CFA 2018 Level 2 FSA

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  Financial Statement Analysis Weight: 15%~20%

  SS5: Intercorporate Investments, Post-Employment and Share- Based Compensation, and Multinational Operations SS6: Earnings Quality Issues and Financial Ratio Analysis

  Introduction of the course Study Session 1-2 Ethics & Professional Standards 10 -15% Study Session 3 Quantitative Analysis 5 -10% Study Session 4 Economics 5 -10% Study Session 5-6 Financial Reporting and Analysis 15 -20% Study Session 7-8 Corporate Finance 5 -15% Study Session 9-11 Equity Investment 15 -25% Study Session 12-13 Fixed Income 10 -20% Study Session 14 Derivatives 5 -15% Study Session 15 Alternative Investments 5 -10% Study Session 16-17 Portfolio Management and Wealth Plan 5 -10% Weights: 100%

  Ø

  • 17年财报考纲发生了较大的变化,删减了一个 Session,但 是由于科目权重维持不变,估计仍然会考4个Case,对于 剩下部分的学习要求会变得更高。
  • Session 6中财报质量的考查可能会穿插一级的知识点,考

  生在准备二级新的知识的通知也应该 适当的复习财报一级 的重要知识点 。

  Summary Investments in Financial Assets

Exam tips:

Tasks:

  Ø Describe the classification, measurement, and disclosure under International Financial Reporting Standards (IFRS) for financial assets.

  Ø Distinguish between IFRS and US GAAP in the classification, measurement,. and disclosure of financial assets. Intercorporate Investments Categorization of Investment

Definition of intercorporate investments

  Ø Intercorporate investments in marketable securities are

  Financial Business Joint Associates Assets Combination Ventures

  categorized as follows:

  • Degree of Shared

  Investments in financial assets (has no significant influence)

  No significant Significant Control influence control

  Investments in associates (has significant influence) •

  Typical

  Business combinations (has control over the investee firm) •

  percentage of < 20% 20% - 50% > 50% Varies interest

  • Joint ventures (the right of control is shared by entities)

  Term of investee N/A Associate Subsidiary N/A

The classification of categories

  Ø Percentage of ownership is typically used to determine the

  • HTM

  AFS

  appropriate category. However, the ownership percentage is

  • Accounting Fair value Acquisition Equity •

  Equity method through

  only a guideline. Ultimately, the category is based on the treatment method method

  Profit / investor’s ability to influence or control the investee . Loss

  Financial Assets Financial Assets

Held-to-maturity investments Definition of financial assets

  Ø Held-to-maturity investments are investments in financial

  Ø The classification below only applies to equity or debt assets with fixed or determinable payments and fixed investment with no significant influence (percentage of maturities (only debt securities) that the investor has the positive intent and ability to hold to maturity. interests < 20%) :

  Ø Initial recognition (similar under IFRS & US GAAP)

  • HTM is only for debt securities

  IFRS: recognized at fair value. •

  • Available for sale security (AFS)
  • US GAAP: recognized at initial price paid.
  • Fair value through P/L (including trading securities &

  Ø Held-to-maturity securities are reported on the balance sheet designated at fair value) at amortized cost .

  • Amortized cost is simply the present value of the Ø GAAP and IFRS are the same about the classification.

Fair value through profit and loss

Available for sale securities

  • Securities acquired with the intend to sell them in the near

  • Both realized and unrealized gain and loss are recognized in the income statement.

  • Designating financial assets at fair value regardless the holding intention.
  • The treatment is similar to that of trading securities.
  • Next slide

  Determine the impact on the firm’s B/S and I/S if the bond investment is classified as held-to-maturity, fair value through profit or loss and available-for-sale . Example Held-to-maturity Ø The balance sheet value is based on amortized cost .

  A company purchased a 9% bond with a face value of $100,000 for $96,209 to yield 10%. The coupon payments are made annually at year end. The fair value of the bond at the end of the year is $98,500.

  Example

  (Both US GAAP and IFRS)

  ü Recognize foreign exchange gain or loss in income statement . ü Recognize other changes in fair value in OCI . Ø Equity: • Recognize all changes of fair value in OCI .

  Available for Sale Securities

  Ø Debt:

  Ø Not classified as held to maturity and fair value through profit and loss securities. Ø Available for sale securities are reported on the balance sheet at fair value . Ø Realized gain and loss are recognized on income statement. Ø Unrealized gain and loss are recognized on equity (OCI). Ø Accounting treatment of available for sale securities when foreign exchange rate is changing .

  Financial Assets

  Ø Designated at fair value

  term. (usually less than 3 months) • Reported on the balance sheet at fair value .

  Ø Held-for-trading securities (Equity & Debt)

  Financial Assets

Foreign exchange rate changes

  • US GAAP: All change in fair value of available for sale investments is recognized in OCI .
  • IFRS:

  Ø At year-end, the company recognizes interest revenue of $9,621 ($96,209 × 10%). --- Income statement Ø At year-end, the bond is reported on the balance sheet at $96,830 ($96,209 + $9,621 - $9,000). --- Balance sheet

  Fair value through profit and loss Ø The balance sheet value is based on fair value of $98,500.

  Ø At year-end, the company recognizes interest revenue of $9,621 ($96,209 × 10%). --- Income statement Ø The unrealized gain of $2,291 ($98,500 - $96,209) are recognized in the income statement.

  Example Example

IFRS

  Available for sale Ø The balance sheet value is based on fair value of $98,500.

  Ø At year-end, the company recognizes interest revenue of $9,621 ($96,209 × 10%). --- Income statement Ø The unrealized gain of $2,291 ($98,500 - $96,209) are recognized in other comprehensive income. (OCI)

  Reclassification of Financial Asset

  Ø

  IFRS typically does not allow reclassification of investments into or out of the designated at fair value category .

  Ø Reclassification of investments out of the held-to-trading category is severely restricted under IFRS. Ø

  Debt securities initially designated as available-for-sale may be reclassified to held-to-maturity if a change in intention or ability has occurred.

  Ø Held-to-maturity securities can be reclassified as available-for- sale if the holder no longer intends or is no longer able to hold the debt to maturity. Reclassification of Financial Asset Summary

U.S. GAAP

  From To Unrealized Gain / Loss Ø U.S. GAAP allows reclassifications of securities between

  Fair value through Income statement Any profit or loss (Restricted under IFRS) all categories when justified.

  Fair value through Income statement Ø

  Fair value of the security is determined at the date of Held to maturity profit or loss (Restricted under IFRS) transfer.

  Held to maturity Available for sale Other comprehensive income Ø

  The treatment of unrealized holding gains and losses on Available for sale Held to maturity Amortized out of OCI the transfer date depends on the initial classification of

  Fair value through Transfer out of OCI the security.

  Available for sale profit or loss (Restricted under IFRS) Impairment of Financial Asset

  Impairment of Financial Asset Both U.S. GAAP and IFRS

Under U.S. GAAP

  Ø Ø

  U.S. GAAP and IFRS require that held to maturity and A security is considered impaired if its decline in value is available for sale securities be evaluated for impairment determined to be other than temporary. For both held at each reporting period. to maturity and available for sale securities, the write Ø

  It’s not necessary for fair value through profit and loss down to fair value is treated as a realized loss . securities because declines in their value are recognized (recognized on the income statement).

  A subsequent reversal of impairment losses is not allowed .

  Ø on the income statement as they occur. Impairment of Financial Asset Impairment of Financial Asset

Under IFRS (HTM) Under IFRS

  Ø Impairment of held to maturity securities

  Ø Impairment of a debt or equity security is indicated if at

  Impaired if its carrying value > PV of cash flow ( • expected

  least one loss event has occurred, and its effect on the

  permanently )

  security’s future cash flows can be estimated reliably. ü A credit rating downgrade or the lack of liquidity are

  not considered to be indications of impairment in the

  • Losses due to occurrences of future events absence of other evidence.

  (regardless of the probability of occurrence) are not

  Impairment loss is recognized on income statement. • recognized .

  Ø Reversal

  • If the recovery can be attributed to an event (eg: credit upgrade), the impairment loss can be reversed.

  Impairment of Financial Asset Impairment of Financial Asset

Under IFRS (AFS)

Under IFRS (AFS)

  Ø Impairment of available for sale securities

  Ø

Impairment of available for sale securities

  Impaired if its carrying value > PV of cash flow (loss event) •

  Cumulative loss in OCI is reclassified to income •

  ü Significant changes in the technological, market, statement. economic, and/or legal environments that adversely

  ü Cumulative loss = Acquisition cost – current fair

  affect the investee and indicate that the initial cost of

  value – impairment loss that has previously been the equity investment may not be recovered. recognized in income statement.

  ü A significant or prolonged(持续性的) decline in the fair value of an equity investment below its cost.

Under IFRS (AFS)

  • Debt: Impairments of available for sale debt securities may
  • Amortized cost
  • Fair value through profit or loss (FVPL)
  • Fair value through other comprehensive income
  • Equity: Can not be reversed through I/S.

  IFRS 9 (New Standards)

  Impairment of Financial Asset

  Ø Reversal of available for sale securities

  be reversed under the same conditions as impairments of held to maturity securities.

  ü Recognized through I/S only when directly related with original events resulting initial loss.

  IFRS 9 (New Standards)

IFRS 9 (New Standards)

  Ø

  IFRS 9 does away with the terms held for trading, available for sale, and held to maturity. Instead, the three classifications are:

  (FVOCI) .

  IFRS 9 (New Standards)

IFRS 9 (New Standards)

IFRS 9 (New Standards)

  Ø FVPL ( Debt & Equity )

Amortized cost ( Debt only ), 2 criteria:

  • Debt: Held for trading or if recognized as amortized cost will results in an accounting mismatch .
  • Equity: Held for trading must be classified as FVPL; Others may be classified as either FVPL or FVOCI, irrevocable .
  • Business model test: Debt securities are being held to collect contractual cash flow.
  • Cash flow characteristic test: The contractual cash
Summary of IFRS 9 Summary

  Ø

  FVOCI ( Equity only ) • Same as available for sale securities.

  flows are either principal, or interest on principal, only.

  Ø

  Ø ☆☆

Importance:

  Ø

Content:

  Intercorporate investments的分类标准; • Financial assets的分类 •

  • Reclassification of financial assets.

  Impairment of financial assets. • Ø

Exam tips:

  主要考察定性的概念及辨析,注意区分GAAP和IFRS的记 • 账方法。

  Definition of Associates

Definition of Associate

  Investment in Associates

  Ø When a company holds 20% - 50% of the voting rights of an associate, it is presumed that the company has significant

  Tasks: influence, but not control , over the investee’s business activities.

  Ø Describe the classification, measurement, and disclosure Representation on the board of directors • under International Financial Reporting Standards (IFRS) for Participation in the policy-making process • Investment in Associates.

  Material transactions between the investor and the investee • Ø Distinguish between IFRS and US GAAP in the classification,

  Interchange of managerial personnel • measurement,. and disclosure of Investment in Associates. Technological dependency • Example Equity Method Equity Method of Accounting

Equity Method of Accounting

  Ø The equity investment is initially recorded on the investor’s Ø December 31, 20X5, Company A invests $1,000 in return for balance sheet at cost . In subsequent periods, the carrying 30% of the common shares of Company B.

  • amount of the investment is adjusted to recognize the During 20X6, Company B earns $400 and pays dividends investor’s proportionate share of the investee’s earnings or of $100.

  losses, and these earnings or losses are reported in income .

  • Dividends or other distributions received from the investee Calculate the effects of the investment on Company A’s are treated as a return of capital and reduce the carrying balance sheet, income statement and cash flow for 20X6. amount of the investment and not reported in the I/S .
  • One – line consolidation.

  Example Equity Method

  Equity Method of Accounting (Answer)

Investment Costs That Exceed the Book Value of the Investee

  Ø Recognize $120 ($400 ×30%) in the I/S from its proportionate share of Ø Acquisition cost is initially recognized as investment in the net income of Company B. associate, and comprises of two parts:

  Ø Increase its investment account on the balance sheet by $120 to Fair value of the net assets acquired. • $1,120 to reflect its proportionate share of the net assets of B.

  Goodwill ( • Not amortized but need to test for impairment ) Ø Receive $30 ($100 ×30%) in cash dividends from Company B and

  Ø The difference between fair value and book value of the net reduce its investment in Company B by that amount to reflect the assets acquired will adjust the I/S of investor’s equity income . decline in the net assets of Company B due to the dividend payment.

  Not simply equals to the net income earned by investee •

  • At the end of 20X6, the book value of the investment on Company A’s B/S = $1,000 + $120 - $30 = $1,090 multiplied by percentage of interests owned.
Equity Method Example

Investment Costs That Exceed the Book Value of the Investee Investment Costs That Exceed the Book Value of the Investee

  Ø At the beginning of the year, A Company purchased 30% of B Goodwill is renewed for

  Company for $80,000. Net asset of company B in book value is impairment on a regular

  $200,000. On the acquisition date, the book value of B’s assets basis. and liabilities were the same except for B’s equipment, which

  This part is amortized to had a book value of $25,000 and a fair value of $75,000 on the the investee’s profit or acquisition date. B’s equipment is depreciated over ten years loss over economic lives. using the straight – line method . At the end of the year, B reported net income of $100,000 and paid dividends of $60,000.

  Example Example

  Question A: Calculate the goodwill

Question B: Calculate Company A’s equity income at the end of Ø Goodwill = Purchase price – Fair value of the net assets the year from its investment in Company B

  = Purchase price – ( Book value of the net assets + Ø Equity income = Proportionate share of B’s net income – Appreciation of the equipment )

  Additional depreciation from excess of purchase price =$80,000 – [$200,000 x 30% + ($75,000 FV - $25,000 BV) allocated to B’s equipment. x 30%]

  Ø Equity income = ($100,000 x 30%) – ( Excess / 10) =$5,000

  • Excess = ($75,000 - $25,000) x 30% = $15,000

  = $28,500

  Ø Both IFRS and US GAAP give the investor the option to account for their equity method investment at fair value.

  Example Fair Value Option

Question C: Calculate the investment in Company B that appears on Company A’s year-end balance sheet

  • Both standards require that the election to use the fair value option occur at the time of initial recognition and is irrevocable .
  • The investment is reported at fair value with unrealized gains and losses

  Ø Investment balance at end of year = Investment balance at beginning of year + Equity income – Dividends pay out

  Ø Investment = $80,000 + $28,500 ( Equity income ) – ($60,000 x 30%)

  • Under the fair value method, the investment account on the investor’s

  = $90,500

  balance sheet does not reflect the investor’s proportionate share of the investee’s profit / loss or dividends .

  • In addition, the excess of cost over the fair value of the investee’s identifiable net assets is not amortized, nor is goodwill created .

  Impairment of Equity Investment

  IFRS Ø The entire carrying amount of the investment is tested for impairment by comparing its recoverable amount with its carrying amount.

  • Recoverable amount of an asset is the higher of its value less costs to sell and its value in use.

  Ø The impairment loss is recognized on the income statement, and the carrying amount of the investment on the balance sheet is either reduced directly or through the use of an

  Impairment of Equity Investment

  Ø If the fair value of the investment declines below its carrying value and the decline is determined to be permanent, an impairment loss to be recognized on the income statement and the carrying value of the investment on the balance sheet is reduced to its fair value.

  Ø Both US GAAP and IFRS prohibit the reversal of impairment losses even if the fair value later increases.

  arising from changes in fair value as well as any interest and dividends received included in the investor’s profit or loss. Transactions with Associates Example of Upstream Transaction

  Upstream ( associate to investor ) Upstream ( associate to investor )

  Ø The profit on the intercompany transaction is recorded on the Ø Suppose that Investor owns 30% of Investee. During the year, associate’s income statement.

  Investee sold goods to Investor and recognized $15,000 of The investor’s share of the unrealized profit is thus included profit from the sale. At year end, half of the goods purchased • in equity income on the investor’s income statement . from Investee remained in Investor’s inventory.

  Ø Investor must reduce its equity income of investee by Ø Investor must reduce its equity income by $2,250 investor’s proportionate share of the unconfirmed profit . ($15,000 x 50%) x 30% = $2,250 •

  • Unconfirmed profit means goods have not been used or Ø Once the inventory is sold by Investor, $2,250 of equity income sold by the investor.

  will be recognized.

  Transactions with Associates Example of Downstream Transaction

  Downstream ( investor to associate )

  Downstream ( investor to associate )

  Ø Suppose that Investor owns 30% of Investee. During the year, Investor

  Ø The investor has recognized all of the profit in its income

  sold $40,000 of goods to Investee for $50,000. Investee sold 90% of statement. the goods by year – end.

  Ø The investor must eliminate the proportionate share of Ø

  Investor’s profit is $10,000 ($50,000 sales - $40,000 COGS) Ø 10% of the profit remains in Investee’s inventory.

  the profit that is unconfirmed.

  Ø Investor must reduce its equity income by the proportionate share of unconfirmed profit:

  • $10,000 profit x 10% unconfirmed amount x 30% = $300

  Once Investee sells the remaining inventory, Investor can • Analytical Issues For Equity Method Summary

  Ø Analysts should question whether the equity method is appropriate Ø ☆☆☆

Importance:

  Ø

  • Ø There can be significant assets and liabilities of the investee that are

  Significant influence or not

Content:

  Definition of Associate (重点理解存在显著影响的判断) •

  not reflected on the investor’s balance sheet, which will significantly

  Equity Method (B/S,I/S的相关处理) • affect debt ratios.

  • Impairment (US GAAP & IFRS)

  Ø Net margin ratios could be overstated because income for the

  Transactions with Associates (upstream & downstream) •

  associate is included in investor net income but is not specifically

  Ø Exam tips: included in sales.

  重点理解使用Equity method对于B/S & I/S的影响。 • Ø Finally, the analyst must consider the quality of the equity method earnings.

  Business Combinations

Definition of Business Combinations

  Ø Business combinations (controlling interest investments) involve

  Business Combinations

  the combination of two or more entities into a larger economic

  Tasks: entity.

  Ø Describe the classification, measurement, and disclosure

  • Under IFRS , there is no distinction among business

  under International Financial Reporting Standards (IFRS) for combinations based on the resulting structure of the larger economic entity. Business combinations.

  • Under US GAAP , business combinations are categorized as: Ø Distinguish between IFRS and US GAAP in the classification,

  ü 吸收合并 Merger ( ) measurement,. and disclosure of Business combinations .

  ü 收购 Acquisition ( ) Business Combinations in US GAAP Business Combinations in US GAAP

  Merger ( 吸收合并 ) 新设合并 )

  Consolidation (

  Ø The distinctive feature of a merger is that only one of the entities

  Ø The distinctive feature of a consolidation is that a new

  remains in existence. One hundred percent of the target is absorbed

  legal entity is formed and none of the predecessor

  into the acquiring company. ( Acquire 100% of the target )

  • Company A + Company B = Company A

  entities remain in existence. A new entity is created to Acquisition ( 收购 ) take over the net assets of Company A and Company B.

  Ø Each entity continues operations but is connected through a

  ( Acquire 100% of the target )

  parent–subsidiary relationship. Each entity is an individual that

  • Company A + Company B = Company C

  maintains separate financial records, but the parent (the acquirer) provides consolidated financial statements in each reporting period.

  • Company A + Company B = (Company A + Company B)

  Accounting Treatment for Business Combination Accounting Treatment for Business Combination Pooling-of-Interests Method ( US GAAP, Prior to June 2001 ) Purchase Method ( US GAAP & IFRS )

  Ø Combining companies that met twelve strict criteria. Companies not

  Ø The assets and liabilities acquired by the Parent should be meeting these criteria used the purchase method . stated at fair value in the consolidated financials statements.

  Ø The target’s assets and liabilities are stated at their book value in the

  Ø An increase in the value of depreciable assets resulted in consolidated financials statements. additional depreciation expense . As a result, for the same level

  Ø Operating results for prior periods are restated as though the two of revenue, the purchase method resulted in lower reported firms were always combined. income than the pooling of interests method .

  Ø Similar rules applied under IFRS, which used the term uniting of

  Ø interests method . (

  IFRS, Prior to March 2004 ) Now, the acquisition method which replaces the purchase

  Ø Currently, neither IFRS nor US GAAP allows use of the pooling or method is required in both US GAAP and IFRS.

  Acquisition Method ( US GAAP & IFRS )

  Ø All of the assets, liabilities, revenues, and expenses of the subsidiary are combined with parent. Ø Intercompany transactions are excluded. Ø The acquisition method addresses three major accounting issues that often arise in business combinations.

  Accounting Treatment for Business Combination

  Ø Suppose that on January 1

  st

  ,2016, Company A acquires 80% of the common stock of Company B by paying $8,000 in cash to the shareholders of Company B. The pre-acquisition balance sheet of Company A and Company B are shown below:

  Example of Acquisition Method – B/S B/S Items Company A ($) Pre-Acquisition Company A ($) Post-Acquisition Company B ($)

  Current assets 48,000 40,000 16,000 Other assets 32,000 32,000 + 8000 8,000 Total 80,000 80,000 24,000 Current liabilities 40,000 40,000 14,000

  • The recognition and measurement of the assets and liabilities of the combined entity .
  • The initial recognition and subsequent accounting for goodwill .
  • The recognition and measurement of any non-controlling interest.

  Common stock 28,000 28,000 6,000 Retained earnings 12,000 12,000 4,000 Total 80,000 80,000 24,000

  Ø In an acquisition, the assets and liabilities are combined. Ø Under the equity method, Company A will report its 80% interest in company B in a one-line investment account on the balance sheet.

Non-controlling interests:

  B/S Items Acquisition Method ($) Equity Method ($) Current assets 56,000 40,000 Investment in B 8,000 Other assets 40,000 32,000 Total 96,000 80,000 Current liabilities 54,000 40,000 Common stock 28,000 28,000 Minority Interest 2,000 Retained earnings 12,000 12,000 Example of Acquisition Method – B/S

  Ø A minority interest (少数股东权益) is the portion of the subsidiary’s equity that is held by third parties. Ø When Company A reports 100% of Company B’s assets and liabilities even though Company A only owns 80%. The remaining 20% of Company B is owned by minority investors and the difference is accounted for using a minority interest account.

  Minority Interest

  • Minority interest = 20% x (4000+6000) = 2000

A more complicated example of combination B/S:

  Ø Company A acquired 100% interest of Company B, the total consideration (收购对价) is $500M.

  Goodwill B/S Items Company B (Historical) Company B (Adjusted) Company A (Post - Acquisition) Adjustment for Acquisition Method Acquisition Method Cash

  30 30 600 -500 =100 130 Inventory

  50 50 +30 =80 150 230

  50 50 150 200 PP&E 250 250 +50 =300 400 700 Intangible asset

Goodwill = 500 - (560-180) = 120 Recognition and Measurement of Goodwill:

  • 100 =100 100
    • TIPS: 使用Acquisition method时必须要使用正确的 时点数据。 ü Acquirer: 使用收购完成时的报表数据。 ü Target: 使用调整完成后的公允价值报表数据。

  Capital 150 150 550 -150 550

  50 50 350 -50 350 FV adjusted +300 =300 -300 Total L + E 380 680 1300 1480 Measurement of Minority Interest

  • Full goodwill = Fair value of equity of whole
  • Partial goodwill = Purchase price - % Owned x Fair value of net identifiable assets of the subsidiary Ø US GAAP allows full goodwill method only.

  subsidiary – fair value of net identifiable net assets of the subsidiary

  Goodwill

  Company A paid $450 million for 75% of the stock of company B. Calculate the amount of goodwill Company A should report using the full goodwill method and the partial goodwill method.

  The fair value of the PP&E was $120 million more than its recorded book value. The fair values of all other identifiable assets and liabilities were

  Example B/S items Book Value (million)

  Current assets

  80 PP&E 760 Goodwill

  30 Liabilities 400 Equity 470

  Investment +500 =500 -500 Goodwill +120 =120 120 Total asset 380 380 +300 =680 1300 1480 A/P 180 180 400 580

  Ø IFRS allows two options for recognizing goodwill.

  • Fair value of the subsidiary = 450 / 0.75 = 600 million
  • Fair value of identifiable net assets

  Although goodwill is not amortized, it must be tested for impairment at least annually.

  Ø Under IFRS

  A reporting unit of a US corporation has a fair value of $1,300,000 and a carrying value of $1,400,000 that includes recorded goodwill of $300,000. The estimated fair value of the identifiable net assets of the reporting unit at the impairment test date is $1,200,000. (The recoverable amount of the cash-generating unit is determined to be €1,300,000.) Calculate the impairment loss.

  Impairment of Goodwill

  2. The loss is measured as the difference between the

  1. Impairment exists if the carrying value of the reporting unit (including the goodwill) exceeds its fair value.

  Ø Under US GAAP, goodwill impairment involves two steps.

  Ø Under IFRS, if the carrying amount of the cash generating unit exceeds the recoverable amount , an impairment loss is recognized. (single step approach)

  Ø Under full goodwill method, minority interest is based on the acquired company’s fair value.

  Ø Goodwill is lower using the partial goodwill method . How is this reflected on liabilities and equity side of the balance sheet?

  Answer Measurement of minority interest:

  • Acquisition goodwill = 600 – 560 = 40 million Ø Partial goodwill method
  • Purchase price = 450 million
  • Proportionate share of the fair value of identifiable net assets

  ü = 0.75 x 560 = 420 million

  ü = 80 + (760 + 120) – 400 = 560 million

  Ø Full goodwill method

  • 600 x 25% = 150 million Ø Under partial goodwill method, minority interest is based on the fair value of the acquired company’s identifiable net assets.
  • 560 x 25% = 140 million Ø The full goodwill method results in higher total assets, higher total equity and lower ROE than the partial goodwill method.
  • Acquisition goodwill = 450 – 420 = 30 million

  Example of Goodwill Impairment

  • Recoverable amount of unit < Carrying amount of unit
  • Impairment loss = 1.3 m – 1.4 m = €100,000
Example of Goodwill Impairment in US GAAP Bargain Purchase

  Ø Under US GAAP

  In rare case, acquisition purchase price is less than the fair

  Step 1 – Determination of an Impairment Loss • value of net asset acquired.

  ü $1,300,000 (Fair value of unit) < $1,400,000 (Carrying value)

  Ø Both IFRS and US GAAP require that the difference

  Step 2 – Measurement of the Impairment Loss •

  between fair value of net assets and purchase price be

  ü Fair value of unit – fair value of net identifiable asset recognized as gain in the income statement.

  = $1,300,000 - $1,200,000 = $100,000 ( Implied goodwill ) ü Impairment loss = Carrying value of GW – Implied GW = $300,000 - $100,000 = $200,000

  Acquisition Method – I/S Summary of Acquisition Method – I/S

  Ø Some items might be adjusted due to the fair value adjustment :

Original income statement: I/S Items Company A ($) Company B ($)

  COGS is adjusted to reflect the fair value of inventory of the target •

  Revenue 60,000 20,000 prior to acquisition. Expense (40,000) (16,000)

  • reflect the fair value of PP&E Depreciation is adjusted to of the

  Net income 20,000 4,000 target prior to acquisition.

Consolidated income statement: (80% acquisition) • Amortization of I/A is also adjusted as similar with that in PP&E. I/S Items Acquisition Method ($) Equity Method ($)

  • Minority interest is created by multiplying the subsidiary’s net

  Revenue 80,000 60,000 Expense (56,000) (40,000) income by the percentage of the subsidiary not owned. Operating income 24,000 20,000 ü Minority interest is subtracted in arriving at consolidated net income.

  Equity income 3,200 Ø Goodwill is not amortized. Minority interest (800)

  Company B Company B Company A Adjustment for Acquisition B/S Items (Historical) (Adjusted) (Post - Acquisition) Acquisition Method Method Example of Acquisition Method – I/S

  Cash

  30 30 600-500=100 130 Ø Remaining useful lives of PP&E of target company are 10 years.

  Inventory

  50 50 +30 =80 150 230

  • 调整公允价值后的固定资产会增加额外折旧:50/10 = 5

  50 50 150 200 Ø Remaining useful lives of intangible assets are 10 years.

  PP&E 250 250 +50 =300 400 700

  • 调整公允价值后的无形资产会增加额外摊销:100/10 = 10

  Intangible

  • 100 =100 100

  asset Ø Inventory increased fair value of 30.

  Investment 0+500=500 -500 Fair Value Acquisition B/S Items Acquiror ($) Target ($)

  Goodwill 0+120=120 120 Adjustment ($) Method ($)

  Total asset 380 380+300=680 1300 1480 Revenue 2,000 1,000 3,000 COGS (1,000) (6,00) (30) (1,630)

  Dep. of PP&E (40) (30) (5) (75) Capital 150 150 550 -150 550

  Amort. of I/A (10) (10)

  50 50 350 -50 350 SG&A (300) (200) (500)

  FV adjusted 0+300=300 -300 Taxation (200) (50) (250)

  Total L + E 380 680 1300 1480 Net income 460 120 (45) 535

  Summary Ø ☆☆☆

Importance:

  Joint Ventures, SPE & VIE Ø

Content:

  Definition of Subsidiary (重点辨析和Associate的区别) •

Tasks:

  Acquisition Method (B/S,I/S的相关处理) • Ø Describe the classification, measurement, and disclosure

  • 了解因公允价值调整对于对于

  Acquisition method的影响 under International Financial Reporting Standards (IFRS) for

  • Full goodwill and partial goodwill method (IFRS & US GAAP) Joint Ventures, SPE & VIE.
  • Impairment of goodwill (IFRS & US GAAP)

  Ø Distinguish between IFRS and US GAAP in the classification,

  • Minority interest (Full & Partial goodwill) measurement,. and disclosure of Joint Ventures, SPE & VIE.

  Ø Exam tips:

  • 此部分为考试重点,需要重点关注。
Definition of Joint Ventures Definition of SPE

Definition of Special Purpose Entities Definition of Joint Venture

  Ø Special purpose entities (SPEs) are enterprises that are created to Ø Ventures undertaken and controlled by two or more parties. accommodate specific needs of the sponsoring entity.

  Ø

  IFRS identify the following common characteristics of joint ventures: Ø

  An SPE can take the form of a corporation, partnership, joint

  • A contractual arrangement exists between two or more

  venture, or trust, the typical motivation is to reduce risk and ventures. thereby lower the cost of financing . The contractual arrangement establishes joint control. •

  Ø SPEs are often structured such that the sponsor company has control over its financing / operating activities while third parties

  Ø Both IFRS and US GAAP require the equity method of accounting have controlling interest in the SPE’s equity. for joint ventures.

  Ø According to IFRS 10, the sponsoring entity must consolidate if it controls the SPE .

  Definition of VIE SPE & VIE

  Definition of Variable Interest Entity Ø

  The basis issue in regarding with VIE or SPE is to consider

  Ø The FASB uses the term variable interest entity (VIE) to describe a

  whether it should be consolidated by the Primary special purpose entity that meets certain conditions. Beneficiary.

  • At-risk equity is insufficient to finance the entity’s activi
  • In most cases, the creator/sponsor of the entity retains without additional financial support.
  • a significant beneficial interest in the SPE even though it

  Equity investors lack any one of the following: ü

  The ability to make decisions may own little or none of the SPE’s voting equity.

  ü The obligation to absorb losses

  Ø Consolidation of VIE or SPE will significantly affect the

  ü The right to receive returns financial statements and ratios.

  Ø If an SPE is considered a VIE, it must be consolidated by the primary

Importance:

Content:

  • Definition of Joint venture (能判断特征)
  • Definition of SPE & VIE (知晓SPE & VIE的合并规定)

Tasks:

Exam tips:

  • 此部分知识点相对比较独立,只是补充了合并报表的一些

  Lower

  Higher – net income is the same and assets are lower

  Lower ROA

  Higher – equity is lower and net income is the same

  Lower ROE

  Net profit margin Higher - sales are lower and net income is the same

  Acquisition vs. Equity Method Reported financial results from different accounting methods:

  Ø Assets and liabilities are higher under the acquisition method. Ø Revenues and expenses are higher under the acquisition method.

  Ø All methods report the same net income. Ø Under acquisition method, equity will be higher by the amount of minority interest.

  There are four important effects on the balance sheet and income statement items that result from the choice of accounting method.

  Acquisition vs. Equity Method

  Ø Analyze how different methods used to account for intercorporate investments affect financial statements and ratios.

  Summary Analysis of Financial Results

  特殊情况,在考试中出现的情况不多。

  Ø

  ☆ Ø

  Ø

Ratios Equity Method Acquisition Method

Additional issues in business combinations

Importance:

Content:

  • IFRS and U.S. GAAP recognize IPR&D acquired in a business combination as a separate intangible asset and measure it at fair value.
  • In subsequent periods R&D is subject to amortization upon completion or impairment.
  • Acquisition vs. Equity Method (重点辨析I/S & B/S)
  • Effects on ratios (了解两种方法下各种财务比率的异同)
  • Additional issues (了解两种特殊情况)

  • IFRS and US GAAP do not recognize restructuring costs that are associated with the business combination as part of the cost of the acquisition. Instead, they are recognized as an expense in the periods the restructuring costs are incurred .

  Ø Other post-retirement benefits ( OPB )

  Ø Defined-benefit pension plan ( DB )

  Ø Defined-contribution pension plan ( DC )

  Overview of Post-retirement Plan

  Ø Describe the types of post-employment benefit plans and implications for financial reports.

  Summary Post-retirement Plan

  Ø

  ü In-process R&D ü Restructuring costs

  Ø

  ☆

  Ø

  Ø Restructuring costs

  Ø In-process R&D

  Additional Issues in Combinations

Exam tips:

  • 这部分主要考查两种合并报表方法下对于财务数据的影响, 出题形式多为定性方式。

The typical post-retirement plans include:

  • The amount contributed by employers are defined but the future value of plan is unknown.

Tasks:

  • Employer promises to pay a certain annual amount to employees after retirement.
  • Life insurance premiums, health insurance, etc…

  2. Subject to “early termination” risk if employee is terminated early.

  Summary Accounting for DB Plan

  ☆ Ø

  Ø

  3. Not bear risk/return consequences of investment.

  1. Receive periodic payments starting at retirement.

  3. Sponsor (employer) is responsible for managing the plan asset.

  2. Determined by stated criteria usually related to years of service and salary.

  1. Liability of employer

  DB Plan

  3. Must make all investment decisions given available investment vehicles.

  2. Bear all risk/return consequences of investment.

  1. Own the plan and can transport account to other employment situations.

  3. The plan must offer sufficient investment vehicles.

  2. Only financial liability is making contributions to employee’s account.

  1. People keeps all contributions current.

  ☆ ) Plan Type Employer Employee DC

  DC Plan (

Plan Type Employer Employee DB

Importance:

Content:

  • Post-retirement Plan (了解常见的养老金分类)

Tasks:

  Ø

  Ø Explain and calculate measures of a defined benefit pension obligation and net pension liability. Ø

  Describe the components of a company’s defined benefit pension costs.

  ü DB Plan 雇主承担投资风险 ü Other post-retirement benefits 保险或者其他福利

  ü DC Plan 雇员承担投资风险

Exam tips:

  • 考试主要考查的是DB Plan的会计处理。
Projected Benefit Obligation Projected Benefit Obligation

  Definition of projected benefit obligation (PBO)

The way how PBO is created

  Ø PBO is the actuarial present value of all future pension benefits earned to date, based on expected future salary increases . Ø PBO measures the value of the obligation, assuming the firm is going concern and the employees will continue to work for the company until they retire . Ø

  PBO changes as a result of current service cost, interest cost, * past service cost, changes in actuarial assumptions and benefits paid to employees .

  Measurement of PBO Measurement of PBO

Past (prior) service costs Current service cost

  Ø Ø Past (prior) service costs are retroactive benefits ( 追溯的利益 )

  The present value of benefits earned by the employees during the awarded to employees when a plan is initiated or amended. current period. Service cost includes an estimate of compensation • Under IFRS, past service costs are expensed immediately . growth if the pension benefits are based on future compensation.

  • Under US GAAP, past service costs are amortized over the average

  Interest cost service life of employees.

  Ø Interest cost is the increase in the obligation due to the passage of

  Changes in actuarial assumptions ( 精算假设 )

  time. Interest cost is equal to the pension obligation at the Ø

  Gains and losses that result from changes in variables such as mortality, beginning of the period multiplied by the discount rate. employee turnover, retirement age, and the discount rate .

  Benefits paid • An actuarial gain will decrease the benefit obligation.

  Ø Benefits paid will reduce the PBO .

Definition of funded status:

  Ø The difference in the benefit obligation and the plan assets is referred to as the funded status of the plan.

  Balance Sheet Presentation Example of PBO Change

  Funded Status of DB Plan

  • If the plan assets exceed the pension obligation, the plan is said to be overfunded .
  • If the pension obligation exceeds the plan assets, the plan is underfunded .

  Ø Funded status = Fair value of plan assets – PBO Ø Balance sheet asset / liability = Funded status

  Year Years of Service Projected Salary ($) Year in Retirement Benefit Payment ($) Present Value ($) 2016 1 50,000 - - PBO = 3,460.01 2017

   折 现

  2055

  … 2,563.30

  1 2,563.30 …

  21,940.55 2041

  2039 24 123,235.78 - - 2040 25 128,165.21 - -

  2 52,000 - - … … …

  PBO at the end of 2016

  Example of PBO Change

  Ø The discount rate is 8% Ø John’s salary will increase by 4% per year (compensation growth rate) Ø John will work for 25 years Ø John will live for 15 years after retirement and receive 15

  and 2

  st

  , 2016 and is eligible to participate in the company’s DB pension plan. He is promised an annual payment of 2% of his final annual salary for each year of service. John’s starting annual salary is $50,000. Calculate the PBO at the end of 1

  st

  John was hired on January 1

  nd year.

  • 15 2,563.30
    • PV of 15 year annuity of $2,563.30 at 8% = $21,940.55
    Example of PBO Change Example of PBO Change

  PBO at the end of 2017 During 2017, the PBO increased $4,013.61. The increase is a

  Years of Projected Year in Benefit Year

  result of current service cost and interest cost as follows:

  Service Salary ($) Retirement Payment ($) Present Value ($) 1 50,000

  Ø 2016 PBO $3,460.01

  • 2016
  • 2017 - -

  2 52,000 PBO = 7,473.62

  • Current service cost $3,736.81

  … … …

  (PV of 15 payments of $2,563.30 in 23 years)

  2039 - - 24 123,235.78

  2040 25 128,165.21 - 43,881.09

  • 2041 - -
    • Interest cost $276.80 ($3,460.01 x 8%)

  1 5,126.61 … …

  Ø 2017 PBO $4,473.62

  • 5,126.61

  折 现

  15 5,126.61

  • 2055 - -

  The current service cost is the present value of the benefits

  • PV of 15 year annuity of $5,126.61 at 8% = $43,881.09 earned during 2017 and the interest cost is the increase in the *PBO = $43,881.09 discounted at 8% for 23 years. PBO due to the passage of time.

  Periodic Pension Cost Periodic Pension Cost

Definition of total periodic pension cost (TPPC)

Total periodic pension cost in IFRS & US GAAP

  Ø TPPC is the employer’s contributions adjusted for changes in

  Ø The main difference between US GAAP and IFRS is the

  funded status. The expense to the company is either paid via

  allocation of total periodic pension cost between the

  contributions or deferred via a worsening of the plan’s funded income statement (pension expense) and OCI. status . Ø TPPC = Employer contribution – (Ending funded status –

  Ø Under both US GAAP and IFRS

  Beginning funded status)

  • TPPC = Periodic pension cost in I/S + Periodic pension

  Ø TPPC = Current service cost + Interest cost – Actual return on

  cost in OCI

  plan assets -/+ Actuarial G/L due to changes in assumptions Periodic Pension Cost in US GAAP Periodic Pension Cost in US GAAP

  Ø Current service cost : is the increase in the PBO that is the Ø Actuarial gains and losses : There are two components within result of the employees working one more period. Current actuarial gains and losses.

  1. The gain or loss due to decrease or increase in PBO occurring on service cost is immediately recognized in the income account of changes in actuarial assumptions. statement .

  2. The difference between actual and expected return on plan Ø Interest cost : is the increase in the PBO due to the passage of assets. time. It is calculated by multiplying the PBO at the beginning of

  Actuarial gains and losses are recognized in OCI. • the period by the discount rate . ü Under IFRS, actuarial gains and losses are not amortized. Ø Expected return on plan assets : The return on the plan assets

  ü Under US GAAP, actuarial gains and losses are amortized has no effect on the PBO . However, the expected return on using the corridor approach . plan assets will reduces pension expense .

  Corridor Approach in US GAAP Example of Corridor Approach

  Assume that the beginning balance of the PBO is $5,000,000, the Once the beginning balance of actuarial gains and losses exceed beginning balance of fair value of plan asset is $3,900,000, and the 10% of the greater of the beginning PBO or plan assets , beginning balance of unrecognized actuarial losses is $600,000. amortization is required. The excess amount over the “corridor” is

  The expected average remaining working lives of the employee is amortized as a component of periodic pension cost in I/S over the 15 years. remaining service life of the employees.

  Ø The corridor is $500,000, which is 10% of the PBO ( selected as the

  Ø The amortization of an actuarial gain reduces periodic pension greater of the PBO or the fair value of plan assets ). cost .

  Ø Because the balance of unrecognized actuarial losses exceeds the Ø

  $500,000 corridor, amortization is required. ( $600,000 > $500,000 ) The amortization of an actuarial loss increases periodic

  Ø The amount of the amortization is $6,666.67 pension cost .

  [ ($600,000 - $500,000) / 15 years ] = $6,666.67 •

  Periodic Pension Cost in US GAAP

  Ø Past service costs : When a firm adopts or amends its pension plan, the PBO is immediately increased.

  • Under US GAAP, instead of expensing the cost immediately,
  • Under IFRS, the net interest expense/income is defined as the discount rate multiplied by the beginning funded status.
  • If the plan is underfunded, an expense is reported.
  • If the plan is overfunded, interest income is reported.
    • Remeasurement is recognized in OCI and not subsequently amortized to the income statement.

  it is reported as a part of other comprehensive income and amortized over the remaining service life of the affected employees.

  • Under US GAAP, the amortization of actuarial gains and losses and the amortization of past service costs reduces the volatility of

  periodic pension cost in I/S . Thus, the amortization process results in periodic pension cost in I/S that is “ smoothed ”.

  Periodic Pension Cost in IFRS

  Ø Current service cost : is the increase in the PBO that is the result of the employees working one more period. Current service cost is immediately recognized in the income statement .

  Ø Interest cost : is calculated by multiplying the net pension liability or net pension asset by the discount rate used in determining the present value of the pension liability.

  Periodic Pension Cost in IFRS

  Ø Expected return on assets : Under IFRS, the expected rate of return on plan assets is implicitly assumed to be the same as the discount rate used for computation of PBO and a net interest expense/income is reported in I/S.

  Ø Actuarial gains and losses : Under IFRS, actuarial gains and losses are not amortized. Ø Past service costs : Under IFRS, the past service costs are recognized in periodic pension cost in I/S immediately. (not amortized)

  Remeasurement

  Remeasurement is an account in OCI under IFRS and includes: Ø Actuarial gains and losses = Changes in a company’s pension obligation arising from changes in actuarial assumptions.

  Ø Net return on plan asset = Actual return – (plan assets x interest rate)

  Example of Periodic Pension Cost The following information is provided about the DB pension plan of a company: Ø Employer contributions $1,200 Ø Current service costs $1,850 Ø Past service costs $120 Ø Beginning PBO $38,750 Ø

  Ending PBO $43,619 Ø

  Increase in PBO due to changes in $628 actuarial assumption Ø

  Beginning plan assets $28,322 Ø

  Ending plan assets $30.682 Ø

  Actual return on plan assets $1,795 Ø

  Benefits paid $635 Ø

  Unamortized actuarial losses (US GAAP only) $3,150 Ø

  Expected rate of return on plan assets 6% Ø

  Discount rate used in estimating PBO 7.5% Example of Periodic Pension Cost

  Answer for Question A A: Total periodic pension cost.

Calculate:

  Answer: A. Total periodic pension cost.

  TPPC = employer contribution – change in funded status

  B. Periodic pension cost reported in I/S under US GAAP

  = 1,200 – [ (-12,937) – (-10,428) ] = $3,709

  (ignore amortization of past service cost)

  Alternatively, C. Periodic pension cost in reported in I/S under IFRS. TPPC = current service cost + interest cost +past service cost + actuarial losses

  D. Periodic pension cost reported in OCI under US GAAP

  • actual return E. Periodic pension cost reported in OCI under IFRS.

  = 1,850 + 2,906 + 120 + 628 – 1,795 = $3,709 Interest cost = Discount rate x Beginning PBO * Answer for Question B Answer for Question C B: Periodic pension cost reported in I/S under US GAAP.

  C: Periodic pension cost in reported in I/S under IFRS. Answer:

  Answer: Corridor approach:

  Periodic pension cost = Current service cost + Past service cost + Beginning PBO > Beginning plan assets, we take 10% of beginning PBO as

  Net interest cost corridor = $3,875; Since unamortized actuarial losses ($3,150) do not = 1,850 + 120 + 782 = $2,752 exceed $3,875, no amortization is necessary .

  Periodic pension cost = Current service cost + Interest cost – Expected Net interest cost = Discount rate x Beginning funded status * return on plan assets

  = 1,850 + 2,906 - 1,699 = $3,057 = 7.5% x (-10,428) = -$782 Expected return = Expected rate of return x Beginning plan assets *

  = 6% x 28,322 = $1,699

  Answer for Question D & E Summary Ø ☆

  D: Periodic pension cost reported in OCI under US GAAP

  Importance:

  Answer:

  Ø

Content:

  • The presentation of PBO on balance sheet

  Periodic pension cost in OCI = Total periodic pension cost – ü 掌握影响期末

  PBO变动的因素 periodic pension cost in I/S

  • The presentation of plan assets on balance sheet

  = 3,709 – 3,057 = $652 掌握影响期末养老金资产余额的因素

  ü

  E: Periodic pension cost reported in OCI under IFRS Periodic pension cost in I/S under IFRS & US GAAP •

  Answer: 辨析

  ü

  IFRS和US GAAP在披露养老金费用是的异同点 可能考

  ü Pension expense的计算 Periodic pension cost in OCI = Total periodic pension cost –

  Ø

  periodic pension cost in I/S Exam tips:

  Assumptions of Defined Benefit Obligation and Periodic Pension Cost

  The firm discloses three assumptions used in its pension calculations:

  Analysis and Adjustment of Pension Ø Discount rate : the interest rate used to compute the PV of the benefit obligation and the current service cost component of pension expense .

  Accounting

  • Based on interest rates of high quality corporate fixed income

  Tasks: investments with a maturity profile similar to the future obligation .

  Ø Explain and calculate the effect of a defined benefit plan’s Affects the PBO as well as pension expense. • assumptions on the defined benefit obligation and periodic pension

  Ø Rate of compensation growth : affects both the PBO and pension expense. cost.

  Ø Expected return on plan assets : assumed long-term rate of return on the Ø Explain and calculate how adjusting for items of pension and other plan’s investments. post- employment benefits that are reported in the notes to the

  The expected return is assumed only under US GAAP. • financial statements affects financial statements and ratios

  • Under IFRS, expected return is equal to the discount rate.

  Effect of Changing Pension Assumption Effect of Changing Pension Assumption

  Increasing the discount rate:

Decreasing the compensation growth rate:

  Ø Reduce PV; PBO is lower ; improve the funded status. Ø Reduce future pension payments; PBO is lower ; improve the funded Ø Usually result in lower pension expense because of lower service cost. status.

  • The current service cost is a PV calculation.

  Ø Reduce current service cost and lower interest cost ; pension expense Ø Usually reduce interest cost (PBO * discount rate) unless the plan is will decrease. mature.

  Increasing the expected return on plan assets (under US GAAP): • The beginning PBO is reduced when the discount rate increases.

  Ø Reduce periodic pension cost reported in I/S.

  For a nonmature plan this decrease more than offsets the impact • But will leave the total periodic pension cost unchanged. of the increased rate at which we compute the interest cost.

  Ø Not affect the benefit obligation or the funded status of the plan. Effect of Changing Pension Assumption Assumption of other post-employment benefits

Accounting for other post-employment benefits: Increase Decrease Rate of Increase Expected Effect on Items Discount Rate Compensation Growth Rate of Return

  Ø The assumptions are similar for other post-employment benefits

  Balance Sheet Decrease Decrease No Effect expect the compensation growth rate is replaced by a healthcare Liability

  inflation rate. This constant rate is known as the ultimate healthcare

  Total Periodic Decrease Decrease No Effect Pension Cost trend rate .

  Periodic Pension Decrease* Decrease Decrease**

  Ø Firms can reduce the post-employment benefit obligation and periodic

  cost in I/S

  expense by: Ø

  • For mature plans, a higher discount rate might increase interest costs . In

  Decreasing the near term healthcare inflation rate. • rare cases, interest cost will increase by enough to offset the decrease in Decreasing the ultimate healthcare trend rate. • the current service cost, and periodic pension cost will increase . Reducing the time needed to reach the ultimate healthcare trend •

  Ø **Under U.S. GAAP only. Not applicable under IFRS. rate.

  Adjusting Items of Pension Benefits for Analytical Purposes Adjusting Items of Pension Benefits for Analytical Purposes

  Several aspects of the accounting for pensions and other post-employment Ø Differences between IFRS and U.S. GAAP in recognizing total periodic benefits can affect comparative financial analysis using ratios based on pension cost

  • financial statements.

  Periodic pension costs may not be comparable. IFRS and U.S. GAAP Ø

  Gross vs. net pension assets/liabilities differ in their provisions about costs recognized in P&L versus in OCI .

  • Ø The firm's total assets and total liabilities are both less than if the Reporting of periodic pension costs in P&L may not be comparable .
  • Under US GAAP firm reported the gross amounts.

  , all of the components of pension costs in P&L are

  • Under both IFRS and U.S. GAAP standards, the amount disclosed in reported in operating expense on the income statement even the balance sheet is a net amount .

  though some of the components are of a financial nature. (interest Ø

  Differences in assumptions used expense and the expected return on assets)

  • Under IFRS , the components of periodic pension costs in P&L can be • Differences in key assumptions can affect comparisons across
Adjusting Items of Pension Benefits for Analytical Purposes Example of Reclassifying Periodic Pension Cost

  Use the following information to reclassify the components of periodic

  Ø Analysts can adjust GAAP-reported income by: (ignores

  pension cost between operating and nonoperating items:

  any amortization)

  Ø Operating profit = $145,000

  Adding back the periodic pension cost in I/S and •

  Ø Interest expense = ($12,000)

  subtracting only service cost in determining Ø Other income = $2,000

  Ø Income before tax = $ 135,000 operating income . Ø Other data:

  Interest cost should be added to the firm's interest •

  • Current service cost = $7,000 expense .
  • Interest cost = $5,000

  Actual return on plan assets should be added to non- •

  • Expected Return on assets = $8,000
  • Actual return on assets = $9,500 operating income .

  Example of Reclassifying Periodic Pension Cost Analyst’s View on Cash Flow Adjustment Answer:

Cash flow refers to pension including the amount of contribution

  Ø Periodic pension cost (in P&L) of $4,000 ($7,000 current service cost + and the amount of benefits paid .

  $5,000 interest cost - $8,000 expected return on assets ) is added back Ø If the firm's contributions exceed its total periodic pension cost, the to operating profit. difference can be viewed as a reduction in the overall pension

  Ø Service cost of $7,000 is subtracted from operating profit. obligation .

  Ø Interest cost of $5,000 is added to interest expense.

  Ø if the total periodic pension cost exceeds the contributions, the Ø The actual return on assets of $9,500 is added to other income . difference can be viewed as a source of borrowing .

  I/S Reported ($) Adjustments ($) Adjusted ($)

  Ø If the difference between cash flow and total periodic pension cost is

  Operating profit 145,000 + 4,000 – 7,000 142,000

  material, the analyst should consider reclassifying the difference from

  Interest expense (12,000) - 5,000 (17,000) Other income 2,000 + 9,500 11,500 operating activities to financing activities in the cash flow statement.

Analysis of cash flow

  • CFO adjustment = CFO + (Contribution - TPPC)*(1-t)
  • CFF adjustment = CFF - (Contribution - TPPC)*(1-t)
  • CFO adjustment = CFO - (Contribution - TPPC)*(1-t)
  • CFF adjustment = CFF + (Contribution - TPPC)*(1-t)

  Ø

  Summary

Importance:

Content:

  • Effect of Changing Pension Assumption ü 掌握三大假设对于报表和财务比率的影响
  • Adjusting Items of Pension Benefits for Analytical Purposes ü

  何分析各种和养老金相关的可能带来数据操纵的科目。

  Ø

  重点掌握分析师如何调整养老金的现金流

  Ø

  ☆

  = 340 – (2,180 – 2,530) = 340 – (-350) = $690 million Ø The company’s contribution were $350 million less than TPPC

  Answer: Ø Total periodic pension cost = contributions – (ending funded status - beginning funded status)

  Example of Adjusting Cash Flow

  Calculate CFO and CFF after making appropriate adjustments .

  An analyst finds out a company made a $340 million contribution to the plan during the year. He collects the following additional information about the company: Ø Beginning funded status = $2,530 million Ø Ending funded status = $2,180 million Ø Net income of the company = $812 million Ø CFO = $948 million Ø CFF =$112 million Ø Tax rate = 40% Calculate the total periodic pension cost during the year.

  Example of Adjusting Cash Flow

  ( Borrowing )

  ( Repayment ) Ø Under-contribution : contribution < total periodic pension expenses

  Ø Over-contribution : contribution > total periodic pension costs

  Analyst’s View on Cash Flow Adjustment

Exam tips:

  • After tax shortfall = 350(1 - 0.4) = $210 million
  • Adjusted CFO = 948 - 210 = $738 million
  • Adjusted CFF = 112 + 210 = $322million
  • 此部分多以定性判断为主,主要是站在分析师的角度,如

Share-based compensation plans can take several forms , including stock options and share grants

Tasks:

  Ø Stock compensation plan takes many forms

  Share-based Compensation

  Ø Explain issues associated with accounting for share-based compensation. Ø Explain how accounting for stock grants and stock options affects financial statements, and the importance of companies’ assumptions in valuing these grants and options.

  Share-based Compensation

  Ø They have the advantages of serving to motivate and retain employees as well as being a way to reward employees with no additional outlay of cash.

  • Stock options
  • Stock grants
  • Stock appreciation rights
  • Phantom shares

  Equity settled (权益结算) Cash settled (现金结算) Accounting for Share-based Compensation

  • Compensation expense is based on the fair value of the options on the grant date based on the number of options that are expected to vest . ü

  The vesting date is the first date the employee can actually exercise the options.

  ü The compensation expense is allocated in the income statement over the service period. (grand date to vesting date)

  ü Fair value of the stock option at the grant date is used to determine the compensation expense over the service period.

  ü Recognition of compensation expense will decrease net income and retained earnings ; however, paid-in capital is increased by an

  Accounting for Share-based Compensation

  Ø Stock options

  • * Option pricing model can be used to determine the fair value of

  stock options. (eg: BSM,…)

  Ø Stock options

Accounting for Share-based Compensation

  • Compensation expense for stock granted to an employee is based on the fair value of the stock on the grant date .
  • The compensation expense is allocated over the employee's service period. (grand date to vesting date)
  • The difference between a stock appreciation right and an option is the form of payment.
  • A stock appreciation award gives the employee the right to

  • Transfer of stock without condition : Vesting immediately at grant date
  • Restricted stock : Transferred stock cannot be sold until vesting date
  • Performance stock : Contingent on meeting performance goals (eg: EPS,

  • The firm might pay the appreciation in cash, equity, or a combination of both.
  • Since no shares are actually issued, there is no dilution to existing shareholders.

  ☆ Ø

  Summary

Importance:

Phantom stock

Content:

  • Phantom stock is similar to stock appreciation rights
  • Accounting for Share-based Compensation ü 掌握四种权益授予薪酬(奖金)的形式 ü
  • Phantom stock can be used in privately held firms and firms with highly illiquid stock .

  不是考试的重点,仅作了解要求。

  Ø

  其中重点是股票期权授予和直接授予股票这两种 形式

  except the payoff is based on the performance of hypothetical stock instead of the firm's actual shares.

  Ø

  Accounting for Share-based Compensation Ø

  receive compensation based on the increase in the price of the firm's stock over a predetermined amount.

  Ø Stock appreciation rights

  Accounting for Share-based Compensation

  ROE, etc…) ü May result in manipulation

  Ø Types of stock grants

  Ø Stock grants

Exam tips:

  • 此部分多以定性判断为主,作为养老金福利的一种补充,
Influence of Foreign Currency Accounting

  Foreign currency can affect a multinational firm's financial

  Classification of Currencies in

  statements in two ways:

  Multinational Financial Reporting

  Ø The multinational company may engage in business transactions that are denominated in a foreign currency.

Tasks:

  among presentation (reporting) currency, functional Foreign currency transaction currency, and local currency.

  • Ø Distinguish

  Ø the multinational company may invest in subsidiaries that Ø Describe foreign currency transaction exposure, including maintain their books and records in a foreign currency. accounting for and disclosures about foreign currency transaction

  • Foreign currency translation ( 考试主要针对考查这种情况 ) gains and losses.

  Classification of Currencies Foreign Currency Transactions

Currencies that are involved in multinational accounting

  Foreign currency denominated transactions are

  Ø The local currency

  measured in the presentation (reporting) currency at

  The currency of the country in which the entity is located. • the spot rate on the transaction date.

  Ø The functional currency (之后章节会介绍详细的认定标准) The currency of the primary economic environment in which the entity

  Ø Foreign currency risk arises when the transaction

  • operates. It is usually the currency in which the entity generates and date and the payment date differ .

  expends cash .

  • The functional currency can be the local currency or some other currency . Ø The presentation (reporting) currency
  • The currency in which the parent company prepares its financial
Foreign Currency Transactions Example of Foreign Currency Transactions

A U.S. firm that sells goods to an Italian company for €10 , 000 when Treatment of foreign currency transactions: the spot exchange rate is $1.60 per euro. Payment is due in 30 days

  Ø Transactions in foreign currencies are translated into the When payment is actually received, the euro has depreciated to $1. 50. functional currency at the exchange rates at the date of

  Ø On the transaction date , the U.S. firm recognizes a sale, and an transaction. account receivable, in the amount of $16,000 (€10,000 x $1.60 )

  Ø On the payment date , the U.S. firm receives €10,000 and

  Ø Monetary assets and liabilities dominated in foreign

  immediately converts the euros to $15,000 (€10,000 x $1.50 )

  currencies at the balance sheet date are re-valued at the

  Ø As a result of the depreciating euro, the U.S. firm recognizes a exchange rate at that date.

  $1 ,000 loss in the income statement.

  Ø

  Ø

  Differences arising on the transactions are recognized on The Italian firm recognized no gain or loss since the purchase and settlement transactions were both denominated in euros. the I/S.

  Foreign Currency Transactions Summary

Analytical issues and disclosure analysis

Impact due to changes in foreign currency exchange rate

  Ø While transaction gains and losses are recognized in the income

Foreign Currency

  statement, the accounting standards do not provide any guidance

  Types of Transactions to include them within operating or non-operating income .

Exposure

  Appreciation Depreciation

  Ø Neither standard requires disclosure of where such gains/losses would be recorded.

Export Sales Asset (A/R) Gain Loss

  Ø The comparability of operating margins between entities would

  Import Purchase Liability (A/P) Loss Gain be diminished if the compared entities used different methods.

Importance:

Content:

  • Accounting for foreign currency transactions

Tasks:

Exam tips:

  • 此部分多以定性判断为主,重点是辨析Transaction和

  Ø The currency that influences labor, material, and other costs . Ø The currency from which funds are generated. Ø The currency in which receipts from operating activities are usually retained.

  According to the IASB, management should consider the following factors in deciding on the functional currency: Ø The currency that influences sales prices for goods and services . Ø Currency of the country whose competitive forces and regulations mainly determine the sale price of goods and services.

  Identification of Functional Currency

  Ø Two methods are usually adopted in the translation under different scenarios:

  Ø Translation of foreign currency financial statements refers to the method used to translate the entity’s financial statements to Presentation Currency (reporting currency).

  Foreign Currency Translation

  Ø Calculate the translation effects and evaluate the translation of a subsidiary’s balance sheet and income statement into the parent company’s presentation currency.

  Ø Compare the current rate method and the temporal method, evaluate how each affects the parent company’s balance sheet and income statement, and deter- mine which method is appropriate in various scenarios.

  Summary Accounting for Multinational Operations

  Translation的区别,Foreign currency transaction不是考试重 点,但需要了解。

  Ø

  ü 主要掌握在进行外贸交易时,由于应收款或者应付款科目在 记账日和结算日间由于外币汇率发生波动而带来利得或者损 失的记账方法。

  ☆ Ø

  Ø

Overview

  • Current rate method
Current Rate Method & Temporal Method Current Rate Method & Temporal Method Determine the appropriate translation method:

Determine the appropriate translation method:

  Ø If the functional currency and the parent's presentation Ø In the case where the local currency the functional currency, and currency differ, the current rate method is used to translate the the presentation currency all differ , both the temporal method foreign currency financial statements. and the current rate method are used .

  • Translation usually involves self-contained, independent

  Eg: Consider a U.S. firm that owns a German subsidiary whose • subsidiaries whose operating, investing, and financing activities are functional currency is the euro. The German subsidiary is also decentralized from the parent. denominating a few transactions in Swiss francs.

  Ø If the functional currency is the same as the parent's presentation currency, the temporal method is used to • In this case, the temporal method is used to remeasure from the local remeasure the foreign currency financial statements. currency (Swiss francs) into the functional currency (euros) . Then, the

  • Remeasurement usually occurs when a subsidiary is well integrated

  current rate method is used to translate from the functional currency with the parent. (euros) to the presentation currency (U.S. dollar)

  Current Rate Method & Temporal Method Current Rate Method & Temporal Method

Determine the appropriate translation method: Three Methods for Remeasurement or Translation:

  Ø If a subsidiary is operating in a hyperinflationary environment, the functional currency is considered to be the parent's presentation currency, and the temporal method is used under U.S. GAAP .

  Ø Under IFRS , the subsidiary's financial statements are restated for inflation and then translated using the current rate method .

  Ø Monetary assets and liabilities are remeasured using the current exchange rate.

  Ø

  Current Rate Method & Temporal Method We need to define a few exchange rates which will be used in applying the current rate and the temporal method.

Applying the Current Rate Method

  Ø The current rate is the exchange rate on the balance sheet date Ø The average rate is the average exchange rate over the reporting period .

  Ø The historical rate is the actual rate that was in effect when the original transaction occurred .

  Current Rate Method

  Ø All income statement accounts are translated at the average rate.

  Ø All balance sheet accounts are translated at the current rate except for common stock , which is translated at the historical (actual) rate that applied when the stock was issued.

  Ø Dividends are translated at the rate that applied when they were paid.

  Ø Translation gain or loss is reported in shareholders' equity as a part of the cumulative translation adjustment (CTA).

  Temporal Method

  Temporal Method

Applying the Temporal Method

Applying the Temporal Method

  Ø Common stock and dividends paid are remeasured at the historical (actual) rate.

Expenses related to nonmonetary assets such as COGS

  • Monetary assets and liabilities are fixed in the amount of currency to

  depreciation expense, and amortization expense are remeasured based on the historical rates prevailing at the time of purchase . Ø Revenues and all other expenses are translated at the average rate. Ø Remeasurement gain or loss is recognized in the income statement.

  Ø All other assets and liabilities are considered nonmonetary and are remeasured at the historical (actual) rate.

  be received or paid and include : cash, receivables, payables, and short- term and long-term debt .

  • The most common nonmonetary assets include inventory, fixed assets, and intangible assets . An example of a nonmonetary
  • This results in more volatile net income as compared to the current rate method.
Comparison of Two Methods – B/S Comparison of Two Methods – I/S

  FX Rate under Temporal FX Rate under Current FX Rate under Temporal FX Rate under Current Rate B/S Items

  I/S Items Method Rate Method Method Method

  Monetary Current rate Current rate Revenue Average rate Average rate Assets / Liabilities

  SG&A Average rate Average rate Non – Monetary Historical rate Current rate Assets / Liabilities

  COGS Historical rate Average rate Common stock Historical rate Historical rate Depreciation Historical rate Average rate

  勾稽后得到 勾稽后得到 Retain Earning Balancing ( ) Balancing ( ) Net income Mixed rate Average rate

  Equity (as a whole) Mixed (Because the change in Current rate retained earnings is mixed) Recognized on I/S Recognized in equity Translation G/L (Affects retained earnings, (B/S, not through I/S)

  • Liability is usually regarded as monetary except for unearned

  no CTA ) resulting in CTA revenue.

  Inventory & COGS Under the Temporal Method Calculating the Translation/Remeasurement Gain or Loss

  Under Temporal Method, the inventories are re-measured at Current Rate Method Ø

  Company A is a U.S. company with a subsidiary, Company B, historical FX rate. The ending inventories are re-measured at located in the country of M. Company B was acquired by the rate that existed when the inventories assumed to still be Company A in 2014. Company A reports its financial results in U.S. on hand at the B/S date was acquired. dollars. The currency of M is the local currency (LC).

  Ø Under FIFO, the ending inventories are re-measured at relatively Ø

  Company B 2015 Income Statement recent rate.

  Revenue 5,000 (LC)

  Ø Under LIFO, the ending inventories are re-measured at relatively

  COGS (3,300) older rate. Gross margin 1,700

  Ø The FX rate used in re-measuring the COGS will differ depending on

  SG&A (400) Depreciation expense (600) the cost flow assumption , FIFO, LIFO and weighted average.

Company B December 31, 2014 and 2015 Balance Sheet B/S Items 2014 (LC) 2015 (LC)

  Cash 100 100 Account receivable 500 650 Inventory 1,000 1,200 Current assets 1,600 1,950

The following exchange rates between the U.5. dollar and the LC were observed:

  Fixed assets 800 1,600 Accumulated depreciation (100) (700) Net fixed assets 700 900 Total assets 2,300 2,850

  (600) 0.4762 $/LC (285.7) Net income 700 333.3

  Revenue 5,000 0.4762 $/LC 2,381 COGS (3,300) 0.4762 $/LC (1,571.5) Gross margin 1,700 809.5 SG&A (400) 0.4762 $/LC (190.5) Depreciation expense

  Calculating the Translation/Remeasurement Gain or Loss

  Company B is relatively self-contained, which likely means the LC is the functional currency, the current rate method is used to translate Company B's financial statements from the functional currency to the parent's presentation currency.

  The majority of company's operational, financial, and investment decisions are made locally in M , use the appropriate method to translate company B's 2015 balance sheet and income statement into U.S. dollars.

  Calculating the Translation/Remeasurement Gain or Loss

  Ø Historical rate for ending inventory = Average rate during the year

  Ø Historical rate for depreciation = $0.4878 = 1.00 LC

  Ø Historical rate for COGS = $0.4834 = 1.00 LC

  Ø Historical rate for accumulated depreciation = $0.4896 = 1.00 LC

  Ø Historical rate for fixed assets: $0.4881 = 1.00 LC

  Ø Historical rate for equity: $0.50 = 1.00 LC

  Ø Average for 2015: $0.4762 = 1.00 LC

  Ø December 31 , 2015: $0.4545 = 1.00 LC

  Ø December 31 , 2014: $0.50 = 1.00 LC

  Calculating the Translation/Remeasurement Gain or Loss

  Total equity 500 1,200 Total liabilities and equity 2,300 2,850 Retained earnings on December 31 , 2014, were $50

  Accounts payable 400 500 Current debt 100 200 Long-term debt 1,300 950 Total liabilities 1,800 1,650 Common stock 400 400 Retained earnings 100 800

Company B’s 2015 Income Statement Under the Current Rate Method I/S Items 2015 (LC) Rate 2015 ($)

Answer:

  B: The CTA is a plug figure that makes the accounting equation balance

  Company B’s 2015 Balance Sheet Under the Current Rate Method B/S Items 2015 (LC) Rate 2015 ($) Cash 100 0.4545 $/LC

  45.5 Account receivable 650 0.4545 $/LC 295.4 Inventory 1,200 0.4545 $/LC 545.4 Current assets 1,950 886.3 Fixed assets 1,600 0.4545 $/LC 727.2

Company B’s 2015 Balance Sheet Under the Current Rate Method

  Accumulated depreciation (700) 0.4545 $/LC (318.2) Net fixed assets 900 409 Total assets 2,850 1,295.3 Accounts payable 500 0.4545 $/LC 227.2

  Current debt 200 0.4545 $/LC

  90.9 Long-term debt 950 0.4545 $/LC 431.8 Total liabilities 1,650 749.9 Common stock 400 0.5 $/LC 200

  Calculating the Translation/Remeasurement Gain or Loss

  Ø

  A: Beginning (2015) retained earnings were $50, so ending (2015) retained earnings are $50 + $333.3 = $383.3

  Ø

  • CTA = Assets – Liabilities – Common stock – Retained

  earnings = $1,295.3 – $749.9 – $200 – $383.3 = – $37.9 Calculating the Translation/Remeasurement Gain or Loss

  Ø Suppose instead that the majority of Company B's operational, financial, and investment decisions are made by the parent company A. Use the temporal method to translate Company B's 2015 balance sheet and income statement into U.S. dollars.

  Ø Under the temporal method, we'll start with the balance sheet.

  Company B’s 2015 Balance Sheet Under the Temporal Method B/S Items 2015 (LC) Rate 2015 ($) Cash 100 0.4545 $/LC

  45.5 Account receivable 650 0.4545 $/LC 295.4 Inventory 1,200 0.4762 $/LC 571.4 Current assets 1,950 912.3 Fixed assets 1,600 0.4881 $/LC 781

  Accumulated depreciation (700) 0.4896 $/LC (342.7) Net fixed assets 900 438.3 Total assets 2,850 1,350.6 Accounts payable 500 0.4545 $/LC 227.2

  Current debt 200 0.4545 $/LC

  90.9 Long-term debt 950 0.4545 $/LC 431.8 Total liabilities 1,650 749.9 Common stock 400 0.5 $/LC 200

  Retained earnings 800 400.7 (A) Total equity 1,200 600.7

  Retained earnings 800 383.3 (A) CTA (37.9) (B) Total equity 1,200 545.4 Total liabilities and equity 2,850 1,295.3

The Temporal Method

  Calculating the Translation/Remeasurement Gain or Loss Calculating the Translation/Remeasurement Gain or Loss

Company B’s 2015 Income Statement Under the Temporal Method Company B’s 2015 Balance Sheet Under the Temporal I/S Items 2015 (LC) Rate 2015 ($) Method

  Revenue 5,000 0.4762 $/LC 2,381 Ø

  accounting equation balance: Gross margin 1,700 785.7

  • Retained earnings = Assets – Liabilities – Common

  SG&A (400) 0.4762 $/LC (190.5) stock

  Depreciation expense (600) 0.4878 $/LC (292.7) = $1,350.6 - $749.9 - $200 = $400.7

  Remeasurement G/L 48.2 (B) Ø

Then we see the income statement

  Net income 700 350.7 (A) Calculating the Translation/Remeasurement Gain or Loss Current Rate Method vs. Temporal Method

Company B’s 2015 Balance Sheet Under the Temporal Method Current Rate Method vs. Temporal Method

  Ø

  A: Net income is derived from the beginning and ending balances

  of retained earnings and dividend paid:

  B/S & I/S Items Current Rate Method ($) Temporal Method ($)

  • Beginning retained earnings + Net income – Dividend paid =
    • $37.9 $48.2

  Translation G/L

  Ending retained earnings

  ( on the balance sheet ) ( on the income statement )

  • Net income = $400.7 - $50 = $350.7

  Net income $333.3 $350.7

  Ø

  B: The remeasurement G/L is a plug that is equal to the difference Total assets $1,295.3 $1,350.6

  in net income and income before remeasurement G/L: Remeasurement G/L = Net income – Income before • remeasurement G/L = $48.2

We can make the following observations:

  • This is because of the different exchange rates used to translate COGS and depreciation expense.
  • In addition, the gain/loss recognized under the two methods are reported in different financial statements .
  • The current rate method results in a translation loss, while the
  • This is because inventory and net fixed assets are different.

Importance:

  录汇兑损益。 ü

  Ø Analyze how currency fluctuations potentially affect financial results,

  Ø Analyze how the current rate method and the temporal method affect financial statements and ratios. Ø Analyze how alternative translation methods for subsidiaries operating in hyper- inflationary economies affect financial statements and ratios.

  Summary Analysis of accounting for Multinational Company

  Ø

  定性的分析两种方法下导致会计科目发生变化的原因。

  计算汇兑损益 ü

  Ø

  ☆

  Ø

  Inventory and fixed assets are translated at the current rate under the current rate method but translated at historical rate under temporal method.

  Ø Total assets are different between the two methods.

  Current Rate Method vs. Temporal Method Ø Net income is different between the two methods.

  Holding net monetary liabilities in a depreciating environment results in a gain.

  temporal method results in a translation gain. This is NOT an unusual occurrence . Under the current rate method, Company B's net assets (assets > liabilities) are exposed to the depreciating local currency . Under the temporal method, Company B's net monetary liabilities (monetary liabilities > monetary assets) are exposed .

  Ø The translation gain/loss is different between the two methods; it’s not even the same sign.

  Current Rate Method vs. Temporal Method

Content:

  • Current Rate Method & Temporal Method ü 主要掌握两种方法分别是如何在利润表以及资产负债表中记

Tasks:

Exam tips:

  • 这部分是考试的重中之重,要求掌握到熟练计算的程度。
Financial Ratios under Current Rate & Temporal Method Financial Ratios under Current Rate & Temporal Method Ø Pure balance sheet and pure income statement ratios.

  Ø Example of pure financial statement ratios.

  Pure statements means that all of the components of the •

  2014 ($) B/S Items 2014 (LC) (current rate method)

  ratio are from the balance sheet, or all of the components

  Current ratio

  2.79

  2.79 are from the income statement.

  Quick ratio

  1.07

  1.07

  • Pure income statements and pure balance sheet ratios are

  LTD to total capital

  0.44

  0.44 unaffected by the application of the current rate method .

  ü Both the numerator and denominator are from the balance

  2014 ($) I/S Items 2014 (LC) (current rate method) sheet and are translated at the current rate .

  ü Both the numerator and denominator are from the income

  Gross profit margin 34% 34% statement and are translated at the average rate .

  Net profit margin 14% 14% Financial Ratios under Current Rate & Temporal Method Financial Ratios under Current Rate & Temporal Method

  Ø Mixed balance sheet & income statement ratios. Ø Example of mixed financial statement ratios. ( Depreciating LC )

  2015 ($)

  A mixed ratio combines inputs from both the income •

  Ratios 2015 (LC) (current rate method) statement and balance sheet.

  ROA 24.6% 25.7%

  ROE 58.3% 61.1%

  The current rate method results in small changes in mixed •

  Total asset turnover

  1.75

  1.84

  ratios because the numerator and the denominator are almost

  Inventory turnover

  2.75

  2.88 Accounts receivable turnover

  7.69

  8.06 always translated at different exchange rates.

  • Ratios are calculated using end-of-period balance sheet numbers.
    • If we are using end-period balance sheet figures, there are

  Ø The translated ratio is larger than the original ratio . This will always be conclusions as following: the case when the foreign currency is depreciating because the

  ü The analysis that follows does not necessarily apply for mixed average rate ( 分子 ) is greater than the ending rate ( 分母 ). Current Rate V.S. Temporal Method Ratios

  Example: Try to analyze the fixed asset turnover ratio, assumes the foreign currency is depreciating.

  Translation Method in Hyperinflationary Economies

  Ø Pure balance sheet and pure income statement ratios will be the same. Ø If the foreign currency is depreciating , translated mixed ratios

  (with an income statement item in the numerator and an end- of-period balance sheet item in the denominator) will be larger than the original ratio. Ø If the foreign currency is appreciating , translated mixed ratios

  (with an income statement item in the numerator and an end- of-period balance sheet item in the denominator) will be smaller than the original ratio .

  Current Rate V.S. Temporal Method Ratios

  The basic procedure of analyzing the effect on the financial ratios of the choice of current rate and temporal method. ( still base on end-of-period balance sheet figures ) Ø Determine whether the foreign currency is appreciating or depreciating . Ø

  Determine which rate ( historical rate, average rate, or current rate ) is used to convert the numerator under both methods .

  Ø Determine which rate ( historical rate, average rate, or current rate ) is used to convert the denominator under both methods .

  Ø Determine whether the ratio will increase, decrease, or stay the same based on the direction of change in the numerator and the denominator.

  Summary of Original & Current Rate Method Ratios

Definition of hyperinflationary environment

Answer:

  Ø The denominator (fixed assets) is converted at the historical rate under the temporal method and the current rate under the current rate method . If the foreign currency is depreciating, the historical rate will be higher than the current rate , which means fixed assets will be higher under the temporal method.

  Ø Since fixed assets are higher, turnover will be lower under the

  Ø The numerator (revenue) is converted at the same rate (the average rate) under both methods.

  Ø According to the FASB , a hyperinflationary environment is one where cumulative inflation exceeds 100% over a 3-year period.

  • Assuming compounding, an annual inflation rate of
    • 1 is approximately equal to 100% )

  • The temporal method is used to remeasure the

  more than 26% over three years (

  1.26

  3 Translation Method in Hyperinflationary Economies Example of Adjusting Financial Statements for Inflation

Definition of hyperinflationary environment

  In LC 2014 2015 Cash 5,000 8,000 Ø The IASB does not specifically define hyperinflation. Inventory 25,000 25,000

  Ø Under IFRS . The foreign currency financial statements are restated for

  Total assets 30,000 33,000 inflation and then translated using the current exchange rate . Accounts payable 20,000 20,000

  Nonmonetary assets and nonmonetary liabilities are restated for inflation • Common stock 10,000 10,000 using a price index.

  Retained earnings 3,000 • monetary assets and monetary liabilities It is not necessary to restate . Liabilities and equity 30,000 33,000

  • The components of shareholders' equity ( other than retained earnings ) are

  Revenue 15,000 restated by applying the change in the price index. Expenses (12,000) The • income statement items are restated by multiplying by the change in

  Net income 3,000 the price index from the date the transactions occur .

  CPI (2014/12/31) = 100

  • The net purchasing power gain or loss is recognized in the income statement CPI (2015/12/31) = 150 based on the net monetary asset or liability exposure.

  Average CPI for 2015 = 125 Example of Adjusting Financial Statements for Inflation Example of Adjusting Financial Statements for Inflation

Adjustment Inflation Calculation of net purchasing power gain / loss In LC 2015 Factor Adjusted

  Ø

  A: Cash = 8000 = 5000 ( 受一整年的通胀影响 ) + 3000 ( 年中受 Cash 8,000 8,000 Inventory 25,000 150 / 100 37,500

  通胀影响,以平均值测算 )

  Total assets 33,000 45,500

  • Monetary asset 受通胀影响会导致loss

  Accounts payable 20,000 20,000

  • Common stock 10,000 150 / 100 15,000 Loss = [-5,000 x (150-100) / 100] + [-3,000 x (150-125) /

  Retained earnings 3,000 10,500

  125]

  Liabilities and equity 33,000 45,500

  • Monetary liability受通胀影响会导致Gain

  Revenue 15,000 150 / 125 18,000

  • Expenses (12,000) 150 / 125 (14,400) Gain = [20,000 x (150-100) / 100]

  Net purchasing power 6,900 (A) Net purchasing power gain / loss = Gain + Loss = 6,900 • gain / loss

  • Changes in the mix of profits from different countries (with varying tax rates).
  • Changes in tax rates.

  Ø

  Ø Demonstrate the use of a conceptual framework for assessing the quality of a company’s financial reports. Ø Describe the concept of sustainable (persistent) earnings. Ø Explain potential problems that affect the quality of financial reports.

  Summary Evaluate the Earnings and Reporting Quality

  Ø

  ü Net purchasing power gain / loss

  ü Current Rate Method V.S. Temporal Method

  ü Current Rate Method V.S. Original

  Ø

  ☆

  Ø Disclosures may enable an analyst to evaluate the impact of changes in currency values on company’s business.

  Foreign exchange risks include the impact of changes in currency values on assets and liabilities of a business, as well as on future sales.

  Ø Analysts separate the two because the growth in revenues due to price or volume changes are more sustainable.

  Revenue growth can occur due to price or volume changes and due to changes in exchange rates .

  Revenue Growth Issue and Foreign Exchange Risks

  Changes in effective tax rate on account of foreign operations can be due to:

  Tax Implications of Multinational Operations Earnings of multinational companies are subject to multiple tax jurisdictions; hence, the statutory tax rate often differs from the effective tax rate. Ø

Importance:

Content:

  • 主要掌握不同方法下汇率转换导致的财务比例分析

Tasks:

  • 计算恶性通货膨胀下导致的通胀损益
  • 辨析有效税率和法定税率

Exam tips:

  • 这部分同样是考试重点考查的内容,知识比较繁杂,需

  Potential problems that affect the quality of financial reports Quality of financial reports

Potential problems Quality of financial reports

  Ø Measurement and timing issues (Aggressive/conservative Ø The quality of financial reports can be viewed along two highly revenue recognition) related dimensions:

  Ø Classification issues (operating/Non-operating items)

  • Earnings quality

Quality issues and mergers and acquisitions

  Reporting quality (decision-useful) • Ø Mergers and acquisitions provide opportunities and

  Ø Reporting quality is an assessment of the information disclosed motivations to manage financial results in the reports

Financial reporting that diverges from economic reality despite

  Ø High-quality earnings refers to a high level of earnings as well

  compliance with accounting rules

  as sustainability of earnings. Good economic performance and Ø An accounting treatment may conform to reporting standard, sustainable earnings are considered higher quality but does not faithfully represent economic reality

  Evaluate the quality of a company's financial report Evaluate the quality of a company's financial report

Steps in evaluating the quality of financial reports

Steps in evaluating the quality of financial reports

  Ø Step 1: Understand the company, its industry, and the

  Ø Step 5: Check for warning signs

  accounting principles it uses and why such principles are appropriate Ø

  Ø

  Step 2: Understand management including the terms of their Step 6: For firms in multiple lines of business or for compensation. Also evaluate any insider trades and related party

  multinational firms, check for shifting of profits or

  transactions

  revenues to a specific part of the business that the firm

  Ø Step 3: Identify material areas of accounting that are vulnerable

  wants to highlight to subjectivity.

  Ø

  Ø

  Step 7: Use quantitative tools to evaluate the likelihood

  Step 4: Make cross-sectional and time series comparisons of financial statements and important ratios.

  of misreporting. Quantitative tools Indicators of earnings quality

Beneish model

High-quality earnings are characterized by two elements

  Ø Beneish model is a probit regression model that estimates the

  Ø Sustainable: high-quality earnings tend to persist in the

  probability of earnings manipulation using eight dependent variables.

  future.

  Ø M-score > -1.78 indicates a higher than acceptable probability of

  Ø Adequate: high-quality earnings cover the company’s earnings manipulation.

  Limitation: Beneish Model Relies on accounting data, may not • cost of capital. reflect economic reality.

Low-quality earnings come about due to: Altman’s model

  Ø Altman’s model is to assess the probability that a firm will file for

  Ø Earnings that are below the firm’s cost of capital

  bankruptcy

  Ø Earnings that are not sustainable

  Limitation: (1) The same as Beneish model. (2) Just a single- • period static model

  Ø Poor reporting quality

  Sustainable earnings Mean Reversion

Mean reversion

  Ø Sustainable earnings Ø Mean reversion: Earnings at extreme levels revert back to normal levels

  Sustainable earnings are earnings that are expected to recur in the • over time future. Earnings comprised of a high proportion of non-recurring

  • A company experiencing poor earnings performance will shut down items are considered to be non-sustainable (and hence low-quality) .

  or minimize its losing operations and replace inferior managers

  • Ø Earnings = α + β Earnings ε

  t+1 1 t

  with ones capable of executing an improved strategy, resulting in improved earnings. A higher value of β1 indicates higher persistence of earnings •

  • A company experiencing abnormally high profits will attract

  α + β + Cash flow + Ø Earnings = β Accruals ε

  t+1 1 t 2 t

  competition. New competitors may reduce their prices to gain a

  • Earnings can be viewed as being composed of a cash component and

  foothold in an existing company’s markets, thereby reducing the an accruals component, the coefficient on cash flow ( β1) has been existing company’s profits over time. shown to be higher than the coefficient on accruals ( β2) , indicating

  • When earnings are largely comprised of accruals, Mean reversion
  • Step 1: Understand the basics ( analysis of disclosure )
  • Step 2: Evaluate and question aging receivables
  • Step 3: Cash versus accruals
  • Step 4: Compare financial statement with physical data provided by the company.
  • Step 5: Evaluate revenue trends and compare with peers
  • Step 6: Check for related party transactions Ø Expense recognition issues
  • Step 1: Understand the basics ( analysis of disclosure )
  • Step 2: Trend and comparative (peer) analysis
  • Step 3: Check for related party transactions

  Indicators of Balance Sheet Quality

  Evaluating the Earnings Quality of a Company

  Ø

  Indicators of Cash Flow Quality

Two major contributions to earnings manipulation

Indicators of Cash Flow Quality

Revenue recognition issues

  Ø High-quality cash flow is characterized by positive CFO that is derived from sustainable sources and is adequate to cover capital expenditures, dividends, and debt repayments Ø Furthermore, high-quality CFO is characterized by lower volatility than that of the firm's peers. Significant differences between CFO and earnings, or differences that widen over time, can be an indicator of earnings manipulation.

  Evaluate The Cash Flow Quality

High-quality financial balance sheet reporting is evidenced by completeness, unbiased measurement and clarity of presentation

Evaluation of the statement of cash flows entails:

  Ø Completeness of a balance sheet is compromised by the existence of off-balance sheet liabilities such as incorrect use of the operating lease classification.

  Ø Clear presentation(clarity of presentation)

  in the B/S, they do not typically specify how such items must be presented.

  Ø Checking for strategic provisioning ( non – cash expenses )

  Ø Checking revenue quality ( aggressive revenue )

  Ø Checking for any unusual items or items that have not shown up in prior years.

  • While accounting standard specify which items should be included

  Indicators of Balance Sheet Quality Sources of Information About Risky

  Ø Unbiased Measurement, The balance sheet reflects subjectivity

There are several sources of information about such risks:

  in the measurement of several assets and liabilities :

  Ø Financial statements

  Value of the pension liability (based on several actuarial •

  Ø Auditor's report

  assumptions )

  Ø Notes to financial statements

  • Value of investment in debt or equity of other companies or which

  Ø Management Discussion and Analysis (MD&A) a market value is not readily available.

  Ø SEC Forms

  • Goodwill value (subjectivity in impairment testing)

  Ø

  Inventory valuation (subjectivity in testing for impairment ) Financial press ( 金融媒体 ) •

  • Impairment of PP&E and other assets

  Summary Ø ☆

Importance:

  Framework for Financial Analysis Ø

Content:

  • 定性了解进行财务质量的分析流程

  ü Earnings quality (二级重点)

Tasks:

  ü Reporting quality Ø Demonstrate the use of a framework for the analysis of financial

  • 定量分析上市公司盈利质量 statements, given a particular problem, question, or purpose .

  Ø

Exam tips:

  Ø Evaluate how a given change in accounting standards, methods, or

  • 这部分知识比较繁杂,在考试中常常穿插在案例中与其 assumptions affects financial statements and ratios.

  他概念混合考查。

Framework for Analysis

  • Analyst' s perspective (evaluate a debt or equity investment, or
  • Financial statements
  • Communication with management,
  • Needs communicated by client or supervisor
  • Institutional guidelines

  Framework for Analysis of Financial Statement

  Output:

  Ø 4、Analyze data Input:

  Framework for Analysis of Financial Statement

  Output:

  Ø 3、Process data Input:

  suppliers,customers, and competitors Output:

  Ø 2、Data collection Input:

  Framework for Analysis of Financial Statement

  Output:

  establish a credit rating)

  Ø 1、Define the purpose and context of the analysis Input:

  Framework for Analysis of Financial Statement Framework for Analysis

  • Purpose statement and specific questions to be answered
  • Organized financial information
  • Nature and content of final report
  • Timetable and budget

Framework for Analysis

Framework for Analysis

  • Data from the previous phase
  • Data from the step 2 and 3
  • Adjusted financial statements
  • Common-size statements
  • Ratios
  • Results
Framework for Analysis of Financial Statement Framework for Analysis of Financial Statement Framework for Analysis

Framework for Analysis

  Ø Ø

  5、Develop and communicate conclusions 6、Follow-up Input:

  Input:

  • Analytical results and previous reports
  • Periodically update information

  Institutional guidelines for published reports • Output: Output:

  • Update analysis and recommendations
  • Report answering questions posed in step 1
  • Recommendations

  How to Analyze Identify Financial Reporting Choices and Biases

  The analysis focuses on the following:

Earnings sources and performance

  Ø Earnings sources and performance

  Ø Return on equity (ROE) can be decomposed using the

  Ø Asset base extended DuPont equation

  Ø Capital structure

  Financial Asset Tax Interest EBIT Leverage

  Turnover Burden Burden Margin Ø

  Capital allocation decisions Ø

  Earnings quality and cash flow analysis Ø

  Market value decomposition Ø

  Off-balance-sheet financing

Example: Equity Method Adjustment $in millions 2015 2014 2013

Earnings sources and performance

  Ø Determine whether the firm's earnings are generated internally from operations or from externally .

  Ø Adjustment

  Identify Financial Reporting Choices and Biases

  Revenue $52,000 $48,300 -- EBIT 7,250 6,500 -- EBT 6,600 5,900 -- Equity income* 900 700 -- Net income 5,570 4,800 -- (* not included in EBT) Total asset $56,200 $49,900 $50,300 Equity investment 4,400 4,100 3,500 Stockholders’ equity 26,600 25,900 24,000

  Identify Financial Reporting Choices and Biases

  • Remove equity method income and the investment asset from the extended DuPont equation.

  Tax burden 84.4% 81.4% X interest burden 91.0% 90.8%

  X EBIT margin 13.9% 13.5% =net profit margin 10.7% 10.0% X total asset turnover

  0.98

  2.0

  2.0 =ROE 21.0% 19.2% Identify Financial Reporting Choices and Biases

  Example: Equity Method Adjustment Identify Financial Reporting Choices and Biases

Example: Equity Method Adjustment As reported 2015 2014

  Identify Financial Reporting Choices and Biases Identify Financial Reporting Choices and Biases Example: Equity Method Adjustment

Asset base

  Ø Examine the composition of the balance sheet assets over time.

  Presenting balance sheet items in a common-size • format is a useful starting point . Note the significance of goodwill(impairment,no • amortization).

  Identify Financial Reporting Choices and Biases Identify Financial Reporting Choices and Biases Capital structure

Capital allocation decisions

  Ø Ø

  The capital structure must support management's Consolidation can hide the individual characteristics of strategic objectives and allow the firm to honor its future dissimilar subsidiaries.

  Firms are required to disaggregate financial information by Ø Liabilities such as employee benefit obligations, deferred segments to assist users.

  Ø obligations.

  Ø taxes, restructuring provisions are less burdensome and Segment disclosures are valuable in identifying:

  • may or may not require a cash outflow in the future. Revenue and profit by segment

  The relationship between capital expenditures and returns • Identify Financial Reporting Choices and Biases Identify Financial Reporting Choices and Biases Segment disclosure example

Segment disclosure example Total Assets Capital Expenditures Revenue EBIT

  Seg 2015 2014 2015 2014 Seg 2015 2014 2015 2014 A $370 36% $170 21% $10 15% $9 17%

  A $270 20% $220 20% $60 29% $50 27% B 500 49% 490 60% 35 54% 30 56%

  B 870 66% 820 66% 130 63% 120 65% C 160 15% 150 19% 20 31% 15 28% C

  180 14% 170 14% 15 7% 15 8% $1,030 $810 $65 $54 $1,320 $1,210 $205 $185

  Ø Segment B has highest assets and capital expenditures

  Ø Segment B contributes the highest revenue and EBIT

  Ø Segment C has the lowest assets while C contributes the lowest.

  Ø Segment A has the lowest capital expenditures

  Identify Financial Reporting Choices and Biases Identify Financial Reporting Choices and Biases Segment disclosure example

Segment disclosure example

  Ø EBIT Margin CapEx%/Assets%

  If ratio of proportional capex to proportional assets is Seg 2015 2014 2015 2014 greater than 1, Firm is growing the segment by allocating

  A 22% 23%

  0.42

  0.81 more resources to the segment. B 15% 15%

  1.10

  0.93 C 8% 9%

  2.07

  1.47 Ø

  If ratio of proportional capex to proportional assets is Ø less than 1, Firm is allocating less resources to the C has lowest EBIT margin and it is declining

  C's proportional capex to proportional asset ratio is > 1 Ø

  Ø segment .

  If trend continues, the segment will become less indicating over-allocation of resources to lowest margin

Accruals ratio

Earnings quality

  • Accruals
  • Accruals ratio
    • NOA
      • NOA

  • Net operating asset (NOA) is the difference between operating assets and operating liabilities
  • Balance sheet approach
  • Cash flow statement approach Ø

  BEG

  CF

  = NI-CFO-CFI

  CF

  = (NI-CFO-CFI) / [(NOA

  END

  Ø Adjustment

  )*1/2]

  Identify Financial Reporting Choices and Biases

  Ø Cash basis ratios

  Identify Financial Reporting Choices and Biases

  Ø The implied value

  exchange, it may be necessary to convert the market value of the associate to the parent's reporting currency.

  Identify Financial Reporting Choices and Biases

  Ø Cash flow statement approach

  ü NOA = (Total assets – Cash – Marketable securities) – (Total liabilities – Total debt)

  )*1/2]

  BEG

  Ø Earnings quality refers to the persistence and sustainability of a firm's earnings.

  Ø Earnings can be disaggregated into cash flow and accruals using:

  Measure earnings quality using the ratio of accruals to average net operating assets, the lower the ratio, the higher the earnings quality.

  Identify Financial Reporting Choices and Biases

  Ø Balance sheet approach

  BS

  = NOA END - NOA BEG

  BS

  = (NOA

  END

  BEG

  ) / [(NOA

  END

  • Accruals
  • Accruals ratio
    • NOA

Cash flow analysis

Market value decomposition

  • Because of the potential for earnings manipulation by increasing accruals, comparing operating cash flow to operating income .
  • Operating cash flow deducts interest and taxes while operating income does not, adding-back cash interest and cash taxes.
  • The implied value is equal to the parent's market value less the parent's pro-rata share of the associate's market value.
  • If the associate's stock is traded on a foreign stock
  • Cash return on total assets = CFO / Average total assets
  • Cash flow to reinvestment = CFO / Capital expenditures
  • Cash flow to total debt = CFO before interest and taxes / Total debt
  • Cash flow interest coverage = CFO before interest and taxes / Cash
  • Market capitalization of parent
    • Parent's share of associates' market cap
    Identify Financial Reporting Choices and Biases Identify Financial Reporting Choices and Biases Market value decomposition

Market value decomposition example

  Ø The implied P/E of the parent without associates Thunderbird Corporation, located in the U.S., owns 30% of Implied value of parent excluding associates Eagle Company which is located in the U.K

  Net income — Parent's share of associates' earnings Thunderbird Eagle

  Market capitalization $60,000 ₤20,000 Ø

  It may be necessary to convert the associates' earnings Net income $5,000 ₤1,000 to the parent's reporting currency using the average

  Current FX rate ($/₤) $1.70 exchange rate. Average FX rate ($/₤) $1.60

  Identify Financial Reporting Choices and Biases Summary Ø ☆

Importance: ☆ Implied Thunderbird value excluding Eagle

  Thunderbird market cap $60,000 Ø

Content:

  • Share of Eagle $10,200 (₤20,000 X 30% X $1.70 )
    • 重点掌握在分析盈利质量时需要用到的定量方法

  $49,800

  DuPont equation •

  • Accruals ratio

Implied Thunderbird net income excluding Eagle

  ü Balance sheet approach ü Cash flow statement approach

  Thunderbird market cap $50,000

  • Share of Eagle $480 (₤1,000 X 30% X $1.60 ) Cash flow analysis • $4,520

  Market value decomposition •

  Ø Implied Thunderbird P/E 11.0 ($49,800 /$4,520)

Exam tips:

  Actual Thunderbird P/E 12.0 ($60,000 /$5,000)

  这部分知识在这个章节是最重要的,常常会考计算题, •

Off-Balance-Sheet Financing (OBS)

  • Assets and liabilities are initially increased by the same amount,

Tasks:

  • Remove rent expense (payment) from the income statement and replace with depreciation expense and interest expense.

  1.6

  2.6 EBIT $7.9 [$6 EBIT + $6.9 PMT - ($30 / 6 Yrs)] Interest Expense $5.0 [$2 Interest Exp + ($30 X 10%)] Adjusted coverage

  3.0 Total Debt $130 ($100dent + $30 PV lease) SH Equity $50 Adjusted D/E

  2.0 Interest coverage

  Debt/Equity

  Ø

  Ø Reported ratios:

  Evaluate the quality of a company's financial data

  Total Debt $100 million SH Equity $50 million EBIT $6 million Interest expense $2 million

  Tex lnc. is the lessee in an operating lease. The PV of lease payments is $30 million discounted at an interest rate of 10%. The lease term is 6 years and the annual payment is $6.9 million. Adjust the following for the lease and calculate Tex's total debt-to- equity and interest coverage ratios.

  Evaluate the quality of a company's financial data

  Ø Other OBS techniques are debt guarantees, sales of receivable with recourse, take-or-pay agreement ( 照付不议条款 ).

  Capitalizing an operating lease will increase financial leverage because of the increase in liabilities .

  Ø Operating lease V.S. Capital lease • For analytical purposes, treat an operating lease as a capital lease .

  Evaluate the quality of a company's financial data

  Ø Analyze and interpret how balance sheet modifications, earnings normalization, and cash flow statement related modifications affect a company’s financial statements, financial ratios, and overall financial condition.

  The Quality of Financial Data

Lease capitalization example

Lease capitalization example

Adjusted Ratios ($ in millions)

  • Beginning of this fiscal year

  Anticipating Changing Accounting standard Ratio analysis

Changes in accounting standards

Ratio analysis is used to evaluate 5 basic facets of the company

  Ø Be aware of proposed changes in accounting standards because

  Ø Internal liquidity of potential impact on the financial statements and valuation.

  Ø Operating efficiency and profitability

  Example:

  Ø Risk profile: business and financial

  FASB is currently working on a proposal to potentially eliminate •

  Ø Growth potential

  operating lease, if enacted, firms would be required to capitalize

  Ø operating lease.

  External liquidity

  • To avoid the increase in leverage from capitalizing a lease, the firm

  could raise additional equity, which dilute existing investors' ownership interest.

  Review of DuPont Analysis Review of Inventory analysis

  DuPont System: Extended Equation:

In periods of rising prices Statements LIFO FIFO Higher COGS Lower COGS Lower EBIT Higher EBIT Income statement

Lower Tax Higher Tax

  Lower net income Higher net income Higher inventory Lower inventory balance balance Balance sheet Higher working Lower working capital capital Cash flow Higher CFO Lower CFO statement (Less tax paid) (More tax paid)

In periods of rising prices Ratios LIFO FIFO Profitability

Statements Items Capitalizing Expensing B/S & Ratios Total assets Higher Lower Total equity Higher Lower Leverage ratio (D/A, D/E) Lower Higher I/S & Ratios Net Income volatility Lower Higher Net income – first year (ROA, ROE) Higher Lower Net income – later year (ROA, ROE) Lower Higher Cash flow statement Total cash flow Same Same CFO Higher Lower CFI Lower Higher Capitalizing vs. Expensing

  Ø

  Summary

  Review of Inventory analysis

  Lower gross and net margins Higher gross and net margins

  Liquidity Lower current ratio Higher current ratio Solvency Higher D/A and D/E Lower D/A and D/E

  Higher inventory turnover Lower inventory turnover

  Review of Long-lived asset analysis

Activity

  Conservative & Aggressive Accounting

Importance:

Aggressive Conservative

Content:

  Capitalizing current period costs Expensing current period costs Longer estimates of the lives of depreciable assets

  ☆ Ø

  • 掌握在财务报表数据调整的方法

  会出现一级中协会默认考生已掌握的知识点,有必要针对一级的 重要知识点进行复习。(尤其是长期资产和存货,虽然 17年开始 在考纲中被删减掉了,但仍然可能在具体的场景分析中被考到。

  Ø

  ü Off-Balance-Sheet data ü Changes in accounting standards ü Ratio analysis

  Less accrual of reserves for bad debt More accrual of reserves for bad debt Smaller valuation allowances on DTA Larger valuation allowances on DTA

  Straight-line depreciation Accelerated depreciation Delayed recognition of impairments Early recognition of impairments

  Shorter estimates of the lives of depreciable assets Higher estimates of salvage values Lower estimates of salvage values

Exam tips:

  • 这部分知识和一级已经学习过的知识存在穿插,介于二级可能还

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