International Financial Statement Analysis provides the most up-to-date detail for the successful assessment of company performance and financial positions. This rich, clear reference covers all aspects from financial reporting mechanics and standards to understanding income and balance sheets.

Preface xix Acknowledgments xxi About the CFA Investment Series xxiii CHAPTER 1 Financial Statement Analysis: An Introduction 1 Learning Outcomes 1 1. Introduction 1 2. Scope of Financial Statement Analysis 2 3. Major Financial Statements and Other Information Sources 7 3.1. Financial Statements and Supplementary Information 8 3.2. Other Sources of Information 27 4. Financial Statement Analysis Framework 28 4.1. Articulate the Purpose and Context of Analysis 30 4.2. Collect Data 30 4.3. Process Data 31 4.4. Analyze/Interpret the Processed Data 31 4.5. Develop and Communicate Conclusions/Recommendations 32 4.6. Follow-Up 32 5. Summary 32 References 34 Problems 34 CHAPTER 2 Financial Reporting Mechanics 37 Learning Outcomes 37 1. Introduction 38 2. The Classification of Business Activities 38 3. Accounts and Financial Statements 39 3.1. Financial Statement Elements and Accounts 40 3.2. Accounting Equations 42 4. The Accounting Process 47 4.1. An Illustration 47 4.2. The Accounting Records 49 4.3. Financial Statements 62 5. Accruals and Valuation Adjustments 65 5.1. Accruals 65 5.2. Valuation Adjustments 67 6. Accounting Systems 67 6.1. Flow of Information in an Accounting System 68 6.2. Debits and Credits 69 7. Using Financial Statements in Security Analysis 69 7.1. The Use of Judgment in Accounts and Entries 69 7.2. Misrepresentations 70 8. Summary 71 Appendix: A Debit/Credit Accounting System 71 Problems 87 CHAPTER 3 Financial Reporting Standards 91 Learning Outcomes 91 1. Introduction 92 2. The Objective of Financial Reporting 92 3. Standard-Setting Bodies and Regulatory Authorities 95 3.1. Accounting Standards Boards 96 3.2. Regulatory Authorities 99 4. Convergence of Global Financial Reporting Standards 104 5. The International Financial Reporting Standards Framework 107 5.1. Objective of Financial Reports 109 5.2. Qualitative Characteristics of Financial Reports 109 5.3. Constraints on Financial Reports 110 5.4. The Elements of Financial Statements 112 5.5. General Requirements for Financial Statements 114 5.6. Convergence of Conceptual Framework 118 6. Effective Financial Reporting 119 6.1. Characteristics of an Effective Financial Reporting Framework 119 6.2. Barriers to a Single Coherent Framework 120 7. Comparison of IFRS with Alternative Reporting Systems 121 8. Monitoring Developments in Financial Reporting Standards 123 8.1. New Products or Types of Transactions 123 8.2. Evolving Standards and the Role of CFA Institute 124 8.3. Company Disclosures 125 9. Summary 128 Problems 130 CHAPTER 4 Understanding Income Statements 133 Learning Outcomes 133 1. Introduction 134 2. Components and Format of the Income Statement 135 3. Revenue Recognition 139 3.1. General Principles 140 3.2. Revenue Recognition in Special Cases 143 3.3. Implications for Financial Analysis 150 4. Expense Recognition 152 4.1. General Principles 152 4.2. Issues in Expense Recognition 156 4.3. Implications for Financial Analysis 161 5. Non-Recurring Items and Non-Operating Items 162 5.1. Discontinued Operations 163 5.2. Extraordinary Items 163 5.3. Unusual or Infrequent Items 164 5.4. Changes in Accounting Policies 165 5.5. Non-Operating Items 168 6. Earnings per Share 169 6.1. Simple versus Complex Capital Structure 169 6.2. Basic EPS 170 6.3. Diluted EPS 171 6.4. Changes in EPS 178 7. Analysis of the Income Statement 178 7.1. Common-Size Analysis of the Income Statement 178 7.2. Income Statement Ratios 181 8. Comprehensive Income 183 9. Summary 186 Problems 188 CHAPTER 5 Understanding Balance Sheets 193 Learning Outcomes 193 1. Introduction 193 2. Components and Format of the Balance Sheet 194 2.1. Balance Sheet Components 195 2.2. Current and Non-Current Classification 197 2.3. Liquidity-Based Presentation 198 3. Current Assets and Current Liabilities 199 3.1. Current Assets 199 3.2. Current Liabilities 206 4. Non-Current Assets 209 4.1. Property, Plant, and Equipment 211 4.2. Investment Property 212 4.3. Intangible Assets 212 4.4. Goodwill 215 4.5. Financial Assets 217 5. Non-Current Liabilities 220 5.1. Long-term Financial Liabilities 222 5.2. Deferred Tax Liabilities 222 6. Equity 223 6.1. Components of Equity 223 6.2. Statement of Changes in Equity 225 7. Analysis of the Balance Sheet 227 7.1. Common-Size Analysis of the Balance Sheet 227 7.2. Balance Sheet Ratios 235 8. Summary 237 Problems 239 CHAPTER 6 Understanding Cash Flow Statements 243 Learning Outcomes 243 1. Introduction 243 2. Components and Format of the Cash Flow Statement 244 2.1. Classification of Cash Flows and Non-Cash Activities 245 2.2. A Summary of Diff erences between IFRS and US GAAP 247 2.3. Direct and Indirect Methods for Reporting Cash Flow from Operating Activities 248 3. The Cash Flow Statement: Linkages and Preparation 258 3.1. Linkages of the Cash Flow Statement with the Income Statement and Balance Sheet 258 3.2. Steps in Preparing the Cash Flow Statement 260 3.3. Conversion of Cash Flows from the Indirect to the Direct Method 272 4. Cash Flow Statement Analysis 273 4.1. Evaluation of the Sources and Uses of Cash 274 4.2. Common-Size Analysis of the Statement of Cash Flows 277 4.3. Free Cash Flow to the Firm and Free Cash Flow to Equity 282 4.4. Cash Flow Ratios 283 5. Summary 285 Reference 286 Problems 286 CHAPTER 7 Financial Analysis Techniques 291 Learning Outcomes 291 1. Introduction 291 2. The Financial Analysis Process 292 2.1. The Objectives of the Financial Analysis Process 293 2.2. Distinguishing between Computations and Analysis 294 3. Analytical Tools and Techniques 296 3.1. Ratios 300 3.2. Common-Size Analysis 304 3.3. The Use of Graphs as an Analytical Tool 311 3.4. Regression Analysis 312 4. Common Ratios Used in Financial Analysis 313 4.1. Interpretation and Context 313 4.2. Activity Ratios 314 4.3. Liquidity Ratios 320 4.4. Solvency Ratios 325 4.5. Profitability Ratios 329 4.6. Integrated Financial Ratio Analysis 333 5. Equity Analysis 341 5.1. Valuation Ratios 341 5.2. Industry-Specific Ratios 344 5.3. Research on Ratios in Equity Analysis 346 6. Credit Analysis 347 6.1. The Credit Rating Process 347 6.2. Research on Ratios in Credit Analysis 349 7. Business and Geographic Segments 350 7.1. Segment Reporting Requirements 350 7.2. Segment Ratios 351 8. Model Building and Forecasting 353 9. Summary 353 References 354 Problems 355 CHAPTER 8 Inventories 363 Learning Outcomes 363 1. Introduction 363 2. Cost of Inventories 365 3. Inventory Valuation Methods 366 3.1. Specific Identification 367 3.2. First-In, First-Out (FIFO) 367 3.3. Weighted Average Cost 367 3.4. Last-In, First-Out (LIFO) 368 3.5. Calculation of Cost of Sales, Gross Profit, and Ending Inventory 368 3.6. Periodic versus Perpetual Inventory Systems 370 3.7. Comparison of Inventory Valuation Methods 373 4. The LIFO Method 375 4.1. LIFO Reserve 375 4.2. LIFO Liquidations 382 5. Inventory Method Changes 386 6. Inventory Adjustments 386 7. Evaluation of Inventory Management 393 7.1. Presentation and Disclosure 394 7.2. Inventory Ratios 394 7.3. Financial Analysis Illustrations 395 8. Summary 406 Problems 408 CHAPTER 9 Long-Lived Assets 421 Learning Outcomes 421 1. Introduction 422 2. Acquisition of Long-Lived Assets 423 2.1. Property, Plant, and Equipment 423 2.2. Intangible Assets 426 2.3. Capitalizing versus Expensing Impact on Financial Statements and Ratios 429 2.4. Capitalization of Interest Costs 434 2.5. Capitalization of Internal Development Costs 437 3. Depreciation and Amortization of Long-Lived Assets 440 3.1. Depreciation Methods and Calculation of Depreciation Expense 441 3.2. Amortization Methods and Calculation of Amortization Expense 449 4. The Revaluation Model 450 5. Impairment of Assets 453 5.1. Impairment of Property, Plant, and Equipment 454 5.2. Impairment of Intangible Assets with a Finite Life 455 5.3. Impairment of Intangibles with Indefinite Lives 455 5.4. Impairment of Long-Lived Assets Held for Sale 455 5.5. Reversals of Impairments of Long-Lived Assets 455 6. Derecognition 456 6.1. Sale of Long-Lived Assets 456 6.2. Long-Lived Assets Disposed of Other Than by a Sale 457 7. Presentation and Disclosures 458 8. Investment Property 469 9. Leasing 471 9.1. The Lease versus Buy Decision 472 9.2. Finance versus Operating Leases 472 10. Summary 493 Problems 495 CHAPTER 10 Non-Current (Long-Term) Liabilities 505 Learning Outcomes 505 1. Introduction 506 2. Bonds Payable 506 2.1. Accounting for Bond Issuance 506 2.2. Accounting for Bond Amortisation, Interest Expense, and Interest Payments 510 2.3. Current Market Rates and Fair Value Reporting Option 515 2.4. Derecognition of Debt 517 2.5. Debt Covenants 520 2.6. Presentation and Disclosure of Long-Term Debt 522 3. Leases 525 3.1. Advantages of Leasing 526 3.2. Finance (or Capital) Leases versus Operating Leases 526 4. Introduction to Pensions and Other Post-Employment Benefits 544 5. Evaluating Solvency: Leverage and Coverage Ratios 547 6. Summary 551 Problems 552 CHAPTER 11 Financial Reporting Quality 555 Learning Outcomes 555 1. Introduction 556 2. Conceptual Overview 557 2.1. GAAP, Decision-Useful, Sustainable, and Adequate Returns 558 2.2. GAAP, Decision-Useful, but Sustainable? 559 2.3. Biased Accounting Choices 560 2.4. Departures from GAAP 567 2.5. Differentiate between Conservative and Aggressive Accounting 569 3. Context for Assessing Financial Reporting Quality 573 3.1. Motivations 573 3.2. Conditions Conducive to Issuing Low-Quality Financial Reports 574 3.3. Mechanisms That Discipline Financial Reporting Quality 575 4. Detection of Financial Reporting Quality Issues 581 4.1. Presentation Choices 581 4.2. Accounting Choices and Estimates 586 4.3. Warning Signs 603 5. Summary 609 References 610 Problems 611 CHAPTER 12 Financial Statement Analysis: Applications 613 Learning Outcomes 613 1. Introduction 614 2. Application: Evaluating Past Financial Performance 614 3. Application: Projecting Future Financial Performance 623 3.1. Projecting Performance: An Input to Market-Based Valuation 624 3.2. Projecting Multiple-Period Performance 629 4. Application: Assessing Credit Risk 633 5. Application: Screening for Potential Equity Investments 637 6. Analyst Adjustments to Reported Financials 640 6.1. A Framework for Analyst Adjustments 640 6.2. Analyst Adjustments Related to Investments 641 6.3. Analyst Adjustments Related to Inventory 641 6.4. Analyst Adjustments Related to Property, Plant, and Equipment 645 6.5. Analyst Adjustments Related to Goodwill 646 6.6. Analyst Adjustments Related to Off -Balance-Sheet Financing 649 7. Summary 656 References 656 Problems 657 CHAPTER 13 Income Taxes 661 Learning Outcomes 661 1. Introduction 662 2. Differences between Accounting Profit and Taxable Income 662 2.1. Current Tax Assets and Liabilities 663 2.2. Deferred Tax Assets and Liabilities 664 3. Determining the Tax Base of Assets and Liabilities 667 3.1. Determining the Tax Base of an Asset 668 3.2. Determining the Tax Base of a Liability 669 3.3. Changes in Income Tax Rates 671 4. Temporary and Permanent Differences between Taxable and Accounting Profit 672 4.1. Taxable Temporary Differences 673 4.2. Deductible Temporary Differences 673 4.3. Examples of Taxable and Deductible Temporary Differences 674 4.4. Temporary Differences at Initial Recognition of Assets and Liabilities 676 4.5. Business Combinations and Deferred Taxes 677 4.6. Investments in Subsidiaries, Branches, Associates and Interests in Joint Ventures 677 5. Unused Tax Losses and Tax Credits 677 6. Recognition and Measurement of Current and Deferred Tax 678 6.1. Recognition of a Valuation Allowance 679 6.2. Recognition of Current and Deferred Tax Charged Directly to Equity 679 7. Presentation and Disclosure 682 8. Comparison of IFRS and US GAAP 687 9. Summary 690 Problems 691 CHAPTER 14 Employee Compensation: Post-Employment and Share-Based 697 Learning Outcomes 697 1. Introduction 697 2. Pensions and Other Post-Employment Benefits 698 2.1. Types of Post-Employment Benefit Plans 698 2.2. Measuring a Defined Benefit Pension Plan s Obligations 701 2.3. Financial Statement Reporting of Pension Plans and Other Post-Employment Benefits 702 2.4. Disclosures of Pension and Other Post-Employment Benefits 715 3. Share-Based Compensation 726 3.1. Stock Grants 728 3.2. Stock Options 729 3.3. Other Types of Share-Based Compensation 732 4. Summary 732 Reference 733 Problems 733 CHAPTER 15 Intercorporate Investments 739 Learning Outcomes 739 1. Introduction 739 2. Basic Corporate Investment Categories 741 3. Investments in Financial Assets: Standard IAS 39 (as of December 2012) 742 3.1. Held-to-Maturity 743 3.2. Fair Value through Profit or Loss 743 3.3. Available-for-Sale 744 3.4. Loans and Receivables 745 3.5. ReClassification of Investments 746 3.6. Impairments 747 4. Investments in Financial Assets: IFRS 9 (as of December 2012) 752 4.1. Classification and Measurement 752 4.2. ReClassification of Investments 754 5. Investments in Associates and Joint Ventures 755 5.1. Equity Method of Accounting: Basic Principles 756 5.2. Investment Costs That Exceed the Book Value of the Investee 759 5.3. Amortization of Excess Purchase Price 761 5.4. Fair Value Option 763 5.5. Impairment 763 5.6. Transactions with Associates 764 5.7. Disclosure 766 5.8. Issues for Analysts 767 6. Business Combinations 767 6.1. Pooling of Interests and Purchase Methods 769 6.2. Acquisition Method 770 6.3. Impact of the Acquisition Method on Financial Statements, Post-Acquisition 772 6.4. The Consolidation Process 775 6.5. Financial Statement Presentation Subsequent to the Business Combination 781 6.6. Variable Interest and Special Purpose Entities 784 6.7. Additional Issues in Business Combinations That Impair Comparability 788 7. Summary 789 Problems 790 CHAPTER 16 Multinational Operations 799 Learning Outcomes 799 1. Introduction 800 2. Foreign Currency Transactions 801 2.1. Foreign Currency Transaction Exposure to Foreign Exchange Risk 802 2.2. Analytical Issues 805 2.3. Disclosures Related to Foreign Currency Transaction Gains and Losses 808 3. Translation of Foreign Currency Financial Statements 814 3.1. Translation Conceptual Issues 814 3.2. Translation Methods 819 3.3. Illustration of Translation Methods (Excluding Hyperinflationary Economies) 827 3.4. Translation Analytical Issues 830 3.5. Translation when a Foreign Subsidiary Operates in a Hyperinflationary Economy 842 3.6. Companies Use Both Translation Methods at the Same Time 846 3.7. Disclosures Related to Translation Methods 847 4. Multinational Operations and a Company s Effective Tax Rate 853 5. Additional Disclosures on the Effects of Foreign Currency 856 5.1. Disclosures Related to Sales Growth 856 5.2. Disclosures Related to Major Sources of Foreign Exchange Risk 859 6. Summary 860 Problems 862 CHAPTER 17 Evaluating Quality of Financial Reports 869 Learning Outcomes 869 1. Introduction 869 2. Quality of Financial Reports 871 2.1. Conceptual Framework for Assessing the Quality of Financial Reports 871 2.2. Potential Problems That Affect the Quality of Financial Reports 873 3. Evaluating the Quality of Financial Reports 884 3.1. General Steps to Evaluate the Quality of Financial Reports 885 3.2. Quantitative Tools to Assess the Likelihood of Misreporting 886 4. Earnings Quality 889 4.1. Indicators of Earnings Quality 889 4.2. Evaluating the Earnings Quality of a Company (Cases) 899 4.3. Bankruptcy Prediction Models 910 5. Cash Flow Quality 911 5.1. Indicators of Cash Flow Quality 912 5.2. Evaluating Cash Flow Quality 913 6. Balance Sheet Quality 921 7. Sources of Information about Risk 925 7.1. Limited Usefulness of Auditor s Opinion as a Source of Information about Risk 925 7.2. Risk-Related Disclosures in the Notes 929 7.3. Management Commentary (Management Discussion and Analysis, or MD&A) 933 7.4. Other Required Disclosures 936 7.5. Financial Press as a Source of Information about Risk 937 8. Summary 937 References 939 Problems 940 CHAPTER 18 Integration of Financial Statement Analysis Techniques 943 Learning Outcomes 943 1. Introduction 944 2. Case Study 1: Long-Term Equity Investment 945 2.1. Phase 1: Define a Purpose for the Analysis 945 2.2. Phase 2: Collect Input Data 945 2.3. Phase 3: Process Data/Phase 4: Analyze/Interpret the Processed Data 946 2.4. Phase 5: Develop and Communicate Conclusions and Recommendations (e.g., with an Analysis Report) 971 2.5. Phase 6: Follow-up 972 3. Case Study 2: Off -Balance Sheet Leverage from Operating Leases 972 3.1. Phase 1: Define a Purpose for the Analysis 973 3.2. Phase 2: Collect Input Data 973 3.3. Phase 3: Process Data/Phase 4: Analyze/Interpret the Processed Data 973 3.4. Phase 5: Develop and Communicate Conclusions and Recommendations (e.g., with an Analysis Report) 975 3.5. Phase 6: Follow-up 976 4. Case Study 3: Anticipating Effects of Changes in Accounting Standards 976 4.1. Phase 1: Define a Purpose for the Analysis 977 4.2. Phase 2: Collect Input Data 977 4.3. Phase 3: Process Data/Phase 4: Analyze/Interpret the Processed Data 977 4.4. Phase 5: Develop and Communicate Conclusions and Recommendations (e.g., with an Analysis Report) 980 4.5. Phase 6: Follow-up 980 5. Summary 980 Problems 981 Glossary 987 About the Authors 999 About the CFA Program 1003 Index 1005 WORKBOOK PART I Learning Outcomes, Summary Overview, and Problems CHAPTER 1 Financial Statement Analysis: An Introduction 3 Learning Outcomes 3 Summary Overview 3 Problems 5 CHAPTER 2 Financial Reporting Mechanics 7 Learning Outcomes 7 Summary Overview 7 Problems 8 CHAPTER 3 Financial Reporting Standards 13 Learning Outcomes 13 Summary Overview 14 Problems 15 CHAPTER 4 Understanding Income Statements 19 Learning Outcomes 19 Summary Overview 20 Problems 21 CHAPTER 5 Understanding Balance Sheets 25 Learning Outcomes 25 Summary Overview 25 Problems 27 CHAPTER 6 Understanding Cash Flow Statements 31 Learning Outcomes 31 Summary Overview 31 Problems 32 CHAPTER 7 Financial Analysis Techniques 37 Learning Outcomes 37 Summary Overview 37 Problems 38 CHAPTER 8 Inventories 45 Learning Outcomes 45 Summary Overview 45 Problems 47 CHAPTER 9 Long-Lived Assets 61 Learning Outcomes 61 Summary Overview 62 Problems 64 CHAPTER 10 Non-Current (Long-Term) Liabilities 73 Learning Outcomes 73 Summary Overview 73 Problems 75 CHAPTER 11 Financial Reporting Quality 79 Learning Outcomes 79 Summary Overview 79 Problems 80 CHAPTER 12 Financial Statement Analysis: Applications 83 Learning Outcomes 83 Summary Overview 83 Problems 84 CHAPTER 13 Income Taxes 87 Learning Outcomes 87 Summary Overview 88 Problems 88 CHAPTER 14 Employee Compensation: Post-Employment and Share-Based 93 Learning Outcomes 93 Summary Overview 93 Problems 94 CHAPTER 15 Intercorporate Investments 101 Learning Outcomes 101 Summary Overview 101 Problems 102 CHAPTER 16 Multinational Operations 111 Learning Outcomes 111 Summary Overview 112 Problems 114 CHAPTER 17 Evaluating Quality of Financial Reports 121 Learning Outcomes 121 Summary Overview 121 Problems 123 CHAPTER 18 Integration of Financial Statement Analysis Techniques 125 Learning Outcomes 125 Summary Overview 125 Problems 126 PART II Solutions CHAPTER 1 Financial Statement Analysis: An Introduction 135 Solutions 135 CHAPTER 2 Financial Reporting Mechanics 137 Solutions 137 CHAPTER 3 Financial Reporting Standards 141 Solutions 141 CHAPTER 4 Understanding Income Statements 143 Solutions 143 CHAPTER 5 Understanding Balance Sheets 145 Solutions 145 CHAPTER 6 Understanding Cash Flow Statements 147 Solutions 147 CHAPTER 7 Financial Analysis Techniques 151 Solutions 151 CHAPTER 8 Inventories 155 Solutions 155 CHAPTER 9 Long-Lived Assets 161 Solutions 161 CHAPTER 10 Non-Current (Long-Term) Liabilities 165 Solutions 165 CHAPTER 11 Financial Reporting Quality 167 Solutions 167 CHAPTER 12 Financial Statement Analysis: Applications 171 Solutions 171 CHAPTER 13 Income Taxes 173 Solutions 173 CHAPTER 14 Employee Compensation: Post-Employment and Share-Based 175 Solutions 175 CHAPTER 15 Intercorporate Investments 179 Solutions 179 CHAPTER 16 Multinational Operations 183 Solutions 183 CHAPTER 17 Evaluating Quality of Financial Reports 187 Solutions 187 CHAPTER 18 Integration of Financial Statement Analysis Techniques 189 Solutions 189 About the CFA Program 193