1
Q
Goodwill
What are the types? How is each calculated?
A
The excess purchase price of an investment not attributable to the difference in fair and book values of net identifiable assets. Can be full or partial.
Full goodwill = Fair market value of subsidiary’s shares - Fair market value of subsidiary’s net assets
Partial goodwill = Total excess purchase price - [(Fair value of net identifiable assets - Book value of net identifiable assets) x proportion of ownership]
2
Q
Excess purchase price
How is it calculated?
A
The purchase price of an investment exceeding the investor’s share of its book value.
Excess purchase price = Amount paid for purchase - (Book value of investment x proportion owned)
3
Q
Equity income
What are its components?
A
The investor’s share in the investee’s profits.
- Investor’s share in the investee’s reported income
- Unrealized profits from related-party transactions
4
Q
Capital stock
A
The total par value of the firm’s shares.
5
Q
Additional paid-in capital
A
The excess of the market value of a firm’s shares over the book value.
6
Q
Non-controlling interest (NCI)
What are the two ways in which it can be calculated?
A
The value of the unacquired portion of a subsidiary in a less-than-complete acquisition.
The calculation depends on the goodwill methodology used:
NCI with full goodwill = Fair market value of subsidiary’s shares x proportion not acquired
NCI with partial goodwill = Fair market value of subsidiary’s net assets x Proportion not acquired
7
Q
Impairment loss
How is it calculated?
A
A line item on the income statement pertaining to goodwill that records:
IFRS: Carrying amount of CGU - Recoverable amount of CGU
OR
US GAAP: Carrying amount of reporting unit - Fair value of reporting unit
8
Q
Downstream
A
A transaction between an parent and subsidiary such that the parent records a profit on its income statement.
9
Q
Upstream
A
A transaction between an parent and subsidiary such that the subsidiary records a profit on its income statement.
10
Q
Service condition
A
A criterion in which an individual must be employed at a firm for a certain amount of time in order to qualify for receiving SBC awards.
11
Q
Performance condition
A
A criterion on top of a service condition that requires the firm achieve a goal in order for SBC awards to vest.
12
Q
Market condition
A
A portion of a performance condition that specifies a firm’s share price goal that must be met in order for SBC awards to vest.
13
Q
Restricted stock
A
Common shares granted to employees but subject to trading and other restrictions.
14
Q
Performance shares
A
Restricted shares based on one or more performance conditions.
15
Q
Restricted stock unit (RSU)
A
Instruments representing the right to receive restricted stock upon settlement.
16
Q
Treasury stock method
How are diluted shares outstanding calculated under this method?
A
Diluted shares outstanding =
BSO + Sₙ - [(P꜀ + USBCE)/s)
Where:
BSO = basic shares outstanding,
Sₙ = shares issued from unvested RSUs/unexercised ITM stock options
P꜀ = cash proceeds from exercise of SBC
s = average share price over reporting period
17
Q
Excess tax benefit
How is it calculated?
A
The excess of a tax deduction related to an SBC award over the recognized SBC expense; occurs when the value of an SBC award at settlement exceeds its value at the grant date.
Excess tax benefit = Statutory tax rate x [RSUs vested x (fair value at settlement - Fair value at grant)
18
Q
Share-based compensation award (SBC award)
A
Refers to either an RSU or a stock option.
19
Q
Frozen DB plan
A
A DB plan in which future payments to beneficiaries are fixed because the plan no longer accrues benefits.
20
Q
Closed DB plan
A
A DB plan that new employees can no longer enter.
21
Q
Other post-employment benefits (OPEB)
A
DB plans that pay non-monetary benefits, such as life insurance and medical care; these must be pre-funded.
22
Q
Unfunded
A
Refers to a DB plan (usually OPEBs) that have no specific assets set aside to meet pension obligations; benefits of unfunded plans must be paid out of company cash.
23
Q
Funded status
A
Fair value of plan assets - Pension obligation.
A plan is overfunded when fair value of plan assets > pension obligation
A plan is underfunded when fair value of plan assets < pension obligation
24
Q
Pension obligation
A
The present value of future payments required to settle the owings to employees for their current and prior service.
25
Fair value of plan assets
The market value of assets held by the plan exclusively for paying benefits.
26
Components of pension expense under IFRS
1. Service cost (current and past)
2. Net interest expense
3. Remeasurement
27
Components of pension expense under US GAAP
1. Current service cost
2. Interest cost
3. Expected return on plan assets
4. Amortization of past service costs
5. Amortization of net gains or losses
28
Net interest income
| How is it calculated?
The component of the pension obligation under IFRS that represents its accretion from the passage of time.
Net interest income = Funded status x discount rate
29
Remeasurement, IFRS
The component of the pension obligation consisting of:
1. Actual return on plan assets - discount rate
2. Actuarial gains/losses
30
Interest cost
The component of the pension obligation under US GAAP that represents its accretion from the passage of time.
Pension obligation at beginning of year x discount rate
31
Expected return on plan assets
A component of the pension obligation under US GAAP.
Expected return on plan assets = Expected rate of return x fair value of plan assets at beginning of year
32
Presentation currency
The currency in which a firm's financial statements are presented.
33
Functional currency
The currency used in the primary economic environment in which the firm operates.
34
Local currency
The currency of the country in which a firm operates.
35
Foreign currency transactions
Transactions denominated in a currency other than its functional currency.
36
Exposure to foreign exchange risk
The risk that an asset or liability denominated in a foreign currency will change in value due to a change in exchange rates; the two types of exposures are transaction exposure and balance sheet translation exposure.
37
Transaction exposure
A type of exposure to foreign exchange risk related to an import purchase or export sale whose payment is deferred.
38
Unrealized profits from related-party transactions
| How is it calculated?
Gain on sale to related party x Proportion of goods unsold by related party x Proportion of ownership in related party
39
Current exchange rate
The spot exchange rate on the balance sheet date.
40
Monetary assets and liabilities
Assets and liabilities with values equal to a fixed amount of currency.
Monetary assets: Cash, A/R
Monetary liabilities: A/P, Bonds payable, Mortgages payable, and most other liabilities
41
Non-monetary assets and liabilities
All assets and liabilities that are not monetary assets and liabilities.
Non-monetary assets: Inventory, fixed assets, intangibles
Non-monetary liabilities: Deferred revenue
42
Historical exchange rate
The exchange rate in effect when the asset or liability was acquired.
43
Balance sheet translation exposure
The exposure of assets and liabilities translated at current exchange rates to revaluation due to fluctuations in the exchange rates.
Net asset balance sheet translation exposure: Assets translated at current exchange rates > Liabilities translated at current exchange rates
Net liability balance sheet translation exposure: Liabilities translated at current exchange rates > Assets translated at current exchange rates
44
Current rate method
The approach to translating foreign currency financial statements for consolidation in which all assets and liabilities are translated using the current exchange rate, and all revenues and expenses are translated using the average exchange rate for the year; this is the prevalent translation method.
45
Monetary/non-monetary method
The approach to translating foreign currency financial statements for consolidation in which all monetary assets and liabilities are translated using the current exchange rate, while all non-monetary assets and liabilities are translated using their historical exchange rates.
46
Temporal method
The approach to translating foreign currency financial statements for consolidation in which all monetary assets and liabilities, as well as all non-monetary assets and liabilities stated at their current value, are translated at the current rate; used when the functional currency is not the local currency.
Under this method, line items are translated at the following rates:
**Balance Sheet**
Cash: Current
A/R: Current
Inventory: Historical
PP&E: Historical
Accumulated Depreciation: Historical
A/P: Current
Notes Payable: Current
Capital Stock: Historical
**Income Statement**
Revenue: Average
COGS: Historical
SG&A: Average
Depreciation Expense: Historical
Interest Expense: Average
Income Tax: Average
Dividends: Historical
47
Purchasing power gain
| What results in a purchasing power gain?
An increase in value due to changes in the price level; holding payables during inflation results in a purchasing power gain.
48
Purchasing power loss
| What results in a purchasing power gain?
A decrease in value due to changes in the price level; holding cash and receivables during inflation results in a purchasing power loss.
49
Equity method
An investment accounting method in which the investor includes its share of the investee's net income as a single line item; used when the investor has significant influence over the investee as well as in most joint ventures.
50
Acquisition method
An investment accounting method in which the investor consolidates its financial statements with that of the investee; used in business combinations such as mergers, acquisitions, consolidations, and SPEs.
51
Proportionate consolidation method
An investment accounting method in which the investor reports its own items in combination with its share of the investee's items line-by-line; used in rare cases of joint ventures.
52
Merger
A business combination in which one of the entities ceases to exist.
Company A + Company B = Company A
53
Acquisition
A business combination in which both entities continue to operate separately but are connected via a parent-subsidiary relationship.
Company A + Company B = (Company A + Company B)
54
Consolidation
A business combination in which an entirely new entity is created and the original two entities cease to exist.
Company A + Company B = Company C
55
Special purpose entity (SPE)
An enterprise created to accommodate the specific needs of the sponsoring entity, which transfers to and obtains the right to use assets of the SPE and performs services for the SPE.
56
Capital adequacy
| What does Basel III require?
The proportion of a bank's risk-weighted assets (RWA) funded with each of Common Equity Tier 1, Other Tier 1, and Tier 2 Capital.
Common Equity Tier 1 Capital must be at least 4.5% of risk-weighted assets.
Total Tier 1 Capital must be at least 6.0% of risk-weighted assets.
Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 8.0% of risk-weighted assets.
57
Asset quality
The composition of a bank's assets and its credit quality thereof.
58
Fair value hierarchy
A pecking order used to determine earnings quality with respect to financial institutions.
Level 1 inputs are quoted prices for identical financial assets or liabilities in active markets.
Level 2 inputs are observable but are not the quoted prices for identical financial instruments in active markets.
Level 3 inputs are unobservable.
59
Liquidity position
The assessment of a financial institution's ability to pay off its short-term liabilities using the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).
60
Sensitivity to market risk
Exposure to changes in interest rates, exchange rates, equity prices and commodity prices.
61
Common equity tier 1 capital
Common stock, issuance surplus related to common stock, retained earnings, accumulated OCI, and intangible asset and deferred tax adjustments.
62
Other tier 1 capital
Instruments subordinate to such obligations as deposits and other debt obligations, instruments with no fixed maturity, and instruments that do not have any type of non-discretionary payment of dividends or interest.
63
Tier 2 capital
Instruments that are subordinate to depositors and to general creditors of the bank, have an original minimum maturity of five years.
64
Liquidity coverage ratio (LCR)
The minimum percentage of a bank's expected cash outflows that must be held in highly liquid assets.
LCR = Highly liquid assets / Expected cash outflows
65
Net stable funding ratio (NSFR)
The minimum percentage of a bank's required stable funding that must be sourced from available stable funding.
NSFR = Required stable funding / Available stable funding
66
Non-CAMELS bank analysis factors
1.) Government support, which is affected by size of the bank and the status of the country's banking system
2.) Government ownership
3.) Mission of the banking entity
4.) Corporate culture, including scope of investment strategy, compliance with internal controls, equity-based compensation to management, and experiences with loss reserves and asset write-downs
67
Allowance for loan losses
A contra-asset account for loans akin to allowances for bad debt.
68
Provisions for loan losses
An expense on a bank's income statement that increases the amount of allowances for loan losses, akin to bad debt expense.
69
Premium
The amount paid by the purchaser of insurance products.
70
Float
The amount collected as premium not yet paid out as benefits.
71
Casualty insurance
| A.k.a. Liability insurance
Insurance that protects against a legal debt arising from an insured event.
72
Property insurance
Insurance that protects against the damage of covered property.
73
Multiple peril policies
Insurance that contains clauses relating to both property and casualty claims.
74
Loss and loss adjustment expense ratio (LAER)
Indicates the degree of success in estimating the insured risks; the lower the better.
LAER = (Loss expense + Loss adjustment expense) / Net premiums earned
75
Underwriting expense ratio (UER)
Measures the efficiency of money in obtaining new premiums; the lower the better.
UER = Underwriting expense / Net premiums written
76
Combined ratio (CR)
Measures the overall efficiency of an underwriting operation; a combined ratio < 100% is efficient.
Combined ratio = LAER + UER
77
Dividends to policy/shareholders ratio (DPSR)
A measure of the liquidity of an underwriting operation; the higher the better.
DPSR = Dividends to policy/shareholders / Net premiums earned
78
Combined ratio after dividends (CRaD)
Indicates the cash satisfaction of policyholders and shareholders after considering the entire underwriting operation.
CRaD = CR + DPSR
79
Effects of foreign currency fluctuations on translation gains, losses, and adjustments
Foreign currency strengthens against domestic currency + Net monetary asset = Translation loss/negative translation adjustment
Foreign currency strengthens against domestic currency + Net monetary liability = Translation gain/positive translation adjustment
Foreign currency weakens against domestic currency + Net monetary asset = Translation gain/positive translation adjustment
Foreign currency weakens against domestic currency + Net monetary liability = Translation loss/negative translation adjustment
80
Current ratio
| How is it calculated?
Current ratio = Current assets / Current liabilities
81
Days of inventory on hand (DoH)
DoH = (Average inventory / COGS) x 365 days
82
Fixed asset turnover (FAT)
FAT = Revenue / Average fixed assets
83
Receivables turnover
Receivables turnover = Revenue / Average accounts receivable
84
Steps to evaluate financial reporting quality
1. Understand the firm and its industry
2. Learn about management
3. Identify areas in which accounting decisions significantly affect reported financal performance
4. Compare current year's report with prior year's report, compare reports with those of other firms, and compare ratios with those of industry competitors
5. Check for warning signs of possible issues with financial reporting quality
6. For multinational firms, assess whether there is an appearance of being exposed to geographic regions desired by the investment community
7. Use appropriate quantitative tools to assess the likelihood of misreporting
85
Persistence of earnings
Earningsₜ₊₁ = a + β₁Cash Flowₜ + β₂Accrualsₜ
86
Carrying value of investment
| What are its components?
1. Initial cost
2. Equity income
3. Investor's share in investee's dividends paid
4. Amortization of excess purchase price attributable to PP&E
87
Vesting
When an employee becomes unconditionally entitled to a given form of compensation.
88
Short-term benefits
Compensation expected to be paid within 12 months; includes salaries and wages, annual bonuses, non-monetary benefits (e.g. medical care), contributions to social security schemes, and paid leave.
89
Long-term benefits
Compensation expected to be paid after 12 months; includes sabbatical and disability benefits.
90
Termination benefits
Compensation paid in the event of employee termination; includes severance, continued access to non-monetary benefits, career counselling and outplacement services.
91
Post-employment benefits
Compensation expected to be paid after employee retirement; includes pension and lump sum payments to retirees, and retiree life insurance and medical care.
92
Days sales outstanding (DSO)
| a.k.a. Days sales receivable or DSR
The average number of days it takes a company to collect after a sale.
(Accounts receivable / Revenue) x 365
93
Framework for financial statement analysis
1. Define purpose and context of the analysis, including the nature of analyst's function, the needs/concerns of client or supervisor, and insitutional guidelines on developing the work product
2. Collect input data from financial statements, questionnaires, economic/industry data discussions with management, customers, suppliers, and other stakeholders, and company site visits
3. Process input data as required into analytically useful information
4. Analyze/interpret the data
5. Develop and communicate conclusions and recommendations, possibly using previous reports and institutional guidelines as a reference
6. Follow-up by periodically repeating above steps
94
Indicators of a high quality balance sheet
Completeness: OBS items, as well as unconsolidated equity interests that are not reported, should be minimized.
Unbiased measurement: Important for items in which valuation is subjective, such as goodwill impairment, valuation allowances for deferred tax assets, and inputs low on the fair value hierarchy.
Clear presentation: The proper use of a company's own discretion on which items should be reported line-by-line and which ones should be aggregated.
95
Altman model
A bankruptcy prediction model with NWC/TA, RE/TA, EBIT/TA, Sales/TA, and MVE/BVL as factors; a higher resulting Z-score indicates less probability of bankruptcy and vice versa.
96
Beneish model
A quantitative tool used to assess the likelihood of financial misreporting. Each term (except accruals) is an index representing a factor's value in period t relative to its value in period t-1:
DSR -> A high DSR @ t relative to t-1 may indicate improper revenue recognition
GMI -> A high GPM @ t relative to t-1 may indicate propensity to manipulate earnings
AQI -> A high value @ t relative to t-1 may indicate excessive capitalization
SGI -> A high value @ t relative to t-1 may indicate propensity to manipulate earnings
DEPI -> A low value @ t relative to t-1 may indicate manipulated earnings due to decreasing depreciation rates
SGAI -> A high value @ t relative to t-1 may indicate inefficient overhead use which may drive propensity to manipulate earnings
Accruals -> Higher accruals can indictate earnings manipulation
LEVI -> A high value @ t relative to t-1 may indicate a propensity to manipulate earnings.
The resulting M-score is always negative. The closer to 0, the likelier the firm is to be manipulating earnings.
97
Balance sheet accruals ratio (BSAR)
| How is it calculated?
Change in NOA / Average NOA
98
Cash flow accruals ratio (CFAR)
| How is it calculated?
[NI - (CFO + CFI)] / Average NOA
99
Accounts receivable turnover
The efficiency of a company in collecting on its accounts receivables.
A/R turnover = Sales / A/R
100
Inventory turnover
The amount of times a company sells and replaces all of its inventory over a given period.
Inventory turnover = COGS / Inventory
101
Accounts payable turnover
The swiftness of a company in paying its accounts payable.
A/P turnover = Purchases / A/P
102
Average return on fixed-income assets of an FI
| How is it calculated?
Average return on fixed-income assets = Interest income + Gain/loss on fixed-income investments) / [0.5 x (Debt securities + Loans and deposits)]
103
Amortized cost of debt instrument
Amortized cost of debt instrument = Value of investment - [(Par value of instrument x Coupon rate) - (Value of investment x Market rate)]
104
Segment growth
| How is it calculated?
Segment growth = Segment % of total CAPEX / Segment % of total assets
CFA L2
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