CFA L2 Apostila 01 Exame 2018 - COMPLETA IMPRESSÃO

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Bond Amortization RefresherYear Carrying Interest Coupon Amort. Value Income1 60 30.052 900.53 90.05 60 33.063 930.58 93.06 60 36.36End of 3 963.64 96.36 1,000© Kaplan, Inc. 12LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Trading Security/Fair ValueEnd of Year 1Balance sheet $950.00 [930.58 + 19.42 gain]Income statement [$60 + 30.05] Interest income $90.05 Unrealized gain 19.42 $109.47Cumulative unrealized gain ($950.00 – $930.58) =$19.42Periodic unrealized gain = $19.42 – $0 = $19.42© Kaplan, Inc. 14 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Held-to-Maturity Security: SolutionEnd of Year 1Balance sheet $930.58 [$900.53 + $30.05 discount]Income statement [$60 + 30.05] Interest income $90.05 Alternatively [900.53×10%]Sell for $955 at beginning of Year 2Income statementRealized gain $24.42 [955.00 – 930.58]© Kaplan, Inc. 13LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Trading Security/Fair ValueSell for $955 at beginning of Year 2 CumulativeIncome statement unrealized gains from priorReverse unrealized gain ($19.42) periodsRealized gain 24.42Net gain $5.00 [955.00 – 950.00] [955.00 – 930.58] © Kaplan, Inc. 15ers - Exame CFA 4

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Available-for-Sale SecurityEnd of Year 1Balance sheet $950.00 [930.58 + 19.42 gain] [$60 + 30.05]Income statementInterest income $90.05Cumulative unrealized gain ($950.00 – $930.58) =$19.42 taken to equity (OCI)© Kaplan, Inc. 16LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 ReclassificationFrom To Unrealized Gain or Loss AnyHeld-for- Income statement (to extenttrading* not recognized)Held-to-maturity Held-for-trading* Income statementHeld-to-maturity Available-for-sale Other comprehensive incomeAvailable-for- Held-to-maturity Amortize out of othersale comprehensive incomeAvailable-for- Held-for-trading* Transfer out of othersale comprehensive income into I/S*Prohibited under IFRS All transfers at fair value on transfer date 18© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Available-for-Sale SecuritySell for $955 at beginning of Year 2Income statement Realized gain $24.42 [955.00 – 930.58]Note: $19.42 cumulative unrealized gain is removedfrom equity (OCI).© Kaplan, Inc. 17LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 IFRS 9 (Current Standards)(Applicable from 1/1/2018—early adoption allowed) 1. Amortized cost (debt securities only) 19 Conditions: 1. Business model test (how the asset is managed) 2. Cash flow characteristic test (are the payments solely interest and principal) Business model: must be to collect contractual cash flows Accounting treatment same as held-to-maturity© Kaplan, Inc.ers - Exame CFA 5

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 IFRS 9 (New Standards) (Applicable from 1/1/2018—early adoption allowed)2. Fair value through profit or loss (debt and equity securities) Accounting treatment same as held-for-trading.3. Fair value through OCI (debt and equity securities) Accounting treatment same as available-for-sale.© Kaplan, Inc. 20LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 IFRS 9 (New Standards) (cont.)Reclassification: Unrecognized gains/losses on debt securities carried at amortized cost and reclassified as FVPL are recognized in the income statement. Debt securities reclassified out of FVPL to amortized cost are transferred at fair value on the transfer date, and that fair value will become the carrying amount.© Kaplan, Inc. 22 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 IFRS 9 (New Standards) (cont.)Reclassification: Initial choice of FVPL/FVOCI is irrevocable, hence there is no reclassification of equity securities. Reclassification of debt securities is permitted only if the business model has changed.© Kaplan, Inc. 21LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Investment in Associates and Joint Ventures: Equity Method>20% but ≤ 50% ownership, includes joint ventures Significant influenceBalance sheet: Reported at cost + %earnings – %div’sIncome statement: %Earnings∆ Balance sheet investment= (%Share in co × Earnings) – (%Share in co × Div)= %Share in company × (Earnings – Dividends) = %Share in company × ∆ in Retained earnings 23© Kaplan, Inc.ers - Exame CFA 6

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Equity Method – ExampleBriatore Inc., invests $400m in Paladini Enterprisesfor a 40% stake on January 1, 20x4. Earnings anddividends for the next two years are:Paladini Enterprises 20x4 20x5Earnings $100m $120mDividends $20m $30m© Kaplan, Inc. 24LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Purchase Price > BV Using the example Britatore Inc., 40% stake $400m purchase price at the start of 20x4 Book Value $m Fair Value $m Current Assets 500 500 PP&E Total Assets 950 $250m 1,200 Liabilities Net Assets 1,450 1,700© Kaplan, Inc. 1,000 1,000 450 700 26 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Equity Method – SolutionBriatore Balance Sheet 20x4 20x5 $m $mInvestment in Paladini Enterprises 400 432 40 48 Opening balance (8) (12) 432 468 + % Earnings Original – % Dividends investment 40 48 Closing balance 25 Briatore Income Statement Equity income© Kaplan, Inc.LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Purchase Price > BVPurchase Price $280 $m The investment40% BV Net Assets 400 is still shown inAttributable to FMVadj: (180) the B/S at $400mPPE 40% × $250mGoodwill (100) Goodwill of 120 $120m is included in the carrying value % ownership×FMV net assets 27 40%×$700m© Kaplan, Inc.ers - Exame CFA 7

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Briatore Accounts Y/E 20x4Briatore Balance Sheet $m % share of FMVadj to PPE Purchase Price 400 $250m × 40% % Share of NI 40 = $100m Dividends Received (8) Amortized over 10 years Additional Dep’n (10) Year-end Investment 422Briatore Income Statement Equity Income 30 $40m – $10m© Kaplan, Inc. 28LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Upstream ExamplePaladini sold inventory to Briatore in 20x4 andrecorded a $5m profit on the transaction. At the endof 20x4, none of the inventory had been resold byBriatore. Adjustment $5m × 40%Before Adjustment B/S $m After Adjustment B/S $mInvestment in Paladini 422 Investment in Paladini 420I/S I/SEquity Income 20x4 30 Equity Income 20x4 28© Kaplan, Inc. 30 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Transactions With Associates Intercompany transfers  Upstream profit on transaction in associate’s accounts  Downstream profit on transaction in parent’s (investor’s) accounts Investor company can influence amount and timing Pro-rata share of profit not confirmed through resale or use is eliminated from equity income© Kaplan, Inc. 29LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Downstream ExampleIn addition, Paladini purchased $25m inventory fromBriatore in 20x4. The inventory sold had beenrecorded at $15m in Briatore’s accounts. Paladiniresold $18.75m of this inventory in 20x4. Before After Resold Adjustment $18.75m / $25m = 75%B/S Adjustment Briatore Profit $m $25m – $15m = $10mInvestment in $m 419 Unconfirmed Profit $10m × 25% = $2.5mPaladini 420 27 Pro-rata ShareI/SEquity Income 28© Kaplan, Inc. $2.5m × 40% = $311 mers - Exame CFA 8

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Analyst Issues – Equity Method Is Equity Method appropriate? Influence should dominate bright-line ownership % Balance Sheet Netting assets against liabilities may obscure liabilities and understate leverage Income Statement  Only share of NI shown  Earnings may not be distributed as dividends – lower earnings quality© Kaplan, Inc. 32LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Business Combinations: Acquisition Method (Control)Income Statement5. Eliminate subsidiary earnings from parent (dividends)6. Subtract minority share of earnings (share of earnings not owned)7. Combine revenues and expenses* of both firms (net of intercompany transactions) *Only include post-acquisition results© Kaplan, Inc. 34 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Business Combinations: Acquisition Method (Control)Balance Sheet1. Eliminate investment account (purchase price) of parent and equity* accounts of subsidiary2. Create minority interest (share of equity not owned)3. Calculate goodwill4. Combine 100% of assets and liabilities of both firms (net of intercompany transactions)© Kaplan, Inc. *Only eliminate pre-acquisition sub R/E 33LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition ExampleOn January 1, Parent acquired 75% of Sub for €110m. Usethe following post-acquisition balance sheets to consolidatethe investment: Balance Parent Sub Adj Consolidated Sheet €m €m €m €m Current 370 160 5304 assets Goodwill 0 0 353 354 Investment 110 0 (110)1 04 Fixed Assets 320 80 4004 Total Assets 800 240 965© Kaplan, Inc. 35ers - Exame CFA 9

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition Example cont.Balance Sheet Parent Sub Adj Consolidated €m €m €m €mTotal Liabilities 400 140Minority Interest 252 5404Equity 0 0 1001 254Total L+E 400 100 800 240 4004 9654Partial Goodwill = Proceeds – %(FMVadj Net Assets)Partial Goodwill = €110m – 0.75(€100m) = €35mNoncontrolling interest = MI%×FMVadj Net AssetsNoncontrolling interest = 0.25×€100m = €25m© Kaplan, Inc. 36LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition Method: ExampleOn January 1, Black acquired 50% of Blue for $500at the start of the period by issuing stock. Both firmsuse straight-line depreciation over five years with nosalvage value. At the acquisition date, the bookvalue of Blue’s fixed assets was $450.Required: Prepare the post-acquisition balancesheet and year-ended income statement inaccordance with IFRS assuming Black accounts forthe investment using: Equity method  Acquisition (partial goodwill) 38© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition ExampleUse the following year-end income statements toconsolidate the earnings of Sub one year after acquisition:Income Statement Parent Sub Adj Consolidated €m €m €m €mRevenues 600 200Expenses (160) 8007Income from sub (400)Minority interest 30 0 (560)7Net Income 0 0 40 (30)5 07 230 (10)6 (10)7 230© Kaplan, Inc. 37LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Equity Method: Solution Balance Sheet Black BV Blue FMV Equity $400 Method Current assets $700 600 Fixed assets 800 $700 Investment 0 200 800 Total assets 350 500 Current liabilities 1,500 Long-term debt $300 2,000 Equity Liabilities + Equity 400 $300 800 400© Kaplan, Inc. 1,500 1,300 2,000 39ers - Exame CFA 10

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Acquisition Method: Solution Balance Sheet Black Blue Acquisition BV FMV Current assets Fixed assets $700 $400 $1,100 Goodwill 800 Total assets 0 600 1,400 275* Purchase price 1,500– FMV net assets 2,775 $500 *Goodwill 225 FMV assets $1,000 275 – FMV liabilities 550 © Kaplan, Inc. FMV net assets 450 40LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Equity Method: SolutionIncome Statement Black Blue Equity MethodRevenue $1,200 $900 $1,200Expenses (800) (600)Tax provision (120) (800)Income from associates (90) (120)Net Income 280 210 90* 370 * Blue pro-rata net income $105 ($150/5yrs)×50% Additional depreciation (15) Income from Blue 42 90© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition Method: Solution (cont.)Balance Sheet Black Blue Acquisition BV FMVCurrent liabilities 500Long-term debt $300 200 750Equity 400 1,300Minority interest 800 350 225*Liab. & equity 2,775 1,500*Non-controlling interest = FMV net assets ×MI% = $450 × 50% = $225 41© Kaplan, Inc.LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Acquisition Method: SolutionIncome Statement Black Blue Acquisition $900Revenue $1,200 (600) $2,100 (1,400)Expenses (800) (90) (30)1Additional dep’n (FMVadj) 210 (210) (90)2Tax provision (120) 370Minority interestNet Income 280© Kaplan, Inc. 1Additional dep’n = $150/5 years 43 2Minority interest = $180×50%ers - Exame CFA 11

LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Comparison of MethodsBalance Sheet Equity Acquisition MethodCurrent Assets $1,100Fixed Assets $700 1,400Investment 800 0Goodwill 500 275Total assets 0 2,775 2,000© Kaplan, Inc. 44LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Comparison of MethodsIncome Statement Equity Acquisition methodRevenue $2,100Expenses $1,200 (1,430)*Tax provision (800)Income from associate (120) (210)Minority interest 90Net Income (90) 370 370© Kaplan, Inc. * Includes additional depreciation 46 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Comparison of Methods (cont.)Balance Sheet Equity Acquisition MethodCurrent liabilities $500Long-term debt $300 750Equity 400Minority interest 1,300Liabilities & equity 1,300 225 0 2,775 2,000© Kaplan, Inc. 45LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Partial vs. Full GoodwillU.S. GAAP requires full goodwill, but IFRSpermits full or partial goodwill method Partial goodwill: Goodwill is purchase price (of partial interest), minus the % owned times fair value of net identifiable assets. Goodwill is allocated to the cash generating units that will benefit from synergies. Noncontrolling (minority interest) is % not owned times fair value of net identifiable assets.© Kaplan, Inc. 47ers - Exame CFA 12

LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Partial vs. Full Goodwill (cont.)U.S. GAAP requires full goodwill, but IFRSpermits full or partial goodwill method. Full goodwill equals total fair value of subsidiary minus FV of net identifiable assets. Goodwill is allocated to the reporting units that will benefit from synergies. Noncontrolling (minority) interest is % not owned times total fair value of subsidiary.© Kaplan, Inc. 48LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Comparison of MethodsBalance Full Goodwill Partial GoodwillSheetGoodwill $2m – $1.7m $1.4m – (0.7×$1.7m) = $300,000Non- = $210,000controlling 30%×$2minterest = $600,000 70% 30%×$1.7m $90k = $510,000 $90kTotal assets and total liabilities + equity are $90,000 more withfull goodwill. Note: No difference for 100% owned subs’ 50© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Partial vs. Full Goodwill – Example Company purchases 70% of subsidiary for $1,400,000. Fair value of subsidiary is 1.4 / 0.7 = $2 million. Fair value of identifiable assets less identifiable liabilities = $1,700,000. Full goodwill is $300,000. Partial goodwill is 0.70 × 300,000 = $210,000.© Kaplan, Inc. 49LOS 16.a Describe Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Impairment of Goodwill  Goodwill is not amortized; it is tested for 51 impairment annually.  Goodwill cannot be separated from the overall business.  Goodwill is impaired when carrying value of business unit is greater than its fair value.  Impairment is reported as line item on income statement.  Goodwill impairments cannot be reversed.© Kaplan, Inc.ers - Exame CFA 13

LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Impairment of Goodwill IFRS vs. U.S. GAAP1. IFRS—Allocated across cash generating units that will benefit from acquisitionU.S. GAAP—Allocated across reporting units:operating segment or component© Kaplan, Inc. 52LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Impairment of Goodwill IFRS vs. U.S. GAAP3. IFRS—If loss is greater than unit goodwill, remainder is allocated proportionally to (impairment of) other (non-cash) assets of the unit.U.S. GAAP—If loss is greater than current fairvalue of unit goodwill, unit goodwill is reduced tozero; no other allocation of impairment amount. Under both standards, impairment loss is 54 recognized in the income statement as a separate line item.© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10Impairment of Goodwill IFRS vs. U.S. GAAP2. IFRS—One-step process  If recoverable amount of cash generating unit < carrying value, recognize difference as impairment U.S. GAAP—Two-step process  If fair value of reporting unit < carrying value, goodwill is impaired  Amount of impairment is unit’s reported goodwill – current fair value of unit’s goodwill (recalculated with current asset/liability values)© Kaplan, Inc. 53LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Goodwill Example U.S. GAAPHoops Inc., acquired a subsidiary Parejo Companyfor $1 billion. The fair value of net assets at this timewas $800m.The full amount of goodwill was allocated to a singlereporting unit.At the end of the current year, the reporting unit hada carrying value of $1.2 billion including goodwill.The fair value of the reporting unit was estimated at$1.1 billion and the fair value of identifiable netassets $950m. 55© Kaplan, Inc.ers - Exame CFA 14

LOS 16.b Distinguish Intercorporate InvestmentsSchweser B2 pg 1, CFAI V2 pg 10 Goodwill SolutionOn Acquisition $m Impairment lossProceeds 1,000 2. Loss Measurement:FMV Net Assets Acq (800) $200m – $150m = $50mGoodwill 200 Current Period $m 1. Identification: FMV 1,100 $1.2bn > $1.1bn FMV Net Assets (950) There has been an impairment Implied GW 150© Kaplan, Inc. 56LOS 16.c Analyze Intercorporate InvestmentsSchweser B2 pg 25, CFAI V2 pg 35Equity Method = Best RatiosRatio Equity Acquisition MethodNet profit margin LowerROE Higher Lower*ROA Lower Higher* Higher *Only the case if there are minority interests 58© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 16.c Analyze Intercorporate InvestmentsSchweser B2 pg 25, CFAI V2 pg 35 Comparison of MethodsItem Equity Acquisition Method MethodSales HigherExpenses Lower HigherNet Income Lower SameAssets & Liabilities Same HigherSH Equity* Lower Higher Lower *Only the case for subs with minority interests© Kaplan, Inc. 57 FinFaixnecdiaIlnRceopmoertIinnvgeasntmd eAnntaslysis Intercorporate Investments, Post- Employment and Share-Based Compensation, and Multinational Operations 17. Employee Compensation: Post Employment and Share-Baseders - Exame CFA 15

LOS 17.a Describe PensionsSchweser B2 pg 37, CFAI V2 pg 73 Defined Benefit AccountingNon-Pay-Related Plans Pay-Related PlansPension benefits are Pension benefits areunrelated to the based on futureemployee’s salary level compensation Employer (plan sponsor) bears the investment risk in all defined plans because it has promised a specific benefit amount. The employer needs to estimate future benefit payments to determine required contributions.  Difficult accounting/analysis issues 60© Kaplan, Inc.LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 B/S Asset/Liability IFRS and U.S. GAAP  Net of PBO and fair value of plan assets  Asset/liability = funded status  If overfunded, asset  If underfunded, liability© Kaplan, Inc. 62 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 Pension Liability MeasuresProjected Benefit Obligation (PBO) Present value of all future pension payments earned to date based on expected salary increases over time. Assumes employee works until retirement. Estimate of liability on a going concern basis. Under IFRS, the PBO is referred to as the present value of the defined benefit obligation (PVDBO).© Kaplan, Inc. 61LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO ComponentsService The change in PBO attributed toCost employees’ efforts during the year. The actuarial PV of pension benefits earned in a yearInterest The increase in the PBO resultingCost from the passage of time. PBO at start of period × discount rate*© Kaplan, Inc. *Subject to discount rate remaining 63 constanters - Exame CFA 16

LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO Components Actuarial Gains and losses resulting from Gains and changes in actuarial assumptions Losses affecting the PBO Past Retroactive impact on past benefits Service awarded to employees resulting Costs from plan amendments. For example, changing the payout from Benefits 60% to 65% of final salary. Paid Payments made from the fund to© Kaplan, Inc. existing retirees 64LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO Calculation: Example  Retirement age: 65  Pension: 2% of final salary × years worked  Life expectancy post retirement = 15 years  Discount rate = 10%One employee:Kevin Gallen (age 39) has 26 years to retirement.Kevin’s final salary is expected to be $150,000.Employment starts beginning of the year.© Kaplan, Inc. 66 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO Components X Opening PBO Only actuarial + Service cost assumptions + Interest cost affecting PBO +/– Actuarial (gains) or losses +/– Past service cost Reconciliation – Benefits paid disclosed in = Closing PBO footnotes© Kaplan, Inc. 65LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO CalculationYear 1 $3,000 2% ofRetirement annuity 15 150kYears paid $22,818PV at retirement 25 N = 15Years to retirement 2,1061 I = 10PV today PMT = 3,0001PV of a $3,000, 15-year annuity that begins in 25years, discounted at 10% [N = 25, I = 10, PMT = 0,FV = 22,818, solve for PV]© Kaplan, Inc. 67ers - Exame CFA 17

LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO CalculationYear 2 $6,000 4% ofRetirement annuity 15 150kYears paid $45,636PV at retirement 24 N = 15Years to retirement $4,6331 I = 10PV today PMT = 6,0001PV of a $6,000, 15-year annuity that begins in 24years, discounted at 10% [N = 24, I = 10, PMT = 0,FV = 45,636, solve for PV]© Kaplan, Inc. 68LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 Fair Value of Plan AssetsEmployer Funding policy is a function of:Contributions  Income tax  ERISA rules (U.S.)  Cash flow considerations Actual Return Actual capital on Assets gains/dividends/interest (will (ROA) fluctuate with market) Benefits Payments made from the fund to Paid existing retirees© Kaplan, Inc. 70 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 PBO ReconciliationPBO – Year 1 $2,106 2 2,106 beginningService cost 2,3171 PBO × 10%Interest cost 2112PBO – Year 2 $4,63431Service cost is the PV of benefits earned fromworking one more year; that is, the PV of a $3,000,15-year annuity that begins in 24 years, discountedat 10%[N = 24, I = 10, PMT = 0, FV = 22,818, Solve for PV] 3Rounding difference from previous slide 69© Kaplan, Inc.LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 Fair Value of Plan Assets X Fair value of plan assets at start of year +/– Actual return on plan assets Reconciliation + Employer contributions disclosed in – Benefits paid to retirees foot notes = Fair value of plan assets at end of year Note: Don’t be confused; this is exactly what the name implies—the market value of plan assets© Kaplan, Inc. 71ers - Exame CFA 18

LOS 17.b Explain/Calculate PensionsSchweser B2 pg 38, CFAI V2 pg 75 Funded Status Fair Value of Plan Assets – PBO = Funded StatusFV > PBO = OverfundedFV < PBO = Underfunded Funded Status = Economic Position of Plan Funded Status = Balance Sheet Asset/Liability**If reporting asset, subject to ceiling of PV of futureeconomic benefits© Kaplan, Inc. 72LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 I/S (U.S. GAAP)+ Service cost Recurring costs (actual)+ Interest cost–+/– Expected return on plan assets Smoothed+/–= Amort. of actuarial (gains) and losses events Amortization of past service costs Periodic Pension cost on income statement Unamortized past service cost and actuarial gains and losses in OCI.© Kaplan, Inc. 74 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 Periodic Pension CostTotal Periodic Pension Cost = Contributions –Funded Status TPPC = Contributions – (End FS – Beg FS) Total Periodic Pension Cost = I/S Expense + OCI ExpenseTotal Periodic pension cost is same under IFRS andU.S. GAAP but differ on where the pension cost isreflected (Income statement vs. OCI)TPPC = economic/true cost© Kaplan, Inc. 73LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 I/S (IFRS)+ Service cost+/– Net interest expense/(income)*+/– Past service costs= Periodic Pension cost on income statementRemeasurements are reflected in OCI and notamortized.*Net interest expense/(income) = beg funded status × discount rate© Kaplan, Inc. 75ers - Exame CFA 19

LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 IFRS vs. U.S. GAAPOpening PBO × discount rate = $ Interest expense U.S. GAAP allows different ratesOpening plan × % expected = $ expected returnassets returnOpening × discount rate = $ Net interestfunded status expense/income IFRS expected return = discount rate© Kaplan, Inc. 76LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 Impact of Assumptions Higher Higher Higher Discount Wage Rate Expected Increases Return on Rate Assets*PBO Lower Higher No change Lower HigherPPC in Higher LowerP&L Not AffectedTPPC Lower 78*© Kaplan, Inc. U.S. GAAP only ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.d Explain/Calculate PensionsSchweser B2 pg 47, CFAI V2 pg 81Actuarial Pension Plan Assumptions All plans must make/disclose three assumptions: 1. Discount rate 2. Rate of compensation increase 3. Expected return on plan assets (U.S. GAAP only) These assumptions can affect:  Balance sheet (through effect on PBO)  Income statement (periodic pension cost) Pension accounting: The greatest earnings 77 manipulation tool known to management© Kaplan, Inc.LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 Delayed Recognition of Pension Costs IFRS allows for recognition of certain events that affect the Pension cost in OCI (instead of income statement) Under U.S. GAAP, the events are amortized in the income statement over time (until then, in OCI) Terminology:  IFRS: Remeasurement gains and losses = actuarial gains and losses (affecting PBO) plus differences in actual and expected return on assets  U.S. GAAP: Actuarial gains and losses = IFRS definition of remeasurement gains and losses© Kaplan, Inc. 79ers - Exame CFA 20

LOS 17.c Describe Intercorporate InvestmentsSchweser B2 pg 42, CFAI V2 pg 78Delayed Recognition of Pension EventsThe two main delayed events:1. Remeasurements (IFRS & U.S. GAAP) From changes in actuarial assumptions affecting the PBO (Actuarial gains and losses) From differences in the actual and expected return on plan assets (Note IFRS, exp. return = disc. rate)2. Past service costs (U.S. GAAP only)Changes in PBO due to plan amendments. Amortizedover service life of plan participants. Expensedimmediately under IFRS© Kaplan, Inc. 80LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78Actuarial Gains and Losses – Corridor Approach (U.S. GAAP only) Amortize over the remaining service life, the beginning net gain/loss that exceeds: 10% of greater of opening values of: PBO Plan Assets© Kaplan, Inc. 82 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 Remeasurements Net Plan Liabilities (PBO)Plan Assets Actuarial gains and lossesActual vs. Expected resulting from changes inreturns actuarial assumptions: Assumed (GAAP) or  Discount rate discount rate (IFRS)  Rate of salary increase  Composition of participants© Kaplan, Inc. 81LOS 17.c Describe PensionsSchweser B2 pg 42, CFAI V2 pg 78 IFRS vs. U.S. GAAP1. U.S. GAAP expected return and discount rate may differ. IFRS expected return = discount rate2. U.S. GAAP interest and $ expected return shown separately. IFRS netted3. U.S. GAAP Opening OCI balances 10% corridor amortization. IFRS no amortization4. IFRS past service costs taken to I/S, U.S. GAAP past service costs taken to OCI and amortized over remaining service life© Kaplan, Inc. 83ers - Exame CFA 21

LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 Pension: ExampleAt the beginning of the year, Slayton Companyreported following:Plan assets at fair value $79,800 (132,500)Projected benefit obligation ($52,700)Funded status $20,750Note:Unamortized remeasurementlosses (cumulative)© Kaplan, Inc. 84LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 PVDBO/PBO: Solution Beginning PBO $132,500 + Current service cost 8,000 + Past service cost 2,000 + Interest cost 13,2501 – Benefits paid (9,000) Closing PBO $146,750© Kaplan, Inc. 1Interest cost = opening PBO×discount 86 rate Interest cost = $132,500×10% ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 Pension: Example (cont.)Use the following to calculate the end-of-year PBO,plan assets, pension expense, and the balancesheet asset or liability (under U.S. GAAP and IFRS):Current service cost $8,000 Discount 10% $2,000 ratePast service cost $11,000 12% ExpectedActual return (plan $9,000 return (plan 20assets) $13,500 assets) yearsBenefits paid Remaining 85Employer contribution service life © Kaplan, Inc.LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 87 FV Plan Assets: Solution Beginning plan assets $79,800 13,500 + Employer contributions 11,000 +/- Actual return on plan (9,000) assets 95,300 – Benefits paid Closing plan assets© Kaplan, Inc.ers - Exame CFA 22

LOS 17.b,c Explain/Calculate/Describe Intercorporate InvestmentsSchweser B2 pg 38, CFAI V2 pg 75Balance Sheet Asset/(Liability): SolutionPension asset/liability at end of year:Plan assets at fair value $95,300Projected benefit obligation (146,750)Funded status ($51,450) Net pension liability $51,450© Kaplan, Inc. 88LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75Pension Cost (U.S. GAAP): Solution+ Current service cost $8,000+ Interest cost 13,2501– Expected return on plan assets (9,576)2+/– Amortization 4753Pension expense (I/S) $12,149+/– Actuarial losses/(gains) (β) 101Total periodic pension cost $12,250© Kaplan, Inc. 1,2,3,4Next slide 90 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 Pension Cost (IFRS): Solution+ Current service cost $8,000+/- Past service cost 2,000+/- Net interest expense 5,2701 Pension expense (I/S) $15,270+/- Remeasurements (3,020)2 Total periodic pension cost $12,2501Opening funded status x DR% = [$52,700 × 10%] 2$11,000 Actual return – 7,980 Expected return 89© Kaplan, Inc.LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 U.S. GAAP - Notes1Interest Cost = Beg PBO x 10%2Expected return = opening plan assets × 12%3Amortization of prior service cost = $2,000/20 = $100 Amortization of Act loss = $7,500/20 = $375 Total Amortization = $475 Opening actuarial loss $20,750 10% of Greater Corridor (13,250) of opening Excess PBO or FV $7,500 assets© Kaplan, Inc. 91ers - Exame CFA 23

LOS 17.b,c Explain/Calculate/Describe PensionsSchweser B2 pg 38, CFAI V2 pg 75 92 Pension Reconciliation Total Periodic Pension Cost = Contributions – ∆ Funded Status = $13,500 – $1,2501 = $12,250 1Change in funded status Closing funded status ($51,450) Opening funded status (52,700) ∆ Funded status $1,250© Kaplan, Inc.LOS 17.e Explain/Calculate PensionsSchweser B2 pg 50, CFAI V2 pg 88 94 Example: I/S Adjustments Slayton Company reports under U.S. GAAP (excerpts from income statement)Revenues $528,800Operating expenses $408,500Operating profit $120,300Interest expenseInterest/Investment income $18,520Earnings before tax $ 1,120 $102,900© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.e Explain/Calculate PensionsSchweser B2 pg 50, CFAI V2 pg 88 Analyst Adjustments: I/S Full pension expense is taken through operating expenses (SG&A) Only service cost is operating Remove pension expense from operating expenses and include service cost Add interest cost to interest expense Add actual return on plan assets to non-operating income Amortization ignored Total I/S effect = Service + Interest – Actual Return© Kaplan, Inc. 93LOS 17.e Explain/Calculate PensionsSchweser B2 pg 50, CFAI V2 pg 88 Solution: I/S AdjustmentsRev Reported Adj AdjustedOp. exp $528,800 - $528,800Op. profit $408,500Int exp $120,300 – $4,1491 $404,351Int/Inv inc $124,449EBT $18,520 +$13,250 $ 1,120 +$11,0002 $31,770 $12,120 $102,900 $104,799 1 – 12,149 + 8,000 95 2actual return© Kaplan, Inc.ers - Exame CFA 24

LOS 17.f Interpret PensionsSchweser B2 pg 51, CFAI V2 pg 97Analyst Adjustment: Cash Flow StatementFor analytical purposes, adjust CFO and CFF for theafter-tax difference in economic pension expenseand cash contributions.  Contribution > Total Periodic Pension Cost = Principal PMT (Contribution – TPPC)(1 – T) CFF CFO  Contribution < Total Periodic Pension Cost = Borrowing (Contribution – TPPC)(1 – T) CFF CFO© Kaplan, Inc. 96LLOOSS1197.g.gExpElxaipnlain Intercorporate InvestmentsSchweser B2 pg 53, CFAI V2 pg 98 Share-Based CompensationDisclosures Required 1. Nature and extent of share-based compensation arrangements during the period 2. How fair value was determined 3. Impact on income for the periodAccounting  Allocate fair value over service period (the period benefited by the employees’ service)© Kaplan, Inc. 98 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 17.f Interpret PensionsSchweser B2 pg 51, CFAI V2 pg 97 Cash Flow Adjustment: SolutionFor analytical purposes, adjust CFO and CFF for theafter-tax difference in economic pension expenseand cash contributions:Employer contributions $13,500Total periodic cost (12,250)Excess contribution 1,250 CFOAfter-tax effect (1 – 40%) $750 CFF Contribution > Total Pension Cost = Principal PMT Contribution < Total Pension Cost = Borrowing 97© Kaplan, Inc.LLOOSS1197.g.gExpElxaipnlain Intercorporate InvestmentsSchweser B2 pg 53, CFAI V2 pg 98 Share-Based CompensationStock Grants Compensation expense equals market value at grant date Restricted stock: Ownership returned to company if conditions are not met (length of service or performance goals) Performance shares: Granted on meeting performance goals © Kaplan, Inc. 99ers - Exame CFA 25

LLOOSS1197.g.gExpElxaipnlain Intercorporate InvestmentsSchweser B2 pg 53, CFAI V2 pg 98Share-Based Compensation cont.Stock Options Fair value at grant date = estimated option premium Service period equals time between grant date and vesting date Vesting date = first date the options may be exercised Fair value expensed over the vesting period: RE declines, paid-in-capital increases, no net change in total equity!© Kaplan, Inc. 100LLOOSS1197.h.hExpElxaipnlain Intercorporate InvestmentsSchweser B2 pg 53, CFAI V2 pg 101 Model AssumptionsAll models require six assumptions:1. Exercise price2. Stock price at grant date Assumptions affect3. Volatility fair value and4. Risk-free rate hence5. Expected term (time to expiry) compensation6. Dividend yield expense© Kaplan, Inc. 102 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLLOOSS1197.h.gExpElxaipnlain Intercorporate InvestmentsSchweser B2 pg 53, CFAI V2 pg 98 Option Valuation Methods Fair value measured “based on the observable market price (premium) of an option with the same or similar terms and conditions, if one is available” In the absence of a market-based instrument, fair value is determined by an option valuation model: 1. Black-Scholes-Merton model 2. Binomial model 3. Monte Carlo simulation© Kaplan, Inc. 101 FFiixneadncIinacl oRmepeorIntivnegsatnmdeAnntaslysis Intercorporate Investments, Post- Employment and Share-Based Compensation, and Multinational Operations 18. Multinational Operationsers - Exame CFA 26

LOS 18.b Describe Multinational OperationsSchweser B2 pg 64, CFAI V2 pg 118 Translation ExposureTranslation of foreign currency financial statements: Converting the accounts of overseas subsidiaries to reporting currency Three-step process:1. Identify subs functional currency2. Convert foreign currency balances into functional currency3. Convert functional currency balances to parent’s reporting currency using closing rates (if functional and reporting currencies differ)© Kaplan, Inc. 104LOS 18.d Compare/Evaluate/Determine Multinational OperationsSchweser B2 pg 65, CFAI V2 pg 134Foreign Currency Translation SFAS 52 LOCAL FUNCTIONAL PRESENTATIONCURRENCY CURRENCY CURRENCY Temporal method of translation a.k.a. “Remeasurement” LOCAL FUNCTIONAL PRESENTATIONCURRENCY CURRENCY CURRENCYCurrent rate method of translation a.k.a.© Kaplan, Inc. “Translation” 106 ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 18.a Distinguish Multinational OperationsSchweser B2 pg 63, CFAI V2 pg 117 Foreign Currency Translation SFAS 52 DEFINITIONSFunctional The currency of the primary economiccurrency environment in which the firm operates. This is the currency in which the firm generates and spends cash (some subjectivity).Presentational The currency in which the multi-nationalcurrency firm prepares its final, consolidated financial statementsLocal The currency of the country in which 105currency the foreign subsidiary is located © Kaplan, Inc.LOS 18.d Compare/Evaluate/Determine Multinational OperationsSchweser B2 pg 65, CFAI V2 pg 134 Exchange Rate Definitions1. Current rate = Foreign exchange (FX) rate as of balance sheet date (i.e., closing rate)2. Average rate = Average FX rate over reporting period3. Historical rate = FX rate that existed when a particular transaction occurred  Not fixed in time  Example: Rate when stock was issued© Kaplan, Inc. 107ers - Exame CFA 27

LOS 18.c,d Analyze/Compare/Evaluate/DetermineSchweser B2 pg 65, CFAI V2 pg 130 Multinational Operations Temporal Method Alternative names: Remeasurement, monetary/nonmonetary method Views the overseas operation as an extension of the parent companies activities Assets and liabilities translated at rates that preserve the measurement bases after translation: 1. Current value 2. Historic cost© Kaplan, Inc. 108LOS 18.c,d Analyze/Compare/Evaluate/DetermineSchweser B2 pg 65, CFAI V2 pg 130 Multinational Operations Temporal Method1. Produce top of Balance Sheet (Total Assets)2. Produce Shareholders’ Equity and Liabilities (retained earnings = plug figure to ensure that the balance sheet balances) $ Liabilities (current) X Common Stock (historic) X Retained Earnings X Same as Liabilities + Equity X Total Assets 110© Kaplan, Inc. ©2018 FK Partne

SS 05 - Intercorporate Investments, Post-Employment Compensation, and Multinational OperationsLOS 18.c,d Analyze/Compare/Evaluate/DetermineSchweser B2 pg 65, CFAI V2 pg 130 Multinational Operations Temporal MethodBalance Sheet Income StatementMonetary Assets & Liabilities Revenues & Expenses(Cash/AR/AP/STD/LTD) Average rateCurrent rateAll other Assets & Liabilities COGS, Depreciation, &(PP&E, Intangibles, Inv. at cost) AmortizationHistorical rate Historical rate Capital Stock Exchange gains/(losses) Historical rate Dividends = Historical Total Equity Rate when declared Mixed rate 109© Kaplan, Inc.LOS 18.c,d Analyze/Compare/Evaluate/ DetermineSchweser B2 pg 65, CFAI V2 pg 130 Multinational Operations Temporal Method (cont.)3. Derive net income from reconciliation of retainedearnings $ Opening R/E X NI β X Dividends (X) Closing R/E X © Kaplan, Inc. 111ers - Exame CFA 28