# CIA.Accting

This paper is dense, hard to read, and appears on almost every exam. Luckily, the exam questions are repetetive. You need to understand how the 3 different classes of bonds are dealt with from an accounting standpoint. The 3 bond classes are: (HTM, AFS, HFT) = (Held to Maturity, Available for Sale, Held for Trading)   Forum

## Pop Quiz

If the discount rate used to calculate policy liabilities goes UP, what happens to the related actuarial liabilities on the B/S – up or down?

## BattlePlan

Based on past exams, the main things you need to know (in rough order of importance) are:

• bond values on B/S - how HTM, AFS, HFT bonds are carried on the balance sheet
• investment income using coupons and year-over-year changes in balance sheet values
• tainting of HTM bonds, consequences of tainting
• qualitative impact on bond values due to change in market rate
• calculate the impact on NI, OCI, Equity when market rates change (this is a difficult calculation problem)
reference part (a) part (b) part (c) part (d)
E (2018.Spring #13) bond values on B/S:
- HTM, AFS, HFT
chg in market rate:
- qualitative impact 4
E (2017.Fall #14) net income:
- calculate 1
define:
FV, HC 2
E (2017.Spring #12) NI, OCI, Equity:
- calculate impact
E (2016.Fall #13) investment income:
- calculate 3
bond values on B/S:
- HTM, AFS, HFT
OCI:
- calculate
chg in market rate:
- qualitative impact
E (2016.Spring #26) bond values on B/S:
- HTM, AFS, HFT
investment income:
- calculate 3
tainting of HTM:
- consequences
E (2015.Fall #14) NI, OCI, Equity:
- calculate impact
E (2015.Fall #27) bond values on B/S:
- HTM, AFS, HFT
tainting of HTM:
- consequences
chg in market rate:
- qualitative impact
E (2014.Fall #28) chg in market rate:
- qualitative impact
E (2013.Fall #25) investment income:
- calculate 3
bond values on B/S:
- HTM, AFS, HFT
OCI:
- calculate
chg in market rate:
- qualitative impact
E (2012.Fall #25) chg in market rate:
- asset impact
chg in market rate:
- liability impact
chg in market rate:
- I/S impact
chg in market rate:
- OCI impact
1 Part of a larger problem involving APV(claim liabilities) and financial statements. (See also CIA.MfAD, CCIR.ARinstr)
2 FV = Fair Value, HC = Historical Cost
3 These problems on investment income have caused a tremendous amount of confusion because the source reading does not properly explain how to solve them. They are discussed in detail in this wiki article.
4 The answer to part (b.ii) of #13 in the examiner's report is wrong. See this forum thread for an explanation.

## In Plain English!

 Source Readings: BattleActs covers all material from past exams. It also covers significant material that has not appeared on past exams but that I've judged to be important. Still, it's a good idea to spend at least little time reviewing the source readings. You may have a different opinion on what's important and what you can skip. You cannot read all 2,500 pages in depth, but BattleActs give you the necessary background knowledge so that the time you do spend on the source readings will be much more efficient.

### Section 1,2: Intro & Background

This paper covers CIA standards 3855 & 1530 – basically when to recognize assets on the B/S, and for what amount. Consider this chain of reasoning:

→ The value of B/S assets affects the calculated investment return...
→ ...the investment return affects the selected discount rate...
→ ...the discount rate affects the PV of the policy liabilities.

Why is this such a big deal in Canada? (versus the U.S.)

Answer: Because in Canada, policy liabilities are discounted. (So a change in how assets are valued affects the calculation of liabilities that appear on the B/S.)

The foundational knowledge for this paper is the 3 different bond types. See (2016.Fall #13b), (2016.Spring #26a)

abbreviation full name valuation on B/S
HTM Held to Maturity AV (Amortized Value)
AFS Available for Sale FV or MV (Fair Value or Market Value)
HFT Held for Trading FV (Fair Value)

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### Section 3: Implications for Actuaries

#### Qualitative Effect of Market Rate Changes

• There are 6 tables from Section 3 that you absolutely, positively HAVE TO UNDERSTAND!!! But I don't like the way these tables are laid out, so I created my own tables (see below). A typical exam question might be as follows:
 If market rates go up (or down), what effect does a HTM bond have on the NI, OCI, Equity. (NI = Net Income, OCI = Other Comprehensive Income)
• This is the easiest case because HTM bonds have no effect on NI, OCI, Equity. If you're asked about AFS or HFT bonds, you have to do a little more work to come up with the answer. That's were these tables come in. The answer to the question above can be found in the first 2 rows of this table. ("--" means "no effect")
 market rate bond type A + L NI OCI Equity up HTM -- -- -- down HTM -- -- -- up AFS up down depends down AFS down up depends up HFT depends -- depends down HFT depends -- depends
• If the question had asked about AFS or HFT bonds, then just find the appropriate row in the table and read across to see the effect on NI, OCI, Equity. Of course, this isn't enough - you must also be able to explain the reasoning behind these entries. (Note that the column for A + L or Assets + Liabilities is intentionally blank. You could insert the appropriate entries, but they aren't relevant to the reasoning.)
• To explain the reasoning behind the above table, we need 2 more similar tables, 1 for the effect that Assets have on the balance sheet items, and 1 for the effect of the Liabilities:
 market rate bond type Assets NI OCI Equity up HTM -- -- -- down HTM -- -- -- up AFS down -- down down down AFS up -- up up up HFT down down -- down down HFT up up -- up
 market rate bond type Liabilities NI OCI Equity up HTM -- -- -- down HTM -- -- -- up AFS down up -- up down AFS up down -- down up HFT down up -- up down HFT up down -- down
• Let's use the tables to answer this question:
 If market rates go up , what effect does an AFS bond have on the NI, OCI, Equity.
• Locate the up/AFS row in the Asset table and observe that (NI, OCI, Equity) = (--, down, down)
• Locate the up/AFS row in the Liability table and observe that (NI, OCI, Equity) = (up, --, up)
 Then "sum" these vectors to get (up, down, depends).
• (Note that down + up = depends because we don't know the relative magnitude of the down and the up.)
• You don't have to memorize these tables.
• The way to learn this is to practice thinking through the reasoning behind each row in the Asset and Liability tables. It isn't hard, but during the exam, it's easy to get ups and downs confused if you're rushing. Remember, as the Brits do: Keep calm and carry on...
• See (2016.Fall #13d) for a classic example of this type of question.
• Here are few points to keep in mind:
1. The HTM rows are easy because these bonds are not affected by changes in market rates.
2. Market rates & discount rates always move in the same direction.
3. If market rates go up then asset & liability values go down (and vice versa.)
4. Only AFS Assets affect OCI (Other Comprehensive Income).
 Note that in the mini BattleQuiz below, some of the BattleCards are actually old exam questions. Click E in the left-hand column to open a PDF with the full exam question and answer.

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#### Calculating NI & OCI

There are 3 old exam problems that have caused much confusion:

E (2016.Fall #13)provides only current year bond values

E (2016.Spring #26)provides current and prior year bond values

E (2013.Fall #25)provides only current year bond values

In these problems, you're given information about HTM, AFS, and HFT bonds and are asked to calculate:

• NI (Net Income)
• OCI (Other Comprehensive Income)

The reasons for confusion are:

• The questions are asked in slightly different ways.
• The information is provided in different ways: 2016.Spring gives current and prior year-end bond values but 2016.Fall and 2013.Fall provide only current year-end values.
• The formulas required for the calculations are not clearly presented in the source paper.

Let's see if we can sort this out...

##### 2016.Spring #26b

Use the following abbreviations for the year-end values in the tables:

AV: Amortized Value
MV: Market Value
FV: Fair Value (used interchangeably with Market Value)

Given: (In this problem, we aren't given the inception date of the company, but it's obviously been around for at least 2 years.)

 Bond Classification AV (2014) MV or FV (2014) Coupon (2015) AV (2015) MV or FV (2015) AAA HTM 2,000 2,100 50 2,000 2,200 BBB AFS 1,000 900 100 900 950 CCC HFT 1,500 1,600 75 1,400 1,300

Calculate: NI (Net Income) and OCI (Other Comprehensive Income). Note that we're given current and prior year-end bond values.

We'll calculate NI & OCI separately for each bond. Start with NI:
• NI(HTM) = chg(AV) + (dividends, coupons) = (2,000 - 2,000) + 50 = 50
• NI(AFS) = chg(AV) + (dividends, coupons) = (900 - 1,000) + 100 = 0
• NI(HFT) = chg(MV) + (dividends, coupons) = (1,300 - 1,600) + 75 = -225
Then add them up to get NI = -175
For OCI:
• OCI(HTM) = 0 always
• OCI(AFS) = chg(MV-AV) year-over-year = (950 - 900) - (900-1000) = 150
• OCI(HFT) = 0 always
Then add them up to get OCI = 150

That seems pretty easy. You would think 2016.Fall and 2013.Fall could be solved the same way, but in those problems, the data is provided in a different way and you can't use the same formulas. (User passexam6c asked in the forum why OCI for HTM is always 0. Their question and my answer can be found here.)

##### 2016.Fall #13ac

Given: (Here we are given the inception date, Jan 1, 2016, so we have only current year data to work with)

 Asset Classification Coupon (2016) AV (2016) MV or FV (2016) AAA Bond HFT 50 4,000 3,800 BBB Bond AFS 175 2,500 3,000 CCC Bond HTM 200 7,000 6,500

Calculate: Total net investment income shown in the 2016 income statement. (OCI is asked in part c.) Note that we're given only current year bond values.

• The first bit of silliness in this problem is that they listed the bonds in a different order as compared to the way they're normally listed. (They usually put HTM first, then AFS, then HFT.) It definitely feels like the examiner's were trying to trick us by doing that. So pay attention!
• Another minor point is that they changed the wording of the question versus 2016.Spring. They ask for the total net investment income, but this is just NI (from investment income.)
• The big difference is the given information: Here you're given year-end values of the bonds for only 1 year. But the formulas used for 2016.Fall require current & prior year values.
Anyway, let's go ahead with part (a), calculate NI, using the method in the examiner's report: (OCI is asked in part d)
• NI(HTM) = value of coupon = 200
• NI(AFS) = value of coupon = 175
• NI(HFT) = value of coupon + [(MV - AV) for (HFT bonds)] = 50 + (3,800 - 4,000) = -150
Then add them up to get NI = 225
The inclusion of the coupons is the same as for 2016.Fall, and indeed it's obvious the coupons should be included in NI (the coupons represent realized gains.) But the HFT calculation has an extra term, highlighted above in red.
• In the forum, several people have made contributions to resolving this confusion (mdattilo, passexam6c, jkhmonkey, chrisboersma, genevievie) And Javid wrapped it all up nicely. Click Javid's post. (You might have to scroll up.) But it all comes down to a missing piece of information:
 Missing piece of information: In the 2 versions of this problem where you're given only current year values, the question did not mention that the bonds are priced at par. This is a critical piece of information because the formula for NI will look slightly different, as explained above. The reason is provided in Javid's post. (You might have to scroll up.)
• jkhmoneky had originally noticed that the 2016.Fall and 2013.Fall were similar problems.
Part (c) of this problem asks you to calculate OCI. Again, you cannot use the method of 2016.Spring because you are only given the current year's data. According to the examiner's report:
• OCI(HTM) = 0 (always)
• OCI(AFS) = [(MV - AV) for (AFS bonds)] = 3,000 - 2,500 = 500
• OCI(HFT) = 0 (always)
Then add them up to get OCI = 500
##### 2013.Fall #25ac

This is just like 2016.Fall. Give it a try! (You might also want to reproduce the above solutions to make sure you understand them. Links are provided in mini BattleQuiz below.)

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##### Final Comment

Learn how to do each of these problems. Then if you get a problem like either of these on your exam, just use the method that's most appropriate for the way the information is given.

### Section 4: Details of Standards 3855 & 1530

• This section is incredibly detailed, and my suggestion is to not spend much time on it aside from one of the CAS's favorite exam questions. (2016.Fall #13b), (2016.Spring #26a), but these were covered in the mini BattleQuiz for Sections 1 & 2. (It seemed to make more sense to put those very easy concepts at the beginning.)
• If you feel like it, here are a few questions from Section 4. They're pretty easy. The remaining details are available in the Custom Battles section of the BattlePlan in the main part of the BattleActs site, but my candid advice is that you basically skip it. The questions on this paper (and the whole 6C exam for that matter) are repetitive, so you should focus almost exclusively on what's been asked before.

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### New(ish) Calculation Problem

#### Quantitative Effect of Market Rate Changes

• Questions (2017.Spring #12) & (2015.Fall #14) were very difficult calculation problems on this topic. (I think it was an unfair question because there was nothing in the paper to prepare you for it.) It is the quantitative version of the qualitative problem discussed above in Section 3. In Section 3, you only had to say whether (NI, OCI, Equity) went up or down; here, you have to calculate the amount by which those quantities go up or down. This question type is actually a combination of an MfAD problem and an accounting problem.
• You should already know how to calculate APV(claims liabilities) from the MfAD paper, but you also need to know a couple of accounting formulas:
• chg(NI) = chg(PV(FVO)) - chg(APV(liabilities))
• chg(OCI) = chg(PV(AFS))
• chg(Eq) = chg(NI) + chg(OCI)
• The mini BattleQuiz has a very easy version of this problem type. References are also provided to the hard version that has appeared twice on old exams. Additionally, I've provided PDFs with more examples of the hard version. I recommend looking at the PDFs before looking at the examiner's reports. I found the examiner's reports to be confusing, so I reorganized the solution in a way that personally helped me understand better what was going on.

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Accounting Practice 1: Calculating Change in Equity This is 10 pages long.

Accounting Practice 2: Calculating Change in Equity This is 10 pages long.

### Reference to Old Exam Qs

• There are 4 types of calculation problems that are commonly asked from this paper:
1. How are the different bond types valued on the B/S?
2. What is the qualitative effect of a change in market rates related to each bond type?
3. How to calculate NI and OCI given amortized or market values, and coupons for different bond types?
4. What is the quantitative effect of a change in market rates related to each bond type?
• Each was covered above. The final mini BattleQuiz is a mixture of problems from old exams. You will need to have either printed or electronic copies of old examiner's reports handy because the given information was too detailed to easily fit into a BattleCard.

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## BattleCodes

• Memorize:
• What are the 3 different types of bonds?
• How can HTM bonds be tainted and what are the consequences of tainting.
• A few less important facts (covered in the BattleQuizzes)
• Conceptual:
• The 3 different bond types have different impacts on the balance sheet and income statement. That means that the CFO should give careful thought to the types of bonds she or he buys. (You can think of this as a legal form of financial statement manipulation!)
• Calculational:
1. How are the different bond types valued on the B/S?
2. What is the qualitative effect of a change in market rates related to each bond type?
3. How to calculate NI and OCI given amortized or market values, and coupons for different bond types?
4. What is the quantitative effect of a change in market rates related to each bond type?
• Expect 2-3 pts from this paper on the exam

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## POP QUIZ ANSWERS

• discount rate UP → actuarial liabilities DOWN
• Reason: because the discounted liabilities, or PV(actuarial liabilities), is obtained by dividing the undiscounted liabilities by (1+ discount_rate)^t