KASNEB Financial Statements Analysis Notes

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CIFA INTERMEDIATE LEVEL

FINANCIAL STATEMENTS ANALYSIS UNIT DESCRIPTION

This paper is intended to equip the candidate with the knowledge, skills and attitudes that will enable him/her to analyse and interpret the financial statements of a firm.

LEARNING OUTCOMES

A candidate who passes this paper should be able to:

• Evaluate the various alternative sources of financial information
• Apply the various financial statement analytical tools and techniques in analysing financial statements
• Demonstrate an understanding of accounting measurements and recognition
• Compare the financial reporting and accounting treatments of assets and liabilities
• Comply with the requirements of IASs, IFRSs and IPSASs
• Evaluate the financial performance of a firm.

CONTENT

Overview of financial statements analysis

• Definition of financial statements analysis
• Different reporting environment frameworks
• Steps in analysing financial statements
• Importance and challenges of financial statements analysis
• Sources    of    information   for    analysis    (financial   statements,    auditors report, management commentary, filing with regulatory authorities and press reports)
• Approaches to analysing financial statements (macro, industry and firm – either top down or bottom up)

Financial reporting on assets and liabilities

• Investment properties; presentation and disclosure
• Accounting policies, changes in accounting estimates and errors (prior period errors)
• Events after the reporting period
• Non-recurrent items and non-operating items; discontinued operations (exclude disposal of subsidiaries), extra ordinary items, unusual or infrequent items, changes in accounting policies
• Financial   instruments:   presentation,   recognition,   measurement,   de-recognition, disclosures and impairment
• Non-current assets held for sale
• Intangible assets
• Leases: types of leases; presentation, disclosure, recognition, off balance sheet leverage from operating leases.
• Income taxes: accounting profit and taxable income, deferred tax assets and liabilities, tax base of assets and liabilities, temporary and permanent differences, recognition and measurement of current and deferred tax, presentation and disclosure
• Employee benefits (post-employment benefits): types of post employment benefits; impact of the assumptions used such as discount rates, return on plan assets and salary growth on the defined benefit obligation and period expenses; pension plan footnote disclosure, effect on underlying economic liability (asset) of a company’s pension and other post employment benefits; share based compensation
• Multinational   operations:   foreign   currency   transactions;   translation   of foreign currency in the financial statements, effects of changing prices and inflation

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Quality of earnings and earnings management

• Categories of earnings: Earnings before interest, tax depreciation and amortisation (EBITDA), operating earnings, net income among others
• Measures of the accrual component of earnings and earning quality
• Earnings per share (EPS); Basic EPS, diluted EPS, using EPS to value firms, criticism of EPS.
• Segment reporting; disclosure requirements, geographical segments, segment ratios

Other inter-corporate investments

• Subsidiaries
• Associate companies
• Jointly controlled entities
• Evaluating the effect of inter-corporate investments on financial statements given the different accounting treatment

Analysing the financial statements

• Income statement: Components and format of the income statement, revenue recognition and expenses recognition; analysis of the income statement-common size analysis and ratio analysis
• Statement of financial position; components and format of statement of financial position (assets, liabilities and equity), off balance sheet items; analysis of the statement of financial position and common size analysis, cross sectional analysis, ratio analysis
• Statement of changes in equity; components of equity, equity valuation ratios
• Cash flow statements; component and format of the cash flow statement, categories of cash flow items, direct and indirect methods for preparing cash flow statements; cash flow statement analysis-evaluation and uses of cash, common size analysis, free cash flow to the firm and free cash flow to equity, cash flow ratios

Financial statement analytical tools

• Financial analysis techniques; financial analysis framework/process; computations and analysis
• Value, purpose and limitation of ratio analysis
• Interpretation in context
• Profitability analysis: Desegregation and interpreting return on assets (ROA), return on capital employed (ROCE), relating ROA to ROCE, DuPont analysis
• Analysis of growth and sustainable earning; growth analysis, analysis of changes in profitability and sustainable earnings, analysis of growth in shareholder’s equity, growth, sustainable earnings and the evaluation of price to book (P/B) ratios and price earnings (P/E) ratios.
• Dividend ratios
• Analysis of liquidity and efficiency
• Analytical tools and techniques; ratio analysis, common size analysis, graphs
• Model building and forecasting; sensitivity analysis, scenario analysis, simulation
• Application of ratio analysis – cross sectional analysis, trend analysis, forecast financial statements, credit analysis and rating

Qualitative and other current issues in the Analysis of financial statements

• Qualities of useful financial statements
• Red flags and accounting warning signs that may indicate financial statements are of poor quality
• Accounting scandals

• Accounting shenanigans on the cash flow statement; creative accounting and manipulating financial statements
• Misrepresentation in the financial statements
• Adjustments that may be required to make financial statements comparable

Emerging issues and trends

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