Ac3102 Risk Reporting and Analysis Bible

Seminar 1

Risk

• Uncertainty
• E.g. chance that an investment’s actual return will differ from its expected return /

possibility of losing some or all of the original investment

• Exposure: firm has to manage a risk only if it is exposed to the uncertainty

Risk Management (≠ Elimination)

1. Avoidance: attempt to avoid the risk by carefully circumscribing its activities
2. Acceptance: accepting the rick as an inevitable, unavoidable result of business decisions
3. Sharing: transferring, at a cost, all or part of the risk to another party, e.g. partnership, outsourcing, joint-venture
4. Reduction: attempt to reduce the risk by designing and implementing proactive policies, procedures and processes, considered the best method

• Systematic (market) risk vs unsystematic (firm-specific / diversifiable) risk
• Risk tolerance: maximum level of risk that an investor is willing to tolerate for each specific risk / objective
• Risk capacity: amount of risk that an investor “must” take in order to reach financial goals
• Note: High risk -> high returns, but NO risk -> low returns (rf)

Risk Analysis

• 2 factors

1. Probability (likelihood of occurrence)
2. Impact / effect (magnitude of consequence, e.g. monetary losses)

[pic 3][pic 4]

Risk Reporting

• Qualitative disclosures

• Risk exposure

• Risk management policy

• Quantitative disclosures

• VaR (value-at-risk)
• Sensitivity analysis
• Others

Business Combinations

• Unsystematic risk (e.g. business cyclical risk) may be reduced through diversification
• One of the main reasons for business combinations is to manage unsystematic risks
• Types

1. Merger: when 2 firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated; aka “merger of equals”

• Horizontal, vertical, market-extension, product-extension, conglomeration

1. Acquisition: when one company purchases and takes over another, and clearly established itself as the new owner

• Target company ceases to exists legally while buyer’s shares continue to be traded
• May involved the purchase of the target company’s assets & / or liabilities

and equity / shares (focus)

• Reverse merger is a form of acquisition where a small private company with strong prospects is eager to raises financing buys a publicly-listed larger shell company, usually one with no business and limited assets, aka backdoor listing (e.g. Capital City acquiring Terratech Group)

Consolidated Financial Statements (CFS)

• A business combination is “a transaction...in which an acquirer obtains control of one or

more businesses” (FRS 103 App A)

• Accounted using acquisition method (FRs 103.4)
• Each separate legal entity (e.g. parent and subsidiary) in a business combination will have to prepare their own set of financial statements
• Parent also has to prepare and present consolidated financial statements

Control

Parent: controls one or more entities (FRS 110 App A)

• FRS 110.7: An investor (P) controls an investee (S) if & only if the investor has

1. Power over the investee (e.g. decide financial (bonds / shares) and operating (workweek) policies),
2. Exposure to variable returns of the investee, and
3. Ability to use power to affect the investee’s returns (e.g. change strategies to diversity product line)

• Assume if A holds > 50% of voting shares in B, then A has control over B

Exemption from Presenting CFS

• FRS 110.4(a): P need not present CFS if

• P is a wholly-owned S, or partially-owned S and its other owners do not object,

[pic 5]

or

[pic 6]

• P’s debt / equity instruments are not traded in a domestic / foreign exchange
• P is not in process of being listed, and
• P’s ultimate / intermediate parent produces CFS available for public use.

• Note that the exemption can only apply to intermediate parents!
• IFRS 10.4(a) further requires in 4th criteria that P’s ultimate / intermediate parent produces CFS that comply with IFRSs, i.e. if the A is a U.S. company and comply with GAAP instead, B cannot be exempted from presenting CFS

Seminar 2

Combination of Accounts

• Single entity concept

1. Add across same accounts of P & S
2. Eliminate P’s “Investment in S” account

• Adding together P’s & S’s assets & liabilities line-by-line and P’s “Investment in S”

account will double-count S’s net assets

• Need to eliminate P’s “Investment in S” account against S’s pre-acquisition share capital & retained earnings
• These items arose prior to P obtaining control over S (i.e. representing S’s net assets

at the point of acquisition by P)

Fair Value Adjustments (FVA)

• Recognition principle: To recognize, separately from goodwill, S’s identifiable (recognized / unrecognized) acquired assets & assumed liabilities, & NCI (FRS 103.10)
• Measurement principle: To measure S’s assets & liabilities at “acquisition-date fair value” (FRS 103.18)

• *Only for S! Take P’s book value (BV) even if P has not revalued its own

assets/liabilities

...