CFA Level 2 - Financial Reporting and Analysis

Inventory
LIFO -> FIFO: during time of increasing cost of inventory
  Inv↑, COGS↓, NI↑, equity↑, cash ratio↓ (because of additional taxes paid)

LIFO reserve:
  the diff. between LIFO inv. carrying amount and amount that would be reported under FIFO

change LIFO to FIFO, impacts cash flow from operating activities only in income taxes paid.

Long-lived Assets
capitalised expenditure: Asset↑, investing cash outflow

expensed expenditure : NI↓(NI - expense(1-T)), RE↓, operating cash outflow expense

interest expenditure:
for own use, capitalised interest as part of long-lived asset, expense over time as depreciation expense
for sale, capitalised interest as part of inv. expense as cost of good sales when asset is sold
expense interest reduce oper. cash flow

IFRS: 

research expenditure: expense
in process R&D: capitalised

development expenditure: can be recog. as asset if feasibility is completed

adjust NI from capitalising to expensing:

   expense cost reduce NI in early years

   no amortization increase NI in later years

depreciation: NI↓, Asset↓, no impact on cash flow, depreciation does have an indirect affect on cash flow, it affects taxable income and tax payable

Revaluation

IFRS:

long lived assets can use historical cost model or revaluation model

historical cost model: long lived assets are at cost less accum. depreciation, adjusted for impartment

revaluation model: long lived assets are at fair value

  fair value less accum. depreciation and impairment loss

US GAAP:
 only historical cost model

revaluation: 

 carrying amount ↓ -> goes to P/L

 carrying amount ↑ -> goes to OCI, revaluation surplus appears in equity

 carrying amount ↑ -> asset ↑ and shareholder equity ↑ -> financial leverage ↓
 carrying amount ↓ -> NI and asset goes down, return on asset ↑

leverage = assets / equity

  
Impairment

IFRS:
- if carrying amount > recoverable amount, need to measure impairment loss

- recoverable amount: higher of its fair value less cost to sell, or its value in use (discounted future cash flows)
- impairment loss: the difference of carrying amt over recoverable amt

US GAAP:

  Two step process

  1. recoverable amount: if carrying amount > undiscounted future cash flow, then go to step 2

  2. impairment loss is the difference btn fair value and carrying amount

If impairment: asset↓, NI↓, cash flow no effect

Leasing
finance lease:
  for lessee:
   balance sheet: leased asset, lease payable
   income statement: interest expense on the lease, depreciation expense
   CF statement: lease interest expense is an operating cash outflow
                 lease principal expense (that reduce lease liability) is an financing cash outflow
  for lessor:
   balance sheet: sale of leased asset, lease receivable
   income statement: interest income on the lease, without  depreciation expense, without lease revenue
   CF statement: increase in lease interest is an operating cash inflow
                 lease payment received (that reduce lease receivable) is an investing cash inflow

operating lease:
  for lessee:
   balance sheet:
   income statement: lease expense
   CF statement: lease expense is an operating cash outflow
  for lessor:
   balance sheet: assets under operating assets classified in PP&E as capital assets
   income statement: lease  revenue

finance lease: higher operating cash flow
operating lease: higher return measures in early years

Intercorporate Investments
1. investment in financial assets
  typical percentage interest < 20%
  4 types:

•   held to maturity
•   available for sale
•   fair value thru P/L

            held for trading
            designated as fair value

•   loans and receivables

Initially, All investments in financial assets are recognised at fair value, dividends and NI reported in Income statement

held to maturity investment such as debt securities, reported at amortised cost. Any diff, discount or premium, btn fair value and par value is amortised over the life of securities. Amortization affect carrying value of securities.

held for trading, reported at fair value, with unrealised gain/loss reported in P/L

available for sale (AFS), reported at fair value, with unrealised gain or loss reported in OCI. dividends from equities securities are in P/L. For AFS debt securities, under IFRS, foreign exchange gain/loss reported in P/L, remaining portion reported in OCI. Under US GAAP, the total change in fair value reported in OCI.

IFRS generally prohibits reclassification of securities.
held to maturity -> available for sale, if intention change, at time of reclassification, the diff btn amortised cost and fair value reported in OCI

available for sale -> held to maturity, if intention change, fair value become new amortised cost. Any gain/loss is recog. in OCI is amortised to P/L


New standard, IFRS 9, as of December 2012:

2. investment in associates -> equity method
  typical percentage interest, 20% to 50%
  single line item on the income statement, single line item on the balance sheet
  earnings/loss proportion to economic ownership
  dividends also proportion to economic ownership
  asset proportion to economic ownership
  revenue not affected
  EBIT / Interest Expense not affected
On the income statement, share of net income gain/loss as one line item after EBIT, but before taxes. Dividends are included in interest income.

The equity method is carried at cost, plus its share of post acquisition income, less dividends received

If Equity investment > proportionate share of the book value of the investee's net identifiable assets:
  the difference is first allocated to specific assets, then the difference is amortised to the proportionate share of the investee's P/L over the economic life of the assets whose fair value > book value.

Cost of acquisition > proportionate share of the fair value of the net identifiable assets is goodwill. Any remaining diff btn acquisition cost and fair value of net identifiable assets that cannot be allocated to specific assets, is treated as goodwill. Goodwill is not amortised. Goodwill is impaired.

3. business combinations -> acquisition method
  typical percentage interest > 50%
  assets and liabilities of the acquiree measured at fair value at date of acquisition

Measurement of Goodwill:
  IFRS: full goodwill: fair value of entity - fair value of identifiable asset,
           or partial goodwill: fair value of of consideration(purchase price) - proportion of identifiable net asset
  US GAAP: full goodwill only, fair value of entity - fair value of identifiable asset

  allocation of excess purchase price: to diff between fair value and book value of assets, remaining of the amount is goodwill

non-controlling (minority) interest: balance sheet
  IFRS: proportion of acquiree's measured fair value (full goodwill), or proportionate share of acquiree's net identifiable assets (partial goodwill)
 US GAAP : full goodwill only, at proportion of acquiree's measured fair value

Net income is not affected by the accounting method used to account for active investment in other companies --> acquisition method would subtract the minority interest, net effect same as equity method or proportionate method

Employee Compensation
Pensions and Other Post-Employment Benefits
  defined contributions
  defined benefits

defined benefits pension plans:
  pension funded status reported on balance sheet
  periodic pension cost, change in net pension liability/asset adjusted for employer's contribution
  under IFRS
    1. service cost (current service cost, past svc cost)->P/L
    2. net interest expense/income->P/L
    3. remeasurement of net pension liability/asset -> OCI

current service cost: amount of pension obligation increase as employee's service
current service cost = annual pension credit / [(1+r)^{years until retirement}]

Multinational Operations
Translations of Foreign Exchange Financial Stmt:
Current rate method: (All asset/liabilities at current exchange rate)
Temporal  method: (Monetary asset/liabilities at current exchange rate)

Parent currency as the functional currency -> use temporal method

foreign currency as the functional currency -> use current rate method

1. Current rate method:
Asset/liabilities at current exchange rate
stockholder equity at historical rate
revenue/expense  at average rate

translation adjustment shows in stockholder's equity

2. Temporal method:
Monetary asset/liabilities at current exchange rate
Non-monetary asset/liabilities measured at historical cost at historical exchange rate, Non-monetary asset/liabilities measured at current value at date of current rate
stockholder equity at historical rate
revenue/expense  at average rate
revenue/expense of COGS, depreciation at exchange rate of related assets

translation adjustment shows in income statement

temporal method tends to have net liability position (monetary assets - monetary liabilities), because only a few items are monetary assets and many monetary liabilities

monetary assets: cash and AR
non-monetary assets: marketable securities at current rate
non-monetary assets: PPE at historical rate
monetary liabilities: AP, accrued expense, LT debt, deferred income tax

US GAAP defines highly inflationary economy, a cumulative 3 year inflation rate > 100%

Integrated Financial Statement Analysis

compare revenue growth to asset growth to receivables growth

selling receivables to 3rd party, company can boost OCF, and DSO goes down

IFRS                                                                          US GAAP

  interest paid: operating/financing                     operating

  interest received: operating/investing              operating

  dividend received: operating/investing              operating

cash flow from non-trading securities -> investing cash flow
cash flow from trading securities -> operating cash flow

Extended DuPont Analysis
                                   NI    EBT   EBIT
Net profit margin = -----*-------*--------
                                  EBT  EBIT  Sales

             NI    EBT   EBIT          Sales               Total Assets
ROE = -----*-------*-------- *--------------- * ------------------------
            EBT  EBIT  Sales    Total Assets  shareholder equity