FRA Flashcards
Explain Special Purpose Entities (SPEs).
Special Purpose Entities (SPEs) allow the sponsoring company to retain financial control over the SPE’s assets and/or operating activities, while third parties hold most of the voting interest in the SPE.
Typically, these third parties funded investments in the SPE with debt directly or indirectly guaranteed by the sponsoring company.
Describe other factors to consider in analyzing a bank.
Describe the two methods by which the periodic pension cost may be calculated.
Describe how to evaluate the quality of a company’s financial reports.
Describe debt security impairment under U.S. GAAP.
Impairment means that the investor will be unable to collect all amounts owed according to contractual terms at acquisition.
Differentiate between loans and receivables under IFRS and U.S. GAAP.
List choices that affect the balance sheet or cash flow statement.
Overstated equity due to understating liabilities or contingent liabilities or overstating financial assets.
Cash flow from operations may be increased by deferring payments on payables, accelerating payments from customers, deferring purchases of inventory, and deferring other expenditures.
Identify the components of high financial reporting quality.
Describe recognition of noncontrolling interests on the consolidated balance sheet and income statement.
On what does the current period’s translation adjustment results in a gain or loss depends on?
Describe how an analyst’s viewpoint on the permanence of earnings should affect a forecast.
Analysts should consider whether events occur with enough regularity to be considered a permanent source of income or expense, or whether the event is a one-off with little likelihood of repeating.
Distinguish between IFRS and U.S. GAAP for those pension costs that are not capitalized.
List the forms of accounting difficulties that can result in a delay of filing.
(1) Internal disagreements on an accounting principle or estimate, (2) lack of adequate financial staff, or (3) discovery of an accounting fraud that requires further examination.
Distinguish between impairment under IFRS and U.S. GAAP.
Explain the income tax paid by multinational companies.
Describe effects of increasing the expected return on plan assets under U.S. GAAP.
Explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion.
Describe impairment of goodwill.
List other types of postretirement benefits.
Health care insurance
Life insurance premium payments
Describe effects of an assumed increase in compensation growth.
List the indicators of influence of investments in associates.
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 dirty surplus accounting.
Identify the disadvantages of share-based compensation.
Describe available-for-sale (AFS) investments.
Explain how remeasurement is recognized.
Remeasurement generally results from a change in assumptions. This component of periodic pension cost is recognized in OCI under both IFRS and U.S. GAAP, but amortized to P&L only under U.S. GAAP.
Demonstrate the use of a framework for the analysis of financial statements.
Define the purpose
Collect input data
Process the data
Analyze the data
Develop/communicate recommendations
Follow up to obtain feedback on decisions
Demonstrate the use of various types of analysis given a particular problem, question, or purpose.
Describe defined contribution pension (DC) plans.
Explain measurement under the acquisition method.
All identifiable tangible and intangible assets and liabilities of the acquired entity are measured at fair value.
The acquirer must also recognize any assets and liabilities that the acquiree has not recognized on its financial statements.
Identify the limitations of quantitative models.
Explain IFRS and U.S. GAAP disclosure requirements relating to foreign currency transaction gains and losses.
Give the formula used to calculate the periodic pension cost of a company’s DB pension plan.
Periodic pension cost = Current service costs + Interest costs + Prior service costs + Actuarial losses − Actuarial gains − Actual return on plan assets
How do IFRS and U.S. GAAP differ on the treatment of contingent assets and liabilities?
Describe purchasing power gains and losses from inflation.
Describe determination of the interest rate used to discount future pension benefits.
How are debt instruments measured?
At amortized cost, fair value through other comprehensive income (FVOCI), or fair value through profit or loss (FVPL), depending on the business model.
List the advantages of share-based compensation.
Explain the accounting for DC plans.
Describe the types of stock grants.
Outright stock grants: Shares are granted to an employee without any conditions.
Restricted stock grants: An employee returns shares to the company for failing to meet certain conditions.
Performance shares: Contingent on meeting performance goals, where performance is usually measured by accounting earnings or return on assets.
Explain accounting for share-based compensation.
Both IFRS and U.S. GAAP require companies to measure share-based compensation expense based on the fair value of the compensation granted.
Describe sources of information about risk.
Describe reclassification for equity and debt instruments under the new standards.
How is net interest expense/income on the pension obligation calculated?
Net interest expense (income) = Net pension liability (asset) × Discount rate
= (Pension obligation − Fair value of plan assets) × r
Differentiate between equity-settled and cash-settled share-based compensation.
Evaluate the quality of a company’s financial reports.
Explain the net income difference between the current rate method and the temporal method.
COGS and depreciation are translated at different rates under the two methods.
Under the current rate method, the translation gain/loss is reported in shareholders’ equity. Under the temporal method it is reported on the income statement.
List estimates required to determine the pension obligation.
Projected compensation levels and increases.
A discount rate used to determine the present value of future pension payments. Higher discount rates lead to lower pension obligation.
The probability that some employees will not satisfy the plan’s vesting requirements.
Define interest expense.
How may financial assets be classified under IFRS?
Describe disclosures related to sources of foreign exchange risk.
(1) Source(s) of its currency risks and approach to measuring and managing those risks (usually in MD&A).
(2) Present a sensitivity analysis on the effects of currency fluctuations (usually in the additional disclosures sections of the notes).
List aggressive pension-related assumptions that improve reported financial performance.
A higher discount rate.
A lower compensation growth rate.
A higher expected rate of return on plan assets.
Describe foreign currency transaction exposure, including accounting for and disclosure of foreign currency transaction gains and losses.
Evaluate the quality of a company’s financial data and recommend appropriate adjustments to improve quality and comparability with similar companies, including adjustments for differences in accounting standards, methods, and assumptions.
When should analysts consider organic sales growth?
Identify the required disclosures foreign currency translations gains and losses under IFRS and U.S. GAAP.
Explain the equity method of accounting.
The investment is initially recognized on the investor’s balance sheet at cost (within a single line item) under noncurrent assets.
The investor’s proportionate share of investee earnings is reported within a single line item on its income statement.
Distinguish between choices and classification.
Describe the approach used by IFRS 9.
(1) The contractual characteristic of cash flows and (2) the management of the financial assets. The classifications available-for-sale and held-to-maturity are replaced by fair value through profit or loss, fair value through other comprehensive income, and amortized cost.
Analyze a bank based on financial statements and other factors.
List choices that affect the income statement.
Identify the translation procedures for the current method.
The income statement and statement of retained earnings are translated first, and then the balance sheet is translated; all accounts except common equity are translated at the current rate.
Capital stock is translated at the historical rate that existed on the date of capital contribution. Dividends are translated at the rate that applied when they were declared. Translation gain/loss balances equity.
Explain the corridor method.
Describe key ratios to consider in analyzing an insurance company (1).
(Loss expense + Loss adjustment expense)/ net premiums earned
Underwriting expense/net premiums written
Combined ratio = a + b above
Dividends/net premiums earned
Combined ratio after dividends = c – d
Describe differences between periodic pension cost under IFRS and U.S. GAAP.
Both current and past service costs are P&L expense under IFRS; current and amortization of past service costs from OCI to P&L under USGAAP.
Amortizing amounts from OCI into P&L is not permitted under IFRS.
Return on plan assets equals the discount rate under IFRS; expected return on plan assets under USGAAP.
Describe what occurs if the amount paid by the investor to purchase shares in the investee is greater than the book value of those shares.
Describe the DuPont analysis.
ROE can be decomposed into return on Assets × Leverage, or Net profit margin × Asset turnover × Leverage, or EBIT margin × Tax burden × Interest burden × Asset turnover × Leverage.
The goals of different formulations depend on the analysis purpose, but in general DuPont seeks to understand cost structure management, efficiency of asset use, and the burden of leverage on the net profit margin.
Describe indicators of earnings quality.
How are AFS debt securities reclassified as HTM securities?
Describe the notes required on financial statements about risks related to contingent obligations, pension, and postemployment benefits, and financial instruments.
List changes that affect sales growth.
Describe other factors to consider in analyzing an insurance company.
Explain how to adjust P&L under U.S. GAAP for comparison to a P&L under IFRS.
Describe the funded status.
List assumptions that lead to higher periodic medical costs and associated obligation.
List the reasons the fair value of assets held in a pension trust will increase.
Describe the translation gain/loss difference under the current rate method and temporal method.
How can HTM (debt) securities be reclassified as AFS securities?
Identify the advantages and disadvantages of stock appreciate rights (SARs).
Advantages:
- SARs holders have limited downside risk and unlimited upside potential, which may encourage risk.
- Protects share owners from dilution.
Disadvantage:
- SARs require a current cash outflow.
Describe noncontrolling interest under full goodwill and partial goodwill methods.
Distinguish among presenting (reporting) currency, functional currency, and local currency.
Evaluate the cash flow quality of a company.
Explain the accounting for compensation expense related to stock options.
Immediate: Entire cost of award at fair value is recognized in the period of the grant date.
Specified service period: Allocates compensation expense over the service period.
Conditional: Recognized over the estimated service period required to fulfill condition.
Describe how financial institutions differ from other companies.
Systemic importance; that is, their extreme importance to a smoothly functioning economy.
Describe the effects of using the temporal method to translate COGS under FIFO and under LIFO.
Explain the purchase method.
How may the beginning and ending balances of the fair value of plan assets be reconciled?
Describe the pooling-of-interests method (U.S. GAAP)/uniting-of-interests method (IFRS).
Demonstrate the use of a conceptual framework for assessing the quality of a company’s financial reports.
Evaluate the earnings quality of a company.
Explain AFS investments under IFRS.
AFS investments are initially recognized at fair value and remeasured at each reporting date to reflect fair value.
All unrealized gains/losses (except for gains/losses on AFS debt securities arising from exchange rate movements) are recognized (net of taxes) in equity under other comprehensive income.
Unrealized gains/losses on AFS debt securities resulting from exchange rate movements are recognized on the income statement.
Realized gains/losses, interest income, and dividend income, are also recognized on the income statement.
Under IFRS, when is an equity security considered impaired?
Describe approaches to translating foreign currency financial statements.
Current rate method (revaluation) – Translate financial statements from functional currency (FC) into presentation currency (PC) at the current exchange rate.
Temporal method (remeasurement) – Translate financial statements from local currency (LC) into functional currency (FC). Financial assets and nonfinancial assets held at current value translate at the current exchange rate while nonfinancial assets held at historical cost translate at historical rates.
Differentiate between periodic pension cost and periodic pension expense.
Explain current service costs.
Describe effects of increasing the discount rate associated with pension obligations.
Decreases the opening pension obligation (decreases the PV of promised payments).
Typically decreases total periodic pension cost.
Typically decreases the closing pension obligation.
When is a debt security considered impaired?
If at least one loss event (which has an impact on its estimated future cash flows that can be reliably estimated) has occurred.
Explain the CAMELS approach to analyzing a bank, including key ratios and its limitations.
Explain measurement of compensation expense related to stock options.
If the number of shares and option price are known, compensation expense is measured at the grant date.
If the fair value of options depends on events after the grant date, compensation expense is measured at the exercise date.
Define a joint venture.
Distinguish between aggressive and conservative accounting choices.
Define a high-inflation economy.
Define defined-benefit (DB) pension plans.
The employer promises to pay a defined amount of pension to a beneficiary in the future. The promised annual pension payment typically considers the employee’s age, years of service, and salary.
The sponsoring entity benefits from gains and suffers losses. The entity also bears the risk of requiring additional contributions in the event of insufficient plan assets.
Indicate components affected by the discount rate.
Calculate end of period pension obligation for a defined benefit plan.
How does income before translation gain/loss differ between the current rate and temporal methods?
The temporal method uses historical rates for depreciation and COGS.
Describe the concept of sustainable (persistent) earnings.
Describe key ratios to consider in analyzing an insurance company (2).
List items that change a company’s defined benefit pension costs.
Changes in the pension obligation
- Economic expenses for the period.
- Benefits paid to employees.
Changes in the fair value of plan assets
- The actual return on plan assets.
- Benefits paid to employees.
- Employer contributions.
Explain transactions with associates.
Describe a pension trust through which DB plans are usually funded.
How is a company’s pension obligation measured under both IFRS and U.S. GAAP?
Identify what occurs when the fair value method is applied.
Explain held-to-maturity (HTM) investments.
List the adjustments analysts should make to reflect a company’s operating performance more accurately on the income statement.
Explain past service costs (PSC).
Calculate periodic pension cost using the approach for adjusting the change in net pension liability (asset) for employer contributions.
With the convergence between IFRS and U.S. GAAP, describe the analysis of investments in financial assets.
Analysis of operating performance should exclude items related to investing activities.
Nonoperating assets should be excluded from the calculation of return on operating assets.
Use of market values of financial assets is encouraged when assessing performance ratios. Both IFRS and U.S. GAAP require disclosure of the fair value of all classes of financial assets.
Give examples of unbiased measurement.
Proper measurement of liabilities and assets, recognition of asset impairment, and appropriate estimates for other items requiring subjective valuation.
List the types of investments classified as fair value through profit or loss.
Describe goodwill impairment testing under U.S. GAAP.
Describe indicators of cash flow quality.
Explain disclosure for share-based compensation.
Both IFRS and U.S. GAAP require disclosure of:
- The nature and extent.
- The basis for determining fair value.
- The effects of share-based compensation on the company’s net income and financial position.
Categorize investments in marketable debt and equity securities.
Describe key aspects of financial regulations of financial institutions.
Regulation focuses on the quality of bank assets and responsible use of financial leverage. Basel III specifies minimum:
- Percentage of risk-weighted assets funded with equity.
- High-quality liquid assets necessary to fund the bank for 30 days based on a stress test.
- Amount of stable funding for bank liquidity needs over one year.
List foreign currency-related activities that require special accounting treatment.
Transactions denominated in foreign currencies.
Investment in foreign subsidiaries that keep their accounts in foreign currencies.
