IV. FINANCIAL STATEMENT ANALYSIS

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A. Financial Reporting System

1. General concepts and rules

2. U.S. Generally Accepted Accounting Principles (GAAP)

3. International Accounting Standards (IAS)

B. Principal Financial Statements

1. Balance sheet

a. Format and classification (e.g., assets, liabilities, stockholders’ equity)

b. Measurement of assets and liabilities

c. Uses of the balance sheet

2. Income statement

a. Format and classification

b. The accrual concept of income

c. Revenue and expense recognition

(1) General principles

(2) Percentage-of-completion method

(3) Completed contract method

(4) Installment method

(5) Cost recovery method

d. Nonrecurring items (e.g., extraordinary items, unusual items, restructuring

charges, discontinued operations, changes in accounting standards, disclosure of

nonrecurring items, analysis of nonrecurring items)

e. Earnings quality

f. Earnings per share

3. Statement of cash flows

a. Direct and indirect method cash flow statements

b. Preparing a direct method statement of cash flows (e.g., cash flow from

operations, investing cash flow, financing cash flow)

c. Indirect method

d. Reported versus observed changes in assets and liabilities (e.g., acquisitions and

divestitures, translation of foreign subsidiaries)

e. Analysis of cash flow information

4. Statement of stockholders’ equity

a. Format, classification, and uses

b. Other comprehensive income

5. Other sources of financial information

a. Letter to shareholders

b. Footnotes

c. Management discussion and analysis

d. Segment/disaggregated information

e. Operating and performance data

f. Forward looking information/plans

g. Role of the auditor

h. Annual report to regulators (e.g., Form 10K in U.S.)

i. Proxy statement

j. Change in material status report (e.g., Form 8K in U.S.)

k. Quarterly reports

l. News releases

C. Earnings Quality and Nonrecurring Items

1. Earnings quality

a. Stock options

b. Revenue recognition

c. Assumptions

d. Reserves

2. Nonrecurring items

a. Extraordinary items

b. Restructuring charges

c. Unusual items

D. Analysis of Inventories

1. Relationship between inventory and cost of goods sold

a. Stable prices

b. Rising prices

2. Inventory methods

a. Specific identification

b. First-in, first-out (FIFO)

c. Average cost

d. Last-in, first-out (LIFO)

e. Adjustment from LIFO to FIFO

(1) Adjustment of inventory balances

(2) Adjustment of cost of goods sold

f. Adjustment of income to current cost income

g. Effect of LIFO/FIFO choice on financial ratios (e.g., profitability, liquidity,

activity, solvency)

h. Analysis implications of changes to and from LIFO

i. Comparison of companies using different inventory valuation methods

j. International comparisons of inventory accounting methods

E. Analysis of Long-Lived Assets

1. Capitalization versus expensing

a. Financial statement effects of capitalization (e.g., income variability, profitability,

cash flow from operations, leverage ratios)

b. Capitalization of interest costs

c. Intangible assets (e.g., research and development, patents and copyrights,

franchises and licenses, brands and trademarks, goodwill)

d. Asset revaluation

e. International differences

f. Adjustments for capitalization and expensing

g. Need for analytic adjustments

2. Depreciation methods

a. Alternatives (e.g., annuity or sinking fund depreciation, straight line depreciation,

accelerated depreciation)

b. Depletion

c. Amortization

d. Depreciation method disclosures

e. Impact of depreciation methods on financial statements

f. Accelerated depreciation and taxes

g. Impact of inflation on depreciation

h. Changes in depreciation method

3. Analysis of fixed asset disclosures

4. Impairment of long-lived assets

5. Retirement of long-term assets

6. Liabilities for closure and environmental costs

F. Analysis of Income Taxes

1. Issues in tax and financial reporting

2. Deferred tax assets and liabilities

a. Accounting for deferred taxes

b. Analysis of deferred tax assets

c. Non-U.S. financial reporting (e.g., IASC standards)

G. Analysis of Financing Liabilities

1. Analysis of balance sheet debt

a. Analysis of current liabilities

b. Analysis of long-term debt

c. Analysis of debt with equity features (e.g., convertible bonds, warrants,

commodity bonds, perpetual debt, preferred stock)

d. Analysis of changes in interest rates (e.g., estimating the market value of a firm’s

debt)

e. Retirement of debt prior to maturity

2. Bond covenants

3. International accounting and reporting practices for balance sheet debt

H. Analysis of Leases

1. Incentives for leasing

2. Lease classification issues from lessee perspective (e.g., capital lease, operating lease)

3. Financial reporting by lessees

4. Financial reporting by lessors

5. Financial reporting for sales with leasebacks

I. Analysis of Off-Balance-Sheet Assets and Liabilities

1. Disclosure of off-balance-sheet assets

2. Disclosure of off-balance-sheet liabilities

3. Take-or-pay and throughput arrangements

4. Sale of receivables

5. Finance subsidiaries

6. Joint ventures and investment in affiliates

J. Analysis of Pensions, Stock Compensation, and Other Employee Benefits

1. Disclosures

a. Components of pension cost

b. Plan status

c. Reconciliation

d. Assumptions used to calculate pension cost and obligations

2. Analysis of pension costs and liability

a. Importance of assumptions

(1) Factors affecting benefit obligations (e.g., service cost, interest cost, actuarial

gains and losses, prior service cost from plan amendments, benefits paid)

(2) Factors affecting plan assets (e.g., employer contribution, return on assets,

benefits paid)

(3) Factors affecting pension expense (e.g., service cost and interest cost,

expected return on assets, amortization of gains or losses, amortization of

prior service cost, amortization of transition asset or liability)

b. Analysis of plan status, costs, and cash flows

c. Impact of pension reporting on corporate earnings

3. Employee stock compensation plans

a. Disclosures

b. Analysis of costs and liability

K. Analysis of Inter-Corporate Investments

1. Accounting for marketable securities

a. Cost method

b. Market method

c. Lower of cost or market method

d. U.S. and international accounting requirements

2. Analysis of marketable securities

a. Separation of operating from investment results

b. Effects of classification of marketable securities

c. Analysis of investment performance

3. Equity method of accounting

a. Conditions for use

b. Equity accounting and analysis

4. Consolidations policy and procedures

a. Comparison of consolidation with the equity method

b. Analysis of minority interest

c. Non-U.S. consolidation practices

d. Analysis of segment data

L. Analysis of Business Combinations

1. Accounting for acquisitions

2. Effects of accounting methods

3. International differences in accounting for business combinations

4. Analysis of goodwill

5. Choosing the acquisition method

6. Spin-offs and tracking stocks

M. Analysis of Multinational Operations

1. Effects of exchange rate changes on a firm’s actual and reported performance

a. Flow effect

b. Holding gain/loss effect

2. Basic accounting issues

a. Choice of exchange rates (e.g., historical rate or current rate)

b. Assets or liabilities to be adjusted for exchange rate changes

c. Treatment of translation gains and losses

3. Prescribed foreign currency translation

4. Choice of the functional currency for a foreign subsidiary

5. Comparison of translation and remeasurement

a. Income statement effects

b. Balance sheet effects

c. Impact on financial ratios

d. Impact on reported cash flows

6. Analysis of foreign currency disclosures

a. Exchange rate changes: exposure and effects

N. Ratio and Financial Analysis

1. Common-size statements

2. Activity analysis and turnover ratios

a. Short-term and long-term activity ratios

b. Turnover ratios (inventory, receivables, payables, working capital, fixed asset and

total asset)

3. Liquidity analysis

a. Length of cash cycle

b. Working capital ratios

4. Long-term debt analysis

a. Debt covenants

b. Debt ratios

c. Interest coverage ratios

5. Profitability analysis

a. Return on sales (gross margin, operating margin, pretax margin, profit margin)

b. Return on investment (e.g., return on assets, return on total capital, return on

equity)

6. Operating and financial leverage

7. Earnings per share (EPS)

a. Basic EPS

b. Diluted EPS

c. Weighted-average number of common shares outstanding

d. Convertible securities

e. Options and warrants

f. Contingent shares

8. Other ratios and value metrics

a. Earnings before interest, taxes, depreciation and amortization (EBITDA)

b. Price-to-earnings (P/E)

c. Price-to-book value (P/B)

9. Integrated ratio analysis

10. Valuation implications of financial statement analysis

a. Inter-corporate investments

b. Business combinations

c. Multinational operations

d. Ratio and financial analysis