2020 L2 Fra

Updated: January 27,2020
Intercorporate Investments
a. describe the classification, measurement, and disclosure under International

Financial Reporting Standards (IFRS) for 1) investments in financial assets,
2) investments in associates, 3) joint ventures, 4) business combinations, and
5) special purpose and variable interest entities;
b. distinguish between IFRS and US GAAP in the classification, measurement,

and disclosure of investments in financial assets, investments in associates,
joint ventures, business combinations, and special purpose and variable
interest entities;
c. analyze how different methods used to account for intercorporate

investments affect financial statements and ratios.
Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

Transaction: 0056282335,
⇒ Intercorporate Investments ➞ investments in other companies Pg-1
➞ Debt or Equity diversify their asset base

enter new markets
obtain competitive advantage
achieve additional profitability
⇒ Basic Corporate Investment Categories/
1) Investments in Financial Assets
- no significant influence or control, typically < 20% equity interest
- classified as · FV ➞P/L, FV ➞ OCI, amortized cost
(prior to IFRS 9 ➞ held to maturity, available for sale, FV ➞ P/L,
loans & receivables)
2) Investments in Associates
- significant influence but no control, typically 20%-50% equity
interest
3) Joint Ventures
- control is shared by 2 or more entities
⇒ Basic Corporate Investment Categories/ Pg-2
4) Business Combinations (including investments in subsidiaries)

- control, typically > 50% equity interest
⇒ Investments in Financial Assets/
- categories
1/ amortized cost – the financial assets are being held to collect
(only debt) contractual cash flows
- cash flows are solely principal + interest
if the asset can be sold, can elect 203 below

2/ FV through profit or loss (FVPL)
all equity, some debt
3/ FV through OCI (FVOCI)
- all are measured at FV when initially acquired
- all interest & dividends are recognized as income in P/L

Pg-3
Reclassifications:
Equity ➞ No
Debt ➞ if point 1 or 2
change
(no prior period
restatement required)
choice is - on reclassification:
- measured at FV
irrevocable
- unrealized g/L → P/L
FV = new carrying value
all income goes

to P/L
- also Derivatives
that are NOT hedging instruments
⇒ Summary/
Pg-4
· evaluate company performance separately
for operating and investing activities
- analysis of operations should exclude:
· interest income
· dividend income
· gains/losses on investments
- exclude non-operating assets in net operating assets

Associates/ JV
⇒ 20%-50% voting rights

Pg-5
- significant influence but no control
⇒ Equity method
- Investment initially recorded at cost of acquired shares
- each subsequent period – adjusted for
proportionate share of the changes in investee’s net assets
i.e./ + prop. share of earnings IS separate
- prop. share of dividends BS only disclosures
- classified as non-current assets
e.g./ ABC purchases 20% interest in XYZ for Pg-6
$480k Jan. 2/13 (48,000 shares @ $10/sh.)
Investment in Associate 480k

BS
Cash 480k
XYZ reports NI = 200k for 2013

Investment in Associate 40k BS
Investment Income (loss) 40k IS
Dec. 31, FV/sh. = $12.00
- no changes
Jan. 28/14 Cash Dividend $100k

Cash 20k
BS
Investment in Associates 20k
- Note: Dividends & FV do not affect NI

e.g./ Income Dividends Pg-7

2010 200k 50k - assume a 20%
2011 300k 100k interest for $200k
2012 400k 200k
Investment in Associate:
Initial Cost 200k

2010 Income 40k (IS + 40k)
2010 Div. (10k) (cash + 10k)
2011 Income 60k (IS + 60k)
2011 Div. (20k) (cash + 20k)
2012 Income 80k (IS + 80k)
2012 Div. (40k) (cash + 40k)
310k
⇒ 2 issues
Pg-8
1) acquisition cost ≠ BV (on a % basis)
e.g./ Jan 1/14, My Co. buys 25% of Your Co. for $8.5M
but BV of Your Co. = $30M
Purchase $ = 8.5M difference first

allocated to specific assets
25% of BV = 7.5M why?
Excess
1.0M
- assume dep. assets are undervalued by $2.4M
25% = $600k $400k Goodwill
tested yearly for

assets have 8 yr. life
impairment
- reduce ‘Inv. in. Assoc.’ by
(IFRS/GAAP)
$75,000/yr.
- reduces Inv. Income as well

e.g. Con’t/ Your Co. reports Pg-9

- NI – 2.8 M (2014)
Issue - includes loss on Disc. Ops. of $400k
#2 - Dividends declared & paid Dec. 31/14 = $ 1.4M
Jan. 1/14/ Inv. in Associates $8.5 M Initial

Cash 8.5M Cost
Dec. 31/14/ Inv. in Associates 700k - share of NI
Loss from Disc. Ops. 100k ‘as earned’
Invest. Income (loss) 800k Issue #2
Cash 350k
Dividends
Inv. in Associates 350k
Invest. Income (loss) 75k amort. of
Inv. in Associates 75k identifiable
excess
e.g./ Pg-10
BV FV
CA 10k 10k - acquire 30% for %100k
P&E 190k 220k 30% × BV
Land 120k 140k = .3 × 220k = $66k
320k 370k Excess = $34k
Liab. 100k 100k
Net Assets 220k 270k
FV – BV
= 270K -220K = 50K 9k – P&E ⇒ amortized
× 30% 6k – Land ⇒ no amort.
= 15k attributable
to specific assets
∴ Goodwill = $19k

⇒ FV option/ IFRS/GAAP
Pg-11
all entries
restricted
(VC, MF, trusts)
- Investment reported at FV
- unrealized +/- ⇒ NI
- Interest/Dividends ⇒ NI
- excess over BV ⇒ not amortized
⇒ Impairment/ IFRS/GAAP – periodic reviews of ‘equity
method’ investments for impairment
- entire carrying amount is tested
- if so, written down to recoverable amount ⇒ NI.
B.S.
- Reversals prohibited (IFRS & GAAP)
- Transactions with associates/ Pg-12

investor
upstream downstream - profit recorded on
investor’s P&L
associate
profit recorded
on associate’s P&L
IFRS/GAAP
- profits from such transactions cannot
be realized until confirmed either through
1) use
2) sale to 3rd party
unrealized profit
- proportionate amount must be taken out of
investor’s ‘Income from Investment’ until confirmed

e.g./ · Jan. 1, 2011 Wicker acquires 25% of Foxworth for $1M Pg-13
· BV = $3.8M · FV = $3.84M ⇒ $40k for a building 20-yr. life

· Div = $3,200 · NI = 20,000
$8,000 from an upstream sale of inventory

Purchase Price $1M
2011, Investment Income/
25% BV 950k
25% NI = 5,000
Excess 50k
Amort. (500)
Building (10k)
Unrealized
Goodwill 40k
profit (2,000)
- dep. exp./yr. = 10K/20 = 500
2,500
YR-end 2011 Purchase Price $1M
Balance Sheet: + NI share 2,500
- Dividends (800)
1,001,700
e.g./ · Jones owns 25% of Jason Co. Pg-14

· annual amort. of excess paid = $8k
$96,000 $160,000
2011/
(Jones) Jason Co. $120,000 (2011)
Inventory sale (paid) COGS
$40,000 (2012)
2011 NI = 800k
2012 NI = 820k
2011 Jones equity income? 2012 Jones equity income?

25% share 200,000 25% share 205,000
- Amort. (8,000) - Amort. (8,000)
- Unreal. Pr. (25%) (4,000) - Realized Pr. 4,000
188,000 201,000
25% unsold
Margin on sale = $64k
(.25 × 64k) = 16k unreal. pr.

⇒ Disclosure/ Pg-15
· classified as non-current assets
NI before Disc. Op.
· Income recorded as earned
Disc. Op.
OCI
- separate line item on BS, and for each Income item (or in the Notes)
- FV for any of these investments that have a market price
- information about differences in year ends between Investor and associate
- IFRS/ + info on associates – assets, liabilities, revenue, NI
⇒ Issues for analysts/ Pg-16

- is equity method appropriate
e.g. 19% but sig. influence
25% but no influence
- Investment in Associate – single line on Investor B.S.
- may not reflect FV of net assets
- Investment Income – prop. share included in NI but
no prop. reflection in Sales
- equity method ‘earnings’ are non-cash earnings
Business Combinations
⇒ move from influence to control Pg-17

⇒ move from ‘equity method’ to ‘acquisition method’
- IFRS ⇒ no designation/distinction regarding the resulting structure
- GAAP ⇒ Merger: A + B = A (B is gone)
⇒ acquisition: A + B = A – B (A&B continue, parent-
- need not be 100% subsidiary relationship)
- parent reports on a consolidated basis
⇒ consolidation: A + B = C (A&B are gone, C emerges)
⇒ SPE/VIE: no voting control but sponsor company may have control

- pre-June 2001 ➞ GAAP allowed either (as did IFRS) Pg-18
1) pooling of interests 𝐁𝐕𝐀 + 𝐁𝐕𝐁

2) purchase method (when pooling criteria not met)
𝐁𝐕𝐀 + 𝐅𝐕𝐁
- post-June 2001 ➞ GAAP – purchase method only
- IFRS – allowed both
- post-March 2004 ➞ IFRS/GAAP – purchase method only
- post Jan. 1, 2013 ➞ IRFS – acquisition method
- control defined as
IFRS 10, 3
1) investor has ability to exert
FASB ASC 805
810 influence on financial & operating policy
2) investor is exposed to, or has rights to, variable returns
Pg-19
- GAAP ➞ VIE: primary beneficiary consolidates
- party that will absorb

majority of expected losses or receive
majority of expected residual returns
➞ voting–interest ➞ control as evidenced by voting rights
⇒ All business combinations ➞ acquisition method
- less than 100% ➞ parent reports consolidated statements
Acquisition Method
⇒ both IFRS & GAAP/ required for all Bus. Comb.

Pg-20
- price paid (i.e. consideration given), both clear
and contingent, is the FV of the acquisition
➞ 3 issues/
➀ recognition and measurement of assets &
liabilities of combined entity
➁ initial recognition and subsequent accounting for goodwill
➂ recognition and measurement of any
non-controlling interest (covered when we discuss Consolidation)

Pg-21
⇒ Issue #1: Recognition and Measurement of/
A) Identifiable Assets & Liabilities
1) tangible and intangible assets & liabilities
at FV as of date of acquisition
2) must also recognize assets & liabilities
not previously recognized (of acquiree)
(i.e. internally generated brands, patents)
B) Contingent liabilities
a ll IFRS/ 1) it is a present obligation arising from past events
e n c i es
conting 2) can be measured reliably
- expected costs not included (e.g. restructuring costs)
⇒ Issue #1: Recognition and Measurement of/ Pg-22

B) Contingent liabilities
GAAP/ - only contingencies that are
probable and can be measured reliable
C) Indemnification Assets
- arise when the seller indemnifies the
buyer for the outcome of a contingency
e.g./ Contingent Liability – measured at $20M
- seller indemnifies buyer for
Acquirer: B.S. all costs > $15M
Indem. Asset $5M Contingent Liability $20M

⇒ Issue #1: Recognition and Measurement of/ Pg-23

D) Financial Assets/
- will be reclassified from acquiree
to acquirer’s business model
(i.e. FV–PL, FV–OCI, amort. cost)
⇒ Issue #2: Recognition and Measurement of Goodwill
IFRS – 2 options GAAP – 1 option · not amortized

· tested for impairment
Partial Full
- FV of acquisition - FV of entity as a whole

less FV of net less FV of net identifiable
identifiable assets assets
⇒ Issue #2: Recognition and Measurement of Goodwill

Pg-24
e.g./ $800k for 80% of target ∴ FVentity = 1M
FVnet assets = $900k
Partial Full
FV of acquisition 800k FVentity $1M
- 80% of FVnet assets 720k - FVnet assets 900k
80k 100k
Goodwill recognized
Note/ if acquisition price < FV
- called a bargain acquisition
- FVnet assets less acquisition price = gain on IS

⇒ Impact on FS – Franklin acquires 100% of Pg-25

Jefferson by issuing 1,000,000 shares, par value €1, MV = €15M
FJ
10,300
15,000
31,500
Goodwill 9,600
66,400
8,600
17,800
26,400
6,000
20,000
14,000
66,400
The Consolidation Process
- combine the statements of the parent & subsidiaries Pg-26
as if they were one economic unit

- transactions between parent & sub. eliminated
intercompany transactions
- avoid double-counting & premature revenue recognition
⇒ Business Combinations < 100% acquisition/
(but > 50%)
- parent consolidates
- introduces ‘Non-Controlling (Minority) Interests’
- the portion of the subsidiary’s equity
that is held by 3rd parties
(IFRS & GAAP are similar)

⇒ Business Combinations < 100% acquisition/ Pg-27

‘Non-Controlling (Minority) Interests’
- presented on the consolidated balance
sheet as a separate component of stockholder’s equity
Issue - IFSRS & GAAP differ on the measurement
#3
Partial or Full Goodwill
Full Goodwill method only
method
e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of

Subsidiary Co. for €180,000 (no par common)
FMV = €200k
con’t ⇒
e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of Pg-28

Subsidiary Co. for €180,000 (no par. common)
FMV = €200k
Goodwill
Partial:
𝟏𝟖𝟎, 𝟎𝟎𝟎
(− 𝟏𝟔𝟎, 𝟎𝟎𝟎 × . 𝟗)
= 𝟑𝟔, 𝟎𝟎𝟎
Full:
𝟐𝟎𝟎, 𝟎𝟎𝟎
− 𝟏𝟔𝟎, 𝟎𝟎𝟎
= 𝟒𝟎, 𝟎𝟎𝟎

e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of Pg-29

FMV = €200k
Partial Full
55 55
205 205
390 390
36 GW 40
686 690
75 75
190 190
265 265
16 NCI 20
267 267
138 138
686 690
⇒ Income Statement/ Pg-30
(all inter-company transactions eliminated)

𝟓𝟕.𝟏𝟓 𝟓𝟕.𝟏𝟓
ROA 𝟔𝟗𝟎
= 𝟖. 𝟐𝟖% 𝟔𝟖𝟔
= 𝟖. 𝟑𝟑%
𝟓𝟕.𝟏𝟓 𝟓𝟕.𝟏𝟓
ROE 𝟒𝟐𝟓
= 𝟏𝟑. 𝟒𝟓% 𝟒𝟐𝟏
= 𝟏𝟑. 𝟓𝟕%

⇒ Goodwill Impairment/ Pg-31

- tested annually – if impaired ⇒ written down
not reversible
IFRS ⇒ at time of acquisition:
Total Goodwill
allocated to each:
acquirer’s cash-generating units that will
benefit from expected synergies
- loss reported
as a separate recoverable amount/unit compared
line item in the
with carrying amount/unit
consolidated IS
⇒ loss applied to goodwill for that unit
⇒ once carrying value = 0, remaining loss
allocated to other assets on a pro-rata basis
⇒ Goodwill Impairment/ Pg-32

- tested annually – if impaired ⇒ written down
not reversible
GAAP ⇒ at time of acquisition:
Total Goodwill
allocated to each:
acquirer’s reporting units
carrying value of the whole

reporting unit vs. FV
Impairment loss =
Implied FV of - Carrying amount
unit’s goodwill
· applied to the unit until = ∅

· no other allocation

e.g./ IFRS: Cash-generating unit Pg-33

Carrying value = $1.4M
- includes $300k Goodwill
Recoverable amount = $1.3M Recoverable amount = $800k

𝐅𝐕𝐚𝐬𝐬𝐞𝐭𝐬 = $𝟏. 𝟐𝐌 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = $𝟏. 𝟐𝐌
Rec. amt. = 1.3M Rec. amt. = 800k

C. value = 1.4M C. value = 1.4M
- 100k impairment - 600k impairment
loss loss
new C. value - $1.3M new C. value = $800k
- includes $200k Goodwill - includes ∅ Goodwill
- 300k allocated to other assets
e.g./ GAAP: Reporting-unit Pg-34

Carrying value = $1.4M
- includes $300k Goodwill
FV = $1.3M (unit) 𝐅𝐕𝐮𝐧𝐢𝐭 = 800k

𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = $1.2M 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = $1.2M
- since 𝐅𝐕𝐮𝐧𝐢𝐭 < C. value, potential loss
𝐅𝐕𝐮𝐧𝐢𝐭 = 1.3M 𝐅𝐕𝐮𝐧𝐢𝐭 = 800k

- 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = 1.2M - 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = 1.2M
implied Goodwill 100k implied Goodw. -400k
Current Goodwill 300k Current G. = 300k
- Implied Goodwill 100k - Implied G. = 400k
∅
impairment loss 200k
impairment loss = 300k

VIE/SPE
· special purpose entity - IFRS/ GAAP Pg-35

· variable interest entity - GAAP
right to use
the assets outside
funding
Sponsor Company SPE
typically strict
transfers
limits placed on
typically retains assets
governing BOD
significant beneficial interest
in the SPE even though it
may have little voting control
· companies were able to avoid consolidation

· transferred assets were recorded as sales
e.g./ Enron
IFRS 10 ➞ definition of control now encompasses SPEs Pg-36
- GAAP – uses VIE when control is present

- an SPE is a VIE when/
➀ total equity at risk is insufficient to finance
activities without outside financial support
➁ equity investors lack:
- the ability to make decisions
- the obligation to absorb losses
- the right to receive returns
- primary beneficiary of a VIE must consolidate
- party absorbing majority of losses

Pg-37
Sponsor must Assets are Leased to Sponsor
consolidate/
SPE Leases Asset

to Sponsor minimal 3rd
party equity
end result:
Sponsor Sponsor B.S. will look the
SPE
- retains same if it
risk of - borrowed to buy
default - used the VIE/SPE
SPE borrows from debt

Sponsor makes cash lease market and builds or
payments used to pay off debt acquires an asset
+ provide return to - lower rd
equity holders

Employee Compensation: Post-Employment

and Share-Based
a. describe the types of post-employment benefit plans and implications for

financial reports;
b. explain and calculate measures of a defined benefit pension obligation (i.e.,

present value of the defined benefit obligation and projected benefit
obligation) and net pension liability (or asset);
c. describe the components of a company’s defined benefit pension costs;
d. explain and calculate the effect of a defined benefit plan’s assumptions on

the defined benefit obligation and periodic pension cost;
e. 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;
f. interpret pension plan note disclosures including cash flow related

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

Benefit Plans
A/ Defined Contribution – DC LOS a

-describe
- specific, agreed upon, contributions are
Pg-1
made to an employee’s pension plan
⇒ employer’s contributions are defined, employee’s
benefits are not no further
- employer’s contribution = pension expense obligation
· generally, in the period in which the employee provides service

- amounts paid usually attributed to specific individuals
⇒ future value depends on plan performance
- all gains/losses accrue to employee
B/ Defined Benefit - DB LOS a

-describe
- specifies the benefit the employee receives
Pg-2
- employer’s contribution is not fixed
- creates a future obligation based on current service
- the entitlement to the benefits increase
with the length of the employee’s service
Note/ DC – employee is the beneficiary

DB – employer is the beneficiary – plan assets
𝐏𝐕 [𝐅𝐮𝐭𝐮𝐫𝐞 𝐛𝐞𝐧𝐞𝐟𝐢𝐭] = 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐨𝐛𝐥𝐢𝐠𝐚𝐭𝐢𝐨𝐧
𝐅𝐕 [𝐏𝐥𝐚𝐧 𝐚𝐬𝐬𝐞𝐭𝐬] = 𝐎𝐟𝐟𝐬𝐞𝐭𝐭𝐢𝐧𝐠 𝐚𝐬𝐬𝐞𝐭

B/ Defined Benefit - DB LOS a

- if plan assets > current obligation -describe
Pg-3
- overfunded ⇒ may be possible for the
employer to recapture funds either by
➀ reduced future funding
➁ reversion of funds
- the expense to be recognized each period is not the
same as the employer’s cash funding contribution
- rely on actuaries to determine level of
obligation funding each period
- use of actuarial assumptions
- mortality rates, employee turnover, interest
rates, earnings rates, etc…
C/ Other Post-Employment benefits - OPB LOS a

-describe
- health
Pg-4
- life insurance premiums
- typically classified as DB plans (similar actg.)
- company funding requirements may not be as stringent for OPB plans
- typically, do not pre-fund

One-Person Plan Example
⇒ Pension obligation - PV of future benefits LOS b

-explain
earned by employee’s for service provided to date
-calculate
IFRS – PVDBO – PV of defined benefit obligation
Pg-5
GAAP – PBO – projected benefit obligation
e.g./ ✱ assumptions
35 yrs. ✱ life
expectancy
Lee = 12 yrs. ✱
Jan. 1/13 Dec. 31, 2047
(30) (65)
$37,500 → 4%✱ salary increases/yr. $150k/yr.
Benefit ⇒ 2% of salary at retirement for each yr. service

= (2% × final salary) × yrs service
LOS b
YR. 1/ r = 6% (assumed)
-explain
annual pension benefit -calculate
(. 𝟎𝟐 × 𝟏𝟓𝟎, 𝟎𝟎𝟎) × 𝟏 = 𝟑, 𝟎𝟎𝟎 Pg-6
3k 3k… 3k
PMT = 3000
𝑷𝑽𝟑𝟓
t0 PV1 = (𝟏.𝟎𝟔)𝟑𝟒
= 𝟑, 𝟒𝟔𝟖. 𝟔𝟖 t35 t47 I/Y = 6
PV35 = 25,151.53 FV = 0
- current service cost = $3,468.68
N = 12
YR. 2/
3k 3k… 3k
𝑷𝑽𝟑𝟓
PV2 = (𝟏.𝟎𝟔)𝟑𝟑
= 𝟑, 𝟔𝟕𝟔. 𝟖𝟏 t35 t47
PV35 = 25,151.53
YR2 service cost = $3,676.81

⇒ Pension Obligation LOS b

-explain
6k 6k… 6k -calculate
𝑷𝑽𝟑𝟓 Pg-7
PV2 = = 𝟕, 𝟑𝟓𝟒 t35 t47
(𝟏.𝟎𝟔)𝟑𝟑
PV35 = 50,303.04 PMT = 6000
I/Y = 6
FV = 0
PO1 = 3,469 × .06 = 208
- interest on outstanding N = 12
PO2 = 3,677
7,146
obligation = r (current market rate
208 on IG Corporate Bonds)
7,354
YR. 2 IFRS
Current Service Cost
3,677 interest rate
Interest Cost
208 =
3,885 discount rate
⇒ Pension Obligation/ 7,354 (end YR2) LOS b

8000 - asset -explain
Plan Assets -calculate
7000 - liability
Pg-8
⇒ Actuarial gains/losses
- result from a) change in assumptions
b) an experience gain/loss
- difference between actual vs. estimate
- if life expectancy increases 1yr. to 13 yrs.

⇒ PO = 7,765 (7,765 – 7,354) = 411
actuarial loss
(OCI)

Component Costs
LOS c
⇒ DC – reported as expense on IS
-describe
- no BS effect Pg-9
⇒ DB – funded status – on BS
𝐏𝐎 > 𝐅𝐕𝐚𝐬𝐬𝐞𝐭𝐬 – underfunded
PO, end of period
- net pension liability
- FV (plan assets)
𝐏𝐎 < 𝐅𝐕𝐚𝐬𝐬𝐞𝐭𝐬 – overfunded
= funded status
- net pension asset
(subject to a ceiling)
(PV of future refunds & reductions)
e.g./ ABC DEF
pension obligation 6723 5485
FV (plan assets) 4880 5998 – ceiling = 326
net pension liability 1843
net pension asset 326
⇒ Periodic Pension Cost/ IFRS (immediate recognition approach) LOS c

-describe
1) Service Costs
Pg-10
- current and past (retroactive benefits or
retroactive curtailments)
past service cost
past service benefit
- recognized in P/L
2) Net interest expense/income
- net pension liability/asset × discount rate
- recognized in P/L
3) Remeasurement
- actuarial gains/losses
- difference between actual return on
plan assets and expected return
- recognized in OCI

LOS c
⇒ Periodic Pension Cost/ GAAP (deferral & amortization approach)
-describe
1) Service Costs Pg-11
- current ⇒ P/L
- past ⇒ OCI in the period giving rise to the cost
- amortized to P/L over avg. service
lives of affected employees
2) (+) Interest expense (discount rate × P0)
P/L
(-) Return on plan assets (expected return)
not presented net

3) Remeasurements - actual vs. expected returns are
treated as actuarial gains/losses ⇒ OCI
- corridor approach
⇒ Deferral & Amortization + Corridor Approaches/ LOS c

-describe
- delay recognition of 1) past service costs
Pg-12
2) actuarial gains/losses in plan expense
- amounts not reflected in P/L are called unrecognized
past service costs or unrecognized actuarial gains/losses
- motivation is to reduce period-to-period volatility in pension expense
⇒ unrecog. act. gains/losses
- actuarial gains/losses are expected to offset
each other over time
- but what if no offsetting occurs?
⇒ Corridor approach

Corridor approach (commonly used) LOS c

- used when unrecog. act. gains/losses -describe
Pg-13
continue to grow (no offsetting occurs)
- amortized when balance grows too large
- at beginning of period, if net cumulative unrecog.
act. gains/losses > 10% of the larger of 1) P0
2) FV (plan assets)
then excess is amortized over expected average
remaining working lives of employees in the plan
LOS c
2013 2014 2015 -describe
P0 (beg) 2.1M 2.6M 2.9M Pg-14
𝐅𝐕𝐚𝐬𝐬𝐞𝐭𝐬 (beg) 2.6M 2.8M 2.7M

act. +/- (YR) 400k 300k (170k)
Corridor 260k 280k 290k
(a) (b) (c) (d) (e) (f)

unrecog. amt. to amort. act. unrecog.
Corridor +/- be amort. over +/- act. +/-
(beg YR.) (beg YR.) (b-a) 5.5 yrs. (YR.) (end YR.)
2013 260k 400k 400k
2014 280 400k 120k 21,818 300 678,182
2015 290 678,182 388,182 70,579 (170) 437,603

Actuarial Assumptions
LOS d
⇒ an increase in P0 from a change in
-explain
assumptions ⇒ actuarial loss -calculate
- a decrease ⇒ actuarial gain Pg-15
- when P0 changes ➝ interest expense changes
· employee turnover
P0, beg of YR
· life expectancy
+ Current Service Cost
· future inflation
+ Interest Cost
· interest rates
- Benefits paid
· future compensation levels
+/- Past service costs/benefits
· rate of increase in compensation
-/+ Actuarial gains/losses
· long-term equity growth rate
P0, end of YR.
LOS d
5 yrs. -explain
r = 6%
-calculate
Pg-16
50k 60,198.56
4.75% increase/yr 50k(1.0475)4
= 60,198.56
1/ Benefit = (𝟏. 𝟓% × 𝐟𝐢𝐧𝐚𝐥 𝐬𝐚𝐥𝐚𝐫𝐲) × 𝐲𝐫𝐬. 𝐬𝐞𝐫𝐯𝐢𝐜𝐞
- paid in lumpsum
(. 𝟎𝟏𝟓 × 𝟔𝟎, 𝟏𝟗𝟖. 𝟓𝟔) × 𝟓 = 𝟒, 𝟓𝟏𝟒. 𝟖𝟗
annual
unit credit = $902.98
1 2 3 4 5
P0, beg YR. ∅ 715.24 1516.31 2410.94 3407.47
+ 6% interest ∅ 42.91 90.98 144.66 204.45
+ Current service costs 715.24 758.16 803.65 851.87 902.97
= P0, end YR. 715.24 1516.31 2410.94 3407.47 4514.89

LOS d
-explain
5 yrs.
-calculate
Pg-17
r = 6%
50k 60,198.56
4.75% increase/yr

- paid as a lumpsum + past service = 10 yrs. credit
(. 𝟎𝟏𝟓 × 𝟔𝟎, 𝟏𝟗𝟖. 𝟓𝟔) × 𝟏𝟓 = 𝟏𝟑, 𝟓𝟒𝟒. 𝟔𝟖 𝟗𝟎𝟐. 𝟗𝟖 × 𝟏𝟎 = 𝟗𝟎𝟐𝟗. 𝟖𝟎
annual ÷ (𝟏. 𝟎𝟔)𝟓 = 𝟔𝟕𝟒𝟕. 𝟓𝟖
unit credit = $902.98
1 2 3 4 5
P0, beg YR. 6747.58 7867.67 9097.89 10447.41 11926.13
+ 6% interest 404.85 472.06 545.87 626.85 715.57
= P0, end YR. 7867.67 9097.89 10447.41 11926.13 13544.68
LOS d
5 yrs. -explain
20 yrs. -calculate
Pg-18
of
r = 6% retirement
50k 60,198.56
payments
4.75% increase/yr PMT = 4514.89
PV = 51,785.46 I/Y = 6
- annual unit credit = 902.98 N = 20
- total obligation (5 yrs.) = 4514.89 FV = 0
𝟓𝟏,𝟕𝟖𝟓.𝟒𝟔
∴ new annual unit credit = = 𝟏𝟎, 𝟑𝟓𝟕. 𝟎𝟗
𝟓
1 2 3 4 5
P0, beg YR. ∅ 8203.75 17392.03 27653.32 39083.36
+ 6% interest ∅ 492.23 1043.52 1659.20 2345.00

= P0, end YR. 8203.75 17392.03 27653.32 39083.36 51785.46
e.g./ 10 yr. past service LOS d

20 yrs. retirement benefit -explain
-calculate
6% discount rate
Pg-19
(. 𝟎𝟏𝟓 × 𝟔𝟎, 𝟏𝟗𝟖. 𝟓𝟔) × 𝟏𝟓 = 𝟏𝟑. 𝟓𝟒𝟒. 𝟔𝟖/yr
𝐏𝐕𝟓 = 𝟏𝟓𝟓, 𝟑𝟓𝟔. 𝟒𝟏 [÷ 𝟏𝟓 = 𝟏𝟎, 𝟑𝟓𝟕. 𝟎𝟗]
6% 7%
𝐏𝐎𝐛𝐞𝐠 77394.23 68205.46 lower beg. P.O.
+ Int. 4643.65 4776.38 higher int. cost
- SC 8203.79 7297.99 lower SC lower
= 𝐏𝐎𝐞𝐧𝐝 90241.67 802777.83 pension
12,074.37 cost
12,847.44
𝟕𝟕, 𝟑𝟗𝟒. 𝟐𝟑 – 𝟔𝟖, 𝟐𝟎𝟓. 𝟒𝟔 = 𝟗, 𝟏𝟖𝟖. 𝟕𝟕 ⇒ actuarial gain
(experience gain)
Disclosures
- comparability can be affected by: LOS e

-explain
➀ differences in key assumptions
-calculate
➁ periodic pension costs recognized in P/L may not be comparable Pg-20
- immediate recognition vs. defer & amortize
➂ Reporting differences between GAAP/IFRS
- affects where on the statements specific line items appear
➃ Cash flow reporting differences
- IFRS ➞ financing/operating activities
- GAAP ➞ operating activities

1/ Assumptions: LOS e
- assumptions are disclosed -explain
-calculate
· discount rates, expected compensation
Pg-21
increases, medical exp., inflation, expected
return on assets for GAAP
- other post-employment benefits
- increase in health care costs
-future inflation rate (health care) is known
as the ‘ultimate health care trend rate’
- higher near-term costs
- higher ultimate trend rate higher periodic costs
- longer time to reach trend rate
LOS e
-explain
-calculate
Pg-22
differences
may reflect
differences in
timing of
obligations

LOS e
-explain
-calculate
Pg-23
sooner to
trend
$440M
7% 9% × 𝟐=
46M
CNH CAT CNH CAT

L 16,398 50,738 16,504 50,958
100bps ↑ 6,704 8,603
E 6,810 8,823
P/E 2.408 5.75 2.462 5.923
⇒ Net Pension Liability/Asset LOS f

- IFRS/GAAP ⇒ amt. on B.S. is ‘net’ -interpret
pg-24
- gross amounts Pension Obligation (PV)
Fund Assets
in the Notes
- not consolidated since the plan is a separate legal entity
2/ Total Periodic Pension Costs

- 𝚫net pension liability/asset (before considering
employer contributions)
Periodic pension cost = ending funded status
- employer contribution
- beginning funded status

LOS f
3/ ⇒ Costs recognized in P/L vs. OCI
-interpret
IFRS GAAP pg-25
P/L - past + current SC - current SC P/L
- past SC OCI (amortized)
P/L - interest cost - expected P/L
return
OCI - actuarial gains/losses - actuarial gains/ OCI
(no amortizing losses - P/L > 10%
permitted)
could adjust GAAP NI ➞ - past SC for the

period
* or just use Total CI +/- adjust E(R) rate
for discount rate
- amortized act. +/-
for prior period
LOS f
3/ Classification in P/L -interpret
- pension expense generally treated as operating expenses pg-26
- interest expense/income may be better treated as
non-operating expenses
- adjustment/ - reduce Op. Inc. by all components of
pension expense except current service costs
- increase Int. Exp. by ‘interest component’
- increase Int. Inc. by ‘expected return’
- further ⇒ P/L (IFRS/GAAP) includes expected return
- can adjust to reflect actual return

Reclassifying IS Costs
2. Reclassify as Op. Ex., LOS f

-interpret
Int. Exp., & Int. Inc.
pg-26a
Revenue 18,020 18.020
Op. Ex. (15,401) + 36 - 11 15,376
Op. Inc. 2,619 2,644
Int. Exp. (879) - 39 (918)
Int. Inc. 316 + 47 363
Share of Assoc. 873 ` 873
PBT 2929 2,962
Current SC (11) 1) Adjust PBT for actual (R) vs. E(R)

Int. costs (39) Actual 47
E(R) 14 -E(R) 14
(36) 33
Actual 47 PBT = 2,929 + 33 = 2,962
Cash Flow Disclosures
4/ ⇒ Cash flow impact = employer’s contribution to the fund LOS f

-interpret
- if contributions to a plan in a given year are
pg-27
in excess of current pension expenses
reduces pension obligation

(economically equivalent to pre-paying principal on a loan)
e.g./ Total pension cost 20xx = $437M 67M more

Contribution in 20xx = $504M × (1 - .287)
CFO = 6,161M = 48M after-tax
CFF = (1,741M) CFO = 6161 + 48M = 6,209
t = 28.7% CFF = (1741) – 48M = (1,789)

Share-Based Compensation
- salary/bonus oriented to short-term LOS g, h

- long-run compensation typically involves some -explain
pg-28
form of equity participation based on some
long-term measures
- do not involve the use of cash
- equity compensation rewards depend on future events
∴ continued employment is usually a necessary element (vesting)
1) CSOPs – compensatory stock option plans
2) Direct awards of stock
3) SARs – stock appreciation rights plans
4) Performance – type plans
- main issues – recognition – when should the cost be recognized LOS g, h

- measurement - how the cost should be measured -explain
pg-29
- problem/ - stock options issued by the company for
ESOPs/CSOPs do not trade on exchanges
ESOP - employee stock CSOP – compensatory SOP
option plan
- transactions are seen - alternative way to
as capital transactions compensate
- Charged to equity accounts - charged to operating
income on IS
- several disadvantages LOS g, h

· mgmt. usually has limited influence over -explain
share/price market value pg-30
· ownership may lead to risk aversion

· IFRS/GAAP ⇒ FV of any share-based compensation
granted = compensation expense
⇒ FV depends on the type of compensation
CSOPs/ ⇒ FV is calculated on the date the options are
granted (grant date = measurement date)
- no adjustments are made after the grant date
for any subsequent changes in option value

CSOPs/ LOS g, h
-explain
service period – costs allocated over this period
pg-31
grant vesting expiry date

date date exercise dates
(various)
measurement (if vesting is immediate, measurement date = allocation date)

date
- if the stock options are not exercised by the
expiry date ⇒ the costs are not reversed
(the fact that an option was not exercised
does not mean that some compensation with some
value was not made)
- measurement – requires a valuation model LOS g, h

-explain
- BSM or binomial pricing model
pg-32
inputs/ · exercise price
· expected life of option - longer
· P0 (stock) FV ↑
· volatility of stock - higher
· expected dividend yield - higher - FV ↓
· 𝐫𝐟
Stock grants/ outright grant (nonmonetary reciprocal transaction)

⇒ FV = P0 on grant date
- allocated over service period

Stock grants/ · restricted stock LOS g, h

-explain
· employee forfeits stock if certain conditions are not met
pg-33
tenure or performance
⇒ FV=P0 at grant date, allocated over service period
· contingent grants
- called performance shares
- usually based on non-share price measures (ROE, ROA, etc…)
= FV=P0 at grant date, allocated over service period
- Disclosures/ · valuation model used LOS g, h

· inputs to the model including all assumptions -explain
pg-34
· number & value of options issued, exercised,
forfeited, expired
· total compensation cost in NI and contributed surplus
e.g./ Jan. 1/15 ⇒ options on 10,000 shares granted
⇒ 2 yr. vesting
⇒ FV = $220,000
Dec. 31/15 Compensation Expense 110,000
Contributed Surplus 110,000
e.g./Con’t June 1/18 20% exercised @ $60 LOS g, h

-explain
Cash (2,000 × 60) 120,000
pg-35
Contributed Surplus (20% of 220,000) 44,000
Common Shares 164,000
SARs/ stock appreciation rights/phantom stock

- compensation is tied to the value of
the shares without the need to issue shares/options
(cash–settled share-based compensation)
⇒ FV at grant date, allocated over service period

Multinational Operations
a. distinguish among presentation (reporting) currency, functional currency,

and local currency;
b. describe foreign currency transaction exposure, including accounting for and

disclosures about foreign currency transaction gains and losses;
c. analyze how changes in exchange rates affect the translated sales of the
subsidiary and parent company;
d. compare the current rate method and the temporal method, evaluate how
each affects the parent company’s balance sheet and income statement, and
determine which method is appropriate in varies scenarios;
e. calculate the translation effects and evaluate the translation of a subsidiary’s

balance sheet and income statement into the parent company’s presentation
currency;
f. analyze how the current rate method and the temporal method affect
financial statements and ratios;
g. analyze how alternative translation methods for subsidiaries operating in

hyperinflationary economies affect financial statements and ratios;
h. describe how multinational operations affect a company’s effective tax rate;
i. explain how changes in the components of sales effect the sustainability of

sales growth;
j. analyze how currency fluctuations potentially affect financial results, given a

company’s countries of operation.

Currency Terminology
LOS a
export -distinguish
Pg-1
A B
USD USD
AP-MXN
AR-MXN
60 days
translate
to USD foreign
currency
AR PMT transaction
USD.MXN fluctuates
∴ USD value of AR/AP

fluctuates
LOS a
B’s functional -distinguish
B
currency = CAD Pg-2
(CAD)
A’s functional etc.
currency .
= USD .
C
.
(MXN)
A
(USD) foreign
currency
D
consolidate subsidiaries
(EUR)
↓ - records kept in host
translate currencies country currency
to USD (local currency)
E
presentation (AUD)
currency

LOS a
⇒ Presentation currency/ the currency in which -distinguish
financial statement amounts are presented Pg-3
(typically currency of country where the company
is located)
⇒ Functional currency/ the currency of the primary economic

environment in which an entity operates
(the currency in which the entity primarily
generates and expends cash)
- typically “presentation currency = functional currency”
⇒ Local currency/ - currency where the company operates
- typically all 3 are the same currency
Currency Transactions
- by definition then, a foreign currency is LOS b

-describe
any currency other than a company’s
Pg-4
functional currency
⇒ foreign currency transactions are those denominated

in a currency other than the functional
CAD-for. curr.
A
Transaction
USD
1) import/export
USD = for. curr. in a for. curr.
func. curr.
B 2) borrow/lend in a
= USD
CAD for. curr.
(local)
func. curr. = CAD
leads to asset/liability
(local)
in a for. curr.

exports LOS b
-describe
Pg-5
A B
(MXN)
(EUR)
45 days
- owes MXN (fixed amount)
- uses EUR to buy MXN (variable amount)
- exposure to forex risk
transaction exposure
record payment IFRS/GAAP

date date - the 𝜟value of for. curr.
asset/liability resulting from a
gain/loss for. curr. transaction = gain/loss
on IS
exports LOS b
-describe
Pg-6
A B
(MXN)
(EUR) Nov 15/
45 days
Dec 15/15
Inventory 6840
Nov 1/15
AP 6840
100,000 MXN MXN.EUR = 0.0703
MXN.EUR = 0.0684 Dec 15/

(1) AP 6840
∴ 100,000 MXN = 6840 EUR = 7030 EUR Loss 190
payment costs Cash 7030
€190 more = €190 loss
BS IS
Cash ↓7030 ↑190t forex loss 190 (realized)
Inv ↑6840
Ret Earn ↓190(1-t)

LOS b
Nov 15 Dec 31 Jan 15
-describe
Pg-7
AR = £10k reporting payment date £10k
date
GBP.EUR = 1.4600 GBP.EUR = 1.4800 GBP.EUR = 1.4750
∴ £10k = €14,600 = €14,800 = €14,750
unrealized gain loss = €50 IFRS/GAAP: curr.

= €200 translation ± ⇒ IS
a) component of other
for. curr. Op. Inc/Exp
strengths weakens b) component of Non-Op.
AR(asset) + - Inc/Exp
AP(liability) - + choice will affect
Op. Pr. margin
e.g./ LOS b
-describe
20X1 20X2 Pg-8
Revenue 20k 20k
COGS 12k 12k
20X1 – gain 200
Other Op Ex. 5k 5k
20X2 – loss 50
Non-Op. Ex 1.2k 1.2k
20X1/ Op-Ex Non-Op Ex 20X2/ Op-Ex Non-Op-Ex.

Rev 20 20 20 20
- COGS 12 12 12 12
= gr-pr. 8 - 40% - 8 8 - 40% - 8
Op. Ex 4.8 - gain 5 5.05 - loss 5
Op. Pr. 3.2 (16%) 3 (15%) 2.95 (14.75%) 3 (15%)
Non-Op. Ex 1.2 1.0 - gain 1.20 1.25 - loss
NI 2.0 - 10% - 2.0 1.75 - 8.75% - 1.75

LOS b
- since standards specify no placement
-describe
on the IS, companies can choose Pg-9
- unrealized gains/losses are included in NI on BS date
may not actually be realized
Disclosures/
• IFRS requires disclosure of ‘the amount of
exchange differences recognized in P/L’
• GAAP requires disclosure of ‘the aggregate
transaction gain/loss included in determining
net income for the period’
- neither requires disclosure of the line item in
which gains/losses are located
LOS b
Disclosures/ - can be found in MD&A or Notes
-describe
- if the amounts are immaterial, not disclosed Pg-10
• limited transactions
• forex pegged/fixed/stable
• offsetting transactions
A imports AP-CAD
(USD) (CAD)
sells (CAD) AR-CAD
• hedging practice (forwards, options)

Current Rate vs. Temporal

LOS d
B -compare
-evaluate
CAD
-determine
A records and FS Pg-11
USD in local currency
C
parent MXN Q: 1/ What is the appropriate
consolidates exchange rate w.r.t. each
subs
FS account?
(assets, liabilities,
2/ How should the translation
revenues, exp)
adjustment be reflected in the
- must translate for subs. FS
consolidated FS?
into presentation currency
- gain/loss IS
- Equity adj BS
LOS d
e.g./ Spanco Amerco - set up Dec 31/20X1
-compare
(EUR) (USD) €10,000 -evaluate
USD.EUR = 1.00 -determine
Cash $3,000 Loans $5,000 = $10,000 Pg-12
Inv 12,000 Com. St. 10,000 - borrows $5k, buys $12k Inventory
15,000 15,000
Mar 31,20X2 – no transactions USD.EUR = 0.80 – current spot

USD.EUR = 1.00 – historical rate
⇒ Initial investment of €10,000 – historical fact

∴ use historical rate
proof/ @ par USD.EUR = 0.80 Cash €8,000
(A) Cash $10,000 Cash €8,000 Com. St. €10,000
vs.
(E) Com. St. $10,000 Com. St. €8,000 Loss (€2,000)
- no gain or loss? €8,000

⇒ 2 approaches for A/L accts on B.S. LOS d

-compare
➀ all A/L translated at current rates
-evaluate
(spot)
➁ monetary A/L only @ spot -determine
Pg-13
non-monetary A/L @ historical rates
➀ all @ spot ➁ monetary @ spot

Cash $ 3,000 × .8 € 2,400 × .8 € 2,400
Inv. 12,000 × .8 9,600 × 1.0 12,000
15,000 12,000 14,400
Loan 5,000 × .8 4,000 × .8 4,000

Com. St. 10,000 × 1.0 10,000 × 1.0 10,000
15,000 14,000 14,000
(2,000) 400
translation adjustment
12,000 14,000
⇒ current rate/ LOS d

-compare
- asset translation adj -3,000
-evaluate
- liability transl. adj. 1,000 -determine
-2,000 - net foreign currency Pg-14
translation gain/loss
- typically A > L, since A = L + E (unrealized)
∴ |𝐚𝐬𝐬𝐞𝐭 𝐭𝐫𝐚𝐧𝐬𝐥. 𝐚𝐝𝐣| > |𝐥𝐢𝐚𝐛. 𝐭𝐫𝐚𝐧𝐬. 𝐚𝐝𝐣|
deferred in
⇒ monetary A/L only/ IS? separate component
- asset transl. adj -600 in Equity on BS?
- liab. transl. adj. 1,000
400 - net foreign curr. transl. g/L
(unrealized)

LOS d
⇒ Balance Sheet Exposure/
-compare
- A/L transl. @ spot ⇒ ‘exposed’ to transl. adj. -evaluate
called balance sheet transl. exposure -determine
Pg-15
(actg. exposure)
net asset BS exp ⇒ exposed A value > exposed L value

net liability BS exp ⇒ exposed A value < exposed L value
For. Curr. - transl. adj. component

Strengthens Weakens on BS is a
net A exp. pos. adj neg. adj cumulative account
𝐧
net L exp. neg. adj pos. adj _`(𝐭𝐫𝐚𝐧𝐬𝐥. 𝐚𝐝𝐣. )𝐐 c

𝐐b𝟏
LOS d
-compare
⇒ Translation Methods/ -evaluate
-determine
1) current rate method – all A/L @ spot @ BS date Pg-16
2) monetary/non-monetary method – all monetary A/L @ spot @ BS date
- all non-monetary A/L at historical rates
temporal non-monetary A/L measured at current

⇒ if
method value @ current rates @ meas. date
non-monetary A/L measured at historical
value @ historical rates
AAP measurement basis in the for. curr.

IFRS/G
is preserved after transl. to pres. curr.
• A/L at current value ⇒ transl. at current
• A/L at historical value ⇒ transl. at historical

Which method is appropriate? LOS d

-compare
- depends on the for. entity’s func. curr.
-evaluate
same as Different -determine
Pg-17
parent (current rate)
(temporal)
- Func. curr. determination:
1. The currency that mainly influences sales prices for g/s
key
2. The currency of the country whose competitive forces and regulations
mainly determine the sales price of its g/s
3. The currency that mainly influences labour, material, and other costs of
providing g/s
4. The currency in which funds from financing activities are generated
5. The currency in which receipts from operating activities are usually retained
- if mixed, mgmt. uses judgement
Process/ 1. Identify the Func. Curr. LOS d

-compare
2. Translate for. curr. on for. entity
-evaluate
FS into func. curr.
-determine
3. use current forex rate to transl. for. entity’s Pg-18
func. curr. balances to parents pres. curr.
(if different)
➀ func. curr. = CAD ➁ func. curr. = USD
USD USD
EUR EUR
CAD exposure CAD GBP exposure
GBP CAD
➁ ➁ all to
➂ to USD consolidate
all to USD
(current rate) at USD
CAD (temporal)

LOS d
- For. Curr. = Func. Curr - the entire investment
-compare
➀ all A/L @ spot is exposed -evaluate
➁ Equity accts. @ historical (except R/E) -determine
➂ Rev/Exp @ rate when transactions took place Pg-19
(average rate)
Current Rate ⇒ ∴ transl. adj → separate component of Sh. Equity
- cumulative balance Q-to-Q (if subs. sold,
balanced transferred to IS as realized gain/loss)
- since A > L
→ net asset BS exposure
Thus, if for. curr. ↑, pos transl. adj.
if for. curr. ↓, neg transl. adj
forecasting brings in possible currency moves
- Pres Curr = Func. Curr. - only A/L @ current LOS d

-compare
values are exposed
-evaluate
-determine
USD CAD - required to keep all books Pg-20
in CAD (still a CAD taxable
transl. to USD reporting entity)
consolidate
remeasure (GAAP)
1. a) monetary A/L @ spot @ BS date

b) non-monetary A/L measured @ historical value @ hist. rates
c) non-monetary A/L measured @ current value @ rate when
curr. value was measured
2. Sh. Equity – historical rates (except R/E)
3. a) Rev/Exp – rates when transactions took place
(except for b)

LOS d
3. a) Rev/Exp – rates when transactions took place
-compare
(except for b) -evaluate
b) expenses related to non-monetary assets (COGS, Dep, Am) -determine
⇒ transl. @ rates used to transl. the related Pg-21
assets
Inventory (FIFO, LIFO, Avg-Cost) COGS(FIFO, LIFO, Avg-Cost)
recent older average older recent average
rates rates rates rates rates rates
translation adjustment as g/l on IS

(GAAP ⇒ Remeasurement g/l)
- since func. curr. = pres. curr., then for. entity’s monetary
items denominated in a for. curr. will generate realized
gains/losses in the near term
LOS d
exposed A > exposed L ⇒ net asset B.S. exp. -compare
-evaluate
exposed A < exposed L ⇒ net liability B.S. exp. -determine
Retained Earnings/ Pg-22
NI (FC) transl. by method used NI (PC)

to translate IS
- Div (FC) Div (PC)
= R/E (FC) × rate when Div. declared = R/E (PC)
Beg R/E (FC) Beg R/E (PC)

+ NI (FC) transl. by method used + NI (PC)
to translate IS
- Div (FC) Div (PC)
= End R/E (FC) × rate when Div. declared = End R/E (PC)

Extended Example
LOS c, e
parent sub. -analyze
Interco Canadaco
- established -calculate
(EUR) CAD
Jan 1,20X1 -evaluate
Pg-23
Jan 1/20X1 Dec 31/20X1
(Dec 31/20X1) LOS c, e

Pg-24

LOS c, e
Pg-25
LOS c, e
Pg-26

LOS f
Pg-27
Ratios will differ

when different
rates are used
under each method
to calculate the
numerator and/or
denominator.
Ratios from func. curr.
to current rate
ratios will mostly
be preserved.
LOS f
Pg-28

Hyperinflation
- if for. entity is in a highly inflationary LOS g

-analyze
environment. func. curr. not very relevant
Pg-29
IFRS/ • for. entity’s FS first restated for changes in the
local general price level, then translated at current
rates 25%
1000 1250 × current rate

GAAP/ • must use temporal method
25%
1000 1000 × historical rate
- excessive inflation (i) ⇒ (𝟏 + 𝐢)𝟑 − 𝟏 > 𝟏. 𝟎𝟎 (𝐢~𝟐𝟔%)
e.g./ Jan 1/00 Dec 31/00 Dec 31/01 Dec 31/02 LOS g
-analyze
Pg-30
TL 542,700 670,880 1,474,525 1,669,000
(per USD) i=38% i=69% i=45%
542,700,000 670,880,000 1,474,525,000 1,669,000,000

current
$1,000 $809 $368 $325 rate
g/l (191) (441) (43)
cum. g/l (191) (632) (675)
542,700,000
temporal
$1,000 $1,000 $1,000 $1,000 - hist. rate
g/l 0 0 0 - required by
cum. g/l 0 0 0
GAAP

e.g./ Jan 1/00 Dec 31/00 Dec 31/01 Dec 31/02 LOS g
-analyze
TL 542,700 670,880 1,474,525 1,669,000 Pg-31
(per USD) i=38% i=69% i=45%
542,700,000 670,880,000 1,474,525,000 1,669,000,000

current
$1,000 $809 $368 $325 rate
g/l (191) (441) (43)
cum. g/l (191) (632) (675)
542,700,000 748,296,000 1,265,684,940 1,835,243,163

(×1.38) (×1.69) (×1.45)
required
$1,000 (÷670,880) (÷1,474,525) (÷1,669,000) by
$1,116 $858 $1,100
(250) 242
IFRS
g/l 116
cum. g/l 116 (142) 100 (IAS 21)
- GAAP – temporal method LOS g

-analyze
- IFRS/ Balance Sheet Pg-32
• monetary A/L not restated for inflation
- exposed to ± in P.P. ⇒ g/l ⇒ IS
• non-monetary A/L restated for inflation stated at
- restated from the date of B.S. valuation initial
or from revaluation date purchasing
• equity accounts – all components restated for power
inflation from beg. of the period (P.P.)
Income Statement – all IS items restated by
applying 𝜟GPI from dates when the item was
originally recorded on B.S.
- net g/l from holding monetary assets ⇒ IS

LOS g
- holding monetary assets during periods of
-analyze
inflation – purchasing power loss Pg-33
- holding monetary liabilities during periods of inflation
- purchasing power gain
LOS g
Jan 1 Dec 31
-analyze
100 avg. = 125 200 ⇒ GPI
Pg-34
1.00 avg. = 0.80 0.50 ⇒ forex rate

(per USD)

LOS g
Jan 1 Dec 31 -analyze
100 avg. = 125 200 ⇒ GPI Pg-35
1.00 avg. = 0.80 0.50 ⇒ forex rate

(per USD)
Effective Tax Rate
- multinationals incur taxes in country in which LOS h

-describe
profit is earned
Pg-36
sub1 •most countries hold tax

t=25%
treaties that prevent
parent double-taxation
t=35% (grant credit for
sub2
low tax tax paid in another
t=20% country)
intercompany jurisdiction
transactions/
• transfer prices
on these transactions can affect
Typically, regulation
the allocation of profit
regarding non-market
- companies may set tr. prices so
transactions
a higher portion of profit is allocated
to lower tax jurisdictions

- if home tax rate > foreign tax rate LOS h

-describe
incremental Pg-37
= home rate – foreign rate
tax rate
(may be the case that the profit is

not taxed until repatriated)
Disclosures/
• must provide an explanation between tax expense
and accounting profit
i.e. reconcile:
𝐒𝐭𝐚𝐭𝐮𝐭𝐨𝐫𝐲 𝐭𝐚𝐱 𝐫𝐚𝐭𝐞
± 𝐚𝐝𝐣𝐮𝐬𝐭𝐦𝐞𝐧𝐭𝐬
= 𝐚𝐯𝐠. 𝐞𝐟𝐟𝐞𝐜𝐭𝐢𝐯𝐞 𝐭𝐚𝐱 𝐫𝐚𝐭𝐞
LOS h
-describe
Pg-38

LOS h
-describe
Pg-39
lower tax jurisdictions

2010-2011 – earned more profit in higher tax
jurisdictions
or/ - tax rates increased where it earned
profit
Sales Growth
- sales growth = Q × P × rate LOS i

Q = 10 -explain
Pg-40
P = $5
rate = 1 1.1 1.2 1.3 50(1+g)3 = 65

Sales 50 55 60 65 Sales g = 9.13%/yr
organic sales g = 0%

Financial Results
- parent may have subs. using temporal method LOS i

-explain
and others using current rate – results in both a
Pg-41
translation +/- ⇒ IS & transl. adj. +/- ⇒ B.S.
for. curr
Str. Wkn completely
net A exp follows the
net L exp direction of
the currency
- Disclosures/ IFRS/GAAP LOS i

-explain
• amt. of exchange differences recognized in NI Pg-42
• amt. of cum. transl. adj. on B.S.
(reconciliation of beg. & end cum. balances)
- GAAP – amt. transferred from B.S. IS when for. entity is

sold/disposed of
- no requirement to separate amounts from
- transactions
vs
- translations (temporal method)

Analysis of Financial Institutions
a. describe how financial institutions differ from other companies;
b. describe key aspects of financial regulations of financial institutions;
c. explain the CAMELS (capital adequacy, asset quality, management,

earnings, liquidity, and sensitivity) approach to analyzing a bank, including
key ratios and its limitations;
d. describe other factors to consider in analyzing a bank;
e. analyze a bank based on financial statements and other factors;
f. describe key ratios and other factors to consider in analyzing an insurance

company.

1/ Systemic importance ➞ their smooth functioning is LOS a

essential to the overall health of an economy -describe
Pg-1
· systemic risk – a risk of disruption to financial services
that is i) caused by an impairment of all or parts
of the financial system
ii) has the potential to have serious negative
consequences for the economy as a whole
➞ because of this, financial institutions activities are heavily regulated
2/ the nature of the liabilities ➞ liabilities of most banks are made
up primarily of deposits
- failure to honor its deposits could have negative
consequences ➞ a loss of faith in the banking system
∴ deposits are often insured
3/ the nature of the assets ➞ predominately financial assets vs.
tangible assets interest rates
- create direct exposure to risks credit
market
liquidity
3/ the nature of the assets ➞ often measured at fair LOS a

market value for financial reporting -describe
Pg-2
➞ goal of regulation is to minimize systemic risk

LOS b
- harmonization & globalization of regulatory rules -describe
➞ promote consistency of standards and regulation to help
minimize regulatory arbitrage
Basel 3: · minimum capital requirements - the minimum %age of
risk-weighted assets that a bank must fund with
equity capital
· minimum liquidity – a bank must hold enough high-quality
liquid assets to cover its liquidity needs in a 30-day
liquidity stress scenario
· stable funding - minimum amount of stable funding
relative to the liquidity needs over a one-year horizon

Basel 3: · stable funding – longer term deposits, consumer LOS b

deposits (vs. short-term deposits, interbank funds) -describe
Pg-3
has forced banks to ➞ focus on asset quality

➞ hold capital against other types of risks
➞ develop improved risk assessment processes
⇒ CAMELS/ LOS c
-explain
1/ Capital adequacy – defined in terms of the proportion of
the bank’s assets funded with capital
- assets are adjusted based on their risk (risker assets
require a higher weighting)
e.g./ Cash ➞ 0%
Corporate loans ➞ 100%
others > 100%
(non- performing loans)
⇒ CAMELS/ LOS c
1/ Capital adequacy -explain
➞ Capital – classified into hierarchical tiers Pg-4
· most important ➞ Common Equity Tier 1 Capital
(must be at lease 4.5% of risk-weighted assets)
(Total Tier 1 Capital must be at least 6.0% of
risk-weighted assets)
· most loss-absorbing form of capital
· places shareholder’s funds at risk of loss first
➞ includes: common stock, surplus over issuance value, retained
earnings, AOCI, (adjustments; e.g. deduction of
intangible assets and any DTAs)
· Tier 2 Capital ➞ instruments that are subordinate to depositor’s
and to general creditor’s + original minimum maturity of
five years
(Total Capital must be at least 8% of risk-weighted assets) (Ex. #1)

⇒ CAMELS/ LOS c
2/ Asset Quality – pertains to the amount of credit -explain
risk associated with the assets Pg-5
· loans - creditworthiness of borrowers, adequacy of adjustments

for expected loan losses
- measured at amortized cost, shown net of allowances
for loan losses
· investment in securities issued by other entities
) IFRS ➞ amortized cost FV/PL FV/OCI
2, 3
(ex. #
GAAP ➞ HTM (debt) HFT AFS (debt)
(debt/equity)
3/ Management Capabilities – identifying profit opportunities while

managing risk (credit, market, operating, legal)
- strong governance structure
- sound internal controls
- financial reporting quality
⇒ CAMELS/ LOS c
4/ Earnings – high quality and trending upward -explain
net interest income Pg-6
sustainable, rather than non-recurring service income
trading income
(most volatile)
- reliable estimates of load impairment allowances
- estimates of fair value
⇒ fair value hierarchy – categorized on the basis of the types of
inputs used to establish FV
Level 1 ➞ inputs are quoted prices
2 ➞ observable, but not the quoted prices for identical
instruments in active markets
(may be similar instruments in active markets, or
identical instruments in non-active markets)
- combine with interest rates, credit spreads, volatility as
inputs to a model to estimate FV
(example #4) 3 ➞ unobservable, FV is based on a model

⇒ CAMELS/ LOS c
5/ Liquidity Position – 2 minimum liquidity standards -explain
from Basel 3: 1) Liquidity Coverage Ratio (LCR) – the Pg-7
minimum %age of a bank’s expected cash outflows that must

be held in highly liquid assets
𝐇𝐢𝐠𝐡𝐥𝐲 𝐥𝐢𝐪𝐮𝐢𝐝 𝐚𝐬𝐬𝐞𝐭𝐬 (𝐞𝐚𝐬𝐢𝐥𝐲 𝐜𝐨𝐧𝐯𝐞𝐫𝐭𝐞𝐝 𝐭𝐨 𝐜𝐚𝐬𝐡)
𝐎𝐧𝐞k𝐦𝐨𝐧𝐭𝐡 𝐥𝐢𝐪𝐮𝐢𝐝𝐢𝐭𝐲 𝐧𝐞𝐞𝐝𝐬 𝐢𝐧 𝐚 𝐬𝐭𝐫𝐞𝐬𝐬 𝐬𝐜𝐞𝐧𝐚𝐫𝐢𝐨
= 𝟏𝟎𝟎%
2) Net Stable Funding Ratio (NSFR) – the

minimum %age of a bank’s required stable funding that must be
sourced from available stable funding
- function of the composition and maturity of the:
assign capital & 𝐚𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞 ➞ bank’s funding sources
> 100%
liabilities to one 𝐫𝐞𝐪𝐮𝐢𝐫𝐞𝐝 ➞ bank’s asset base
of 5 categories · loans with long-dated maturities
- multiply by an ASF factor require stable funding
(available stable funding) (Ex. #8) · highly liquid assets do not
⇒ CAMELS/ LOS c
5/ Liquidity Position - others -explain
Pg-8
a) concentration of funding – the proportion of funding that
is available from a single source
b) contractual maturity mismatch – maturity date of assets
compared to maturity dates of funding sources
- example 5
6/ Sensitivity to Market Risk – sensitivity of earnings to a +/- in
interest rates, fx. rates, etc.
- disclosures are in annual filings
- example #6
⇒ Other Relevant Factors/ · Banking Specific LOS d

-describe
· Government Support - it is in the gov.’s interests to
have a healthy banking system
· too big to fail
· systematically important financial institutions (SIFE)

LOS d
⇒ Other Relevant Factors/ · Banking Specific
-describe
· Government Ownership (a dimension of security Pg-9
for investors)
- development view ➞ ownership aids financial development of
banks, leading to broad economic growth
or/ - banking system is not strong enough to stand on its own
- more likely to intervene on the bank’s behalf in the event of
economic distress
· Mission of banking entity – qualitative assessment
- regional vs. national vs. global
diversification vs. concentration of loan exposures

· Corporate culture – risk averse & cautious versus risk-seeking
inadequate returns boom/bust

results volatility
⇒ Other Relevant Factors/ · Non-bank specific LOS d

-describe
1/ Competitive Environment – regional/national/global
Pg-10
2/ Off-balance Sheet items – non-recognized liabilities that still
provide a creditor with a claim on future cash flows
- variable interest entities (VIEs)
- consolidation or disclosure
- pension/benefit plans ➞ potential shortfalls in assets due
to market performance
- assets under management ➞ drive fee income
3/ Segment information
4/ Currency exposure – issue for global banks
5/ Risk factors
6/ Basel 3 disclosures – require extensive disclosure

LOS f
➞ Insurance companies – earn revenue from premiums
-describe
and income earned on the float ➞ premiums not yet Pg-11
paid out as benefits
- categorized as i) property & casualty (P&C) – more variable
ii) life & health (L&H) – more predictable
products differ in terms of contract duration

variability of claims
Property & Casualty/
a) Business profile ➞ property (buildings, autos) personal or
casualty (liability to a third party) commercial
- direct or agency writing
their own sales agents/brokers

& mktg. staff profitability
b) Earnings characteristics soft pricing
- business is cyclical market hard
- price sensitive pricing
market
b) Earnings characteristics LOS f

- underwriting cycle is driven largely by the expenses -describe
Pg-12
of the participants
𝐓𝐨𝐭𝐚𝐥 𝐢𝐧𝐬𝐮𝐫𝐚𝐧𝐜𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞 low = hard pricing mkt.
𝐜𝐨𝐦𝐛𝐢𝐧𝐞𝐝 𝐫𝐚𝐭𝐢𝐨 = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝
high = soft pricing mkt.
> 100% ➞ indicates an underwriting loss
· In US, insurance companies must prepare financial reports according
to statutory accounting rules (differ from GAAP & IFRS)
define the combined ratio as the sum of 2 ratios (using stat. fin. st.)
combined ratio = underwriting loss ratio + expense ratio
𝐋𝐨𝐬𝐬𝐞𝐬 𝐔𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬

Indicator of 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐰𝐫𝐢𝐭𝐭𝐞𝐧
the quality of
- indicator of the efficiency of a
underwriting
company’s operations in acquiring
activities
& managing underwriting business


-describe
loss reserves - underestimation may lead to undercharging
Pg-13
for risks assumed
- subject to management discretion (Exhibit #28)
- new premiums written - direct premiums written – reinsurance
- net premiums earned – accrual basis premiums paid
- profitability ratios
𝐋𝐨𝐬𝐬 𝐞𝐱𝐩. r 𝐋𝐨𝐬𝐬 𝐚𝐝𝐣.𝐞𝐱𝐩.
1/ Loss & loss adjustment expense ratio = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝
- degree of success in estimating risks insured (lower = better)
𝐔𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞
2/ Underwriting expense ratio = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐰𝐫𝐢𝐭𝐭𝐞𝐧
- measures the efficiency of money spent in obtaining new premiums
3/ Combined ratio = 1 + 2 above

- overall efficiency of an underwriting operation

-describe
- profitability ratios
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬 Pg-14
4/ Dividends to policyholders/shareholders ratio = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝
- measure of liquidity
- relates cash outflow to premiums earned in the same period
5/ Combined ratio after dividends = Combined ratio + 4 above
c) Investment returns – steady return, low risk assets
𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐩𝐞𝐫𝐟𝐨𝐫𝐦𝐚𝐧𝐜𝐞 =
𝐓𝐨𝐭𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐢𝐧𝐜𝐨𝐦𝐞 ➞ with and without
𝐈𝐧𝐯𝐞𝐬𝐭𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
unrealized gain
d) Liquidity – high degree
- examine status in the hierarchy of fair value reporting
(Exhibit #31)
e) Capitalization – no global standard exists

- various jurisdictions do have their own capital standards

Life & Health/ LOS f

a) Business profile ➞ life and health insurance -describe
Pg-15
➞ investment products and services
- direct or agency writing
- begin with an understanding of the sources of revenue (ex. # 7)
b) Earnings characteristics
- major expense ➞ benefits payments
- number of items require significant amounts of judgement
➞ specific profitability measures:
𝐓𝐨𝐭𝐚𝐥 𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬 𝐩𝐚𝐢𝐝 𝐂𝐨𝐦𝐦𝐢𝐬𝐬𝐢𝐨𝐧𝐬 & 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬 𝐢𝐧𝐜𝐮𝐫𝐫𝐞𝐝
𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 r 𝐃𝐞𝐩𝐨𝐬𝐢𝐭𝐬 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 r 𝐃𝐞𝐩𝐨𝐬𝐢𝐭𝐬
c) Investment Returns
- key aspect ➞ diversification
𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐢𝐧𝐜𝐨𝐦𝐞
(Ex. # 8) ➞ performance -
𝐈𝐧𝐯𝐞𝐬𝐭𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
➞ interest rate risk – DA vs. DL
LOS f
-describe
Life & Health/
Pg-16
d) Liquidity – driven by its liability structure
- sources of liquidity ➞ operating cash flow, investment assets
𝐀𝐬𝐬𝐞𝐭𝐬
- measures: 𝐋𝐚𝐢𝐛𝐢𝐥𝐢𝐭𝐞𝐬 (some form of this ratio)
e) Capitalization – no global standard

- varies by jurisdiction
- L&H insures typically have lower capital
requirements than P&C (L&H claims are
more predictable, need less equity cushion)

Evaluating Quality of Financial Reports
a. demonstrate the use of a conceptual framework for assessing the quality of a

company’s financial reports;
b. explain potential problems that affect the quality of financial reports;
c. describe how to evaluate the quality of a company’s financial reports;
d. evaluate the quality of a company’s financial reports;
e. describe the concept of sustainable (persistent) earnings;
f. describe indicators of earnings quality;
g. explain mean reversion in earnings and how the accruals component of

earnings affects the speed of mean reversion;
h. evaluate the earnings quality of a company;
i. describe indicators of cash flow quality;
j. evaluate the cash flow quality of a company;
k. describe indicators of balance sheet quality;
l. evaluate the balance sheet quality of a company;
m. describe sources of information about risk.

Quality Framework
LOS a
➀ Reporting ➁ Earnings quality demonstrate
quality - earnings & cash generated Pg-1
- relevant
- faithful representation high +
high
company
value
low -
low - stop
- impedes assessment of earnings
quality & impedes valuation
LOS a
demonstrate
Pg-2
1. Are reports GAAP - complaint

& decision useful?
aggressive (relevant, faithful
representation)
conservative 2. Are earnings
high quality?
(adequate ROIC,
sustainable)

Potential Problems
LOS b
-explain
Pg-3
aggressive, premature, fictitious

Revenue ↑ (NI ➝ E ➝ A)
↑A / ↓L ⇒ ↑E conservative recognition
-
↓ (NI ➝ E ➝ A)
over/understate FV
Expenses omission, delayed recognition
↑A
financial A/L = ↓Exp. ➝ ↑NI ➝ ↑E
↓L
Net Income
deferring cash
CFO expenditures
Assets = Liabilities + Equity
deferring AP
understated contingents ➝ ↑E accelerating AR
↑NI or ↑OCI
LOS b
-explain
Pg-4

⇒ Classification LOS b
improve ratios · selling ARs
Balance Sheet/ · selling to SPV/ VIE
-explain
hide issues
Pg-5
· reclassifying as LT-Rec
Income Statement/ - classify revenue as core, continuing Ops.
- classify expenses as non-operating
OCI/ vs. through NI · holding +/- on financial A/L

· +/- on revaluations
· for. curr. transl. +/-
· changes to net pension A/L
CFO/ · classify non-CFO CFs as operating · sale of assets

· capitalize vs. expense op. exp. · ↑CFO, ↓CFI
⇒ Classification LOS b
· motivation is typically to bias NI↑ -explain
· new mgmt. may be aggressive (expensing, write-downs) Pg-6
to bias NI↓ (enhance future periods)

⇒ M&A/
· dilute CFO problems, conceal past actg. misstatements
· stock deals ⇒ acquirer may ‘manage’ earnings up
prior to the acquisition to raise sh. price
⇒ target may do the same, get a more
favorable price
· maximize Goodwill – understate value of amortizable intangibles

⇒ Impairment/Restructuring/ LOS b
-explain
· how often do they occur?
Pg-7
one-off? regularly?
· exclude from earnings · normalize earnings

- spread the cost over
prior and current periods
Others/ · revisions to estimates (i.e. useful lives)

· sudden increases to allowances/reserves (past NI overstated)
· large accruals for losses (prior period NI overstated)
· unrecognized/unreported A/L
Financial Reporting Quality
- before beginning assessment/ LOS c, d

⇒ Purpose? What Q. do I want answered? -describe
-evaluate
⇒ Level of detail required?
Pg-8
⇒ Data available?
⇒ Factors/relationships that will influence analysis?
⇒ Analytical limitations? Do they impair analysis?
General Steps/
1. Understand company/industry
- basis for understanding actg. principles
used (appropriate) & useful/informative financial metrics

General Steps/ LOS c, d

2/ Management – disclosures about compensation -describe
-evaluate
(speaks to motivation to misreport)
Pg-9
- insider transactions
3/ Significant actg. areas – where judgment is used

FS
4/ Make comparisons – year-over-year disclosures
risk disclosures
- major differences segment disclosures
classification of rev./exp.
- actg. policies with competitor(s)
- ratio analysis
General Steps/ LOS c, d

5/ Warning signs – declining AR turnover -describe
-evaluate
- Days Inventory building
Pg-10
- NI > CFO
6/ Multi-segment business – is a desirable segment

showing positive performance while company as a whole is not?
7/ Quantitative Tools – Beneish Model

- attempts to capture the probability of manipulation
M–score ～ N (0,1) (z–score)

[cut-off = -1.78]
p(1) = 3.8%

M-score = -4.84 days receivable index LOS c, d

-describe
+ .920 (DSR) 𝐀𝐑 𝐭
v x -evaluate
𝐒𝐚𝐥𝐞𝐬𝐭 Pg-11
y 𝐀𝐑
𝐭k𝟏
v x
𝐒𝐚𝐥𝐞𝐬𝐭k𝟏
gross margin index
+ .528 (GMI) 𝐆𝐏𝐭k𝟏
v x
𝐒𝐚𝐥𝐞𝐬𝐭k𝟏
y 𝐆𝐏 - deteriorating
𝐭
v x margin
𝐒𝐚𝐥𝐞𝐬𝐭
asset quality index
+ .404 (AQI) (𝐏𝐏𝐄𝐭 + 𝐂𝐀 𝐭 )
v𝟏 − x
𝐓𝐀 𝐭
y (𝐏𝐏𝐄𝐭k𝟏 + 𝐂𝐀 𝐭k𝟏 )
v𝟏 − 𝐓𝐀 x
𝐭k𝟏
- change in assets other than PPE + CA

(may indicate excessive expenditure capitalization)
sales growth index LOS c, d

+ .892 (SGI) 𝐒𝐚𝐥𝐞𝐬𝐭 -describe
|𝐒𝐚𝐥𝐞𝐬 -evaluate
𝐭k𝟏
Pg-12
+.115 (DEPI) depreciation index
𝐃𝐞𝐩. 𝐫𝐚𝐭𝐞𝐭k𝟏
|𝐃𝐞𝐩. 𝐫𝐚𝐭𝐞 𝐃𝐞𝐩.
𝐭 |(𝐃𝐞𝐩. +𝐏𝐏𝐄)
- declining Dep. rate could indicate

understated Dep.
-.172 (SGAI) SG & A index
𝐒𝐆𝐀𝐭
} |𝐒𝐚𝐥𝐞𝐬 ~
𝐭y
𝐒𝐆𝐀𝐭k𝟏
} |𝐒𝐚𝐥𝐞𝐬 ~
𝐭k𝟏
+4.67 (Accruals) }𝐈𝐧𝐜𝐨𝐦𝐞 𝐛𝐞𝐟𝐨𝐫𝐞 𝐄𝐱𝐭. 𝐈𝐭𝐞𝐦𝐬 − 𝐂𝐅𝐎|𝐓𝐀~
-.327 (LEVI) 𝐋𝐞𝐯𝐞𝐫𝐚𝐠𝐞𝐭 •𝐃|𝐓𝐀€

|𝐋𝐞𝐯𝐞𝐫𝐚𝐠𝐞
𝐭k𝟏

Sustainable Earnings
- earnings quality – sustainable LOS e, f

-describe
- ROIC > WACC
Pg-13
⇒ Recurring Earnings/ · expected to continue
- evaluate non-recurring items for inclusion/exclusion
may not always be classified as such

(subjective classification)
- ‘classification shifting’ – leaves NI

unchanged but changes Op. Inc.
i.e. ⇒ reclassifying expenses
- pay attention to income-decreasing special items

(especially if Op. Inc. is strong)
- companies may disclose extra info to help LOS e, f

guide the selection of recurring/non-recurring items -describe
Pg-14
i.e. Total Income vs. Pro-forma earnings (non-GAAP)
- adjusted to exclude
non-recurring items
(if pro-forma used, company must provide reconciliation
between pro-forma and NI)
Earnings Persistence/Measures of Accruals
· sustainability non-cash Inc./Exp.

· persistence of growth
𝐄𝐭r𝟏 = 𝛂 + 𝛃𝟏 𝐄𝐭 + 𝛆

Earnings LOS e, f
-describe
cash component accruals component Pg-15
⇓ ⇓
more persistent matching-principle regardless of cash
𝐄𝐭r𝟏 = 𝛂 + 𝛃𝟏 𝐂𝐅 + 𝛃𝟐 𝐀𝐜𝐜𝐫𝐮𝐚𝐥𝐬 + 𝛆 𝛃𝟏 > 𝛃𝟐
∴ earnings with a higher accruals component would be less persistent
Accruals (NI – Op.CF)
normal transactions discretionary accruals

· 𝐀𝐜𝐜 = 𝛂 + 𝛃𝟏 (𝐠𝐫𝐨𝐰𝐭𝐡 𝐢𝐧 𝐜𝐫𝐞𝐝𝐢𝐭 𝐬𝐚𝐥𝐞𝐬) + 𝛃𝟐 ($ 𝐨𝐟 𝐃𝐞𝐩. 𝐀𝐬𝐬𝐞𝐭𝐬) + 𝛆
· NI > CFO look for
∑𝐚𝐜𝐜𝐫𝐮𝐚𝐥𝐬
· compare 𝐀𝐯𝐠.𝐎𝐩.𝐈𝐧𝐜. across companies outliers
Earnings Mean Reversion
- extreme levels of earnings, high & low, tend LOS g

-explain
to revert to normal levels
Pg-16
1) Low ⇒ shut operations, change mgmt.
2) High ⇒ attracts competition
∴ cannot extrapolate L/H earnings into the future
- must normalize (i.e. 3-stage models)
- the higher the accruals component, the faster the mean reversion may be
Revenue Recognition
- fully understand rev. recog. policies LOS h
- shipping terms, right of return, rebates, multiple -evaluate
deliverables Pg-17
- receivables do not improve with age

- DSO trends over time and across companies
- Cash vs. Accrual
𝐀𝐑|
𝐒𝐚𝐥𝐞𝐬 over time and across companies
- Pay attention to non-financial data
- Revenue trends – kinds of revenue recognized
- growth in revenue vs. growth in AR

Capitalizing Expenses
LOS h
- fully understand cost capitalization policies
-evaluate
- what costs are capitalized in inventory? Pg-18
- depreciation rates/useful lives
- trend analysis – over time & vs. competitors

- non-current assets increasing FA + stable/increasing margins
- margins may indicate capitalization of expenses
- asset turnover 𝐑𝐞𝐯.|

𝐓𝐀
𝐝𝐞𝐩𝐫𝐞𝐜.| 𝐄𝐱𝐩.|
- 𝐚𝐦𝐨𝐫𝐭. 𝐁𝐚𝐬𝐞
· 𝐂𝐀𝐏𝐄𝐗|𝐏𝐏𝐄
Bankruptcy Prediction Models
- attempt to quantify the likelihood that a LOS h

-evaluate
company will default on its debt/declare bankruptcy
Pg-19
liquidity profitability leverage
Altman Model/
𝐍𝐖𝐂 𝐑𝐄 𝐄𝐁𝐈𝐓 𝐌𝐕𝐄 𝐒𝐚𝐥𝐞𝐬
Z-score = 𝟏. 𝟐 ‡ 𝐓𝐀
‰ + 𝟏. 𝟒 ‡𝐓𝐀‰ + 𝟑. 𝟑 ‡ 𝐓𝐀
‰ + 𝟎. 𝟔 ‡𝐁𝐕k𝐋𝐢𝐚𝐛.‰ + 𝟏. 𝟎 ‡ 𝐓𝐀
‰
activity
< 1.81 – higher Prob.
- higher Z-scores are better
> 3.00 – lower Prob.
but// · ratios are only at a point in time
· reflect past performance only

Cash Flow Quality

LOS i, j
⇒ Indicators of cash flow quality/
-evaluate
- positive OCF Pg-20
· relevant
- OCF from sustainable sources
· faithful
- OCF > (Capex + Div. + Debt. Repay.)
representation
- OCF w/ low volatility
depends on life cycle stage

⇒ OCF less easily manipulated than Op. Inc./NI
· can still be
CR
- selling AR leave B.S. footprints
asset
- delaying AP
utilization
- shift CFF/CFI to CFO
ratios
Balance Sheet Quality
⇒ Results Quality/ · optimal amount of leverage LOS k, l

-describe
· adequate liquidity
-evaluate
· economically successful asset allocation Pg-21
· ratio analysis
· common size statements
⇒ Reporting Quality/
1) Completeness
- relevant items on-balance sheet
adjust for
- off-balance sheet items may understate leverage
these – PV of
(i.e. operating leases, purchase contracts)
future obligations
(constructive
capitalization)

LOS k, l
⇒ Reporting Quality/
-describe
1) Completeness – unconsolidated JV or equity -evaluate
method investees Pg-22
- parent reports share of NI but not
shares of sales
⇒ profitability ratios overstated
2) Unbiased measurement – particularly when subjective

valuation is involved
inv.
· understatement of impairment PPE ↑A, ↑NI, ↑E
goodwill
· understate valuation allowance for DTA (↑A)
· financial A/L with no market data
· pension liabilities
⇒ Reporting Quality/ LOS k, l

-describe
3) Clear presentation
-evaluate
- separate vs. aggregate line items Pg-23
vs. note disclosure
- clear language
- adequate disclosure decision
- appropriate level of detail useful

Risk Disclosures
1. Auditor/ opinion ⇒ limited usefulness LOS m

-describe
- change in auditor – important signal
Pg-24
2. Notes to F.S./
- IFRS/GAAP require specific disclosures
(e.g. contingent obligations, pension and
post-employment benefits, financial instrument risks)
3. MD&A/ · nature of business strategic

· objectives and strategies commercial
· resources, risks and relationships operational
· results and prospects financial
· performance measures and indicators
3. MD&A/ - risk disclosures are those that LOS m

significantly affect the entity’s strategies -describe
Pg-25
and progress of the entity’s value
U.S./ · liquidity
· capital resources
· results of operations item 7
10-k
· off-balance sheet arrangements
· contractual arrangements
⇒ impacts of risk exposure interest rates
i.e. fluctuations in forex
commodity prices
4) Other sources LOS m

Form 8-k – material events -describe
· capital raising Pg-26
· change of mgmt.
· non-timely filings
· legal disputes
· change of control (M&A)
5) Media
- requires independent follow-up/investigation

Integration of Financial Statement Analysis Techniques
a. demonstrate the use of a framework for the analysis of financial statements,

given a particular problem, question, or purpose (e.g., valuing equity based
on comparables, critiquing a credit rating, obtaining a comprehensive picture
of financial leverage, evaluating the perspectives given in management’s
discussion of financial results);
b. identify financial reporting choices and biases that affect the quality and
comparability of companies’ financial statements and explain how such
biases may affect financial decisions;
c. evaluate the quality of a company’s financial data and recommend

appropriate adjustments to improve quality and comparability with similar
companies, including adjustments for differences in accounting standards,
methods, and assumptions;
d. evaluate how a given change in accounting standards, methods, or

assumptions affects financial statements and ratios;
e. 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
conditions.

Financial Statement Analysis
⇒ Analysis Framework/ Pg-1
1) Define the purpose and context of analysis

- list of questions ultimately to be answered
2) Collect input data
3) Process data, consistent with 1) above
- analytically useful output
4) Analyze/Interpret data
5) Develop/communicate conclusions
- report
6) Follow-up
Case 1/ Long-Term equity investment Pg-2
Q1: Sources of earnings growth

Relevant
- Sustainable?
Faithful representation
- Recurring? (repeatable)
(5-10yrs)
Q2: NI – CFO (accruals)

relationship
Q3: Capital Structure – leverage

Assets – composition/value – pending write-downs
Liabilities – legal/obligations - contingents
5-way Dupont analysis:

NI margin
𝐍𝐈 𝐄𝐁𝐓 𝐄𝐁𝐈𝐓 𝐒𝐚𝐥𝐞𝐬 𝐀𝐯𝐠. 𝐀𝐬𝐬𝐞𝐭𝐬

𝐑𝐎𝐄 = × × × ×
𝐄𝐁𝐓 𝐄𝐁𝐈𝐓 𝐒𝐚𝐥𝐞𝐬 𝐀𝐯𝐠. 𝐀𝐬𝐬𝐞𝐭𝐬 𝐒𝐡. 𝐄𝐪𝐮𝐢𝐭𝐲
ROA
Tax Interest Op. Inc. Asset Leverage
burden burden margin turnover

With
𝟏𝟏, 𝟑𝟖𝟐
𝟏𝟎𝟕, 𝟓𝟓𝟐
= 𝟏𝟎. 𝟓𝟖
Without
𝑵𝑰 𝑬𝑩𝑻 𝑬𝑩𝑰𝑻 10.58 = 9.39x
𝑵𝑷𝑴 = × ×
𝑬𝑩𝑻 𝑬𝑩𝑰𝑻 𝑺𝒂𝒍𝒆𝒔
= 1.127
𝟏𝟎, 𝟏𝟎𝟐 𝟏𝟑, 𝟓𝟏𝟖 𝟏𝟒, 𝟒𝟑𝟖
= × ×
𝟏𝟑, 𝟓𝟏𝟖 𝟏𝟒, 𝟒𝟑𝟖 𝟏𝟎𝟕, 𝟓𝟓𝟐
= . 𝟕𝟒𝟕𝟑 ×. 𝟗𝟑𝟔𝟓 ×. 𝟏𝟑𝟒𝟐 = 𝟗. 𝟑𝟗%
Defensive Interval ratio:
𝐂𝐚𝐬𝐡 + 𝐌𝐤𝐭. 𝐒𝐞𝐜 + 𝐀𝐑

𝐃𝐚𝐢𝐥𝐲 𝐂𝐚𝐬𝐡 𝐄𝐱𝐩.
𝟐𝟒, 𝟗𝟏𝟕
𝟒𝟓, 𝟎𝟑𝟕 + 𝟗, 𝟏𝟎𝟒 + 𝟑𝟔, 𝟓𝟏𝟐 + 𝟏, 𝟖𝟕𝟓 − 𝟑, 𝟐𝟏𝟏 + (𝟓𝟗𝟎 − 𝟒𝟖𝟐) + (𝟏, 𝟒𝟗𝟐 − 𝟓𝟕𝟔)|
𝟑𝟔𝟓


Accruals Ratio/ - measure of earnings quality
- 2 approaches
1) Balance Sheet aggregate accruals
= NOAt – NOAt-1
NOA = (TA-Cash) – (TL-Debt)
𝐍𝐎𝐀𝐭 − 𝐍𝐎𝐀𝐭k𝟏 - adjusts for

𝐀𝐜𝐜𝐫𝐮𝐚𝐥𝐬 𝐫𝐚𝐭𝐢𝐨 =
(𝐍𝐎𝐀𝐭 + 𝐍𝐎𝐀𝐭k𝟏 )| differences in
𝟐
company size
Accruals Ratio/ - measure of earnings quality

- 2 approaches
2) Cash-flow based aggregate accruals
= NI – (CFO + CFI)
[𝐍𝐈 − (𝐂𝐅𝐎 + 𝐂𝐅𝐈)]

𝐀𝐜𝐜𝐫𝐮𝐚𝐥𝐬 𝐫𝐚𝐭𝐢𝐨 =
(𝐍𝐎𝐀𝐭 + 𝐍𝐎𝐀𝐭k𝟏 )|
𝟐
- smaller the accruals, higher the quality of earnings

Updated: January 27, 2020
REVIEW

Investment in: Pg-1
Financial Assets < 20% - FVPL, FVOCI, amortised cost

Investment in Associates 20% - 50% - equity method
Business Combinations > 50% - consolidation
Financial assets
- measured at FV when
initially acquired
Debt ➞ any category
Equity ➞ never amortised cost
- all dividends/interest go
choice is to P/L (IS)
irrevocable - reclassification ➞ Debt only
when business model changes
FVPL FVOCI
· Associates/JV > 20%, less than 50% Pg-2

· Equity Method ➞ one-line item in Non-current assets
‘Investment in Associates’
- initially recorded at cost of acquired shares
· each period: add share of NI ‘as earned’
subtract dividends received
- Share of NI ➞ reported on IS
- FV of associates & Div. Rec. ➞ no effect on IS
taxable but not reported on IS

- acquisition cost ≠ BV/ differences first allocated to specific assets
(amort. Dep. over useful life) - reduces Inv. in
Assoc. each year
· Balance = Goodwill
- tested yearly for impairment

⇒ Associates/JVs > 20%, less than 50% Pg-3

· Equity Method
· Impairment – IFRS/GAAP
- if so, written down to recoverable amt. ⇒ NI
- reversals prohibited
Note: GAAP allows FV options – investment carried at FV
(IFRS does as well - unrealized +/- ➞ NI
but restricted to - Div./Int ➞ NI
VC, MF, trusts, etc.) - excess over BV ➞ not amortized
⇒ Transactions with associates/
upstream profits from such transactions cannot
(assoc. to investor) be realized until confirmed by
downstream 1) use
(investor to assoc.) 2) sale to 3rd party
- proportionate amount must be taken out
of investor’s ‘Income from Investment’
⇒ Control > 50% ⇒ acquisition method Pg-4

- parent reports on a consolidated basis
- price paid is FV of acquisition (clear & contingent)
Issue A/ Recognition/Measurement of
1) Identifiable A/L – FV at acquisition date
(+ other A/L not previously recognized)
2) Contingent L – potential liability resulting from past transactions
3) Indemnification Assets
seller indemnifies
buyer from certain
costs
4) Financial Assets
- reclassified to acquirer’s bus. model
Issue B/ Goodwill IFRS GAAP
Partial Full
FV of acquisition FV of entity as a whole
less FV of net less FV of net identifiable
identifiable assets assets

Issue B/ Goodwill Pg-5

e.g./ $800k for 80% of target ∴ 𝐅𝐕𝐞𝐧𝐭𝐢𝐭𝐲 = $𝟏𝐌
𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 = $𝟗𝟎𝟎𝐤
Partial Full
FV of acquisition 800k 𝐅𝐕𝐞𝐧𝐭𝐢𝐭𝐲 $1M
- 80% of 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 720k (. 𝟐 × 𝟗𝟎𝟎𝐤) - 𝐅𝐕𝐧𝐞𝐭 𝐚𝐬𝐬𝐞𝐭𝐬 900k
100k – Goodwill
80k - Goodwill recognized
recognized
- if acquisition price < FV – bargain acquisition
- gain on IS example
(pg. 38)
- less than 100% introduces non-controlling interest
(portion of subsidiary’s equity held
by 3rd party)
- presented as a separate component of
shareholder equity example
(pg. 41, 42)
- affected by Partial/Full Goodwill allocation
⇒ Impact on FS – Franklin acquires 100% of

Jefferson by issuing 1,000,000 shares, par value €1, MV = €15M
FJ
10,300
15,000
31,500
Goodwill 9,600
66,400
8,600
17,800
26,400
6,000
20,000
14,000
66,400


FMV = €200k
Goodwill
Partial:
𝟏𝟖𝟎, 𝟎𝟎𝟎
(− 𝟏𝟔𝟎, 𝟎𝟎𝟎 × . 𝟗)
= 𝟑𝟔, 𝟎𝟎𝟎
Full:
𝟐𝟎𝟎, 𝟎𝟎𝟎
− 𝟏𝟔𝟎, 𝟎𝟎𝟎
= 𝟒𝟎, 𝟎𝟎𝟎

FMV = €200k
Partial Full
55 55
205 205
390 390
36 GW 40
686 690
75 75
190 190
265 265
16 NCI 20
267 267
138 138
686 690

⇒ Consolidation Process/ Pg-6

- goodwill impairment – tested annually
- if yes, written down
non-reversable
IFRS GAAP
Total Goodwill Total Goodwill
allocated to allocated to
cash-generating units reporting units
- until unit = 0, the allocated - until unit = 0, then no more
to other units (example pg. 46,47)
⇒ VIE/SPE IFRS/GAAP
transfer assets outside
funding
GAAP Company S SPE
only PE
right to use the equity
if significant
assets investors lack
beneficial interest retained
in SPE, must consolidate ability to make
decisions
GAAP ⇒ primary beneficiary of a VIE must
consolidate

Post-Employment/Share-Based Compensation
1) Defined Contribution - contribution = pension expense Pg-1

2) Defined Benefit - creates a future obligation based on
current service
Pension obligation (PO) - PV of future benefits earned
(many actuarial assumptions) by employee’s for service to date
PO > FVplan assets – net pension liability (underfunded)
PO < FVplan assets – net pension asset (may be subject to a ceiling)
(overfunded – employee may recapture
funds – ➀ reduce future funding ➁ reversion of funds)
- Periodic Pension Costs/
benefits
1) Service Costs - current and retroactive
curtailments
(P/L)
7 )
(5-
pg. 2) Net interest expense/income
(P/L) - net pension L/A discount rate
actuarial gains/losses
3) Remeasurement
experience gains/losses
OCI
One-Person Plan Example
LOS b
⇒ Pension obligation - PV of future benefits -explain
-calculate
earned by employee’s for service provided to date
Pg-5
IFRS – PVDBO – PV of defined benefit obligation
GAAP – PBO – projected benefit obligation
e.g./ ✱ assumptions 35 yrs. ✱

life
Lee expectancy
Jan. 1/13 Dec. 31, 2047 = 12 yrs. ✱
(30) (65)
$37,500 → 4%✱ salary increases/yr. $150k/yr.
Benefit ⇒ 2% of salary at retirement for each yr. service

= (2% final salary) yrs service

YR. 1/ r= 6% (assumed) LOS b

annual pension benefit -explain
(.02 × 150,000) × 1 = 3,000 -calculate
Pg-6
3k 3k… 3k
𝑷𝑽𝟑𝟓
t0 PV1 = (𝟏.𝟎𝟔)𝟑𝟒
= 𝟑, 𝟒𝟔𝟖. 𝟔𝟖 t35 t49
PMT = 3000
PV35 = 25,151.53
- current service cost = $3,468.68 I/Y = 6
FV = 0
YR. 2/ N = 12
3k 3k… 3k
𝑷𝑽𝟑𝟓 t35 t49
PV2 = (𝟏.𝟎𝟔)𝟑𝟑
= 𝟑, 𝟔𝟕𝟔. 𝟖𝟏
PV35 = 25,151.53
YR2 service cost = $3,676.81
⇒ Pension Obligation LOS b

-explain
6k 6k… 6k -calculate
Pg-7
PV2 =
𝑷𝑽𝟑𝟓
= 𝟕, 𝟑𝟓𝟒 t35 t49
(𝟏.𝟎𝟔)𝟑𝟑
PV35 = 50,303.04 PMT = 6000
I/Y = 6
FV = 0
PO1 = 3,469 × .06 = 208
- interest on outstanding N = 12
PO2 = 3,677
7,146
obligation = r (current market rate
208 on IG Corporate Bonds)
7,354
YR. 2 IFRS
Current Service Cost
3,677 interest rate
Interest Cost
208 =
3,885 discount rate

health Pg-2
3) Other Post-Employment benefits
life insurance premiums
⇒ DB – Periodic Pension Cost/

1) Service Cost IFRS – immediate recognition approach
- current & past ⇒ IS
GAAP – deferral & amortized approach
- current ⇒ IS
- past ⇒ OCI – amortized to IS over avg.
service lives of employees
2) Net interest Expense/Income
- net pension liability/asset discount rate – current
IRFS ➞ discount rate = interest rate = expected ret. r on IG
GAAP/Interest Exp. ➞ discount rate P0 corporate
Return on Plan Assets ➞ expected return bonds
⇒ DB – Periodic Pension Cost/ Pg-3

changes in
3) Remeasurements IFRS/ · actuarial gains/loses
assumptions
· difference between actual vs.
expected return on plan assets
OCI
GAAP ⇒ OCI as well
- corridor approach – used when actuarial +/- do not
offset each other
PO
- cumulative unrecog. +/- > 10% of the larger of
FVplan assets
excess is amortized over avg. exp.
(pg. 14)
remaining working lives of employees in plan
⇒ Actuarial Assumptions/
· employee turnover - long-term
· life expectancy equity growth
- rate of increase in · future inflation rates
compensation · interest rates
· future compensation levels

Component Costs
2013 2014 2015 LOS c

-describe
P0 (beg) 2.1M 2.6M 2.9M
Pg-14
FVassets (beg) 2.6M 2.8M 2.7M
act. +/- (YR) 400k 300k (170k)
Corridor 260k 280k 290k
(a) (b) (c) (d) (e) (f)

unrecog. amt. to amort. act. unrecog.
Corridor +/- be amort. over +/- act. +/-
(beg YR.) (beg YR.) (b-a) 5.5 yrs. (YR.) (end YR.)
2013 260k 400k 400k
2014 280 400k 120k 21,818 300 678,182
2015 290 678,182 388,182 70,579 (170) 437,603
⇒ Actuarial Assumptions/ Pg-4

when P0 changes ➝ interest expense changes
PO, beg YR.
+ Service costs
+ Interest cost
(review pg. 16-18) 19
- Benefits paid
+/- past service costs
+/- actuarial gains/losses po, end.
⇒ Disclosures/ comparability affected by differences in assumptions

immediate vs. defer &
amortize
contributions in
Cash flow reporting differences
excess of current
IFRS ➝ CFF/CFO (where on statements
pension exp. ➝ CFF
GAAP ➝ CFO line items appear)
outflow
· gross amounts PO in the notes (not consolidated)

Plan Assets

Actuarial Assumptions
5 yrs. LOS d
-explain
-calculate
r = 6% Pg-17
50k 60,198.56
4.75% increase/yr

- paid in lumpsum + past service = 10 yrs. credit
(. 𝟎𝟏𝟓 × 𝟔𝟎, 𝟏𝟗𝟖. 𝟓𝟔) × 𝟏𝟓 = 𝟏𝟑, 𝟓𝟒𝟒. 𝟔𝟖 𝟗𝟎𝟐. 𝟗𝟖 × 𝟏𝟎 = 𝟗𝟎𝟐𝟗. 𝟖𝟎
annual ÷ (𝟏. 𝟎𝟔)𝟓 = 𝟔𝟕𝟒𝟕. 𝟓𝟖
unit credit - $902.98
1 2 3 4 5
P0, beg YR. 6747.58 7867.67 9097.89 10447.41 11926.13
+ 6% interest 404.85 472.06 545.87 626.85 715.57
= P0, end YR. 7867.67 9097.89 10447.41 11926.13 13544.68
LOS d
5 yrs. -explain
20 yrs. -calculate
of Pg-18
r = 6% retirement
50k 60,198.56
payments
4.75% increase/yr PMT = 4514.89
PV = 51,785.46 I/Y = 6
- annual unit credit = 902.98 N = 20
- total obligation (5 yrs.) = 4514.89 FV = 0
𝟓𝟏,𝟕𝟖𝟓.𝟒𝟔
∴ new annual unit credit = = 𝟏𝟎, 𝟑𝟓𝟕. 𝟎𝟗
𝟓
1 2 3 4 5
P0, beg YR. ∅ 8203.75 17392.03 27653.32 39083.36
+ 6% interest ∅ 492.23 1043.52 1659.20 2345.00
= P0, end YR. 8203.75 17392.03 27653.32 39083.36 51785.46

⇒ Actuarial Assumptions/ Pg-4

when P0 changes ➝ interest expense changes
PO, beg YR.
+ Service costs
+ Interest Cost
(review pg. 16-18) 19
- Benefits paid
+/- past service costs
+/- actuarial gains/losses po, end.
⇒ Disclosures/ comparability affected by differences in assumptions

immediate vs. defer &
amortize
contributions in
Cash flow reporting differences
excess of current
IFRS ➝ CFF/CFO (where on statements
pension exp. ➝ CFF
GAAP ➝ CFO line items appear)
outflow
· gross amounts PO in the notes (not consolidated)

Plan Assets
⇒ Disclosures/ Pg-5
- total periodic pension costs = ending funding status
- employer contribution
- beginning funded status
⇒ Don’t get confused!
Pension Obligation - PV (future benefits)
Return on plan assets – actual vs. expected (plan assets E(R))
Net int. exp./inc. – net pension L/A × disc. rate (IFRS)
GAAP – expected return on assets $
interest expense ($)
+/-
Actuarial +/- → changes in assumptions
Remeasurements → actual r – expected r (plan assets)
Benefits paid → Plan assets (beg) + contributions + actual return
- plan assets (end)

Pg-6
⇒ Share-Based Compensation/
ESOP – employee stock option plan – seen as capital
transactions (charged to equity accounts)
CSOP – compensatory SOP – seen as compensation
expense (charges to operating income)
- compensation exp. = PV of ay share-based compensation
calculated on the date granted

(no subsequent adjustments)
service period – costs allocated over

this period
grant vesting expiry ➞ if not exercised,

date date exercise dates date costs not reversed
measurement – requires a
date valuation Model
⇒ Share-Based Compensation Pg-7

- exercise price
- P0 (stock)
- volatility - higher
- time to exp. - longer FV ↑
- rf - higher
- expected dividend - higher ➞ FV ↓
- Stock grant/ FV = P0 (allocated over service period)
- outright vs. restricted (conditions tenure

performance
- SAR-stock appreciation rights/phantom stock
(cash settled)
- compensation tied to value of shares without
the need to issue shares/options

Multinational Operations
Pg-1
⇒ Foreign currency – transaction (A sells to B in a different currency)
- translation
- A owns B and B is in a different country
• presentation currency – currency company prepares statements in
• local currency – currency of the country company is in
• functional currency – currency company primarily does business in
⇒ Transaction/
transaction exposure
• import/export ⇒
record date payment date
• lend/borrow
leads to A/L on BS gains/losses on IS (IFRS/GAAP
for. curr component of

strengthens weakens other Op. Inc/Exp
AR (asset) + - or /component of
Ap (liability) - + Non-Op. Inc/Exp.
⇒ Transaction/ Disclosure → the amount of transaction gain/loss Pg-2

(con’t) (MD&A or Notes) - if not material, not disclosed
⇒ Translation/ 2 approaches to translation (A/C accounts only + Ret. Earn)

1) all A/C translated at current spot rates
current
- typically, A > L ⇒ net asset B.S. exposure
method
-if for. curr ↑, translation gain
2) monetary A/C translated at current spot rates non-monetary
A/L @ historical⇒rates
Temporal
- typically, L > A ⇒ net liability B.S. exposure
method
- if for. curr↓, translation gain
- translation adjustment ⇒ amount required to balance after translation
for. curr - is a BS
strengthens weakens cumulative
net A exp. pos adj neg adj account in
net L exp. neg adj pos adj Equity section

Pg-3
⇒ Translation/ current rate – all A/L @ current rates at BS date
monetary/non-monetary
↳ all @ current rates
• if non-monetary A/L measured @ current value
temporal
- then use current rates (i.e. inventory)
method
• if non-monetary A/L measured @ historical cost
- then use historical rates (i.e. PPE)
⇒ Current or Temporal/
- if foreign entity’s functional
⇒ currency same as parent
use temporal, else use current
- functional currency determination: (p.17)
USD func.cur = CAD USD func.cur = USD
CAD EUR CAD EUR

to USD all to GBP consolidate all to GBP
(current rate) CAD to USD USD CAD
(temporal)
LOS d
- Which method is appropriate? -compare
- depends on the for. entity’s func. curr. -evaluate
-determine
same as Different Pg-17
parent (current rate)
(temporal)
- Func. curr. determination:
key 1. The currency that mainly influences sales
⇒ prices for g/s
2. The currency of the country whose competitive forces and regulations
mainly determine the sales price of its g/s
3. The currency that mainly influences labour, material, and other costs of
providing g/s
4. The currency in which funds from financing activities are generated
5. The currency in which receipts from operating activities are usually retained
- if mixed, mgmt. uses judgment

⇒ Translation/ Current Method: (net asset BS exp) Pg-4
- all A/L @ current rates @ BS date

- equity accts @historical (except Ret. Earn)
- translation adj: - Rev/Exp 2rate when transactions took place
- separate component of SH. Equity (cumulative). (average rate)
- if subs. sold, balanced transferred to IS as realized g/L
Temporal Method: (net liability BS exp)
translation adj: - monetary
⇒ A/L @ current rates @ BS date
- gain/loss on IS - non-monetary A/L measured at current value
(GAAP ⇒ Remeasurement) @ rate when current value measured
(net income open - non-monetary A/L measured at historical value
to for. curr risk) @ historical rate
- Equity accts @ historical (except Ret. Earn)
- Rev/Exp @ rate when transactions took place
(except non-mon @ hist)
⇒ Translation/ Retained Earnings (p.22) Pg-5
⇒ Extended example – pg. 23 → 28
⇒ Hyperinflation/ IFRS → for entity’s FS restated for changes in local

CPI, then translated at current rates
- monetary A/L not restated
- non-monetary A/L restated (from ⇒ BS valuation date)
- equity accounts all restated (from beg. of period)
Income Statement – restated by 𝜟CPI from dates when items originally
recorded on BS. (avg)
⇒ monetary assets > monetary liabilities = loss of PPP
GAAP → must use temporal method

exposed A > exposed L ⇒ net asset B.S. exp. LOS d

-compare
exposed A < exposed L ⇒ net liability B.S. exp. -evaluate
-determine
Retained Earnings/ Pg-22
NI (FC) transl. by method used NI (PC)
to translate IS
- Div (FC) Div (PC)
⇒
= R/E (FC) × rate when Div. declared = R/E (PC)
Beg R/E (FC) Beg R/E (PC)

+ NI (FC) transl. by method used + NI (PC)
to translate IS
- Div (FC) Div (PC)
= End R/E (FC) × rate when Div. declared = End R/E (PC)
LOS c, e
parent -analyze
sub.
Interco Canadaco -calculate
- established
(EUR) CAD -evaluate
Jan 1,20X1
Pg-23
Jan 1/20X1 Dec 31/20X1

LOS c, e
(Dec 31/20X1) Pg-24
LOS c, e
Pg-25
Extended Example

LOS c, e
Pg-26
LOS f
Pg-27
Ratios will differ

when different
c
rates are used
under each method
to calculate the
numerator and/or
denominator.
Ratios from func. curr.
to current rate ratios
will mostly
be preserved.

LOS f
Pg-28
Pg-5
⇒ Translation/ Retained Earnings (p.22)
⇒ Extended example – pg. 23 → 28

c⇒ Hyperinflation/ IFRS → for entity’s FS restated for changes in local
CPI, then translated at current rates
- monetary A/L not restated
- non-monetary A/L restated (from BS valuation date)
- equity accounts all restated (from beg. of period)
Income Statement – restated by 𝜟CPI from dates when items originally
recorded on BS. (avg.)
⇒ monetary assets > monetary liabilities = loss of PPP
GAAP → must use temporal method

Pg-6
⇒ Effective Tax Rate/ - companies incur taxes in the country in
which profit is earned
home tax rate > foreign tax rate
c Incremental
= home rate – foreign rate
tax rate
Disclosure: 𝐒𝐭𝐚𝐭𝐮𝐭𝐨𝐫𝐲 𝐭𝐚𝐱 𝐫𝐚𝐭𝐞

± 𝐚𝐝𝐣𝐮𝐬𝐭𝐦𝐞𝐧𝐭𝐬
= 𝐞𝐟𝐟𝐞𝐜𝐭𝐢𝐯𝐞 𝐭𝐚𝐱 𝐫𝐚𝐭𝐞
⇒ Sales Growth/ Q × P × rate
Financial Results
LOS i
- parent may have subs. using temporal method and others using
-explain
current rate – results in both a translation +/- ⇒ IS & transl. Pg-41
adj. +/- ⇒ B.S.
c
for. curr.
completely
Str. Wkn
follows the
net A exp
n direction of
net L exp
the currency

LOS a - describe/
Pg-1
1/ Systemic importance ➞ systemic risk – a risk of disruption to
financial services that is
a) caused by an impairment of all or parts of the
financial system
b) has the potential to have serious negative
consequences for the economy as a whole
2/ the nature of the liabilities – customer deposits
3/ the nature of the assets - predominately financial w/ direct
exposure to risks → credit, interest rates, market, liquidity
LOS b - describe/ - goal of regulation is to minimize systemic risk
Basel 3: · minimum capital requirements - %age of risk-weighted
assets funded with equity capital
· minimum liquidity - 30-day stress test scenario
· stable funding - one-yr horizon
LOS c - explain/CAMELS Pg-2

1/ Capital adequacy – proportion of assets funded with capital
adjusted based on their risk

e.g./ Cash ➞ 0%, Corporate loans ➞ 100%,
non-performing loans > 100%
- Capital: most important ➞ Common Equity Tier 1 Capital ≥ 4.5% rwa
(common stock, surplus over issuance, RE, AOCI
less – ded. of intangible assets, DTAs)
· Total Tier 1 Capital ≥ 6% rwa (+ sub. securities w/ no maturity)
- Tier 2 - instruments subordinate to depositor’s, min. maturity of 5 yrs.
· Total Capital ≥ 8% rwa
2/ Asset Quality – pertains to the amount of credit risk associated
with assets (loans + investments in securities)
3/ Management capabilities – governance, internal controls, financial
reporting quality

LOS c - explain/CAMELS Pg-3

net interest income
4/ Earnings – high quality, trending upward service income
trading income
- reliable loan impairment allowances
- fair value hierarchy: Level 1 ➞ inputs are quoted prices
2 ➞ observable, but not the quoted
prices for identical instruments in active markets
3 ➞ unobservable, FV is based on a model
5/ Liquidity – 2 min. liquidity standards from Basel 3

𝐇𝐢𝐠𝐡𝐥𝐲 𝐥𝐢𝐪𝐮𝐢𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
1/ Liquidity Coverage Ratio (LCR) = 𝟏 𝐦𝐨𝐧𝐭𝐡 𝐥𝐢𝐪𝐮𝐢𝐝𝐢𝐭𝐲 𝐧𝐞𝐞𝐝𝐬 = 𝟏𝟎𝟎%
𝐢𝐧 𝐚 𝐬𝐭𝐫𝐞𝐬𝐬 𝐬𝐜𝐞𝐧𝐚𝐫𝐢𝐨
2/ Net Stable Funding Ratio (NSFR)
- assign capital & liabilities to funding sources 𝐀𝐯𝐚𝐢𝐥𝐚𝐛𝐥𝐞

> 100%
one of 5 categories (multiply asset base 𝐑𝐞𝐪𝐮𝐢𝐫𝐞𝐝
by ASF factor) loans with long-
dated maturities require stable funding
available stable funding
Pg-4
LOS c - explain/CAMELS
concentration of funding
5/ Liquidity ➞ others contractual maturity mismatch – maturity date
of assets compared vs. maturity date of funding
sources
6/ Sensitivity to market risk ➞ sensitivity of earnings to +/- in
interest rates, fx., etc…
LOS d - describe/ Banking Specific
· Government support - too big to fail
· Government ownership – more likely to intervene on bank’s behalf
· Mission of banking entity - regional vs. national vs. global
· Corporate culture – risk-averse vs. risk-seeking
Non-bank specific
· Competitive environment · Currency exposure
· Off-balance sheet items · Risk factors
· Segment information

Pg-5
LOS f - describe/
premiums
· revenue
investment income
Property & Casualty – more variable
· categories
Life & Health – more predictable
· Property/Casualty/ · direct or agency writing soft pricing

market
· business is cyclical & price sensitive
hard
𝐓𝐨𝐭𝐚𝐥 𝐢𝐧𝐬𝐮𝐫𝐚𝐧𝐜𝐞 𝐞𝐱𝐩𝐞𝐧𝐬𝐞 > 100% pricing
𝐂𝐨𝐦𝐛𝐢𝐧𝐞𝐝 𝐫𝐚𝐭𝐢𝐨 = market
𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝 indicates an
𝐋𝐨𝐬𝐬𝐞𝐬
𝐔𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐫𝐚𝐭𝐢𝐨 = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝 underwriting loss
𝐔𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐞𝐱𝐩𝐞𝐧𝐬𝐞𝐬 quality of underwriting
𝐄𝐱𝐩𝐞𝐧𝐬𝐞 𝐫𝐚𝐭𝐢𝐨 = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 activities
efficiency of operations
· net premiums written: written–reinsurance in acquiring underwriting
· new premiums earned: accrual basis business
Pg-6
LOS f - describe/
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
· Property/Casualty: Dividends ratio = 𝐍𝐞𝐭 𝐩𝐫𝐞𝐦𝐢𝐮𝐦𝐬 𝐞𝐚𝐫𝐧𝐞𝐝
· Combined ratio after dividends = Comb. Ratio + Div. Ratio

𝐓𝐨𝐭𝐚𝐥 𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐢𝐧𝐜𝐨𝐦𝐞
· Investment performance = 𝐈𝐧𝐯𝐞𝐬𝐭𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
w/ & w/o
steady return, low unrealized
risk assets gain
· require a high degree of liquidity
· Life/Health: · direct or agency writing

· profitability measures
𝐓𝐨𝐭𝐚𝐥 𝐛𝐞𝐧𝐞𝐟𝐢𝐭𝐬 𝐩𝐚𝐢𝐝 𝐂𝐨𝐦𝐦.& 𝐞𝐱𝐩. 𝐢𝐧𝐜𝐮𝐫𝐫𝐞𝐝
𝐍𝐞𝐭 𝐩𝐫. 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 d 𝐃𝐞𝐩𝐨𝐬𝐢𝐭𝐬 𝐍𝐞𝐭 𝐩𝐫. 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 d 𝐃𝐞𝐩𝐨𝐬𝐢𝐭𝐬
𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐢𝐧𝐜𝐨𝐦𝐞
· investment returns 𝐈𝐧𝐯𝐞𝐬𝐭𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬
+ (DA = DL)
· liquidity ➞ driven by its liability structure

Quality of Financial Reports
Pg-1
⇒ Reporting Quality high Earning Quality high
-relevant Company
value
-faithful rep. low – stop - impedes low
assessment of earnings quality
⇒ Potential Problems/
• misclassifications
aggressive
(BS, IS, CFO, OCI) Revenues conservative
• M&A (conceal past mistakes) omissions
- Expenses
(max. goodwill) delayed recog.
=
• Impairment/Restructuring
Net Income
FV (over/understated) deferring AD
CFO accelerating AR
Assets = Liabilities + Equity
Contingents?
⇒ Reporting Quality Assessment/ Pg-2

1) Understand company /industry
compensation
2) Management insider transactions
3) Significant accounting areas (judgement)
𝐀𝐑 𝐀𝐑 4) Make comparisons
j 𝐭k𝐒𝐚𝐥𝐞𝐬 l ∕ j 𝐭n𝟏k𝐒𝐚𝐥𝐞𝐬 l
𝐭 𝐭n𝟏 declining AR turnover
5) Warning signs
NI > CFO
Days Rec. Index
6) Segment Analysis – focus on a desirable segment
Gross Margin Index
7) Quantitative Tools – Beneish Model
Asset Quality Index
Sales Growth Index M-score ∼ N (0,1)
Dep. Index - prob. of manipulation
SG&A Index
+ Accruals Index
+ Leverage Index -1.78
(3.8%)

⇒ Earnings Quality/ ROIC > WACC Pg-3

• Recurring earnings/ expected to continue
Pro-forma
Op. vs. non-Op
- adjusted to exclude
non-recurring non-recur. items
• Persistence/ sustainability
persistence of growth
Earnings
cash component accruals component (less persistent)
more persistent normal discretionary
𝚬𝐭d𝟏 = ∝ +𝛃𝟏 𝐂𝐅 + 𝛃𝟐 𝐀𝐜𝐜𝐫𝐮𝐚𝐥𝐬 + 𝛆𝐭 NI > CFO

∑ 𝐚𝐜𝐜𝐫𝐮𝐚𝐥𝐬 across
(𝛃𝟏 > 𝛃𝟐 ) compare 𝐀𝐯𝐠. 𝐎𝐩. 𝐈𝐧𝐜 companies
- extreme levels of earnings tend to

revert to normal levels – higher the accruals component, faster the
mean reversion
Pg-4
⇒ Earnings Quality/
• Revenue Recog. policies
• AR-age, DSO trends
• non-financial data
• Revenue trends - growth in Rev vs. growth in AR
- Capitalizing Expenses – lower exp = higher asset

- increasing FA + stable/increasing margins may
indicate capitalization of exp.
⇒ Bankruptcy Prediction Models/
Altman Model/ liquidity profitability leverage
𝐍𝐖𝐀 𝐑𝐄 𝐄𝐁𝐈𝐓 𝐌𝐕𝐄 𝐒𝐚𝐥𝐞𝐬

Z-score = 𝟏. 𝟐 p 𝐓𝐀
r + 𝟏. 𝟒 p𝐓𝐀r + 𝟑. 𝟑 p 𝐓𝐀
r + 𝟎. 𝟔 p𝐁𝐕n𝐥𝐢𝐚𝐛r + 𝟏. 𝟎 p 𝐓𝐀
r
higher = better activity

⇒ Cash Flow Quality/ positive CFO from sustainable sources Pg-5

CFO > (CAPEX + Div. + Debt. Repay)
less easily CFO w/low volatility
manipulated
depends on life cycle stage
⇒ Balance Sheet Quality/
- completeness – relevant items on BS.
- unbiased measurement
- clear presentation
⇒ Risk Disclosures/ Auditor
Notes
MD&A
Other Sources
Media


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Updated: January 27,2020

a. describe the classification, measurement, and disclosure under International

b. distinguish between IFRS and US GAAP in the classification, measurement,

c. analyze how different methods used to account for intercorporate

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Intercorporate Investments ➞ investments in other companies Pg-1

➞ Debt or Equity diversify their asset base

⇒ Basic Corporate Investment Categories/ Pg-2

4) Business Combinations (including investments in subsidiaries)

if the asset can be sold, can elect 203 below

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

all income goes

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ 20%-50% voting rights

e.g./ ABC purchases 20% interest in XYZ for Pg-6

$480k Jan. 2/13 (48,000 shares @ $10/sh.)

Investment in Associate 480k

XYZ reports NI = 200k for 2013

Jan. 28/14 Cash Dividend $100k

- Note: Dividends & FV do not affect NI

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

e.g./ Income Dividends Pg-7

Initial Cost 200k

Purchase $ = 8.5M difference first

tested yearly for

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

e.g. Con’t/ Your Co. reports Pg-9

Jan. 1/14/ Inv. in Associates $8.5 M Initial

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

- Transactions with associates/ Pg-12

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

· BV = $3.8M · FV = $3.84M ⇒ $40k for a building 20-yr. life

$8,000 from an upstream sale of inventory

e.g./ · Jones owns 25% of Jason Co. Pg-14

2011 Jones equity income? 2012 Jones equity income?

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Issues for analysts/ Pg-16

⇒ move from influence to control Pg-17

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

- pre-June 2001 ➞ GAAP allowed either (as did IFRS) Pg-18

1) pooling of interests 𝐁𝐕𝐀 + 𝐁𝐕𝐁

- party that will absorb

⇒ both IFRS & GAAP/ required for all Bus. Comb.

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Issue #1: Recognition and Measurement of/ Pg-22

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Issue #1: Recognition and Measurement of/ Pg-23

IFRS – 2 options GAAP – 1 option · not amortized

- FV of acquisition - FV of entity as a whole

⇒ Issue #2: Recognition and Measurement of Goodwill

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Impact on FS – Franklin acquires 100% of Pg-25

The Consolidation Process

- combine the statements of the parent & subsidiaries Pg-26

as if they were one economic unit

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

⇒ Business Combinations < 100% acquisition/ Pg-27

e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of

e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of Pg-28

Prepared exclusively for Jitrapa Rodjanapattarakul ,jitrapa_r@hotmail.com

e.g./ Jan. 1/12 Parent Co. acquires 90% of shares of Pg-29

⇒ Income Statement/ Pg-30