Course Content
INTRODUCTION TO FINANCIAL STATEMENT ANALYSIS
This topic covers the LOS (Learning Outcome Statements) 19 as covered by the CFA institute. According to this statement, after going through this reading, a student shall be able to: a. Describe the role of financial reporting and financial statement analysis. b. Describe the role of key financial statements, i.e. i. Statement of financial position, ii. Statement of comprehensive income, iii. Statement of changes in equity, and iv. Statement of cash flows. c. Describe the importance of financial statement notes and supplementary information. This includes: i. Disclosures of accounting policies, ii. Methods, and iii. Estimates used in financial reporting. d. Describe the: i. Objectives of audit of financial statements, ii. the types of audit reports, and iii. the importance of effective internal controls. e. Identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information; f. Describe the steps in the financial statement analysis framework.
0/8
Introduction
00:00
Role of Financial Statements and Financial Statement Analysis
00:00
Major Financial Statements
00:00
Other Documents
00:00
Other Sources of Information
00:00
Auditor’s Report
00:00
Internal Control
00:00
Financial Statement Analysis Framework
00:00
FINANCIAL REPORTING STANDARDS
This part of the study session 6 is covered under the LOS (Learning Outcome Statement) 20, as covered by the CFA institute. After going through this chapter, a student shall be able to: a. describe the objective of financial statements and the importance of financial reporting standards in security analysis and valuation; b. describe roles and desirable attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards, and describe the role of the International Organization of Securities Commissions; c. 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; d. describe general requirements for financial statements under International Financial Reporting Standards (IFRS); e. describe implications for the financial analysis of differing financial reporting systems and the importance of monitoring developments in financial reporting standards; analyze company disclosures of significant accounting policies. There are revisions and amendments that keep happening to the existing financial reporting standards o n a regular basis. It is thus advisable to the students to keep updating themselves regarding such changes to maintain a decent understanding regarding the financial reporting framework towards a better analysis.
0/7
Introduction
00:00
The Objectives of Financial Reporting
00:00
Standard Setting Bodies and Regulatory Authorities
00:00
Convergence of Global Financial Reporting Standards
00:00
International Financial Reporting Standards Framework
00:00
Effective Financial Reporting
00:00
Comparison of IFRS with Alternative Reporting Systems
00:00
UNDERSTANDING INCOME STATEMENTS
This part of the study session 7 is covered under the LOS (Learning Outcome Statement) 21, as covered by the CFA institute. After going through this chapter, a student shall be able to: a. describe the components of the income statement and alternative presentation formats of that statement; b. 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; c. calculate revenue given information that might influence the choice of revenue recognition method; d. describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis; e. describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, extraordinary items, unusual or infrequent items) and changes in accounting standards; f. distinguish between the operating and non-operating components of the income statement; g. describe how earnings per share are 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; h. distinguish between dilutive and anti-dilutive securities, and describe the implications of each for the earnings per share calculation; i. convert income statements to common-size income statements; j. evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement; k. describe, calculate, and interpret comprehensive income; l. describe other comprehensive income, and identify major types of items included in it.
0/8
Introduction
00:00
Income Statement Components
00:00
Presentation Format of Income Statements
00:00
Revenue Recognition
00:00
Expense Recognition
00:00
Non- Recurring / Operating Items
00:00
Earnings Per Share
00:00
Income Statement Analysis
00:00
UNDERSTANDING BALANCE SHEETS
This part of the study session 7 is covered under the Reading 22, as covered by the CFA institute. After going through this chapter, a student shall be able to: a. describe the elements of the balance sheet: assets, liabilities, and equity; b. describe uses and limitations of the balance sheet in financial analysis; c. describe alternative formats of balance sheet presentation; d. distinguish between current and non-current assets, and current and non-current liabilities; e. describe different types of assets and liabilities and the measurement bases of each; f. describe the components of shareholders’ equity; g. convert balance sheets to common-size balance sheets and interpret common-size balance sheets; h. calculate and interpret liquidity and solvency ratios.
0/8
Introduction
00:00
Elements of Balance Sheet
00:00
Uses and Limitations of Balance Sheet
00:00
Alternative Formats of Balance Sheet
00:00
Current Assets/Liabilities vs. Non-Current Assets/Liabilities
00:00
Types of Assets and Liabilities
00:00
Vertical Common Sized Balance Sheet
00:00
Calculation and Interpretation of Solvency and Liquidity Ratios
00:00
UNDERSTANDING CASH FLOW STATEMENTS
This part of the study session 7 is covered under the Reading 23, as covered by the CFA institute. After going through this chapter, a student shall be able to: a. 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; b. describe how non-cash investing and financing activities are reported; c. contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP); d. distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method; e. describe how the cash flow statement is linked to the income statement and the balance sheet; f. 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; g. convert cash flows from the indirect to direct method; h. analyze and interpret both reported and common-size cash flow statements; i. calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios.
0/10
Introduction
00:00
Components of Cash Flow Statements
00:00
Reporting of Non-Cash Investing and Financing Activities
00:00
Difference between the Cash Flow Statement Prepared Under IFRS and US GAAP
00:00
Difference between Direct and Indirect Method of Preparing Cash Flow Statement
00:00
Other Relationships in Cash Flow Statement
00:00
Steps in Preparation of Cash Flow Statements
00:00
Conversion of Cash Flow from Indirect to Direct Method
00:00
Analysis and Interpretation of Cash Flow Statement
00:00
Calculation and Interpretation of Cash flow Ratios
00:00
FINANCIAL ANALYSIS TECHNIQUES
This part of the study session 7 is covered under the Reading 24, as covered by the CFA institute. After going through this chapter, a student shall be able to: a. describe tools and techniques used in financial analysis, including their uses and limitations; b. classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios; c. describe relationships among ratios and evaluate a company using ratio analysis; d. demonstrate the application of DuPont analysis of return on equity, and calculate and interpret effects of changes in its components; e. calculate and interpret ratios used in equity analysis and credit analysis; f. explain the requirements for segment reporting, and calculate and interpret segment ratios; g. describe how ratio analysis and other techniques can be used to model and forecast earnings.
0/7
Introduction
00:00
Tools and Techniques Used in Financial Analysis
00:00
Classifications, Calculation, and Interpretation of Various Ratios
00:00
Du-Pont Analysis
00:00
Equity and Credit Analysis
00:00
Segment Reporting
00:00
Use of Ratio Analysis to Model and Forecast Earnings
00:00
INVENTORIES
This part of the study session 8 is covered under Reading 25, as covered by the CFA Institute. The candidate should be able to: a distinguish between costs included in inventories and costs recognised as expenses in the period in which they are incurred; b describe different inventory valuation methods (cost formulas); c calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems; d calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods; e explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios; f convert a company’s reported financial statements from LIFO to FIFO for purposes of comparison; g describe the measurement of inventory at the lower of cost and net realisable value; h describe implications of valuing inventory at net realisable value for financial statements and ratios; i describe the financial statement presentation of and disclosures relating to inventories; j explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information; k calculate and compare ratios of companies, including companies that use different inventory methods; l analyze and compare the financial statements of companies, including companies that use different inventory methods.
0/10
Introduction
00:00
Product Cost and Period Cost
00:00
Inventory Valuation Method
00:00
Calculation of COGS and Value of Ending Inventory
00:00
Concept of LIFO Reserve and Conversion of LIFO to FIFO / AVCO Method of Valuation
00:00
Measurement of Inventory
00:00
Presentation and Disclosures of Inventory and Related Items
00:00
Issues Involved in Evaluating Inventory
00:00
Impact of Choice of Valuation Methods on the Ratios
00:00
Inventory Analysis
00:00
LONG-LIVED ASSETS
This part the study session 8 is covered under Reading 26, as covered by the CFA Institute. After reading this chapter a candidate should be able to: a. distinguish between costs that are capitalised and costs that are expensed in the period in which they are incurred; b. compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination; c. explain and evaluate how capitalising versus expensing costs in the period in which they are incurred affects financial statements and ratios; d. describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense; e. describe how the choice of depreciation method and assumptions concerning useful life and residual value affect depreciation expense, financial statements, and ratios; f. describe the different amortisation methods for intangible assets with finite lives and calculate amortisation expense; g. describe how the choice of amortisation method and assumptions concerning useful life and residual value affect amortisation expense, financial statements, and ratios; h. describe the revaluation model; i. explain the impairment of property, plant, and equipment and intangible assets; j. explain the derecognition of property, plant, and equipment and intangible assets; k. explain and evaluate how impairment, revaluation, and derecognition of property, plant, and equipment and intangible assets affect financial statements and ratios; l. describe the financial statement presentation of and disclosures relating to property, plant, and equipment and intangible assets; m. analyze and interpret financial statement disclosures regarding property, plant, and equipment and intangible assets; n. compare the financial reporting of investment property with that of property, plant, and equipment.
0/16
Introduction
00:00
Capitalization of Cost Vs. Expensing
00:00
Intangible Assets
00:00
Impact of Capitalizing vs. Expensing the Assets on Financial Statements and Ratios
00:00
Calculation of Depreciation Expense
00:00
Impact of Choices for Depreciation on Financial Statements and Ratios
00:00
Amortization
00:00
Impact of Choices for Amortization on Financial Statements and Ratios
00:00
Revaluation Model
00:00
Impairment of Assets
00:00
De-recognition of Assets
00:00
Effects of Revaluation, Impairment, and De-Recognition
00:00
Disclosures
00:00
Evaluation of Important Ratios
00:00
Investment Property
00:00
Leasing
00:00
INCOME TAXES
This part of the study session 8 is covered under Reading 28, as covered by the CFA Institute. After reading this chapter a candidate should be able to: a. 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; 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; c. calculate the tax base of a company’s assets and liabilities; d. 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; e. evaluate the impact of tax rate changes on a company’s financial statements and ratios; f. distinguish between temporary and permanent differences in pre-tax accounting income and taxable income; g. describe the valuation allowance for deferred tax assets—when it is required and what impact it has on financial statements; h. compare a company’s deferred tax items; i. 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; j. identify the key provisions of and differences between income tax accounting under International Financial Reporting Standards (IFRS) and the US generally accepted accounting principles (GAAP).
0/11
Introduction
00:00
Definition of Key Terms
00:00
Creation and Treatment of Deferred Tax Assets / Liabilities
00:00
Tax Base
00:00
Calculation of Tax Expense, Income Tax Payable, Deferred Tax Asset / Liability
00:00
Changes in Tax
00:00
Differences in Temporary and Permanent Differences
00:00
Valuation Allowance
00:00
Current vs. Deferred Tax
00:00
Disclosure Requirements for Deferred Tax Assets / Liabilities
00:00
Key Differences in the Tax Accounting Under IFRS and GAAP
00:00
NON-CURRENT (LONG-TERM) LIABILITIES
This part of the study session 8 is covered under Reading 28, as covered by the CFA Institute. After reading this chapter a candidate should be able to: a. determine the initial recognition, initial measurement, and subsequent measurement of bonds; b. describe the effective interest method and calculate interest expense, amortization of bond discounts/premiums, and interest payments; c. explain the derecognition of debt; d. describe the role of debt covenants in protecting creditors; e. describe the financial statement presentation of and disclosures relating to debt; f. explain motivations for leasing assets instead of purchasing them; g. explain the financial reporting of leases from a lessee’s perspective; h. explain the financial reporting of leases from a lessor’s perspective; i. compare the presentation and disclosure of defined contribution and defined benefit pension plans; j. calculate and interpret leverage and coverage ratios.
0/11
Introduction
00:00
Bonds
00:00
Methods of Accounting for Bonds
00:00
Derecognition of Bonds
00:00
Debt Covenants
00:00
Presentation and Disclosure of Bonds
00:00
Leases
00:00
Benefits of Leasing
00:00
Financial Reporting From Lessee’s and Lessor’s Perspective
00:00
Pension Plans
00:00
Leverage and Coverage Ratios
00:00
FINANCIAL REPORTING QUALITY
This part of the study session 9 is covered under Reading 29, as covered by the CFA Institute. After reading this chapter a candidate should be able to: a. distinguish between financial reporting quality and quality of reported results (including quality of earnings, cash flow, and balance sheet items); b. describe a spectrum for assessing financial reporting quality; c. distinguish between conservative and aggressive accounting; d. describe motivations that might cause management to issue financial reports that are not high quality; e. describe conditions that are conducive to issuing low-quality, or even fraudulent, financial reports; f. describe mechanisms that discipline financial reporting quality and the potential limitations of those mechanisms; g. describe presentation choices, including non-GAAP measures, that could be used to influence an analyst’s opinion; h. describe accounting methods (choices and estimates) that could be used to manage earnings, cash flow, and balance sheet items; i. describe accounting warning signs and methods for detecting manipulation of information in financial reports.
0/10
Introduction
00:00
Difference between Financial Reporting Quality and Quality of Reported Results
00:00
Spectrum for Assessing the Financial Reporting Quality
00:00
Conservative and Aggressive Accounting
00:00
Motivation Behind Low Quality Financial Reports
00:00
Conditions Conducive to Low Quality Reporting
00:00
Mechanisms That Discipline Financial Reporting Quality and Limitations to Mechanisms
00:00
Presentation Choices That Could Influence Analyst’s Opinion
00:00
Methods Used to Manage Earnings, Cash Flow & Balance Sheet Items
00:00
Warning Signs Indicating Manipulation of Financial Reports
00:00
APPLICATIONS OF FINANCIAL STATEMENT ANALYSIS
This part of the study session 9 is covered under Reading 30, as covered by the CFA Institute. After reading this chapter a candidate should be able to: a. evaluate a company’s past financial performance and explain how a company’s strategy is reflected in past financial performance; b. forecast a company’s future net income and cash flow; c. describe the role of financial statement analysis in assessing the credit quality of a potential debt investment; d. describe the use of financial statement analysis in screening for potential equity investments; e. explain appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company.
0/6
Introduction
00:00
Evaluation of Performance Vis-à-vis Strategy
00:00
Forecasting Company’s Net Income Cash Flow
00:00
Assessing the Credit Quality
00:00
Screening for Potential Equity Investment
00:00
Adjustment Necessary to Facilitate Comparisons
00:00
Financial Reporting and Analysis
About Lesson

LOS I requires us to:

compare the presentation and disclosure of defined contribution and defined benefit pension plans

 

Pension is a type of compensation to the employees, which is earned by them during their service to the firm but is deferred for payment after that. There are basically two types of pension plans: defined contribution plans and defined benefit plans.

1.         Defined Contribution Plans

a.  Defined contribution pension plans are those plans where the contribution to the planned asset is defined, but the outcome is not.

b.  As per this plan, the company contributes a defined amount to the plan along with the employees.

c.  The contribution is then invested in the financial assets (such as equity, mutual funds, bonds, debentures, etc.), and the investment decision is left to the employees. The risk of investment is also borne by the employees.

d.  The company makes no commitment regarding the future value of the plan.

e.  The pension expense, i.e. the amount contributed by the employer each year is expensed through the income statement. There, however, is no separate line item to record the pension expense in the income statement; it is normally clubbed along with the salary expense in the requisite heads.

f.  The ‘plan assets’ are shown under the head investments in the asset side of the balance sheet. And, then liabilities for the payment of pension are shown on the ‘current liabilities’ section if it is due within the next twelve months or in the ‘non-current liability’ section if it is payable post 12 months.

2.         Defined Benefit Plan

a.  According to this plan, the contributions to be made are not fixed, but the amount of benefits from the pension plan is pre-defined. The company, here, makes a promise to pay the future benefits. These plans are typically funded through a separate legal entity; this reduces the liquidity and solvency risk of the company from the assets.

b.  The most common way of defining the benefits receivable by the employees is by deciding the percentage of average last drawn salary of a certain number of years, for the number of years of service. i.e.

Defined Benefits = X% × number of years of service × average of last n year’s gross salary

 

c.  The amount and the periodicity (it may be a one-time lump-sum payment or an annuity as well) of the investment are pre-decided.

d.  The company, here, makes the payment and invests the same into a financial asset.

e.  Since the obligation for the payment of pension is pre-decided, the risk of investment lies with the employer/company.

f.  Therefore, for calculating the amount of investment required today which equals the present value of the retirement obligations, the company needs to make certain assumptions regarding the discount rates, and the expected life of the employee post-retirement, etc.

g.  The amount due for payment as pension is called the pension obligation. And the amount lying to the debit in the investment made for the plan is called plan asset.

h.  If at any particular point in time, on the balance sheet, the pension obligations exceed the plan assets, then the plan is said to be under-funded. However, if the estimated pension obligation, is below the plan asset, it is said to be over-funded.

i.  There may be a change in the value of pension assets, in terms of their fair value or carrying value. These changes may result in reportable gains or losses. These gains or losses due to change in the value of asset or purchase or sale of underlying assets should be reported in the income statement, under the head of ‘other comprehensive income’.

j.  IFRS requires disclosure regarding three major components of the pension plans. These are:

     i.  Employee Service Cost. It is the present value of the increase in the amount of benefits as a result of one more year of service, or as a result of plan changes to reflect the prior year’s service.

    ii.  Net interest expense/income. It is the net pension asset or liability multiplied by the estimated discount rate.

   iii.  Re-measurements. These represent two things: actuarial gains or losses resulting due to the changes in assumptions, and the actual return on the plan assets. These have the effect of increasing or decreasing the value of net assets or liabilities.

k.  GAAP requires disclosures regarding the following five components:

     i.  The employee service cost needs to be disclosed in the income statement under pension expense.

    ii.  The interest expense accrued on the beginning pension obligation should be expensed in the income statement.

   iii.  The expected return on the planned assets should be reduced from the pension expense, and be reported in the income statement.

   iv.  The past service cost should be reported in the other comprehensive income.

    v.  The actuarial gains/losses should be reported with the other comprehensive income.

3.         Disclosures

a.  The expense in relation to the pension expense for the:

     i.  production employees should be allocated based on the absorption costing, and therefore, be captured in the cost of inventory;

    ii.  Non-production employees should be a part of ‘selling, general, and administration expense’.

b.  In the disclosures section, we can find the details regarding the retirement obligations, plan assets, deficits/surplus, etc.

c.  In the balance sheet, the amount of pension liabilities or assets can also be found.

 

Previous
Next