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Financial Statement Analysis Flashcards

1
Q

CAMELS

A

capital adequacy
asset quality
management
earnings
liquidity
sensitivity

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2
Q

Funded Status

A

FV of plan asset - Pension Obligation
Required reporting on balance sheet

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3
Q

FV of Plan Assets

A

Assets held exclusively for paying benefits. Legally protected in event of bankruptcy.
Measures at price received in an orderly sale.

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4
Q

Pension Obligation

A

PV of expected future payments needed to settle the obligation resulting from employee service in the current and prior periods.
Discounted using investment grade corporate bond yields (or government yields if not available)

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5
Q

Pension expense accounting logic

A

On income statement the cost of providing the benefit is recorded not the contribution.

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6
Q

Pension Service Cost (Current) (IFRS)

A

Operating expense.
An employee accruing a year of service may result in future benefits payment increase

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7
Q

Pension Service Cost (Past) (IFRS)

A

Operating expense.
Amendment that changes the pension obligation related to prior periods

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8
Q

Pension net interest cost (IFRS)

A

Calculated by multiplying net pension liability or asset at the beginning of the period by the interest rate

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9
Q

Pension cost remeasurements

A

Recognised in OCI
(1) Actual return on plan assets - assumed amount from net interest calculation
(2) Actuarial gains/losses from changes in assumptions around salary growth rate, discount rate, mortality rate etc.

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10
Q

Past Service Cost (US GAAP)

A

Recognised initially through OCI then amortised through P&L

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11
Q

Pension Interest Cost (US GAAP)

A

Pension interest costs recognised as gross not net. So discount rate multiplied by pension obligation

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12
Q

Expected return on asset plans (US GAAP)

A

(At least pre-2017)
As interest cost is net, have a gross interest on expected returns from plan assets recognised in P&L

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13
Q

Remeasurement Pension (US GAAP)

A

Unammortised gain/loss begins to be amortised through P&L under corridor approach if it is >10% of the maximum of the PBO or PA

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14
Q

Plug in temporal method

A

Retained Earnings

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15
Q

Plug under current method

A

Cumulative translation adjustment

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16
Q

Full/Partial GW

A

Since purchase price > prorate share of FVNA, goodwill is positive. Full goodwill > partial goodwill and minority interest under full goodwill will be higher than minority interest under partial goodwill. Because minority interest is part of equity, equity will be higher under full goodwill and debt-to-equity ratio will be lower. Net income would be the same and hence ROE under full goodwill will be lower.

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17
Q

NOA

A

Operating Assets - Operating Liabilities

Operating Assets = Total assets - cash - marketable securities

Operating liabilities = Total liabilities - total debt (LT + ST)

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18
Q

Balance sheet Accruals

A

Accruals_BS / Average NOA

Accruals_BS = NOA_end - NOA_bgn

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19
Q

Cash flow Accruals

A

Accruals_CF / Average NOA

Accruals_CF = Net income - CFO - CFI

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20
Q

LIFO liquidation

A

A LIFO liquidation refers to slowing the purchase of inventory items so that older lower costs are used to calculate COGS. Compared to following regular purchase policies, this will reduce COGS, reduce inventory, and artificially increase gross and net margins. Since the percentage decrease in inventory is likely greater than the percentage decrease in COGS, the inventory turnover ratio is likely increased, rather than decreased, by a LIFO liquidation.

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21
Q

Placeholder

A

Revise evaluating quality of financial reports chapter

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22
Q

Remeasurement method when foreign entity viewed as distinct

A

Current Rate Method

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23
Q

Rationale for CRM

A

Parent concerned with overall value of investment and income generated as measured in reporting company FX on entire value

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24
Q

CRM Balance Sheet

A

All assets and liabilities current FX.
Equivalent needed to acquire the assets and settle liabilities today

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25
CRM Income Statement
Revenues, expenses, gains, losses translated using average FX
26
CRM Equity
Capital stock translated at historical rates. Retained earnings = beginning translated retained + translated net income - dividends
27
CRM Balancing
Adjustment in equity through OCI as cumulative translation adjustment as we are concerned with investment and not operational impact
28
Rationale for TRM
View foreign operations as extension of parent's operations, restate transactions as if they occured in parent's currency from the beginning
29
TRM Balance Sheet
Monetary assets at current FX Non-Monetary assets preserve original measurement basis. For historic cost items such as PPE use historical FX
30
TRM Income Statement
Salex/Opex/Interest use average D&A/COGS use historic rates (underlying measured at historic cost)
31
TRM Balancing
Remeasurement Gain/Loss
32
FX Risk CRM
When assets > liabilities, when current rate increases get FX gain
33
FX Risk TRM
When monetary assets > monetary liabilities get FX gain
34
IS item / BS_end ratio CRM
Appreciating currency makes it lower
35
36
How are investments in financial assets classified and measured under IFRS (assuming <20% ownership)?
Debt: Held-to-collect (Amortised Cost), Held-to-collect-and-sell (FVOCI if elected, otherwise Amortised Cost), Held-for-trading (FVPL). Equity: Held-for-trading (FVPL), Not held-for-trading (FVOCI if elected, otherwise FVPL). Derivatives: FVPL (except hedging instruments at FVOCI). Embedded derivatives usually FVPL.
37
When is the Equity Method used for intercorporate investments?
When the investor has significant influence over the investee, typically indicated by ownership between 20% and 50%. Also required for Joint Ventures under IFRS/US GAAP.
38
How does the Equity Method impact the investor's financial statements?
Balance Sheet: Investment recorded in a single "Investment Account" (non-current asset). Income Statement: Investor recognizes its proportionate share of the associate's net income/loss as "Equity Income". Dividends received reduce the Investment Account (return of capital), not recognized as income.
39
How is the excess purchase price allocated under the Equity Method?
First to the proportionate share of the difference between fair value and book value of identifiable assets (amortized over time against equity income). Remaining excess is Goodwill (tested for impairment).
40
When is the Acquisition Method used?
When an investor gains control over an investee, typically with >50% ownership. Requires consolidation of the subsidiary's financials into the parent's.
41
How does the Acquisition Method impact the parent's financial statements?
All assets and liabilities of the subsidiary are brought onto the parent's balance sheet at fair value. If ownership is <100%, the remaining portion is shown as Minority Interest (Non-controlling Interest) in equity. Revenues and expenses are fully consolidated, with minority interest deducted from net income.
42
What is the difference between Full Goodwill and Partial Goodwill (IFRS allows choice)?
Full Goodwill: Fair value of the entire subsidiary - Fair value of identifiable net assets. Minority Interest = Fair Value of Subsidiary * (1 - % acquired). Partial Goodwill: Fair value of the consideration paid - Fair value of acquired identifiable net assets. Minority Interest = Fair Value of Identifiable Net Assets * (1 - % acquired).
43
How are Joint Ventures typically accounted for under IFRS and US GAAP?
Using the Equity Method. Proportionate consolidation is rare.
44
What is a Special Purpose Entity (SPE) / Variable Interest Entity (VIE)?
SPE is a separate legal entity created for specific purposes, often bankruptcy remote. US GAAP uses VIE definition focusing on financial control without majority voting interest. Primary beneficiary (absorbs majority risks/rewards) must consolidate the VIE. Used sometimes for off-balance sheet financing.
45
How is Share-Based Compensation (SBC) generally accounted for?
Expense is recognized over the vesting period. Corresponding entry increases equity (Paid-in Capital), not liability. Decreases Net Income and Retained Earnings, but total equity is unchanged initially. Fair value determined at grant date.
46
What are the main types of Share-Based Compensation?
Restricted Stock/RSUs: Shares/units granted, restrictions lift upon vesting. Stock Options: Right to buy shares at a predetermined strike price. Fair value often estimated using option pricing models (e.g., Black-Scholes).
47
How does SBC affect tax calculations and potentially create tax windfalls/shortfalls?
SBC expense is deductible for tax purposes based on the share price at settlement/exercise, while the accounting expense is based on the grant date fair value. If share price increases, tax deduction > reported expense, creating a tax windfall. US GAAP recognizes windfall/shortfall in Income Statement; IFRS directly in Equity.
48
How is dilution from stock options calculated using the Treasury Stock Method?
Assumes proceeds from exercising in-the-money options (strike price + average unamortized expense) are used to repurchase shares at the average market price. Net increase in shares is added to the denominator for diluted EPS.
49
Contrast Defined Contribution (DC) and Defined Benefit (DB) pension plans.
DC: Employer contributes, employee bears investment risk, final benefit unknown. DB: Employer promises specific benefit, employer bears investment risk, must fund obligation.
50
What is the Pension Obligation (PBO/PVDBO)?
The present value of pension benefits earned by employees to date.
51
What components make up the change in the Pension Obligation?
Beginning PBO + Current Service Cost + Interest Cost +/- Actuarial Gains/Losses + Past Service Cost - Benefits Paid = Ending PBO.
52
What components make up the change in Plan Assets?
Beginning Fair Value + Actual Returns + Contributions - Benefits Paid = Ending Fair Value.
53
What is the Funded Status of a DB plan?
Fair Value of Plan Assets - Pension Obligation (PBO/PVDBO). Shown as net asset or liability on the balance sheet.
54
What is the Total Periodic Pension Cost (TPPC)?
Change in Funded Status - Employer Contributions. Represents the true economic cost for the period. Components include Service Costs (Current & Past), Interest Cost, (minus) Actual Return, +/- Actuarial Gains/Losses.
55
How are TPPC components recognized under IFRS vs. US GAAP?
IFRS: Current Service Cost & Net Interest Cost (Interest Cost - Expected Return) in P&L. Past Service Cost & Remeasurements (Actuarial G/L, Actual Return vs Expected Return) in OCI (not amortized). US GAAP: Current Service Cost, Interest Cost, Expected Return in P&L. Past Service Cost & Actuarial G/L amortized from OCI to P&L (using corridor method for Actuarial G/L).
56
Define Presentation, Functional, and Local Currency.
Local: Currency of the country where the subsidiary operates. Functional: Currency of the primary economic environment of the subsidiary (influences sales, costs, financing). Presentation: Currency used by the parent company for its financial statements.
57
When is the Current Rate Method (Translation) used?
When the subsidiary's Functional Currency (FC) is different from the parent's Presentation Currency (PC). FC = LC usually implies this method.
58
How are accounts treated under the Current Rate Method?
Assets & Liabilities: Translated at the Current (year-end) exchange rate. Income Statement: Translated at the Average exchange rate. Equity: Capital stock at Historical rates; Retained Earnings is a roll-forward; Cumulative Translation Adjustment (CTA) in OCI balances the B/S.
59
When is the Temporal Method (Remeasurement) used?
When the subsidiary's Functional Currency (FC) is the same as the parent's Presentation Currency (PC). Also used under US GAAP if subsidiary is in a hyperinflationary economy.
60
How are accounts treated under the Temporal Method?
Monetary Assets/Liabilities: Remeasured at Current rate. Non-Monetary Assets/Liabilities: Remeasured at Historical rates (if carried at historical cost) or Current rates (if carried at fair value). Income Statement: Mixed rates linked to B/S items (e.g., COGS/Depreciation at historical, Sales/Opex at average). Remeasurement Gain/Loss: Included in Net Income.
61
How is hyperinflationary accounting handled under IFRS vs. US GAAP?
US GAAP: Functional currency = Parent's presentation currency; use Temporal Method. IFRS: Restate subsidiary's local currency statements for inflation first, then translate using the Current Rate Method.
62
What does the CAMELS framework assess for banks?
Capital Adequacy, Asset Quality, Management Capabilities, Earnings Sufficiency, Liquidity Position, Sensitivity to Market Risk.
63
Define key capital adequacy ratios (Basel III).
CET1 Ratio: Common Equity Tier 1 Capital / Risk-Weighted Assets. Tier 1 Ratio: Tier 1 Capital (CET1 + Additional Tier 1) / RWA. Total Capital Ratio: Total Capital (Tier 1 + Tier 2) / RWA.
64
How is asset quality assessed for banks?
Primarily through loan portfolio analysis: level of non-performing loans, adequacy of loan loss provisions, loan concentration risk.
65
How is earnings quality assessed for banks?
Sustainability and adequacy of earnings. Preference for recurring income (net interest income, fees) over volatile sources (trading income). Assessing reliability of fair value estimates (Level 1 > Level 2 > Level 3).
66
What are key liquidity risk indicators for banks?
Reliance on short-term wholesale funding, concentration of funding sources, maturity mismatch between assets (loans) and liabilities (deposits), Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR).
67
What does sensitivity to market risk involve for banks?
Exposure to interest rate risk (due to maturity mismatch, repricing frequency differences), impact of yield curve changes, foreign exchange risk. Measured using tools like Value at Risk (VaR).
68
Define key performance metrics for P&C insurers.
Loss Ratio: (Losses Incurred + Loss Adjustment Expenses) / Net Premiums Earned. Expense Ratio: Underwriting Expenses / Net Premiums Written. Combined Ratio: Loss Ratio + Expense Ratio (measures underwriting profitability; <100% is profit). Combined Ratio after Dividends: Combined Ratio + Dividends to Policyholders Ratio.
69
Define key performance metrics for L&H insurers.
Total Benefits Paid / (Net Premiums Written + Deposits). Commissions & Expenses / (Net Premiums Written + Deposits). Volatility of Net Income.
70
What defines high-quality financial reports?
Decision-useful: Relevant and Faithful Representation (accurate, complete, neutral).
71
What defines high-quality earnings?
Adequate (covers cost of capital) and Sustainable (recurring, persistent).
72
How can accruals impact earnings persistence?
Earnings composed of cash flow and accruals. Accruals portion tends to mean revert faster than the cash flow portion. High accruals may indicate lower earnings quality and lower persistence.
73
What are indicators of potential revenue manipulation?
Revenue growth outpacing peers, increase in receivables relative to revenue (rising DSO), higher related-party transactions, changes in revenue recognition policies, bill-and-hold sales, channel stuffing.
74
What are indicators of potential expense manipulation?
Capitalizing costs that should be expensed (e.g., R&D, advertising), changing depreciation methods/estimates, unsupported increases in non-current assets, declining asset turnover ratios.
75
What are indicators of high cash flow quality?
Positive CFO, CFO sourced from sustainable operations (not one-offs like selling receivables or delaying payables), CFO > Net Income, stable CFO generation.
76
What compromises balance sheet quality?
Off-balance sheet financing (e.g., operating leases, SPEs not consolidated), subjectivity in measuring assets/liabilities (goodwill, inventory, investments without market values), lack of clear presentation

CFA Level 2 (9 decks)

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