CFA - 6, 7 & 9. Financial Reporting and Analysis

CFA – 6, 7 & 9.
Financial Reporting and Analysis
- International Financial Reporting Standards (IFRS) – developed by International

Accounting Standards Board
- US Generally Accepted Accounting Principles (US GAAP) – developed by Financial
Accounting Standards Board
- Audit opinion
o Unqualified audit opinion – true and fair view of financial statements
o Qualified audit opinion – some exception to accounting standards
o Adverse audit opinion – material departure from accounting standards
- Qualitative characteristics of financial statement
o Relevance
o Faithful representation
o Comparability
o Verifiability
o Timeliness
o Understandability
o NOT accuracy
- Characteristics of coherent financial reporting
o Consistency
o Comprehensiveness
o Transparency
- Income statement
o Revenue recognition
 Long-term contracts (e.g. construction) – revenue recognised before goods are
delivered
 Percentage-of-completion method (most preferred) – revenue recognised
based on percentage of completion (which is based on percentage of cost)
 Completed contract method – revenue (and cost) recognised when
completed
 Instalment sales
 Instalment method – revenue (and cost) recognised based on percentage
of cash received
 Cost recovery method – profit recognised when cash received exceeds cost
 Barter
 Revenue from barter transactions should be measured based on fair value
of revenue from similar non-barter transactions with unrelated parties
o Expenses may be grouped by nature or function
 By nature – depreciation
 By function – cost of goods sold
o Non-recurring items
 Discontinued operations – report separately
 No longer such a classification of extraordinary items
 Material items that are unusual or infrequent – report separately
 Self-initiated change in accounting policy – retrospective application for prior
periods shown in a report
o EPS
 Basic EPS = (Net income – preferred dividends) / time-weighted average no. of
shares outstanding
 Stock dividend or stock split are assumed to be retrospective
 Diluted EPS
 As if convertible preference shares were converted – do not need to deduct
preferred dividends from net income
 As if convertible bonds were converted – need to add back after-tax
interest to net income
 As if options were converted, whose proceeds from exercise of options will
be used to repurchase shares
 Basic EPS = diluted EPS for a company with a simple capital structure (issuing
only common stock with no convertible securities)
 Diluted EPS will always be equal to or smaller than diluted EPS, because
antidilutive convertible securities will be excluded in diluted EPS calculation
o Common-size income statement
 State each line of income statement as a percentage of revenue, allowing
comparison by removing the effect of company size
o Other comprehensive income (OCI)
= Foreign currency translation adjustment
+ Unrealised gain or loss on available-for-sale securities
+ Unrealised gain or loss on derivatives as hedges
 Unrealised gain or loss on trading securities – income statement
 Unrealised gain or loss on securities held to maturity – not recognised
 Comprehensive income = Net income + OCI
- Balance sheet
o Classified balance sheet – classifies assets and liabilities as current and non-current,
and calculates net current assets
o Liquidity-based balance sheet – presents assets and liabilities in order of liquidity
o Deferred revenue (unearned revenue)
o Accrued revenue (unbilled revenue)
o Common-size balance sheet
 State each line of balance sheet as a percentage of total assets
- Statement of cash flow
o Operating, investing and financing activities
 Trading securities – operating
 Interest received – (IFRS) operating or investing; (GAAP) operating
 Dividend received – (IFRS) operating or investing; (GAAP) operating
 Interest paid – (IFRS) operating or financing; (GAAP) operating
 Dividend paid – (IFRS) operating or financing; (GAAP) financing
o For reporting operating cash flow
 Direct method – specify sources of cash flows, e.g. customers, suppliers,
employees; more useful information
 Indirect method – mirror a forecasting approach
 Net income + non-cash expense (depreciation) + non-operating loss (on
sale of asset) + increase in deferred tax liability + increase in current
operating liability – increase in current operating asset
o Free cash flow to firm = Operating cash flow + after-tax interest expense – fixed
capital investment
o Free cash flow to equity = Operating cash flow – fixed capital investment +
borrowing – repayment
o Common-size statement of cash flow
 State each line as a percentage of revenue
 State each line of cash inflow (outflow) as a percentage of total inflows
(outflows)
- Liquidity ratios
o Current ratio = current assets/current liabilities
o Quick ratio = (cash + short-term investment + receivable)/current liabilities
o Cash ratio = (cash + short-term investment)/current liabilities
o Operating cycle = days of inventory + days of receivables
o Net operating cycle (cash conversion cycle) = days of inventory + days of
receivables – days of payables
- Solvency ratios
o Debt-to-equity ratio
o Total debt ratio = debt/assets
o Financial leverage = assets/equity

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CFA – 6, 7 & 9.

Financial Reporting and Analysis

- International Financial Reporting Standards (IFRS) – developed by International

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