Financial Reporting and Analysis #1

I’ve discussed important parts of the exam over and over and how some are more critical than others. Well, here we are, what used to be known as FSA (Financial Statement Analysis) is clearly one if not the most important part of the exam. It’s a difficult section for many as its much more about accounting than finance. The two are obviously related but if you are doing this exam, chances are good that you chose the field of finance over accounting. That being said, the two are very much related and any kind of fundamental based trading (which the CFA is all about) requires analysis of financial statements. So here we go

Financial Statements

What is included in each part of these statements:

Income Statement (revenues & expenses)
Balance sheet (assets, liabilities, equity)
Cash Flow Statement (Operating cash flows, Investing cash flows, Financing Cash flows)
Statement notes (accounting methods assumptions & changes, provide additional information)
Supplementary schedule (additional information such as breakdown of revenues & expenses, reserves or hedging activities)
Management discussion and analysis (discussions about the results and any other events, extraordinary items, etc)

You need to know how these are displayed and know what each of them looks like. Take the time to look at examples.

Also, the obvious rule that you must know

Assets = liabilities + equity’s owner

IFRS vs. US Gaap

There are two main accounting standards used around the world and it’s important to know the differences between the two. I would spend some time reading about the differences and, their principles as these will be asked about in the exam.

Revenue Recognition

You can only recognize revenue if you have completed the earnings process and also expect to receive the payment. Once those two conditions are respected, you can use one of these methods:

Percentage of completion: When the costs and revenues can be estimated accurately, percentage of completion is based on costs incurred
Completed-contract method: If outcome is not entirely certain – recognize revenues and costs once the project is done except if you know there will be a loss, which you would then recognize to start off
Installment sales: Recognize profits as payments are made and in that proportion
Cost recovery: Only recognize profits once the cash collected exceeds costs

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