FinTree - FRA Sixty Minute Guide PDF

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com
“Sixty Minute Guide”

Financial Repoerting & Analysis
CFA- Level I
www.FinTreeIndia.com
1. Important Basic concepts
Audit  independent review of an
entity’s financial statements
Unqualified Qualified Adverse

Opinion opinion opinion
Basic accounting equation
Assets = Liabilities + Owners’ equity
Two primary assumptions
1.Accrual basis
2.The Going concern assumption.
Flow of information in
Accounting system
Journal entries
General ledger
Initial trial balance
Adjusted trial balance
Financial Statement
2.Understanding the Income
Statement
Revenue recognition
(Revenue is recognized when earned and expenses are recognized when incurred)
Long Term Contracts Installment sales Barter transactions
% of
completion competed Installment
Contract Normal rev. Sales Cost recovery
Method Recognition
Recognize method Recognise Used if
Method
revenue Recognize revenue collectability
in revenue If collect ability used if
cannot be
proportion only when Is reasonably reasonably collectability
of cost contract assured estimated is highly
incurred is uncertain
complete
Barter transaction: recognize revenue only
If fair value can be estimated
Expense recognition
 is based on the matching principle

 expenses to generate revenue are recognized in the
same period as the revenue
Discontinued operation
 Barter transactions is one that management has decided to dispose
off
 but has not yet done so
IMP
Unusual or infrequent items
 either unusual in nature or infrequent in occurrence, but not both

 These are included in income from continuing operations and are
reported before tax.
extraordinary item
Only under U.S. GAAP
 it is a material transaction or event that is both
unusual and infrequent in occurrence
reported separately in the income statement, net of
tax, after income from continuing operations
IFRS does not allow extraordinary items to be
separated from operating results in the income
statement
Change in accounting principle
 prior-period financial statements are restated to reflect the

change.
Change in accounting estimate
 Prospective application
Dilutive securities
 are stock options,

 warrants,
 convertible debt
 convertible preferred stock
that would decrease EPS if exercised or converted to
common stock
3.Understanding the
Balance Sheet
Investments
(Financial Instruments)
Available for Trading securities

Held to maturity Sale
1.On BS: @ Amortized
1.On BS: @ Fair Value
Cost 1.On BS: @ Fair Value
2.Realised gain:
2.Realised gain: 2.Realised gain:
Taken to income
taken to income Taken to income
statement statement
Statement
3.Unrealised gain:
3.Unrealized gain 3.Unrealised gain:
Taken to other
is not recognized Taken to income
Comprehensive statement
income
4.Understanding the Cash Flow
Statement
Cash Flows
CFO
CFO CFI
CFI CFF
CFF
Inflows and
inflows and
Inflows and outflows of
outflows
outflows of cash resulting from
of cash resulting
cash resulting transactions
from the
from affecting a firm’s capital
acquisition or
transactions structure, such as
disposal of
that issuing or repaying
long-term assets
affect a firm’s debt and issuing
and certain
net income. or repurchasing
investments.
stock .
Item US GAAP
Treatment
IFRS
Treatment
1. Dividends paid Financing activities (CFF) CFO or CFF
(Gives flexibility to management )
2. Interest Operating activities (CFO) CFO or CFF

paid
IMP
3. Dividends received Operating activities (CFO) CFO or CFI
4. Interest received operating activities (CFO) CFO or CFI

5.Taxes paid related to operating activities (CFO) operating activities (CFO)

operating activities
6. Taxes paid related to Operating activities (CFO) CFI and CFF respectively
investing and financing
transactions IMP
FCFF Formula
1.Starting From Net Income
NI + NCC – WCinv +(INT X (1-t)) – FCinv
CFO + (INT X (1-t)) –FCinv
2. Starting From EBIT

(EBIT X (1-t))+ Dep - WCinv - FCinv
CFO + (INT-tax%) -FCinv
5.Inventories
Inventory Cost Flow Methods
FIFO LIFO Weightd avg. Specific

identificn
FIFO LIFO
1.COGS  consist of recent purchases
1.COGS  consist of older purchases
2.Ending Inventory bal consist of
2.Ending Inventory bal consist of more
older cost
recent cost
3.. In either Inflationary or deflationary
3.. In either Inflationary or deflationary
Environment LIFO COGS reflects
Environment FIFO Ending inventory
economic reality
Balance reflects economic reality
4.In inflationary environment,
4.In Inflationary environment,
LIFO closing inventory is lower than
FIFO COGS is lower than LIFO COGS
FIFO closing inventory
6.Long-lived Assets
IFRS
Research cost Development cost
Expensed as Capitalized
incurred
US GAAP
Research cost Development cost
Expensed as Expensed
incurred (Except, software
development cost)
7.Income Taxes
Create DTA if, Create DTL if,
IT Exp. (Income IT Exp. (Income
Statement) is greater Statement) is less
than Tax p’ble than Tax p’ble
Asset’s Tax Base
 Is its value for tax purposes.

 The tax base for a depreciable fixed asset is its cost
minus any depreciation previously taken on the tax
return
Income tax expense
= taxes payable + ΔDTL – ΔDTA.
Increase in DTL
Decrease in DTA ADD

Increase in DTA
Decrease in DTL
LESS
When income tax rate increases  deferred tax
assets and deferred tax liabilities are both increased to
reflect the new rate
If DTA is not likely to be realised  create valuation

allowance to reduce DTA
If DTL is not likely to be reversed  consider it a a

part of equity for analysis purpose
8.Non-current (Long-term)
Liabilities
The book value of the bond liability is equal to the
PV of the remaining future cash flows (coupon payments
and maturity value) discounted at the market rate of
interest at issuance
Premium bond Discount bond
1. coupon rate > market yield 1. coupon rate < market yield
at issuance at issuance
2. reported on the balance 2. reported on the balance

sheet at a value greater than sheet at less than
its face value. its face value .
3. book value of the bond

3. book value of the bond liability will increase until
liability will decrease until it reaches its face value
it reaches its face value at maturity.
at maturity.
4. interest expense is greater
4. interest expense is less than the coupon payment
than the coupon payment
Finance lease
US GAAP
Treat a lease as a capital (finance)
lease if any one of the
IFRS
following criteria is met:
If substantially all the
rights and risks of
1.Title transfer clause ownership are
transferred to the lessee,
2. Bargain purchase option the lease is treated as a
finance lease by both the
3.Lease period > 75% life lessee and lessor
4.PV of lease pmts > 90% of
Fair value of asset
Impact on financial statements
Finance lease Operating lease
Net income Lower Higher

(early yrs)
Net income Higher Lower

(later yrs)
EBIT Higher Lower
CFO Higher Lower
CFF Lower Higher

9.Financial Reporting Quality
Fraud Triangle
 Incentives and pressures—the motive to commit

fraud.
 Opportunities—the firm has a weak internal
control system.
 Attitudes and rationalizations—the mindset that
fraud is justified
US GAAP & IFRS differences
Items US GAAP IFRS
Investment: Joint control Equity method Proportionate

Consolidation
Inventory on balance sheet Lower of cost or market Lower of cost or

value Net realisable value
Recovery of asset write down Not allowed Allowed
Upward Revaluation Not allowed Allowed
Cost of Goods Sold LIFO permitted LIFO not permitted
Operating Expenses Differentiates betn IFRS does not

expenses and losses
Interest capitalization Must Optional
Extraordinary items reported in the income It does not permit

statement, net of tax, firms to treat items as
Both unusual and infrequent
below income from extraordinary in the
continuing operations income statement.

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“Sixty Minute Guide”

Unqualified Qualified Adverse

Initial trial balance

Adjusted trial balance

Long Term Contracts Installment sales Barter transactions

 is based on the matching principle

 either unusual in nature or infrequent in occurrence, but not both

 prior-period financial statements are restated to reflect the

Change in accounting estimate

 are stock options,

Available for Trading securities

2. Interest Operating activities (CFO) CFO or CFF

4. Interest received operating activities (CFO) CFO or CFI

5.Taxes paid related to operating activities (CFO) operating activities (CFO)

CFO + (INT X (1-t)) –FCinv

2. Starting From EBIT

CFO + (INT-tax%) -FCinv

FIFO LIFO Weightd avg. Specific

Research cost Development cost

Research cost Development cost

 Is its value for tax purposes.

Decrease in DTA ADD

If DTA is not likely to be realised  create valuation

If DTL is not likely to be reversed  consider it a a

2. reported on the balance 2. reported on the balance

3. book value of the bond

Net income Lower Higher

Net income Higher Lower

EBIT Higher Lower

CFO Higher Lower

CFF Lower Higher

 Incentives and pressures—the motive to commit

Investment: Joint control Equity method Proportionate

Inventory on balance sheet Lower of cost or market Lower of cost or

Recovery of asset write down Not allowed Allowed

Upward Revaluation Not allowed Allowed

Cost of Goods Sold LIFO permitted LIFO not permitted

Operating Expenses Differentiates betn IFRS does not

Interest capitalization Must Optional

Extraordinary items reported in the income It does not permit

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