FSA Flashcards
Share based compensation expense and effect on financial statements when stock options are given
1) * use fair value of options, not share price *
2) divide aggregate fair value of options by number of years to vest
3) that number is recognized as appropriate expense on income statement, equity is increased by that amount on the balance sheet, and it does not affect cash flows unless indirect method is used, then the amount is added back to net income to reconcile to operating activities
Impact on financial Statement when stock options granted are out of the money
No impact because they will not be exercised
Why is share based compensation not expensed
It would double count impact on eps as it would both reduce net income and increase shares outstanding which would hurt valuation
Tax differences between IFRS & GAAP in treatment of tax windfall and shortfall from shared based compensation
1) Share price on settlement date > share price on grant date (excess tax benefit/tax windfall)
- IFRS: Gain recognized directly in SE
- GAAP: decrease in income tax expense on the income statement
2) share price on settlement date < share price on grant date (tax shortfall)
- IFRS: loss recognized directly in SE
- GAAP: Increase in income tax expense on the income statement
Excess tax benefit (tax windfall)
The amount by which the tax deduction associated with a share based award exceeds the cumulative share based compensation expense recognized in accordance with US GAAP or IFRS (when value at settlement > value at grant date)
How does share based compensation affect basic shares outstanding and diluted shares outstanding
Basic - increases when share awards settle, not changed when they’re not settled
Diluted - included when they’re not settled
Basic shares outstanding + shares issued from conversion of share based awards - assumed proceeds from conversion = diluted shares outstanding
Closed defined benefit plan vs frozen defined benefit plan
1) closed - no new employees can enter
2) frozen - no new benefits are accrued
Where do contributions to DC plan appear on cash flows
Operating cf
Funded status of DB plan
Fair value of plan assets - pension obligation, must be reported on balance sheet
Pension expense under IFRS
1) service cost (income statement)
A) current: amount by which a company’s pension obligation increases as a result of employees service
B) incurred if plan amendments are made
2) net interest expense/income (income statement)
- net pension liability/asset multiplied by discount rate
3) remeasurement (OCI)
A) any differences between the actual return on plan assets and the amount assumed in the net interest expense/income calculation
B) actuarial gains/losses
Pension expense under GAAP
1) Current service costs (Income Statement)
2) Interest cost (Income Statement)
3) Expected return on plan assets (offset in earnings)
4) Amortization of past service cost (OCI)
5) Amortization of net gains or losses (OCI)
Corridor Approach
any unrecognized gain or loss over 10% of the greater pension obligation or the fair value of plan assets is amortized over the expected average remaining working lives of the employees participating in the plan
Presentation currency
Currency in which financial statement amounts are presented
Functional Currency
Currency of the primary economic environment in which an entity operates
Local currency
currency of the country where a company is located
Foreign currency
any currency other than a company’s functional currency
IFRS and GAAP treatment of change of value of foreign currency asset or liability in a transaction
both recognize gain or loss on IS
impact of export Sale of asset and foreign currency strengthens
Gain
impact of export Sale of asset and foreign currency weakens
loss
impact of import purchase of a liability and foreign currency strengthens
gain
impact of import purchase of a liability and foreign currency strengthens
loss
Two approaches for translating the foreign subsidiary’s assets and liabilities
1) All assets and liabilities are translated at the current exchange rate (spot rate)
2) Only monetary assets and liabilities are translated at the current rate and non-monetary assets and liabilities are translated at historical exchange rates
Temporal method
Variation of the monetary/non-monetary translation method where all assets and liabilities that are measured at their current value on the balance sheet are translated at current rates; typically used when functional currency is other than local currency
Disclosures needed related to foreign currency translation
1) the amount of exchange differences recognized in net income
2) the amount of cumulative translation adjustment classified in a separate component of equity, along with a reconciliation
CAMELS Approach
Widely used bank rating approach where 1-5 is assigned to each category
1) Capital Adequacy
2) Asset quality
3) Management capabilities
4) Earnings sufficiency
5) Liquidity Position
6) Sensitivity to market risk
Capital Adequacy
the proportion of the bank’s assets funded with capital, adjusted by risk
- Common Equity Tier 1 Capital - 4.5% of risk weighted assets
- Total Tier 1 Capital- 6% of risk weighted assets
- Total Capital (Tier 1 + Tier 2) - 8% of risk-weighted assets
Basel III
1) Emphasizes common equity tier 1 capital as the predominant form of bank capital
2) Strengthens minimum capital ratio requirements and risk weighting definitions, increases PCA thresholds, establishes a capital conservation buffer, and provides a mechanism to mandate counter-cyclical capital buffers
What is the minimum total capital requirement under Basel III
8% of risk-weighted assets (Tier 1 and Tier 2)
Common Equity Tier 1 Capital
Common stock, issuance surplus, retained earnings, OCI
Asset quality
amount of existing and potential credit risk associated with bank’s assets, mainly financial assets
Management Capabilities
independent board that avoids excessive compensation or self dealing with sound internal controls, and transparency
Earnings
High quality and trending upward, and provide adequate return on capital to their capital providers
Liquidity Position
1) Liquidity Coverage Ratio (LCR) - minimum percentage of a bank’s expected cash outflows (1 month) that must be held in highly liquid assets - minimum of 100%
2) Net Stable Funding Ratio (NSFR) - minimum percentage of a bank’s required stable funding that must be sourced from available stable funding - minimum of 100%
Quality Spectrum of financial reports
1) GAAP, decision-useful, sustainable and adequate returns
2) GAAP, decision-useful, but sustainable? Low “earnings quality”
3) Within GAAP, but biased choices
6) Non-compliant accounting
7) Fictitious transactions
Interpretation of Altman’s Z-Score
Higher Z-score is better, less than 1.81 indicates high probability of bankruptcy, higher than 3 indicates low probability of bankruptcy and between the two are not clear
Characteristics of high quality cash flow
- Positive OCF
- OCF derived from sustainable sources
- OCF adequate to cover capital expenditures, dividends, and debt repayments
- OCF with relatively low volatility
OCF less easily manipulated than earnings
Most important aspect of financial reporting quality for the balance sheet
completeness & then clear presentation
- significant amounts of off-balance-sheet obligations could be a concern because they understate leverage
Where is MD&A required to be disclosed and what is included
Item 7 in Form 10-k
- Liquidity, capital resources, results of operations, off-balance-sheet arrangements, contractual arrangements
Purpose of MD&A
1) Nature of Business
2) Objectives and Strategies
3) Resources, Risk and Relationships
4) Results and Prospects
5) Performance Measures and Indicators
How is Share based compensation expense recorded and how often is it adjusted
at fair value at grant date and not subsequently adjusted. no change in fair value is recorded
Calculate the impairment loss when goodwill is involved, under GAAP
Goodwill at carrying value - goodwill at fair value
- Goodwill at fair value is fair value of total - fair value of identifiable assets
Most stable sources of funding
- Long-dated deposits are better than short-dated ones
- Deposits from retail customers are better than others
4 Banking specific analytical considerations that are not addressed by CAMELS
1) Government support
2) Government ownership
3) Mission of the banking entity
4) Corporate culture
How are unrealized gains from foreign currency translation recorded
Gain/loss on income statement
Excess purchase price
!!!!!!!BOOK VALUE!!!!!! * Ownership stake - Purchase price
Recording depreciation from PP&E in acquisition
(MV of asset - Book value of asset) * acquisition % / useful life of asset
What translation method will be used for a subsidiary when the parent’s presentation currency is not the same as the subsidiary’s functional currency?
Current Rate
The average rate for the year
Risk weighting of cash
0
For an individual in a defined benefit pension plan, the actual future benefit is what
depends entirely on the growth of the plan liability (i.e. years of service, final salary, etc.)
Which classification of financial assets from previous IFRS Standard remains
Fair value through profit and loss
Level 1 Input
Unadjusted quoted prices in active markets for items identical to the asset being measured
Level 2 Input
Inputs other than quote prices in active markets included within level 1 that are directly or indirectly observable
Level 3 Input
Unobservable inputs that are usually determined based on management’s assumptions
In upward sloping yield curve, borrowing short-term and lending long-term, effects on LCR and NSFR
LCR weakens and NSFR weakens
Hard Insurance Market
When combined ratio is low - total insurance expenses divided by the net premiums earned
New entrants come in who cut prices and push the cycle downward
Under GAAP, how does the expected return on plan assets affect the pension obligation
It does not
How does the expected return on plan assets affect the pension expense
The higher the expected return (like rebalancing to stocks over bonds) will offset current pension costs, holding all else constant
Share of equity income to be reported with downstream sale
Share of income - [ (parent company profit on sale * (1-% of inventory resold by subsidiary) * % Ownership stake) ] - amortization of excess purchase price
Cannibalization
Cannibalization factor * sales
According to IFRS, when is compensation costs recognized at fair value
in the period the employee provides services, which is typically also the period when the compensation vests
Under IFRS, how does expected return on plan assets affect pension obligation
under IFRS, the expected return is the discount rate, so an increase in expected return lowers current pension obligation
Factors that influence the choice of the forecast time horizon for a stock
1) Investment strategy
2) The cyclicality of the industry
3) Company-specific factors
4) Analyst’s employer’s preferences
Which insurance business has the highest systematic risk
Reinsurance
Underwriting expense ratio
underwriting expense/net premiums written
measures the efficiency of money spent in obtaining new premiums
a lower ratio indicates higher success
Combined ratio
loss and loss adjustment expense ratio + underwriting expense ratio
indicates the overall efficiency of an underwriting operation
a combined ratio of less than 100 is considered efficient
loss and loss adjustment expense ratio
loss and loss adjustment expenses / net premiums written
indicates the degree of success an underwriter has achieved in estimating the risks insured
the lower the more successful
in analyzing banks, which earnings are best in evaluating the sustainability of earnings
net interest and net fee income (net service income)
Temporal Method | Foreign Currency Strengthens | Net Liability Exposure | Effect on Net Income
Net Income Decreases
Temporal Method | Foreign Currency Strengthens | Net Liability Exposure | Effect on Revenue
Revenues Increase
Temporal Method | Foreign Currency Strengthens | Net Liability Exposure | Effect on Assets
Assets Increase
Temporal Method | Foreign Currency Strengthens | Net Liability Exposure | Effect on Liabilities
Increase
Temporal Method | Foreign Currency Strengthens | Net Liability Exposure | Effect on Shareholders Equity
Decrease -> Translation Loss
Temporal Method | Foreign Currency Weakens| Net Liability Exposure | Effect on Net Income
Net Income Increases
Temporal Method | Foreign Currency Weakens| Net Liability Exposure | Effect on Assets
Assets decrease
Temporal Method | Foreign Currency Weakens| Net Liability Exposure | Effect on Revenues
Revenues Decrease
Temporal Method | Foreign Currency Weakens| Net Liability Exposure | Effect on Liabilities
decreases
Temporal Method | Foreign Currency Weakens| Net Liability Exposure | Effect on Shareholders equity
Increase -> Translation Gain
Temporal Method | Foreign Currency Weakens| Net Asset Exposure | Effect on Shareholders equity
Shareholders Equity decrease -> translation loss
Temporal Method | Foreign Currency Weakens| Net Asset Exposure | Effect on Liabilities
Decrease, everything decreases
Temporal Method | Foreign Currency Weakens| Net Asset Exposure | Effect on Assets
Decrease, everything decreases
Temporal Method | Foreign Currency Weakens| Net Asset Exposure | Effect on Revenues
Decrease, everything decreases
Temporal Method | Foreign Currency Strengthens| Net Asset Exposure | Effect on assets
increase, everything increases
Temporal Method | Foreign Currency Strengthens| Net Asset Exposure | Effect on Revenues
increase, everything increases
Temporal Method | Foreign Currency Strengthens| Net Asset Exposure | Effect on liabilities
increase, everything increases
Current Method | Foreign Currency Strengthens | Effect on shareholders equity
Increases. everything increases, net exposure (asset/liability doesn’t matter)
Temporal Method | Foreign Currency Strengthens| Net Asset Exposure | Effect on net income
increase, everything increases
Temporal Method | Foreign Currency Strengthens| Net Asset Exposure | Effect on shareholders equity
increase, everything increases
Current Method | Foreign Currency Strengthens | Effect on revenues
Increases. everything increases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on assets
Increases. everything increases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on liabilities
Increases. everything increases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Weakens| Effect on shareholders equity
decreases, everything decreases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on net income
Increases. everything increases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on net income
decreases, everything decreases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on assets
decreases, everything decreases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on revenue
decreases, everything decreases, net exposure (asset/liability doesn’t matter)
Current Method | Foreign Currency Strengthens | Effect on liabilities
decreases, everything decreases, net exposure (asset/liability doesn’t matter)
What are the only corporate actions that increases book value per share
Reverse stock split and share repurchase
Where would non-cumulative, perpetual preferred shares be classified by a bank
other Tier 1 capital
Under GAAP, the impact that a decrease in the expected return on plan assets has on pension obligation
No change
Under GAAP, the impact that a decrease in the expected return on plan assets has on pension expense
higher periodic pension expense
Under current method, where are translation gains and losses recorded
equity section on balance sheet
Full goodwill method
Even if parent doesn’t own 100% of the entity, goodwill is treated as 100% owned by the parent
Partial goodwill method
Goodwill based on % ownership
Lower Beneish model score signal on accruals and earnings quality
Lower model score -> lower accruals -> higher earnings quality
IFRS v. GAAP on contingent liabilities
IFRS includes contingent liabilities if their fv can be reliably measured, while GAAP includes them if their fv can be reliably measured AND they are probable
Classification shifting on the income statement is generally done for what purpose
give a boost to operating income
combined ratio
loss and loss adjustment expense ratio + underwriting expense ratio
loss and loss adjustment expense ratio
(loss expense + loss adjustment expense) / net premiums earned
underwriting expense ratio
underwriting expense / net premiums written
Current Rate, how are non-monetary items translated
Current exchange rate
Current rate, how are assets and liabilities translated
current exchange rate
When you use current vs. Temporal method
Current when subsidiary’s functional currency is different than parent’s presentation currency
Temporal when the subsidiary’s functional currency is same as parent’s presentation currency
Current rate, how are all income statement items translated
average rate for the year
Temporal method, how is depreciation translated
historical rate when equipment was purchased
current vs temporal method reporting of translation adjustment
current - separate component on SE
temporal - gain/loss in NI
Hyperinflationary environment - GAAP vs. IFRS
IFRS - restate for inflation then current method, monetary items are not restated
GAAP - do not restate for inflation temporal method
What is a type of cash-settled share-based compensation
Stock Appreciation rights
understatement of deferred tax assets impact on tax expense and net income
understate tax expense and and overstate net income
a hard insurance market is indicated by industry’s combined ratio being high or low
low
total expenses / total premiums earned
attracts new entrants and push prices down
using temporal method, translating cost of sales
weighted average rate when inventory was acquired
Under current method, how is depreciated translated
at average rate for the year
Quality spectrum of earnings reporting
1) GAAP, decision useful, sustainable, adequate returns
2) GAAP, decision useful, sustainable?, low earnings quality
3) Within GAAP, but biased choices
4) Within GAAP, but earnings management
5) Non-compliant
6) Fictitious
Under IFRS, which component of periodic pension cost would go to OCI
actual return on plan assets - estimated return on plan assets
under temporal method, how is land translated
at historical cost
Under IFRS, where do current and past service costs record
directly on the
Conservative revenue practices leads to what
understatement of liabilities
under IFRS, how is land translated
adjusted for inflation and translated back at current rates
are debt instruments allowed to be reclassified under IFRS
yes, only if business model changes
are equities allowed to be reclassified under IFRS
no
Can convertible bond be measured at amortized cost
no
How are actuarial gains and losses treated in GAAP
reported on either OCI or P&L
Minimum standard under Basel III of LCR
100%
Minimum standard under Basel III of NSFR
greater than 100%
Equity Method vs. Acquisition method - Net profit margin
Equity method - higher
Acquisition method lower
Equity Method vs. Acquisition method - ROE
Equity method - higher
Acquisition method lower
Equity Method vs. Acquisition method - ROA
Equity method - higher
Acquisition method lower
Equity Method vs. Acquisition method - ROA
Equity method - lower
Acquisition method - higher
Where are impairment losses, including goodwill, recognized
income statement
Impact on balance sheet ratios if SPE is created
no impact
Impact on cost of borrowing if SPE is created
reduction in cost of borrowing
The cash outflow recognized in CFO from pension statements
employers’ plan contributions
Do foreign currency translations affect net sales growth
yes
net sales growth = organic sales growth +- effects of acquisitions, divestitures, and foreign exchange
balance sheet exposure under current method vs. temporal
under temporal, balance sheet exposure is just net monetary exposure, whereas current method its the entire balance sheet
predominant asset of banks
loans and securities
predominant liability of banks
deposits
5 Classifications of investments in other businesses
1) Investments in financial assets
2) Investments in associates
3) Joint ventures
4) Business combinations
5) Investments in SPE and VIEs
Investments in financial assets definition and classification
Investor has no significant control
1) FVPL
2) FVOCI
3) Amortized cost
Investment in associates definition
Investor has significant influence, but not control over investee’s business activities
Investment in joint venture definition
Investor has significant influence, but not control over investee’s business activites
Reporting method required for investment in associates
Equity method
Reporting method required for joint venture
Equity method
Reporting method for business combinations
Acquisition method
US GAAP vs IFRS measurement of non controlling interest
IFRS - either full goodwill or partial goodwill
GAAP - full goodwill
Equity vs. Acquisition method - Net Income
The Same
revenue recorded from acquisition under equity method
0
expenses recorded from acquisition under equity method
0
where are service costs recorded on income statement
operating expenses
where are net interest expense/income recorded on income statement
below operating income line
cash flow based accruals ratio
(NI - CFO + CFI) / Average NOA
Difference in treatment of tax windfalls IFRS VS GAAP
IFRS - directly to equity
GAAP - income expense (more volatility in effective tax rate)
