Note: this cheat sheet is updated for the latest 2023’s curriculum.
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, or Financial Statement Analysis called nowadays) 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 and continuously updated, 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!
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.
2023 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 Topic 3 which contains 12 Learning Modules (LMs).
Here’s the summary of FRA chapter readings:
Learning Module | Sub-topic | Description |
---|---|---|
1 | Introduction to Financial Statement Analysis | Discusses the scope and framework of financial statement analysis, introduces the major financial statements as a starting point. |
2 | Financial Reporting Standards | Mainly focuses on the IFRS framework and its comparison with US GAAP. |
3 | Understanding Income Statements | Looks 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. |
4 | Understanding Balance Sheets | Walks through each component of the balance sheet in detail: assets (current and long term), liabilities (current and long term) and equity. |
5 | Understanding Cash Flow Statements | Explains 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. |
6 | Financial Analysis Techniques | This is a broader, more theoretical chapter which gives an overview of the tools an analyst could use in analyzing a company. |
7 | Inventories | Compares and contrasts the key inventory valuation methods (LIFO, FIFO, etc) and how it impacts inventory ratios and financial analysis. |
8 | Long-lived Assets | Reviews 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. |
9 | Income Taxes | This 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). |
10 | Non-current (Long-term) Liabilities | Looks at the accounting, presentation and disclosure of long-term debt and introduces leverage and coverage ratios in evaluating solvency of a company. |
11 | Financial Reporting Quality | Discusses conservative and aggressive accounting practices and some tips on how to detect them. |
12 | Financial Statement Analysis: Applications | This 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.
Audit Opinion | What does this mean? |
---|---|
Unqualified | This 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. |
Qualified | This is issued when one or two situations encountered did not comply with GAAP. However, the rest of the financial statements are fairly presented. |
Adverse | An 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. |
Disclaimer | A disclaimer opinion is issued when the auditor could not form, and consequently refuses to present, an opinion on the financial statements. |
Type | Description | Asset or Liability? |
---|---|---|
Unearned revenue | Cash received before goods/services provided | Liability |
Accrued revenue | Cash not yet received after goods/services provided | Asset |
Prepaid expenses | Cash paid before expense incurred | Asset |
Accrued expenses | Cash not yet paid after expenses incurred | Liability |
Objective of financial statements | Provide 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 |
\small Basic \space EPS=\frac{Net \space Income - Preferred \space Dividends}{Weighted \space Average \space Number \space of \space Shares \space 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.
\scriptsize Diluted EPS=\frac{{Net \choose Income}-{Preferred \choose Dividends}+{Convertible \space Preferred \choose Dividends}+{Convertible \space \choose Debt \space Interest}(1-t)}{{Weighted \space \choose avg \space shares}+{Shares \space from \space conversion \space of \choose convertible \space preferred \space shares}+{Shares \space from \space conversion \space of \choose convertible \space preferred \space debt}+{Shares \space issuable \choose from \space stock \space options}}
Remember that:
Held-to-Maturity | Available-for-Sale | Trading Securities | |
---|---|---|---|
Balance Sheet | Cost or Amortized Cost | Fair Value | Fair Value |
Dividend, Interest & Realized Gains & Losses | Income Statement | Income Statement | Income Statement |
Unrealized Gains & Losses | Not reported | Other Comprehensive Income (OCI) | Income Statement |
Items | IFRS | US GAAP |
---|---|---|
Dividend paid | Operating / Financing | Financing |
Interest paid | Operating / Financing | Operating |
Dividends received | Operating / Investing | Operating |
Interest received | Operating / Investing | Operating |
All taxes | Generally categorized as operating. A portion can be categorized as financing or investing if attributable to these areas. | Operating |
Format of statement | Both 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. |
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
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.
Activity ratios | Formula |
---|---|
Inventory turnover | (Cost of goods sold) / (Avg inventory) |
Days of inventory on hand (DOH) | 365 / (Inventory turnover) |
Receivables turnover | Revenue / (Average Receivables) |
Days of sales outstanding (DSO) | 365 / (Receivables Turnover) |
Payables turnover | (Purchases) / (Average Trade Payables) |
Number of days of payables | (365) / (Payables Turnover) |
Working capital turnover | (Revenue) / (Average Working Capital) |
Fixed asset turnover | (Revenue) / (Average Net Fixed Assets) |
Total asset turnover | (Revenue) / (Average Total Assets) |
Liquidity ratios | Formula |
---|---|
Current ratio | (Current assets) / (Current liabilities) |
Quick ratio | (Cash + Marketable securities + Receivables) / (Current liabilities) |
Cash ratio | (Cash + Marketable securities) / (Current liabilities) |
Defensive interval ratio | (Cash + Marketable securities + Receivables) / (Daily cash expenditures) |
Cash conversion cycle | = Days of inventory on hand (DOH) + Days of sales outstanding (DSO) – Number of days of payables |
Solvency ratios | Formula |
---|---|
Debt to asset ratio | (Total debt) / (Total assets) |
Debt to capital ratio | (Total debt) / (Total debt + Total shareholder’s equity) |
Debt to equity ratio | (Total debt) / (Shareholder’s equity) |
Financial leverage ratio | (Average total assets) / (Average total equity) |
Interest coverage ratio | (EBIT) / (Interest payments) |
Fixed charge coverage ratio | (EBIT + Lease payments) / (Interest payments + Lease payments) |
Profitability ratios | Formula |
---|---|
Gross profit margin | (Gross profit) / Revenue |
Operating profit margin | (Operating income) / Revenue |
Pretax margin | EBT / Revenue |
Net profit margin | (Net profit) / Revenue |
Operating ROA | (Operating income or EBIT) / (Average total assets) |
Return on assets (ROA) | (Net income) / (Average total assets) |
Return on total capital | EBIT / (Short term debt + long term debt + equity) |
Return on equity (ROE) | (Net income) / (Equity) |
Return on common equity (ROCE) | (Net income – preferred dividends) / (Average common equity) |
\small \begin{align*} ROE&=\frac{Net \space income}{Average \space total \space assets} \times \frac{Average \space total \space assets}{Average \space shareholders' \space equity} \newline&= ROA \times Leverage \space ratio \end{align*}
\small \begin{align*} ROE&=\frac{Net \space income}{Revenue} \times \frac{Revenue}{Average \space total \space assets} \times \frac{Average \space total \space assets}{Average \space shareholders' \space equity} \newline&= Net \space profit \space margin \times Asset \space turnover \times Leverage \space ratio \end{align*}
\scriptsize \begin{align*} ROE&=\frac{Net \space income}{EBT} \times \frac{EBT}{EBIT} \times \frac{EBIT}{Revenue} \times \frac{Revenue}{Average \space total \space assets} \times \frac{Average \space total \space assets}{Avg \space shareholders' \space equity} \newline&= Tax \space burden \times Interest \space burden \times EBIT \space margin \times Asset \space turnover \times Leverage \space ratio \end{align*}
Valuation ratios | Formula |
---|---|
P/E | (Price per share) / (Earnings per share) |
Dividend payout ratio | (Common share dividend) / (Net income attributable to common shares) |
Retention ratio (RR) | 1 – Dividend payout ratio |
Sustainable growth rate (g) | Retention rate x ROE |
LIFO | FIFO | |
---|---|---|
COGS | Higher | Lower |
Income Taxes | Lower | Higher |
Earnings before Taxes (EBT) | Lower | Higher |
Earnings after Taxes (net income) | Lower | Higher |
Ending inventory | Lower | Higher |
Working capital | Lower | Higher |
Cash flow (after tax) | Higher | Lower |
Item | Capitalizing | Expensing |
---|---|---|
Net income (1st year) | Higher | Lower |
Net income (future years) | Lower | Higher |
Total assets | Higher | Lower |
Shareholders’ equity | Higher | Lower |
Cash flow from operations (CFO) | Higher | Lower |
Cash flow from investing (CFI) | Lower | Higher |
Income variability | Lower | Higher |
Debt to equity ratio | Lower | Higher |
Interest coverage (1st year) | Higher | Lower |
Interest coverage (future years) | Lower | Higher |
ROA and ROE (1st year) | Higher | Lower |
ROA and ROE (future years) | Lower | Higher |
Depreciation methods | Depreciation expense formula |
---|---|
Straight line | (Original cost – Salvage value) / Depreciable life |
Double declining balance (DDB) | 2 / (Depreciable life) x Book value at beginning of year t |
Units of production | (Cost – Salvage value) / (Total output) x Output units at time t |
IFRS | US GAAP |
---|---|
Assets tested for impairment annually | Assets tested for impairment only when firm may not recover carrying value through future use. |
An asset is impaired when carrying value > recoverable amount | An 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 cost | Loss recoveries are not permitted |
Deferred Tax Assets (DTA) | Deferred Tax Liability (DTL) | |
---|---|---|
Definition | Created 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 |
Income tax expense = Income tax payable + Change in DTL – Change in DTA
A lease must be classified by a lessee as a finance lease if any one of the 5 criteria below is met:
If none of the criteria above is met, then the lessee should classify the lease as an operating lease under US GAAP.
IFRS requires all leases to be treated the same manner as finance lease under US GAAP.
IFRS has one accounting model for both finance or operating lease for lessees, but US GAAP has different accounting models for each.
IFRS | US GAAP | |
---|---|---|
Balance sheet | IFRS 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 on a straight line basis. Lease payable is amortized. Asset and liability portion differ over the lifetime of the lease. | Similar treatment as IFRS for finance lease. For operating lease (like a rental agreement): at inception, the PV of future lease payments is recognized as an asset and the related debt as a liability. Both asset and lease payable are amortized the same way. Hence, asset and liability portion will always equal each other. |
Income statement | Interest expense = liability at the beginning of period x discount rate | Finance lease: similar treatment as IFRS. Operating lease: interest and amortization expense is reported as one single lease payment (not separated out), treated as an operating expense. |
Cashflow statement | Interest expense of finance lease payment can be classified as 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. Interest and principal repayments are NOT reported separately. |
Operating leases (IFRS & US GAAP) | Finance leases (IFRS & US GAAP) | |
---|---|---|
Balance sheet | Asset is recognized on the balance sheet. | Lease asset is removed from the balance sheet. Lease receivable (PV of future lease payments) and residual value is reported. |
Income statement | Lease income and depreciation expense is reported. | Interest income on lease receivable is reported as revenue. |
Cashflow statement | Lease payments received are classified as operating cashflow. | Lease payments received are classified as operating cashflow. |
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:
More Cheat Sheet articles will be published and continuously updated. Get ahead of other CFA candidates by signing up to our member’s list to get notified.
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View Comments
Hello, there are formula on the cheatsheet which is not visible due to error - "katex is not defined". Can somebody help me with this?
Hi Sujaan, I don't see it myself. Which chapter reading is this?
L1 cheat sheets had been a great help!
Would love Level 2 cheat sheets!!
Hoping to work on 2023 ones! :) L2 is a beast -_- ||
typo?
FIFO Net Income = FIFO Net Income + Change in LIFO Reserve * (1-t)
should be
FIFO Net Income = LIFO Net Income + Change in LIFO Reserve * (1-t)
Yes Flerken Cat! Thanks for spotting this, corrected :)
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
can anyone of you send me this cheat sheet in PDF Formate....
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!
Hi, are the PDF versions of the cheat sheets already available?
Cheers
I'm afraid not, sorry! So far we're finding that it's more advantageous to maintain an online, always-updated version, since PDFs can get outdated.
Thank you!
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!
very helpful but what about reading 29 and 30
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.
This summary is very helpful, thank you for sharing!
Noticed a typo though, it should be
Sustainable growth rate (g) = Retention rate x ROE
Ooh yes, thanks for spotting that Ank! Corrected :)
You've been studying hard!
This summarize is just wonderful !
I'm glad you found it helpful! More coming for other topics :)
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