GAAP Chapt1 (aka SN807)-Analysis For Fin mgmt

Question 1

Define operating profit, operating income, pretax income, and net income

Answer 1

1. Prem - expense - benefit = operating profit = operating income
2. Operating income + investment income = EBIT (earnings before interest and tax)
3. EBIT - interest expense = pretax income = operating earnings
4. Pretax income - taxes = net income
5. Note older SOA exam problems sometimes use “operating earnings” similar to operating income except it included investment income

Question 2

Income statement:
Describe accrual accounting,
Depreciation,
and dual tax reporting

Answer 2

1. Accrual accounting: matching the costs to revenues
2. Depreciation
   
   2. 1 spread the cost over useful life
   3. 2 if depreciate assets rapidly, understate current earnings
3. Taxes
   
   3. 1 dual reporting means tax payments differ from provision for income taxes on income statement
   4. 2 taxes paid = provision for income taxes + increase in balance sheet tax asset account + decrease in tax liability account

Question 3

Components of the income statement

Answer 3

1. Revenues: premium, policyholder charges, investment income, realized capital gains and losses
2. Expenses: claims, surrenders, dividends, expenses, commissions, change in reserves
3. Net income before tax
4. Net income after tax
5. Net income after extraordinary items

Question 4

Changes in Equity formula

Answer 4

1. Beginning of year equity
2. Comprehensive income
   
   2. 1 (add) net income and other comprehensive income
3. Owner transactions
   
   3. 1 (add) capital contributions
   4. 2 (subtract) shareholder dividends
4. (Equals) end of year equity

Question 5

Describe sources and uses statements

Answer 5

1. Generate cash in two ways:
   
   1. 1 by reducing an asset or by increasing a liability
2. Use cash in two ways:
   
   2. 1 increase an asset or reduce a liability
3. Total uses of cash over period must equal total sources

Question 6

Cash Flow statement: focus, advantages, and disadvantages

Answer 6

1. The focus of the cash flow statement is solvency
2. Problems
   
   2. 1 negative net cash does not necessarily indicate poor performance
   3. 2 apportioning among operating, investing, and financing is ambiguous
3. Cash flow statement virtues
   
   3. 1 easier to understand for some users
   4. 2 more info about taxes and securitization than income statements and balance sheets
   5. 3 highlights extent operations generating or consuming cash
   6. 4 can manipulate net income. Movement of cash more objective

Question 7

Cash flow definitions

Answer 7

1. Net cash flow = net income + no cash items
2. Cash flow from operating activities = net cash flow +- changes in current assets and liabilities
3. Free cash flow = cash available for distribution after finding worthwhile investment

Question 8

Market value bs book value

Answer 8

1. Balance sheet shareholders equity know as book value
2. MV of S equity = number of common shares outstanding times the market price per share
3. BV (shareholders equity) different than company worth to shareholders
   
   3. 1 backward looking and cost based
   4. 2 provide few clues about future income
4. Goodwill
   
   4. 1 goodwill asset = price - replacement value

Question 9

Financial statement disclosures

Answer 9

1. Market risk disclosure: quantitative and qualitative information
2. Changes in accounting principles
3. Subsequent events
4. Footnotes of financial statements may include
   
   4. 1 description of company and products
   5. 2 significant accounting policies
   6. 3 details on invested assets
   7. 4 details on leases, receivables and claims liabilities
   8. 5 sale or purchase transactions
   9. 6 capital transactions
   10. 7 reconciliation to statutory financial data

Question 10

Describe the balance sheet

Answer 10

1. Point in time of assets and claims against those assets
2. Assets = Liabilities + Shareholders’ equity
3. Current Assets and Liabilities
   
   3. 1 expects to turn into cash within one year