- Acquisition method equity will be higher by the amount of minority interest.
- Assets and liabilities are higher under the acquisition method.
- Sales are higher under the acquisition method.
What are indicators of significant influence?
Representation on the board of directors
Participation in the policy-making process
Material transactions between the investor and the investee
Interchange of managerial personnel
Technological dependency
Describe the types of post-employment benefit plans and implications for financial reports.
Defined-contribution plan (DC): the firm contributes a certain amount each period to the employee’s retirement account. The firm makes no promise regarding the future value of the plan assets; thus, the employee assumes all of the investment risk. Accounting is straight-forward; pension expense is equal to the firm’s contribution.
Defined-benefit plan (DB): the firm promises to make periodic payments to the employee after retirement. The benefit is usually based on the employee’s years of service and the employee’s salary at, or near, retirement. Since the employee’s future benefit is defined, the employer assumes the investment risk. Accounting is complicated because many assumptions are involved.
What is a projected benefit obligation (PBO)?
The projected benefit obligation (PBO) is the actuarial present value of future pension benefits earned to date, based on expected future salary increases.
B/S asset (liability) “Funded Status = fair value of plan assets − PBO
What are the components of a company’s “Pension Expense” IFRS vs GAAP?
This is the amount of Total periodic pension cost that goes on the I/S
IFRS:
- Current Service cost
- Past Service cost
- Net Interest Income/Expense = Beg Funded Status x Discount Rate
GAAP:
- Current service cost
- Interest cost
- Expected return on plan assets (if not available use actual return)
- Amortization of actuarial losses “bad”
- Amortization of actuarial gains “good”
What are Current Service Cost and how are they accounted for?
Current service cost: the present value of benefits earned by the employees during the current period. Expensed in income statement.
What is the Annual Unit Credit?
The annual unit credit is the amount each year that the employee earns towards their DB plan. This amount can be used to find the PBO.
Annual Unit Credit = Value at retirement ÷ Years of service
Total Amount Earned = Value at retirement x Years served ÷ Years of services
or
Annual U nit Credit x Years Served
PBO = Total Amount Earned ÷ (1 + Discount Rate)^Time until retirement
What is the Amortization of past service cost in regards to a PBO?
Amortization of past service cost:
Under GAAP only, an increase in PBO resulting from plan amendments granting a retroactive increase in benefits is amortized.
Under IFRS, past service costs are immediately expensed in the income statement.
What are Interest Cost regarding a PBO and how are they accounted for using GAAP or IFRS?
Interest cost: the increase in the PBO due to the passage of time. Expensed in income statement.
Interest cost (GAAP) = discount rate × [beg PBO + past service cost]
Net interest cost (IFRS) = discount rate × (beginning funded status – prior service cost)
What is the Amortization of actuarial gains and losses in regards to a PBO?
Amortization of actuarial gains and losses: under GAAP only, the losses (or gains) during the year due to changes in actuarial assumptions and due to differences between expected and actual return are recognized in OCI and amortized using the corridor method.
Under IFRS, the actuarial gains and losses during the year are recognized in OCI and are not amortized.
What are Total Periodic Pension Costs and what do they include?
Total periodic pension cost includes costs reflected in the income statement (pension expense) as well as in OCI.
total periodic pension cost = contributions + change in funded status
or
total periodic pension cost = current service cost + interest cost − actual return on plan assets +/− actuarial losses/gains due to changes in assumptions affecting PBO + prior service cost
Explain and calculate the effect of a defined benefit plan’s assumptions on the defined benefit obligation and periodic pension cost.
Firms can improve reported results by increasing the discount rate, lowering the compensation growth rate, or, in the case of U.S. GAAP, increasing the expected return on plan assets.
What are the Expected return on plan assets regards to a PBO?
Expected return on plan assets: offsets reported pension cost.
Under GAAP, the expected rate of return is assumed.
Under IFRS, the expected rate of return is the same as the discount rate.
What are some of the differences in accounting treatments for pensions?
Comparative financial analysis using published financial statements is complicated by differences in accounting treatment for pensions:
- Gross vs. net pension assets/liabilities.
- Differences in assumptions used.
- Differences between IFRS and GAAP in recognizing periodic pension cost in the income statement.
- Differences due to classification in the income statement.
Interpret pension plan note disclosures regarding cash flow related information.
Reduction in the overall pension obligation: If the firm’s contributions exceed the total periodic pension cost, similar to an excess principal payment on a loan.
Source of borrowing: if the total periodic pension cost exceeds the firm’s contributions,.
If the differences in cash flow and total periodic pension cost are material, the analyst should consider reclassifying the difference from operating activities to financing activities in the cash flow statement.
Explain issues associated with accounting for share-based compensation.
Share-based compensation raises issues about the valuation of the specific compensation as well as about the period in which, or periods over which, the compensation expense should be recorded.
Explain how accounting for stock grants and stock options affects financial statements, and the importance of companies’ assumptions in valuing these grants and options.
Share-based compensation expense is based on the fair value of the option or stock at the grant date. To determine fair value, it is often necessary to use imperfect pricing models.
Many of the option pricing model inputs require subjective estimates that can significantly affect the fair value of the option and, ultimately, compensation expense.
What is the presentation in (reporting) currency, functional currency, and local currency.
Presentation Currency (PC): is the currency in which the parent company reports its financial statements. It is typically the currency of the country where the parent is located.
Functional Currency (FC): is the currency of the primary business environment in which an entity operates. It is usually the currency in which the entity primarily generates and expends cash.
Local Currency (LC): is the currency of the country where the subsidiary operates.
Describe foreign currency transaction exposure, including accounting for and disclosures about foreign currency transaction gains and losses though the life cycle of a transaction.
Foreign currency denominated transactions, including sales, are measured in the presentation (reporting) currency at the spot rate on the transaction date.
If the exchange rate changes, gain or loss is recognized on the settlement date.
If the balance sheet date occurs before the transaction is settled, the gain or loss is based on the exchange rate on the balance sheet date.
Once the transaction is settled, additional gain or loss is recognized if the exchange rate changes after the balance sheet date.
Analyze how changes in exchange rates affect the translated sales of the subsidiary and parent company.
Revenues are translated at average exchange rate under both the temporal method and under the current rate method.
