CFAspace. CFA Level I. Provided by APF. Academy of Professional Finance 专业金融学院. Financial Reporting and Analysis (FRA) CFA Lecturer: Juyun Lu

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1 CFAspace Provided by APF CFA Level I Financial Reporting and Analysis (FRA) CFA Lecturer: Juyun Lu

2 Contents 1 Brief introduction of FRA part in CFA exam 2 Reading 22. FRA: An Introduction (LOS a. & b)

3 Brief introduction of FRA part in CFA exam FRA is 20% of Level I 36/180 each session 4 sessions/14 readings/109 LOSs Study Session 7: An Introduction Study Session 8: Income Statements, Balance Sheets, and Cash Flow Statements Study Session 9: Inventories, Long-lived Assets, Income Taxes, and Non-current Liabilities Study Session 10: Evaluating Financial Reporting Quality and Other Applications

4 LOS 22.a: describe the roles of financial reporting and financial statement analysis. Financial Reporting - to provide a variety of users with useful information about a company's performance and financial position. Financial Statement Analysis - to use the data from financial statements to support economic decisions.

5 Learning Outcome Statement 1 LOS 22.a: describe the roles of financial reporting and financial statement analysis. Providing information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users is most accurately described as the role of: A. financial reporting. B. the auditor s report. C. financial statement analysis. A is correct. The role of financial reporting is to provide information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users in making economic decisions. B is incorrect. The role of the auditor s report is to provide reasonable assurance that the financial statements are free of material mistakes. C is incorrect. The role of financial statement analysis is to help analysts or investors to make a wide array of economic decisions, including evaluating potential equity or venture capital investments, evaluating corporate division or subsidiaries and forecasting future financial performance.

6 Learning Outcome Statement 1 LOS 22.a: describe the roles of financial reporting and financial statement analysis. Which of the following statements least accurately describes a role of financial statement analysis? A. Use the information in financial statements to make economic decisions. B. Provide reasonable assurance that the financial statements are free o f material errors. C. Evaluate an entity's financial position and past performance to form opinions about its future ability to earn profits and generate cash flow. B is correct. This statement describes the role of an auditor, rather than the role of an analyst. The other responses describe the role of financial statement analysis.

7 LOS 22.b: describe the roles of the key financial statements (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. Balance sheet/statement of financial position/ statement of financial condition reports the firm's financial position at a point in time. The balance sheet consists of three elements: 1. Assets are the resources controlled by the firm. 2. Liabilities are amounts owed to lenders and other creditors. 3. Owners' equity is the residual interest in the net assets of an entity that remains after deducting its liabilities. assets = liabilities + owners' equity (A = L + E)

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9 LOS 22.b: describe the roles of the key financial statements (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. Income statement/ statement of operations/profit and loss statement reports on the financial performance of the firm over a period of time. The income statement consists of: 1. Revenues are inflows from delivering or producing goods, rendering services that constitute the entity's ongoing major or central operations. 2. Expenses are outflows from delivering or producing goods or services that constitute the entity's ongoing major or central operations. 3. Other income includes gains that may or may not arise in the ordinary course of business.

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11 LOS 22.b: describe the roles of the key financial statements (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. Statement of cash flow reports on the company's cash receipts and payments. These cash flows are classified as: 1. Operating CF include the cash effects of transactions that involve the normal business of the firm. 2. Investing CF are those resulting from the acquisition or sale of property, plant, and equipment; of a subsidiary or segment; of securities; and of investments in other firms. 3. Financing CF are those resulting from issuance or retirement of the firm's debt and equity securities and include dividends paid to stockholders.

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13 LOS 22.b: describe the roles of the key financial statements (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. Statement of comprehensive income reports all changes in equity expect for shareholder transactions (e.g., issuing stock, repurchasing stock, and paying dividends). Statement of changes in equity reports the amounts and sources of changes in equity investors' investment in the firm over a period of time.

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16 LOS 22.b: describe the roles of the key financial statements (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. Information about a company s financial position at a point in time is most likely found in the: A. balance sheet. B. income statement. C. cash flow statement. A is correct. The balance sheet reports the company s financial position at a point in time. The income statement reports on financial performance over a period of time. The cash flow statement reports a company s cash receipts and payments over a period of time.

17 LOS 22.b: describe the roles of the key financial statements (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. The financial statement that would be most helpful to an analyst in understanding the changes that have occurred in a company s retained earnings over a year is the statement of: A. changes in equity. B. financial position. C. comprehensive income. A is correct. The statement of changes in equity reports the changes in the components of shareholders equity over the year, which would include the retained earnings account. B is incorrect. The statement of financial position (Balance Sheet) reports a company s financial position at a specific time. C is incorrect. The statement of comprehensive income illustrates the financial performance and results of operations of a particular company or entity for a period of time.

18 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. Financial statement notes/footnotes - detail accounting methods, assumptions, and estimates used by management business acquisitions or disposals, legal actions, employee benefit plans, contingencies and commitments, significant customers, sales to related parties, and segments of the firm Audited

19 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. Supplementary schedules operating income or sales by region or business segments reserves for an oil and gas company info about hedging activities and financial instruments not audited

20 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. Management's commentary/ management's report, operating and financial review/management's discussion and analysis (MD&A) - management nature of the business, past performance, and future outlook publicly held firms in the US - discuss trends and identify significant events and uncertainties that affect the firm's liquidity, capital resources, and results of operations effects of inflation, impact of off-balance-sheet obligations, accounting policies that require significant judgment, forwardlooking expenditures not audited

21 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. Information about accounting estimates, assumptions, and methods chosen for reporting is most likely found in: A. the auditor's opinion. B. financial statement notes. C. Management's Discussion and Analysis B is correct. Information about accounting methods and estimates is contained in the footnotes to the financial statements.

22 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. Information regarding which of the following items is usually included in the footnotes to financial statements? A. A five-year summary of the company s financial performance. B. A summary of significant accounting policies. C. A review of the company s operating performance and financial condition. B is correct. The summary of significant accounting policies is generally the first of the footnotes presented with audited financial statements prepared in conformity with generally accepted accounting principles. The footnotes are an integral part of statements. A is incorrect. A five-year summary of financial performance is generally included with the (unaudited) supplementary schedules, which are not part of the footnotes. C is incorrect. A review of the company s operating performance and financial condition is included as part of the management discussion and analysis (MD&A) section, which is not part of the footnotes.

23 LOS 22.c: Describe the importance of financial statement notes and supplementary information-including disclosures of accounting policies, methods, and estimates-and management's commentary. An analyst finds information about significant uncertainties affecting a company s liquidity, capital resources and results of operations in the: A. notes to the financial statements. B. balance sheet and income statement. C. management discussion and analysis. C is correct. Management discussion and analysis includes topics: a review of the company s consolidated operating performance and its financial condition, an assessment of the significant effects of known treads, the capital resources available to the firm and its liquidity, extraordinary or unusual events, and a review of the performance of operating segments. Management must highlight any favorable and unfavorable trends and identify significant events and uncertainties that affect the company s liquidity, capital resources and results of operations in the management discussion and analysis (MD&A). A is incorrect. Notes to the financial statement provide detailed disclosures. For example, a summary of the significant accounting policies, disclosures for most asset categories and income taxes. B is incorrect. Balance sheet reports major classes and amounts of assets, liabilities, and equity capital at a specific point in time. The income statement reports on the performance of the firm for a specific period of time.

24 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. Objective - to provide an opinion on the statements' fairness and reliability. Standard auditor report: Independent review though FS prepared by mgmt and are its responsibility Reasonable assurance of no material errors FS prepared in accordance with accepted accounting principles, reasonable accounting principles and estimates, consistency Explanatory paragraph: when a material loss is probable but amount cannot be reasonably estimated. Uncertainties may relate to the going concern assumption

25 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. Types of audit report unqualified (clean) opinion - the statements are free from material omissions and errors qualified opinion - notes any exceptions to accounting principle adverse opinion - the statements are not presented fairly disclaimer of opinion - the auditor is unable to express an opinion

26 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. The importance of effective internal controls Internal control - the processes by which the company ensures that it presents accurate financial statements (under US GAAP): Opinion on internal controls

27 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. Which of the following statements is most accurate about the responsibilities of an auditor for a publicly traded firm in the United States? The auditor: A. Assures the reader that the financial statements are free from error, fraud, or illegal acts. B. Must express an opinion about the effectiveness of the company s internal control systems. C. Must state that he prepared the financial statements according to generally accepted accounting principles. B is correct. For a publicly traded firm in the United States, the auditor must express an opinion as to whether the company s internal control system is in accordance with the Public Company Accounting Oversight Board, under the Sarbanes Oxley Act. This is done either as a final paragraph in the auditor s report or as a separate opinion. A is incorrect. An auditor can only provide reasonable assurance that the financial statements are free from error, fraud, or illegal acts. C is incorrect. Auditors responsibility is to express an opinion that the financial statements are free from error, fraud, or illegal acts. Preparing the financial statement is not the responsibility.

28 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. Which of the following statements best describes the level of accuracy provided by a standard audit report with respect to errors? The audited financial statements are: A. fully assured to be free of material errors. B. reasonable assured to be free of all errors. C. reasonable assured to be free of material errors. C is correct. Audits provide reasonable assurance that the financial statements are fairly presented, meaning that there is a high degree of probability that they are free of material error, fraud or illegal acts.

29 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. If an auditor finds that a company's financial statements have made a specific exception to applicable accounting principles, she is most likely to issue a: A. dissenting opinion. B. cautionary note. C. qualified opinion. C is correct. Audits provide reasonable assurance that the financial statements are fairly presented, meaning that there is a high degree of probability that they are free of material error, fraud or illegal acts.

30 LOS 22.d: Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls. When the financial statements materially depart from accounting standards and are not fairly presented, the audit opinion would be a(n): A. adverse opinion. B. qualified opinion. C. disclaimer of opinion. A is correct. An adverse opinion occurs when the financial statements materially depart from accounting standards and are not fairly presented. A qualified opinion is one in which there is some limitation or exception to accounting standards. B is incorrect. A qualified opinion is issued when there is a material instance of noncompliance with applicable accounting standards or there is a limitation on the auditor s ability to complete the audit as required by auditing standards. A qualified opinion will include an explanatory paragraph describing the problem that prevents the auditors from issuing an unqualified opinion. C is incorrect. A disclaimer of opinion s issued when the auditor doer not have the ability to issue an opinion for some reason.

31 LOS 22.e: Identify and explain information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information. Interim reports - Quarterly or Semiannual reports SEC filings 8K,10K,10Q Proxy statements - to shareholders when there are matters that require a shareholder vote. About election of board members, compensation, management and qualifications and issuance of stock options Corporate reports and press releases

32 LOS 22.e: Identify and explain information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information. Information about management compensation and any potential conflicts of interest that may exist between management and shareholders is most likely found in the: A. Proxy statement. B. Notes to the financial statements. C. Management discussion and analysis A is correct. Information about management compensation and any potential conflicts of interest that may exist between management and shareholders is typically provided in the proxy statement. B is incorrect. Notes to the financial statement provide detailed disclosures. For example, a summary of the significant accounting policies, disclosures for most asset categories and income taxes. C is incorrect. Management discussion and analysis includes topics: a review of the company s consolidated operating performance and its financial condition, an assessment of the significant effects of known treads, the capital resources available to the firm and its liquidity, extraordinary or unusual events, and a review of the performance of operating segments.

33 LOS 22.e: Identify and explain information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information. Which of the following is least likely to appear in a company s proxy statement? A. Compensation arrangements for management and directors B. Significant event and contingencies that may affect future operations C. Potential conflicts of interest between management, directors, and shareholders. B is correct. Proxy statements are issued by publicly held companies in connection with shareholder meetings and contain useful information about board members and management, executive compensation, stock options and major shareholders. Significant events, conditions, trends, and contingencies that may affect future operations are contained in Management s Discussion and Analysis. Compensation agreements for directors and management and their potential conflicts of interest are required in the proxy statement.

34 LOS 22.e: Identify and explain information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information. Which of the following sources of information should an analyst consider the least reliable? A. Form 10-Q. B. Proxy statement. C. Corporate press release. C is correct. Corporate press releases are written by management and are often view as public relations or sales materials because of the great possibility of inherent management bias in such documents. Often, little or none of the material is independently reviewed by outside auditors. Such documents are not mandated by the securities regulators. A and B are incorrect. Form 10-Q (quarterly financial statements) and Proxy statement are mandatory SEC filings in the U.S., which inherently increases their reliability given the penalties that can be imposed by the SEC if any serious irregularities are subsequently found.

35 LOS 22.f: Describe the steps in the financial statement analysis framework. Step 1: State the objective and context. Step 2: Gather data. Step 3: Process the data. Step 4: Analyze and interpret the data. Step 5: Report the conclusions or recommendations. Step 6: Update the analysis.

36 LOS 22.f: Describe the steps in the financial statement analysis framework. Common-size financial statements are most likely an output of which step in the financial analysis framework? A. Collect data B. Process data C. Analyze/interpret data B is correct. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

37 LOS 22.f: Describe the steps in the financial statement analysis framework. Common-size financial statements are most likely an output of which step in the financial analysis framework? A. Collect data B. Process data C. Analyze/interpret data B is correct. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

38 LOS 22.f: Describe the steps in the financial statement analysis framework. Which of these steps is least likely to be a part of the financial statement analysis framework? A. State the purpose and context of the analysis. B. Determine whether the company's securities are suitable for the client. C. Adjust the financial statement data and compare the company to its industry peers. B is correct. Determining the suitability of an investment for a client is not one of the six steps in the financial statement analysis framework. The analyst would only perform this function if he also had an advisory relationship with the client. Stating the objective and processing the data are two of the six steps in the framework. The others are gathering the data, analyzing the data, updating the analysis, and reporting the conclusions.

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