Financial Reporting & Analysis - Apnacourse

1 Financial Reporting & Analysis Level II 2016 Topic Weight 15-20% (3 to 4 case studies) Ankur Kulshrestha, CFA Chartered Accountant, Certified Valuer M. Com, B. Com (H) +91 9711 066 000 .com Overview of FRA: 6 hours Three new topics hours Inter-corporate Investments hr Pensions hr Multinationals 1 hr Level 1 concepts: Inventory, LLA hours Quality of Earnings / Analysis 2 .com Inter-Corporate Investments 3 -What would be the impact on your security if the company makes an investment into any other corporate? -How would standalone results be different from the consolidated ones? -Whether to purchase shares of the group s holding company (like Tata Sons) or invest in any of its subsidiary (Tata Steel)?.

2 Com Scope of discussion Different levels of equity acquisition Passive investments (Marketable Securities) Active investments Accounting Treatment of inter-corporate Investments Equity Method Proportionate Consolidation Full Consolidation Important points Goodwill Creation and Impairment Inter-company transfer adjustment Minority Interest valuation Variable Interest Entities 4 .com Categories of Inter Corporate Investments 5 Type of method of accounting is dependent on the level of involvement investor company is able to have in the investee. To make this criteria objective, % holding has been used a guideline to classify and differentiate between different types of investments Ownership % Degree of influence Method of accounting under the US GAAP Method of accounting under IFRS Less than 20% No influence Amortized cost/ Fair value Amortized cost/ Fair value 20% - 50% Significant influence Equity method Equity method More than 50% Control Full Consolidation Full Consolidation Joint Venture Joint Control Equity method Proportionate consolidation is allowed only selectively Equity Method is preferred/ Proportionate consolidation is allowed only selectively Substance over form.

3 The holding % is more than 50% but there is no control due to barriers like bankruptcy, government interventions, etc No Consolidation is done % holding is 20% to 50% but the investor is not able to exercise any influence Equity method is not used % holding is less than 20% but the investor is able to exercise any influence Use Equity Method 1 2 3 4 .com Practice Question Equity Security 6 A company purchased a share at beginning of the year for $90,000. During the year, dividend of $8,000 was distributed. Fair value of share at the end of the year is $98,500. Find out the Balance Sheet value, Income statement impact if you classify the security into: to Maturity for Sale What would be the impact on Financial statements if this security was sold for 100,000 next year?

4 B/S Value Income St OCI Income St. OCI HTM AFS Trading Next year .com Calculation of Amortized Cost 7 Year Opening Invest Interest Income Coupon Rec Delta Closing Invest 1 2 3 A company purchased a five year 9% bond with FV of $100,000 at beginning of the year. The bond was issued for $96,209 to yield 10%. The coupon payments are made annually at year end..com Practice Question Debt Security 8 A company purchased a five year 9% bond with FV of $100,000 at beginning of the year. The bond was issued for $96,209 to yield 10%. The coupon payments are made annually at year end. Fair value of bond at the end of the year is $98,500. Find out the Balance Sheet value, Income statement impact if you classify the security into: to Maturity for Sale What would be the impact on Financial statements if this security was sold for 100,000 next year?

5 B/S Value Income St OCI Income St. OCI HTM AFS Trading Next year .com Valuation of Passive Investments Marketable Securities OR Financial Assets Securities in which the objective of investment is not to participate in the management of the investee but earn interest / dividend and Capital gain. There are two broad options of valuation : Value options: All securities are valued at fair value and the changes in values are taken to income statement. The investor need to make this choice upfront and state the same in the footnotes the security into the following three categories: US GAAP (new & Old) = IFRS Old Valuation Income (Dividend / Interest) Realized gain / Loss Unrealized gain / loss Held Till Maturity Historical cost / Amortized cost Income Statement Not recognized Available for Sale Fair value Equity Held for Trading Fair value Income Statement IFRS has come up with the new IFRS 9 on passive investments.

6 We focus on Old rules .com Valuation of Passive Investments Marketable Securities OR Financial Assets 10 Amortized cost is equal to face value less any unamortized discount or plus any unamortized premium. It is the present value of the remaining cash flows (coupon and fv) discounted at YTM (also the market rate of interest at issuance) In case of debt security: Amortized cost replaces Historical cost for all practical purpose Under IFRS: Only ON DEBT security - If the unrealized gain / loss for AFS security is caused due to forex fluctuation, then it is taken to income statement rather than to the OCI. US investor purchased a Debt Security in the UK at GBP 100 when the spot rate was 1 GBP = USD. At the close of the year, the exchange rate was 1 GBP = USD.

7 Find out the balance sheet value of the security if it was classified as AFS. Only Debt securities can be classified as HTM .com Reclassification from one category to another 11 B/S Value Income St OCI Income St. OCI HTM 96,830 9,621 3,170 AFS 98,500 9,621 1,670 3,170 -1,670 Trading 98,500 9,621+1670 1,500 Next year Sometimes its prospective and sometimes it retrospective From To Treatment Trading AFS AFS Trading AFS HTM HTM AFS .com Reclassification of marketable securities Under US GAAP 12 From To Treatment Trading AFS Unrealized gain / Loss previously recognized in Income statement to not transferred to OCI AFS Trading Unrealized gain / loss previously recognized in OCI is transferred to Income Statement AFS HTM The Fair value becomes the new carrying value for the HTM security.

8 The Unrealized gain previously recognized in OCI is amortized over life of the security HTM AFS The security is valued at the Fair value and the Unrealized gain / loss is recognized in OCI Notes: (1)Standard allows transfer from HTM to Trading directly but not vice versa (2)Above treatment for Trading category is applicable for Fair Value Option also (3)Once classified out of HTM, a firm may no longer be able to classify that particular security or similar securities into HTM in future Change in classification possible if there is change in intention of holding the security .com Reclassification of marketable securities Under IFRS 13 Notes: (1)Once classified out of HTM, a firm may no longer be able to classify that particular security or similar securities into HTM in future (2)IFRS restricts any movement from / to Trading category and Fair Value option.

9 From To Treatment AFS HTM The Fair value becomes the new carrying value for the HTM security. The Unrealized gain previously recognized in OCI is amortized over life of the security HTM AFS The security is valued at the Fair value and the Unrealized gain / loss is recognized in OCI Change in classification possible if there is change in intention of holding the security .com Impairment of Marketable Securities Impairment is required if any event which warrants impairment has occurred. Check for impairment at the end of every Reporting period Since Under fair Value option and for Trading securities, valuation has already been done on fair Value and difference taken to Income statement, there is no need to impair these Criteria of impairment debt: When atleast one loss event has occurred and the impact of such event can be measured on the cash flows from that security Likely bankruptcy, default on interest / principle payment, Does not include any delisting, credit downgrade, lack of liquidity in the security Equity: If its fair value has experienced substantial or extended decline below its carrying value Treatment under impairment.

10 Revised fair value is calculated by discounting revised cash flows using YTM at the time of purchase. Impairment loss (T/F Income Statement) = Carrying value Revised fair value : Impairment loss (T/F Income Statement) = Carrying value (which would also be at FV) Revised fair value Reversal of Impairment Loss US GAAP: Impairment loss can be reversed on HTM but not AFS IFRS: Impairment loss can be reversed on all Debt securities but not on Equity security 14 .com Equity Method of Accounting for Inter-corporate Investments Some examples of significant influence: representation in policy making inter company transaction of managerial personnel on technology 15 Ownership % Degree of influence Method of accounting under the US GAAP Method of accounting under IFRS Less than 20% No influence Amortized cost/ Fair value Amortized cost/ Fair value 20% - 50% Significant influence Equity method Equity method More than 50% Control Full Consolidation Full Consolidation Joint Venture Joint Control Equity method Proportionate consolidation is allowed only selectively Equity Method is preferred/ Proportionate consolidation is allowed only selectively Substance over form.