FRA - Intercorporate and PBO Flashcards
Classification of Corporate Investments
<20%
Financial Assets - Passive
20-50%
Associates - Influence
>50%
Business Combination - Control
Financial Assets Treatment - Amortized Cost
DEBT securities meeting the business model and cash flow characteristics tests
- Interest income reported on Income Statement
- Interest income = coupon + amortized discount (or minus amortized premium)
- Carried on the BS at amortized cost
- Changes in market value not recognized unless impaired
FVPL
Financial Assets - debt and equity securities
- interest and dividend income reported on income statement
- Interest = coupon + amortized discount (or less premium)
- Carried on BS at fair value
- Unrealized gains / losses recognized on income statement
FVOCI
Financial Assets - Debt and Equity Securities
- interest and dividend income reported on income statement
- interest = coupon +/- amortized discount (premium)
- carried on balance sheet at fair value
- unrealized gains / losses reported directly in equity
- when sold, realized G/L is recognized on the income statement
Treatment of Unrealized Gains / Losses - Intercorporate Investments
Debt Securities:
Fair value - amortized cost = cumulative unrealized gain
Equity Securities:
Fair value - purchase price = cumulative unrealized gain
Note: unrealized gain/ loss for a period = the change in cumulative unrealized gain from BGN to END of period on BS
Reclassification of securities - Intercorporates
- Equity Securities: NO RECLASSIFICATION - initial choice of FVPL / FVOCI is irrevocable
-
Debt Securities: ONLY if the business model has changed
- Unrecognized gains/losses carried at amortized cost and reclassified as FVPL are recognized in the income statement
- If reclassififed out of FVPL to amortized cost, it’s transferred at fair value on the transfer date, and that fair value becomes the carrying amount of the security
Business Combination - Steps of Acquisition Method (control)
Balance Sheet
- Eliminate investment account (purchase price) of parent and equity (only pre-acquisition sub R/E) accounts of subsidiary
- Create minority interest (share of equity not owned)
- Calculate goodwill
- Combine 100% of the assets and liabilities of both firms (net of intercompany transactions)
Income Statement
- Eliminate subsidiary earnings from parent (dividends)
- Subtract minority share of earnings (share of earnings not owned)
- Combine revenues and expenses (only post-acquisition results) of both firms (net of intercompany transactions)
Partial vs. Full Goodwill
- GAAP Requires full goodwill, IFRS permits full or partial
-
Partial Goodwill:
- Goodwill is purchase price (of partial interest), minus the % owned times fair value of net identifiable assets
- Goodwill is allocated to the cash generating units that will benefit from the synergies
- Noncontrolling (minority interest) is % not owned times fair value of net identifiable assets
-
Full Goodwill:
- required by GAAP, IFRS permits both
- Goodwill allocated to the reporting units that will benefit from the synergies
- Noncontrolling (minority) interest is % not owned times total FV of the subsidiary
Impairment of Goodwill
- Goodwill impairments CANNOT BE REVERSED
- Goodwill not amortized, tested annually for impairment
- Cannot be separated from the overall business
- Goodwill is impaired when the carrying value of the biz unit is greater than its FV
- Impairment is reported as a line item on the income statement
Goodwill Impairment - IFRS vs. GAAP
- IFRS - allocated across cash generating units that will benefit from acquisition
- GAAP - Allocated across reporting units: operating segment or component
-
IFRS = one-step process
- if recoverable amount of cash generating unit < carrying value, recognize the difference as impairment
-
GAAP = two-step process
- if FV of reporting unit < carrying value, goodwill is impaired
- Amount of impairment is unit’s reported goodwill - current FV of unit’s goodwill (recalculated with current asset / liablity values)
- IFRS: if loss is greater than unit goodwill, remainder is allocated proportionally to (impairment of) other (non-cash) assets of the unit
- GAAP: if loss is greater than current FV of unit goodwill, unit goodwill is reduced to zero; no other allocation of impairment amount
- Under both standards, impariment loss is recognized in income statement as a separate line item
Acquisition vs. Equity Method - Compare effects on:
- Sales
- Expenses
- Net Income
- Assets & Liabilities
- SH Equity (only for the case with sibs with minority interests)
NOTE: NET PROFIT MARGIN, ROE, and ROA ARE ALL HIGHER UNDER EQUITY METHOD
PBO
- Present value of all future pension payments earned to date based on expected salary increase over time. Assumes employee works until retirement.
- Estimate of liabiltiy on a going concern basis
- “Present value of the defined benefit obligation” (PVDBO) under IFRS
Reconciliation disclosed in footnotes:
Opening PBO
+ Service Cost
+ Interest Cost
+/- Actuarial G/L
+/- Past service cost
- Benefits paid
= Closing PBO
Definitions:
- Service Cost
- Interest Cost
- Actuarial G/L
- Past Service Costs
- Benefits Paid
- Service Cost (+) = The change in PBO attributed to Employees’ efforts during the year. The actuarial PV of pension benefits earned in a year.
- Interest Cost (+) = The increase in PBO resulting from the passage of time. PBO at the start of period x discount rate
- Actuarial Gains / Losses (+/-) = G/L resulting fro mchanges in actuarial assumptions affecting the PBO
- Past Service Costs (+/-) = retroactive impact on past benefits awarded to employees resulting from plan amendments. e.g. chanign payout from 60 to 65% of final salary
- Benefits Paid (-) = payments made from the fund to existing retirees
Pension Plan on the Balance Sheet
- PBO - fair value of plan assets
- Asset / liability = funded status - funded status goes on the BS as one line
- Overfunded = asset, Underfunded = liability
Fair Value of Plan Assets
-
Employer Contributions
- Funding policy determined by Income Tax, ERISA Rules, Cash flow considertions
-
Actual Return on Plan Assets:
- Actual capital gains/dividends/interest (will fluctuate iwth market)
-
Benefits Paid:
- Payments made from fund to existing retirees
FV of plan assets at start of year
+/- Actual return on plan assets
+ Employer contributions
- Benefits paid to retirees
= FVPA at end of year
(reconciliation disclosed in footnotes - note that it’s exactly what it implies - just the market value of plan assets)
Impact of Required Actuarial Assumptions on BS and IS
Intercorporates “Shoeboxes”
IFRS vs. GAAP Goodwill Impairment
Different Methods effect on Accounts and Ratios
Pension Expense: Build up and differences between GAAP and IFRS
Actuarial Assumptions effects on PBO and Pension Expense
