CFA Level I Financial Reporting and Analysis (Part II)

By Stella Goh – Market Data Analyst | 24 July 2019

In my previous Article of “CFA Level I Financial Reporting and Analysis (Part I)”, I hope you had understood Reading 21 and Reading 22. Today, I would like to continue to discuss on what content we can learn from Reading 23 to Reading 26.

Reading 23 Understanding Income Statements

In this reading, candidates can have a better understanding of the income statement together with the comprehensive income. The income statement is a statement which is also known as Profit & Loss (P&L) statements, Statements of Earnings, and Statements of Operations. The income statements display a company’s revenue, cost incurred, gross profit, selling and administrative expenses, other expenses and income, taxes paid and net profit. The basic equation which underlying the income statements are as follow:-


Total Revenue – Total Expenses = Net Income

Besides, in this reading candidate are also able to learn on the general principles of revenue recognition, accrual accounting, specific revenue recognition applications, the implication of revenue recognition, principles of expenses recognition, specific expenses recognition applications, and impact of expense recognition. Candidates can differentiate between income statement presented by International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP). Moreover, the differences between operating components versus non-operating components of income statements, dilutive securities versus anti-dilutive securities, changes in accounting policies, analysis of non-recurring items and the explanation about financial reporting treatment also will be discussed in this reading together with some examples provided.

 

Reading 24 Understanding Balance Sheets

In this reading, candidates can have a better understanding of balance sheets. A balance sheet is a financial statement of a company that used to report on the company’s assets, liabilities and shareholder’s equity. A balance sheet can be used to assist investors in computing the rates of returns and evaluating the company’s capital structure. Assets in the balance sheet can be classified into either short-term or long-term assets. The short-term assets such as cash, marketable securities, and accounts receivables will be consumed within one year. Whereas the long-term assets such as lands, buildings, office types of equipment, furniture, fixtures and fittings, will be consumed more than one year. While for liabilities, it can also be categorised into either current liabilities or non-current liabilities in the balance sheet. A liability is an obligation or legal financial debts that arise during business operations.

For balance sheet to reflect on the true picture, the assets are always equal to the liabilities plus equities. The formula is as follow:-

Assets = Liabilities + Equity

Besides elements of balance sheets, candidates are also able to learn on:

  • How to interpret and convert the balance sheets into the standard size of balance sheets,
  • How to determine the use and limitation of a balance sheet, alternative formats of balance sheet presentation, components of shareholder’s equity,
  • How to calculate and interpret the solvency and liquidity ratios in this reading, together with some examples provided.

Reading 25 Understanding Cash Flow Statements

In reading 25, candidates are also able to have a better understanding of how the cash flow activities are reflected in the company’s cash flow statement. Cash flow statements are used to measure how the companies use it to manage their cash position.

Besides, candidates are also able to learn how to differentiate the three primary areas, such as operating activities, investment activities, and financing activities. Operating activities such as account receivables, account payables, inventory costs, depreciation, etc are used to measure how much cash is generated by a company’s products or services and how much money is being spent to produce or deliver products and services. For investing activities, it highlights the changes in cash outflow, which results from capital expenditures such as new property, business vehicles, or equipment, etc. While for financing activities such as the issuance of stocks, dividend payment, and so on, it records the changes in the cash flow, which are regarding the companies to raise capital for their business.

Moreover, candidates are to learn:

  • To differentiate between the direct and indirect methods from the operating activities
  • How to convert cash flow from indirect methods to direct practices, know the steps to prepare direct and indirect cash flow statements,
  • How non-cash investing and financing activities are reported,
  • How the cash flow statement linked to the income statement and balance sheet statement, cash-based information versus accrual-based information from an income statement
  • How to contrast the cash flow statements prepared under International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (US GAAP).

Reading 26 Financial Analysis Techniques

A financial analysis tool is essential, which can be used to assess a company’s performance and trends. The primary sources of data they use for analysis will be the company’s annual reports, financial statements, notes, and management commentary. In this reading, candidates can learn more about the different ways of data presented in the financial reports prepared under the International Financial Reporting Standard (IFRS) and United Generally Accounting Principles (US GAAP). An analyst typically needs to supplement the information found in the financial reports with other details such as information on the economy, industry, comparable companies and the company itself.

Besides, candidates are to learn tools and techniques for financial analysis, interpret the relationship between ratios, a requirement of segment reporting.

Also, on how the ratio analysis with other methods can be used to model and forecast the earnings in this reading. Last but not least, the application of DuPont Analysis, Return on Equity, and Credit Analysis, also will be discussed in this reading, together with some examples provided.

Conclusion

In conclusion, candidates can understand very well on the three major of financial statements such as income statement, balance sheet and cash flow statement. Essential things in these readings are the purpose, elements, construction, pertinent ratios, and standard size analysis are presented for each of the significant financial statements. At the end of these reading, it concludes with a discussion on financial analysis technique, which includes the use of ratios to evaluate the corporate financial health.

CFA Level I Financial Reporting and Analysis (Part I)

By Stella Goh – Market Data Analyst | 17 July 2019

In these two readings of this chapter, the reporting framework played an important role because it can assist in security valuation and other financial analysis. The most interesting in this chapter is that candidates able to learn on the desirable characteristics for financial reports, elements of financial statements, underlying assumptions and constraints of financial reporting. The readings as we will have a discussion later will be include of conceptual objectives of financial reporting standards, parties involved in standard-setting processes, and how the financial reporting standards are converging into one global set of rules.

Reading 21 Financial Statement Analysis: An Introduction

In this reading, candidates can understand more on financial statement analysis. Financial statement analysis is a process used by financial analysts to examine the financial information of a company such as annual reports, historical and projected profitability, cash flow, and risk to make a decision or recommendation whether to invest in either equity market. Investors who invest in the equity market will concern more on the company’s ability to pay a dividend, and the share prices have the potential to increase in the future.

Besides, the role of the financial position statement, comprehensive income statement, change of equity statement, and cash flows statement is discussed in this reading. Candidates must understand all of these very well because most of them are used to indicate what is the current position of a company, what is the performance for the company over a period, and as additional information regarding what are the changes in company’s current situation. Moreover, the objective of audits for financial statements, types of audit reports, the importance of adequate internal controls, and supplementary information which include with disclosure of accounting policies, methods and estimate, management’s commentary will be discussed in this reading together with some examples provided.

Reading 22 Financial Reporting Standards

In this reading, it will be more focuses on the objectives, importance and the framework of Financial Reporting Standards. In Malaysia, the Financial Reporting framework served as a guideline for all the registered companies to prepare their financial statements. For examples, it used to determine the types and amount of information that must be disclosed to investors and creditors to help them make informed decisions. The statements prepared by the companies must be by the approved accounting standards which have been set forth by the Malaysian Accounting Standard Board (MASB).

While for foreign companies, there will be some differences compare to local companies in Malaysia. The foreign companies which listed in the Malaysia Stock Exchange can prepare their financial reports by the internationally recognised accounting standards, which are known as International Financial Reporting Standards (IFRS). Besides, the qualitative characteristics, constraints and assumptions for preparing financial statements, and the general requirements for financial statements of IFRS also will be discussed more in this reading together with some examples provided. International Financial Reporting Standards (IFRS) is a set of accounting standard developed by an independent, non-profit organisation known as the International Accounting Standards Board’s conceptual framework (IASB). By adopting a single set of universal rules will help to simplify the accounting procedure which means that the company is allowed to use one reporting language that can be interpreted from company to company or from country to country. IFRS is also designed to maintain credibility and transparency in the financial world.

Moreover, candidates are also able to learn on the differences between the concepts of financial reporting standards under IFRS and US Generally Accepted Accounting Principles (US GAAP) reporting system. Generally Accepted Accounting Principles (GAAP) represent the accounting framework such as accounting rules, principles, standards and procedures practices followed by public traded companies in the United States as guidance to compile their financial statements. Financial Accounting Standard Board primarily sets them (FASB), a private organisation of accounting professionals, the Securities and Exchange Commission (SEC), and a US government agency. In summary, US GAAP is more focuses on rule-based, while IFRS is more focuses on general principles-based.

Last but not least, candidates are also able to learn on how to describe roles and attributes of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing the reporting standards and describe the part of Internal Organization of Security Commission. The status of global convergence of accounting standards and ongoing barriers to developing one universally accepted set of financial reporting standards, the implications for economic analysis of differing the financial reporting systems and the importance of monitoring developments in financial reporting standards also will be discussed in this reading together with some examples provided.

Conclusion

In conclusion, the readings in this chapter are quite essential and it may difficult for those who do not have accounting knowledge to understand especially the International Financial Reporting Standards (IFRS) versus Generally Accepted Accounting Principles (US GAAP). For the different readings that include in Financial Reporting and Analysis, we will discuss in the next coming articles which I will categorise it as Financial Reporting and Analysis (Part II).

CFA Level I Microeconomics and Macroeconomics (Part II)

By Stella Goh – Market Data Analyst | 11 July 2019

As discussed earlier in my previous Article of “CFA Level I Microeconomics and Macroeconomics (Part I)”, I believe that all of you have a better understanding on what reading 14 to reading 17 are regarding about in this topic. Today, I would like to continue to talk about what content we can learn from reading 18 until reading 20 on the topic of Microeconomics and Macroeconomics.

Reading 18 Monetary and Fiscal Policy

In this reading, candidates can learn on the comparison between monetary policy versus fiscal policy and the ways to determine whether the monetary policy is expansionary or contractionary. Monetary policy is an action consists with the process of drafting, announcing, and implementing the plans which taken by the central bank, currency board, or other competent authority of a country to control the quantity of money supply and interest rate in the economy. There are three objectives of monetary policies such as controlling inflation, reduce unemployment, and to promote moderate long-term interest rates.

Fiscal policy is generally focused on the estimation of taxation and government spending, which will influence the economic conditions such as demand for goods and services, employment, inflation and economic growth. The objective of fiscal policy is to create a healthy economic of growth. Both the monetary and fiscal policies are used to accelerate growth when an economy starts to slow down, moderate growth or inflation is stable and low.

Besides, in this reading, candidates can also have a better understanding on the functions of money, creation process of money, theories of demand and supply of money, tools used to implement monetary policy, monetary transmission mechanism, Fisher effects, differences between the use of inflation, interest rates, and exchange rates, limitation of monetary policy and so on. A summary and practice problems will conclude the readings.

Reading 19 Internal Trade and Capital Flows

In this reading, candidates can have a better understanding of the framework of analysing the patterns and trends in the international trade, capital flows and their economic implications. International trade is referring to the financial transactions which used to exchange the products and services between foreign countries across the international borders. It allows firms to compete in the global market and employ competitive pricing in their products and services. When there are more and more products available in the market, consumers will meet their needs and satisfy their wants. As a result, the national economy will grow as the exchange of goods and services such as imports or exports are increasing. Thus, the balances of international payments will increase, and it can be a potent driver for sustained GDP growth and improve the standard living in a country.

Besides, from this reading, candidates are also able to know what are the advantages of trading blocs, conventional markets, economic unions, and even able to understand what decisions made by the consumers, firms and governments that can affect the balance of payments. However, the most exciting thing in this topic is candidates can learn on such as how to distinguish between the absolute and comparative advantages, gross domestic product versus gross national product, types of trades, capital restrictions, Richardian and Hecksher-Ohlin Models of trade, objectives of capital restrictions imposed by the government. Moreover, the functions and purposes of international organisations that facilitate trade, which including the World Bank, the International Monetary Fund, and World Trade Organization are also discussed in this reading together with some examples provided.

Reading 20 Currency Exchange Rates

In the last reading of this topic, you can see there are more discussions on the basic concept and terminology of the exchange rates. Candidates are also able to know who the major players are, how they conduct their business, and how they respond to the changes in exchange rates. Exchange rates represent the price of one currency in terms of another currency, which will be used all over the international market. Additionally, these rates can either be floating or fixed. Floating exchange rates are decided by the mechanism of the market demand and supply, whereas the central banks of a country decide the fixed exchange rates. The most crucial thing in this reading are candidates have to take note that the convention used in various foreign markets around the world because they can vary widely. Sometimes, the exchange rates quoted in term of the domestic currency, but sometimes they will be quoted oppositely.

Besides, candidates are also able to learn on such as what are the differences between nominal rates versus real exchange rates, spot rates versus forward exchange rates, forward discount versus forward premium, currency cross rate, functions and participants in the foreign market. Last but not least, the exchange rate regimes, forward quotations expressed on point basis or in percentage terms into outright forward quotation, effects of exchange rates on countries’ international trade and capital flows, the arbitrage relationship between spot rates, forward rates and interest rates will be discussed in this reading together with some of the examples provided in the textbook.

Conclusion

In conclusion, candidates must be able to demonstrate the knowledge of microeconomics and macroeconomic principles. In Part II, we can see that the session begins with the discussion on the function of monetary and fiscal policy used by central banks and governments. After that, international trade and capital flows have been discussed together with the relationship between the different types of flows and the advantages of trade to trade partners. At the end of the session, it concludes with an overview of currency market fundamental and the foreign exchange risk in the operations and investment in the global market. It is important that the candidates must be familiar with the material covered in this topic since this topic carry a quite higher percentage of marks in the exam.

CFA Level I Microeconomics and Macroeconomics (Part I)

By Stella Goh – Market Data Analyst | 2 July 2019

Economics is a social science which studied the production, distribution, and consumption of goods and services which divided into two broad areas such as Microeconomics and Macroeconomics. Microeconomics is a study that focuses on an individual’s decision making on resources allocation to satisfy their needs and wants within the economy, such as households, workers, and business. The main subjects in Microeconomics include the theory of demand, the theory of the firm, demand for labour and other factors of productions.

While for macroeconomics, it studied the behaviour and performance of the economy as a whole. For examples, macroeconomics analyses the aggregate changes in the economy such as unemployment, growth of production, gross domestic products (GDP), inflation, deficits, level of exports and imports. Both of the microeconomics and macroeconomics are interdependent and complement.

Reading 14 Topics in Demand and Supply Analysis

In this reading, candidates must able to familiar with the basic concepts of demand and supply. Demand is referring to the consumer’s desire to purchase the goods and services and willingness to pay the price for specific products or services. When the cost of goods increases, the quantity demand of the goods will decreasing, vice versa. Besides, candidates are also able to learn several theories such as Marginal Utility Analysis, Indifference Curve Analysis and Revealed Preference Theory. While for Supply is referring to the willingness and ability of the producers to supply goods and services to the market. Supply is positively related to the price given because the higher the rate, the people more willing to provide more, which may help to increase the revenue and profits. Both supply and demand are interrelated; from this reading, candidates can explore more on how the buyers and sellers interact to determine the transactions of the prices and quantities.

Besides, candidates are also able to learn on how to differentiate between Substitution effect versus Income effects, Normal goods versus Inferior Goods, Breakeven versus Shut down points of productions, etc. The ways to interpret the price, income, cross-price elasticity of demand, factors that affect each measure, how the economies of scale and diseconomies of scale affect the cost will be discussed in the textbook provided with the examples.

Reading 15 The Firm and Market Structure 

In this reading, candidates can have a better understanding of market structure. Market structure is essential because an individual can learn the skills of analysing issues such as the firm’s pricing of its products, which will bring potential to increase profitability. In the highly competitive market, long-run profits will be driven down by the forces of competition. While for the less competitive markets, large profits are possible even in the long run. Therefore, by understanding the forces behind the market structures can helps financial analysts to determine the short-term and long-term prospects of a firm.

Besides, candidates are also able to learn on how to analyse the demand, supply, optimal price, output and factors that can affect the long-run equilibrium for perfect competition, monopolistic competition, oligopoly and monopoly. The relationship between the price, marginal revenue, marginal costs, economic profits, and the elasticity of demand under each market structure, also will be discussed in the textbook, together with some examples.

Reading 16 Aggregate Output, Prices, and Economic Growth

In reading 16, candidates will have a better understanding of Gross Domestic Product (GDP) and related measures of domestic output and income. Gross Domestic Product (GDP) is a primary indicator which used to gauge the economic health of a country. It measures the aggregate income earned by all households, companies, governments, the flow of output and income in the economy. GDP can be determined in different manners, such as an income approach and expenditure approach. In the income approach, GDP is calculated as the total amount earned by the households and companies in the economy. The income approach formula to GDP as follows:-

GDP = Total National Income + Sales Taxes + Depreciation + Net Foreign Factor Income

Note:
Total national income is equal to the sum of all wages plus rents plus interest and profits.

While in the expenditure approach, GDP is calculated as the total amount spent on the goods and services that had been produced in the economy within a given period. The formula of the expenditure approach for GDP is as follow:-


GDP = Gross Private Consumption Expenditures (C) + Gross Private Investment (I) + Government Purchases (G) + Exports (X) – Imports (M)

Besides, candidates are also able to learn on how to distinguish the differences between sum-value added versus the value of final output methods, nominal GDP versus real GDP, GDP deflator, national income, personal income and disposable income. Furthermore, candidates are also able to learn all the relationship between savings, investment, fiscal balance and trade balance from this reading. The types of macroeconomics equilibrium, long-run full employment, short-run recessionary gap, short-run inflationary gap and short-run stagflation also will be discussed in the textbook together with some examples provided.

Reading 17 Understanding the Business Cycle

In this reading, candidates can know more about what are the changes in economic activity, and the factors affect it. For examples, changes in population, technology and capital are the factors that affect the long-term sustainability of economic growth. However, the short-term economic fluctuations can lead by specific factors such as money supply and inflation.

Besides, candidates are also able to learn how to describe the business cycle and its phases. A business cycle is an economic cycle or trade cycle which can be used to describe the rise and fall in the production of the output of goods and services. The business cycle is useful because it can help an investor to make their investment decision. There are four stages in the business cycles such as expansion, peak, contraction and trough. In the textbook for this reading, candidates also can learn how the different of the economics school of thought interprets the business cycle and their recommendations with it.

Last but not least, candidates are also able to know what are the differences between inflation, hyperinflation, disinflation and deflation. The basic concepts concerning about the types of unemployment, construction of indexed used to measure inflation, cost-push inflation versus demand-pull inflation, and a set of economic indicators will be discussed in the textbook together with the examples provided.

Conclusion

In conclusion, the key considerations such as demand and supply, global trade flows, market structure, business cycle, etc are beneficial to help in conducting own investment analysis and economic forecasting. For the other readings that include in Microeconomics and Macroeconomics, we will discuss on the next coming articles which I will be categorised as Microeconomics and Macroeconomics (Part II).