FM.2-Accounting-standards-slides.pdf

INFINITY EDUCATION
FM.2 Accounting Standards Slides
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FINANCIAL MODELING COURSE

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« Req (2) | Accounting Principles and Standards For Financial Analysts
The objective of accounting standards is to bring uniformity and comparability to the financial
statements, which then allows them to be relied upon by investors, lenders, creditors and others.
Two key accounting standards setting bodies in the world
International Accounting Standards Board (IASB)
International Financial Reporting Standards
(IFRS)
Financial Accounting Standards Board (FASB)
Generally Accepted Accounting Principles (US
GAAP)
Accounting standards are the rules and guidelines issued by the accounting institutions that specify how
transactions and other events are to be recognized, measured, presented and disclosed in financial
statements.
Some of the key standards that are relevant to financial analysts include :
Leases Income Taxes Share-based Payments Business Combinations
Financing Fees & Transaction Costs
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« Req (2) | Accounting Standards For Financial Analysts
Accounting for Leases
Asset
Lessor Lessee
Finance lease Operating lease
Right to Control Right to Control
Right to obtain substantially all
(≥ 90%) of the economic
benefits.
Right to direct the use of the
asset.
Right to Control
IFRS 16
IAS 17
2019
$20,000 | 5 years
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
Total lease = $100,000
PV = FV / (1+ D) ^ n
D = 6%
Pv = 20,000
( 1 + 6%) ^ 1
$18,867.92
Pv = 20,000
( 1 + 6%) ^ 2
$17,799.93
Pv = 20,000
( 1 + 6%) ^ 3
$16,792.39
Pv = 20,000
( 1 + 6%) ^ 4
$15,841.87
Pv = 20,000
( 1 + 6%) ^ 5
$14,945.16
PV
Total PV
$ 84,247
PV = FV * Factor
= 20,000 * 4.2124 = $ 84, 247
Total FV
$ 100,000
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
D = 6%
$18,867.92 $17,799.93 $16,792.39 $15,841.87 $14,945.16
PV
Right-of-Use Asset Lease Liability
Assets Dr. Right-of-Use Asset
Total PV
$ 84,247
$ 84,247 $ 84,247
Cr. Lease Liability
Liabilities
Initial Recognition
Journal entries
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
D = 6%
Right-of-Use Asset
Total PV
$ 84,247 Subsequent Recognition
Journal entries
Dr. Amortization Expense
Cr. Accumulated Amortization
84,247 / 5
= $16,849
$16,849 $16,849 $16,849 $16,849 $16,849
Amortization Expense
$16,849
$16,849
1
2 Dr. Amortization Expense
$16,849
$16,849
Right-of-Use Asset $ 84,247
Accumulated Amortization $16,849
$ 67,398
$16,849
$50,548
Right-of-Use Asset
Accumulated Amortization
Right-of-Use Asset
$ 67,398
Right-of-Use Asset $50,548 $ 33,699 $ 16,849 0
Right-of-Use Asset
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
D = 6%
Lease Liability
Total PV
$ 84,247
Dr. Interest Expense
Dr. Lease Liability
Cr. Cash $20,000
84,247 * 6% = $5,055
Interest Expense $5,055
$5,055
$14,945
1
$ 4,158
Dr. Interest Expense
Dr. Lease Liability
Cr. Cash $20,000
2 $ 4,158
$15,842
Lease Liability $69,302 $53,460
$ 3,208
$ 36,668
$ 2,200
$ 18,868
$ 1,132
0
* 6% * 6% * 6% * 6%
Lease Liability
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A lease is a contract that conveys the right to control the use of an identified asset for a period of
time in exchange for consideration.
Accounting Treatment of Leases
IFRS
All leases are classified as finance leases.
There are exemptions for short term
leases (< 1 year) and low value leases
(< $5K approximate asset value or less).
US GAAP
Leases are classified based on
whether the arrangement is
effectively a purchase of the
asset:
Finance lease (control of the
underlying asset is transferred
to the lessee)
Operating lease (control of
the underlying asset is not
transferred to the lessee)
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Finance Lease
Financial Statement Impact
Operating Lease
Balance Sheet
Right-of-Use Asset
Lease Liability
Right-of-Use Asset
Lease Liability
Income Statement
Interest Expense
Lease Expense
Cash Flow Statement
Principle Payments
Interest Payments
Lease Payments
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Initial Recognition of Balance Sheet Amounts
A right-of-use asset and lease liability must be recognized on the balance sheet for all leases
at lease commencement.
Lease Liability
Present value of the remaining
lease payments, discounted at
either:
The rate implicit in the lease
The lessee’s incremental
borrowing rate (IBR)
Right-of-Use Asset
The amount of the lease liability at
lease commencement
+ Lease payments made before
the commencement date, less any
lease incentives received
- Initial direct costs incurred
*IBR = The rate of interest that a lessee would have to
pay to borrow over a similar term, and with a similar
security, the funds necessary to obtain an asset of a
similar value to the right-of-use asset in a similar
economic environment.
2019
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The income statement recognition and classification is based on how the lease is classified.
Finance Lease Operating Lease
Interest Expense
Based on the outstanding lease
liability balance
Straight-line over the
shorter of the lease
term or the asset useful
life
Lease Expense
Interest Expense Amortization Expense
Difference between the
average annual lease
payment and interest
expense
Based on the
outstanding lease
liability balance
Subsequent Recognition and Measurement
Over the lease term, the right-of-use asset must be amortized and interest expense on the
lease liability must be recorded.
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Asset
Lessor Lessee
Finance lease Operating lease
Right to Control Right to Control
Right to obtain substantially all
(≥ 90%) of the economic
benefits.
Right to direct the use of the
asset.
Right to Control
IFRS 16
IAS 17
2019
$20,000 | 5 years
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
D = 6%
Interest Expense $5,055 $ 4,158
$ 3,208
$ 36,668
$ 2,200
$ 18,868
$ 1,132
0
Lease Liability
= Lease payment – interest expense
1 = 20,000 – 5,055 = 14,945
$14,945
2 = 20,000 – 4,158 = 15,842
3 = 20,000 – 3,208 = 16,792
4 = 20,000 – 2,200 = 17,800
5 = 20,000 – 1,132 = 18,868
$15,842 $16,792 $17,800 $18,868
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Lessee $20,000 $20,000 $20,000 $20,000 $20,000
1 2 3 4 5
D = 6%
Interest Expense $5,055 $ 4,158
$ 3,208
$ 36,668
$ 2,200
$ 18,868
$ 1,132
0
Amortization Expense $14,945 $15,842 $16,792 $17,800 $18,868
Right-of-Use Asset
Total PV
$ 84,247
-
$69,302 $53,460 $36,668 $18,868 0
Subsequent Recognition
Journal entries
Dr. Lease Expense
Dr. Lease Liability
Cr.Cash
$20,000
$14,945
$14,945
$20,000
Interest Expense
Amortization Expense $14,945
$5,055
- - - -
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Accounting Treatment of Income Taxes
Accountant Tax Advisor
IFRS Tax laws
Income Before Tax “EBT”
- Income tax
Net income
Revenue
Expenses
$22 k
$2 k
$20 k
Fixed assets
Cash $6,000
Depreciation rate for accounting
purposes is 33.3%
$7,000 35%
Tax rate
$13,000
Fixed assets
Accounting dep. $2,000
Tax dep. $1,500
Difference $500
Expenses - $500
Income Before Tax “EBT” $20,500
$7,175
Income tax
Net income $13,325
$7,175
Income Tax
Income Tax
$7,000
$2,000
Cash $6,000
Tax depreciation rate is 25%
$1,500
3 Years 4 Years
2021 | Income statement
IAS 12
Income tax
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$7,175
Income Tax
Income Tax
$7,000
Accountant
IFRS
Tax Advisor
Tax laws
Difference
Temporary permanent
Tax Depreciation & Accounting Depreciation
Accrued Expenses
Unearned Revenue
Tax Losses
Installment Sales
Capitalized Development Costs Amortized Over Time
Temporary Differences = carrying amount - Tax base
- $175
IAS 12
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Sales/Revenue
Cost of Goods Sold (COGS)
Gross Income (profit)
Selling/General/Administrative
Expenses “SG&A”
Research & Development “R&D”
Other expenses
Operating Income “EBIT”
Interest Expense
Tax
Net income “net profit/Loss”
Accounting Income
Income statement
Accounting income Taxable income
Expenses not deductible
under tax laws but
recognized for accounting
purposes .
+
Income included under tax
laws but not recognized for
accounting purposes
+
Expenses deductible
under tax laws but not
recognized for accounting
purposes.
-
Income not included under
tax laws but recognized for
accounting purposes.
-
= Taxable Income
IAS 12
Accountant
Tax Advisor
Tax laws
IFRS
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1 2 3 4
Cash $6,000
Depreciation rate for accounting purposes is 33.3%
Journal entries
Dr. depreciation expenses
Cr. Accumulated depreciation
$2,000
$2,000
initial Cost $6,000
Dr. Fixed Assets ( PP&E)
Cr.Cash
$6,000
$6,000
depreciation
0
Income statement
Balance sheet
0
IAS 12
$2,000 $2,000 $2,000 0
- $2,000
- $2,000
- $2,000
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1 2 3 4
Cash $6,000
Tax Dep.
25%
Tax Dep . Rate
Accounting Dep.
Accounting Income
+ $ 2,000
Taxable Income
$ 20,000
Accounting Dep.
Tax Dep.
IAS 12
$2,000 $2,000 $2,000 0
25% 25% 25%
$1,500 $1,500 $1,500 $1,500
$ 20,000 $ 20,000 $ 20,000
+ $ 2,000 + $ 2,000 0
- $1,500 - $1,500 - $1,500 - $1,500
$20,500 $20,500 $20,500 $18,500
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1 2 3 4
IAS 12
Accumulated depreciation - $2,000 - $4,000 - $6,000 0
Cash $6,000
Carrying amount
“Net book value “
Fixed Assets (initial cost ) $6,000
Accounting Dep. $2,000 $2,000 $2,000 0
$6,000 $6,000
$4,000 $2,000 0 0
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1 2 3 4
IAS 12
Tax dep. to date
Cash $6,000
Tax Base
Fixed Assets (initial cost )
$4,500 $3,000 $1,500 0
Tax Dep. $1,500 $1,500 $1,500 $1,500
$6,000 $6,000 $6,000 $6,000
- $1,500 - $3,000 - $4,500 - $6,000
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1 2 3 4
IAS 12
Tax Base
Carrying amount
“Net book value “
Temporary Difference - $500 - $1,000 - $1,500 0
<
$4,000 $2,000 0 0
$4,500 $3,000 $1,500 0
< <
TD Beginning Balance 0
TD Ending Balance - $500 - $1,000 - $1,500
Annual Temporary Difference - $500
- $500
- $500
- $1,000
- $500
- $1,500
0
$1,500
- - -
0
Total
Carrying amount of Asset > Tax Base of Asset = Deferred tax liability
Carrying amount of Asset < Tax Base of Asset = Deferred tax Asset
Cash $6,000
D D D T www.infinity-ed.com

1 2 3 4
Taxable Income
IAS 12
$20,500 $20,500 $20,500 $18,500
Current Tax expenses (35%) $7,175 $7,175 $7,175 $6,475
Annual Temporary Difference - $500 - $500 - $500 $1,500
-$175 -$175 -$175 $525
Deferred Tax Expense (35%)
Total Income Tax Expense $7,000 $7,000 $7,000 $7,000
+
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Accounting for Share-based Payments
Investors
ABC Inc.
Current share price $100
Increase in share price
CEO
wealth maximization
Buy ABC Inc shares
Maximize short-term profits
Bonus
CFO
R&D Expenses
R&D Expenses
$300,000
$100,000
Net Income
Decrease in share price
IFRS 2
Share-based Payments (SBP)
Jan -2022
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Accounting for Share-based Payments
Senior managers
Share-based Payments (SBP)
Equity-settled Payments Cash-settled Payments
Cash Share price
Shares
Classification
IFRS 2
Jan -2022
Agreement
BOD
Grant date | Rights Conferred Approved
Vesting Conditions
Service Conditions Performance Conditions
2 years of service
Market Conditions Non-market Conditions
Vesting period
3 years
Net Income
Employee Benefits
Shares
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Accounting for Share-based Payments IFRS 2
Calculating Employee benefit expense
At Jan -2022 Company XYZ grants 100 share options to each of its 500 employees,
which can be exercised at anytime over 3 years subject to a 2-year service condition.
• The fair value of each option is determined to be $20 at the grant date.
• An estimated 75% of the 500 employees will complete the service condition required
for receiving the options.
Grant date : Jan - 2022
Given :
Classification : Equity-settled Payments
Vesting period : 3 years
Service Conditions : 2 years service
fair value : $20
75% will complete
Grant date
Y 0 Y 1 Y 2 Y 3
Vesting period
Jan -2022 Jan -2023 Jan -2024 Jan -2025
N. Shares options : 100 per each
employee
Y 1 | Employee benefit expense
100 * 500 * 75% * $20 * ½ = $375,000
Y 2 | Employee benefit expense
( 100 * 500 * 75% * $20 * 2/2 ) - $375,000 = $375,000
Total Employee benefit expense = $ 375,000 + $ 375,000 = $ 750,000
Example n.1
500 emp
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Accounting for Share-based Payments IFRS 2
Example n.2
Company XYZ grants 100 share options to each of its 500 employees, exercisable over 3 years and
subject to:
i) A 3-year service condition;
ii) Company XYZ’s stock price must be at least 25% higher after the 3-year period compared to at the
grant date.
• 90% of employees are estimated to meet the service condition.
• The fair value of each option is determined to be $20 at the grant date
Grant date
Y 0 Y 1 Y 2 Y 3
Vesting period
Jan -2022 Jan -2023 Jan -2024 Jan -2025
Y 1 | Employee benefit expense = 100 x 500 x 90% x $20 x 1/3 = $ 300,000
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Accounting for Share based Payments IFRS 2
At the end of Year 2,
The price of Company XYZ’s stock has fallen and is 5% lower than at the grant date.
• Fewer employees left the company than expected and the revised estimate of employees that will meet
the service condition is 95%.
• The fair value of the options has fallen to $15.
Y 2 | Employee benefit expense = (100 x 500 x 95% x $20 x 2/3 ) - $300,000= $ 333,333
At the end of Year 3,
The price of Company XYZ’s stock has risen and is 25% higher than at the grant date.
The fair value of the options has risen to $30. Also, 480 employees have met the service condition.
Y 3 | Employee benefit expense = 100 x 480 x $20 x 3/3 – ($300,000 + $333,333) = $326,667
Total Employee benefit expense = $ 300,000 + $ 333,333 + $326,667 = $ 960,000
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Accounting For Business Combinations
A B
Control
> 90 % of a single asset
“single production line”
Asset acquisition
Business combinations
Inputs Substantive Process Output
Fair value concentration test
1
2
3
> 90 % of a group of assets
Test for Outputs
IFRS 3
economic resources systems The result of inputs and processes
Business combination
MAR 2022
| Acquirer | Acquiree
| Acquisition Date
workforce
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Accounting For Business Combinations
A B
| Acquirer | Acquiree
$75,000,000 | Cash paid
$25,000,000 | Shares to B shareholders
$2,000,000 | Transaction cost
Fair Value of Company B Tangible Assets $85,000,000
Fair Value of Company B Assumed Liabilities $25,000,000
Fair Value of Company B Intangible Assets $15,000,000
| Acquisition Consideration
Cash Consideration $75,000,000
Value of Shares to B shareholders $25,000,000
Total Consideration Transferred $100,000,000
| Net Assets Acquired
Tangible Assets $85,000,000
Intangible Assets $15,000,000
Assumed Liabilities - $25,000,000
$75,000,000
Fair Value of Acquired Net Assets
| Goodwill $100,000,000 - $75,000,000 = $25,000,000
pay
> Fair value of B
<
Goodwill
Fair value of B Bargain purchase
IFRS 3
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Accounting For Business Combinations IFRS 3
The acquisition method is used to account for business combinations and involves four steps:
Identify the Acquirer
Determine the Acquisition Date
Recognize and Measure the Assets Acquired, and the Liabilities Assumed
The acquisition date is the date on which the acquirer obtains control of the acquiree.
All forms of consideration are measured at fair value.
The assets acquired, liabilities assumed, and any non-controlling
interests are identified and measured at fair value
The acquirer begins consolidating the acquiree, if required.
On the acquisition date, the acquirer shall recognize, separately from
goodwill, the identifiable assets acquired, the liabilities assumed, and
any noncontrolling interest in the acquiree.
In a business combination, an acquirer must be identified for accounting purposes.
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Identifiable assets acquired and liabilities assumed must:
Accounting For Business Combinations IFRS 3
Recognize and Measure Goodwill
Recognition Principles
Meet the definition of assets and liabilities.
Be part of what the acquirer and acquiree exchanged in the business combination.
Measurement Principles
An acquirer is required to measure the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree at their acquisition-date fair values.
Goodwill represents the future economic benefits arising from other assets acquired in a
business combination that are not individually identified and separately recognized.
Goodwill = Consideration Transferred - Fair Value of Net Assets Acquired
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Accounting For Financing Fees and Transaction Costs
A
Finance
Debt
Equity
Bank loan
Bonds
Common stocks
Preferred stocks
Bond | $ 1,000,000
Term | 5 Years
Annual Interest Rate | 5%
Debt Issuance Fee | 1%
Issuance Fee
Legal and Accounting Fees
Underwriting Fees
Registration Fees
Or
Financing Fees
Debt Issuance Fee = $1,000,000 * 1% = $10,000
Y1 Y2 Y3 Y4 Y5
$ 1,000,000
0 0 0 0
Principal
Interest
Annual Interest Rate = $1,000,000 * 5% = $50,000
$50,000 $50,000 $50,000 $50,000 $50,000
Investors
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A
Y1 Y2 Y3 Y4 Y5
$ 1,000,000
0 0 0 0
Principal
Interest $50,000 $50,000 $50,000 $50,000 $50,000
Fee Amortization = Total issuance fee * ( outstanding principal amount as of current year / total years principal amount )
Fee Amortization Y1 = $10,000 * ( $1,000,000 / $5,000,000) = $2,000
Fee Amortization Y2 = $10,000 * ( $1,000,000 / $5,000,000) = $2,000
Fee Amortization $2,000 $2,000 $2,000 $2,000 $2,000
Total Interest $52,000 $52,000 $52,000 $52,000 $52,000
+ + + + +
Issuance Fee $8,000 $6,000 $4,000 $2,000 0
Investor
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A
Finance
Debt
Equity
Bank loan
Bonds
Common stocks
Preferred stocks
Gross proceeds | $ 5,000,000
Share Issuance Fee | 4%
Issuance Fee
Legal and Accounting Fees
Underwriting Fees
Registration Fees
Or
Financing Fees
= $5,000,000 * 4% = $200,000
Share capital
Investor
| $25,000,000 Cash Balance | $250,000
Net Proceeds = $5,000,000 - $200,000
= $4,800,000
Share capital | $29,800,000
+
+
Cash Balance | $5,050,000
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A
Cash Balance = $5,050.000 - $4,800,000 - $100,000
B
Acquisition
M&A Advisory Fees | $100,000
Acquisition Financing $4,800,000
= $150,000
Transaction cost
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Financing fees and transaction costs are incurred when companies undertake certain
transactions such as securing external financing or business combinations.
Financing Fees
Debt Issuance Costs Share Issue Costs
The accounting treatment differs depending on the nature of the cost.
Transaction Costs
Debt issuance costs are the costs incurred by a company when they raise new debt.
These costs are recognized initially on the balance sheet as a contra account under
liabilities, and then amortized over the term of the related debt liability.
Share issue costs are the costs incurred by a company when they issue shares to the
public. These costs directly reduce the proceeds a company receives from an equity
offering.
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Transaction costs are incurred by both acquirers and targets during the course of an M&A transaction.
Transaction costs represent services that have been rendered to and consumed by the
acquirer and are expensed as they are incurred.
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