Financial Statement Analysis Flashcards
Classifications of Securities under IFRS 9
Amortized Cost: Only debt can use amortized cost, debt must be held to collect cash flows and collect interest/principal on collect
FV thru P&L: Debt can be held as this if its held for trading or would cause accounting mismatch. Equities that are trading must be held in P&L, other equities have choice. One you decide where an equity goes can’t revoke
FV thru OCI: Other equities (available for sale) can be held in OCI
Reclassification: Once an equity is classified it can’t be reclassed. Debt can be reclassed only if business model has changed, if going from Amort -> P&L must realize gain/loss in income statement, if going from P&L -> amort than must use current FV as base for amortization
Equity Method & Acquisition Method
Equity Method: Record investment like NAV, asset on your books will be net asset that you own. If distribution is made than your value will go down, if you have a gain than your value will go up.
Two adjustments: When you acquire stake you must adjust PP&E to FV and use depreciation method they use and you can’t record rev of stuff sold downstream if the downstream associate has not sold to someone else.
Acquisition Method: Consolidate whole company into your BS and IS, will have full ownership of assets/liabs/net income. Minority shareholders will have there interest shown in equity section as Minority Interest and they will also get a portion of the NI after.
NI will be the same under both methods, but equity method will not show all the assets/liabs/sales that acquisition method will show. Therefore profit margin ratios/ROE/ROA will all look better under equity method even if the same picture is being painted.
% Breakdown + Influence & Special Purpose Vehicles
% Breakdown:
Less than 20%, no significant influence, use amort/FV thru P&L/OCI
20%-50%, significant influence, use equity method
50%+, control, use acquisition method
Use amount of influence over % if questioning between two categories
Special Purpose Vehicles/Variable Interest Entities (VIE): Established to isolate asset/liability, may be a profit opportunity or a debt obligation or to obtain low cost financing. Must be consolidated into primary beneficiary
Plan Assets, PBO, Funded Status, TPPC
Plan Assets = Beginning Plan Assets + Contributions + Actual Returns - Benefits Paid
PBO = Beginning PBO + Service Cost + Interest Cost +- Actuarial G/L + Plan Amendments - Benefits Paid
Actuarial gain that means that you made more than you expected and the PBO (liability) will be reduce because of this
Funded Status = PV Plan Assets - PBO, Asset if positive, Liab if negative
TPPC = Ending PBO - Beginning PBO + Benefits paid - Actual Return on assets
Total Periodic Pension Cost = Contributions - (△ Funded Status)
Pension Expense Components (PBO Components)
Service Cost: Reflects pension benefits that were earned by the current employees that year, will increase PBO, falls on income statement for both US and IFRS
Interest Cost: Reflects interest owed on current benefit obligation, aka the amount you accrued to pay the current retirees, causes PBO to increase, on income statement for both US and IFRS
Post Service Cost: Caused by plan amendments, US GAAP will amort over service life on OCI, IFRS will expense all to income statement immediately
Expected Return: Amount expected to be earned on assets, US uses the long term average rate of return, IFRS uses discount rate as rate of return
Actuarial G/L: Actual Return - Expected Return, US GAAP will either amort thru income statement or expense immediately thru OCI, IFRS will expense all immediately thru OCI
Fundamental Plan Assumptions
1) Discount Rate: Rate used to calc PV of Benefit Obligation (PBO), if discount rate goes up than PBO down, TPPC down, pension cost in P&L down as discounting at higher rate will cause obligation to go down
2) Rate of compensation increases, if comp increases slow down than PBO will go down, TPPC will go down, and pension cost in P&L will go down as you will need to pay employees less when they retire
3) Expected Rate of Return, if expected rate of return up than pension cost to P&L will go down, no affect on PBO or TPPC
Forecasting aggressively will cause earnings quality to go down but will increase earnings, reduce pension expense, and reduce PBO
Transaction Exposure (Temporal and Current Rate Methods)
Transaction Exposure: FX transactions are measured in reporting currency at the spot rate on transaction date. If FX rate changes by settlement date than g/L is recognized, same if there is a BS date prior to settlement date, use BS date.
Temporal Method: If sub is well integrated with parent company than the functional currency is the parent/presentation currency and use temporal method for accounting
Current Rate Method: If sub is independent than use current rate method, functional currency will be the local currency, which would be the currency the company has its operations and cash flows in
Temporal Method
Temporal Method: Use current rate monetary assets/liabs, average rate for revenue and SG&A expenses (yearly income statement items) and historical FX rate for everything else, non-monetary assets/liabs, COGS, depreciation. Due to this Net Income and Equity will be mixed due to different rates being used throughout the BS and IS. FX g/L will flow through the IS.
FX g/L is calced by taking the temporal rate exposure * △FX rate. Temporal rate exposure = Net Monetary Assets (anything that is accounted for using current rate) = (Cash + AR) - (AP + Current Debt + Long Term Debt). No CTA using temporal method since it flows through IS
If local currency appreciates over the year than IS/BS ratios will appreciate as well for the most part due to IS using Average rate but BS using historical rate
Current Rate Method
Current Rate Method: Current Rates are used for everything on the BS and average yearly rates are used for everything on the IS. Common stock is only outlier, which is historical rate when issued.
Exchange rate g/L exposure will be equal to equity as the whole BS will be in current rates. Any exchange rate translation will flow through CTA, Cumulative Translation Adjustment) which goes into OCI which then goes into equity.
CTA = △FX rate * equity exposure amount
If local currency appreciates than IS/BS ratios will most likely go down since IS is average rates and will go up less than BS which is current rates. Pure ratios should stay the same
Financial Institution Risks & Insurance
Financial Institutions have a higher financial risk than other industries, need more regulation, Basel Committee’s international Regulatory Framework set up CAMELS
Insurance Companies: Generate revenue from premiums and investments. Life and Health Insurance (L&H): Long term contracts and east to predict
Property and Causality (P&C): Shorter contracts (1 year), harder to predict due to storms/climate
CAMELS
Capital Adequacy: Banks ability to cover possible losses (Equity 4.5%, Tier I 6%, overall 8%)
Asset Quality: Consider how assets are related and how off balance sheet items are used like credit
Management Capabilities: How good is managements ability the manage judged by controls, governance, compliance
Earnings: Earnings quality and how earnings cover cost of capital and how earnings are biased
Liquidity: Compares liquid assets with cash outflows needed in the future
Sensitivity to Market Risk: How sensitive is the bank to market, both small and large shifts
Other areas to consider are of BS liabs, govt support, FX expense, mission of bank
Earnings Quality
High quality earnings are sustainable and adequate
Earnings can be manipulated by aggressive revenue recognition and over expense capitalization
Earnings usually mean revert overtime
Earnings quality want high quality CF and BS, which means no unusual/large items in CF, no excessive outflows for aggressive recognition in CF and no restructuring charges in CF. Also BS needs to be complete (no off BS liabs), unbiased (not aggressive) and clear.
Financial Statement Analysis Techniques & IFRS vs US GAAP Goodwill
Establish objectives, collect/process/analyze data, develop/communicate conclusion and follow up
FSA Techniques: Examine earnings (DuPont via CF), examine BS overtime, add back off-BS liabs, understand segment composure, understand rule changes
US GAAP vs IFRS Differences:
Investment in Associates: FV for VS & Mutual Funds for IFRS, US GAAP allows FV accounting for all
Goodwill Acquisition Method: IFRS allows partial or full good will, US GAAP only allows full good will. (Partial goodwill uses purchase price while full goodwill uses FV of net assets)
Goodwill Impairment: IFRS uses 1 step process, US GAAP uses 2 step process
Contingent Assets: Not allowed under IFRS, allowed under US GAAP
Pension Differences: IFRS Prior Service costs are expensed, discount rate = rate of return, remeasurements immediately go fully to OCI.
US GAAP: Prior service cost to OCI and amortization, expected rate of return does not have to equal the discount rate, actuarial g/L in OCI and amort
Hyperinflation: IFRS: Take loss in purchasing power in IS, US GAAP: Use temporal method
