CIFA Intermediate Level

Financial Statements Analysis flashcards

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What is the difference between financial reporting and financial statement analysis?

Financial reporting is the company's own responsibility: preparing and communicating statements that fairly represent its performance, position and cash flows. Financial statement analysis is the user's responsibility: applying judgement and technique to that reported information to answer a specific decision question, such as an investor's buy or sell decision or a lender's credit decision.

Into which three measurement categories does IFRS 9 classify financial assets, and on what basis?

By the entity's business model for holding the asset and the nature of its contractual cash flows: Amortised cost: held to collect contractual cash flows that are solely principal and interest. Fair value through other comprehensive income: held both to collect and to sell; fair value changes go to OCI. Fair value through profit or loss: the default, including most equity investments and derivatives.

How do you tell whether a temporary difference on an asset gives a deferred tax asset or a deferred tax liability?

Temporary difference = carrying amount - tax base. Carrying amount above tax base: a deferred tax liability, tax payable in future periods. Tax base above carrying amount: a deferred tax asset, tax relief in future periods, recognised only to the extent future taxable profit is probable.

How does the three-step DuPont analysis decompose return on equity?

ROE = net profit margin x asset turnover x equity multiplier. Net profit margin = net income / sales. Asset turnover = sales / average total assets. Equity multiplier = average total assets / average equity. Check the answer by recomputing ROE directly: net income / average equity.

How do free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) differ?

FCFF = cash flow from operations + after-tax interest - capital expenditure: the cash available to all capital providers, debt and equity. FCFE = cash flow from operations - capital expenditure + net borrowing: the cash left for equity holders once debt has been serviced. FCFF adds back after-tax interest; FCFE does not, but adds net borrowing.

What is the accrual component of earnings, and why is a large positive figure a warning sign?

Aggregate accruals = net income - cash flow from operations: the part of profit not backed by cash. Accruals rest on management judgement and estimate, while cash flow is comparatively hard to manipulate, so net income persistently and materially above operating cash flow deserves scrutiny.

How are a subsidiary and an associate distinguished, and how is each accounted for?

Subsidiary: the investor has control (power over the investee and exposure to its variable returns), usually more than 50% of the votes. Fully consolidated line by line, with a non-controlling interest for the part not owned. Associate: the investor has significant influence but not control, presumed at 20% to 50% of the votes. Equity method: cost, adjusted for the investor's share of profit or loss.

Which sector-specific metrics are used to assess a bank, and why those?

Net interest margin, the non-performing loan ratio and the capital adequacy ratio. They reflect a bank's core business of intermediating deposits and loans under prudential capital rules.

What are big bath accounting, cookie jar reserves and channel stuffing?

Big bath accounting: an unusually large write-off or provision in one, often already poor, period, so later periods look stronger by comparison. Cookie jar reserves: provisions overstated in a strong period and released in a weaker one to smooth earnings. Channel stuffing: pushing distributors to take more inventory than they need near period end, inflating current sales at the expense of future sales.

What is the difference between physical and transition climate risk in the financial statements?

Physical risk: assets exposed to climate-related damage, which may need earlier or larger impairment. Transition risk: assets tied to carbon-intensive activities, which may face shortened useful lives or stranded-asset write-downs as policy and markets shift. Both can affect the going-concern assumption, useful-life estimates and impairment testing.

Who sets IFRS and US GAAP, and what role do national regulators play?