SS. 11. Reading 33 . BB example 13. Q.2B
1)The second year adjusted NI (including OCI) should be 2.48+1, hence increasing the RI to be 2.44.
However, their solution has a lowered RI viz. 0.45. what am I missing?
(In the solution it is same as without adjustment)
I agree with you partly on 1). Maybe you have a type there, but the 2nd year adjust NI (including OC) should be:
RI = (NI + OCI) − (SE_t_–1 × r)=2.45
I agree regarding 2): The computation of equity should be adjusted because it is not correctly computed, each period we should add Comprehensive Income to equity ( recalling Comprehensive Income= Net Income+ Other Comprehensive Income ), but here we are subtracting OCI instead.
Haha thanks for affirming on it. But this example is shaking a lesser mortal’s foundation. What should I do in exam. (Is this example in errata…)
No problem, this is actually not in errata. I can write CFAI an e-mail to ask whether this is a mistake, but maybe there is someone in the forum who can also confirm that this is indeed a mistake and we are not missing something here. I am not 100% confident in my FRA knowledge.
Its correct. The reason why its minus is to reduce V0 from 2.A equal to V0 from 1.
Exhibit 12 says “less OCI” also.
Ok, I see that by deducting OCI we reduce V0 to match V0 but the formula says to add OCI not deduct OCI.
Are you saying we just have to either add OCI or deduct OCI depending on how the V0 from DDM looks like?
I guess. Any adjustments from OCI could be + or -.
note 22 says, See Lundholm and O’Keefe (2001a and 2001b), who show how RI model and DDM valuations will differ when the analyst fails to include OCI in residual income calculations or makes inconsistent assumptions about the growth rates of net income, dividends, and residual income.
hmm, I see. Thanks for pointing that out.
I will keep my eyes open for similar questions, maybe it will come up again and then we can compare.
RI is based on clean surplus accounting assumption. So any discrepancy is due to OCI.
OCI could be anything. It could be any loss/gain reclassification so + or - depends on info given.
Oh yeah, of course, I did not think of the fact that all. OCI can include loss/gain and thus we cannot say always add or deduct.
Now it makes sense. Thank you so much clarifying that!!
In all of these cases in which items bypass the income statement, the book value of equity is stated accurately because it includes “accumulated other comprehensive income,” but net income is not stated properly from the perspective of residual income valuation.
Preach it, brother!
Got it!! Thank you sp much.
But in this example (AFAIK) they haven’t clarified on what the OCI item is, so one thinks of adding by default.