Reading 29: Analyzing Balance Sheets

Book 2: FSA

Intangible Asset

nonmonetary asset and lacks physical substance

Are securities intangible assets?

No.

Identifiable Intangible Asset

can be acquired separately or are the result of rights or privileges conveyed to the owner

Examples of identifiable intangible assets?

patents, copyright, trademarks

Under IFRS, how are identifiable intangible assets that are purchased reported on the balance sheet?

Cost model

Revaluation model

• Can only use when there is an active market for the asset

Under GAAP, how are identifiable intangible assets that are purchased reported on the balance sheet?

Cost model

Unidentifiable Intangible Asset

cannot be acquired separately and may have an unlimited life

Example of unidentifiable intangible asset

goodwill

Under GAAP, how are internally-created intangible assets treated on financial statements?

expensed as incurred

Under IFRS, how are internally-created intangible assets treated on financial statements?

must identify between research and development stage and can capitalize the development stage

Criteria a project must meet to be capitalized

1.) Project is technically feasible

2.) Resources exists to complete the project

3.) A market exists for the product

4.) The company has the intention and resources to complete the project and sell the product

In the context of capitalizing vs expensing intangible assets, what are some project costs that should be expensed?

Start-up and training costs

administrative overhead

advertising and promotion costs

relocation and reorganization costs

termination costs

Goodwill

the amount by which the purchase price is greater than the fair value of the acquired company’s identifiable net assets

What happens if an acquirer purchases a target for less than fair value?

It is reported as a gain on the income statement

How is internally generated goodwill treated?

Expensed as incurred

True or False: Goodwill impairment affects cash flow.

False

It is an intangible asset and provides no cash flows

How can firms manipulate an acquisition to better benefit their financial statements?

Allocate more of the purchase to goodwill than intangible assets. This makes the depreciation expense less every year

Economic Goodwill

the expected future performance of the firm

How should analysts treat goodwill in firm analysis?

Eliminate from balance sheet and impairment charges from the income statement

Financial Instrument

contracts that give rise to both a financial asset and a financial liability or equity instrument of another entity

US GAAP Financial Asset Measurement Basis

Historical Cost

• Unlisted equity securities

• Loans and notes receivable

Amortized Cost

• HTM securities

Fair Value

• Trading securities

• AFS securities

• Derivatives

Held-To-Maturity Assets (HTM)

debt securities acquired with the intent to hold them until maturity

Amortized Cost for HTM Calculation

Amortized Cost = original issue price - principal payment - impairment losses - amortized premiums + amortized discounts

Mark-To-Marketing Accounting

measures financial assets at fair value

Trading Securities

debt securities acquired with the intent to sell them in the near term

With trading securities, how are unrealized gains and losses recorded?

income statement

True or False: All equity securities are also treated with mark-to-marketing account.

False

Have to have quoted market prices and cannot give a firm significant influence over another

Available-For-Sale Securities (AFS)

debt securities that are not expected to be held to maturity or traded in the near term

Where are AFS securities recorded?

Balance sheet

Where are unrealized gains and losses recorded for AFS?

Comprehensive income in the equity section of the balance sheet

IFRS Treatment of Marketable Securities

Measured at Amortized Cost

• HTM

• Loans & note receivable

• Unlisted equity securities if fair value can’t be determined

Measured at Fair Value Through Other Comprehensive Income

• Debt securities acquired with the intent to collect interest payments but sell before maturity

• Equity securities only if this treatment is chosen at time of purchase

Measured at Fair Value Through Profit and Loss

• Debt securities acquired with intent to sell in near term

• Equity securities

• Derivatives

• Any security not assigned to the other two categories

• Any security for which this treatment is chosen at the time of purchase

Examples of Long-Term Financial Liabilities

bank loans, notes payable, bonds payable, and some derivatives

How are LT Financial Liabilities recorded?

At face value or at amortized cost on the balance sheet

Amortized Cost Calculation for LT Financial Liabilities

Amortized Cost = issue price - principal payments + amortized discount - amortized premium

Which LT Financial Liabilities are recorded at face value

Held-For-Trading Liabilities

• Short positions in equity

• Derivative liabilities

• nonderivative liabilities with exposures hedged by derivatives

Tax-Deferred Liabilities

income taxes payable in the future periods as a result of timing differences between financial accounting and tax accounting

Common-Size Balance Sheet

expresses each item as a % of total assets

Which returns are typically greater: Returns on WC or Returns on LT Assets?

LT assets

Liquidity Ratios

current ratio

quick ratio

cash ratio

Solvency Ratios

Long-term Debt-to-Equity Ratio

Total Debt-to-Equity Ratio

Debt Ratio

Financial Leverage Ratio