CFA Level I Financial Reporting and Analysis Part III

I hope you have a better understanding of what are the majors’ things of the financial statements after reading my previous article. This current article is a continuation from the last blog titled “CFA Level I Financial Reporting and Analysis (Part II)”. Today we will talk about content we can learn from reading 27 to reading 30.

Reading 27 Inventories

In this reading, candidates can have a better understanding of what are inventories in the balance sheet. The merchandisers, such as wholesalers and retailers, will purchase the stocks and sell it to generate profits. There are three types of inventories, which are raw materials, work-in-progress and finished goods. Raw materials are materials in the primary production or manufacturing of products. Work-in-progress’s list refers to the stocks that have started the conversion process from raw materials into finished products but not yet complete.

Finished products relate to the goods that have been finished by the manufacturing process and ready for sale.

The most exciting things candidates can learn in this reading are that they can know the three different types of inventory valuation methods as below:

1. Weighted-Average Cost Method

2. First In, First Out (FIFO),

3. Last In, First Out (LIFO).

 

For companies in the United States, they operate under US Generally Accepted Accounting Principles (US GAAP) allows for all three methods. While for International Financial Reporting Standards (IFRS), it only permits the Weighted-Average Cost Method and First In, First Out Method.

Moreover, candidates are also able to learn on: –

  • How to distinguish between cost included in inventories and price recognised as expenses
  • Explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods
  • Explain FIFO reserve and LIFO liquidation together with their effects
  • Convert the company’s reported financial statements from LIFO to FIFO
  • Explain the issues that analysts should consider when examining a company’s inventory disclosures and other sources of information
  • Calculate and compare the ratios of companies, including companies, use different inventory methods.

 

Reading 28 Long-Lived Assets

In Reading 28, candidates can have a better understanding of such as the acquisitions of long-lived assets, allocation of the costs of long-lived assets over their useful lives, and accounting for de-recognition of long-lived assets. Long-lived assets are also known as non-current assets which classify into tangible assets, intangible assets and financial assets which can retain for more than one year.

Tangible assets are physical and measurable assets that in a company’s operation such as property, plant and equipment. It is sometimes used as a fixed asset such as land, buildings, furniture and fixtures, machinery and equipment, and vehicles — intangible assets, also known as non-physical assets such as goodwill, brands, recognitions and intellectual property. Intellectual property includes patents, trademarks, and copyrights. While for financial assets, it includes investment in equity or debt securities issued by other companies.

Besides, candidates are also able to learn on: –

  • Revaluation model based on the changes in fair value of an asset
  • Concepts if impairments such as an unexpected decline in value of an asset
  • Describes financial statement presentation, disclosures, and analysis of long-lived assets
  • Differences in financial reporting of investment property compared with property, plant and equipment
  • Explain and evaluate how leasing, purchasing assets, finance lease and operating lease affect the financial statements and ratios from the perspective of both the lessor and lessee.

Reading 29 Income Taxes

In this reading, it will focus more on income tax accounting and reporting. Income tax refers to the tax imposed by the government on income generated by business or individual within their jurisdictions. Every taxpayer must file an income tax return annually to determine their tax obligations. Government collect taxes to fund their activities such as provides goods for citizens, pay government obligation. The analysts will find it challenging to analyse income tax expenses. It was due to various permanent and temporary timing differences between accounting that are used for income tax reporting and the accounting in the company’s financial statements.

Besides, candidates are also able to learn on how to differentiate between the taxable income and accounting profit, recognition and measurement of current and deferred taxes, calculation on the tax base of a company’s assets and liabilities together with some examples provided in the textbook. Moreover, candidates are also able to learn on: –

  • How to explain the deferred tax liabilities and assets are created
  • Factors used to determine how a company’s deferred tax liabilities and assets should be treated for financial analysis
  • Evaluate the effects of tax rate changes on a company’s financial statements and ratios
  • Identify the key provisions of and differences between income tax accounting under International Financial Reporting Standards (IFRS) and the US Generally Accepted Accounting Principles (US GAAP)

 

Reading 30 Non-Current (Long-Term) Liabilities

In reading 30, it focuses more on bonds payable, leases together with the pension liabilities. Non-current liabilities, also known as long-term liabilities, are the obligations that arise from different sources of financing and various types of creditors. For examples, bonds, payables, finance lease, deferred tax liabilities, and so on. Bonds, also known as a fixed-income security, is a type of debt instrument created to raise capital to finance their projects and operations. Usually, it is issuing by the corporation, cities, and national government at a fair value.

Besides non-current liabilities, candidates are also able to learn how to differentiate between a finance lease and an operating lease. Finance lease and operating lease are a common form of lease agreements that an individual goes for it. A lease is an agreement wherein the lessor will grant rights to the lessee to use the lessor’s property in exchange for certain periodic payments. Moreover, candidates can also learn more on a pension, other post-employment benefits, and disclosure of defined contribution in this reading together with some examples provided.

Furthermore, candidates are also able to learn on:

  • How to describe the interest methods and calculate the interest expenses and interest payment
  • Amortisation of any bonds discount or premium
  • Derecognition of debts
  • Disclosure of information about debt financing
  • Calculate and interpret the leverage and coverage ratios

 

Conclusion

In conclusion, candidates will learn on the specific categories in financial reporting. Such as assets and liabilities, but also inventories, long-lived assets, income taxes, and non-current liabilities because they can bring effects to the financial statements. Besides, the specific categories in financial reporting also used to report the measures of profitability, liquidity, and solvency. Based on these, candidates and analysts can choose which accounting treatments are corresponding to the effect on the reported performance, and the potential for the financial statement manipulation.

Written by Stella Goh | 2nd August 2019

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