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Sixty Minute Guide Financial Reporting & Analysis CFA- Level I


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1. Important Basic concepts

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Audit independent review of an entitys financial statements

Unqualified Opinion

Qualified opinion

Adverse opinion

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Basic accounting equation Assets = Liabilities + Owners equity

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Two primary assumptions 1.Accrual basis 2.The Going concern assumption.

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Flow of information in Accounting system


Journal entries

General ledger

Initial trial balance

Adjusted trial balance

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Financial Statement

2.Understanding the Income Statement

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Revenue recognition
(Revenue is recognized when earned and expenses are recognized when incurred)

Long Term Contracts

Installment sales

Barter transactions

% of completion competed Contract Method method Recognize


revenue in proportion of cost incurred Recognize revenue only when contract is complete

Recognize revenue If collect ability Is reasonably assured

Normal rev. Recognition

Installment Sales
Used if collectability cannot be reasonably estimated

Cost recovery Method used if collectability is highly uncertain

Barter transaction: recognize revenue only


If fair value can be estimated

Expense recognition
is based on the matching principle expenses to generate revenue are recognized in the same period as the revenue

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Discontinued operation
Barter transactions is one that management has decided to dispose off but has not yet done so

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IMP
Unusual or infrequent items
either unusual in nature or infrequent in occurrence, but not both These are included in income from continuing operations and are reported before tax.

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extraordinary item

Only under U.S. GAAP it is a material transaction or event that is both

unusual and infrequent in occurrence reported separately in the income statement, net of tax, after income from continuing operations IFRS does not allow extraordinary items to be separated from operating results in the income statement
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Change in accounting principle


prior-period financial statements are restated to reflect the change.

Change in accounting estimate


Prospective application
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Dilutive securities
are stock options, warrants, convertible debt convertible preferred stock that would decrease EPS if exercised or converted to common stock

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3.Understanding the Balance Sheet

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Investments (Financial Instruments)

Held to maturity
1.On BS: @ Amortized Cost 2.Realised gain: taken to income Statement

Available for Sale


1.On BS: @ Fair Value 2.Realised gain: Taken to income statement 3.Unrealised gain: Taken to other Comprehensive income
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Trading securities
1.On BS: @ Fair Value 2.Realised gain: Taken to income statement

3.Unrealized gain is not recognized

3.Unrealised gain: Taken to income statement

4.Understanding the Cash Flow Statement

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Cash Flows
CFO CFO
Inflows and outflows of cash resulting from transactions that affect a firms net income.

CFI CFI
inflows and outflows of cash resulting from the acquisition or disposal of long-term assets and certain investments.

CFF CFF
Inflows and outflows of cash resulting from transactions affecting a firms capital structure, such as issuing or repaying debt and issuing or repurchasing stock .

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Item
1. Dividends paid 2. Interest paid 3. Dividends received

US GAAP Treatment
Financing activities (CFF)

IFRS Treatment
CFO or CFF (Gives flexibility to management ) CFO or CFF (Gives flexibility to management )

Operating activities (CFO)

IMP
Operating activities (CFO)

CFO or CFI (Gives flexibility to management )

4. Interest received

operating activities (CFO)

CFO or CFI (Gives flexibility to management )

5.Taxes paid related to operating activities 6. Taxes paid related to investing and financing transactions

operating activities (CFO)

operating activities (CFO)

Operating activities (CFO)

CFI and CFF respectively

IMP

FCFF Formula
1.Starting From Net Income NI + NCC WCinv +(INT X (1-t)) FCinv CFO + (INT X (1-t)) FCinv

2. Starting From EBIT (EBIT X (1-t))+ Dep - WCinv CFO + (INT-tax%)


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- FCinv

-FCinv

5.Inventories

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Inventory Cost Flow Methods

FIFO

LIFO

Weightd avg.

Specific
identificn

1.COGS consist of older purchases 2.Ending Inventory bal consist of more recent cost 3.. In either Inflationary or deflationary Environment FIFO Ending inventory Balance reflects economic reality 4.In Inflationary environment, FIFO COGS is lower than LIFO COGS

FIFO

1.COGS consist of recent purchases 2.Ending Inventory bal consist of older cost 3.. In either Inflationary or deflationary Environment LIFO COGS reflects economic reality 4.In inflationary environment, LIFO closing inventory is lower than FIFO closing inventory

LIFO

6.Long-lived Assets

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IFRS
Research cost Development cost

Expensed as incurred

Capitalized

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US GAAP
Research cost Development cost

Expensed as incurred

Expensed
(Except, software

development cost)

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7.Income Taxes

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Create

IT Exp. (Income Statement) is greater


than Tax pble

DTA if,

Create

IT Exp. (Income Statement) is less


than Tax pble

DTL if,

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Assets Tax Base


Is its value for tax purposes. The tax base for a depreciable fixed asset is its cost minus any depreciation previously taken on the tax return

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Income tax expense = taxes payable + DTL DTA.


Increase in DTL Decrease in DTA Increase in DTA Decrease in DTL

ADD LESS
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When income tax rate increases deferred tax assets and deferred tax liabilities are both increased to reflect the new rate If DTA is not likely to be realized create valuation allowance to reduce DTA

If DTL is not likely to be reversed consider it a part of equity for analysis purpose

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8.Non-current (Long-term) Liabilities

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The book value of the bond liability is equal to the PV of the remaining future cash flows (coupon payments and maturity value) discounted at the market rate of interest at issuance

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1. coupon rate > market yield at issuance

Premium bond
2. reported on the balance

1. coupon rate < market yield at issuance 2. reported on the balance sheet at less than its face value . 3. book value of the bond liability will increase until it reaches its face value at maturity. 4. interest expense is greater than the coupon payment

Discount bond

sheet at a value greater than its face value.

3. book value of the bond


liability will decrease until it reaches its face value at maturity.

4. interest expense is less


than the coupon payment

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Finance lease
US GAAP
Treat a lease as a capital (finance) lease if any one of the following criteria is met: 1.Title transfer clause 2. Bargain purchase option 3.Lease period > 75% life 4.PV of lease pmts > 90% of Fair value of asset

IFRS
If substantially all the rights and risks of ownership are transferred to the lessee, the lease is treated as a finance lease by both the lessee and lessor

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Impact on financial statements


Finance lease Operating lease

Net income
(early yrs)

Lower

Higher

Net income
(later yrs)

Higher
Higher Higher Lower

Lower
Lower Lower Higher

EBIT CFO CFF

9.Financial Reporting Quality

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Fraud Triangle
Incentives and pressuresthe motive to commit

fraud.

Opportunitiesthe firm has a weak internal

control system.

Attitudes and rationalizationsthe mindset that

fraud is justified

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US GAAP & IFRS differences


Items Investment: Joint control Inventory on balance sheet Recovery of asset write down Upward Revaluation Cost of Goods Sold Operating Expenses Interest capitalization Extraordinary items Both unusual and infrequent
US GAAP Equity method Lower of cost or market value Not allowed Not allowed LIFO permitted Differentiates betn expenses and losses Must reported in the income statement, net of tax, below income from continuing operations IFRS Proportionate Consolidation Lower of cost or Net realizable value Allowed Allowed LIFO not permitted IFRS does not Optional It does not permit firms to treat items as extraordinary in the income statement.

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