Financial Statement

Analysis

LEARNING OUTCOMES

Introduction to Financial Statement Analysis

The candidate should be able to:
□ describe the roles of financial reporting and financial statement analysis
□ 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
□ describe the importance of financial statement notes and supplementary
information—including disclosures of accounting policies, methods, and
estimates—and management’s commentary
□ describe the objective of audits of financial statements, the types of audit
reports, and the importance of effective internal controls
□ identify and describe information sources that analysts use in financial statement
analysis besides annual financial statements and supplementary information
□ describe the steps in the financial statement analysis framework

Financial Reporting Standards

The candidate should be able to:
□ describe the objective of financial reporting and the importance of financial
reporting standards in security analysis and valuation
□ describe the roles of financial reporting standard-setting bodies and regulatory
authorities in establishing and enforcing reporting standards
□ describe the International Accounting Standards Board’s conceptual framework,
including qualitative characteristics of financial reports, constraints on financial
reports, and required reporting elements
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□ describe general requirements for financial statements under International

Financial Reporting Standards (IFRS)
□ describe implications for financial analysis of alternative financial reporting
systems and the importance of monitoring developments in financial reporting
standards

Understanding Income Statements

The candidate should be able to:
□ describe the components of the income statement and alternative presentation
formats of that statement
□ describe general principles of revenue recognition and accounting standards for
revenue recognition
□ calculate revenue given information that might influence the choice of revenue
recognition method
□ describe general principles of expense recognition, specific expense recognition
applications, and implications of expense recognition choices for financial
analysis
□ describe the financial reporting treatment and analysis of non-recurring items
(including discontinued operations, unusual or infrequent items) and changes in
accounting policies
□ contrast operating and non-operating components of the income statement
□ 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
□ contrast dilutive and antidilutive securities and describe the implications of each
for the earnings per share calculation
□ formulate income statements into common-size income statements
□ evaluate a company’s financial performance using common-size income
statements and financial ratios based on the income statement
□ describe, calculate, and interpret comprehensive income
□ describe other comprehensive income and identify major types of items included
in it

Understanding Balance Sheets

The candidate should be able to:
□ describe the elements of the balance sheet: assets, liabilities, and equity
□ describe uses and limitations of the balance sheet in financial analysis
□ describe alternative formats of balance sheet presentation
□ contrast current and non-current assets and current and non-current liabilities
□ describe different types of assets and liabilities and the measurement bases of
each
□ describe the components of shareholders’ equity
□ demonstrate the conversion of balance sheets to common-size balance sheets
and interpret common-size balance sheets
□ calculate and interpret liquidity and solvency ratios

Understanding Cash Flow Statements

The candidate should be able to:
□ 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
□ describe how non-cash investing and financing activities are reported
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□ contrast cash flow statements prepared under International Financial Reporting

Standards (IFRS) and US generally accepted accounting principles (US GAAP)
□ compare and contrast the direct and indirect methods of presenting cash from
operating activities and describe arguments in favor of each method
□ describe how the cash flow statement is linked to the income statement and the
balance sheet
□ 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
□ demonstrate the conversion of cash flows from the indirect to direct method
□ analyze and interpret both reported and common-size cash flow statements
□ calculate and interpret free cash flow to the firm, free cash flow to equity, and
performance and coverage cash flow ratios

Financial Analysis Techniques

The candidate should be able to:
□ describe tools and techniques used in financial analysis, including their uses and
limitations
□ identify, calculate, and interpret activity, liquidity, solvency, profitability, and
valuation ratios
□ describe relationships among ratios and evaluate a company using ratio analysis
□ demonstrate the application of DuPont analysis of return on equity and calculate
and interpret effects of changes in its components
□ calculate and interpret ratios used in equity analysis and credit analysis
□ explain the requirements for segment reporting and calculate and interpret
segment ratios
□ describe how ratio analysis and other techniques can be used to model and
forecast earnings

Inventories
The candidate should be able to:
□ contrast costs included in inventories and costs recognised as expenses in the
period in which they are incurred
□ describe different inventory valuation methods (cost formulas)
□ calculate and compare cost of sales, gross profit, and ending inventory using
different inventory valuation methods and using perpetual and periodic
inventory systems
□ calculate and explain how inflation and deflation of inventory costs affect
the financial statements and ratios of companies that use different inventory
valuation methods
□ explain LIFO reserve and LIFO liquidation and their effects on financial
statements and ratios
□ demonstrate the conversion of a company’s reported financial statements from
LIFO to FIFO for purposes of comparison
□ describe the measurement of inventory at the lower of cost and net realisable
value
□ describe implications of valuing inventory at net realisable value for financial
statements and ratios
□ describe the financial statement presentation of and disclosures relating to
inventories
□ explain issues that analysts should consider when examining a company’s
inventory disclosures and other sources of information
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□ calculate and compare ratios of companies, including companies that use

different inventory methods
□ analyze and compare the financial statements of companies, including
companies that use different inventory methods

Long-Lived Assets
The candidate should be able to:
□ compare the financial reporting of the following types of intangible assets:
purchased, internally developed, acquired in a business combination
□ explain and evaluate how capitalising versus expensing costs in the period in
which they are incurred affects financial statements and ratios
□ describe the different depreciation methods for property, plant, and equipment
and calculate depreciation expense
□ describe how the choice of depreciation method and assumptions concerning
useful life and residual value affect depreciation expense, financial statements,
and ratios
□ explain and evaluate how impairment, revaluation, and derecognition of
property, plant, and equipment and intangible assets affect financial statements
and ratios
□ describe the different amortisation methods for intangible assets with finite lives
and calculate amortisation expense
□ describe how the choice of amortisation method and assumptions concerning
useful life and residual value affect amortisation expense, financial statements,
and ratios
□ describe the revaluation model
□ explain the impairment of property, plant, and equipment and intangible assets
□ explain the derecognition of property, plant, and equipment and intangible
assets
□ describe the financial statement presentation of and disclosures relating to
property, plant, and equipment and intangible assets
□ analyze and interpret financial statement disclosures regarding property, plant,
and equipment and intangible assets
□ compare the financial reporting of investment property with that of property,
plant, and equipment
□ identify and contrast costs that are capitalised and costs that are expensed in the
period in which they are incurred

Income Taxes
The candidate should be able to:
□ 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
□ 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
□ 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
□ calculate the tax base of a company’s assets and liabilities
□ evaluate the effect of tax rate changes on a company’s financial statements and
ratios
□ identify and contrast temporary versus permanent differences in pre-tax
accounting income and taxable income
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□ explain recognition and measurement of current and deferred tax items

□ describe the valuation allowance for deferred tax assets—when it is required and
what effect it has on financial statements
□ 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
□ identify the key provisions of and differences between income tax accounting
under International Financial Reporting Standards (IFRS) and US generally
accepted accounting principles (GAAP)

Non-Current (Long-Term) Liabilities

The candidate should be able to:
□ determine the initial recognition, initial measurement and subsequent
measurement of bonds
□ describe the effective interest method and calculate interest expense,
amortisation of bond discounts/premiums, and interest payments
□ explain the derecognition of debt
□ describe the role of debt covenants in protecting creditors
□ describe the financial statement presentation of and disclosures relating to debt
□ explain motivations for leasing assets instead of purchasing them
□ explain the financial reporting of leases from a lessee’s perspective
□ explain the financial reporting of leases from a lessor’s perspective
□ compare the presentation and disclosure of defined contribution and defined
benefit pension plans
□ calculate and interpret leverage and coverage ratios

Financial Reporting Quality

The candidate should be able to:
□ compare and contrast financial reporting quality with the quality of reported
results (including quality of earnings, cash flow, and balance sheet items)
□ describe a spectrum for assessing financial reporting quality
□ explain the difference between conservative and aggressive accounting
□ describe motivations that might cause management to issue financial reports
that are not high quality
□ describe conditions that are conducive to issuing low-quality, or even fraudulent,
financial reports
□ describe mechanisms that discipline financial reporting quality and the potential
limitations of those mechanisms
□ describe presentation choices, including non-GAAP measures, that could be
used to influence an analyst’s opinion
□ describe accounting methods (choices and estimates) that could be used to
manage earnings, cash flow, and balance sheet items
□ describe accounting warning signs and methods for detecting manipulation of
information in financial reports

Applications of Financial Statement Analysis

The candidate should be able to:
□ evaluate a company’s past financial performance and explain how a company’s
strategy is reflected in past financial performance
□ demonstrate how to forecast a company’s future net income and cash flow
□ describe the role of financial statement analysis in assessing the credit quality of
a potential debt investment
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□ describe the use of financial statement analysis in screening for potential equity
investments
□ explain appropriate analyst adjustments to a company’s financial statements to
facilitate comparison with another company