CFA Studying

What are the 8 C’s for Credit?

Micro Factors
1) Capacity
2) Character
3) Collateral
4) Capital
5) Covenants

Macro Factors
5) Conditions
6) Country
7) Currency

What is PESTLE Analysis used for and what does it stand for?

Useful for understanding how the company is impacted by factors it doesn’t control

P- Political
E - Economic
S - Social
T - Technology
L - Legal
E - Environmental

What is Porter’s 5 Forces and what do these 5 forces consist of?

A framework for analyzing a business’s competitive landscape.

1) Pricing power of suppliers
2) Pricing power of customers
3) Threat of new entrants
4) Threat of substitute products
5) Rivalry amongst existing competitors

Under IFRS, an impairment loss on a property, plant, and equipment asset is measured as the excess of the carrying amount over the asset’s:

Recoverable amount.

The recoverable amount is the higher of:

1) Asset’s fair value less costs to sell
2) Value in use (Basically a DCF)

IFRS vs. US GAAP on PP&E valuation after purchase

IFRS - Uses the revaluation model for valuing PP&E. Impairment test is done comparing the asset’s carrying value with its recoverable amount.

IFRS also allows PP&E to be revalued higher than the initial purchase! If this happens, an account called revaluation surplus is created.

US GAAP - Uses the cost model - Allows for impairment test

US GAAP doesn’t allow revaluation to be higher of initial cost.

What is the revaluation surplus account under IFRS and the rationale of this account

A reserve created when revaluing property, plant, and equipment above their initial costs under IFRS, reflecting the increase in asset value. This account falls right under Sharesholder Equity. The implication of this is that it prevents revaluation gains from going to net income!

Note this account doesn’t exist under US GAAP.

In a business combination, if an asset is neither tangible nor identifiable intangible assets, how is that item treated?

It is added to Goodwill and represents the premium paid over fair value.

The type of equity voting right that gransts one vote for each share of equity owned is referred to as

Common Equity - Statutory voting

Sponsored vs. Unsponsored Depository Receipts

Sponsored - Foreign company directly involved. Investors have ownership rights

Unsponsored - Foreign company not involved. Depository has rights of ownerhship

Types of Depository Receipts

1) GDR - Global Repository Receipts - Issued outside of home country of the issuer and outside of U.S

2) American Depository Receipts - Foreign company issued shares in their company in the U.S

8 C’s of Credit - What does Capacity mean?

Capacity refers to a borrower's ability to repay a loan based on their income, expenses, and overall financial situation. It assesses the adequacy of cash flow in meeting payment obligations on time.

8 C’s of Credit - What does Collateral mean?

Collateral refers to assets that a borrower or issuer offers to secure a loan, which can be claimed by the lender in case of default. It provides the lender with a level of protection against loss.

The quality spectrum for financial reports is as follows (high to low):

1) GAAP, decision-useful, sustainable, and adequate returns
2_ GAAP, decision-useful, but questionable sustainability, low earnings quality
3) Within GAAP, biased choices
4) Within GAAP, but earnings management (real or accounting)
4) Non-compliant accounting
5) Fake transactions

3 and 4 are the ones to pay attention to.

What is the five-step revenue recognition process?

1) Identify the contract with a customer
2) Identify the performance obligations in the contract
3) Determine the transaction price
4) Allocate the transaction price to the performance obligations
5) Recognize revenue when performance obligations are satisfied

8 C’s of Credit - What does Character mean?

Character refers to a borrower's reliability and integrity in repaying debts, often assessed through credit history and behavioral patterns. It reflects the borrower's willingness to fulfill financial obligations.

Participating preference shares entitle shareholders to:

Receive an additional dividend if the company’s profits exceed a pre-determined level

8 C’s of Credit - What does Covenants mean?

Covenants are agreements or clauses in a loan contract that outline specific actions the borrower must or must not take, intended to protect the interests of the lender and reduce risk.

8 C’s of Credit - What does Capital mean?

Capital refers to the financial resources or assets that a borrower uses to fund their business operations or investments, which demonstrate their ability to repay the loan without relying on debt.

8 C’s of Credit - What does Currency mean?

Currency refers to the specific type of money used in a loan agreement, which can influence the borrower’s repayment ability by reflecting exchange rates and inflation. It is crucial for evaluating the economic context of the loan. Note that currency applies to borrowers who receives cash flows in one currency and makes bond payments in another.

8 C’s of Credit - What does Condition mean?

Condition refers to the overall economic environment affecting a borrower’s ability to repay a loan, including factors like economic trends, industry conditions, and market stability.

8 C’s of Credit - What does Country mean?

Country refers to the economic and political stability of the borrower's home nation, which can impact loan repayment risk by influencing factors such as regulatory environment, financial market integrity, and overall economic performance.

How is interest-paying or dividends received recorded under IFRS vs. US GAAP on the cash flow statement?

US GAAP - Interest and dividends earned are reported as operating activities.

IFRS - Interest and dividends can be classified as either operating or investing activities, depending on the entity's policy.

What is a Collateralized debt oblidation (CDO)?

Generic term describing securitization backed by diversified collateral pools of non-mortgage debt (bonds or other loans)

How is a cash flow hedge treated in accounting?

A cash flow hedge is treated as a derivative instrument in accounting, where the effective portion of the gain or loss on the hedge is recorded in other comprehensive income until

Marked-to-market changes are reported in OCI. And then once the derivative matures, the net effect of the hedge gets reclassified into P&L.

Ineffective parts of the hedge gets reported to P&L.

How is a fair value hedge treated in accounting?

A fair value hedge is treated as a derivative instrument in accounting, where the gains and losses on the hedge are recognized in profit and loss (P&L) immediately.

Typically used for market investments where participants are mitigating the risk of changes in the value of an asset/liability due to market volatility.

How is a net investment hedge treated in accounting

Similar in nature to a fair value hedge but gains and losses on the hedge are recognized in OCI.

Shipping Terms – FOB Shipping Point vs Destination

• FOB Shipping Point → Revenue recognize when shipped

• FOB Destination → Revenue recognize when received by customer

What is the principle of sovereign immunity?

Under the principle of sovereign immunity, national laws limit investors’ ability to force a sovereign government into bankruptcy or liquidate its assets to settle debt claims as would be the case for a corporate issuer.

5 Qualitative Factors of Government Creditworthiness

1) Government policy and regulations
2) Fiscal flexibility
3) Monetary effectiveness
4) Economic flexibility
5) External Status

Long-Term Contracts Revenue Recognition

Revenue is recognized over time using either:

• Input method (E.g Cost-to-cost)

• Output method (E.g Based on milestones or units completed)

Bill-and-Hold Arrangements

A revenue recognition technique where a seller bills a customer for a product but retains possession of the product until a later date, allowing revenue to be recognized at the time of billing.

IFRS 15 & US GAAP criteria need to be met:

• Customer must request the delay

• Seller cannot use or redirect the goods

What are signs of aggressive or premature revenue recognition?

• High A/R relative to sales

• Rising DSO (days sales outstanding) - How long a company takes to collect cash after making a sale

• Sudden spike in revenue near quarter-end or year-end

• Multiple-element arrangements with vague allocations

• Changes in shipping or return terms (Like to FOB shipping point or Bill-and-Hold arrangments

What is channel-stuffing?

A practice where a manufacturer ships more products to distributors than they can sell in the short term, often to inflate revenues. This can lead to a build-up of unsold inventory and is considered aggressive revenue recognition.

What is COGS? What components make up COGS and when should these expenses be recognized?

COGS represents the direct costs of producing goods sold during a period — usually including:

• Raw materials

• Direct labor

• Manufacturing overhead (allocated)

Under the matching principle, COGS should be recognized in the same period as the revenue it helped generate

Inventory Costing Methods & Impact on COGS

Method	Effect During Rising Prices	CFA Implication
FIFO	Lower COGS, Higher Net Income	Higher inventory on B/S, higher taxes
LIFO	Higher COGS, Lower Net Income	Lower inventory, potential tax savings
Weighted Avg	Smooths fluctuations	Middle-ground effect on income/taxes

LIFO is allowed only under US GAAP, not IFRS.

What is LIFO Reserve?

LIFO reserve is the difference between FIFO & LIFO inventory. It helps with comparability between companies using different methods.

You can convert LIFO to FIFO using LIFO Reserve:

• FIFO Inventory = LIFO + LIFO Reserve

• FIFO COGS = LIFO Inventory - Change in LIFO Reserve

What are common Inventory Red Flags?

• High inventory levels + low turnover = obsolescence risk

• Large inventory write-downs = poor demand forecasting or aggressive capitalization

• Gorss margin suddenly improving during inflation = possilble LIFO liquidation

Operaing Expenses - Capitalizing vs. Expensing. What’s the impact if expenses are capitalized vs. expensed immediately?

Expensed immediately - Lower net income

Capitalized - Expenses spread over future periods - Boosts current net income

What possible Non-Recurring Items can be hidden in Operating Expenses?

Companies may bury:

• restructuring costs, legal settlements, or write-downs in SG&A

What’s the Key Difference between IFRS and U.S GAAP regarding functional vs. natural classification of operating expenses?

Topic	IFRS	US GAAP

Classification Options

Allows classification by function or nature

Generally reports by function (e.g., COGS, SG&A)

Disclosure Requirement

If function is used, must also disclose nature breakdown in notes

No explicit requirement to reconcile function with nature

Flexibility

More flexible → less comparability across firms

More consistent → easier peer analysis

What is the treatment of RSU’s?

RSU’s are treated under stock-based compensation. It is expensed based on the fair value of the shares when issued. If there is a vesting period, it is expensed evenly over the vesting period until fully vested.

What is the treatment of Stock options/warrants?

Stock options and warrants are classified as stock-based compensation, expensed based on the fair value at grant date, and recognized over the vesting period if applicable.

The fair value is calculated using Black Scholes model or binomial model

How are RSU’s treated as the stock prices change during the vesting schedule?

No impact - the fair value is determined at the grant date and does not change during the vesting period. This applies to both IFRS and US GAAP.

What are Development Costs in relation to Intangible Assets? What’s the treatment of these costs in IFRS vs U.S GAAP?

Costs incurred to develop intangible assets that can be capitalized under IFRS. Typically, they are expensed but if strict criteria are met, they can be capitalized

While under U.S. GAAP, these costs are generally expensed as incurred. These costs can include:

• Software

• New technologies or products

• Engineering designs

• Prototype creation

What’s the impact of development costs to financial statements?

Capitalized development costs will appear in investing cash flows section in the cash flow statement and in the balance sheet as intangible assets. These intangible assets will be depreciated over time.

Methods to Record Depreciation and impact

Methods

• Straight-line: Common, smooth expense over time

• Accelerated (e.g., double declining): More expense upfront, lowers early net income

• Units-of-production: Expense tied to asset usage

Impairment recognition and treatment of IFRS vs GAAP

Triggered when the recoverable value is lower than carrying value.

IFRS: Allows reversals of prior impairments (Except goodwill)

US GAAP: Prohibits reversals

Revaluation of Long-Lived Assets - IFRS vs US GAAP

Applies to tangible and intangible assets.

IFRS - Allows for these assets to be revaluated to fair value. Changes go to:

• OCI if upward (Equity boost, not income)

• P&L if downward

US GAAP - Prohibits revaluation

How is Interest Expense recorded?

Interest is recorded as incurred, not when paid (Accrual accounting)

When can interest expense be capitalized and what is the impact?

Interest on debt used to finance the construction of a qualifying asset (E.g A factory) is capitalized into the asset’s cost

Impacts: Higher asset value, costs spread over time via depreciation boosting short-term net income

What is the effective interest rate method? - Applies to Bonds

Bond interest expense based on the Carrying Value of Debt * Effective Interest Rate, not the coupon payments

Required under both IFRS and US GAAP

What is the tax expense item comprise of?

1) Current tax payable
2) Change in deferred tax liabilities/assets

What is Temporary vs. Permanent Differences in Taxation?

Difference Type	Description
Temporary	Timing differences (e.g., depreciation methods) — these reverse over time
Permanent	Do not reverse (e.g., fines, tax-exempt income) — impact effective tax rate only

Temporary Differences lead to Deferred Tax Assets and Liabilities

Effect of Tax Rate Changes - DTL/DTA’s

DTAs and DTLs must be revalued:

• If tax rate goes down, the value of DTA/DTL’s go down resulting in tax expense or benefit in current period

IFRS vs US GAAP Differences in tax expense

US GAAP: Valuation allowance used for Deferred tax assets if management believes these tax assets will not be realized

IFRS: No valuation allowance; considers expectations of future profitability when recognizing tax assets.

Key Difference between IFRS & US GAAP for Accounts Receivable

Topic	IFRS	U.S. GAAP

Impairment Model

Expected Credit Loss (ECL) model — recognize losses earlier

Incurred loss model (more delayed recognition)

What is Days Sales Outstanding formula and the impact of this metric?

DSO=(Average A/R/Revenue​)×Number of Days

A measure of how quickly a company collects cash from its accounts receivable, influencing cash flow and liquidity.

Key Concept with Accounts Payable and Accrual Accounting

Reflects expenses incurred regardless of whether cash has been paid

Days Payable Outstanding Formula and Explanation

DPO = (Average A/P / Cost of Goods Sold) × Number of Days.

A measure of how long a company takes to pay its suppliers, impacting cash flow and operational efficiency.

What are the common adjustments made to net income when calculating operating cash flow?

1) Depcreciation & Amortization
2) Stock-based comp
3) Changes in A/R, Inventory, A/P
4) Interest paid/received - GAAP: Operating, IFRS: Operating or financing/investing
5) Taxes paid - Typically operating but IFRS allows flexibility

What is quality of earnings analysis?

Comparing net income to CFO to assess earnings sustainability

What are common items under cash flows from debt and equity transactions

1) Issuance or repayment of debt
2) Issuance or repurchase of equity
3) Dividends paid

How is basic EPS calculated and what does it indicate?

EPS = (Net Income - Preferred Dividends) / (Weighted Average Shares Outstanding)

Reflects earnings per each common share

What documents and disclosures complement the financial statements?

Auditor’s report, management commentary (MD&A), footnotes, proxy statements, and regulatory filings (e.g., 10-K, 20-F)

What key principle distinguishes accrual accounting from cash accounting?

Accrual accounting recognizes revenue and expenses when earned or incurred, not when cash is exchanged, aligning with the matching principle.

What does accruals ratio measure and why is it important?

Accruals Ratio = (Net Income - Cash Flow from Operations) / Average Assets


High ratio suggests earnings rely heavily on accruals and that cash collection isn’t good or that there may be potential issues in revenue recognition.

What is the 3-step DuPont equation and what each component reavels?

ROE =
1) Net Profit Margin = Net Income / Revenue
2) Asset Turnover = Revenue / Average Total Assets
3) Equity Multiplier = Average Total Assets / Average Shareholders Equity

Simple terms: Profit from revenue * How many times it happens * Equity leverage

What does the extended (5-step) DuPont framework include?

ROE =
1) EBIT Margin * Asset Turnover * Leverage * Tax Burden * Interest Burden

This formula is a different perspective on DuPont ROE. It’s essentially the 3-step but Net Income is broken down into EBIT, Interest Burden and tax burden.

Basically, the interest burden and tax burden is 1 - Tax Rate and Interest Rate, respectively. The denominator is EBIT for Interest Burden and Earnings before Taxes for Tax Burden.

What is Interest Burden formula?

EBT / EBIT

What is Tax Burden formula?

Net Income / EBT

Inventory Turnover formula?

COGS / Average Inventory

Quick ratio formula?

Quick Ratio = (Cash + Marketable Securities + A/R) / Current Liabilities. The quick ratio excludes inventory.

Free Cash Flow to the Firm Formula

CFO - CapEx + Interest (1 - tax rate)

Essentiallyit measures the cash generated by the company that is available to all providers of capital, including equity and debt holders.

Cash Flow Interest Coverage Ratio

CFO / Interest Paid

How many times the CFO covers interest paid

Reinvestment Ratio

Capex / CFO

Proportion of CFO that is being reinvested into the business

Inventory Reporting IFRS vs U.S GAAP

Aspect	IFRS	U.S. GAAP
Costing Methods Allowed	FIFO, Weighted Average	FIFO, Weighted Average, LIFO (unique to GAAP)
Measurement Basis	Lower of Cost or Net Realizable Value (NRV)	Lower of Cost or Market
Market Definition	Not applicable (uses NRV)	Market = Replacement cost, capped at NRV, floored at NRV – normal profit
Inventory Write-Downs	Required if NRV < Cost	Required if Market < Cost
Write-Down Reversals	Allowed if NRV subsequently increases (limited to prior write-down)	Not allowed — no reversal once written down
Write-Ups (Reversals of Losses)	Permitted, but only up to original cost	Prohibited

US GAAP vs IFRS treatment of Pro-Forma measures

Pro-Forma measures can be both non-GAAP and can be non-IFRS.

Pro-Forma measures can be anything as long as the company disclosures them in the financial statements

Treatment of Equity Investments under US GAAP & IFRS

IFRS - FV through P&L or through OCI if elected on acquisition.

US GAAP - Requires them to be measured at FV through P&L

Treatment of Debt Securities unfer US GAAP & IFRS

• Amortized cost if held to maturity

• Fair value through OCI if available-for-sale

• Fair value through P&L if held for trading

Applies for both US GAAP & IFRS

What is the Cash Ratio Formula? What’s its interpretation

Cash and Cash Equivalents / Current Liabilities

Cash ratio of > 1 means the compnay has more cash than it needs to ay its short-term obligations


Too high of a ratio means the company may not be investing enough in growth opportunities.

High quality earnings are:

Recurring earnings that are sustainable and represent returns equal to or in excess to the company’s cost of capital.

Earnings quality vs Financial reporting quality

Earnings quality:

• Focused on how sustainable the calculated earnings are of the company

• Are earnings from recurring profits or from one-time gains?

Financial reporting quality:

• Presentation and accuracy of financial information

• Use of aggressive accounting or omission of disclosures

• Are the reports generated conservatively

What does an unqualified opinion provided by an auditor means?

It indicates that the financial statements present a true and fair view of the company's financial position and comply with relevant accounting standards. This opinion assures stakeholders that the financial information is accurate and free from significant misstatements.

Diluted EPS Formula?

Net Income / (Weighted Average Shares Outstanding + Dilutive Shares)

What’s the process of the Treasury Stock Method?

1) Assume exercise price is the proceeds that is received by management

2) Management use the proceeds to purchase any stock back at the average market price for the period. They would use this stock to give to employees to fulfil the exercise of stock options, and warrants.

Formula of Net Identifiable Assets under IFRS and US GAAP?

FV of Identifiable Assets - FV of Liabilities

Identifiable Assets also includes Intangible Assets under US. GAAP & IFRS.

For US GAAP - Even if the target company has previously expensed internally developed technology costs, they have to be included in the fair value of the acquistion

What is the short-term lease exemption and the impact for both IFRS and US GAAP for lessees?

Under both IFRS & US GAAP, there is a short-term lease exemption for leases with a term of 12 months or less. Caveat: If there is a renewal option, accounting standards deem that the lease is > 12 months and thus doesn’t qualify for the short-term lease exemption

This exemption allows lessees to bypass lease accounting and record the lease as an expense and not recognize an asset on its balance sheet.

What are the types of classifcations are there for lease accounting?

1) Finance Lease
2) Operating Lease

The above only applies for US GAAP for lessees. In IFRS, the accounting treatment for either type of lease is identical. There is no distinction.

Do lessors have the short-term lease exemption available to them?

No because they own the asset. So it doesn’t make sense for them to leave the asset out of their balance sheet and just recognize the cost of ownerships in their income statement

Difference in classification types for lessess (IFRS vs GAAP) - Lessee perspective

For IFRS - All leases are treated as capital leases. For US GAAP - leases can be classified as either finance or operating leases, leading to different accounting treatments for each.

Differences in initial recognition of the lease (IFRS vs GAAP) - Lessee perspective

For IFRS - There is no distinction between operating and finance lease. All leases are treated as a right-of-use asset on the asset side and lease liability at the liability side. The measurement of the ROU asset and lease liability is the PV of future payments.

For US GAAP - Lease is treated as a right-of-use asset on the asset side and lease liabiltiy at the liability side but the classification determines whether the lease is a finance lease or an operating lease, which affects expense recognition. The measurement of the ROU asset and lease liability is the PV of future payments.

How is subsequent years of the lease recorded (IFRS) - Lessee perspective

For IFRS, the right-of-use asset is amortized on a straight-line basis. For the lease liability, it gets reduced by the principal repayments. Interest expense is recognized on the lease liability every year. Cash gets credited by the lease payment.

On the cash flow statement, the principal repayment is classified under a financing activity. The interest goes under operations or financing depending on the company

How is subsequent years of an operating lease recorded (US GAAP) - Lessee perspective

For US GAAP, the treatment depends on whether it is classified as an operating lease or capital lease. At a high-level, US GAAP treats this transaction like a rental agreement. They just want investors to see the actual asset value the company is leasing from.

For operating lease - The right-of-use asset and the lease liability is reduced by the principal repayments. Interest expense on the lease liability and amortization expense are combined to form “lease expense.” - In simple terms, the lease expense is simply a straight line amortization of the total lease payments over the lease term. The entire lease expense is recorded as a cash outflow under operating activities.

How is subsequent years of a finance lease recorded (US GAAP) - Lessee perspective

Identical to IFRS treatment

How is the accounting treatment for lessors under IFRS vs US GAAP?

They are almost identical for U.S GAAP vs. IFRS. However, differences in accounting treatment arise based on the classification of the lease.

Operating lease - The lessor doesn’t remove the asset from its books. Lessor records the entire cash receipt as lease revenue b/c they treat it like a rental agreement. The entire cash receipt is reported under operating activities under the cash flow statement

Finance lease - The lessor removes the asset from its book and replaces it with lease receivable at the PV of future payments that its going to receive from the lessee. Any differences between the PV of future payments and carrying value are recognized at a gain/loss straight to P&L. It receives interest income or revenue if leasing is its primary business. Note that interest income is only recorded on the income statement. The entire cash receipt is recorded under the firm’s cash flow from operations.

What is a sole proprietorship?

Business owned and operated by one individual with unlimited liability; taxed at the owner's personal rate

What is the key liability difference between general and limited partners?

General partners have unlimited liability; limited partners' liability is capped at their investment.

What are the defining features of a corporation?

1) Separate legal identity
2) limited liability for shareholders
3) perpetual existence
4) The ability to raise capital via equity or debt.