STUDY SESSION 6 Financial Reporting and Analysis : An Introduction
The readings in this study session describe the general principles of financial reporting, underscoring the critical role of the analysis of financial reports in investment decision making. The first reading introduces the range of information that is available to analyze the financial performance of a company, including the principal financial statements (the income statement, balance sheet, cash flow statement, and statement of changes in owners’ equity), notes to those statements, and management discussion and analysis of results. A general framework for addressing most financial statement analysis tasks is also presented. A company’s financial statements are the end-products of a process for recording the business transactions of the company. The second reading illustrates this process, introducing such basic concepts as the accounting equation and accounting accruals. The presentation of financial information to the public by a company must conform to applicable financial reporting standards based on factors such as the jurisdiction in which the information is released. The final reading in this study session explores the roles of financial reporting standard-setting bodies and regulatory authorities. The International Accounting Standards Board’s conceptual framework and the movement towards global convergence of financial reporting standards are also described.
STUDY SESSION 7 Financial Reporting and Analysis
Income Statements, Balance Sheets, and Cash Flow Statements
The first three readings in this study session focus on the three major financial statements: the income statement, the balance sheet, and the cash flow statement. For each financial statement, the reading describes its purpose, construction, pertinent ratios, and common-size analysis. These readings provide a background for evaluating trends in a company’s performance over several measurement periods and for comparing the performance of different companies over a given period. The final reading covers in greater depth financial analysis techniques based on the financial reports.
Reading 24 Understanding Income Statements
Reading 25 Understanding Balance Sheets
Reading 26 Understanding Cash Flow Statements
Reading 27 Financial Analysis Techniques
STUDY SESSION 8 Financial Reporting and Analysis
Inventories, Long-lived Assets, Income Taxes, and Non-current Liabilities
The readings in this study session examine financial reporting for specific categories of assets and liabilities. Analysts must understand the effects of alternative financial reporting policies on financial statements and ratios and be able to execute appropriate adjustments to enhance comparability between companies. In addition, analysts must be alert to differences between a company’s reported financial statements and economic reality. The description and measurement of inventories require careful attention because inventories are frequently the largest current asset for merchandising and manufacturing companies. For these companies, the measurement of inventory cost (i.e., cost of sales) is a critical factor in determining gross profit and other measures of profitability. Long-lived operating assets are often the largest category of assets on a company’s balance sheet. The analyst needs to scrutinize management’s choices with respect to recognizing expenses associated with these operating assets because of the potentially large effect such choices can have on reported earnings and the opportunities for financial statement manipulation. A company’s accounting policies (such as depreciation choices) can cause differences in taxes reported in financial statements and taxes reported on tax returns. Issues relating to deferred taxes are discussed. Non-current liabilities affect a company’s liquidity and solvency and have consequences for its long-term growth and viability. The notes to the financial statements must be carefully reviewed to ensure that all potential liabilities (e.g., leasing arrangements and other contractual commitments) are appropriately evaluated for their conformity to economic reality. Adjustments to the financial statements may be required to achieve comparability when evaluating several companies.
Reading 28 Inventories
Reading 29 Long-lived Assets
Reading 30 Income Taxes
Reading 31 Non-current (Long-term) Liabilities
STUDY SESSION 9 Financial Reporting and Analysis
Financial Reporting Quality and Financial Statement Analysis
This study session discusses financial reporting quality and shows the application of financial statement analysis to debt and equity investments. Frequently used tools and techniques for evaluating companies include common-size analysis, cross-sectional analysis, trend analysis, and ratio analysis. Beyond mere knowledge of these tools and techniques, however, the analyst must recognize the implications of accounting choices on the quality of a company’s reported financial results. Then the analyst can apply financial analysis techniques to tasks such as the evaluation of past and future financial performance, credit risk and analysis, the screening of potential equity investments, and other job needs. The readings also explain adjustments to reported financials that analysts often make. Such adjustments are often needed to put companies’ reported results on a comparable basis.