CFA Level 1 - December 2009

A word before getting to SS8 - Financial Statements

noreply@blogger.com (Zuzia) — Mon, 03 Aug 2009 08:24:00 +0000

I’m back from vacation. According to the plan I should be studying reading 31 today. I have already posted my notes for it (before I travelled) so I’m just revising. Hopefully tomorrow I’ll start on study session 8 and follow the plan.

Prior to analyzing what I think is important for the various financial statements I want to share with you how I study the statements. I downloaded many financial statements from company’s websites and the ones provided as part of CFA toolkit on the CFA website. Using this as an example it’s easier to understand all the different methods discussed here and to apply the concepts where application is required.
I’m hoping that if I go quickly through the next 3 chapters (32 – 34) then maybe we can analyze at least one statement together in that way. What do you think?

Additionally, the following readings often require formulas to be remembered I’m creating a new section on this website where I’ll write these formulas. Hopefully by the time the studies are over (i.e. 23rd October) we’ll have a list of all the formulas.

I find it very useful to, once a week, list names of all formulas studied until date and try to write it down – to see if I remember. The page with just names and blanks to be filled will also be available soon. I’ll update it once a week just before I do my own ‘memory refreshment test’.

How are you doing? On track?

Free (legal) resources for CFA course

noreply@blogger.com (Zuzia) — Thu, 25 Jun 2009 04:07:00 +0000

Hello,

Yesterday while surfing the net I found some really great offer for studying for the CFA.

This site offers what they call a CFA waiver program. They'll give you all the materials now - for free. The materials include videos, mp3s, study notes, sample exams and more.

You'll only pay for the materials if you pass the course. If you fail - you don't have to pay a penny. Clearly it's in their best benefit to send you as much useful information as possible so that you can pass.

I did my first longer test yesterday - 60 questions on full ethics and session 7 (FSA that was posted here). I got 85%.

I got 9 questions wrong. In those 3/20 were wrong in ethics and 6/40 wrong in FSA.

Today I'm starting session 8 so stay tuned for more notes :)

Reading 31 - Financial Reporting Standards

noreply@blogger.com (Zuzia) — Wed, 24 Jun 2009 00:19:00 +0000

a. Explain the objective of financial statements and the importance of reporting standards in security analysis and valuation;

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity. This information should be useful to a wide range of users for the purpose of making economic decisions. Financial reporting requires policy choices and estimates. These choices and estimates require judgment which can vary from one preparer to the next. Accordingly standards are needed to attempt to ensure some type of consistency in these judgments.

b. Explain the role of standard-setting bodies, such as the International Accounting Standards Board and the U.S. Financial Accounting Standards Board, and regulatory authorities such as the International Organization of Securities Commissions, the U.K. Financial Services Authority, and the U.S. Securities and Exchange Commission in establishing and enforcing financial reporting standards;

The standard-setting bodies (IASB or FASB) are part of the private sector and are responsible for making the rules and regulations. The four goals of IASB are (1) develop global standards (2) promote the use of those standards (3) adjust standards to special needs of some entities (4) bring about convergence of various standards.

Regulatory authorities (SEC in US and FSA in UK) are governmental bodies who main aim is to enforce the rules and regulations set up by standard-setting bodies.

IOSCO was formed in 1983 and regulates more than 90% of world’s financial capital markets. Its core objectives are (1) protect investors (2) ensure that markets are fair, efficient and transparent (3) reduce systematic risk.

SEC formed in 1934 is one of the oldest and most developed regulatory authorities. It ensures that investors regularly receive financial and other significant information about available securities. From 2005, SEC filings are required to be made electronically. EDGAR has made corporate and financial info more readily available to investors and the financial community.

c. Discuss the ongoing barriers to developing one universally accepted set of financial reporting standards;

The barriers include (a) honest differences in opinions - i.e. various bodies have different views on what is best (b) other pressing priorities (c) they may be influenced by strong industry lobbying groups and others that will be subject to these reporting standards

d. Describe the International Financial Reporting Standards (IFRS) framework, including the objective of financial statements, their qualitative characteristics, required reporting elements, and the constraints and assumptions in preparing financial statements;

IFRS framework sets forth the concepts that underline the preparation and presentation of financial statements for external uses. The Framework is designed to assist the IASB in developing standards to instruct prepares of financial statements on the principles of financial statement construction; and assisting users in interpreting the information contained in financial statements.

Objective is to provide fair presentation of

– Financial position; - Financial performance; - Cash flows

Qualitative Characteristics:

Understandability; Comparability; Relevance; Reliability (faithful representation; substance over form; neutrality, prudence, completeness)

Required Reporting Elements:

- Performance: Income; Expenses; Capital maintenance adjustments

- Financial Position: Assets, Liabilities, Equity

Constraints: relevance vs. reliability; costs vs. benefit; non-quantifiable info omitted from financial reporting

Assumptions: going concern (company will continue to exist in foreseeable future); accrual basis (txn are recorded as incurred and not when cash is exchanged – except for the cash flow statement)

e. Explain the general requirements for financial statements;

International Accounting Standard (IAS) provides the:

Required financial statements:

- Balance sheet; - Income Statement; - Stmt of changes in equity; - Cash flow stmt; - Accounting policies and notes

Fundamental principles underlying their presentation: fair presentation, going concern, accrual basis; consistency; materiality

Principles of presentation: aggregation when appropriate, no offsetting, classified balance sheet, minimum information on face, minim note disclosures, comparative information

f. Compare and contrast key concepts of financial reporting standards under IFRS and alternative reporting systems, and discuss the implications for financial analysis of differing financial reporting systems;

Purpose of the Framework: IFRS mgmt is required to consider the framework if no standard or interpretation exists; FASB does not have such provision

Objectives of Fin. Stmt: FASB provides separate objectives for business entities vs. non-business entities; IASB has one set of objectives

Underlying assumptions: IASB has the going concern and accrual assumptions; in FASB they are not given such importance (going concern is not well developed

Qualitative Characteristics: FASB has same characteristics as IASB but also establishes a hierarchy for them. Relevance and reliability are primary qualities, comparability is secondary; understandability is treated as user-specific.

Constraints: Similar in both frameworks

Fin. Stmt Elements:

- Performance Elements: FASB additionally contains: gains, losses & other comprehensive income (includes all changes in equity other than contributions)

- Financial position elements – FASB has different definition for financial position elements; asset – ‘ a future economic benefit’ , it also includes the term ‘probable’ to define assets and liabilities elements.

- Recognition of elements: FASB does not discuss term ‘probable’ in recognition of criteria; it has a separate recognition criteria of relevance

- Measurement of elements: measurement attributes are broadly consistent and both lack fully developed measurement concepts. FASB framework prohibits revaluations except for certain categories of financial instruments.

g. Identify the characteristics of a coherent financial reporting framework and barriers to creating a coherent financial reporting network;

- Characteristics – transparency (full disclosure & fair presentation); comprehensiveness (full spectrum of transactions that have fin. consequence); consistency (across companies and time periods)

- Barriers – Valuation: fair value which requires judgment may be more relevant; historical cost is more reliable; Standard setting approach reporting standards can be established based on (1) principles based – provides broad framework with little specific guidance on how to report particular element//transaction. IFRS uses this approach (2) rules based – characterized by a list of specific rules and numerical tests for classifying transactions, exceptions and alternative treatments – FASB was criticized for using this approach (3) objectives based – is a mix of two provides framework with appropriate levels of implementation guidance and is now used by FASB.

h. Discuss the importance of monitoring developments in financial reporting standards and evaluate company disclosures of significant accounting policies.

Analysts can remain aware of ongoing developments in financial reporting by monitoring three areas: new products or transactions, standard setters’ and regulators’ actions, and company disclosures regarding critical policies and estimates.

The conclusions that a company can reach about new standard include

- The standard does not apply

- The standard will have no material impact

- Discussion of impact of adoption

- Management is still evaluating the impact – creates some uncertainty about whether the change might materially affect the company

Schedule again

noreply@blogger.com (Zuzia) — Mon, 22 Jun 2009 10:02:00 +0000

I got an email asking whether I shouldn't schedule more days for the heavily weighted topics. Well, not the way I see it. Here is why:
The idea is that I scheduled them in order of importance. So FSA has hightest % therefore is first. As I already mentioned I purchased SchweserPRO (the questions DB) and every day after studying I take an exam.
The software has an option to choose which chapters you want to be tested on and how many questions. So I choose all the chapters done until that given date. Usually I do 30 - 60 questions a day.

This way I spend the same amount of time (i.e 1 chapter per day - which I find way more than enough) on chapters; however I take way more practice tests on the topics which are heavily weighted than I would eventually on the lesser ones.

Additionally, at the end of session I am planning to take a full session test. For all sessions completed until that given day. I have scheduled a special day for this and it will include 120 questions. Again by December I would do way more of the heavily weighted topics than of the others.

However feel free to modify this schedule as you like. As it is, the plan is to start on August 1 and I have already started giving myself couple of days for any 'delays'.

Reading 30 - Financial Reporting Mechanics

noreply@blogger.com (Zuzia) — Fri, 19 Jun 2009 19:34:00 +0000

a. Identify the groups (operating, investing, and financing activities) into which business activities are categorized for financial reporting purposes and classify any business activity into the appropriate group;

- Operating activities are those activities that are part of the day-to-day business functioning of an entity.

- Investing activities are those activities associated with acquisition and disposal of long term assets

- Financing activities are those activities related to obtaining or repaying capital. The two primary sources for such funds are owners or creditors.

Understanding the nature of activities helps the analyst understand where the company is doing well and where it is not doing so well. Ideally an analyst would prefer that most of company’s profits (and cash flow) come from its operating activities.

b. Explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements;

Business activities resulting in transactions are reflected in the broad groupings of financial statements elements: Assets, Liabilities, Owner’s Equity, Revenue and Expenses. Accounts are individual records of increases and decreases in specific elements.

Assets are the economic resources of the company; Liabilities are the creditor’s claims on the resources of a company; owners’ equity is the residual claim on those resources; revenues are inflows of economic resources to the company; and expenses are outflows of economic resources or increase in liabilities.

The actual accounts used in a co’s accounting system will be set forth in a chart of accounts. Generally the chart of accounts is far more detailed than the information presented in financial statements.

Any account that is offset or deducted from another account is called a “contra account”. Common contra assets accounts include allowance for bad debts, accumulated depreciation and sales returns and allowances.

For presentation purposes assets (and liabilities) are sometimes categorized as “current” or “noncurrent”. Noncurrent are assets (or liabilities) that are expected to benefit (or cost) the company over an extended period of time (usually more than one year). Current are those that are expected to be consumed (or repaid) in the near future (less than one accounting cycle).

c. Explain the accounting equation in its basic and expanded forms;

Assets = Liabilities + Owner’s Equity

Owner’s Equity = Contributed capital + retained earnings

Net Income (Loss) = Revenue – Expenses

è Assets = Liabilities + Contributed capital + Beginning retained earnings + Revenue – Expenses - Dividends

The statement of retained earnings shows the linkage between the balance sheet and income statement.

d. Explain the process of recording business transactions using an accounting system based on the accounting equations;

An accounting system will translate the company’s business activities into usable financial records. Every transaction has to be entered twice (hence double-entry accounting). e.g. increase in one asset and decrease in another; or increase in one asset and decrease in liabilities

To record transaction the following steps are taken:

- identify which accounts are affected, by what amount and whether the accounts are increased or decreased; - determine the element type for each account and whether it fits in the basic accounting equation; - using information from previous steps enter amounts in the appropriate column of the spreadsheet; - verify that the accounting equation is still in balance

e. Explain the need for accruals and other adjustments in preparing financial statements;

Accrual accounting requires that revenue be recorded when earned and that expenses be recorded when incurred, irrespective of when the related cash movements occur. The purpose of accrual entries is to report revenue and expense in the proper accounting period.

Cash movement may occur before or after accounting recognition, in which case accrual are required. There are four types of accrual entries:

- Unearned (deferred) revenue – arises when a company receives cash prior to earning the revenue;

- Unbilled (accrued) revenue – arises when a company earns revenue prior to receiving cash but has not yet recognized the revenue at the end of accounting period;

- Prepaid expense – arises when a company makes a cash payment prior to recognizing an expense;

- Accrued expenses – arise when a company incurs expenses that have not yet been paid as of the end of an accounting period;

Valuation adjustments are made to a company’s assets or liabilities only when required by accounting standards, so that the accounting records reflect the current market value rather than the historical costs.

f. Prepare financial statements, given account balances or other elements in the relevant accounting equation, and explain the relationships among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity;

This point cannot be easily summarized. I strongly recommend referring to the optional part of the prescribed book pp 72 -87. It is a very good example on how to create “T” type accounts and convert them into various statements.

Note that balance sheet will show position at the time of preparing the statements. Other statements such as income, cash flow and changes in owner’s equity show activities throughout the given accounting period.

g. Describe the flow of information in an accounting system;

1. Journal entries and adjusting entries – The business transactions are recorded chronologically as they occur. Adjusting journal entries, a subset of journal entries, typically made at the end of accounting period to record items such as accrual that are not yet reflected in the accounting system.

2. General ledger and T-accounts - A ledger is a document or computer file that shows all business transactions by account. T-accounts are representations of ledger accounts and are frequently used to describe or analyze accounting transactions.

3. Trial balance and adjusted trial balance – A trial balance is a document that lists account balances at a particular point in time. It shows total ending balances of each account. Adjusted trial balance is the same but included all the adjusting entries.

4. Financial statements – Financial statements, final product of accounting system are prepared based on the account totals from an adjusted trial balance.

h. Explain the use of the results of the accounting process in security analysis.

Analysts typically will not have access to the accounting system or individual entries. They will need to infer what transactions were recorded by examining the financial stmts. Analysts may need to make adjustments to reflect times not reported in the statements; analysts may also need to assess the reasonableness of mgmt judgment.

- The use of judgment in account entries

- Misrepresentations – entries could be structured in a way to create nonexistent liabilities / assets that cover fictitious money amounts.

Reading 29 - Financial Statement Analysis: An Introduction

noreply@blogger.com (Zuzia) — Wed, 10 Jun 2009 20:23:00 +0000

a. Discuss the roles of financial reporting and financial statement analysis;
- The role of financial reporting by companies is to provide information about their performance, financial position, and changes in financial position that is useful to a wide range of users in making economic decisions.
- The role of FSA is to take financial reports prepared by companies, combined with other information to evaluate the past current and prospective performance and financial position of a company for the purpose of making investment, credit and other economic decisions. There are certain themes in financial analysis. Analysts seek to :
· Examine the performance and financial position of companies
· Forecast future performance and financial position
· They are concerned about factors that affect risks to the company’s future performance and financial position

b. Discuss the role of key financial statements (income statement, balance sheet, cash flow statement and statement of changes in owners’ equity) in evaluating a company’s performance and financial position;
- Income Statement – shows information on the financial results over a period of time. It shows how much revenue was generated and how much did it cost.Net Income = Revenue - Expenses
- Balance Sheet – shows company’s position @ point in time. It discloses the resources that the company controls (assets) and what it owes (liabilities). Owner’s equity represents the excess of assets over liabilities and is attributable to owners or shareholders of the business. It is the residual interest in the assets of an entity.Assets – Liabilities = Owner’s Equity
- Cash Flow Statement – presents the sources and uses of cash in order to help evaluate company’s liquidity, solvency and financial flexibility (ability to react and adapt to financial adversities and opportunities). ; it divides it into
· Investing – associated with acquisition and disposal of long-term assets
· Financing – related to obtaining or repaying capital to be used in the business
· Operating – involve transactions that enter into determination of net income and are primarily activities that comprise the hay-to-day business functions of a company.
- Statement of Changes in Owner’s Equity – primarily serves to report changes in the owners’ investment in the business over time and assist the analyst in understanding the changes in financial position reflected on the balance sheet.

c. Discuss the importance of financial statement notes and supplementary information (including disclosures of accounting methods, estimates and assumptions) and management’s discussion and analysis;
- Financial notes – Footnotes contain information about business expansion and disposals, legal actions, employee benefits plans, significant customers, sales to related parties. They allow users to assess the accounting methods and assumptions used to estimate the figures in the financial reports. The footnotes are audited.
- Supplementary schedules are not audited and contain such information as operating income for each business segment/ region. Reserves for an oil and gas company. Information about hedging activities and financial instruments.
- MD&A – provides an assessment of financial performance and condition of company from mgmt’s point of view. It has to discuss results from operations including any trends; capital resources and liquidity and general business overview based on known trends. It could also include discussion of accounting policies that require significant judgments by management; discussion of significant effects of currently known trends/events/uncertainties; liquidity and capital resource issues; discontinued operations, extraordinary items; disclosure of segment’s need for cash flow
- External auditor’s report

d. Discuss the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls;
Audit is an independent review of entity’s financial statements.
- Objective of audits – To enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework
- Types of audit reports
o Unqualified audit opinion – financial stmt gives a true and fair view
o Qualified audit opinion – there is some limitation or exception to accy standards (an additional explanatory paragraph is required to explain the exception)
o Adverse opinion – financial stmt materially depart from accy standards and are not fairly presented
o Disclaimer of opinion – for some reason auditors are unable to issue an opinion
- Importance of effective internal controls is co’s internal system designed to ensure that company’s process for generating financial reports is sound. It is mgmt’s responsibility to demonstrate that the internal controls are effective

e. Identify and explain information sources other than annual financial statements and supplementary information that analysts use in financial statement analysis;
Other information sources include:
- Interim reports – present the four key financial stmts and footnotes but are not audited
- Proxy statements – for distribution to shareholders on matters that are to be put to a vote; useful info regarding mgmt and director compensation, co’s stock performance and potential conflicts of interest that may exists between mgmt, board and shareholders
- Websites, press releases and conference calls
- External sources: economy, industry, peer companies

f. Describe the steps in the financial statement analysis framework.
- Objective
- Collect data
- Process data
- Analyze & interpret data
- Report conclusion / recommendation
- Update analysis

Study Plan

noreply@blogger.com (Zuzia) — Wed, 10 Jun 2009 04:55:00 +0000

This is my study plan. I assume I'll start it on 1st August. (I'm going on vacation before that).

After completing each unit I'll take a schweser test from that unit and mark my score.

Last month is just for practicing.

I have made this as an excel table and the start day and number of days per chapter can be changed and then dates changed. If anyone wants my excel sheet just leave me your email in a comment here and I'll send it.

The beginning

noreply@blogger.com (Zuzia) — Tue, 09 Jun 2009 04:34:00 +0000

Initially I worked as a software developer... that was fun but not enough interaction with people. So I went to do my MBA and while doing that I really loved finance and anything to do with it. I'm also very much interested in econometrics.
So I started studying for CFA and attempted it for first time in December 2008. I guess I underestimated the difficulty.
My major mistake was that I spent too much studying and too little practicing.

I was planning to nail the exam in June 2009, but had a full house of guests for over 3 month starting from mid January. We don't get guests that often and so this time I didn't study. I wrote to CFA and postponed the exam until December. CFA does not allow postponing of the exam, I basicly asked them to withdraw application (lost the registration fee) and re-registered myself for December 2009.

This time I designed a whole system aimed at passing the exam and I'll pass it. I have a time table. I have a plan. I have ProBank from Schweser. I'm also going to make good use of candidate toolkit.
I study and practice and practice and practice and study and practice and practice and practice and so on...

I have changed the order of studying from the curriculum one to my own order, which you'll see in my next post when I put my study plan here.
Obviously I can't post questions here because they belong to Schweser not to me. However I also search other discussion groups for questions.
So if I find interesting problems posted elsewhere I'll try to discuss them here. This way I'll motivate myself to nail the exam.

Please note that I'm not an expert on any of these subjects. I'm just learning - just like anyone reading this post. I can misunderstand. I can make mistakes. If you spot any please correct me. We can learn from each other.

Good luck to all of you. Good luck to me. Let's get started.