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CFA Level 1-Financial Statement notes 2022
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CFA Level 1-Financial Statement notes 2022
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Financial Statement and Corporateissuers
Understanding Income Statements
Intro
Net income can be defined as:
o Income-expenses
o Revenue plus other income plus gains minus expenses
o Revenue plus other income plus gains minus expenses in the ordinary activities of the
business minus other expenses, and minus losses re-arrange to net income equals (i)
revenue minus expenses in the ordinary activities of the business, plus (ii) other income
minus other expenses, plus (iii) gains minus losses.
When use a gross profit (revenue less COS) known as a multi-step format
Operating profit is deducting operating expenses, selling, admin, R+D from Gross profit. Reflects
profit before tax and interest
Operating profit sometimes referred to as EBIT (Earnings before interest &tax) Might not be the
same
Under IFRS increases from IB include enhancements of assets not related to owners
contribution
Under US GAAP, operating activities generally involve producing and delivering goods and
providing services and include all transactions and other events that are not defined as investing
or financing activities
In common-size analysis of a company’s income statement, each income and expense line item
is expressed as a percentage of net revenues (net sales)
Revenue recognition
IASB: Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to contributions from equity participants
When adopting IASB FASB profitability will be higher after 2014
IFRS: income includes rev and gains (secondary form of activity to generate profit:
Steps:
1. Identify the contract(s) with a customer
2. Performance obligations in the contract
3. 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
Customer takes control of asset when:
1. Entity has a present right to payment
2. Customer has legal title
3. Customer has physical possession
4. Customer has the significant risks and rewards of ownership
5. Customer has accepted the asset
,Expense recognition
IASB: decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than
those relating to distributions to equity participants
Expenses encompasses losses as well as those
expenses that arise in the course of the ordinary
activities of the enterprise
Matching principle- recognizes expenses in the
period that it consumes the economic benefits
associated with the expenditure, or loses previously recognized as economic benefit
Can do by Function or nature
Function- such as COGS
Nature: depreciation-single line
Depreciation and Amortization
Depreciation is the process of systematically allocating costs of long-lived assets over the period
during which the assets are expected to provide economic benefits
Amortisation is the term commonly applied to this process for intangible long-lived assets with
a finite useful life
2 options for PPE: Cost or re-valuation
Under the cost model, the asset is reported at its cost less any accumulated depreciation. Under
the revaluation model, the asset is reported at its fair value. The revaluation model is not
permitted under US GAAP
Straight-line- evenly across life of asset- residual value at end of useful life
Alternatives are known as accelerated as they speed up the timing of depreciation. Allocate
more in earlier years- 100% or 200%- 200 is known as double decline balance dep
Goodwill and intangible assets with indefinite life are not amortised- tested for impairment
If the current value of an intangible asset or goodwill is materially lower than its value in the
company’s books, the value of the asset is considered to be impaired and its value in the
company’s books must be decreased
A declining balance depreciation with a short useful life is most conservative with a short useful
life- most amount of depreciation in the first year- lowering income
Basic EPS and Diluted EPS
IFRS and GAAP require: the presentation of EPS on the face of the income statement for net
profit or loss (net income) and profit or loss (income) from continuing operations
EPS that would result if all dilutive financial instruments were converted is called diluted EPS. In
contrast, basic EPS is calculated using the reported earnings available to common shareholders
of the parent company and the weighted average number of shares outstanding.
If have a simple structure ie no options if you issue stocks Basic EPS is calculated using weighted
avg and basic EPS=Diluted EPS
Diluted always equal to or less than basic eps
Convertible Preferred stock- If converted method. No preferred div- higher net income
attributable to shareholders. However, there are now more shares- weighted avg is higher.
Convertible debt- Company would not have paid interest on the convertible debt, so the net
income available to common shareholders would increase by the after-tax amount of interest
expense on the debt converted
, Treasury stock method- Diluted EPS is calculated as if the financial instruments had been
exercised and the company had used the proceeds from exercise to repurchase as many shares
of common stock as possible at the average market price of common stock during the period.
The weighted average number of shares outstanding for diluted EPS is thus increased by the
number of shares that would be issued upon exercise minus the number of shares that would
have been purchased with the proceeds.
Anti-dilutive- would result in higher EPS and not included in calculation of diluted EPS.
If there was a stock split 2 for 1 (receive 2 for every 1), Do the calculation as normal then double
it at the end.
Comprehensive income
IFRS, other comprehensive income includes items of income and expense that are “not
recognized in profit or loss as required or permitted by other IFRS.”
Total comprehensive income is “the change in equity during a period resulting from transaction
and other events, other than those changes resulting from transactions with owners in their
capacity as owners
OCI=CI-Net income. Comprehensive income includes both net income and other revenue and
expense items that are excluded from the net income calculation
Assume equity at start is £110m. Net income is £10m. Dividend is £2m. No repurchase/issue.
Actual ending equity is £123m but (123-(110+10-2)= £5m has bypassed the net income
calculation. Ending equity is thus £118M (110+10-2)
Four items treated as other comprehensive income:
o Foreign currency translation adjustments. In consolidating the financial statements of
foreign subsidiaries, the effects of translating the subsidiaries’ balance sheet assets and
liabilities at current exchange rates are included as other comprehensive income.
o Unrealized gains or losses on derivatives contracts accounted for as hedges. Changes in
the fair value of derivatives are recorded each period, but certain changes in value are
treated as other comprehensive income and thus bypass the income statement.
o Unrealized holding gains and losses on a certain category of investment securities,
namely, available-for-sale debt securities under US GAAP and securities designated as
“fair value through other comprehensive income” under IFRS. (Note: IFRS, but not US
GAAP, also includes a category of equity investments designated at fair value through
other comprehensive income.)
o Certain costs of a company’s defined benefit post-retirement plan that are not
recognized in the current period.
Debt and equity investments are referred to as being measured at fair value through profit or
loss under IFRS no measure under GAAP- these make the income statement as well as trading
securities
Even where unrealized holding gains and losses are excluded from a company’s net income
(profit and loss), they are included in other comprehensive income
OCI not shown in P/E
Understanding Balance Sheets
A balance sheet with separately classified current and non-current assets and liabilities is
referred to as a classified balance sheet
Liquidity-based presentation, rather than a current/non-current presentation, is used when such
a presentation provides information that is reliable and more relevant. With a liquidity-based
presentation, all assets and liabilities are presented broadly in order of liquidity.
, Current Assets and liabilities
Cash equivalents are highly liquid, short-term investments that are so close to maturity. These
are measured and reported at amortised cost or FV
Marketable securities shares and debt. Trading securities unrealized gains and losses reflected
in shareholders equity flow through income into retained earnings
Trade receivables Not paid yet. Allowance for doubtful accounts reflects the company’s estimate
of the amount of receivables that will ultimately be uncollectible. Written off by reducing
accounts receivable and the allowance for doubtful accounts. The allowance for doubtful
accounts is called a contra account. Receivables are reported net of the allowance for doubtful
accounts.
Inventories- Inventories are measured at the lower of cost and net realizable value (NRV) under
IFRS. In US if fall below a carrying amount- must write off the stock. Can be reversed if these
increases
Accrual expenses- expenses that have been recognized on a company’s income statement but
not yet been paid as of the balance sheet date e.g expenses
Deferred income is a liability. Receive payment and not given the goods/services to customer
yet. Known as deferred revenue or unearned revenue.
Vertical common-size analysis involves stating each balance sheet item as a percentage of total
assets
Property, Plant and Equipment
Property, plant, and equipment (PPE) are tangible assets that are used in company operations
and expected to be used (provide economic benefits) over more than one fiscal period
Investment property under IFRS cost or fair value
US GAAP permits only the cost model for reporting PPE.
Two methods:
Cost- PPE carried at amortised cost (Costs-acc depreciation-impairment losses). Historical cost
generally consists of an asset’s purchase price, plus its delivery cost, and any other additional
costs incurred to make the asset operable (such as costs to install a machine)
Impairment losses are when the assets recoverable amount is less than its carrying amount:
o Recoverable amount: The higher of an asset’s fair value less cost to sell, and its value in
use.
o Fair value less cost to sell: The amount obtainable in a sale of the asset in a transaction
between knowledgeable willing parties, less the costs of the sale.
o Value in use: The present value of the future cash flows expected to be derived from the
asset
When an asset is considered impaired, the company recognizes the impairment loss in the
income statement in the period the impairment is identified. Reversals of impairment losses are
permitted under IFRS but not under US GAAP.
Revaluation- the reported and carrying value for PPE is the fair value at the date of revaluation
less any subsequent accumulated depreciation. Changes in the value of PPE under the
revaluation model affect equity directly or profit and loss depending upon the circumstances.
Non-Current assets- Intangible
Intangible assets are identifiable non-monetary assets without physical substance
An identifiable asset can be acquired singly (can be separated from the entity) or is the result of
specific contractual or legal rights or privileges e.g patents, licenses and trademarks
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