Financial Reporting & Analysis

Question 1

Describe the roles of financial reporting and financial statement analysis;

Answer 1

1. Providing information:
   - Financial Position
   
   • Performance: profitability & cash flows
2. Evaluation:
   
   • To form expectations about a company’s future
     performance and financial position

Question 2

Describe the roles of the statement of financial position, statement of comprehensive income, statement of changes in equity, and statement of cash flows in
evaluating a company’s performance and financial position;

Answer 2

1. Providers of capital =
   Assets: resource controlled
   Liabilities: what is owed
   Equity: residual claim on assets / net assets, minority interest
2. P & L: revenue + other income - expenses - losses = N.I.
   Statement of Comprehensive income: All items that change owner’s equity except for TRNs w owners.
   P&L - FV changes from CF hedges - exchange differences.
3. Statement of CF: operating, financing, investing (inv. >3m)

Question 3

Describe the importance of financial statement notes and supplementary information—including
disclosures of accounting policies, methods, and estimates—and management’s commentary;

Answer 3

• MD & A: not audited, objectives, strategies, significant risks
• Notes: policies, methods, estimates
• Proxy statement: for shareholders

Question 4

Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls;

Answer 4

Audit: annual statements only, fair representation, express opinion, internal controls:
unqualified (preferred), qualified (except..), adverse, disclaimer (no data)
- Reasonable assurance the .. fairly represented
- Ensure the company’s process for generating financial reports is sound

Question 5

Identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary
information;

Answer 5

• Debt rating or bond issue by performing financial statement analysis.
• Be aware of accounting difference wrt choices
• Press releases: periodic earnings announcemnet

Question 6

Describe the steps in the financial statement analysis framework.

Answer 6

1. Purpose
2. Collect data
3. Process data
4. Analyze / interpret (ratios)
5. Communicate conclusions
6. Follow up (producing updating reports & recommendations)

Question 7

Describe how business activities are classified for financial reporting purposes;

Answer 7

1. Operating - day to day (interest income if bank)
2. Investing - CAPEX (NCA), debt sec (interest income if non-bank)
3. Financing - Debt/equity (NCL), buying back shares

Question 8

Explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements;

Answer 8

1. Assets (resources)
   liabilities (Creditor claims), paid by credit (aka trade payables)
   Equity: contributed capital + beg. retained earning + N.I. - dividends
2. Revenue, expenses

Question 9

Explain the accounting equation in its basic and expanded forms;

Answer 9

1. Statement of Retained Earnings:

beg RE + NI - DIV = ending R.E.

Question 10

Describe the process of recording business transactions using an accounting system based on the accounting equation;

Answer 10

Assets (prepaid expense, inventory, depreciation expense, unbilled rev, prepaid expense, marketable sec/equity instryments)
Liabilities (Accrued rev/expense, reserves)
GL: business TRN by account

Question 11

Describe the need for accruals and valuation adjustments in preparing financial statements;

Answer 11

Accruals: matching principle, receive revenue but not delivered service yet = liability unearned revenue

Question 12

Describe the relationships among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity;

Answer 12

IFRS: valuation adjustments = current market value & unrealized gains ->
Trading investments: P&L.
Available for sale: comprehensive income

Question 13

Describe the flow of information in an accounting system;

Answer 13

Contra account: allowance for bad debts, accumulated depreciation

Question 14

Describe the use of the results of the accounting process in security analysis.

Answer 14

• Analyst need to assess: reasonabless of managemen’s judgements and estimates
• Review for items of fictitious assets or liabilities that might be manipulating.

Question 15

Describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation;

Answer 15

• Provide financial information that is useful to existing/potential investors, creditors, in making decisions about providing resources.
• Requires policiy choices & estimates (standards)

Question 16

Describe roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting
standards, and describe the role of the International Organization of Securities Commissions;

Answer 16

1. Standard setting bodies = make the rules
   IASB, FASB
2. Regulatory Authorities = enforce the rules
   IOSCO
   => rules-based, principles-based, objectives approach
   SEC: forms 10-K & proxy statement
   IOSCO: assist in attaining the goal of uniform regulation and cross-border co-operation in combating violations of securities en derivatives laws.

Question 17

Describe the status of global convergence of accounting standards and ongoing barriers to developing one universally accepted set of financial reporting standards;

Answer 17

=> convergence of standards
=> IFRS: sets forth the concetps that underlie presentation/preparation of fin. st. for external users.
Fundamental characteristics: relevance, faithful representation.
Enhancing characteristics: comparability,timeliness, understandability, verifiability.
=> underlying assumptions: - going concern, - accrual basis.

Question 18

Describe general requirements for financial statements under International Financial Reporting Standards (IFRS);

Answer 18

1. Prepared at least annually
2. Must include comparative information
3. Classified balance sheet
   4.

Question 19

Identify characteristics of a coherent financial reporting framework and the barriers to creating such a framework;

Answer 19

1. Transparency
2. Comprehensiveness
3. Consistency

Constraints:

1. Benefit versus cost
2. Balancing of qualitative characteristics

Question 20

Analyze company disclosures of significant accounting policies.

Answer 20

Orderly disposal = realizable value

Question 21

Describe the components of the income statement and alternative presentation formats of that statement;

Answer 21

1. Multi step vs Single step: single step has all expenses listed as one.

Question 22

Describe general principles of revenue recognition and accrual accounting, specific revenue recognition applications (including accounting for long-term
contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis;

Answer 22

1. Delivery
2. Delivery before sale: % of completion if outcome is
   - probable (cost, sell price, and getting paid).
   - not probable: IFRS recognize rev up to cost vs GAAP recognize rev until completion
3. Delivery after sale:
   - Installment: IFRS PV of payments, GAAP % of total profit each year based on % received.
   - Cost of Recovery: no profit until costs recovered.

Question 23

Describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis;

Answer 23

1. FIFO
2. LIFO (GAAP only)
3. Avg Cost
   => doubtful accounts, warranties, depreciation (TA)/amortization(ITA)
   => IFRS Valuation: cost-depreciation, revaluation (FV)
   GAAP valuation: cost depreciation