CFA Level 1 FRA: Our Cheat Sheet

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Ah, I remember the days where I looked at the sheer volume of formulae and concepts in CFA Level 1 FRA (Financial Reporting and Analysis) in despair. And how I felt 5x worse when studying Level 2’s FRA section…

Financial Reporting and Analysis is one of the largest hurdles in the CFA exams, especially for Level 1 and Level 2. That’s why we decided to create our Cheat Sheet series of articles, which focuses on one specific topic area for one specific CFA Level.

More Cheat Sheets will be published in the coming weeks, sign up to our member’s list to be notified first.

By referring to the CFA Learning Outcome Statements (LOS), we prioritize and highlight the absolute key concepts and formula you need to know for each topic. With some tips at the end too!

Use the Cheat Sheets during your practice sessions to refresh your memory on important concepts.

Let’s dive in – this is a MONSTER article for a monstrous topic 🙂 Bookmark and come back to it often!

CFA Level 1 FRA: An Overview

cfa level 1 fra

FRA is a key foundational topic for CFA Level 1, which forms a basis for Level 2 learnings, but drops off at Level 3.

FRA has the second largest topic weighting after Ethics in Level 1. This is one of the unmissable topic areas – key to passing Levels 1 and 2, and therefore key to the entire CFA program.

CFA Level 1 Financial Reporting and Analysis’ topic weighting is 13%-17%, which means 23-31 questions of the 180 questions of CFA Level 1 exam is centered around this topic.

It is covered in Study Sessions 6-9, which includes Reading 19-30.

Here’s the summary of FRA chapter readings:

Reading NumberSub-topicDescription
19Introduction to Financial Statement AnalysisDiscusses the scope and framework of financial statement analysis, introduces the major financial statements as a starting point.
20Financial Reporting StandardsMainly focuses on the IFRS framework and its comparison with US GAAP.
21Understanding Income StatementsLooks at general principles of revenue and expense recognition, non-recurring items and EPS in the income statements that you’ll come across in financial analysis.
22Understanding Balance SheetsWalks through each component of the balance sheet in detail: assets (current and long term), liabilities (current and long term) and equity.
23Understanding Cash Flow StatementsExplains the connection of cash flow to income and balance sheet, while introducing a myriad of ratios for analysis which serves as an exam question favorite.
24Financial Analysis TechniquesThis is a broader, more theoretical chapter which gives an overview of the tools an analyst could use in analyzing a company.
25InventoriesCompares and contrasts the key inventory valuation methods (LIFO, FIFO, etc) and how it impacts inventory ratios and financial analysis.
26Long-lived AssetsReviews the treatment of long term assets from acquisition, depreciation/amortisation, revaluation, impairment and derecognition of these assets, with an introduction to finance versus operating leases which you should know the difference of.
27Income TaxesThis is a section you need to master, as many exam questions tests your knowledge of the difference between taxable and accounting profit, and what contributes to a deferred tax liability or asset (DTL or DTA).
28Non-current (Long-term) LiabilitiesLooks at the accounting, presentation and disclosure of long-term debt and introduces leverage and coverage ratios in evaluating solvency of a company.
29Financial Reporting QualityDiscusses conservative and aggressive accounting practices and some tips on how to detect them.
30Financial Statement Analysis: ApplicationsThis chapter covers a few working examples of typical analyst adjustments to financial reports in investment analysis, tying together the knowledge learned from this topic area into everyday applications.

This topic area is bread-and-butter for a wide range of financial roles, including buy and sell-side analysts, asset managers, wealth managers and investment bankers.

In essence, the CFA Level 1 Financial Reporting and Analysis topics teaches you how to:

– read and understand each component of the financial statements;
– assess whether these reported financials are fair, and if not, how to make adjustments to these numbers for the purpose of your valuation analysis;
– independently value an asset or a company for investment purposes.

Reading 19: Introduction to Financial Statement Analysis

CFA Level 1 FRA: Our Cheat Sheet 1

4 types of audit reports

Audit OpinionWhat does this mean?
UnqualifiedThis is issued when the financial statements presented are free of material misstatements and are in accordance with GAAP.

This is the best report a company can receive from an external auditor, as it means a company’s financial health is fairly presented in the financial statements.
QualifiedThis is issued when one or two situations encountered did not comply with GAAP. However, the rest of the financial statements are fairly presented.
AdverseAn adverse audit opinion is the opposite of an unqualified opinion. This means that the financial statements of the company audited are materially misstated and generally do not comply with GAAP.
DisclaimerA disclaimer opinion is issued when the auditor could not form, and consequently refuses to present, an opinion on the financial statements.

Accrual accounting

TypeDescriptionAsset or Liability?
Unearned revenueCash received before goods/services providedLiability
Accrued revenueCash not yet received after goods/services providedAsset
Prepaid expensesCash paid before expense incurredAsset
Accrued expensesCash not yet paid after expenses incurredLiability

Reading 20: Financial Reporting Standards

CFA Level 1 FRA: Our Cheat Sheet 2

IASB’s IFRS financial reporting framework

Objective of financial statementsProvide financial information about reporting entity that is useful in making decision about providing resources to the entity
Qualitative characteristics of financial statements – 2 fundamental qualitative characteristics are: Relevance and Faithful Representation.

– 4 supplementary qualitative characteristics are: Comparability, Verifiability, Timeliness, Understandability.
Required reporting elements– Assets, liability, equity
– Revenue and expenses
Constraints– Tradeoff between reliability and timeliness
– Cost
– Intangible aspects
Assumptions– Accrual basis
– Going concern

General requirements for financial statements under IFRS

  1. Fair representation
  2. Going concern
  3. Accrual basis
  4. Materiality and aggregation
  5. No offsetting
  6. Frequency of reporting
  7. Comparative information
  8. Consistency

Reading 21: Understanding Income Statements

CFA Level 1 FRA: Our Cheat Sheet 3

Basic EPS

Basic EPS=Net IncomePreferred DividendsWeighted Average Number of Shares Outstanding

Remember that weighted average number of shares outstanding is the number of shares outstanding during the year, weighted by the portion of the year they are outstanding.

Stock splits and stock dividends are applied retrospectively to the beginning of the year, so the old shares are converted to the new shares for consistency.

One more thing, please ignore dividend paid to common shareholders. Only preference shareholders matter here.

Diluted EPS

Diluted EPS=   NetIncomePreferredDividends+Convertible Preferred          Dividends+Convertible Debt Interest1tWeighted average            shares+Shares from conversion of convertible preferred shares +Shares from conversion of         convertible debt+Shares issuable from        stock options

Remember that:

  • For preference shares, we need to subtract the preference dividends in the numerator, as well as add on the new shares issued from the conversion in the denominator.
  • For convertible bonds, we need to add the after-tax interest in the numerator, as well as add on the new shares issued from the conversion in the denominator.
  • For stock options, use the Treasury stock method.

Reading 22: Understanding Balance Sheets

CFA Level 1 FRA: Our Cheat Sheet 4

Accounting for gains or losses on marketable securities

Held-to-MaturityAvailable-for-SaleTrading Securities
Balance SheetCost or
Amortized Cost
Fair ValueFair Value
Dividend, Interest &
Realized Gains & Losses
Income StatementIncome StatementIncome Statement
Unrealized Gains & LossesNot reportedOther Comprehensive Income (OCI)Income Statement

Reading 23: Understanding Cash Flow Statements

CFA Level 1 FRA: Our Cheat Sheet 5

IFRS vs US GAAP for cash flow components

Dividend paidOperating / FinancingFinancing
Interest paidOperating / FinancingOperating
Dividends receivedOperating / InvestingOperating
Interest receivedOperating / InvestingOperating
All taxesGenerally categorized as operating. A portion can be categorized as financing or investing if attributable to these areas.Operating
Format of statementBoth direct and indirect formats are allowed, but direct is preferred.Both direct and indirect formats are allowed, but direct is preferred. A reconciliation of net income to cash flow from operating activities must be provided for any method.

Free cash flow to firm (FCFF)

FCFF = NI + NCC + [Int * (1-t)] – FCInv – WCInv
= CFO + [Int * (1-t)] – FCInv

where: NI = net income, NCC = non-cash charges, Int = interest expense, t = tax rate, FCInv = fixed capital investment, WCInv = working capital investment

Free cash flow to equity (FCFE)

FCFE = CFO – FCInv + Net Borrowing

FCFE is the cash flow available to a company’s stockholders after all operating expenses and borrowing costs (principal and interest) have been paid, and necessary working capital and fixed capital investments have been made.

Reading 24: Financial Analysis Techniques

CFA Level 1 FRA: Our Cheat Sheet 6

Activity ratios

Activity ratios Formula
Inventory turnover Cost of goods soldAverage inventory
Days of inventory on hand (DOH) 365Inventory turnover
Receivables turnover RevenueAverage receivables
Days of sales outstanding (DSO) 365Receivables turnover
Payables turnover PurchasesAverage trade payables
Number of days of payables 365Payables turnover
Working capital turnover RevenueAverage working capital
Fixed asset turnover RevenueAverage Net Fixed Assets
Total asset turnover RevenueAverage total assets

Liquidity ratios

Liquidity ratios Formula
Current ratio Current assetsCurrent liabilities
Quick ratio Cash+Marketable securities+ReceivablesCurrent liabilities
Cash ratio Cash+Marketable securitiesCurrent liabilities
Defensive interval ratio Cash+Marketable securities+ReceivablesDaily cash expenditures
Cash conversion cycle =Days of inventory on hand(DOH)+Days of sales outstanding (DSO) Number of days of payables

Solvency ratios

Solvency ratios Formula
Debt to asset ratio Total debtTotal asset
Debt to capital ratio Total debtTotal debt+Total shareholders equity
Debt to equity ratio Total debtShareholders equity
Financial leverage ratio Average total assetsAverage total equity
Interest coverage ratio EBITInterest payments
Fixed charge coverage ratio EBIT+Lease paymentsInterest payments+Lease payments

Profitability ratios

Profitability ratios Formula
Gross profit margin Gross profitRevenue
Operating profit margin Operating incomeRevenue
Pretax margin EBTRevenue
Net profit margin Net profitRevenue
Operating ROA Operating income or EBITAverage total assets
Return on assets (ROA) Net incomeAverage total assets
Return on total capital EBITShort term debt+Long term debt+Equity
Return on equity (ROE) Net incomeAverage total equity
Return on common equity (ROCE) Net incomepreferred dividendsAverage common equity

Dupont analysis: decomposition of ROE

ROE=Net incomeAverage total assets×Average total assetsAverage shareholders equity                  =ROA × Leverage ratioROE=Net incomeRevenue×RevenueAverage total assets×Average total assetsAverage shareholders equity          =Net profit margin × Asset turnover × Leverage ratioROE=Net incomeEBT×EBTEBIT×EBITRevenue×RevenueAverage total assets×Average total assetsAverage shareholders equity         =Tax burden × Interest burden × EBIT margin × Asset turnover × Leverage ratio

Valuation ratios

Ratios Formula
P/E Price per shareEarnings per share
Dividend payout ratio Common share dividendNet income attributable to common shares
Retention ratio (RR) 1Dividend payout ratio
Sustainable growth rate (g) Retention rate×ROE

Reading 25: Inventories

CFA Level 1 FRA: Our Cheat Sheet 7

LIFO vs FIFO with rising prices and stable inventory levels

Income TaxesLowerHigher
Earnings before Taxes (EBT)LowerHigher
Earnings after Taxes (net income)LowerHigher
Ending inventoryLowerHigher
Working capitalLowerHigher
Cash flow (after tax)HigherLower

Converting LIFO to FIFO

  • FIFO Inventory = LIFO Inventory + LIFO Reserve
  • FIFO COGS = LIFO COGS – change in LIFO Reserve
  • FIFO Net Income = FIFO Net Income + change in LIFO Reserve * (1-t)
  • FIFO Retained Earnings = LIFO Retained Earnings + LIFO Reserve * (1-t)

Reading 26: Long-lived Assets

CFA Level 1 FRA: Our Cheat Sheet 8

Capitalizing vs expensing: impact on financial statement

Net income (1st year)HigherLower
Net income (future years)LowerHigher
Total assetsHigherLower
Shareholders’ equityHigherLower
Cash flow from operations (CFO)HigherLower
Cash flow from investing (CFI)LowerHigher
Income variabilityLowerHigher
Debt to equity ratioLowerHigher
Interest coverage (1st year)HigherLower
Interest coverage (future years)LowerHigher
ROA and ROE (1st year)HigherLower
ROA and ROE (future years)LowerHigher

Depreciation methods

Depreciation methods Depreciation expense formula
Straight line Original cost  Salvage valueDepreciable life
Double declining balance (DDB) 2Depreciable life×Book value at the beginning of year t
Units of production Cost  Salvage valueTotal output×Output units at time t

Revaluation of long lived assets

  • IFRS allows the use of cost model or revaluation model, but US GAAP only allows cost model.
  • If a revaluation initially decreases asset value, this is recognized as a loss in income statement. In future, if a revaluation subsequently increases asset value, the increase – to the extent that it reverses the amount previously decreased – is recognized as a gain in income statement. Any excess gains beyond the reversal amount is recognized directly in equity as a revaluation surplus.
  • If a revaluation initially increases asset value, the increase goes directly in equity as a revaluation surplus. A subsequent decrease in the valuation amount first reduces the revaluation surplus, and any excess beyond the reversal amount is recognized as a loss in income statement.

IFRS vs GAAP: Impairment of Property, Plant & Equipment and Intangible Assets

Assets tested for impairment annuallyAssets tested for impairment only when firm may not recover carrying value through future use.
An asset is impaired when carrying value > recoverable amountAn asset is impaired when carrying value > undiscounted future cash flows
If impaired, the asset is written down to recoverable amount and a loss is recognized.If impaired, the asset is written down to fair value and a loss is recognized.
Subsequent recoveries are allowed, but cannot exceed historical costLoss recoveries are not permitted

Reading 27: Income Taxes

CFA Level 1 FRA: Our Cheat Sheet 9

Deferred Tax Assets (DTA) & Deferred Tax Liabilities (DTL)

Deferred Tax Assets (DTA)Deferred Tax Liability (DTL)
DefinitionCreated when income tax payable exceeds income tax expense due to temporary difference.

This means that taxable income is higher than accounting profit.
Created when income tax payable is less than income tax expense due to temporary difference.

This means that taxable income is lower than accounting profit.
Examples– Assets tax base > carrying amount
– Liability’s carrying amount > tax base
– Assets carrying amount > tax base
– Liability’s tax base > carrying amount

Impact of tax rate changes

Income tax expense = Income tax payable + Change in DTL – Change in DTA

Reading 28: Non-current (Long-term) Liabilities

CFA Level 1 FRA: Our Cheat Sheet 10

Finance lease criteria under US GAAP

A lease must be classified by a lessee as a finance lease if any one of the 4 criterias below is met:

  • Ownership transfer: Ownership of the asset is transferred to the lessee at the end of the lease term.
  • Bargain purchase option: Lessee has the option to purchase the asset at a price lower than the expected fair value.
  • Lease term: The lease term covers at least 75% of the leased asset’s useful life.
  • Minimum lease payment: If the present value of lease payments is at least 90% of the fair value of the leased asset.

If none of the criteria above is met, then the lessee should classify the lease as an operating lease under US GAAP.

Lessee accounting

Balance sheetIFRS does not allow operating lease classification.

For finance lease: at inception, the PV of future lease payments is recognized as an asset and related debt as a liability.

Asset is depreciated. Lease payable is amortized.
Similar treatment as IFRS for finance (capital) lease.

Operating lease is like a rental agreement. It does not have any entry on balance sheet as it is an off-balance sheet transaction.
Income statementInterest expense = liability at the beginning of period x interest rateFinance lease: similar treatment as IFRS.

Operating lease: rent expense is equal to a single lease payment, treated as an operating expense.
Cashflow statementInterest portion of finance lease payment can be classified within operating or financing cashflow.

Finance lease principal payment is a financing cashflow.
Finance lease: Interest portion of lease payment is classified as an operating cashflow.

Operating lease: a single lease expense is recorded as operating cashflow.

Lessor accounting

  • Under IFRS, there are 2 types of lease for lessors: operating and finance leases.
  • Under US GAAP, there are 3 types of lease for lessors:
    • operating,
    • sales-type (same as finance lease),
    • direct-financing leases (generally where the rights and exposure to the asset and its residual lie with a third party).
Operating leases
IFRS finance lease &
US GAAP sales-type lease
direct-financing lease
Balance sheetAsset is recognized on the balance sheet.Lease asset is removed from the balance sheet. Lease receivable and residual value is reported.Lease asset is removed from the balance sheet. Lease receivable is reported.
Income statementLease income and depreciation expense is reported.Interest revenue on lease receivable is reported.

If applicable, revenue, COGS and selling profit is reported.
Interest revenue on lease receivable is reported.
Cashflow statementLease payments received are classified as operating cashflow.Interest portion of lease payment received is classified as:
– operating or investing cashflow under IFRS,
– operating cash inflow under US GAAP.

Lease principal repayment is an investing cash inflow.

But, the cash flows related to the leases is classified as operating cashflows if providing leases is part of a company’s normal business activity.
Interest portion of lease payment received is an operating cash inflow under US GAAP.

Lease principal repayment is an investing cash inflow.

But, the cash flows related to the leases is classified as operating cashflows if providing leases is part of a company’s normal business activity.

CFA Level 1 FRA Tips

CFA Level 1 FRA: Our Cheat Sheet 11

Unfortunately there is no shortcut to mastering FRA – you’ll have to set aside adequate time in your study plan (get yours free here) to learn this topic area thoroughly.

As mentioned earlier in the article, there is a lot of testable material in the vast amount of readings in the CFA exams.

Not only does the FRA have a 13-17% weighting in the CFA Level 1 exams but FRA can sometimes be weaved into other topic area questions. This topic isn’t a fringe one, so don’t skirt around it – tackle it head-on.

Here are some tips to get you fighting-fit in FRA:

  • Make practice front and center of your FRA plan:
    • Lots of practice questions help solidify your understanding, so make sure you line them up.
    • Try to attempt all the end-of-chapter questions to get used to the breadth of items that can crop up in the actual exam.
    • FRA questions can require a lot of reading and calculation so time management and answering speed will be crucial as well.
  • Videos can help a lot:
    • There are likely a lot of confusing concepts or calculations that you may get lost in repeatedly.
    • A good way to break the cycle of confusion is to simply spend a few minutes on YouTube, or find a third party provider that presents concepts well on video.
    • Find an explanation of the specific concept – sometimes all you need is someone to take you through one example.
  • Pay attention to IFRS and GAAP:
    • ‘IFRS vs GAAP’ questions are a favorite in the CFA exams, so make notes on what the differences and similarities are between the two accounting standards and make sure you have them memorized.
  • Build a 3-statement financial model:
    • To truly understand FRA you’ll need to master the balance sheet, income statement and cash flow statement.
    • A good way to achieve this is to build a simple 3-statement financial model – not nearly as intimidating as it sounds.
    • Pick your favourite company, download their financial reports and get started – preferably with a financial modelling book.

More Cheat Sheet articles will be published over the coming weeks. Get ahead of other CFA candidates by signing up to our member’s list to get notified.

Meanwhile, here are other related articles that may be of interest:


12 thoughts on “CFA Level 1 FRA: Our Cheat Sheet”

  1. Super helpful and well done! Thank you for all these cheatsheets.

    Just one question, “FIFO Net Income = FIFO Net Income + change in LIFO Reserve * (1-t)”, is it FIFO NI in the second part of the formula or LIFO NI? Thanks

    • This is in our to-do list – but for now we don’t have any PDF cheat sheets available. You can always access them online though – with the benefit of them always being updated!

  2. Hello Sophie,

    Thank you for the summaries. Please could you do same summaries for Economics, Fixed Income, Portfolio Management and Alternative Investments

    • Hi Ifeoma, it’s in the plans, but as you know good summaries take time, so we will roll out our new Cheat Sheets in the next few months. Hope your studies are going well!

    • Hi Linnette12, glad you found it helpful. As FRA is such a large section, I’ve focused on the key chapters with concepts/formulae you need to know, leaving out reading 29-30 as they are relatively straightforward and shorter vs. the rest.

  3. This summary is very helpful, thank you for sharing!
    Noticed a typo though, it should be
    Sustainable growth rate (g) = Retention rate x ROE


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