Finance 11 _ SchweserNotes_Book_2_2_112_2020 CFA Programe Exam Preparation | Financial Reporting and Analysis and Corporate Finance

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STUDY SESSION 5 The topical coverage corresponds with the following CFA Institute assigned reading: 13. Intercorporate Investments The candidate should be able to: 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. (page 1) 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. (page 1) c. analyze how different methods used to account for intercorporate investments affect financial statements and ratios. (page 27) The topical coverage corresponds with the following CFA Institute assigned reading: 14. Employee Compensation: Post-Employment and Share-Based The candidate should be able to: a. describe the types of post-employment benefit plans and implications for financial reports. (page 35) 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). (page 37) c. describe the components of a company’s defined benefit pension costs. (page 41) d. explain and calculate the effect of a defined benefit plan’s assumptions on the defined benefit obligation and periodic pension cost. (page 48) 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. (page 51) f. interpret pension plan note disclosures including cash flow related information. (page 53) g. explain issues associated with accounting for share-based compensation. (page 56) 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. (page 56) The topical coverage corresponds with the following CFA Institute assigned reading: 15. Multinational Operations The candidate should be able to: a. distinguish among presentation (reporting) currency, functional currency, and local currency. (page 65) b. describe foreign currency transaction exposure, including accounting for and disclosures about foreign currency transaction gains and losses. (page 66) c. analyze how changes in exchange rates affect the translated sales of the subsidiary and parent company. (page 68) 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 various scenarios. (page 68) 2021新版CFAFRM 一二三级视频课程 需要加微信 cfafrm007e. calculate the translation effects and evaluate the translation of a subsidiary’s balance sheet and income statement into the parent company’s presentation currency. (page 77) f. analyze how the current rate method and the temporal method affect financial statements and ratios. (page 84) g. analyze how alternative translation methods for subsidiaries operating in hyperinflationary economies affect financial statements and ratios. (page 91) h. describe how multinational operations affect a company’s effective tax rate. (page 95) i. explain how changes in the components of sales affect the sustainability of sales growth. (page 96) j. analyze how currency fluctuations potentially affect financial results, given a company’s countries of operation. (page 97) The topical coverage corresponds with the following CFA Institute assigned reading: 16. Analysis of Financial Institutions The candidate should be able to: a. describe how financial institutions differ from other companies. (page 107) b. describe key aspects of financial regulations of financial institutions. (page 108) c. explain the CAMELS (capital adequacy, asset quality, management, earnings, liquidity, and sensitivity) approach to analyzing a bank, including key ratios and its limitations. (page 109) d. describe other factors to consider in analyzing a bank. (page 119) e. analyze a bank based on financial statements and other factors. (page 121) f. describe key ratios and other factors to consider in analyzing an insurance company. (page 125)STUDY SESSION 6 The topical coverage corresponds with the following CFA Institute assigned reading: 17. Evaluating Quality of Financial Reports The candidate should be able to: a. demonstrate the use of a conceptual framework for assessing the quality of a company’s financial reports. (page 137) b. explain potential problems that affect the quality of financial reports. (page 138) c. describe how to evaluate the quality of a company’s financial reports. (page 142) d. evaluate the quality of a company’s financial reports. (page 142) e. describe the concept of sustainable (persistent) earnings. (page 145) f. describe indicators of earnings quality. (page 145) g. explain mean reversion in earnings and how the accruals component of earnings affects the speed of mean reversion. (page 147) h. evaluate the earnings quality of a company. (page 147) i. describe indicators of cash flow quality. (page 150) j. evaluate the cash flow quality of a company. (page 151) k. describe indicators of balance sheet quality. (page 152) l. evaluate the balance sheet quality of a company. (page 152) m. describe sources of information about risk. (page 153) The topical coverage corresponds with the following CFA Institute assigned reading: 18. Integration of Financial Statement Analysis Techniques The candidate should be able to: 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). (page 165) 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. (page 167) 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. (page 167) d. evaluate how a given change in accounting standards, methods, or assumptions affects financial statements and ratios. (page 177) 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 condition. (page 177)STUDY SESSION 7 The topical coverage corresponds with the following CFA Institute assigned reading: 19. Capital Budgeting The candidate should be able to: a. calculate the yearly cash flows of expansion and replacement capital projects and evaluate how the choice of depreciation method affects those cash flows. (page 200) b. explain how inflation affects capital budgeting analysis. (page 207) c. evaluate capital projects and determine the optimal capital project in situations of 1) mutually exclusive projects with unequal lives, using either the least common multiple of lives approach or the equivalent annual annuity approach, and 2) capital rationing. (page 210) d. explain how sensitivity analysis, scenario analysis, and Monte Carlo simulation can be used to assess the stand-alone risk of a capital project. (page 214) e. explain and calculate the discount rate, based on market risk methods, to use in valuing a capital project. (page 217) f. describe types of real options and evaluate a capital project using real options. (page 221) g. describe common capital budgeting pitfalls. (page 224) h. calculate and interpret accounting income and economic income in the context of capital budgeting. (page 225) i. distinguish among the economic profit, residual income, and claims valuation models for capital budgeting and evaluate a capital project using each. (page 229) The topical coverage corresponds with the following CFA Institute assigned reading: 20. Capital Structure The candidate should be able to: a. explain the Modigliani–Miller propositions regarding capital structure, including the effects of leverage, taxes, financial distress, agency costs, and asymmetric information on a company’s cost of equity, cost of capital, and optimal capital structure. (page 244) b. describe target capital structure and explain why a company’s actual capital structure may fluctuate around its target. (page 252) c. describe the role of debt ratings in capital structure policy. (page 252) d. explain factors an analyst should consider in evaluating the effect of capital structure policy on valuation. (page 253) e. describe international differences in the use of financial leverage, factors that explain these differences, and implications of these differences for investment analysis. (page 253) The topical coverage corresponds with the following CFA Institute assigned reading: 21. Analysis of Dividends and Share Repurchases The candidate should be able to: a. describe the expected effect of regular cash dividends, extra dividends, liquidating dividends, stock dividends, stock splits, and reverse stock splits on shareholders’ wealth and a company’s financial ratios. (page 263) b. compare theories of dividend policy and explain implications of each for share value given a description of a corporate dividend action. (page 265) c. describe types of information (signals) that dividend initiations, increases, decreases, and omissions may convey. (page 266)d. explain how clientele effects and agency costs may affect a company’s payout policy. (page 267) e. explain factors that affect dividend policy in practice. (page 269) f. calculate and interpret the effective tax rate on a given currency unit of corporate earnings under double taxation, dividend imputation, and split-rate tax systems. (page 270) g. compare stable dividend, constant dividend payout ratio, and residual dividend payout policies, and calculate the dividend under each policy. (page 274) h. compare share repurchase methods. (page 277) i. calculate and compare the effect of a share repurchase on earnings per share when 1) the repurchase is financed with the company’s surplus cash and 2) the company uses debt to finance the repurchase. (page 277) j. calculate the effect of a share repurchase on book value per share. (page 278) k. explain the choice between paying cash dividends and repurchasing shares. (page 279) l. describe broad trends in corporate payout policies. (page 282) m. calculate and interpret dividend coverage ratios based on 1) net income and 2) free cash flow. (page 283) n. identify characteristics of companies that may not be able to sustain their cash dividend. (page 283)STUDY SESSION 8 The topical coverage corresponds with the following CFA Institute assigned reading: 22. Corporate Governance and Other ESG Considerations in Investment Analysis The candidate should be able to: a. describe global variations in ownership structures and the possible effects of these variations on corporate governance policies and practices. (page 296) b. evaluate the effectiveness of a company’s corporate governance policies and practices. (page 299) c. describe how ESG-related risk exposures and investment opportunities may be identified and evaluated. (page 301) d. evaluate ESG risk exposures and investment opportunities related to a company. (page 302) The topical coverage corresponds with the following CFA Institute assigned reading: 23. Mergers and Acquisitions The candidate should be able to: a. classify merger and acquisition (M&A) activities based on forms of integration and relatedness of business activities. (page 310) b. explain common motivations behind M&A activity. (page 311) c. explain bootstrapping of earnings per share (EPS) and calculate a company’s postmerger EPS. (page 313) d. explain, based on industry life cycles, the relation between merger motivations and types of mergers. (page 315) e. contrast merger transaction characteristics by form of acquisition, method of payment, and attitude of target management. (page 317) f. distinguish among pre-offer and post-offer takeover defense mechanisms. (page 320) g. calculate and interpret the Herfindahl–Hirschman Index and evaluate the likelihood of an antitrust challenge for a given business combination. (page 323) h. compare the discounted cash flow, comparable company, and comparable transaction analyses for valuing a target company, including the advantages and disadvantages of each. (page 337) i. calculate free cash flows for a target company and estimate the company’s intrinsic value based on discounted cash flow analysis. (page 325) j. estimate the value of a target company using comparable company and comparable transaction analyses. (page 330) k. evaluate a takeover bid and calculate the estimated post-acquisition value of an acquirer and the gains accrued to the target shareholders versus the acquirer shareholders. (page 340) l. explain how price and payment method affect the distribution of risks and benefits in M&A transactions. (page 345) m. describe characteristics of M&A transactions that create value. (page 345) n. distinguish among equity carve-outs, spin-offs, split-offs, and liquidation. (page 346) o. explain common reasons for restructuring. (page 347)Video covering this content is available online. The following is a review of the Financial Reporting and Analysis (1) principles designed to address the learning outcome statements set forth by CFA Institute. Cross-Reference to CFA Institute Assigned Reading #13. READING 13: INTERCORPORATE INVESTMENTS Study Session 5 EXAM FOCUS There are no shortcuts here. Spend the time necessary to learn how and when to use each method of accounting for intercorporate investments because the probability of this material being tested is high. Be able to determine the effects of each method on the financial statements and ratios. Pay particular attention to the examples illustrating the difference between the equity method and the acquisition method. MODULE 13.1: CLASSIFICATIONS CATEGORIES OF INTERCORPORATE INVESTMENTS LOS 13.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. LOS 13.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. CFA® Program Curriculum, Volume 2, page 8 Intercorporate investments in marketable securities are categorized as either (1) investments in financial assets (when the investing firm has no significant control over the operations of the investee firm), (2) investments in associates (when the investing firm has significant influence over the operations of the investee firm, but not control), or (3) business combinations (when the investing firm has control over the operations of the investee firm). Percentage of ownership (or voting control) is typically used to determine the appropriate category for financial reporting purposes. However, the ownership percentage is only a guideline. Ultimately, the category is based on the investor’s ability to influence or control the investee. Investments in financial assets. An ownership interest of less than 20% is usually considered a passive investment. In this case, the investor cannot significantly influence or control the investee.Investments in associates. An ownership interest between 20% and 50% is typically a noncontrolling investment; however, the investor can usually significantly influence the investee’s business operations. Significant influence can be evidenced by the following: Board of directors representation. Involvement in policy making. Material intercompany transactions. Interchange of managerial personnel. Dependence on technology. It may be possible to have significant influence with less than 20% ownership. In this case, the investment is considered an investment in associates. Conversely, without significant influence, an ownership interest between 20% and 50% is considered an investment in financial assets. The equity method is used to account for investments in associates. Business combinations. An ownership interest of more than 50% is usually a controlling investment. When the investor can control the investee, the acquisition method is used. It is possible to own more than 50% of an investee and not have control. For example, control can be temporary or barriers may exist such as bankruptcy or governmental intervention. In these cases, the investment is not considered controlling. Conversely, it is possible to control with less than a 50% ownership interest. In this case, the investment is still considered a business combination. Joint ventures. A joint venture is an entity whereby control is shared by two or more investors. Both IFRS and U.S. GAAP require the equity method for joint ventures. In rare cases, IFRS and U.S. GAAP allow proportionate consolidation as opposed to the equity method. Figure 13.1 summarizes the accounting treatment for investments. Figure 13.1: Accounting for Investments Ownership Degree of Influence Accounting Treatment Less than 20% (investments in financial assets) No significant influence Amortized cost, fair value through OCI, fair value through profit or loss 20%–50%(investment in associates) Significant influence Equity method More than 50% (business combinations) Control Acquisition method MODULE QUIZ 13.1 To best evaluate your performance, enter your quiz answers online. 1. Tall Company owns 30% of the common equity of Short Incorporated. Tall has been unsuccessful in its attempts to obtain representation on Short’s board of directors. For financial reporting purposes, Tall’s ownership interest is most likely considered a(n): A. investment in financial assets. B. investment in associates. C. business combination.Video covering this content is available online. MODULE 13.2: INVESTMENTS IN FINANCIAL ASSETS (IFRS 9) IFRS 9 IASB and FASB have each issued similar new standards for accounting for investment in financial assets (minor differences remain). Consistent with the curriculum, the terminology mentioned here is the IFRS terminology. IFRS categorizes financial assets depending on whether they are carried at amortized cost or at fair value. The result is three classifications: amortized cost, fair value through profit or loss, and fair value through OCI. Corresponding classifications under U.S. GAAP are heldto-maturity, held for trading, and available for sale. Amortized Cost (for Debt Securities Only) Debt securities that meet two criteria are accounted for using the amortized cost method. Criteria for amortized cost accounting: 1. Business model test: Debt securities are being held to collect contractual cash flows. 2. Cash flow characteristic test: The contractual cash flows are either principal, or interest on principal, only. These debt securities are reported on the balance sheet at amortized cost. Amortized cost is the original cost of the debt security plus any discount, or minus any premium, that has been amortized to date. Interest income (coupon cash flow adjusted for amortization of premium or discount) is recognized in the income statement, but subsequent changes in fair value are ignored. Fair Value Through Profit or Loss (for Debt and Equity Securities) Debt securities may be classified as fair value through profit or loss (FVPL) if held for trading, or if accounting for those securities at amortized cost results in an accounting mismatch. Equity securities that are held for trading must be classified as FVPL. Other equity securities may be classified as either fair value through profit or loss, or fair value through OCI. Once classified, the choice is irrevocable. Derivatives that are not used for hedging are always carried at FVPL. If an asset has an embedded derivative (e.g., convertible bonds), the asset as a whole is valued at FVPL. FVPL securities are reported on the balance sheet at fair value. The changes in fair value, both realized and unrealized, are recognized in the income statement along with any dividend or interest income. Fair Value Through OCI (for Debt and Equity Securities) Securities classified as fair value through OCI are carried on the balance sheet at fair value and any unrealized gain or loss is reported in OCI. Realized gain or loss, dividends, and interest income are reported in the income statement. Figure 13.2 summarizes the effects of the different classifications for financial assets on thebalance sheet and income statement. Figure 13.2: Summary of Classifications of Financial Assets Amortized Cost Fair Value Through Profit or Loss Fair Value Through OCI Balance sheet Amortized cost Fair value Fair value, with unrealized G/L recognized in equity Income statement Interest (including amortization) Realized G/L* Interest Dividends Realized G/L Unrealized G/L Interest Dividends Realized G/L * G/L = gains and losses Let’s look at an example of the different classifications for financial assets. EXAMPLE: Investment in financial assets At the beginning of the year, Midland Corporation 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. Suppose that the fair value of the bond at the end of the year is $98,500. Determine the impact on Midland’s balance sheet and income statement if the bond investment is classified as 1) amortized cost, 2) fair value through profit or loss, and 3) fair value through OCI. Answer: Amortized cost: Balance sheet value is based on amortized cost. At year-end, Midland recognizes interest revenue of $9,621 ($96,209 beginning bond investment × 10% yield). The interest revenue includes the coupon payment of $9,000 ($100,000 face value × 9% coupon rate) and the amortized discount of $621 ($9,621 interest revenue – $9,000 coupon payment). At year-end, the bond is reported on the balance sheet at $96,830 ($96,209 beginning bond investment + $621 amortized discount). Fair value through profit or loss: The balance sheet value is based on fair value of $98,500. Interest revenue of $9,621 ($96,209 beginning bond investment × 10% yield) and an unrealized gain of $1,670 ($98,500 – $96,209 – $621) are recognized in the income statement. Fair value through OCI: The balance sheet value is based on fair value of $98,500. Interest revenue of $9,621 ($96,209 beginning bond investment × 10% yield) is recognized in the income statement. The unrealized gain of $1,670 ($98,500 – $96,209 – $621) is reported in stockholders’ equity as a component of other comprehensive income. Now let’s imagine that the bonds are called on the first day of the next year for $101,000. Calculate the gain or loss recognition for each classification. Amortized cost: A realized gain of $4,170 ($101,000 – $96,830 carrying value) is recognized in the income statement. Fair value through profit or loss: A net gain of $2,500 ($101,000 – $98,500 carrying value) is recognized in the income statement. Fair value through OCI: The unrealized gain of $1,670 is removed from equity, and a realized gain of $4,170 ($101,000 – $96,830) is recognized in the income statement. Reclassification Under IFRS 9 Reclassification of equity securities under the new standards is not permitted as the initial designation (FVPL or FVOCI) is irrevocable. Reclassification of debt securities is permitted only if the business model has changed. For example, unrecognized gains/losses on debt securities carried at amortized cost and reclassified as FVPL are recognized in the income statement. Debt securities that are reclassified out of FVPL as measured at amortized cost aretransferred at fair value on the transfer date, and that fair value will become the carrying amount. Loan Impairment Under IFRS 9 A key feature of IFRS 9 was that the incurred loss model for loan impairment was replaced by the expected credit loss model. This requires companies to not only evaluate current and historical information about loan (including loan commitments and lease receivables) performance, but to also use forward-looking information. The new criteria results in an earlier recognition of impairment (12-month expected losses for performing loans and lifetime expected losses for nonperforming loans). MODULE QUIZ 13.2 To best evaluate your performance, enter your quiz answers online. Use the following information to answer Questions 1 through 5. Kirk Company acquired shares in the equity of both Company A and Company B. We have the following information from the public market about Company A and Company B’s investment value at the time of purchase and at two subsequent dates: Security Cost t = 1 t = 2 A $950 $850 $900 B 250 180 350 1. Kirk Company will report the initial value of its investment in financial assets as: A. $1,030. B. $1,200. C. $1,250. 2. At t = 1, Kirk will: A. carry the financial assets at cost. [Show More]

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