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STUDY SESSION 8 www.cfainstitute.org/toolkitYour online preparation resource
LEARNING OUTCOMES
Reading 32: Understanding the Income Statement
The candidate should be able to:
a. describe the components of the income statement and construct an income
statement using the alternative presentation formats of that statement;
b. explain the general principles of revenue recognition and accrual accounting,
demonstrate specific revenue recognition applications (including accounting for
long-term contracts, installment sales, barter transactions, and gross and net
reporting of revenue), and discuss the implications of revenue recognition princi-
ples for financial analysis;
c. discuss the general principles of expense recognition, such as the matching prin-
ciple, specific expense recognition applications (including depreciation of long-
term assets and inventory methods), and the implications of expense recognition
principles for financial analysis;
d. determine which method of depreciation, accounting for inventory, or amortizing
intangibles is appropriate, based on facts that might influence the decision;
e. demonstrate the depreciation of long-term assets using each approved method,
accounting for inventory using each approved method, and amortization of
intangibles;
STUDY SESSION 8
FINANCIAL STATEMENT ANALYSIS:
The Income Statement, Balance Sheet, and
Cash Flow Statement
135
E
ach reading in this study session focuses on one of the three major financial
statements: the balance sheet, the income statement, and the statement of
cash flows. For each financial statement, the chapter details its purpose, construc-
tion, pertinent ratios, and common-size analysis. Understanding these concepts
allows a financial analyst to evaluate trends in performance over several measure-
ment periods and to compare the performance of different companies over the
same period(s). Additional analyst tools such as the earnings per share calculation
are also described. 136
Study Session 8
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f. distinguish between the operating and nonoperating components of the income
statement;
g. discuss the financial reporting treatment and analysis of nonrecurring items
(including discontinued operations, extraordinary items, and unusual or infre-
quent items), and changes in accounting standards;
h. describe the components of earnings per share and calculate a companys earn-
ings per share (both basic and diluted earnings per share) for both a simple and
complex capital structure;
i. distinguish between dilutive and antidilutive securities, and discuss the implica-
tions of each for the earnings per share calculation;
j. evaluate a companys financial performance using common-size income state-
ments and financial ratios based on the income statement;
k. state the accounting classification for items that are excluded from the income
statement but affect owners equity, and list the major types of items receiving
that treatment;
l. describe and calculate comprehensive income.
Reading 33: Understanding the Balance Sheet
The candidate should be able to:
a. illustrate and interpret the components of the assets, liabilities, and equity sec-
tions of the balance sheet, and discuss the uses of the balance sheet in financial
analysis;
b. describe the various formats of balance sheet presentation;
c. explain how assets and liabilities arise from the accrual process;
d. compare and contrast current and noncurrent assets and liabilities;
e. explain the measurement bases (e.g., historical cost and fair value) of assets and
liabilities, including current assets, current liabilities, tangible assets, and intangi-
ble assets;
f. discuss off-balance-sheet disclosures;
g. demonstrate the appropriate classifications and related accounting treatments
for marketable and non-marketable financial instruments held as assets or owed
by the company as liabilities;
h. list and explain the components of owners equity;
i. interpret balance sheets, common-size balance sheets, the statement of changes
in equity, and commonly used balance sheet ratios.
Reading 34: Understanding the Cash Flow Statement
The candidate should be able to:
a. compare and contrast cash flows from operating, investing, and financing activi-
ties, and classify cash flow items as relating to one of these three categories,
given a description of the items;
b. describe how noncash investing and financing activities are reported;
c. compare and contrast the key differences in cash flow statements prepared
under international financial reporting standards and U.S. generally accepted
accounting principles; d. demonstrate the difference between the direct and indirect methods of present-
ing cash from operating activities and explain the arguments in favor of each;
e. demonstrate how the cash flow statement is linked to the income statement and
balance sheet;
f. demonstrate the steps in the preparation of direct and indirect cash flow state-
ments, including how cash flows can be computed using income statement and
balance sheet data;
g. describe the process of converting a statement of cash flows from the direct to
the indirect method of presentation;
h. analyze and interpret a cash flow statement using both total currency amounts
and common-size cash flow statements;
i. explain and calculate free cash flow to the firm, free cash flow to equity, and
other cash flow ratios.
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Study Session 8
www.cfainstitute.org/toolkitYour online preparation resource