CFA fsa

Comprehensive question-and-answer flashcards covering intercorporate investments, share-based and pension compensation, multinational operations, bank and insurance analysis, financial reporting quality, and FSA techniques under IFRS and U.S. GAAP.

Under IFRS and U.S. GAAP, what reporting method is required when an investor holds an ownership interest between $20\%$ and $50\%$ in an investee?

The equity method, representing significant influence over the investee.

Under IFRS 9, what two criteria must a debt security satisfy to be accounted for using the amortized cost method?

1. Business model test: The security is held to collect contractual cash flows.
2. Cash flow characteristic test: Contractual cash flows are solely payments of principal and interest on principal.

Under IFRS 9, when is the reclassification of equity securities permitted after initial classification?

Reclassification of equity securities is never permitted because the initial designation (FVPL or FVOCI) is irrevocable.

How do dividend payments from an investee affect the investor's balance sheet under the equity method?

Dividends paid by the investee increase cash and decrease the investment account on the asset side of the balance sheet, resulting in no change to total assets or net income.

What two specific balance sheet adjustments are required under the equity method?

1. Additional depreciation expense resulting from the excess of the fair value over book value of the investee's fixed assets at acquisition.
2. Elimination of the investor's pro rata share of unconfirmed intercompany profits from upstream or downstream transactions.

How is minority interest calculated and presented on the balance sheet under the acquisition method?

Minority interest is calculated as the proportion of the subsidiary not owned by the parent multiplied by the net equity of the subsidiary, and it is presented as a separate component of stockholders' equity.

Assuming positive net income, why do net profit margin, ROE, and ROA appear higher under the equity method compared to the acquisition method?

Net income is identical under both methods, but sales, total equity (due to minority interest), and total assets are higher under the acquisition method, making the equity method ratios higher.

Under U.S. GAAP, what entity must consolidate a variable interest entity (VIE)?

The primary beneficiary of the variable interest entity.

How does using an artificially low estimate of future volatility impact the financial statements when valuing stock options for compensation expense?

It lowers the estimated fair value of the options on the grant date, which understates compensation expense and overstates reported earnings during the vesting period.

How do Restricted Stock Units (RSUs) differ from performance shares regarding dividends during the vesting period?

RSUs do not accrue dividends during the vesting period; therefore, their grant-date value is reduced by the present value of expected dividends over the vesting period.

How is a tax windfall (excess tax benefit) from share-based compensation accounted for under U.S. GAAP versus IFRS?

Under U.S. GAAP, tax windfalls reduce income tax expense in the income statement. Under IFRS, tax windfalls are recognized directly in equity.

How is the number of repurchased treasury shares calculated under the treasury stock method when evaluating diluted EPS?

$\text{Number of treasury shares} = \frac{\text{Assumed proceeds}}{\text{Average share price during reporting period}}$, where assumed proceeds equal cash proceeds plus average unrecognized share-based compensation expense.

What benchmark interest rate is typically used as the discount rate to compute the projected benefit obligation (PBO)?

The yield on investment-grade corporate bonds.

How does the accounting treatment of past (prior) service costs differ between U.S. GAAP and IFRS?

Under U.S. GAAP, past service costs are recorded in Other Comprehensive Income (OCI) and amortized over the remaining service life of affected employees. Under IFRS, they are recognized immediately in profit and loss (P&L).

Under IFRS, how is the net interest expense or income for a defined benefit pension plan calculated?

$\text{Net interest income (expense)} = \text{Discount rate} \times \text{Beginning funded status}$, where the expected rate of return on plan assets is implicitly set equal to the discount rate.

Under U.S. GAAP, when does the corridor approach require amortization of actuarial gains and losses?

When the beginning balance of cumulative actuarial gains and losses exceeds $10\%$ of the greater of the beginning PBO or beginning plan assets, the excess is amortized over the employees' average remaining service life.

How are actuarial gains and losses (remeasurements) treated under IFRS?

They are recognized in Other Comprehensive Income (OCI) and are never amortized to the income statement.

According to the provided diagram, what translation method applies when moving from the local currency to the functional currency, and what method applies when translating from the functional currency to the presentation currency?

The temporal method ($T$) translates the local currency to the functional currency, and the current rate method ($CR$) translates the functional currency to the presentation currency.

When a foreign subsidiary operates in a self-contained, independent manner primarily within the local market, which currency is its functional currency and which translation method is applied?

Its functional currency is the local currency, and the current rate method is used for translation.

Under the temporal method, which exchange rates are used to remeasure monetary assets/liabilities, nonmonetary assets/liabilities, and Cost of Goods Sold (COGS)?

Monetary assets and liabilities are remeasured at the current rate; nonmonetary assets and liabilities are remeasured at historical rates; and COGS is remeasured at historical rates.

How does balance sheet exposure differ between the current rate method and the temporal method?

Exposure under the current rate method equals shareholders' equity (total assets minus total liabilities). Exposure under the temporal method equals net monetary assets (monetary assets minus monetary liabilities).

Where are translation gains and losses reported under the current rate method versus the temporal method?

Under the current rate method, gains and losses are reported in shareholders' equity under OCI as a cumulative translation adjustment (CTA). Under the temporal method, remeasurement gains and losses are recognized directly in the income statement.

How do IFRS and U.S. GAAP treat financial statement translation for subsidiaries operating in hyperinflationary economies?

Under IFRS, local currency financial statements are restated for inflation using an index and then translated at the current rate. Under U.S. GAAP, the temporal method must be used.

What are the Basel III minimum capital requirements for Common Equity Tier 1 (CET1), Total Tier 1, and Total Capital relative to risk-weighted assets (RWA)?

1. Common Equity Tier 1: Minimum $4.5\%$ of RWA.
2. Total Tier 1: Minimum $6.0\%$ of RWA.
3. Total Capital (Tier 1 + Tier 2): Minimum $8.0\%$ of RWA.

What do the letters in the bank regulatory analysis framework CAMELS stand for?

Capital adequacy, Asset quality, Management capability, Earnings sufficiency, Liquidity position, and Sensitivity to market risk.

What are the two major sources of revenue for an insurance company?

1. Premiums collected from policyholders.
2. Investment returns earned on funds collected as premiums held to pay future claims.

What are the two defining characteristics of high-quality earnings?

1. Sustainable: Expected to persist and recur in future periods.
2. Adequate: Generates returns sufficient to cover the company's cost of capital.

What is the primary purpose of the Beneish model, and what limitation has reduced its predictive power over time?

It estimates the probability of earnings manipulation using eight variables; its predictive power has declined because managers aware of the model game its input variables.

How does the accounting treatment for goodwill impairment differ between IFRS and U.S. GAAP?

IFRS uses a 1-step impairment process, whereas U.S. GAAP uses a 2-step process.

Under the acquisition method, what is the difference between IFRS and U.S. GAAP regarding the computation of goodwill?

IFRS permits either the partial goodwill or full goodwill method, while U.S. GAAP only permits the full goodwill method.