Financial Statement Analysis
Weight: 15%~20%
SS5: Intercorporate Investments, Post-Employment and 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 Exam tips:
• 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
Tasks:
Ø Describe the classification, measurement, and disclosure under International Financial Reporting Standards (IFRS) for financial assets.
Intercorporate Investments
Definition of intercorporate investmentsØ Intercorporate investments in marketable securities are categorized as follows:
• Investments in financial assets (has no significant influence)
• Investments in associates (has significant influence)
• Business combinations (has control over the investee firm)
• Joint ventures (the right of control is shared by entities)
The classification of categories
Ø Percentage of ownership is typically used to determine the appropriate category. However, the ownership percentage is only a guideline. Ultimately, the category is based on the investor’s ability to influence or control the investee.
Categorization of Investment
Financial
Assets Associates CombinationBusiness VenturesJoint
Degree of
influence No significant Significant Control Shared control Typical
percentage of
interest < 20% 20% - 50% > 50% Varies
Term of investee N/A Associate Subsidiary N/A
Accounting
Equity method Acquisition method methodEquity
Financial Assets
Definition of financial assets
Ø The classification below only applies to equity or debt investment with no significant influence (percentage of interests < 20%) :
• HTM is only for debt securities
• Available for sale security (AFS)
• Fair value through P/L (including trading securities & designated at fair value)
Ø GAAP and IFRS are the same about the classification.
Financial Assets
Held-to-maturity investments
Ø Held-to-maturity investments are investments in financial assets with fixed or determinable payments and fixed maturities (only debt securities) that the investor has the positive intent and ability to hold to maturity. Ø Initial recognition (similar under IFRS & US GAAP)
• IFRS: recognized at fair value.
• US GAAP: recognized at initial price paid.
Ø Held-to-maturity securities are reported on the balance sheet at amortized cost.
Financial Assets
Fair value through profit and loss
Ø Held-for-trading securities (Equity & Debt)
• Securities acquired with the intend to sell them in the near term. (usually less than 3 months)
• Reported on the balance sheet at fair value.
• Both realized and unrealized gain and loss are recognized in the income statement.
Ø Designated at fair value
• Designating financial assets at fair value regardless the holding intention.
• The treatment is similar to that of trading securities.
Financial Assets
Available for sale securities
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.
• Next slide
Available for Sale Securities
Foreign exchange rate changes
Ø Debt:
• US GAAP: All change in fair value of available for sale investments is recognized in OCI.
• 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. (Both US GAAP and IFRS)
Example
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
Held-to-maturity
Ø The balance sheet value is based on amortized cost.
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
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
IFRS
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.
Reclassification of Financial Asset
U.S. GAAP
Ø U.S. GAAP allows reclassifications of securities between
all categories when justified.
Ø Fair value of the security is determined at the date of transfer.
Ø The treatment of unrealized holding gains and losses on the transfer date depends on the initial classification of the security.
Summary
From To Unrealized Gain / Loss
Fair value through
profit or loss Any (Restricted under IFRS)Income statement
Held to maturity Fair value through profit or loss (Restricted under IFRS)Income statement
Held to maturity Available for sale Other comprehensive income
Available for sale Held to maturity Amortized out of OCI
Available for sale Fair value through profit or loss (Restricted under IFRS)Transfer out of OCI
Impairment of Financial Asset
Both U.S. GAAP and IFRS
Ø U.S. GAAP and IFRS require that held to maturity and
available for sale securities be evaluated for impairment
at each reporting period.
Ø It’s not necessary for fair value through profit and loss
securities because declines in their value are recognized on the income statement as they occur.
Impairment of Financial Asset
Under U.S. GAAP
Ø A security is considered impaired if its decline in value is determined to be other than temporary. For both held to maturity and available for sale securities, the write down to fair value is treated as a realized loss. (recognized on the income statement).
Ø A subsequent reversal of impairment losses is not
Impairment of Financial Asset
Under IFRS
Ø Impairment of a debt or equity security is indicated if at least one loss event has occurred, and its effect on the security’s future cash flows can be estimated reliably. • Losses due to occurrences of future events
(regardless of the probability of occurrence) are not recognized.
Impairment of Financial Asset
Under IFRS (HTM)Ø Impairment of held to maturity securities
• Impaired if its carrying value > PV of cash flow (expected permanently)
ü A credit rating downgrade or the lack of liquidity are not considered to be indications of impairment in the absence of other evidence.
• Impairment loss is recognized on income statement. Ø Reversal
• If the recovery can be attributed to an event (eg: credit upgrade), the impairment loss can be reversed.
Impairment of Financial Asset
Under IFRS (AFS)
Ø Impairment of available for sale securities
• Impaired if its carrying value > PV of cash flow (loss event) ü Significant changes in the technological, market,
economic, and/or legal environments that adversely affect the investee and indicate that the initial cost of the equity investment may not be recovered. ü A significant or prolonged(持续性的) decline in the fair
value of an equity investment below its cost.
Impairment of Financial Asset
Under IFRS (AFS)
Ø Impairment of available for sale securities • Cumulative loss in OCI is reclassified to income
statement.
ü Cumulative loss = Acquisition cost – current fair
Impairment of Financial Asset
Under IFRS (AFS)
Ø Reversal of available for sale securities
• Debt: Impairments of available for sale debt securities may 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.
• Equity: Can not be reversed through I/S.
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:
• Amortized cost
• Fair value through profit or loss (FVPL) • Fair value through other comprehensive income
(FVOCI).
IFRS 9 (New Standards)
IFRS 9 (New Standards)
Ø Amortized cost (Debt only), 2 criteria:
• Business model test: Debt securities are being held to collect contractual cash flow.
• Cash flow characteristic test: The contractual cash flows are either principal, or interest on principal, only.
IFRS 9 (New Standards)
IFRS 9 (New Standards)
Ø FVPL (Debt & Equity)
• 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. Ø FVOCI (Equity only)
Summary of IFRS 9
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。
Summary
Investment in Associates
Tasks:
Ø Describe the classification, measurement, and disclosure under International Financial Reporting Standards (IFRS) for Investment in Associates.
Ø Distinguish between IFRS and US GAAP in the classification, measurement,. and disclosure of Investment in Associates.
Definition of Associates
Definition of AssociateØ When a company holds 20% - 50% of the voting rights of an associate, it is presumed that the company has significant influence, but not control, over the investee’s business activities.
• Representation on the board of directors
• Participation in the policy-making process
• Material transactions between the investor and the investee
• Interchange of managerial personnel
Equity Method
Equity Method of Accounting
Ø The equity investment is initially recorded on the investor’s balance sheet at cost. In subsequent periods, the carrying amount of the investment is adjusted to recognize the investor’s proportionate share of the investee’s earnings or losses, and these earnings or losses are reported in income .
• Dividends or other distributions received from the investee are treated as a return of capital and reduce the carrying amount of the investment and not reported in the I/S.
• One – line consolidation.
Example
Equity Method of Accounting
Ø December 31, 20X5, Company A invests $1,000 in return for 30% of the common shares of Company B.
• During 20X6, Company B earns $400 and pays dividends of $100.
Calculate the effects of the investment on Company A’s balance sheet, income statement and cash flow for 20X6.
Example
Equity Method of Accounting (Answer)
Ø Recognize $120 ($400×30%) in the I/S from its proportionate share of the net income of Company B.
Ø Increase its investment account on the balance sheet by $120 to $1,120 to reflect its proportionate share of the net assets of B. Ø Receive $30 ($100×30%) in cash dividends from Company B and
reduce its investment in Company B by that amount to reflect the decline in the net assets of Company B due to the dividend payment. • At the end of 20X6, the book value of the investment on Company
A’s B/S = $1,000 + $120 - $30 = $1,090
Investment Costs That Exceed the Book Value of the Investee
Ø Acquisition cost is initially recognized as investment in associate, and comprises of two parts:
• Fair value of the net assets acquired.
• Goodwill (Not amortized but need to test for impairment) Ø The difference between fair value and book value of the net
assets acquired will adjust the I/S of investor’s equity income.
• Not simply equals to the net income earned by investee multiplied by percentage of interests owned.
Investment Costs That Exceed the Book Value of the Investee
Equity Method
Goodwill is renewed for impairment on a regular basis.
This part is amortized to the investee’s profit or loss over economic lives.
Example
Investment Costs That Exceed the Book Value of the Investee
Ø At the beginning of the year, A Company purchased 30% of B Company for $80,000. Net asset of company B in book value is $200,000. On the acquisition date, the book value of B’s assets and liabilities were the same except for B’s equipment, which had a book value of $25,000 and a fair value of $75,000 on the acquisition date. B’s equipment is depreciated over ten years 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
Question A: Calculate the goodwill
Ø Goodwill = Purchase price – Fair value of the net assets = Purchase price – (Book value of the net assets + Appreciation of the equipment)
=$80,000 – [$200,000 x 30% + ($75,000 FV - $25,000 BV) x 30%]
=$5,000
Question B: Calculate Company A’s equity income at the end of the year from its investment in Company B. Ø Equity income = Proportionate share of B’s net income –
Additional depreciation from excess of purchase price allocated to B’s equipment.
Ø Equity income = ($100,000 x 30%) – (Excess / 10)
• Excess = ($75,000 - $25,000) x 30% = $15,000 = $28,500
Question C: Calculate the investment in Company B that appears on Company A’s year-end balance sheet. 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%)
= $90,500
Example
Fair Value Option
Ø Both IFRS and US GAAP give the investor the option to account for their equity method investment at fair value.
• 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 arising from changes in fair value as well as any interest and dividends received included in the investor’s profit or loss.
• Under the fair value method, the investment account on the investor’s 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 allowance account.
Impairment of Equity Investment
US GAAP
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.
Transactions with Associates
Upstream ( associate to investor )
Ø The profit on the intercompany transaction is recorded on the associate’s income statement.
• The investor’s share of the unrealized profit is thus included in equity income on the investor’s income statement . Ø Investor must reduce its equity income of investee by
investor’s proportionate share of the unconfirmed profit.
• Unconfirmed profit means goods have not been used or sold by the investor.
Example of Upstream Transaction
Upstream ( associate to investor )
Ø Suppose that Investor owns 30% of Investee. During the year, Investee sold goods to Investor and recognized $15,000 of profit from the sale. At year end, half of the goods purchased from Investee remained in Investor’s inventory.
Ø Investor must reduce its equity income by $2,250
• ($15,000 x 50%) x 30% = $2,250
Ø Once the inventory is sold by Investor, $2,250 of equity income will be recognized.
Transactions with Associates
Downstream ( investor to associate )
Ø The investor has recognized all of the profit in its income statement.
Ø The investor must eliminate the proportionate share of
the profit that is unconfirmed.
Example of Downstream Transaction
Downstream ( investor to associate )
Ø Suppose that Investor owns 30% of Investee. During the year, Investor sold $40,000 of goods to Investee for $50,000. Investee sold 90% of the goods by year – end.
Ø Investor’s profit is $10,000 ($50,000 sales - $40,000 COGS) Ø 10% of the profit remains in Investee’s inventory.
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
Ø Analysts should question whether the equity method is appropriate
• Significant influence or not
Ø There can be significant assets and liabilities of the investee that are not reflected on the investor’s balance sheet, which will significantly affect debt ratios.
Ø Net margin ratios could be overstated because income for the associate is included in investor net income but is not specifically included in sales.
Ø Finally, the analyst must consider the quality of the equity method earnings.
Ø Importance: ☆☆☆
Ø Content:
• Definition of Associate (重点理解存在显著影响的判断) • Equity Method (B/S，I/S的相关处理)
• Impairment (US GAAP & IFRS)
• Transactions with Associates (upstream & downstream) Ø Exam tips:
• 重点理解使用Equity method对于B/S & I/S的影响。
Summary
Business Combinations
Tasks:
Ø Describe the classification, measurement, and disclosure under International Financial Reporting Standards (IFRS) for Business combinations.
Ø Distinguish between IFRS and US GAAP in the classification, measurement,. and disclosure of Business combinations .
Definition of Business Combinations
Ø Business combinations (controlling interest investments) involve the combination of two or more entities into a larger economic entity.
• Under IFRS, there is no distinction among business combinations based on the resulting structure of the larger economic entity.
• Under US GAAP, business combinations are categorized as: ü Merger (吸收合并)
ü Acquisition (收购) ü Consolidation (新设合并)
Merger (吸收合并)
Ø The distinctive feature of a merger is that only one of the entities remains in existence. One hundred percent of the target is absorbed into the acquiring company. (Acquire 100% of the target) • Company A + Company B = Company A
Acquisition (收购)
Ø Each entity continues operations but is connected through a
parent–subsidiary relationship. Each entity is an individual that 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)
Business Combinations in US GAAP
Consolidation (新设合并)
Ø The distinctive feature of a consolidation is that a new legal entity is formed and none of the predecessor entities remain in existence. A new entity is created to take over the net assets of Company A and Company B. (Acquire 100% of the target)
• Company A + Company B = Company C
Business Combinations in US GAAP
Pooling-of-Interests Method (US GAAP, Prior to June 2001) Ø Combining companies that met twelve strict criteria. Companies not
meeting these criteria used the purchase method.
Ø The target’s assets and liabilities are stated at their book value in the consolidated financials statements.
Ø Operating results for prior periods are restated as though the two firms were always combined.
Ø Similar rules applied under IFRS, which used the term uniting of interests method. (IFRS, Prior to March 2004)
Ø Currently, neither IFRS nor US GAAP allows use of the pooling or uniting of interests method.
Accounting Treatment for Business Combination
Purchase Method (US GAAP & IFRS)
Ø The assets and liabilities acquired by the Parent should be stated at fair value in the consolidated financials statements. Ø An increase in the value of depreciable assets resulted in
additional depreciation expense. As a result, for the same level of revenue, the purchase method resulted in lower reported income than the pooling of interests method.
Ø Now, the acquisition method which replaces the purchase 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.
• 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.
Accounting Treatment for Business Combination
Ø Suppose that on January 1st ,2016, Company A acquires 80% of the
common stock of Company B by paying $8,000 in cash to the shareholders of Company B. The pre-acquisition balance sheet of Company A and Company B are shown below:
Example of Acquisition Method – B/S
B/S Items Pre-AcquisitionCompany A ($) Post-Acquisition Company B ($)Company A ($) 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
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. B/S Items Acquisition Method ($) Equity Method ($)
Current assets 56,000 40,000
Example of Acquisition Method – B/S
Non-controlling interests:
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 = 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.
• 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。
Goodwill
B/S Items Company B(Historical) Company B(Adjusted) (Post - Acquisition)Company A Acquisition MethodAdjustment for Acquisition MethodCash 30 30 600-500=100 130
Inventory 50 50+30=80 150 230
A/R 50 50 150 200
PP&E 250 250+50=300 400 700
Intangible
asset 0 0+100=100 0 100
Investment 0 0 0+500=500 -500 0
Goodwill 0 0+120=120 0 120
Total asset 380 380+300=680 1300 1480
A/P 180 180 400 580
Capital 150 150 550 -150 550
R/E 50 50 350 -50 350
FV adjusted 0 0+300=300 0 -300 0
Total L + E 380 680 1300 1480
Goodwill = 500 -(560-180) = 120
Recognition and Measurement of Goodwill: Ø IFRS allows two options for recognizing goodwill.
• Full goodwill = Fair value of equity of whole subsidiary – fair value of net identifiable net assets of the subsidiary
• Partial goodwill = Purchase price - % Owned x Fair value of net identifiable assets of the subsidiary
Ø US GAAP allows full goodwill method only.
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 equal to their recorded book value.
Example
B/S items Book Value (million)
Current assets 80
PP&E 760
Goodwill 30
Liabilities 400
Ø Full goodwill method
• Fair value of the subsidiary = 450 / 0.75 = 600 million
• Fair value of identifiable net assets ü = 80 + (760 + 120) – 400 = 560 million
• 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
• Acquisition goodwill = 450 – 420 = 30 million
Answer
Measurement of minority interest:
Ø Goodwill is lower using the partial goodwill method. How is this reflected on liabilities and equity side of the balance sheet? Ø Under full goodwill method, minority interest is based on the acquired
company’s fair value. • 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.
Measurement of Minority Interest
Although goodwill is not amortized, it must be tested for impairment at least annually.
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 US GAAP, goodwill impairment involves two steps. 1. Impairment exists if the carrying value of the reporting
unit (including the goodwill) exceeds its fair value. 2. The loss is measured as the difference between the
carrying value and implied fair value of the goodwill.
Impairment of Goodwill
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.
Ø Under IFRS
• Recoverable amount of unit < Carrying amount of unit
• Impairment loss = 1.3 m – 1.4 m = €100,000
Ø Under US GAAP
• Step 1 – Determination of an Impairment Loss
ü $1,300,000 (Fair value of unit) < $1,400,000 (Carrying value)
• Step 2 – Measurement of the Impairment Loss ü Fair value of unit – fair value of net identifiable asset = $1,300,000 - $1,200,000
= $100,000 (Implied goodwill)
ü Impairment loss = Carrying value of GW – Implied GW = $300,000 - $100,000
= $200,000
Example of Goodwill Impairment in US GAAP
In rare case, acquisition purchase price is less than the fair value of net asset acquired.
Ø Both IFRS and US GAAP require that the difference between fair value of net assets and purchase price be recognized as gain in the income statement.
Bargain Purchase
Original income statement:
Acquisition Method – I/S
I/S Items Company A ($) Company B ($)
Revenue 60,000 20,000
Expense (40,000) (16,000)
Net income 20,000 4,000
Consolidated income statement: (80% acquisition) I/S Items Acquisition Method ($) Equity Method ($)
Revenue 80,000 60,000
Expense (56,000) (40,000)
Operating income 24,000 20,000
Equity income 3,200
Minority interest (800)
Net income 23,200 23,200
Ø Some items might be adjusted due to the fair value adjustment : • COGS is adjusted to reflect the fair value of inventory of the target
prior to acquisition.
• Depreciation is adjusted to reflect the fair value of PP&E of the target prior to acquisition.
• Amortization of I/A is also adjusted as similar with that in PP&E. • Minority interest is created by multiplying the subsidiary’s net
income by the percentage of the subsidiary not owned. ü Minority interest is subtracted in arriving at consolidated net income.
Ø Goodwill is not amortized.
B/S Items Company B(Historical) Company B(Adjusted) (Post - Acquisition)Company A Acquisition MethodAdjustment for Acquisition Method
Cash 30 30 600-500=100 130
Inventory 50 50+30=80 150 230
A/R 50 50 150 200
PP&E 250 250+50=300 400 700
Intangible
asset 0 0+100=100 0 100
Investment 0 0 0+500=500 -500 0
Goodwill 0 0+120=120 0 120
Total asset 380 380+300=680 1300 1480
A/P 180 180 400 580
Capital 150 150 550 -150 550
R/E 50 50 350 -50 350
FV adjusted 0 0+300=300 0 -300 0
Total L + E 380 680 1300 1480
Ø Remaining useful lives of PP&E of target company are 10 years.
• 调整公允价值后的固定资产会增加额外折旧：50/10 = 5 Ø Remaining useful lives of intangible assets are 10 years.
• 调整公允价值后的无形资产会增加额外摊销：100/10 = 10 Ø Inventory increased fair value of 30.
Example of Acquisition Method – I/S
B/S Items Acquiror ($) Target ($) Adjustment ($)Fair Value Acquisition Method ($)
Revenue 2,000 1,000 3,000
COGS (1,000) (6,00) (30) (1,630) Dep. of PP&E (40) (30) (5) (75)
Amort. of I/A 0 0 (10) (10)
SG&A (300) (200) (500)
Taxation (200) (50) (250)
Net income 460 120 (45) 535
Ø Importance: ☆☆☆
Ø Content:
• Definition of Subsidiary (重点辨析和Associate的区别) • Acquisition Method (B/S，I/S的相关处理)
• 了解因公允价值调整对于对于Acquisition method的影响 • Full goodwill and partial goodwill method (IFRS & US GAAP)
• Impairment of goodwill (IFRS & US GAAP)
• Minority interest (Full & Partial goodwill)
Ø Exam tips:
• 此部分为考试重点，需要重点关注。
Summary
Joint Ventures, SPE & VIE
Tasks:
Ø Describe the classification, measurement, and disclosure under International Financial Reporting Standards (IFRS) for Joint Ventures, SPE & VIE.
Definition of Joint Ventures
Definition of Joint VentureØ Ventures undertaken and controlled by two or more parties. Ø IFRS identify the following common characteristics of joint ventures:
• A contractual arrangement exists between two or more ventures.
• The contractual arrangement establishes joint control.
Ø Both IFRS and US GAAP require the equity method of accounting for joint ventures.
Definition of SPE
Definition of Special Purpose Entities
Ø Special purpose entities (SPEs) are enterprises that are created to accommodate specific needs of the sponsoring entity. Ø An SPE can take the form of a corporation, partnership, joint
venture, or trust, the typical motivation is to reduce risk and thereby lower the cost of financing.
Ø SPEs are often structured such that the sponsor company has control over its financing / operating activities while third parties have controlling interest in the SPE’s equity.
Ø According to IFRS 10, the sponsoring entity must consolidate if it controls the SPE.
Definition of VIE
Definition of Variable Interest Entity
Ø The FASB uses the term variable interest entity (VIE) to describe a special purpose entity that meets certain conditions. • At-risk equity is insufficient to finance the entity’s activities
without additional financial support. • Equity investors lack any one of the following:
ü The ability to make decisions ü The obligation to absorb losses ü The right to receive returns
Ø If an SPE is considered a VIE, it must be consolidated by the primary beneficiary that absorbs the majority of the risk and rewards.
SPE & VIE
Ø The basis issue in regarding with VIE or SPE is to consider whether it should be consolidated by the Primary Beneficiary.
• In most cases, the creator/sponsor of the entity retains a significant beneficial interest in the SPE even though it may own little or none of the SPE’s voting equity. Ø Consolidation of VIE or SPE will significantly affect the
Ø Importance: ☆
Ø Content:
• Definition of Joint venture (能判断特征)
• Definition of SPE & VIE (知晓SPE & VIE的合并规定) Ø 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
特殊情况，在考试中出现的情况不多。
Summary
Analysis of Financial Results
Tasks:
Ø Analyze how different methods used to account for intercorporate investments affect financial statements and ratios.
Acquisition vs. Equity Method
There are four important effects on the balance sheet and income statement items that result from the choice of accounting method. Ø All methods report the same net income.
Ø Under acquisition method, equity will be higher by the amount of minority interest.
Ø Assets and liabilities are higher under the acquisition method. Ø Revenues and expenses are higher under the acquisition
method.
Acquisition vs. Equity Method
Reported financial results from different accounting methods:
Ratios Equity Method Acquisition Method
Net profit margin Higher - lower and net sales are
income is the same Lower
ROE Higher – lower and net equity is
income is the same Lower
ROA Higher – is the same and net income
Additional Issues in Combinations
Additional issues in business combinationsØ In-process R&D
• 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. Ø Restructuring costs
• 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 Importance: ☆☆☆
Ø Content:
• 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)
üIn-process R&D üRestructuring costs
Ø 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。
Summary
Post-retirement Plan
Tasks:
Ø Describe the types of post-employment benefit plans and implications for financial reports.
Overview of Post-retirement Plan
The typical post-retirement plans include:Ø Defined-contribution pension plan (DC)
• The amount contributed by employers are defined but the future value of plan is unknown.
Ø Defined-benefit pension plan (DB)
• Employer promises to pay a certain annual amount to employees after retirement.
Ø Other post-retirement benefits (OPB)
DC Plan
Plan
Type Employer Employee
DC
1. People keeps all contributions current. 2. Only financial liability
is making 2. Bear all risk/return
consequences of investment.
3. Must make all investment decisions given available related to years of service and salary. 2. Subject to “early
termination” risk if employee is terminated early.
3. Not bear risk/return consequences of investment.
Ø Importance: ☆
Ø Content:
• Post-retirement Plan (了解常见的养老金分类)
üDC Plan 雇员承担投资风险
üDB Plan 雇主承担投资风险
üOther post-retirement benefits 保险或者其他福利
Ø Exam tips:
• 考试主要考查的是DB Plan的会计处理。
Summary
Accounting for DB Plan
Tasks:
Ø Explain and calculate measures of a defined benefit pension obligation and net pension liability.
Projected Benefit Obligation
Definition of projected benefit obligation (PBO)
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.
Projected Benefit Obligation
The way how PBO is created
Measurement of PBO
Current service cost
Ø The present value of benefits earned by the employees during the current period. Service cost includes an estimate of compensation growth if the pension benefits are based on future compensation. Interest cost
Ø Interest cost is the increase in the obligation due to the passage of time. Interest cost is equal to the pension obligation at the beginning of the period multiplied by the discount rate. Benefits paid
Ø Benefits paid will reduce the PBO.
Measurement of PBO
Past (prior) service costs
Ø Past (prior) service costs are retroactive benefits (追溯的利益) awarded to employees when a plan is initiated or amended. • Under IFRS, past service costs are expensed immediately . • Under US GAAP, past service costs are amortized over the average
service life of employees. Changes in actuarial assumptions (精算假设)
Ø Gains and losses that result from changes in variables such as mortality, employee turnover, retirement age, and the discount rate.
Funded Status of DB Plan
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.
• 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
Balance Sheet Presentation
Example of PBO Change
John was hired on January 1st , 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 1st and 2nd year.
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 annual pension benefit payments.
Example of PBO Change
PBO at the end of 2016
*PV of 15 year annuity of $2,563.30 at 8% = $21,940.55 *PBO = $21,940.55 discounted at 8% for 24 years.
Year Years of Service Projected Salary ($) RetirementYear in Payment ($) Present Value ($)Benefit 2016 1 50,000 - - PBO = 3,460.01
2017 2 52,000 -
-… … … -
-2039 24 123,235.78 -
-2040 25 128,165.21 - - 21,940.55
2041 - - 1 2,563.30
… - - … 2,563.30
2055 - - 15 2,563.30
折
现
Example of PBO Change
PBO at the end of 2017
*PV of 15 year annuity of $5,126.61 at 8% = $43,881.09 *PBO = $43,881.09 discounted at 8% for 23 years.
Year Years of Service Projected Salary ($) RetirementYear in Payment ($) Present Value ($)Benefit
2016 1 50,000 -
-2017 2 52,000 - - PBO = 7,473.62
… … … -
-2039 24 123,235.78 -
-2040 25 128,165.21 - - 43,881.09
2041 - - 1 5,126.61
During 2017, the PBO increased $4,013.61. The increase is a result of current service cost and interest cost as follows: Ø 2016 PBO $3,460.01
+ Current service cost $3,736.81
(PV of 15 payments of $2,563.30 in 23 years) + Interest cost $276.80 ($3,460.01 x 8%) Ø 2017 PBO $4,473.62
* The current service cost is the present value of the benefits earned during 2017 and the interest cost is the increase in the PBO due to the passage of time.
Periodic Pension Cost
Definition of total periodic pension cost (TPPC)
Ø TPPC is the employer’s contributions adjusted for changes in funded status. The expense to the company is either paid via contributions or deferred via a worsening of the plan’s funded status.
Ø TPPC = Employer contribution – (Ending funded status – Beginning funded status)
Ø TPPC = Current service cost + Interest cost – Actual return on plan assets -/+ Actuarial G/L due to changes in assumptions affecting PBO + Prior service cost
Periodic Pension Cost
Total periodic pension cost in IFRS & US GAAP
Ø The main difference between US GAAP and IFRS is the allocation of total periodic pension cost between the income statement (pension expense) and OCI.
Ø Under both US GAAP and IFRS
• TPPC = Periodic pension cost in I/S + Periodic pension
Periodic Pension Cost in US GAAP
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 the increase in the PBO due to the passage of time. It is calculated by multiplying the PBO at the beginning of the period by the discount rate.
Ø Expected return on plan assets: The return on the plan assets has no effect on the PBO. However, the expected return on plan assets will reduces pension expense.
Periodic Pension Cost in US GAAP
Ø Actuarial gains and losses: There are two components within actuarial gains and losses.
1. The gain or loss due to decrease or increase in PBO occurring on account of changes in actuarial assumptions.
2. The difference between actual and expected return on plan assets.
• Actuarial gains and losses are recognized in OCI.
ü Under IFRS, actuarial gains and losses are not amortized. ü Under US GAAP, actuarial gains and losses are amortized
using the corridor approach.
Corridor Approach in US GAAP
Once the beginning balance of actuarial gains and losses exceed 10% of the greater of the beginning PBO or plan assets, amortization is required. The excess amount over the “corridor” is amortized as a component of periodic pension cost in I/S over the remaining service life of the employees.
Ø The amortization of an actuarial gain reduces periodic pension cost.
Ø The amortization of an actuarial loss increases periodic pension cost.
Example of Corridor Approach
Assume that the beginning balance of the PBO is $5,000,000, the beginning balance of fair value of plan asset is $3,900,000, and the beginning balance of unrecognized actuarial losses is $600,000. The expected average remaining working lives of the employee is 15 years.
Ø The corridor is $500,000, which is 10% of the PBO (selected as the greater of the PBO or the fair value of plan assets).
Ø Because the balance of unrecognized actuarial losses exceeds the $500,000 corridor, amortization is required. ($600,000 > $500,000 ) Ø The amount of the amortization is $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, 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.
• 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.
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)
US GAAP VS IFRS
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
Calculate:
A. Total periodic pension cost.
B. Periodic pension cost reported in I/S under US GAAP (ignore amortization of past service cost)
C. Periodic pension cost in reported in I/S under IFRS.
D.Periodic pension cost reported in OCI under US GAAP
E. Periodic pension cost reported in OCI under IFRS.
Answer for Question A
A: Total periodic pension cost. Answer:
TPPC = employer contribution – change in funded status = 1,200 – [ (-12,937) – (-10,428) ] = $3,709
Alternatively,
TPPC = current service cost + interest cost +past service cost + actuarial losses - actual return
= 1,850 + 2,906 + 120 + 628 – 1,795 = $3,709
Answer for Question B
B: Periodic pension cost reported in I/S under US GAAP. Answer:
Corridor approach:
Beginning PBO > Beginning plan assets, we take 10% of beginning PBO as corridor = $3,875; Since unamortized actuarial losses ($3,150) do not exceed $3,875, no amortization is necessary.
Periodic pension cost = Current service cost + Interest cost – Expected return on plan assets
= 1,850 + 2,906 - 1,699 = $3,057
* Expected return = Expected rate of return x Beginning plan assets = 6% x 28,322 = $1,699
Answer for Question C
C: Periodic pension cost in reported in I/S under IFRS. Answer:
Periodic pension cost = Current service cost + Past service cost + Net interest cost
= 1,850 + 120 + 782 = $2,752
* Net interest cost = Discount rate x Beginning funded status = 7.5% x (-10,428) = -$782
Answer for Question D & E
D: Periodic pension cost reported in OCI under US GAAP Answer:
Periodic pension cost in OCI = Total periodic pension cost – periodic pension cost in I/S = 3,709 – 3,057 = $652 E: Periodic pension cost reported in OCI under IFRS Answer:
Periodic pension cost in OCI = Total periodic pension cost – periodic pension cost in I/S = 3,709 – 2,752 = $957
Ø Importance: ☆☆☆
Ø Content:
• The presentation of PBO on balance sheet ü掌握影响期末PBO变动的因素 • The presentation of plan assets on balance sheet
ü掌握影响期末养老金资产余额的因素 • Periodic pension cost in I/S under IFRS & US GAAP
ü辨析IFRS和US GAAP在披露养老金费用是的异同点 ü可能考Pension expense的计算
Ø Exam tips:
• 此部分是这个Reading的核心且为重要考点，务必掌握。
Analysis and Adjustment of Pension
Accounting
Tasks:
Ø Explain and calculate the effect of a defined benefit plan’s assumptions on the defined benefit obligation and periodic pension cost.
Ø Explain and calculate how adjusting for items of pension and other post- employment benefits that are reported in the notes to the financial statements affects financial statements and ratios
Assumptions of Defined Benefit Obligation and Periodic Pension Cost The firm discloses three assumptions used in its pension calculations:
Ø Discount rate: the interest rate used to compute the PV of the benefit obligation and the current service cost component of pension expense . • Based on interest rates of high quality corporate fixed income
investments with a maturity profile similar to the future obligation. • Affects the PBO as well as pension expense.
Ø Rate of compensation growth: affects both the PBO and pension expense. Ø Expected return on plan assets: assumed long-term rate of return on the
plan’s investments.
• The expected return is assumed only under US GAAP. • Under IFRS, expected return is equal to the discount rate.
Effect of Changing Pension Assumption
Increasing the discount rate:Ø Reduce PV; PBO is lower; improve the funded status.
Ø Usually result in lower pension expense because of lower service cost. • The current service cost is a PV calculation.
Ø Usually reduce interest cost (PBO * discount rate) unless the plan is mature.
• The beginning PBO is reduced when the discount rate increases. For a nonmature plan this decrease more than offsets the impact of the increased rate at which we compute the interest cost.
Effect of Changing Pension Assumption
Decreasing the compensation growth rate:Ø Reduce future pension payments; PBO is lower; improve the funded status.
Ø Reduce current service cost and lower interest cost; pension expense will decrease.
Increasing the expected return on plan assets (under US GAAP):
Ø Reduce periodic pension cost reported in I/S.
Effect of Changing Pension Assumption
Effect on Items Discount RateIncrease Compensation GrowthDecrease Rate of Increase Expected Rate of Return Balance Sheet
Liability Decrease Decrease No Effect Total Periodic
Pension Cost Decrease Decrease No Effect Periodic Pension
cost in I/S Decrease* Decrease Decrease**
Ø *For mature plans, a higher discount rate might increase interest costs. In rare cases, interest cost will increase by enough to offset the decrease in the current service cost, and periodic pension cost will increase . Ø **Under U.S. GAAP only. Not applicable under IFRS.
Assumption of other post-employment benefits
Accounting for other post-employment benefits:Ø The assumptions are similar for other post-employment benefits expect the compensation growth rate is replaced by a healthcare inflation rate. This constant rate is known as the ultimate healthcare trend rate.
Ø Firms can reduce the post-employment benefit obligation and periodic expense by:
• Decreasing the near term healthcare inflation rate. • Decreasing the ultimate healthcare trend rate.
• Reducing the time needed to reach the ultimate healthcare trend rate.
Adjusting Items of Pension Benefits for Analytical Purposes
Several aspects of the accounting for pensions and other post-employment benefits can affect comparative financial analysis using ratios based on financial statements.
Ø Gross vs. net pension assets/liabilities
• The firm's total assets and total liabilities are both less than if the firm reported the gross amounts.
• Under both IFRS and U.S. GAAP standards, the amount disclosed in the balance sheet is a net amount.
Ø Differences in assumptions used
• Differences in key assumptions can affect comparisons across companies.
Adjusting Items of Pension Benefits for Analytical Purposes
Ø Differences between IFRS and U.S. GAAP in recognizing total periodic pension cost
• Periodic pension costs may not be comparable. IFRS and U.S. GAAP differ in their provisions about costs recognized in P&L versus in OCI. Ø Reporting of periodic pension costs in P&L may not be comparable .
• Under US GAAP, all of the components of pension costs in P&L are reported in operating expense on the income statement even though some of the components are of a financial nature. (interest expense and the expected return on assets)
Adjusting Items of Pension Benefits for Analytical Purposes
Ø Analysts can adjust GAAP-reported income by: (ignores
any amortization)
• Adding back the periodic pension cost in I/S and subtracting only service cost in determining
operating income.
• Interest cost should be added to the firm's interest
expense.
• Actual return on plan assets should be added to
non-operating income.
Example of Reclassifying Periodic Pension Cost
Use the following information to reclassify the components of periodic pension cost between operating and nonoperating items:
Ø Operating profit = $145,000 Ø Interest expense = ($12,000) Ø Other income = $2,000 Ø Income before tax = $ 135,000 Ø Other data:
• Current service cost = $7,000 • Interest cost = $5,000
• Expected Return on assets = $8,000 • Actual return on assets = $9,500
Example of Reclassifying Periodic Pension Cost
Answer:
Ø Periodic pension cost (in P&L) of $4,000 ($7,000 current service cost + $5,000 interest cost - $8,000 expected return on assets) is added back to operating profit.
Ø Service cost of $7,000 is subtracted from operating profit. Ø Interest cost of $5,000 is added to interest expense. Ø The actual return on assets of $9,500 is added to other income.
I/S Reported ($) Adjustments ($) Adjusted ($) Operating profit 145,000 + 4,000 – 7,000 142,000 Interest expense (12,000) - 5,000 (17,000) Other income 2,000 + 9,500 11,500 Income before tax 135,000 136,500
Analyst’s View on Cash Flow Adjustment
Cash flow refers to pension including the amount of contribution
and the amount of benefits paid.
Ø If the firm's contributions exceed its total periodic pension cost, the difference can be viewed as a reduction in the overall pension obligation.
Ø if the total periodic pension cost exceeds the contributions, the difference can be viewed as a source of borrowing.
Analyst’s View on Cash Flow Adjustment
Analysis of cash flowØ Over-contribution: contribution > total periodic pension costs
• CFO adjustment = CFO + (Contribution - TPPC)*(1-t)
• CFF adjustment = CFF - (Contribution - TPPC)*(1-t) (Repayment)
Ø Under-contribution: contribution < total periodic pension expenses
• CFO adjustment = CFO - (Contribution - TPPC)*(1-t)
• CFF adjustment = CFF + (Contribution - TPPC)*(1-t) (Borrowing)
Example of Adjusting Cash Flow
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. Calculate CFO and CFF after making appropriate adjustments.
Example of Adjusting Cash Flow
Answer:
Ø Total periodic pension cost = contributions – (ending funded status - beginning funded status)
= 340 – (2,180 – 2,530) = 340 – (-350) = $690 million
Ø The company’s contribution were $350 million less than TPPC
• After tax shortfall = 350(1 - 0.4) = $210 million
• Adjusted CFO = 948 - 210 = $738 million
• Adjusted CFF = 112 + 210 = $322million
Ø Importance: ☆☆☆
Ø 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重点掌握分析师如何调整养老金的现金流
Ø Exam tips:
• 此部分多以定性判断为主，主要是站在分析师的角度，如
何分析各种和养老金相关的可能带来数据操纵的科目。
Share-based Compensation
Tasks:
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
Share-based compensation plans can take several forms , including stock options and share grants.
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.
Ø Stock compensation plan takes many forms
• 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
Ø Stock options
• 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 identical amount. This results in no change to total equity.
Accounting for Share-based Compensation
Ø Stock options
Accounting for Share-based Compensation
Ø Stock grants
• 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)
Ø Types of stock grants
• 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,
ROE, etc…)
ü May result in manipulation
Accounting for Share-based Compensation
Ø Stock appreciation rights
• 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 receive compensation based on the increase in the price of the firm's stock over a predetermined amount.
• 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.
Accounting for Share-based Compensation
Ø Phantom stock
• Phantom stock is similar to stock appreciation rights except the payoff is based on the performance of
hypothetical stock instead of the firm's actual shares. • Phantom stock can be used in privately held firms
and firms with highly illiquid stock.
Ø Importance: ☆
Ø Content:
• Accounting for Share-based Compensation ü掌握四种权益授予薪酬（奖金）的形式
ü其中重点是股票期权授予和直接授予股票这两种 形式 Ø 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，
不是考试的重点，仅作了解要求。
Classification of Currencies in
Multinational Financial Reporting
Tasks:
Ø Distinguish among presentation (reporting) currency, functional currency, and local currency.
Ø Describe foreign currency transaction exposure, including accounting for and disclosures about foreign currency transaction gains and losses.
Influence of Foreign Currency Accounting
Foreign currency can affect a multinational firm's financial statements in two ways:
Ø The multinational company may engage in business transactions that are denominated in a foreign currency.
• Foreign currency transaction
Ø the multinational company may invest in subsidiaries that maintain their books and records in a foreign currency.
• Foreign currency translation (考试主要针对考查这种情况)
Classification of Currencies
Currencies that are involved in multinational accounting
Ø The local currency
• The currency of the country in which the entity is located.
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 operates. It is usually the currency in which the entity generates and 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 statements .
Foreign Currency Transactions
Foreign currency denominated transactions are
measured in the
presentation (reporting) currency
at
the spot rate on the transaction date.
Foreign Currency Transactions
Treatment of foreign currency transactions:
Ø Transactions in foreign currencies are translated into the
functional currency at the exchange rates at the date of
transaction.
Ø Monetary assets and liabilities dominated in foreign currencies at the balance sheet date are re-valued at the exchange rate at that date.
Ø Differences arising on the transactions are recognized on the I/S.
Example of Foreign Currency Transactions
A U.S. firm that sells goods to an Italian company for €10 , 000 when the spot exchange rate is $1.60 per euro. Payment is due in 30 days. When payment is actually received, the euro has depreciated to $1. 50. Ø On the transaction date, the U.S. firm recognizes a sale, and an
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
immediately converts the euros to $15,000 (€10,000 x $1.50) Ø As a result of the depreciating euro, the U.S. firm recognizes a
$1 ,000 loss in the income statement.
Ø The Italian firm recognized no gain or loss since the purchase and settlement transactions were both denominated in euros.
Foreign Currency Transactions
Analytical issues and disclosure analysisØ While transaction gains and losses are recognized in the income statement, the accounting standards do not provide any guidance to include them within operating or non-operating income. Ø Neither standard requires disclosure of where such gains/losses
would be recorded.
Ø The comparability of operating margins between entities would be diminished if the compared entities used different methods.
Summary
Impact due to changes in foreign currency exchange rate
Transactions ExposureTypes of
Foreign Currency
Appreciation Depreciation
Export Sales Asset (A/R) Gain Loss
