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
