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)
Total Periodic Pension Cost
Total Periodic Pension Cost = Contributions - change in funded status
TPPC = Contributions - (Ending FS - Beginning FS)
It’s the TRUE/economic cost
Calculation is the same for GAAP and IFRS, but in IFRS it’s in OCI not the income statement
Periodic Pension Cost - GAAP (*not TPPC*)
+ Service Cost
+Interest Cost
- expected return on plan assets
- +/- Amort of actuarial (gains) and losses*
+/- Amort of past service costs
= Periodic Pension Cost on Income Statement
NOTE: service cost and interest cost are actual recurring costs, the other three are “smoothed events”
Periodic Pension Cost - IFRS (*not TPPC*)
+ Service Cost
+/- NET interest expense/ (income) *
+/- Past Service Costs
= Periodic Pension cost on income statement
*NOTE: net interest expense (or income) = beginning funded status * discount rate
What assumptions must pension plans disclose?
- Discount Rate
- Rate of compensation increase
- Expected return on plan assets (GAAP only)
Impact of Required Actuarial Assumptions on BS and IS
Delayed Recognition of Pension Costs
- IFRS: allows recognition of certain events that affect Pension cost in OCI (instead of IS)
- GAAP: events are amortized inthe income statement over time (until then, in OCI)
Terminology:
IFRS: remeasurement G/L = actuarial gains and losses (affecting PBO) plus differences in actual and expected return on assets
GAAP: actuarial gains and losses = IFRS definition of remeasurement gains and losses
Two Main delayed events:
-
Remeasurements (IFRS and GAAP)
- from changes in actuarial assumptions affecting hte PBO (actuarial G&L)
- From differences in the actual and expected return on plan assets (Note: IFRS expected return = discount rate for GAAP)
-
Past Service Costs (GAAP only)
- changes in PBO due to plan amendments. amortized over service life of plan participants. Expensed immediately under IFRS.
DSO, Receivables Turnover
DSO:
(AR/Sales) x 365
Receivables Turnover
Sales
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AR
Accruals Ratio
- Accruals portion of Avg Net Operating Assets
- Useful for comparing accruals across companies for quality of earnings
Calculate Minority Interest
- Full Goodwill:
Fair Value = Purchase Price / ownership % purchased
Minority Interest = the remaining (or 1 - the % above) times the FV
Effect of Volatility and Life on Stock Option Value
- Higher Volatility = Higher value
- therefore, worse for company because higher expense
- Longer Life = Higher Value
- Therefore worse for company because higher expense
(and vice-versa for both)
Adjusted Operating Profit (PBO Material)
Reported operating Profit
+ reported pension expense
- service cost
__________________________
= Adjusted Operating Profit
Finding the Benefits Paid Plug
BGN Plan Assets
+ contributions
+ actual return on plan assets
- Benefits paid (plug)
__________________________
= END Plan Assets
Intercorporates “Shoeboxes”
Equity Method BS and IS Treatment
- Balance Sheet:
- Cost
- pro rata earnings
- dividends
- Income Statement:
- pro rata earnings (% of Net Income)
Acquisition Method BS and IS Treatment
AKA CONSOLIDATION
- Balance Sheet
- Combine Line items (multiple line items as opposed to one in Equity method)
- Income Statement
IFRS vs. GAAP Goodwill Impairment
Different Methods effect on Accounts and Ratios
Pension Expense: Build up and differences between GAAP and IFRS
Prior Service Costs (incl. IFRS vs. GAAP)
- IFRS and GAAP Differ
- Say we told an employee she gets 2% every ear until retirement, then change it to 3%
- GAAP = Amortized over life
- IFRS = change recognized immediately on IS
- E.g. - Prior service cost change of $100:
- GAAP = comprehensive income - $100
- amort:
- $100 / 20 years = +$5 Pension Expense
- IFRS = Pension Expense just goes up by $100
- GAAP = comprehensive income - $100
- Say we told an employee she gets 2% every ear until retirement, then change it to 3%
Actuarial Assumptions effects on PBO and Pension Expense
The Actuarial Assumptions that must be disclosed
- Discount Rate
- Rate of Wage increase
- Expected Return on Plan assets
All GAAP plans must disclose - this is a highly asked question on the exam
Asset Turnover
Sales
______________________
Assets
Quick Ratio
Current Assets - Inventory
_________________________
Current Liabilities
