CFA Level 1 Study Notes – Financial Reporting and Analysis

Study Session 6

Reading 19 – Introduction to Financial Statement Analysis

LOS 19a: describe the roles of financial reporting and financial statement analysis
LOS 19b: 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
LOS 19c: describe the importance of financial statement notes and supplementary information — including disclosures of accounting policies, methods, and estimates — and management’s commentary
LOS 19d: describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls
LOS 19e: identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information
LOS 19f: describe the steps in the financial statement analysis framework

Reading 20 – Financial Reporting Standards

LOS 20a: describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation
LOS 20b: describe roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards
LOS 20c: describe the International Accounting Standards Board’s conceptual framework, including the objective and qualitative characteristics of financial statements, required reporting elements, and constraints and assumptions in preparing financial statements
LOS 20d: describe general requirements for financial statements under International Financial Reporting Standards (IFRS)
LOS 20e: describe implications for financial analysis of differing financial reporting systems and the importance of monitoring developments in financial reporting standards

Study Session 7

Reading 21 – Understanding Income Statements

LOS 21a: describe the components of the income statement and alternative presentation formats of that statement
LOS 21b: 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
LOS 21c: calculate revenue given information that might influence the choice of revenue recognition method
LOS 21d: describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis
LOS 21e: describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies)
LOS 21f: distinguish between the operating and non-operating components of the income statement
LOS 21g: describe how earnings per share is calculated and calculate and interpret a company’s earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures
LOS 21h: distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation
LOS 21i: convert income statements to common-size income statements
LOS 21j: evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement
LOS 21k: describe, calculate, and interpret comprehensive income
LOS 21l: describe other comprehensive income and identify major types of items included in it

Reading 22 – Understanding Balance Sheets

LOS 22a: describe the elements of the balance sheet: assets, liabilities, and equity
LOS 22b: describe uses and limitations of the balance sheet in financial analysis
LOS 22c: describe alternative formats of balance sheet presentation
LOS 22d: distinguish between current and non-current assets and current and noncurrent liabilities
LOS 22e: describe different types of assets and liabilities and the measurement bases of each
LOS 22f: describe the components of shareholders’ equity
LOS 22g: convert balance sheets to common-size balance sheets and interpret common size balance sheets
LOS 22h: calculate and interpret liquidity and solvency ratios

Reading 23 – Understanding Cash Flow Statements

LOS 23a: compare cash flows from operating, investing, and financing activities and classify cash flow items as relating to one of those three categories given a description of the items
LOS 23b: describe how non-cash investing and financing activities are reported
LOS 23c: contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP)
LOS 23d: distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method
LOS 23e: describe how the cash flow statement is linked to the income statement and the balance sheet
LOS 23f: describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data
LOS 23g: convert cash flows from the indirect to direct method
LOS 23h: analyze and interpret both reported and common-size cash flow statements
LOS 23i: calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios

Reading 24 – Financial Analysis Techniques

LOS 24a: describe tools and techniques used in financial analysis, including their uses and limitations
LOS 24b: classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios
LOS 24c: describe relationships among ratios and evaluate a company using ratio analysis
LOS 24d: demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components
LOS 24e: calculate and interpret ratios used in equity analysis and credit analysis
LOS 24f: explain the requirements for segment reporting and calculate and interpret segment ratios
LOS 24g: describe how ratio analysis and other techniques can be used to model and forecast earnings

Study Session 8

Reading 25 – Inventories

LOS 25a: distinguish between costs included in inventories and costs recognised as expenses in the period in which they are incurred
LOS 25b: describe different inventory valuation methods (cost formulas)
LOS 25c: calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems
LOS 25d: calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods
LOS 25e: explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios
LOS 25f: convert a company’s reported financial statements from LIFO to FIFO for purposes of comparison
LOS 25g: describe the measurement of inventory at the lower of cost and net realisable value
LOS 25h: describe implications of valuing inventory at net realisable value for financial statements and ratios
LOS 25i: describe the financial statement presentation of and disclosures relating to inventories
LOS 25j: explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information
LOS 25k: calculate and compare ratios of companies, including companies that use different inventory methods
LOS 25l: analyze and compare the financial statements of companies, including companies that use different inventory methods

Reading 26 – Long-Lived Assets

LOS 26a: distinguish between costs that are capitalised and costs that are expensed in the period in which they are incurred
LOS 26b: compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination
LOS 26c: explain and evaluate how capitalising versus expensing costs in the period in which they are incurred affects financial statements and ratios
LOS 26d: describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense
LOS 26e: describe how the choice of depreciation method and assumptions concerning useful life and residual value affect depreciation expense, financial statements, and ratios
LOS 26f: describe the different amortisation methods for intangible assets with finite lives and calculate amortisation expense
LOS 26g: describe how the choice of amortisation method and assumptions concerning useful life and residual value affect amortisation expense, financial statements, and ratios
LOS 26h: describe the revaluation model
LOS 26i: explain the impairment of property, plant, and equipment and intangible assets
LOS 26j: explain the derecognition of property, plant, and equipment and intangible assets
LOS 26k: explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios
LOS 26l: describe the financial statement presentation of and disclosures relating to property, plant, and equipment and intangible assets
LOS 26m: analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets
LOS 26n: compare the financial reporting of investment property with that of property, plant, and equipment

Reading 27 – Income Taxes

LOS 27a: describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense
LOS 27b: explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for the purposes of financial analysis
LOS 27c: calculate the tax base of a company’s assets and liabilities
LOS 27d: calculate income tax expense, income taxes payable, deferred tax assets, and deferred tax liabilities, and calculate and interpret the adjustment to the financial statements related to a change in the income tax rate
LOS 27e: evaluate the impact of tax rate changes on a company’s financial statements and ratios
LOS 27f: distinguish between temporary and permanent differences in pre-tax accounting income and taxable income
LOS 27g: describe the valuation allowance for deferred tax assets—when it is required and what impact it has on financial statements
LOS 27h: explain recognition and measurement of current and deferred tax items
LOS 27i: analyze disclosures relating to deferred tax items and the effective tax rate reconciliation and explain how information included in these disclosures affects a company’s financial statements and financial ratios
LOS 27j: identify the key provisions of and differences between income tax accounting under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (GAAP)

Reading 28 – Non-Current (Long-Term) Liabilities

LOS 28a: determine the initial recognition, initial measurement and subsequent measurement of bonds
LOS 28b: describe the effective interest method and calculate interest expense, amortisation of bond discounts/premiums, and interest payments
LOS 28c: explain the derecognition of debt
LOS 28d: describe the role of debt covenants in protecting creditors
LOS 28e: describe the financial statement presentation of and disclosures relating to debt
LOS 28f: explain motivations for leasing assets instead of purchasing them
LOS 28g: explain the financial reporting of leases from a lessee’s perspective
LOS 28h: explain the financial reporting of leases from a lessor’s perspective
LOS 28i: compare the presentation and disclosure of defined contribution and defined benefit pension plans
LOS 28j: calculate and interpret leverage and coverage ratios

Study Session 9

Reading 29 – Financial Reporting Quality

LOS 29a: distinguish between financial reporting quality and quality of reported results (including quality of earnings, cash flow, and balance sheet items)
LOS 29b: describe a spectrum for assessing financial reporting quality
LOS 29c: distinguish between conservative and aggressive accounting
LOS 29d: describe motivations that might cause management to issue financial reports that are not high quality
LOS 29e: describe conditions that are conducive to issuing low-quality, or even fraudulent, financial reports
LOS 29f: describe mechanisms that discipline financial reporting quality and the potential limitations of those mechanisms
LOS 29g: describe presentation choices, including non-GAAP measures, that could be used to influence an analyst’s opinion
LOS 29h: describe accounting methods (choices and estimates) that could be used to manage earnings, cash flow, and balance sheet items
LOS 29i: describe accounting warning signs and methods for detecting manipulation of information in financial reports

Reading 30 – Financial Statement Analysis: Applications

LOS 30a: evaluate a company’s past financial performance and explain how a company’s strategy is reflected in past financial performance
LOS 30b: forecast a company’s future net income and cash flow
LOS 30c: describe the role of financial statement analysis in assessing the credit quality of a potential debt investment
LOS 30d: describe the use of financial statement analysis in screening for potential equity investments
LOS 30e: explain appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company

(Reading 22 until 2018 – Financial Reporting Mechanics)

LOS 22a: describe how business activities are classified for financial reporting purposes
LOS 22b: explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements
LOS 22c: explain the accounting equation in its basic and expanded forms
LOS 22d: describe the process of recording business transactions using an accounting system based on the accounting equation
LOS 22e: describe the need for accruals and valuation adjustments in preparing financial statements
LOS 22f: describe the relationships among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity
LOS 22g: describe the flow of information in an accounting system
LOS 22h: describe the use of the results of the accounting process in security analysis

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