CFA Level 1 Study Notes – Financial Statement and Analysis

CFA Level 1 Study Notes – Financial Statement and Analysis

Study Session 6

Reading 15 – Introduction to Financial Statement Analysis

LOS 15a: describe the roles of financial reporting and financial statement analysis
LOS 15b: 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 15c: describe the importance of financial statement notes and supplementary information — including disclosures of accounting policies, methods, and estimates — and management’s commentary
LOS 15d: describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls
LOS 15e: identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information
LOS 15f: describe the steps in the financial statement analysis framework

Reading 16 – Financial Reporting Standards

LOS 16a: describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation
LOS 16b: describe roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards
LOS 16c: 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 16d: describe general requirements for financial statements under International Financial Reporting Standards (IFRS)
LOS 16e: describe implications for financial analysis of differing financial reporting systems and the importance of monitoring developments in financial reporting standards

Study Session 7

Reading 17 – Understanding Income Statements

LOS 17a: describe the components of the income statement and alternative presentation formats of that statement
LOS 17b: 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 17c: calculate revenue given information that might influence the choice of revenue recognition method
LOS 17d: describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis
LOS 17e: describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies)
LOS 17f: distinguish between the operating and non-operating components of the income statement
LOS 17g: 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 17h: distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation
LOS 17i: convert income statements to common-size income statements
LOS 17j: evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement
LOS 17k: describe, calculate, and interpret comprehensive income
LOS 17l: describe other comprehensive income and identify major types of items included in it

Reading 18 – Understanding Balance Sheets

LOS 18a: describe the elements of the balance sheet: assets, liabilities, and equity
LOS 18b: describe uses and limitations of the balance sheet in financial analysis
LOS 18c: describe alternative formats of balance sheet presentation
LOS 18d: distinguish between current and non-current assets and current and noncurrent liabilities
LOS 18e: describe different types of assets and liabilities and the measurement bases of each
LOS 18f: describe the components of shareholders’ equity
LOS 18g: demonstrate the conversion of balance sheets to commonsize balance sheets and interpret commonsize balance sheets
LOS 18h: calculate and interpret liquidity and solvency ratios

Reading 19 – Understanding Cash Flow Statements

LOS 19a: 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 19b: describe how non-cash investing and financing activities are reported
LOS 19c: contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP)
LOS 19d: distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method
LOS 19e: describe how the cash flow statement is linked to the income statement and the balance sheet
LOS 19f: 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 19g: demonstrate the conversion of cash flows from the indirect to direct method
LOS 19h: analyze and interpret both reported and common-size cash flow statements
LOS 19i: calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios

Reading 20 – Financial Analysis Techniques

LOS 20a: describe tools and techniques used in financial analysis, including their uses and limitations
LOS 20b: classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios
LOS 20c: describe relationships among ratios and evaluate a company using ratio analysis
LOS 20d: demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components
LOS 20e: calculate and interpret ratios used in equity analysis and credit analysis
LOS 20f: explain the requirements for segment reporting and calculate and interpret segment ratios
LOS 20g: describe how ratio analysis and other techniques can be used to model and forecast earnings

Study Session 8

Reading 21 – Inventories

LOS 21a: distinguish between costs included in inventories and costs recognised as expenses in the period in which they are incurred
LOS 21b: describe different inventory valuation methods (cost formulas)
LOS 21c: calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems
LOS 21d: 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 21e: explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios
LOS 21f: demonstrate the conversion of a company’s reported financial statements from LIFO to FIFO for purposes of comparison
LOS 21g: describe the measurement of inventory at the lower of cost and net realisable value
LOS 21h: describe implications of valuing inventory at net realisable value for financial statements and ratios
LOS 21i: describe the financial statement presentation of and disclosures relating to inventories
LOS 21j: explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information
LOS 21k: calculate and compare ratios of companies, including companies that use different inventory methods
LOS 21l: analyze and compare the financial statements of companies, including companies that use different inventory methods

Reading 22 – Long-Lived Assets

LOS 22a: identify and contrast costs that are capitalised and costs that are expensed in the period in which they are incurred
LOS 22b: compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination
LOS 22c: explain and evaluate how capitalising versus expensing costs in the period in which they are incurred affects financial statements and ratios
LOS 22d: describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense
LOS 22e: describe how the choice of depreciation method and assumptions concerning useful life and residual value affect depreciation expense, financial statements, and ratios
LOS 22f: describe the different amortisation methods for intangible assets with finite lives and calculate amortisation expense
LOS 22g: describe how the choice of amortisation method and assumptions concerning useful life and residual value affect amortisation expense, financial statements, and ratios
LOS 22h: describe the revaluation model
LOS 22i: explain the impairment of property, plant, and equipment and intangible assets
LOS 22j: explain the derecognition of property, plant, and equipment and intangible assets
LOS 22k: explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios
LOS 22l: describe the financial statement presentation of and disclosures relating to property, plant, and equipment and intangible assets
LOS 22m: analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets
LOS 22n: compare the financial reporting of investment property with that of property, plant, and equipment

Reading 23 – Income Taxes

LOS 23a: 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 23b: 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 23c: calculate the tax base of a company’s assets and liabilities
LOS 23d: 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 23e: evaluate the impact of tax rate changes on a company’s financial statements and ratios
LOS 23f: identify and contrast temporary versus permanent differences in pretax accounting income and taxable income
LOS 23g: describe the valuation allowance for deferred tax assets—when it is required and what impact it has on financial statements
LOS 23h: explain recognition and measurement of current and deferred tax items
LOS 23i: 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 23j: 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 24 – Non-Current (Long-Term) Liabilities

LOS 24a: determine the initial recognition, initial measurement and subsequent measurement of bonds
LOS 24b: describe the effective interest method and calculate interest expense, amortisation of bond discounts/premiums, and interest payments
LOS 24c: explain the derecognition of debt
LOS 24d: describe the role of debt covenants in protecting creditors
LOS 24e: describe the financial statement presentation of and disclosures relating to debt
LOS 24f: explain motivations for leasing assets instead of purchasing them
LOS 24g: explain the financial reporting of leases from a lessee’s perspective
LOS 24h: explain the financial reporting of leases from a lessor’s perspective
LOS 24i: compare the presentation and disclosure of defined contribution and defined benefit pension plans
LOS 24j: calculate and interpret leverage and coverage ratios

Study Session 9

Reading 25 – Financial Reporting Quality

LOS 25a: distinguish between financial reporting quality and quality of reported results (including quality of earnings, cash flow, and balance sheet items)
LOS 25b: describe a spectrum for assessing financial reporting quality
LOS 25c: distinguish between conservative and aggressive accounting
LOS 25d: describe motivations that might cause management to issue financial reports that are not high quality
LOS 25e: describe conditions that are conducive to issuing low-quality, or even fraudulent, financial reports
LOS 25f: describe mechanisms that discipline financial reporting quality and the potential limitations of those mechanisms
LOS 25g: describe presentation choices, including non-GAAP measures, that could be used to influence an analyst’s opinion
LOS 25h: describe accounting methods (choices and estimates) that could be used to manage earnings, cash flow, and balance sheet items
LOS 25i: describe accounting warning signs and methods for detecting manipulation of information in financial reports

Reading 26 – Financial Statement Analysis: Applications

LOS 26a: evaluate a company’s past financial performance and explain how a company’s strategy is reflected in past financial performance
LOS 26b: demonstrate how to forecast a company’s future net income and cash flow
LOS 26c: describe the role of financial statement analysis in assessing the credit quality of a potential debt investment
LOS 26d: describe the use of financial statement analysis in screening for potential equity investments
LOS 26e: 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

2024 Curriculum

Learning Module 1 – Introduction to Financial Statement Analysis

LOS a: describe the steps in the financial statement analysis framework

LOS b: describe the roles of financial statement analysis

LOS c: describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit reports.

LOS d: describe implications for financial analysis of alternative financial reporting systems and the importance of monitoring developments in financial reporting standards

LOS e: describe information sources that analysts use in financial statement analysis besides annual and interim financial reports

Learning Module 2 – Analyzing Income Statements

LOS a: describe general principles of revenue recognition, specific revenue recognition applications, and implications of revenue recognition choices for financial analysis

LOS b: describe general principles of expense recognition, specific expense recognition applications, implications of expense recognition choices for financial analysis and contrast costs that are capitalized versus those that are expensed in the period in which they are incurred

LOS c: describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies

LOS d: describe how earnings per share is calculated and calculate and interpret a company’s basic and diluted earnings per share for companies with simple and complex capital structures including those with antidilutive securities

LOS e: evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement

Learning Module 3 – Analyzing Balance Sheets

LOS a: explain the financial reporting and disclosures related to intangible assets

LOS b: explain the financial reporting and disclosures related to goodwill

LOS c: explain the financial reporting and disclosures related to financial instruments

LOS d: explain the financial reporting and disclosures related to non-current liabilities

LOS e: calculate and interpret common-size balance sheets and related financial ratios

Learning Module 4 – Analyzing Cash Flows Statement 1

LOS a: describe how the cash flow statement is linked to the income statement and the balance sheet

LOS b: 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 c: demonstrate the conversion of cash flows from the indirect to direct method

LOS d: contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP)

Learning Module 5 – Analyzing Cash Flow Statements 2

LOS a: analyze and interpret both reported and common-size cash flow statements

LOS b: calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios

Learning Module 6 – Analysis of Inventories

LOS a: describe the measurement of inventory at the lower of cost and net realisable value and its implications for financial statements and ratios

LOS b: 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 c: describe the presentation and disclosures relating to inventories and explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information

Learning Module 7 – Analysis of Long-Term Assets

LOS a: compare the financial reporting of the following types of intangible assets: purchased, internally developed, and acquired in a business combination

LOS b: explain and evaluate how impairment and derecognition of property, plant, and equipment, and intangible assets affect the financial statements and ratios

LOS c: analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets

Learning Module 8 – Topics in Long-Term Liabilities and Equity

LOS a: explain the financial reporting of leases from the perspectives of the lessors and lessees

LOS b: explain the financial reporting of defined contribution, defined benefit, and stock-based compensation plans

LOS c: describe the financial statement presentation of and disclosures relating to long-term liabilities and share-based compensation

Learning Module 9 – Analysis of Income Taxes

LOS a: contrast accounting profit, taxable income, taxes payable, and income tax expense and temporary versus permanent differences between accounting profit and taxable income

LOS b: 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 c: calculate, interpret, and contrast an issuer’s effective tax rate, statutory tax rate, and cash tax rate

LOS d: 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

Learning Module 10 – Financial Reporting Quality

LOS a: compare financial reporting quality with quality of reported results (including quality of earnings, cash flow, and balance sheet items)

LOS b: describe a spectrum for assessing financial reporting quality

LOS c: explain the difference between conservative and aggressive accounting

LOS d: describe motivations that might cause management to issue financial reports that are not high quality and conditions that are conducive to issuing low-quality, or even fraudulent, financial reports

LOS e: describe mechanisms that discipline financial reporting quality and the potential limitations of those mechanisms

LOS f: describe presentation choices, including non-GAAP measures, that could be used to influence an analyst’s opinion

LOS g: describe accounting methods (choices and estimates) that could be used to manage earnings, cash flow, and balance sheet items

LOS h: describe accounting warning signs and methods for detecting manipulation of information in financial reports

Learning Module 11 Financial Analysis Techniques

LOS a: describe tools and techniques used in financial analysis, including their uses and limitations

LOS b: calculate and interpret activity, liquidity, solvency, and profitability ratios

LOS c: describe relationships among ratios and evaluate a company using ratio analysis

LOS d: demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components

LOS e: describe the uses of industry-specific ratios used in financial analysis

LOS f: describe how ratio analysis and other techniques can be used to model and forecast earnings

Learning Module 12 – Introduction to Financial Statement Modeling

LOS a: demonstrate the development of a sales-based pro forma company model

LOS b: explain how behavioral factors affect analyst forecasts and recommend remedial actions for analyst biases

LOS c: explain how the competitive position of a company based on Porter’s five forces analysis affects prices and costs

LOS d: explain how to forecast industry and company sales and costs when they are subject to price inflation or deflation

LOS e: explain considerations in the choice of an explicit forecast horizon and an analyst’s choices in developing projections beyond the short-term forecast horizon

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