1. I-20.Financial Reporting Standards
1.1. The Objective of Financial Reporting
1.2. Standard-Setting Bodies and Regulatory Authorities
1.2.1. Accounting Standards Boards
1.2.1.1. International Accounting Standards Board's (IASB's)
1.2.1.2. Financial Accounting Standards Board (FASB)
1.2.2. Regulatory Authorities
1.2.2.1. International Organization of Securities Commissions (IOSCO)
1.2.2.2. The Securities and Exchange Commission (US SEC)
1.2.2.2.1. Securities Act of 1933
1.2.2.2.2. Securities Exchange Act of 1934
1.2.2.2.3. Sarbanes– Oxley Act of 2002
1.2.2.2.4. Securities Offerings Registration Statement
1.2.2.2.5. Forms 10-K, 20-F, and 40-F
1.2.2.2.6. Annual Report
1.2.2.2.7. Proxy Statement/ Form DEF-14A
1.2.2.2.8. Forms 10-Q and 6-K
1.2.2.2.9. Form 8-K
1.2.2.2.10. Forms 3, 4, 5 and 144
1.2.2.2.11. Form 11-K
1.2.2.3. Capital Markets Regulation in Europe
1.3. The International Financial Reporting Standards Framework
1.3.1. Qualitative Characteristics of Financial Reports
1.3.1.1. Fundamental qualitative characteristics
1.3.1.1.1. Relevance
1.3.1.1.2. Faithful representation
1.3.1.2. Conceptual Framework
1.3.1.2.1. Comparability
1.3.1.2.2. Verifiability
1.3.1.2.3. Timeliness
1.3.1.2.4. Understandability
1.3.2. Constraints on Financial Reports
1.3.3. The Elements of Financial Statements
1.3.3.1. Underlying Assumptions in Financial Statements
1.3.3.1.1. Accrual basis
1.3.3.1.2. Going concern
1.3.3.2. Recognition of Financial Statement Elements
1.3.3.3. Measurement of Financial Statement Elements
1.3.3.3.1. Historical cost
1.3.3.3.2. Amortised cost
1.3.3.3.3. Current cost
1.3.3.3.4. Realizable (settlement) value
1.3.3.3.5. Present value (PV)
1.3.3.3.6. Fair value
1.3.3.4. Reporting Elements
1.3.3.4.1. Measurement of financial position
1.3.3.4.2. Measurement of financial performance
1.3.4. General Requirements for Financial Statements
1.3.4.1. Required Financial Statements
1.3.4.2. General Features of Financial Statements
1.3.4.2.1. Fair presentation
1.3.4.2.2. Going concern
1.3.4.2.3. Accrual basis
1.3.4.2.4. Materiality and aggregation
1.3.4.2.5. No offsetting
1.3.4.2.6. Frequency of reporting
1.3.4.2.7. Comparative information
1.3.4.2.8. Consistency
1.3.5. Structure and Content Requirements
1.3.5.1. Classified Statement of Financial Position (Balance Sheet)
1.3.5.2. Minimum Information on the Face of the Financial
1.3.5.3. Minimum Information in the Notes
1.3.5.3.1. Disclosure of accounting policies
1.3.5.3.2. Estimation uncertainty
1.3.5.3.3. Other disclosures
1.3.5.4. Comparative Information
1.4. Comparison of IFRS with Alternative Reporting Systems
1.5. Monitoring Developments in Financial Reporting Standards
1.5.1. New Products or Types of Transactions
1.5.2. Evolving Standards and the Role of CFA Institute
2. II-9.Intercorporate Investments
2.1. Learning Outcomes
2.2. Introduction
2.3. Basic Corporate Investment Categories
2.4. Investments In Financial Assets: IFRS 9
2.4.1. Classification and Measurement
2.4.2. Reclassification of Investments
2.5. Investments In Associates And Joint Ventures: Equity Method of Accounting, Basis Principles
2.5.1. Equity Method of Accounting: Basic Principles
2.6. Investment Costs That Exceed the Book Value of the Investee, Amortization of Excess Purchase Price, Fair Value Option and Impairment
2.6.1. Amortization of Excess Purchase Price
2.6.2. Fair Value Option
2.6.3. Impairment
2.7. Transactions with Associates and Disclosure
2.7.1. Disclosure
2.7.2. Issues for Analysts
2.8. Business Combinations: Acquisition Method and Impact of the Acquisition Method on Financial Statements Post-Acquisition
2.8.1. Acquisition Method
2.8.1.1. Recognition and Measurement of Identifiable Assets and Liabilities
2.8.1.2. Recognition and Measurement of Contingent Liabilities
2.8.1.3. Recognition and Measurement of Indemnification Assets
2.8.1.4. Recognition and Measurement of Financial Assets and Liabilities
2.8.1.5. Recognition and Measurement of Goodwill
2.8.1.6. Recognition and Measurement when Acquisition Price Is Less than Fair Value
2.8.2. Impact of the Acquisition Method on Financial Statements, Post-Acquisition
2.9. The Consolidation Process
2.9.1. Business Combination with Less than 100% Acquisition
2.9.2. Non-controlling (Minority) Interests: Balance Sheet
2.9.3. Non-controlling (Minority) Interests: Income Statement
2.9.4. Goodwill Impairment
2.10. Financial Statement Presentation Subsequent to the Business Combination
2.11. Variable Interest and Special Purpose Entities
2.11.1. Securitization of Assets
2.12. Additional Issues in Business Combinations That impair Comparability
2.12.1. Contingent Assets and Liabilities
2.12.2. Contingent Consideration
2.12.3. In-Process R& D
2.12.4. Restructuring Costs
3. II-10.Employee Compensation: Post-Employment and Share-Based
3.1. Learning Outcomes
3.2. Introduction
3.3. Pensions and Other Post-Employment Benefits
3.3.1. Types of Post-Employment Benefit Plans
3.4. Measuring a Defined Benefit Pension Plan's Obligations
3.5. Financial Statement Reporting of Pension Plans and Other Post-Employment Benefits: Defined Contribution Pension Plans
3.5.1. Defined Contribution Pension Plans
3.6. Financial Statement Reporting of Pension Plans: Balance Sheet Reporting for Defined Benefit Pension Plans
3.6.1. Balance Sheet Presentation
3.7. Financial Statement Reporting of Pension Plans: Periodic Pension Costs for Defined Benefit Pension Plans Reporting the Periodic Pension Cost.
3.8. More on the Effect of Assumptions and Actuarial Gains and Losses on Pension and Other Post-Employment Benefit Costs
3.9. Calculation of Defined Benefit Pension Obligation and Current Service Costs
3.10. Disclosures of Pension and Other Post-Employment Benefits: Assumptions
3.10.1. Assumptions
3.11. Disclosures of Pension and Other Post-Employment Benefits: Net Pension Liability (or Asset) and Periodic Pension Costs
3.11.1. Total Periodic Pension Costs
3.11.2. Periodic Pension Costs Recognised in P& L vs. OCI
3.11.3. Classification of Periodic Pension Costs Recognised in P& L
3.12. Disclosures of Pension and Other Post-Employment Benefits: Cash Flow Information
3.13. Share-Based Compensation
3.14. Stock Grants
3.15. Stock Options
3.16. Other Types of Share -Based Compensation
4. II-11.Multinational Operations
4.1. Learning Outcomes
4.2. Introduction and Foreign Currency Transactions: Foreign Currency Transaction Exposure to Foreign Exchange Risk and Analytical Issues
4.2.1. Foreign Currency Transactions
4.2.1.1. Foreign Currency Transaction Exposure to Foreign Exchange Risk
4.2.1.1.1. Accounting for Foreign Currency Transactions with Settlement before Balance Sheet Date
4.2.1.1.2. Accounting for Foreign Currency Transactions with Intervening Balance Sheet Dates
4.2.1.2. Analytical Issues
4.3. Disclosures Related to Foreign Currency Transaction Gains and Losses
4.4. Translation of Foreign Currency Financial Statements and Translation Conceptual Issues
4.4.1. Translation Conceptual Issues
4.4.1.1. All Assets and Liabilities Are Translated at the Current Exchange Rate
4.4.1.2. Only Monetary Assets and Monetary Liabilities Are Translated at the Current Exchange Rate
4.4.1.3. Balance Sheet Exposure
4.5. Translation Methods
4.5.1. Foreign Currency Is the Functional Currency
4.5.2. Parent’s Presentation Currency Is the Functional Currency
4.5.3. Translation of Retained Earnings
4.5.4. Highly Inflationary Economies
4.6. Illustration of Translation Methods (Excluding Hyperinflationary Economies)
4.7. Translation Analytical Issues
4.8. Translation When a Foreign Subsidiary Operates in an Hyperinflationary Economy
4.9. Companies Use Both Translation Methods at the Same Time and Disclosures Related to Translation Methods
4.9.1. Disclosures Related to Translation Methods
4.10. Multinational Operations and a Company's Effective Tax Rate
4.11. Additional Disclosures on the Effects of Foreign Currency
4.11.1. Disclosures Related to Sales Growth
4.11.2. Disclosures Related to Major Sources of Foreign Exchange Risk
5. II-12.Analysis of Financial Institutions
5.1. Learning Outcomes
5.2. Introduction to Financial Institutions
5.2.1. What Makes Financial Institutions Different?
5.2.2. Global Organizations
5.2.3. Individual Jurisdictions’ Regulatory Authorities
5.3. Analyzing a Bank: the CAMELS Approach
5.3.1. The CAMELS Approach
5.3.1.1. Capital Adequacy
5.3.1.2. Asset Quality
5.3.1.3. Management Capabilities
5.3.1.4. Earnings
5.3.1.5. Liquidity Position
5.3.1.6. Sensitivity to Market Risk
5.4. Analyzing a Bank: non-CAMELS Factors
5.4.1. Banking-Specific Analytical Considerations Not Addressed by CAMELS
5.4.2. Analytical Considerations Not Addressed by CAMELS That Are Also Relevant for Any Company
5.5. Analyzing a Bank: Example of CAMELS Approach
5.5.1. Capital Adequacy
5.5.2. Asset Quality
5.5.3. Management Capabilities
5.5.4. Earnings
5.5.5. Liquidity Position
5.5.6. Sensitivity to Market Risk
5.5.7. Overall CAMELS Assessment
5.6. Analyzing Property and Casualty Insurance Companies
5.6.1. Property and Casualty Insurance Companies
5.6.1.1. Operations: Products and Distribution
5.6.1.2. Earnings Characteristics
5.6.1.3. Investment Returns
5.6.1.4. Liquidity
5.6.1.5. Capitalization
5.7. Analyzing Life and Health Insurance Companies
5.7.1. Life and Health Insurance Companies
6. II-13.Evaluating Quality of Financial Reports
6.1. Learning Outcomes
6.2. Introduction
6.3. Quality of Financial Reports: Conceptual Framework
6.3.1. Conceptual Framework for Assessing the Quality of Financial Reports
6.4. Potential Problems that Affect the Quality of Financial Reports and Reported Amounts and Timing of Recognition
6.4.1. Reported Amounts and Timing of Recognition
6.5. Classification
6.6. Quality Issues and Mergers and Acquisitions & Financial Reporting that Diverges from Economic Reality Despite Compliance with Accounting Rules
6.6.1. Financial Reporting that Diverges from Economic Reality Despite Compliance with Accounting Rules
6.7. Evaluating the Quality of Financial Reports: General Steps
6.7.1. General Steps to Evaluate the Quality of Financial Reports
6.8. Quantitative Tools to Assess the Likelihood of Misreporting
6.8.1. Beneish Model
6.8.2. Other Quantitative Models
6.8.3. Limitations of Quantitative Models
6.9. Earnings Quality Indicators and Recurring Earnings
6.9.1. Indicators of Earnings Quality
6.9.1.1. Recurring Earnings
6.10. Earnings Persistence and Related Measures of Accruals
6.11. Mean Reversion in Earnings, Beating Benchmarks and External Indicators of Poor-Quality Earnings
6.11.1. Beating Benchmarks
6.11.2. External Indicators of Poor-Quality Earnings
6.12. Evaluating the Earnings Quality of a Company - Revenue Recognition Case: Sunbeam Corporation
6.12.1. Revenue Recognition Case: Sunbeam Corporation Premature/ Fraudulent Revenue Recognition
6.13. Revenue Recognition Case: MicroStrategy, Inc.
6.13.1. Multiple-Element Contracts
6.14. Cost Capitalization Case: WorldCom Corp.
6.14.1. Property/ Capital Expenditures Analysis
6.15. Bankruptcy Prediction Models: Altman Model, Developments in Bankruptcy Prediction Models
6.15.1. Altman Model
6.15.2. Developments in Bankruptcy Prediction Models
6.16. Cash Flow Quality
6.16.1. Indicators of Cash Flow Quality
6.16.2. Evaluating Cash Flow Quality
6.17. Balance Sheet Quality
6.18. Sources of Information about Risk and Limited Usefulness of Auditor's Report
6.18.1. Limited Usefulness of Auditor’s Opinion as a Source of Information about Risk
6.19. Risk-Related Disclosures in the Notes
6.20. Management Commentary (MD& A), Other Required Disclosures, Financial Press
6.20.1. Other Required Disclosures
6.20.2. Financial Press as a Source of Information about Risk
7. II-14.Integration of Financial Statement Analysis Techniques
7.1. Learning Outcomes
7.2. Introduction
7.3. Case Study 1: Long -Term Equity Investment: Early Phases of the Analysis
7.3.1. Phase 1: Define a Purpose for the Analysis
7.3.2. Phase 2: Collect Input Data
7.3.3. Phases 3 & 4: DuPont Analysis: Isolating "Pure Nestle"
7.3.3.1. Phase 3: Process Data and Phase 4: Analyze/ Interpret the Processed Data
7.3.4. Phases 3 & 4: DuPont Decomposition
7.3.5. Phases 3 & 4: Adjusting for Unusual Charges
7.3.6. Phases 3 & 4: Asset Base Composition Asset Base Composition
7.3.7. Phases 3 & 4: Capital Structure Analysis Capital Structure Analysis
7.3.8. Phases 3 & 4: Segment Analysis: Earnings & Capital Segment Analysis and Capital Allocation
7.3.9. Phases 3 & 4: Segment Analysis: Cash Flow & Capital
7.3.10. Phases 3 & 4: Segment Analysis by Product Group
7.3.11. Phases 3 & 4: Accruals and Earnings Quality
7.3.12. Phases 3 & 4: Cash Flow Relationships
7.3.13. Phases 3 & 4: Decomposition and Analysis of the Company's Valuation
7.3.14. Phases 5 & 6: Develop and Communicate Conclusions and Recommendations and Follow-up
7.3.14.1. Phase 5: Develop and Communicate Conclusions and Recommendations (e.g., with an Analysis Report) Support for an Investment in Nestlé Shares Causes for Concern
7.3.14.2. Phase 6: Follow-up
8. I-26.Long-Lived Assets
8.1. Acquisition of Long-Lived Assets
8.1.1. Property, Plant, and Equipment
8.1.2. Intangible Assets
8.1.2.1. Intangible Assets Purchased in Situations Other Than Business Combinations
8.1.2.2. Intangible Assets Developed Internally
8.1.2.3. Intangible Assets Acquired in a Business Combination
8.1.3. Capitalising versus Expensing: Impact on Financial Statements and Ratios
8.1.4. Capitalisation of Interest Costs
8.1.5. Capitalisation of Internal Development Costs
8.2. Depreciation and Amortisation of Long-Lived Assets
8.2.1. Depreciation Methods and Calculation of Depreciation Expense
8.2.2. Amortisation Methods and Calculation of Amortisation Expense
8.3. The Revaluation Model
8.4. Impairment of Assets
8.4.1. Impairment of Property, Plant, and Equipment
8.4.2. Impairment of Intangible Assets with a Finite Life
8.4.3. Impairment of Intangibles with Indefinite Lives
8.4.4. Impairment of Long-Lived Assets Held for Sale
8.4.5. Reversals of Impairments of Long-Lived Assets
8.5. Derecognition
8.5.1. Sale of Long-Lived Assets
8.5.2. Long-Lived Assets Disposed of Other Than by a Sale
8.6. Presentation and Disclosures
8.7. Investment Property
9. I-28.Non-Current (Long-Term) Liabilities
9.1. Bonds Payable
9.1.1. Accounting for Bond Issuance
9.1.2. Accounting for Bond Amortisation, Interest Expense, and Interest Payments
9.1.3. Current Market Rates and Fair Value Reporting Option
9.1.4. Derecognition of Debt
9.1.5. Debt Covenants
9.1.6. Presentation and Disclosure of Long-Term Debt
9.2. Leases
9.2.1. Lessee accounting
9.2.2. Lessor accounting
9.3. Introduction to Pensions and Other Post-Employment Benefits
9.4. Evaluating Solvency: Leverage and Coverage Ratios
10. I-19.Introduction to Financial Statement Analysis
10.1. Learning Outcomes
10.1.1. a.describe the roles of financial reporting and financial statement analysis
10.1.2. 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
10.1.3. c.describe the importance of financial statement notes and supplementary information— including disclosures of accounting policies, methods, and estimates— and management’s commentary
10.1.4. d.describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls
10.1.5. e.identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information
10.1.6. f.describe the steps in the financial statement analysis framework
10.2. Roles of Financial Reporting and Financial Statement Analysis
10.2.1. Role of financial statement reporting
10.2.2. Role of financial statement analysis
10.3. Primary Financial Statements and Other Information Sources
10.3.1. Financial Statements and Supplementary Information
10.3.1.1. Balance Sheet
10.3.1.2. Statement of Comprehensive Income
10.3.1.2.1. Income Statement
10.3.1.2.2. Other Comprehensive Income
10.3.1.3. Statement of Changes in Equity
10.3.1.4. Cash Flow Statement
10.3.1.5. Financial Notes and Supplementary Schedules
10.3.1.6. Management Commentary or Management’s Discussion and Analysis
10.3.1.7. Auditor’s Reports
10.3.1.7.1. Unqualified
10.3.1.7.2. Qualified
10.3.1.7.3. Adverse
10.3.1.7.4. Disclaimer
10.3.2. Other Sources of Information
10.3.2.1. Interim reports
10.3.2.2. Proxy statements
10.3.2.3. Press releases
10.3.2.4. External sources
10.4. Financial Statement Analysis Framework
10.4.1. 1.Articulate the Purpose and Context of Analysis
10.4.2. 2.Collect Data
10.4.3. 3.Process Data
10.4.4. 4.Analyze/ Interpret the Processed Data
10.4.5. 5.Develop and Communicate Conclusions/ Recommendations
10.4.6. 6.Follow-Up
11. I-21.Understanding Income Statements
11.1. Learning Outcomes
11.1.1. a.Describe the components of the income statement and alternative presentation formats of that statement
11.1.2. b.Describe general principles of revenue recognition and accounting standards for revenue recognition
11.1.3. c.calculate revenue given information that might influence the choice of revenue recognition method
11.1.4. d.describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis
11.1.5. e.describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies
11.1.6. f.distinguish between the operating and non-operating components of the income statement
11.1.7. 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
11.1.8. h.distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation
11.1.9. i.convert income statements to common-size income statements
11.1.10. j.evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement
11.1.11. k.describe, calculate, and interpret comprehensive income
11.1.12. l.describe other comprehensive income and identify major types of items included in it
11.2. Components and Format of the Income Statement
11.2.1. Revenue
11.2.2. Expenses
11.2.2.1. Grouping by Nature
11.2.2.2. Grouping by Function
11.2.3. Gross profit
11.2.4. Operating profit
11.2.5. Net income
11.2.6. Noncontrolling Interests
11.3. Revenue Recognition
11.3.1. Revenue General Principles
11.3.1.1. 1.Identify the contract(s) with a customer
11.3.1.2. 2.Identify the separate or distinct performance obligations in the contract
11.3.1.3. 3.Determine the transaction price
11.3.1.4. 4.Allocate the transaction price to the performance obligations in the contract
11.3.1.5. 5.Recognize revenue when (or as) the entity satisfies a performance obligation
11.3.2. Accounting Standards for Revenue Recognition
11.3.2.1. Revenue from Contracts with Customers
11.3.2.1.1. Identifying the Performance Obligation
11.3.2.1.2. Percentage-of-completion
11.3.2.1.3. Variable consideration
11.3.2.1.4. Cumulative catch-up adjustment
11.3.2.1.5. Suppliers deliver
11.4. Expense Recognition
11.4.1. Expense General Principles
11.4.2. Issues in Expense Recognition
11.4.2.1. Doubtful Accounts
11.4.2.2. Warranties
11.4.2.3. Depreciation and Amortisation
11.4.2.3.1. Straight-line method
11.4.2.3.2. Double declining balance depreciation
11.4.3. Implications for Financial Analysis
11.5. Non-Recurring Items and Non-Operating Items
11.5.1. Discontinued Operations
11.5.2. Unusual or Infrequent Items
11.5.3. Changes in Accounting Policies
11.5.4. Non-Operating Items
11.6. Earnings per Share
11.6.1. Simple versus Complex Capital Structure
11.6.2. Basic EPS
11.6.3. Diluted EPS
11.6.3.1. Diluted EPS When a Company Has Convertible Preferred Stock Outstanding
11.6.3.2. Diluted EPS When a Company Has Convertible Debt Outstanding
11.6.3.3. Diluted EPS When a Company Has Stock Options, Warrants, or Their Equivalents Outstanding
11.6.3.4. Other Issues with Diluted EPS
11.6.4. Changes in EPS
11.7. Analysis of the Income Statement
11.7.1. Common-Size Analysis of the Income Statement
11.7.2. Income Statement Ratios
11.7.2.1. Net Profit Margin = Net Income / Revenue
11.7.2.2. Gross Profit Margin = Gross profit / Revenue
11.8. Comprehensive Income
12. I-22.Understanding Balance Sheets
12.1. Components and Format of the Balance Sheet
12.1.1. Balance Sheet Components
12.1.2. Current and Non-Current Classification
12.1.3. Liquidity-Based Presentation
12.2. Current Assets
12.2.1. Cash and Cash Equivalents
12.2.2. Marketable Securities
12.2.3. Trade Receivables
12.2.4. Inventories
12.2.5. Other Current Assets
12.3. Current Liabilities
12.3.1. Trade payables
12.3.2. Accrued expenses
12.3.3. Deferred income
12.4. Non-Current Assets
12.4.1. Property, Plant, and Equipment
12.4.2. Investment Property
12.4.3. Intangible Assets
12.4.3.1. Identifiable Intangibles
12.4.4. Goodwill
12.4.4.1. Accounting Goodwill
12.4.4.2. Economic Goodwill
12.4.4.3. Goodwill Impairment
12.4.5. Financial Assets
12.4.5.1. Derivatives
12.4.5.2. Amortised cost
12.4.5.3. Held-to-maturity
12.4.5.4. Available-for-sale
12.4.6. Deferred Tax Assets
12.5. Non-Current Liabilities
12.5.1. Long-term Financial Liabilities
12.5.2. Deferred Tax Liabilities
12.6. Equity
12.6.1. Components of Equity
12.6.1.1. Common stock
12.6.1.2. Preferred shares
12.6.1.3. Treasury stock
12.6.1.4. Retained earnings
12.6.1.5. Accumulated other comprehensive income
12.6.1.6. Noncontrolling interest
12.6.2. Statement of Changes in Equity
12.7. Analysis of the Balance Sheet
12.7.1. Common-Size Analysis of the Balance Sheet
12.7.2. Balance Sheet Ratios
12.7.2.1. Liquidity Ratios
12.7.2.1.1. Current = Current assets / Current liabilities
12.7.2.1.2. Quick (acid test) = (Cash + Marketable securities + Receivables) / Current liabilities
12.7.2.1.3. Cash = (Cash + Marketable securities) / Current liabilities
12.7.2.2. Solvency Ratios
12.7.2.2.1. Long-term debt-to-equity = Total long-term debt / Total equity
12.7.2.2.2. Debt-to-equity = Total debt / Total equity
12.7.2.2.3. Total debt = Total debt / Total assets
12.7.2.2.4. Financial leverage = Total assets / Total equity
13. I-23.Understanding Cash Flow Statements
13.1. Components and Format of the Cash Flow Statement
13.1.1. Classification of Cash Flows and Non-Cash Activities
13.1.2. A Summary of Differences between IFRS and US GAAP
13.1.3. Direct and Indirect Methods for Reporting Cash Flow from Operating Activities
13.1.3.1. An Indirect-Format Cash Flow Statement Prepared under IFRS
13.1.3.2. A Direct-Format Cash Flow Statement Prepared under IFRS
13.1.3.3. Illustrations of Cash Flow Statements Prepared under US GAAP
13.2. The Cash Flow Statement: Linkages and Preparation
13.2.1. Linkages of the Cash Flow Statement with the Income Statement and Balance Sheet
13.2.2. Steps in Preparing the Cash Flow Statement
13.2.2.1. Operating Activities: Direct Method
13.2.2.1.1. Cash Received from Customers
13.2.2.1.2. Cash Paid to Suppliers
13.2.2.1.3. Cash Paid to Employees
13.2.2.1.4. Cash Paid for Other Operating Expenses
13.2.2.1.5. Cash Paid for Interest
13.2.2.1.6. Cash Paid for Income Taxes
13.2.2.2. Investing Activities
13.2.2.3. Financing Activities
13.2.2.3.1. Long-Term Debt and Common Stock
13.2.2.3.2. Dividends
13.2.2.4. Overall Statement of Cash Flows: Direct Method
13.2.2.5. Overall Statement of Cash Flows: Indirect Method
13.2.3. Conversion of Cash Flows from the Indirect to the Direct Method
13.3. Free Cash Flow to the Firm and Free Cash Flow to Equity
13.4. Cash Flow Statement Analysis
13.4.1. Evaluation of the Sources and Uses of Cash
13.4.2. Common-Size Analysis of the Statement of Cash Flows
13.4.3. Cash Flow Ratios
14. I-24.Financial Analysis Techniques
14.1. The Financial Analysis Process
14.1.1. The Objectives of the Financial Analysis Process
14.1.2. Distinguishing between Computations and Analysis
14.2. Analytical Tools and Techniques
14.2.1. Ratios
14.2.2. Common-Size Analysis
14.2.3. The Use of Graphs as an Analytical Tool
14.2.4. Regression Analysis
14.3. Common Ratios Used in Financial Analysis
14.3.1. Interpretation and Context
14.3.2. Activity Ratios
14.3.2.1. Inventory turnover = Cost of sales or cost of goods sold / Average inventory
14.3.2.2. Days of inventory on hand (DOH) = Number of days in period / Inventory turnover
14.3.2.3. Receivables turnover = Revenue / Average receivables
14.3.2.4. Days of sales outstanding (DSO) = Number of days in period / Receivables turnover
14.3.2.5. Payables turnover = Purchases / Average trade payables
14.3.2.6. Number of days of payables = Number of days in period / Payables turnover
14.3.2.7. Working capital turnover = Revenue / Average working capital
14.3.2.8. Fixed asset turnover = Revenue / Average net fixed assets
14.3.2.9. Total asset turnover = Revenue / Average total assets
14.3.3. Liquidity Ratios
14.3.3.1. Current ratio = Current assets / Current liabilities
14.3.3.2. Quick ratio = (Cash + Short-term marketable investments + Receivables) / Current liabilities
14.3.3.3. Cash ratio = (Cash + Short-term marketable investments) / Current liabilities
14.3.3.4. Defensive interval ratio = (Cash + Short-term marketable investments + Receivables) / Daily cash expenditures
14.3.3.5. Cash conversion cycle (net operating cycle) = DOH + DSO – Number of days of payables
14.3.4. Solvency Ratios
14.3.4.1. Debt Ratios
14.3.4.1.1. Debt-to-assets ratio = Total debt / Total assets
14.3.4.1.2. Debt-to-capital ratio = Total debt / (Total debt + Total shareholders’ equity)
14.3.4.1.3. Debt-to-equity ratio = Total debt / Total shareholders’ equity
14.3.4.1.4. Financial leverage ratio = Average total assets / Average total equity
14.3.4.1.5. Debt-to-EBITDA = Total debt / EBITDA
14.3.4.2. Coverage Ratios
14.3.4.2.1. Interest coverage = EBIT / Interest payments
14.3.4.2.2. Fixed charge coverage = (EBIT + Lease payments) / (Interest payments + Lease payments)
14.3.5. Profitability Ratios
14.3.5.1. Return on Sales
14.3.5.1.1. Gross profit margin = Gross profit / Revenue
14.3.5.1.2. Operating profit margin = Operating income / Revenue
14.3.5.1.3. Pretax margin = EBT / Revenue
14.3.5.1.4. Net profit margin = Net income / Revenue
14.3.5.2. Return on Investment
14.3.5.2.1. Operating ROA = Operating income / Average total assets
14.3.5.2.2. ROA = Net income / Average total assets
14.3.5.2.3. Return on total capital = EBIT / Average short- and long-term debt and equity
14.3.5.2.4. ROE = Net income / Average total equity
14.3.5.2.5. Return on common equity = (Net income – Preferred dividends) / Average common equity
14.3.6. DuPont Analysis: The Decomposition of ROE
14.3.6.1. ROE = Net income/ Average shareholders’ equity
14.3.6.2. ROE = ROA × Leverage
14.3.6.2.1. ROA = Net Income / Average Total Assets
14.3.6.2.2. Leverage = Average total assets / Average shareholders' equity
14.3.6.3. ROE = Net profit margin × Total asset turnover × Leverage
14.3.6.3.1. Net profit margin = Net income / Revenue
14.3.6.3.2. Total asset turnover = Revenue / Average total assets
14.3.6.3.3. Leverage = Average total assets / Average shareholders' equity
14.3.6.4. ROE = Tax burden × Interest burden × EBIT margin × Total asset turnover × Leverage
14.3.6.4.1. Tax burden = Net income / EBT
14.3.6.4.2. Interest burden = EBT / EBIT
14.3.6.4.3. EBIT margin = EBIT / Revenue
14.3.6.4.4. Total asset turnover = Revenue / Average total assets
14.3.6.4.5. Leverage = Average total assets / Average shareholders' equity
14.4. Equity Analysis
14.4.1. Valuation Ratios
14.4.1.1. Valuation Ratios
14.4.1.1.1. P/ E = Price per share / Earnings per share
14.4.1.1.2. P/ CF = Price per share / Cash flow per share
14.4.1.1.3. P/ S = Price per share / Sales per share
14.4.1.1.4. P/ BV = Price per share / Book value per share
14.4.1.2. Per-Share Quantities
14.4.1.2.1. Basic EPS = Net income minus preferred dividends / Weighted average number of ordinary shares outstanding
14.4.1.2.2. Diluted EPS = Adjusted income available for ordinary shares, reflecting conversion of dilutive securities / Weighted average number of ordinary and potential ordinary shares outstanding
14.4.1.2.3. Cash flow per share = Cash flow from operations / Weighted average number of shares outstanding
14.4.1.2.4. EBITDA per share = EBITDA / Weighted average number of shares outstanding
14.4.1.2.5. Dividends per share = Common dividends declared / Weighted average number of ordinary shares outstanding
14.4.1.3. Dividend-Related Quantities
14.4.1.3.1. Dividend payout ratio = Common share dividends / Net income attributable to common shares
14.4.1.3.2. Retention rate (b) = (Net income attributable to common shares – Common share dividends) / Net income attributable to common shares
14.4.1.3.3. Sustainable growth rate = Retention rate (b) × ROE
14.4.2. Industry-Specific Ratios
14.4.2.1. Business Risk
14.4.2.1.1. Coefficient of variation of operating income = Standard deviation of operating income / Average operating income
14.4.2.1.2. Coefficient of variation of net income = Standard deviation of net income / Average net income
14.4.2.1.3. Coefficient of variation of revenues = Standard deviation of revenue / Average revenue
14.4.2.2. Financial Sector Ratios
14.4.2.2.1. Capital adequacy— banks = Various components of capital / Various measures such as risk-weighted assets, market risk exposure, or level of operational risk assumed
14.4.2.2.2. Monetary reserve requirement (Cash reserve ratio) = Reserves held at central bank / Specified deposit liabilities
14.4.2.2.3. Liquid asset requirement = Approved “readily marketable” securities / Specified deposit liabilities
14.4.2.2.4. Net interest margin = Net interest income / Total interest-earning assets
14.4.2.3. Retail Ratios
14.4.2.3.1. Same (or comparable) store sales = Average revenue growth year over year for stores open in both periods
14.4.2.3.2. Sales per square meter (or square foot) = Revenue / Total retail space in square meters (or square feet)
14.4.2.4. Service Companies
14.4.2.4.1. Revenue per employee = Revenue / Total number of employees
14.4.2.4.2. Net income per employee = Net income / Total number of employees
14.4.2.5. Hotel
14.4.2.5.1. Average daily rate = Room revenue / Number of rooms sold
14.4.2.5.2. Occupancy rate = Number of rooms sold / Number of rooms available
14.4.3. Historical Research on Ratios in Equity Analysis
14.5. Credit Analysis
14.5.1. The Credit Rating Process
14.5.2. Credit Ratio
14.5.2.1. EBITDA interest coverage = EBITDA / Interest expense, including non-cash interest on conventional debt instruments
14.5.2.1.1. EBITDA = earnings before interest, taxes, depreciation, and amortization
14.5.2.2. FFO (Funds from operations) to debt = FFO / Total debt
14.5.2.2.1. FFO = funds from operations, defined as EBITDA minus net interest expense minus current tax expense (plus or minus all applicable adjustments).
14.5.2.3. Free operating cash flow to debt = CFO (adjusted) minus capital expenditures / Total debt
14.5.2.3.1. CFO = cash flow from operations
14.5.2.4. EBIT margin = EBIT / Total revenues
14.5.2.4.1. EBIT = earnings before interest and taxes
14.5.2.5. EBITDA margin = EBITDA / Total revenues
14.5.2.6. Debt to EBITDA = Total debt / EBITDA
14.5.2.7. Return on capital = EBIT / Average beginning-of-year and end-of-year capital
14.5.2.7.1. Capital = debt plus noncurrent deferred taxes plus equity (plus or minus all applicable adjustments)
14.6. Business and Geographic Segments
14.7. Model Building and Forecasting
15. I-30.Applications of Financial Statement Analysis
15.1. Application: Evaluating Past Financial Performance
15.2. Application: Projecting Future Financial Performance
15.2.1. Projecting Performance: An Input to Market-Based Valuation
15.2.2. Projecting Multiple-Period Performance
15.3. Application: Assessing Credit Risk
15.4. Application: Screening for Potential Equity Investments
15.5. Analyst Adjustments to Reported Financials
15.5.1. A Framework for Analyst Adjustments
15.5.2. Analyst Adjustments Related to Investments
15.5.3. Analyst Adjustments Related to Inventory
15.5.4. Analyst Adjustments Related to Property, Plant and Equipment
15.5.5. Analyst Adjustments Related to Goodwill
16. I-25.Inventories
16.1. Cost of Inventories
16.1.1. Costs of purchase
16.1.2. Costs of conversion
16.1.3. Exclude the costs from inventory
16.2. Inventory Adjustments
16.3. Inventory Method Changes
16.4. Inventory Valuation Methods
16.4.1. Specific Identification
16.4.2. First-In, First-Out (FIFO)
16.4.3. Weighted Average Cost
16.4.4. Last-In, First-Out (LIFO)
16.4.4.1. LIFO Reserve
16.4.4.2. LIFO Liquidations
16.4.5. Calculation of Cost of Sales, Gross Profit, and Ending Inventory
16.4.6. Periodic versus Perpetual Inventory Systems
16.4.7. Comparison of Inventory Valuation Methods
16.5. Evaluation of Inventory Management
16.5.1. Presentation and Disclosure
16.5.2. Inventory Ratios
16.5.3. Financial Analysis Illustrations
17. I-27.Income Taxes
17.1. Differences between Accounting Profit and Taxable Income
17.1.1. Current Tax Assets and Liabilities
17.1.2. Deferred Tax Assets and Liabilities
17.2. Determining the Tax Base of Assets and Liabilities
17.2.1. Determining the Tax Base of an Asset
17.2.2. Determining the Tax Base of a Liability
17.2.3. Changes in Income Tax Rates
17.3. Temporary and Permanent Differences Between Taxable and Accounting Profit
17.3.1. Taxable Temporary Differences
17.3.2. Deductible Temporary Differences
17.3.3. Examples of Taxable and Deductible Temporary Differences
17.3.4. Temporary Differences at Initial Recognition of Assets and Liabilities
17.3.5. Business Combinations and Deferred Taxes
17.3.6. Investments in Subsidiaries, Branches, Associates and Interests in Joint Ventures
17.4. Unused Tax Losses and Tax Credits
17.5. Recognition and Measurement of Current and Deferred Tax
17.5.1. Recognition of a Valuation Allowance
17.5.2. Recognition of Current and Deferred Tax Charged Directly to Equity
17.6. Presentation and Disclosure
17.7. Comparison of IFRS and US GAAP
18. I-29.Financial Reporting Quality
18.1. Conceptual Overview
18.1.1. GAAP, Decision-Useful, Sustainable, and Adequate Returns
18.1.2. GAAP, Decision-Useful, but Sustainable?
18.1.3. Biased Accounting Choices
18.1.3.1. Within GAAP, but “Earnings Management”
18.1.4. Departures from GAAP
18.1.5. Differentiate between Conservative and Aggressive Accounting
18.1.5.1. Conservatism in Accounting Standards
18.1.5.2. Bias in the Application of Accounting Standards
18.2. Context for Assessing Financial Reporting Quality
18.2.1. Motivations
18.2.2. Conditions Conducive to Issuing Low-Quality Financial Reports
18.2.3. Mechanisms That Discipline Financial Reporting Quality
18.2.3.1. Market Regulatory Authorities
18.2.3.2. Auditors
18.2.3.3. Private Contracting
18.3. Detection of Financial Reporting Quality Issues
18.3.1. Presentation Choices
18.3.2. Accounting Choices and Estimates
18.3.2.1. How Accounting Choices and Estimates Affect Earnings and Balance Sheets
18.3.2.2. How Choices Affect the Cash Flow Statement
18.3.2.3. Choices That Affect Financial Reporting
18.3.3. Warning Signs