why is BV not effected by items that bypass the income statement, instead flow through BS (i.e., foreign translation, pension, available for sale)? I assume its b/c items that bypass the IS flow to the BS regardless. If the p&l are recognized on the IS they hit the BS as retained earnings and if they bypass the IS they are reflected on the BS, just not as RE. Hence it has not effect on BV (A-L) are still the same, just the makeup of equity is different?
yes, that is right. If you look at unrealized g/l on AFS securities - these go directly to the Equity portion of the BS - (aka the OCI section). So Equity and hence Book value is thus a right number. But traditionally (like in a HFT security) - this should have first hit the Income statement and then flowed to the BS thro’ Retained Earnings. Now in the case of an AFS security - your Net Income would be understated (in case you had a profit on your AFS security) and would be overstated in case of a Loss (on your AFS security). Hence your use of NI (in the RI formula - RIt = NIt - r (BV(t-1)) would result in a wrong number. This thing about gains and losses not being reflected in the NI but moving directly to the Equity - is called as the violation of the “Clean Surplus relation”.
yes understand “clean surplus” but just wanted to confirm thought process on BV. one other question: but it relates to a question on the CFAI mock and I dont want to give a question away, however its not a direct question, more of a general q on consolidation. if you dont respond yes to this I will create another post but I want your input
you can send me an email… cpkrish123@gmail.com – I have not taken the mock yet… just wanted to let you know.
its a general Q anyways, not a specific question on exam. when you are consolidating, you add line by line on IS and BS. Lets say the company you acquired paid divs, is this considered an intercompany transaction? the parent would not report its share (if its 100% or 75% whatever it is) of the divs paid? If not is it b/c the parent would report its share of cash (which would be used to pay divs) so it would be double accounting?