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CFA: Level 1 > Financial Reporting and Analysis: Introduction > Flashcards

Financial Reporting and Analysis: Introduction Flashcards

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1
Q

Financial Statement Analysis: IASB Role of Financial Statement Analysis

A

“The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing an potential investors, lenders, and other creditors in make decisions about providing resources to the entity.

Those decisions involve buying, selling or holding equity and debt instruments, and providing or settline loans and other forms of credit.”

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2
Q

Financial Statement Analysis: Role of Financial Statement Analysis

A
  • Using the information in a company’s financial statements, along with other relevant information to make economic decisions
    • (e.g., evaluate securities, acquisitions, creditworthiness)
  • To evaluate a company’s past performance and current financial posiition in order to form opinions about a firm’s ability to earn profits and generate cash flow in the future.
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3
Q

Financial Statement Analysis: Key Financial Statements: Income Statement

A

Income Statement (statement of operations or the profit and loss statement)

Summarizes events over a period:

  • Revenues are inflows from delivering or producing good, rendering services, or ther activities that constitute the entity’s ongoing makor or central operations
  • Expenses are outflows from delivering or producing goods or services that constitute the entity’s ongoing major or central operations
  • Other income includes gains and losses which may or may not arise in ordinary course of business
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4
Q

Financial Statement Analysis: Key Financial Statements: Statement of Comprehensive Income & Balance Sheet

A
  • Statement of comprehensive income reports all changes in equity except for shareholder transactions
  • Balance sheet- a point in time
    • Assets = liabilities + owners’ equity
    • Assets are the resources controlled by the firm
    • Liabilities are amound owed to lender and other creditors
    • Owners’ equity is the residual interest in the net assets of an entity that remains after deduciting its liabilities
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5
Q

Financial Statement Analysis: Cash flow statement & Statement of Changes in Owners’ Equity

A
  • Cash flow statement reconciles beginning and ending cash balance, splitting changes into three categories:
    • Operating cash flows (CFO)
    • Investing cash flows (CFI)
    • Financing cash flows (CFF)
  • Statement of changes in owners’ equity–

amounts and sources of changes in shareholders’ equity over the period

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6
Q

Financial Statement Analysis: Footnotes and Supplementary Schedules

A
  1. Basis of presentation
  2. Accounting methods and assumptions
  3. Further information on amounts in primary statements
  4. Business acquisitions/disposals
  5. Contigencies
  6. Legal proceedings
  7. Stock option and benefit plans
  8. Significant customers
  9. Segment data
  10. Quarterly data
  11. Related-party transactions
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7
Q

Financial Statement Analysis: Management Discussion and Analysis

A
  1. Nature of the business
  2. Results from operations, business overview
  3. Trends in sales and expenses
  4. Capital resources and liquidity
  5. Cash flow trends
  6. Discussion of critical accounting choices
  7. Effects of inflation, price chanegs, and uncertainties on future results
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8
Q

Financial Statement Analysis: Audits

A
  • Audit: Independent review of company’s financial statements
  • Reasonable assurance that financial stataments are free of material errors
  • Audit opinion:
    • Unqualified:“Clean” opinion
    • Qualified: Exceptios to accounting principles
    • Adverse: Statements not presented fairly
    • Disclaimer of opinion: Unable to form an opinion
  • Must provide opinion on company’s internal controls under U.S. GAAP
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9
Q

Financial Statement Analysis: Audit Report

A
  1. Responsibility of management to prepare accounts (independence of auditors)
  2. Properly prepared in accourdance with relevant GAAP (reasonable assurance that the statements are free from material misstatement
  3. Accountin principles and estimates chosen are reasonable
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10
Q

Financial Statement Analysis: Supplementary Sources of Information

A
  1. Quarterly, semi-annual reports: Updates of major financial statements and footnotes; SEC filings
  2. Proxy statements: Issued when shareholder vote is required; contain information on board elections, management compensation, stock options
  3. Corporate reports, press releases written by management
  4. Economic, industry data from trade journals, reporting services, government agencies
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11
Q

Financial Statement Analysis: Framework

A
  1. Purpose and context of analysis
  2. Collect data
  3. Process data
  4. Analyze/interpret data
  5. Conclusions and recommendations
  6. Update analysis periodically
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12
Q

Financial Statement Analysis: Financial Statements - Problem

A
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13
Q

Financial Reporting Mechanics: Common Asset Accounts

A
  1. Cash and cash equivalents
  2. Accounts receivable, trade receivables
  3. Prepaid expenses
  4. Inventory
  5. Property, plant, and equipment (PP&E)
  6. Investment property
  7. Intangibles
  8. Financial assets (investment securities)
  9. Investments under the equity method
  10. Deferred tax assets
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14
Q

Financial Reporting Mechanics: Common Liability Accounts

A
  1. Accounts payable, trade payables
  2. Provisions/accrued liabilities
  3. Financial liabilities
  4. Current and deferred tax
  5. Unearned revenue
  6. Debt payable
  7. Bonds
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15
Q

Financial Reporting Mechanics: Common Equity Accounts

A
  1. Capital at par value
  2. Additional paid-in capital
  3. Retained earnings
  4. Other comprehensive income
  5. Noncontrolling (minority) interest
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16
Q

Financial Reporting Mechanics: Common Income Statement Items

A
  1. Revenue
    1. Sales
    2. Gains
    3. Investment income
  2. Expenese
    1. Cost of goods sold
    2. SG&A (selling, general, and admin
    3. Depreciation/amortization
    4. Interest
    5. Tax expense
    6. Losses
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17
Q

Financial Reporting Mechanics: Accounting Equations

A
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18
Q

Financial Reporting Mechanics: Accounting for Transactions: Pay a bill & Sell a bond (borrow money)

A

E = A - L

  • Pay a bill
    • Assets “cash” goes down
    • Liability “trade payables” goes down
    • Equity is unchanged
  • Sell a bond (borrow money)
    • Assets “cash” goes up by the proceeds
    • Liability “bonds payable goes up by the proceeds
    • Equity is unchanged
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19
Q

Financial Reporting Mechanics: Accounting for Transactions: Make a Credit sale

A
20
Q

Financial Reporting Mechanics: Accounting for Transactions: Buy materials on credit & Issue Stock

A

E = A - L

  • Buy materials on credit
    • Assets “inventory” increases
    • Liabilitiy “accounts payable” increases
    • Equity is unchanged
  • Issue stock
    • Asset “cash” goes up
    • Liabilities unchanged
    • Equity “common stock” increases
21
Q

Financial Reporting Mechanics: Accounting for Transactions: Incur an expense & Pay a liability

A

E = A - L

  • Incur and expense
    • Liabilitiy increases
    • Assets unchanges
    • Equity “retained earnings” decreases
  • Pay a liability
    • Asset “cash” goes down
    • Liability goes down
    • Equity unchanged
22
Q

Financial Reporting Mechanics: Declare/Pay a dividend

A

E = A - L

  • Declare dividend
    • Liability “dividends payable” increases
    • Assets unchanged
    • Equity “retained earnings” decreases
  • Pay dividend
    • Asset “cash” goes down
    • Liability “dividends payable” goes down
    • Equity unchanged
23
Q

Financial Reporting Mechanics: Accruals & Valuation Adjustments

A

Assets

  1. Bad/doubtful debts
  2. Prepaid expenses
  3. Unbilled (accrued) revenue
  4. Impairments/writedownd
  5. Mark-to-market investments
  • Available for sale
  • Trading Securities

Liabilities

  1. Accrued expenses
  2. Unearned (deferred) revenue
  3. Provisions
24
Q

Financial Reporting Mechanics: Relationships Among Statements

A
25
Q

Financial Reporting Mechanics: Accounting System Flow

A
26
Q

Financial Reporting Mechanics: Statement and Security Analysis

A
  • Financial statements must contain:
    • Accruals and valuations
      • Estimates
      • Judgements
  • Analysts must review
    • Critical accounting policies and estimates sections
      • MDA
      • Foonotes
  • Misrepresenations
    • Accounts balance if DR = CR but still may not be correct!

Make appropriate adjustments for analysis

27
Q

Financial Reporting Mechanics: Financial Reporting - Problem

A
28
Q

Financial Reporting Standards: Financial Accounting Standard Setting

A
29
Q

Financial Reporting Standards: Accounting Standards

A
  1. Financial Accounting Standards Board (FASB) U.S.
  2. International Accounting Standards Board (IASB) most other countries
30
Q

Financial Reporting Standards: Desirable Attributes of Standard Setters

A
  1. Observe high professional standards
  2. Have adequate authority, resources, and competencies to accomplish mission
  3. Clear and consistent standard setting processes
  4. Guided by a well-articulated framework
  5. Operate independently while still seeking input from stakeholders
  6. Not compromised by special interests
  7. Decisions made in public interest result in standards adopted by the regulatory authorities
31
Q

Financial Reporting Standards: Financial Reporting Requirements and Regulation

A
  1. Securities and Exchange Commission (SEC) - U.S.
  2. Financial Services Authority - U.K
  3. International Organization of Securities Commissions (IOSCO) - many other countries
32
Q

Financial Reporting Standards: International Organization of Securities Commissions (IOSCO)

A
  • 181 members regulating 90% of the worlds capital markets (SEC & FSA)
  • 1998 Core Objective of Securities Regulations:
  1. Protecting investors
  2. Ensuring fair, transparent, and efficient markets
  3. Reducing systematic risk
  • Goal = uniform regulation
33
Q

Financial Reporting Standards: SEC Filings/ Forms

A
  1. S1: Sale of new securities to the public
  2. 10K: Annual report
  3. 10Q: Quarterly reports
  4. DEF 14A: Proxy statements prior to vote
  5. 8K: Material events
  6. Form 144: Stock issues to qualified buyers without SEC registration
  7. Forms 3, 4, & 5: Share dealings with corporate insiders
34
Q

Financial Reporting Standards: Global Convergence of Accounting Standards

A

Covergence refers to reducing differences in worldwide accounting standards

  1. Increase comparability
  2. Decrease problems and expenses of raising capital in foreign markets
  3. Decrease problems and expenses of preparing consolidated financial statements for foreign subsidiaries

Accounting standards in most countries are covrgin over time with IFRS

35
Q

Financial Reporting Standards: Barriers to Convergence

A
  1. Differences in view between standard setting bodies
  2. Pressure from business and industry groups
  3. Many different countries involved
36
Q

Financial Reporting Standards: IFRS Conceptual Framework

A

Two qualitative characteristics:

  • Relevance
    • The information can influence users’ ecnonomic decisions or affect users’ evaluations of past events or forecasts of future events
    • Information should have predictive value, confirmatory value (confirm prior expectations, or both. Materiality is an aspect of relevance
  • Faithful representation
    • The information that is faithfully representative is complete, neutral (absence of bias,) and free from error

Charateristics

  • Comparability
  • Verifiability
  • Timeliness
  • Understandability
37
Q

Financial Reporting Standards: IFRS Conceptual Framework Constraints

A
  • Ideal to have all characteristics
  • Reality: trade-offs
    • Relevance versus verifiability
    • Benefits versus cost
    • Excludes non-quantifiable information
38
Q

Financial Reporting Standards: IFRS Required Reporting Elements: Item Recognition

A

An item should be recognized in its financial statement element if a future eocnomic benefit from the item (flowing to or from the firm) is probable and the item’s value or cost can be measured reliably.

39
Q

Financial Reporting Standards: IFRS Required Reporting Elements: Assets, Liability, & Equity

A

Assets

  • Resources controlled by the entity resulting from past transactions
  • Probably future economic benefits flow to enterprise

Liabilities

  • Obligations resulting from past events
  • Settlement results in probable resource outfow

Equity

  • Shareholder’s residual interest
  • Assets - liabilities
40
Q

Financial Reporting Standards: IFRS Required Reporting Elements: Income & Expenses

A
41
Q

Financial Reporting Standards: IASB General Requirments

A
42
Q

Financial Reporting Standards: IFRS/ U.S. GAAP Framerwork Differences

A
  • The IASB Framework lists income and expenses as elements related to performance, while the FASB framework included revenues, expenses, gains, losses, and comprehensive income.
  • The FASB defines an asset as a future economic benefit, whereas the IASB defines it as a resource from which a future economi benefit is expected to flow. Also, the FASB uses the word “probable” to define assets and liabilities.
  • The FASB does not allow the upward valuation of most assets
43
Q

Financial Reporting Standards: Characteristics of a Coherent Reporting Framework

A
  • Transparency
    • Accounts reflect economic substance
    • Full disclosure and fair presentation
  • Comprehensiveness
    • Full specture of financial transactions
    • Framerwork flexible enough to adapt to new transactions
  • Consistency
    • Transactions measured and presented in a similar way (across companies and time)
    • Sufficient flexibility to show economic substance
44
Q

Financial Reporting Standards: Barriers to a Single Framework

A
  • Valuation
    • Historic cost: Minimal judgment - reliable
    • Fair value: Considerable judgement - relevant
    • Both IASB and FASB recognize that some elements should be measured at fair value
  • Standard Setting
    • Principles-based - few specific rules
    • Rules-based - prescriptive but not flexible
    • Objective-based - combine principles and rules
  • Measurement
    • Two potential approaches:
      • Balance sheet: Asset/liability approach
      • Income statement: Revenue/expense approach
    • Standards regarding one statement will have an effect on the other - approaches may conflict
    • Standard writers - asset/liability approach
45
Q

Financial Reporting Standards: Monitoring Development

A
  • Reporting standards are evolving rapidly
  • Analyst focus: impact on financial reports

Monitor:

  • New products/transaction
  • Standard setter/regulator actions
    • IASB (iasb.org)
    • FASB (fasb.org)
    • CFA Centre for Financial Market Intengrity (cfainstitute.org/cfacentre)
  • Company disclosure:
    • MD&A
    • Footnotes
46
Q

Financial Reporting Standards: Company Disclosures

A
  • Critical and significant accounting policies
  • Accounting estimates
  • Changes in accounting policy
  • Footnote disclosure and discussion in MD&A

Analyst focus:

  • What policies have been discussed?
  • Do the policies cover all significant transactions?
  • Which balances require significant estimation
  • Have there been changes?

CFA: Level 1 (18 decks)

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