Financial Reporting and Analysis

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Financial Reporting and Analysis by Mind Map: Financial Reporting and Analysis

1. 1-19.Introduction to Financial Statement Analysis

1.1. Learning Outcomes

1.1.1. a.describe the roles of financial reporting and financial statement analysis

1.1.2. b.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

1.1.3. c.describe the importance of financial statement notes and supplementary information— including disclosures of accounting policies, methods, and estimates— and management’s commentary

1.1.4. d.describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls

1.1.5. e.identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information

1.1.6. f.describe the steps in the financial statement analysis framework

1.2. Roles of Financial Reporting and Financial Statement Analysis

1.2.1. Role of financial statement reporting

1.2.2. Role of financial statement analysis

1.3. Primary Financial Statements and Other Information Sources

1.3.1. Financial Statements and Supplementary Information Balance Sheet Statement of Comprehensive Income Income Statement Other Comprehensive Income Statement of Changes in Equity Cash Flow Statement Financial Notes and Supplementary Schedules Management Commentary or Management’s Discussion and Analysis Auditor’s Reports Unqualified Qualified Adverse Disclaimer

1.3.2. Other Sources of Information Interim reports Proxy statements Press releases External sources

1.4. Financial Statement Analysis Framework

1.4.1. 1.Articulate the Purpose and Context of Analysis

1.4.2. 2.Collect Data

1.4.3. 3.Process Data

1.4.4. 4.Analyze/ Interpret the Processed Data

1.4.5. 5.Develop and Communicate Conclusions/ Recommendations

1.4.6. 6.Follow-Up

2. 1-20.Financial Reporting Standards

2.1. The Objective of Financial Reporting

2.2. Standard-Setting Bodies and Regulatory Authorities

2.2.1. Accounting Standards Boards International Accounting Standards Board's (IASB's) Financial Accounting Standards Board (FASB)

2.2.2. Regulatory Authorities International Organization of Securities Commissions (IOSCO) The Securities and Exchange Commission (US SEC) Securities Act of 1933 Securities Exchange Act of 1934 Sarbanes– Oxley Act of 2002 Securities Offerings Registration Statement Forms 10-K, 20-F, and 40-F Annual Report Proxy Statement/ Form DEF-14A Forms 10-Q and 6-K Form 8-K Forms 3, 4, 5 and 144 Form 11-K Capital Markets Regulation in Europe

2.3. The International Financial Reporting Standards Framework

2.3.1. Qualitative Characteristics of Financial Reports Fundamental qualitative characteristics Relevance Faithful representation Conceptual Framework Comparability Verifiability Timeliness Understandability

2.3.2. Constraints on Financial Reports

2.3.3. The Elements of Financial Statements Underlying Assumptions in Financial Statements Accrual basis Going concern Recognition of Financial Statement Elements Measurement of Financial Statement Elements Historical cost Amortised cost Current cost Realizable (settlement) value Present value (PV) Fair value Reporting Elements Measurement of financial position Measurement of financial performance

2.3.4. General Requirements for Financial Statements Required Financial Statements General Features of Financial Statements Fair presentation Going concern Accrual basis Materiality and aggregation No offsetting Frequency of reporting Comparative information Consistency

2.3.5. Structure and Content Requirements Classified Statement of Financial Position (Balance Sheet) Minimum Information on the Face of the Financial Minimum Information in the Notes Disclosure of accounting policies Estimation uncertainty Other disclosures Comparative Information

2.4. Comparison of IFRS with Alternative Reporting Systems

2.5. Monitoring Developments in Financial Reporting Standards

2.5.1. New Products or Types of Transactions

2.5.2. Evolving Standards and the Role of CFA Institute

3. 1-21.Understanding Income Statements

3.1. Learning Outcomes

3.1.1. a.Describe the components of the income statement and alternative presentation formats of that statement

3.1.2. b.Describe general principles of revenue recognition and accounting standards for revenue recognition

3.1.3. c.calculate revenue given information that might influence the choice of revenue recognition method

3.1.4. d.describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis

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

3.1.6. f.distinguish between the operating and non-operating components of the income statement

3.1.7. g.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

3.1.8. h.distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation

3.1.9. i.convert income statements to common-size income statements

3.1.10. j.evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement

3.1.11. k.describe, calculate, and interpret comprehensive income

3.1.12. l.describe other comprehensive income and identify major types of items included in it

3.2. Components and Format of the Income Statement

3.2.1. Revenue

3.2.2. Expenses Grouping by Nature Grouping by Function

3.2.3. Gross profit

3.2.4. Operating profit

3.2.5. Net income

3.2.6. Noncontrolling Interests

3.3. Revenue Recognition

3.3.1. Revenue General Principles 1.Identify the contract(s) with a customer 2.Identify the separate or distinct performance obligations in the contract 3.Determine the transaction price 4.Allocate the transaction price to the performance obligations in the contract 5.Recognize revenue when (or as) the entity satisfies a performance obligation

3.3.2. Accounting Standards for Revenue Recognition Revenue from Contracts with Customers Identifying the Performance Obligation Percentage-of-completion Variable consideration Cumulative catch-up adjustment Suppliers deliver

3.4. Expense Recognition

3.4.1. Expense General Principles

3.4.2. Issues in Expense Recognition Doubtful Accounts Warranties Depreciation and Amortisation Straight-line method Double declining balance depreciation

3.4.3. Implications for Financial Analysis

3.5. Non-Recurring Items and Non-Operating Items

3.5.1. Discontinued Operations

3.5.2. Unusual or Infrequent Items

3.5.3. Changes in Accounting Policies

3.5.4. Non-Operating Items

3.6. Earnings per Share

3.6.1. Simple versus Complex Capital Structure

3.6.2. Basic EPS

3.6.3. Diluted EPS Diluted EPS When a Company Has Convertible Preferred Stock Outstanding Diluted EPS When a Company Has Convertible Debt Outstanding Diluted EPS When a Company Has Stock Options, Warrants, or Their Equivalents Outstanding Other Issues with Diluted EPS

3.6.4. Changes in EPS

3.7. Analysis of the Income Statement

3.7.1. Common-Size Analysis of the Income Statement

3.7.2. Income Statement Ratios Net Profit Margin = Net Income / Revenue Gross Profit Margin = Gross profit / Revenue

3.8. Comprehensive Income

4. 1-22.Understanding Balance Sheets

4.1. Components and Format of the Balance Sheet

4.1.1. Balance Sheet Components

4.1.2. Current and Non-Current Classification

4.1.3. Liquidity-Based Presentation

4.2. Current Assets

4.2.1. Cash and Cash Equivalents

4.2.2. Marketable Securities

4.2.3. Trade Receivables

4.2.4. Inventories

4.2.5. Other Current Assets

4.3. Current Liabilities

4.3.1. Trade payables

4.3.2. Accrued expenses

4.3.3. Deferred income

4.4. Non-Current Assets

4.4.1. Property, Plant, and Equipment

4.4.2. Investment Property

4.4.3. Intangible Assets Identifiable Intangibles

4.4.4. Goodwill Accounting Goodwill Economic Goodwill Goodwill Impairment

4.4.5. Financial Assets Derivatives Amortised cost Held-to-maturity Available-for-sale

4.4.6. Deferred Tax Assets

4.5. Non-Current Liabilities

4.5.1. Long-term Financial Liabilities

4.5.2. Deferred Tax Liabilities

4.6. Equity

4.6.1. Components of Equity Common stock Preferred shares Treasury stock Retained earnings Accumulated other comprehensive income Noncontrolling interest

4.6.2. Statement of Changes in Equity

4.7. Analysis of the Balance Sheet

4.7.1. Common-Size Analysis of the Balance Sheet

4.7.2. Balance Sheet Ratios Liquidity Ratios Current = Current assets / Current liabilities Quick (acid test) = (Cash + Marketable securities + Receivables) / Current liabilities Cash = (Cash + Marketable securities) / Current liabilities Solvency Ratios Long-term debt-to-equity = Total long-term debt / Total equity Debt-to-equity = Total debt / Total equity Total debt = Total debt / Total assets Financial leverage = Total assets / Total equity

5. 1-23.Understanding Cash Flow Statements

5.1. Components and Format of the Cash Flow Statement

5.1.1. Classification of Cash Flows and Non-Cash Activities

5.1.2. A Summary of Differences between IFRS and US GAAP

5.1.3. Direct and Indirect Methods for Reporting Cash Flow from Operating Activities An Indirect-Format Cash Flow Statement Prepared under IFRS A Direct-Format Cash Flow Statement Prepared under IFRS Illustrations of Cash Flow Statements Prepared under US GAAP

5.2. The Cash Flow Statement: Linkages and Preparation

5.2.1. Linkages of the Cash Flow Statement with the Income Statement and Balance Sheet

5.2.2. Steps in Preparing the Cash Flow Statement Operating Activities: Direct Method Cash Received from Customers Cash Paid to Suppliers Cash Paid to Employees Cash Paid for Other Operating Expenses Cash Paid for Interest Cash Paid for Income Taxes Investing Activities Financing Activities Long-Term Debt and Common Stock Dividends Overall Statement of Cash Flows: Direct Method Overall Statement of Cash Flows: Indirect Method

5.2.3. Conversion of Cash Flows from the Indirect to the Direct Method

5.3. Free Cash Flow to the Firm and Free Cash Flow to Equity

5.4. Cash Flow Statement Analysis

5.4.1. Evaluation of the Sources and Uses of Cash

5.4.2. Common-Size Analysis of the Statement of Cash Flows

5.4.3. Cash Flow Ratios

6. 1-24.Financial Analysis Techniques

6.1. The Financial Analysis Process

6.1.1. The Objectives of the Financial Analysis Process

6.1.2. Distinguishing between Computations and Analysis

6.2. Analytical Tools and Techniques

6.2.1. Ratios

6.2.2. Common-Size Analysis

6.2.3. The Use of Graphs as an Analytical Tool

6.2.4. Regression Analysis

6.3. Common Ratios Used in Financial Analysis

6.3.1. Interpretation and Context

6.3.2. Activity Ratios Inventory turnover = Cost of sales or cost of goods sold / Average inventory Days of inventory on hand (DOH) = Number of days in period / Inventory turnover Receivables turnover = Revenue / Average receivables Days of sales outstanding (DSO) = Number of days in period / Receivables turnover Payables turnover = Purchases / Average trade payables Number of days of payables = Number of days in period / Payables turnover Working capital turnover = Revenue / Average working capital Fixed asset turnover = Revenue / Average net fixed assets Total asset turnover = Revenue / Average total assets

6.3.3. Liquidity Ratios Current ratio = Current assets / Current liabilities Quick ratio = (Cash + Short-term marketable investments + Receivables) / Current liabilities Cash ratio = (Cash + Short-term marketable investments) / Current liabilities Defensive interval ratio = (Cash + Short-term marketable investments + Receivables) / Daily cash expenditures Cash conversion cycle (net operating cycle) = DOH + DSO – Number of days of payables

6.3.4. Solvency Ratios Debt Ratios Debt-to-assets ratio = Total debt / Total assets Debt-to-capital ratio = Total debt / (Total debt + Total shareholders’ equity) Debt-to-equity ratio = Total debt / Total shareholders’ equity Financial leverage ratio = Average total assets / Average total equity Debt-to-EBITDA = Total debt / EBITDA Coverage Ratios Interest coverage = EBIT / Interest payments Fixed charge coverage = (EBIT + Lease payments) / (Interest payments + Lease payments)

6.3.5. Profitability Ratios Return on Sales Gross profit margin = Gross profit / Revenue Operating profit margin = Operating income / Revenue Pretax margin = EBT / Revenue Net profit margin = Net income / Revenue Return on Investment Operating ROA = Operating income / Average total assets ROA = Net income / Average total assets Return on total capital = EBIT / Average short- and long-term debt and equity ROE = Net income / Average total equity Return on common equity = (Net income – Preferred dividends) / Average common equity

6.3.6. DuPont Analysis: The Decomposition of ROE ROE = Net income/ Average shareholders’ equity ROE = ROA × Leverage ROA = Net Income / Average Total Assets Leverage = Average total assets / Average shareholders' equity ROE = Net profit margin × Total asset turnover × Leverage Net profit margin = Net income / Revenue Total asset turnover = Revenue / Average total assets Leverage = Average total assets / Average shareholders' equity ROE = Tax burden × Interest burden × EBIT margin × Total asset turnover × Leverage Tax burden = Net income / EBT Interest burden = EBT / EBIT EBIT margin = EBIT / Revenue Total asset turnover = Revenue / Average total assets Leverage = Average total assets / Average shareholders' equity

6.4. Equity Analysis

6.4.1. Valuation Ratios Valuation Ratios P/ E = Price per share / Earnings per share P/ CF = Price per share / Cash flow per share P/ S = Price per share / Sales per share P/ BV = Price per share / Book value per share Per-Share Quantities Basic EPS = Net income minus preferred dividends / Weighted average number of ordinary shares outstanding Diluted EPS = Adjusted income available for ordinary shares, reflecting conversion of dilutive securities / Weighted average number of ordinary and potential ordinary shares outstanding Cash flow per share = Cash flow from operations / Weighted average number of shares outstanding EBITDA per share = EBITDA / Weighted average number of shares outstanding Dividends per share = Common dividends declared / Weighted average number of ordinary shares outstanding Dividend-Related Quantities Dividend payout ratio = Common share dividends / Net income attributable to common shares Retention rate (b) = (Net income attributable to common shares – Common share dividends) / Net income attributable to common shares Sustainable growth rate = Retention rate (b) × ROE

6.4.2. Industry-Specific Ratios Business Risk Coefficient of variation of operating income = Standard deviation of operating income / Average operating income Coefficient of variation of net income = Standard deviation of net income / Average net income Coefficient of variation of revenues = Standard deviation of revenue / Average revenue Financial Sector Ratios Capital adequacy— banks = Various components of capital / Various measures such as risk-weighted assets, market risk exposure, or level of operational risk assumed Monetary reserve requirement (Cash reserve ratio) = Reserves held at central bank / Specified deposit liabilities Liquid asset requirement = Approved “readily marketable” securities / Specified deposit liabilities Net interest margin = Net interest income / Total interest-earning assets Retail Ratios Same (or comparable) store sales = Average revenue growth year over year for stores open in both periods Sales per square meter (or square foot) = Revenue / Total retail space in square meters (or square feet) Service Companies Revenue per employee = Revenue / Total number of employees Net income per employee = Net income / Total number of employees Hotel Average daily rate = Room revenue / Number of rooms sold Occupancy rate = Number of rooms sold / Number of rooms available

6.4.3. Historical Research on Ratios in Equity Analysis

6.5. Credit Analysis

6.5.1. The Credit Rating Process

6.5.2. Credit Ratio EBITDA interest coverage = EBITDA / Interest expense, including non-cash interest on conventional debt instruments EBITDA = earnings before interest, taxes, depreciation, and amortization FFO (Funds from operations) to debt = FFO / Total debt FFO = funds from operations, defined as EBITDA minus net interest expense minus current tax expense (plus or minus all applicable adjustments). Free operating cash flow to debt = CFO (adjusted) minus capital expenditures / Total debt CFO = cash flow from operations EBIT margin = EBIT / Total revenues EBIT = earnings before interest and taxes EBITDA margin = EBITDA / Total revenues Debt to EBITDA = Total debt / EBITDA Return on capital = EBIT / Average beginning-of-year and end-of-year capital Capital = debt plus noncurrent deferred taxes plus equity (plus or minus all applicable adjustments)

6.6. Business and Geographic Segments

6.7. Model Building and Forecasting

7. 1-30.Applications of Financial Statement Analysis

7.1. Application: Evaluating Past Financial Performance

7.2. Application: Projecting Future Financial Performance

7.2.1. Projecting Performance: An Input to Market-Based Valuation

7.2.2. Projecting Multiple-Period Performance

7.3. Application: Assessing Credit Risk

7.4. Application: Screening for Potential Equity Investments

7.5. Analyst Adjustments to Reported Financials

7.5.1. A Framework for Analyst Adjustments

7.5.2. Analyst Adjustments Related to Investments

7.5.3. Analyst Adjustments Related to Inventory

7.5.4. Analyst Adjustments Related to Property, Plant and Equipment

7.5.5. Analyst Adjustments Related to Goodwill

8. 1-25.Inventories

8.1. Cost of Inventories

8.1.1. Costs of purchase

8.1.2. Costs of conversion

8.1.3. Exclude the costs from inventory

8.2. Inventory Adjustments

8.3. Inventory Method Changes

8.4. Inventory Valuation Methods

8.4.1. Specific Identification

8.4.2. First-In, First-Out (FIFO)

8.4.3. Weighted Average Cost

8.4.4. Last-In, First-Out (LIFO) LIFO Reserve LIFO Liquidations

8.4.5. Calculation of Cost of Sales, Gross Profit, and Ending Inventory

8.4.6. Periodic versus Perpetual Inventory Systems

8.4.7. Comparison of Inventory Valuation Methods

8.5. Evaluation of Inventory Management

8.5.1. Presentation and Disclosure

8.5.2. Inventory Ratios

8.5.3. Financial Analysis Illustrations

9. 1-26.Long-Lived Assets

9.1. Acquisition of Long-Lived Assets

9.1.1. Property, Plant, and Equipment

9.1.2. Intangible Assets Intangible Assets Purchased in Situations Other Than Business Combinations Intangible Assets Developed Internally Intangible Assets Acquired in a Business Combination

9.1.3. Capitalising versus Expensing: Impact on Financial Statements and Ratios

9.1.4. Capitalisation of Interest Costs

9.1.5. Capitalisation of Internal Development Costs

9.2. Depreciation and Amortisation of Long-Lived Assets

9.2.1. Depreciation Methods and Calculation of Depreciation Expense

9.2.2. Amortisation Methods and Calculation of Amortisation Expense

9.3. The Revaluation Model

9.4. Impairment of Assets

9.4.1. Impairment of Property, Plant, and Equipment

9.4.2. Impairment of Intangible Assets with a Finite Life

9.4.3. Impairment of Intangibles with Indefinite Lives

9.4.4. Impairment of Long-Lived Assets Held for Sale

9.4.5. Reversals of Impairments of Long-Lived Assets

9.5. Derecognition

9.5.1. Sale of Long-Lived Assets

9.5.2. Long-Lived Assets Disposed of Other Than by a Sale

9.6. Presentation and Disclosures

9.7. Investment Property

10. 1-27.Income Taxes

10.1. Differences between Accounting Profit and Taxable Income

10.1.1. Current Tax Assets and Liabilities

10.1.2. Deferred Tax Assets and Liabilities

10.2. Determining the Tax Base of Assets and Liabilities

10.2.1. Determining the Tax Base of an Asset

10.2.2. Determining the Tax Base of a Liability

10.2.3. Changes in Income Tax Rates

10.3. Temporary and Permanent Differences Between Taxable and Accounting Profit

10.3.1. Taxable Temporary Differences

10.3.2. Deductible Temporary Differences

10.3.3. Examples of Taxable and Deductible Temporary Differences

10.3.4. Temporary Differences at Initial Recognition of Assets and Liabilities

10.3.5. Business Combinations and Deferred Taxes

10.3.6. Investments in Subsidiaries, Branches, Associates and Interests in Joint Ventures

10.4. Unused Tax Losses and Tax Credits

10.5. Recognition and Measurement of Current and Deferred Tax

10.5.1. Recognition of a Valuation Allowance

10.5.2. Recognition of Current and Deferred Tax Charged Directly to Equity

10.6. Presentation and Disclosure

10.7. Comparison of IFRS and US GAAP

11. 1-28.Non-Current (Long-Term) Liabilities

11.1. Bonds Payable

11.1.1. Accounting for Bond Issuance

11.1.2. Accounting for Bond Amortisation, Interest Expense, and Interest Payments

11.1.3. Current Market Rates and Fair Value Reporting Option

11.1.4. Derecognition of Debt

11.1.5. Debt Covenants

11.1.6. Presentation and Disclosure of Long-Term Debt

11.2. Leases

11.2.1. Lessee accounting

11.2.2. Lessor accounting

11.3. Introduction to Pensions and Other Post-Employment Benefits

11.4. Evaluating Solvency: Leverage and Coverage Ratios

12. 1-29.Financial Reporting Quality

12.1. Conceptual Overview

12.1.1. GAAP, Decision-Useful, Sustainable, and Adequate Returns

12.1.2. GAAP, Decision-Useful, but Sustainable?

12.1.3. Biased Accounting Choices Within GAAP, but “Earnings Management”

12.1.4. Departures from GAAP

12.1.5. Differentiate between Conservative and Aggressive Accounting Conservatism in Accounting Standards Bias in the Application of Accounting Standards

12.2. Context for Assessing Financial Reporting Quality

12.2.1. Motivations

12.2.2. Conditions Conducive to Issuing Low-Quality Financial Reports

12.2.3. Mechanisms That Discipline Financial Reporting Quality Market Regulatory Authorities Auditors Private Contracting

12.3. Detection of Financial Reporting Quality Issues

12.3.1. Presentation Choices

12.3.2. Accounting Choices and Estimates How Accounting Choices and Estimates Affect Earnings and Balance Sheets How Choices Affect the Cash Flow Statement Choices That Affect Financial Reporting

12.3.3. Warning Signs