University:
CFA Institute
Course:
CFA Level 1 - Financial Statement Analysis
Academic year:

2021
Views:

275

Pages:

28
Author:

LabsAnonym

Level I - Financial Reporting and Analysis Understanding Balance Sheets 1 Contents 1. 2. 3. 4. 5. 6. 7. Introduction Components and Format of the Balance Sheet Current Assets and Current Liabilities Non-Current Assets Non-Current Liabilities Equity Analysis of the Balance Sheet 2 1. Introduction • IFRS: Statement of Financial Position versus U.S. GAAP: Balance Sheet • The balance sheet provides information on a company’s resources (assets) and its sources of capital (liabilities and equity) • The fundamental equation: A = L + E • Different items of assets and liabilities may be measured differently 3 2. Components and Format of the Balance Sheet • Assets (A) are what the company owns. They are the resources controlled by the company as a result of past events and from which future economics benefits are expected to flow to the entity. • Liabilities (L) are what company owes. They represent the obligations of a company arising from past events, the settlement of which is expected to result in an outflow of economic benefits from the entity. • Equity (E) represents the owner’s residual interest in the company’s assets after deducting its liabilities. Also known as shareholders’ equity. The accounting equation for determining equity is E = A – L. 4 Balance Sheet Components and Classification • Balance sheet shows a company’s assets, liabilities and equity on a particular date (end of reporting period) ▪ Measurement basis varies across items ▪ “Current value” is the value at the end of the reporting period ▪ Important elements of a company’s ability to generate future cash flows are not shown on the balance sheet • Current and Non-Current (Classified Balance Sheet) versus LiquidityBased Presentation 5 Classified Balance Sheet 6 Liquidity-Based Presentation Source: China Construction Bank 2009 Annual Report 7 3.1 Current Assets Current Assets: Those assets held primarily for trading or expected to be sold, used up or otherwise realized in cash within one year or in one operating business cycle. • Cash and Cash Equivalents ▪ Cash equivalents are highly liquid, short-term investments that are so close to maturity, the risk is minimal that their value will change significantly with changes in interest rates ▪ Cash equivalents are financial assets; reported at fair value or amortized cost • Marketable Securities ▪ Also financial assets and include publically traded debt and equity instruments • Trade Receivables (Accounts Receivables, A/R) ▪ Allowance for doubtful accounts (contra asset account) • Inventories • Other Current Assets (Prepaid expenses) 8 3.2 Current Liabilities Current Liabilities: Those liabilities which are expected to be settled within one year or in one operating business cycle. • • • • • Accounts Payable or Trade Payables Financial liabilities or borrowings i.e. bank loans, trade creditors. Income Taxes Payable Accrued Expenses Deferred Income (Deferred Revenue or Unearned Revenue) 9 4. Non-Current Assets Non-Current Asset: All assets not classified as current. Also called long-term or longlived assets. • • • • • • Property, Plant and Equipment (PPE) Investment Property Intangible Assets Goodwill Financial Assets Deferred tax assets 10 PPE, Investment Property, Intangible Assets • Property, Plant and Equipment (PPE) ▪ ▪ ▪ ▪ Tangible; expected to provide economic benefit over more than one fiscal period IFRS: report using cost model or revaluation model Cost model: historical cost less depreciation; also called amortized cost Land is not depreciated • Investment Property ▪ Property not used in regular operations of company ▪ Purely an IFRS concept • Intangible Assets ▪ Identifiable non-monetary assets without physical substance ▪ IFRS: report using cost model or revaluation model This material will be covered in detail in the reading on Long Lived Assets; come back to the curriculum examples after you’ve done that reading. 11 Goodwill Goodwill arises when one company is purchased by another company. If the purchase price is greater than fair value at acquisition, then goodwill is created in the acquirer’s balance sheet. Goodwill is subject to impairment. Example: Company A buys Company T for $100 million. Book value of Company T’s assets and liabilities: $125 million and $75 million. Fair value of Company T’s assets and liabilities: $160 million and $75 million. What is the goodwill? Reported goodwill (15) is the excess of purchase price (100) over the fair value of net assets (85). 12 Financial Assets Financial asset: financial liability or equity instrument of another entity. Fair value Measurement of financial assets Amortised cost Realized gains shown on income statement for all categories Mark-to-market is the process whereby the value of a financial instrument is adjusted to reflect current value based on market prices 13 Financial Assets - Example Company owners contribute 100,000 which is invested in a 20-year bond with a 5% coupon paid semiannually. After six months company receives the first coupon payment of 2,500. At this stage the market price has increased to 102,000. Show the balance sheet and income statement treatment under each of the following categorizations: held for trading, available for sale, held to maturity. FVTPL AFS HTM Balance Sheet Cash Cost of securities Unrealized gains/losses PIC RE OCI Income Statement Interest income Unrealized gain 14 Solution Company owners contribute 100,000 which is invested in a 20-year bond with a 5% coupon paid semiannually. After six months company receives the first coupon payment of 2,500. At this stage the market price has increased to 102,000. Show the balance sheet and income statement treatment under each of the following categorizations: held for trading, available for sale, held to maturity. FVTPL Balance Sheet Cash Cost of securities Unrealized gains/losses PIC RE OCI Income Statement Interest income Unrealized gain AFS HTM 2,500 100,000 2,000 2,500 100,000 2,000 2,500 100,000 PIC 100,000 RE up by 4,500 PIC 100,000 RE up by 2,500 OCI up by 2,000 PIC 100,000 RE up by 2,500 2,500 2,500 2,500 2,000 15 Measurement of Financial Assets Measured at Cost or Amortized Cost Measured at Fair Value through OCI (HTM) (AFS) Measured at Fair Value through Profit and Loss Debt securities that are to be held to AFS debt securities (US GAAP) maturity Debt securities where business Loans and notes receivable model involves collecting interest/principal and selling the Unquoted equity instruments (in security (IFRS) limited circumstances) Equity instruments for which the company irrevocably elects this measurement at acquisition (IFRS only) All equity instruments unless investor has significant influence (US GAAP) “Trading” debt securities (US GAAP) Securities not assigned to either of the other categories (IFRS) Securities for which company irrevocably elects this method (IFRS) 16 5. Non-Current Liabilities Non-current liability: all liabilities not classified as current • Long-term Financial Liabilities ▪ Loans, notes, bonds payable • Deferred Tax Liabilities ▪ Result from temporary timing difference between a company’s income as reported for tax purposes (taxable income) and income as reported for financial statement purposes (reported income) This material will be covered in detail in the readings on income taxes and noncurrent liabilities. 17 6. Equity Equity is the owner’s residual claim on a company’s assets after subtracting its liabilities. Components of equity: 1. Capital contributed by owners (common stock, issued capital); may have a par (stated) value; disclose number of shares authorized, issued and outstanding 2. Treasury shares 3. Retained earnings 4. Accumulated other comprehensive income 5. Noncontrolling interest (minority interest) 6. Preferred shares: classified as equity or financial liabilities depending on characteristics 18 Equity Components – Simple Illustration At start of Year 1 owners contribute 100. Among other assets, the company purchases financial assets categorized as AFS worth 10. During Year 1 the net income is 20 which is retained. Value of financial assets goes up to 12. During Year 2 there is a treasury stock operation worth 30. Net income is 40, which retained. Financial assets goes up to 15. Show the relevant equity components at the end of Year 1 and Year 2. Component End of Year 1 End of Year 2 Issued Capital Treasury Stock Accumulated Retained Earnings Accumulated Other Comprehensive Income Total Equity 19 Solution At start of Year 1 owners contribute 100. Among other assets, the company purchases financial assets categorized as AFS worth 10. During Year 1 the net income is 20 which is retained. Value of financial assets goes up to 12. During Year 2 there is a treasury stock operation worth 30. Net income is 40, which retained. Financial assets goes up to 15. Show the relevant equity components at the end of Year 1 and Year 2. Component End of Year 1 End of Year 2 Issued Capital 100 100 Treasury Stock (30) Accumulated Retained Earnings 20 60 Accumulated Other Comprehensive Income 2 5 Total Equity 122 135 20 Statement of Changes in Equity The statement of changes in equity presents information about the increases or decreases in a company’s equity over a period. IFRS requires the following information in the statement of changes in equity: ➢ Total comprehensive income for the period; ➢ The effects of any accounting changes that have been retrospectively applied to previous periods; ➢ Capital transactions with owners and distributions to owners; and ➢ Reconciliation of the carrying amounts of each component of equity at the beginning and end of the year. U.S. GAAP requirement is for companies to provide an analysis of changes in each component of equity as shown in the balance sheet. 21 Excerpt from Apple Inc.’s Consolidated Changes in Shareholders Equity 22 7. Analysis of the Balance Sheet • Balance sheet analysis can help us evaluate a company’s liquidity and solvency • Analysis tools: Common-Size Analysis and Balance Sheet Ratios • Common-Size Analysis: All balance sheet items are expressed as a % of total assets Time Series Analysis Cross Sectional Analysis 23 Liquidity Ratios Liquidity ratios tell us about a company’s ability to meet current liabilities Liquidity Ratios Calculation Current Current assets ÷ Current liabilities Quick (acid test) (Cash + Marketable securities + Receivables) ÷ Current liabilities Cash (Cash + Marketable securities) ÷ Current liabilities 24 Solvency Ratios Solvency ratios help us evaluate a company’s: 1. ability to meet long-term and other liabilities 2. financial risk and leverage Solvency Ratios Calculation Long-term debt-to-equity Total long-term debt ÷ Total equity Debt-to-equity Total debt ÷ Total equity Total debt-to-assets Total debt ÷ Total assets Financial leverage Total assets ÷ Total equity 25 General Remarks about Ratio Analysis • Ratio analysis requires judgment; for example, current ratio is only a rough measure of liquidity • Ratios are sensitive to end of period financing and operating decisions • Need to evaluate ratios in the context of a company’s industry More on this in the reading on financial analysis techniques. 26 Summary • Current and Non-Current Assets ▪ Valuation based on categorization of financial assets • Current and Non-Current Liabilities • Components of Shareholder’s Equity • Analysis of the Balance Sheet 27 Conclusion • Read summary • Review learning objectives • Examples • Practice problems: good but not enough • Practice questions from other sources 28