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CFA > Book 2: Chapter 16 > Flashcards

Book 2: Chapter 16 Flashcards

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CFA flashcards
1
Q

What is financial reporting?

A

It’s the way companies show their financial performance to investors, creditors and other interested parties by preparing and presenting financial statements

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2
Q

What is the role of financial statement analysis?

A

To use the information in a company’s financial statements, along with other relevant information, to make economic decisions (eg whether to invest in the company’s securities or recommend them to investors, whether to extend trade or bank credit to the company)

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3
Q

What do analysts use financial statement data for?

A

To evaluate a company’s past performance and current financial position in order to form options about the company’s ability to earn profits and generate cash flow in future

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4
Q

What is the role of the statement of financial condition/statement of financial position/balance sheet?

A

To report the firm’s financial position at a point in time

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5
Q

What does the balance sheet consist of?

A

Assets, liabilities and owners’ equity (=shareholders’ equity, shareholders’ funds/net assets)

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6
Q

Define assets on a balance sheet

A

The resources controlled by the firm

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7
Q

Define liabilities on a balance sheet

A

Amounts owed to lenders and other creditors

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8
Q

Define owners’ equity on a balance sheet

A

The residual interest in the net assets of an entity that remains after deducting its liabilities from its assets

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9
Q

What is the fundamental accounting equation that must hold in a balance sheet

A

Assets = liabilities + owners’ equity

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10
Q

Define the capital structure of a company

A

The proportions of liabilities and equity used to finance a company

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11
Q

What is the role of the income statement/statement of comprehensive income/statement of operations/profit and loss statement?

A

This reports all changes in equity other than shareholder transactions (eg issuing stock/repurchasing stock/paying dividends) and reports on the financial performance of the firm over a period of time

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12
Q

Which elements make up the income statement?

A

Revenues, expenses, gains and losses

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13
Q

Define revenues

A

Inflows from delivering or producing goods, rendering services or other activities that constitute the entity’s ongoing major or central operations

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14
Q

Define expenses

A

Outflows from delivering or producing goods or services that constitute the entity’s ongoing major or central operations

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15
Q

Define other income on the income statement

A

This includes gains that may or may not arise in the ordinary course of business

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16
Q

What do you get when you combine the income statement with “other comprehensive income”

A

A single statement of comprehensive income, alternatively the two can be presented separately

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17
Q

Define the statement of changes in equity

A

This reports the amounts and sources of changes in equity investors’ investment in the firm over a period of time

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18
Q

Define the statement of cash flows

A

This reports the company’s cash receipts and payments

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19
Q

Which cash flows are in the statement of cash flows?

A

Operating cash flows, investing cash flows and financing cash flows

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20
Q

Define operating cash flows

A

These include the cash effects of transactions that involve the normal business of the firm

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21
Q

Define investing cash flows

A

The cash flows resulting from the acquisition or sale of property, plant and equipment, of a subsidiary or segment, or securities, and of investments in other firms

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22
Q

Define financing cash flows

A

Those resulting from issuance or retirement of the firm’s debt and equity securities and include dividends paid to stockholders

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23
Q

What are footnotes?

A

Financial statement notes, they include disclosures that provide further details about the information summarised in financial statements

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24
Q

What do footnotes achieve?

A

They allow users to improve their assessments of the amount, timing and uncertainty of the estimates reported in the financial statements

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25
Q

What 3 roles do footnotes perform?

A

1) discuss the basis of presentation (eg fiscal period covered by the statements and the inclusion of consolidated entities)
2) provide info about accounting methods, assumptions and estimates used by management
3) provide additional info (eg on business acquisitions, disposals, legal actions, employee benefit plans, contingencies and commitments, significant customers, sales related to parties, issuance of stock options and segments of the firm)

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26
Q

What is management’s commentary also known as?

A

Management’s report, operating and financial review, management’s discussion and analysis (MD&A)
This is one of the most useful sections of the annual report!

27
Q

What does IFRS guidance recommend that’s included in the MD&A?

A

The nature of the business, management’s objectives, the company;’s past performance, the performance measures used, the company’s key relationships, resources and risks

28
Q

Are all parts of the MD&A section audited?

A

No, some may not be

29
Q

What does the SEC require that the MD&A section covers?

A

Trends
Identify significant events and uncertainties that effect the firm’s liquidity, K resources, and results of operations
Effects of inflation and changing prices if material
Impact of off-balance sheet obligations and contractual obligations such as purchase commitments
Accounting policies that require significant judgement by management
Forward-looking expenditures or divestitures

30
Q

What is an audit?

A

An independent review of an entity’s financial statements

31
Q

What do public accountants do?

A

They conduct audits and examine the financial reports and supporting records

32
Q

What is the objective of an audit?

A

To enable the auditor to provide an opinion on the fairness and reliability of financial statements

33
Q

Who is responsible for ensuring that the company’s financial statements conform to the applicable accounting standards?

A

The independent certified public accounting firm employed by the board of directors

34
Q

What does the auditor look into?

A

The company’s accounting and internal control systems, confirms assets and liabilities, generally tried to determine that there are no material errors in the financial statements

35
Q

What does the standard’s auditor’s opinion contain?

A

1) the auditor has performed an independent review
2) generally accepted auditing standards were followed, so providing reasonable assurance that the financial statements contain no material errors
3) the auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable
* plus an additional explanation when accounting methods have not been used consistently between periods

36
Q

What is an unqualified/unmodified/clean opinion?

A

This indicates that the auditor believes the statements are free from material omissions and errors

37
Q

What is a qualified opinion?

A

If the statements make any exceptions to the accounting principles. The auditor will explain these exceptions in the audit report

38
Q

What is an adverse opinion?

A

It’s expressed when the statements are not presented fairly or are materially non conforming with accounting standards

39
Q

When is a disclaimer of opinion issued by the auditor?

A

When they’re unable to express an opinion (eg in the case of a scope limitation)

40
Q

What is an opinion other than an unqualified opinion sometimes referred to as?

A

A modified opinion

41
Q

When will the auditor also include an explanatory paragraph?

A

When a material loss is probable but the amount cant be reasonably estimated

42
Q

What kind of things can the uncertainties expressed in the auditor’s explanatory paragraph relate to?

A

1) the “going concern assumption” (the assumption that the firm will continue to operate for the foreseeable future)
2) the valuation or realisation of assets
3) litigation

43
Q

What might the explanatory paragraph made by the auditor signal?

A

Serious problems, this might call for close examination by the analyst

44
Q

What are internal controls?

A

The processes by which the company ensures that it presents accurate financial statements

45
Q

Who is responsible for internal controls?

A

Management of the company

46
Q

True or false; for public ally traded firms in the US the auditor must express an opinion on the firm’s internal controls?

A

True

47
Q

Where can the auditor provide their opinion on the firm’s internal controls?

A

Separately or as the fourth element of the standard opinion

48
Q

What is in the “Key Audit Matters” (international reports) or “Critical Audit Matters” (US) section in the audit report?

A

Accounting choices that are of greatest significance to users of financial statements. Including accounting choices that require significant management judgements and estimates, how significant transactions during a period were accounted for, or choices the auditor finds especially challenging or subjective and which therefore have a significant likelihood of being misstated

49
Q

Other than annual financial statements, what else should an analyst examine?

A

A company’s quarterly or semiannual reports

50
Q

What do quarterly and semiannual reports typically update?

A

The major financial statements and footnotes but they’re not necessarily audited

51
Q

Where are SEC (Securities and Exchange Commission) filings available from?

A

EDGAR (electronic data gathering, analysis and retrieval system)

52
Q

What do SEC filings include?

A

Form 8-K, Form 10-K and Form 10-Q

53
Q

What is a form 8-K?

A

What a company must fiel to report events like acquisitions, disposals of major assets, changes in management or changes in corporate governance

54
Q

What is a Form 10-K?

A

A company’s annual financial statements

55
Q

What is a Form 10-Q?

A

A company’s quarterly financial statements

56
Q

What are proxy statements?

A

Statements issued to shareholders when there are matters that require a shareholder vote, they’re also filed with the SEC and available from EDGAR

57
Q

Proxy statements can be a good source of information about what?

A

The election of (and qualifications of) board members, compensation, management qualifications and the issue of stock options

58
Q

Who writes corporate reports and press releases?

A

Management

59
Q

What are corporate reports and press releases often viewed as?

A

Public relations or sales materials

60
Q

True or false, all of the material in a corporate report/press release is independently reviewed by outside auditors?

A

False- not all of it

61
Q

Where can you often find corporate reports/press releases?

A

The company website

62
Q

What do firms often provide before the financial statements are released?

A

Earnings guidance, once an earnings announcement is made a conference call may be held whereby senior management is available to answer questions

63
Q

Where can you find information about economic conditions, the company’s industry and its competitors?

A

Trade journals, statistical reporting services and government agencies

64
Q

Describe the 6 steps in the financial statement analysis framework

A

1) state the objective and context- determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time is available to perform the analysis
2) gather data- acquire the company’s financial statements and other relevant data on its industry and the economy, ask questions to management, suppliers and customers and visit company sites
3) process the data- make appropriate adjustments to the financial statements, calculate ratios, prepare exhibits such as graphs and common-size balance sheets
4) analyse and interpret the data- use the data to answer the questions in step 1, decide what conclusions or recommendations the information supports
5) report the conclusions or recommendations- prepare a report and communicate it to its intended audience, ensure this report and its dissemination comply with the code and standards that relate to investment analysis and recommendations
6) update the analysis- repeat these steps periodically and change the conclusions or recommendations when necessary

CFA (3 decks)

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