CFA 2018 Level 2 FSA

  Financial Statement Analysis Weight: 15%~20%

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

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

  Ø

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

  生在准备二级新的知识的通知也应该 适当的复习财报一级 的重要知识点 。

  Summary Investments in Financial Assets

Exam tips:

Tasks:

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

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

Definition of intercorporate investments

  Ø Intercorporate investments in marketable securities are

  Financial Business Joint Associates Assets Combination Ventures

  categorized as follows:

• Degree of Shared

  Investments in financial assets (has no significant influence)

  No significant Significant Control influence control

  Investments in associates (has significant influence) •

  Typical

  Business combinations (has control over the investee firm) •

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

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

  Term of investee N/A Associate Subsidiary N/A

The classification of categories

  Ø Percentage of ownership is typically used to determine the

• HTM

  AFS

  appropriate category. However, the ownership percentage is

• Accounting Fair value Acquisition Equity •

  Equity method through

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

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

  Financial Assets Financial Assets

Held-to-maturity investments Definition of financial assets

  Ø Held-to-maturity investments are investments in financial

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

  Ø Initial recognition (similar under IFRS & US GAAP)

• HTM is only for debt securities

  IFRS: recognized at fair value. •

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

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

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

Fair value through profit and loss

Available for sale securities

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

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

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

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

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

  Example

  (Both US GAAP and IFRS)

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

  Available for Sale Securities

  Ø Debt:

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

  Financial Assets

  Ø Designated at fair value

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

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

  Financial Assets

Foreign exchange rate changes

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

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

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

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

  Example Example

IFRS

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

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

  Reclassification of Financial Asset

  Ø

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

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

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

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

U.S. GAAP

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

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

  Fair value through Income statement Ø

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

  Held to maturity Available for sale Other comprehensive income Ø

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

  Fair value through Transfer out of OCI the security.

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

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

Under U.S. GAAP

  Ø Ø

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

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

  A subsequent reversal of impairment losses is not allowed .

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

Under IFRS (HTM) Under IFRS

  Ø Impairment of held to maturity securities

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

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

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

  permanently )

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

  not considered to be indications of impairment in the

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

  (regardless of the probability of occurrence) are not

  Impairment loss is recognized on income statement. • recognized .

  Ø Reversal

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

  Impairment of Financial Asset Impairment of Financial Asset

Under IFRS (AFS)

Under IFRS (AFS)

  Ø Impairment of available for sale securities

  Ø

Impairment of available for sale securities

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

  Cumulative loss in OCI is reclassified to income •

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

  ü Cumulative loss = Acquisition cost – current fair

  affect the investee and indicate that the initial cost of

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

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

Under IFRS (AFS)

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

  IFRS 9 (New Standards)

  Impairment of Financial Asset

  Ø Reversal of available for sale securities

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

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

  IFRS 9 (New Standards)

IFRS 9 (New Standards)

  Ø

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

  (FVOCI) .

  IFRS 9 (New Standards)

IFRS 9 (New Standards)

IFRS 9 (New Standards)

  Ø FVPL ( Debt & Equity )

Amortized cost ( Debt only ), 2 criteria:

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

Summary of IFRS 9 Summary

  Ø

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

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

  Ø

  Ø ☆☆

Importance:

  Ø

Content:

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

• Reclassification of financial assets.

  Impairment of financial assets. • Ø

Exam tips:

  主要考察定性的概念及辨析，注意区分GAAP和IFRS的记 • 账方法。

  Definition of Associates

Definition of Associate

  Investment in Associates

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

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

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

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

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

Equity Method of Accounting

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

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

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

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

  Example Equity Method

  Equity Method of Accounting (Answer)

Investment Costs That Exceed the Book Value of the Investee

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

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

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

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

  Not simply equals to the net income earned by investee •

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

Equity Method Example

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

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

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

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

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

  Example Example

  Question A: Calculate the goodwill

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

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

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

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

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

  = $28,500

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

  Example Fair Value Option

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

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

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

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

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

  = $90,500

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

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

  Impairment of Equity Investment

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

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

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

  Impairment of Equity Investment

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

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

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

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

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

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

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

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

  will be recognized.

  Transactions with Associates Example of Downstream Transaction

  Downstream ( investor to associate )

  Downstream ( investor to associate )

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

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

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

  Ø The investor must eliminate the proportionate share of Ø

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

  the profit that is unconfirmed.

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

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

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

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

Importance:

  Ø

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

  Significant influence or not

Content:

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

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

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

• Impairment (US GAAP & IFRS)

  Ø Net margin ratios could be overstated because income for the

  Transactions with Associates (upstream & downstream) •

  associate is included in investor net income but is not specifically

  Ø Exam tips: included in sales.

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

  Business Combinations

Definition of Business Combinations

  Ø Business combinations (controlling interest investments) involve

  Business Combinations

  the combination of two or more entities into a larger economic

  Tasks: entity.

  Ø Describe the classification, measurement, and disclosure

• Under IFRS , there is no distinction among business

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

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

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

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

  Merger ( 吸收合并 ) 新设合并 )

  Consolidation (

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

  Ø The distinctive feature of a consolidation is that a new

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

  legal entity is formed and none of the predecessor

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

• Company A + Company B = Company A

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

  Ø Each entity continues operations but is connected through a

  ( Acquire 100% of the target )

  parent–subsidiary relationship. Each entity is an individual that

• Company A + Company B = Company C

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

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

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

  Ø Combining companies that met twelve strict criteria. Companies not

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

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

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

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

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

  Ø interests method . (

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

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

  Acquisition Method ( US GAAP & IFRS )

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

  Accounting Treatment for Business Combination

  Ø Suppose that on January 1

  st

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

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

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

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

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

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

Non-controlling interests:

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

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

  Minority Interest

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

A more complicated example of combination B/S:

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

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

  30 30 600 -500 =100 130 Inventory

  50 50 +30 =80 150 230

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

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

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

  Capital 150 150 550 -150 550

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

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

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

  Goodwill

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

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

  Example B/S items Book Value (million)

  Current assets

  80 PP&E 760 Goodwill

  30 Liabilities 400 Equity 470

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

  Ø IFRS allows two options for recognizing goodwill.

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

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

  Ø Under IFRS

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

  Impairment of Goodwill

  2. The loss is measured as the difference between the

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

  Ø Under US GAAP, goodwill impairment involves two steps.

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

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

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

  Answer Measurement of minority interest:

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

  ü = 0.75 x 560 = 420 million

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

  Ø Full goodwill method

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

  Example of Goodwill Impairment

• Recoverable amount of unit < Carrying amount of unit
• Impairment loss = 1.3 m – 1.4 m = €100,000

Example of Goodwill Impairment in US GAAP Bargain Purchase

  Ø Under US GAAP

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

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

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

  Ø Both IFRS and US GAAP require that the difference

  Step 2 – Measurement of the Impairment Loss •

  between fair value of net assets and purchase price be

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  Cash

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

  Inventory

  50 50 +30 =80 150 230

• 调整公允价值后的固定资产会增加额外折旧：50/10 = 5

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

  PP&E 250 250 +50 =300 400 700

• 调整公允价值后的无形资产会增加额外摊销：100/10 = 10

  Intangible

• 100 =100 100

  asset Ø Inventory increased fair value of 30.

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

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

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

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

  Amort. of I/A (10) (10)

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

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

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

  Summary Ø ☆☆☆

Importance:

  Joint Ventures, SPE & VIE Ø

Content:

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

Tasks:

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

• 了解因公允价值调整对于对于

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

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

  Ø Distinguish between IFRS and US GAAP in the classification,

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

  Ø Exam tips:

• 此部分为考试重点，需要重点关注。

Definition of Joint Ventures Definition of SPE

Definition of Special Purpose Entities Definition of Joint Venture

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

  Ø

  IFRS identify the following common characteristics of joint ventures: Ø

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

• A contractual arrangement exists between two or more

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

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

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

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

  Definition of VIE SPE & VIE

  Definition of Variable Interest Entity Ø

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

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

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

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

  Equity investors lack any one of the following: ü

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

  ü The obligation to absorb losses

  Ø Consolidation of VIE or SPE will significantly affect the

  ü The right to receive returns financial statements and ratios.

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

Importance:

Content:

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

Tasks:

Exam tips:

• 此部分知识点相对比较独立，只是补充了合并报表的一些

  Lower

  Higher – net income is the same and assets are lower

  Lower ROA

  Higher – equity is lower and net income is the same

  Lower ROE

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

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

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

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

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

  Acquisition vs. Equity Method

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

  Summary Analysis of Financial Results

  特殊情况，在考试中出现的情况不多。

  Ø

  ☆ Ø

  Ø

Ratios Equity Method Acquisition Method

Additional issues in business combinations

Importance:

Content:

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

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

  Ø Other post-retirement benefits ( OPB )

  Ø Defined-benefit pension plan ( DB )

  Ø Defined-contribution pension plan ( DC )

  Overview of Post-retirement Plan

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

  Summary Post-retirement Plan

  Ø

  ü In-process R&D ü Restructuring costs

  Ø

  ☆ ☆ ☆

  Ø

  Ø Restructuring costs

  Ø In-process R&D

  Additional Issues in Combinations

Exam tips:

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

The typical post-retirement plans include:

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

Tasks:

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

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

  Summary Accounting for DB Plan

  ☆ Ø

  Ø

  3. Not bear risk/return consequences of investment.

  1. Receive periodic payments starting at retirement.

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

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

  1. Liability of employer

  DB Plan

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

  2. Bear all risk/return consequences of investment.

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

  3. The plan must offer sufficient investment vehicles.

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

  1. People keeps all contributions current.

  ☆ ) Plan Type Employer Employee DC

  DC Plan (

Plan Type Employer Employee DB

Importance:

Content:

• Post-retirement Plan (了解常见的养老金分类)

Tasks:

  Ø

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

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

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