CFA Free 101 Concepts

25-05-18 Concept 40: Accruals and Valuation Adjustments

Accruals: The accrual accounting principle requires that a firm recognize revenue when they are earned and expenses when they are incurred. At times, there is a timing difference between the cash movements and the recognition of revenues or expenses. In such cases accrual entries are required. If cash is transferred at the same time when the revenue or expense is incurred, there is no need for accrual entries. The four types of accrual entries are: Unearned revenue: (Cash is received first, and the goods/services will be delivered later.) Increase cash and create a liability for the goods/services that the firm… Read More

101 concepts level I

25-05-18 Concept 41: International Accounting Standards Board’s (IASB) Conceptual Framework

Objective of financial statements: As per the IFRS framework, the objective of financial statements is ‘to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity’. Qualitative characteristics: The two fundamental qualitative characteristics are: Relevance: Financial statements should be useful both for making forecasts as well as to evaluate past forecasts. They should be timely and sufficiently detailed and important facts should not be omitted. Faithful representation: Information presented should be complete, neutral and free from errors. The four supplementary qualitative characteristics… Read More

101 concepts level I

31-05-18 Concept 42: Revenue Recognition

Criteria for revenue recognition: According to the accrual method of accounting, revenue is recognized when earned and expenses are recognized when incurred. Accrual accounting allows firms to manipulate net income through their choices about revenue and expense recognition. Hence to reduce manipulation, standard setting bodies have defined a criteria for revenue recognition. As per U.S. GAAP, revenue can be recognized if the following conditions are met: There is evidence of an arrangement between the buyer and seller. The product has been delivered or the service has been rendered. The price is determined or determinable. The seller is reasonably sure of… Read More

101 concepts level I

31-05-18 Concept 43: Expense Recognition

Matching principle: The most important principle of expense recognition is the matching principle, under which the expenses incurred to generate revenue are recognized in the same period as revenue. If some goods bought in the current year remain unsold at the end of the year, they are not included in the cost of goods sold for the current year. If they are sold in the next year, they will be included in the cost of goods sold for the next year. Periodic costs: Expenses that cannot be tied directly to generation of revenues are called periodic costs. They are expensed… Read More

101 concepts level I

31-05-18 Concept 44: Non-Recurring Items & Changes in Accounting Policies

Non-recurring items: A company needs to separate revenues and expenses into items that are likely to continue in the future and items that are not likely to continue in the future. This helps analysts to predict future earnings of the company. Items that are not likely to continue can be classified as: Discontinued operations: An operation that the company has disposed in the current period or is planning to dispose in future. On the income statement, discontinued operations are shown as a separate line item, net of tax, after net income from continuing operations. Extraordinary items: IFRS does not allow… Read More

101 concepts level I

31-05-18 Concept 45: Earnings Per Share (EPS)

Earnings per share is a very important profitability measure. It depicts the earnings per ordinary share. Some basic terminology related to EPS are: Potentially dilutive securities: Securities that can be converted into ordinary share are called potentially dilutive securities. This includes convertible bonds, convertible preferred stock, and employee stock options. Simple capital structure: If a company has no potentially dilutive securities, it is said to have a simple capital structure. Complex capital structure: If a company has potentially dilutive securities, it is said to have a complex capital structure. Dilutive securities: A potentially dilutive security that decreases EPS when exercised… Read More

101 concepts level I

31-05-18 Concept 46: Measurement Bases for Different Types of Assets and Liabilities

Measurement bases Historical cost – Cost at which the item was actually purchased. Historical cost is highly reliable, but its relevance to an analyst declines as values change. Fair value – Cost at which an item can be purchased now, in an arm’s length transaction. Fair value is more relevant to an analyst but is less reliable compared to historical cost, because it involves some level of judgment. Different types of assets and liabilities Current assets Cash and cash equivalents – Highly liquid, low risk securities with maturity less than 90 days. They are reported at either fair value or… Read More

101 concepts level I

31-05-18 Concept 47: Components of Shareholders’ Equity

The six components of equity are: Contributed capital: Total amount paid in by common and preferred shareholders. Treasury shares: These are shares that have been repurchased by the company, but not yet retired. Retained earnings: Cumulative income of firm since inception that has not been distributed as dividends. Accumulated other comprehensive income: These include items which lead to changes in equity but are not part of income statement or from issuing stock, reacquiring stock, and paying dividends. Non-controlling interest (minority interest): It is the portion of a subsidiary not owned by parent company. For example, if a firm owns 80%… Read More

101 concepts level I

31-05-18 Concept 48: Liquidity and Solvency Ratios

Liquidity ratios measure a company’s ability to meet current liabilities. The higher the liquidity ratio, the more likely the firm will be able to meet its short term obligations. Current ratio – It is the most widely used measure of liquidity. Current ratio = current assets / current liabilities Quick ratio – It is a more conservative measure of liquidity. It excludes inventories and less liquid assets from the numerator Cash ratio – It is the most conservative measure of liquidity. Even receivables are excluded from the numerator. Solvency ratios measure a company’s ability to meet long-term obligations. A high… Read More

101 concepts level I

01-06-18 Concept 49: Steps in the Preparation of Direct and Indirect Cash Flow Statements

Operating Cash Flow Direct method: In the direct method, we take each item from the income statement and convert it to its cash equivalent by removing the impact of accrual accounting. The rules to adjust are: Increase in asset is use of cash (-ve adjustment) and decrease in asset is source of cash (+ve adjustment) Increase in liability is source of cash (+ve adjustment) and decrease in liability is use of cash (-ve adjustment) Cash collected from customers: Adjust sales for changes in accounts receivables and unearned revenue. Cash for inputs: Adjust COGS for changes in inventory and accounts payable…. Read More

101 concepts level I

Category: 101 Concepts for Level I

25-05-18 Concept 40: Accruals and Valuation Adjustments

25-05-18 Concept 41: International Accounting Standards Board’s (IASB) Conceptual Framework

31-05-18 Concept 42: Revenue Recognition

31-05-18 Concept 43: Expense Recognition

31-05-18 Concept 44: Non-Recurring Items & Changes in Accounting Policies

31-05-18 Concept 45: Earnings Per Share (EPS)

31-05-18 Concept 46: Measurement Bases for Different Types of Assets and Liabilities

31-05-18 Concept 47: Components of Shareholders’ Equity

31-05-18 Concept 48: Liquidity and Solvency Ratios

01-06-18 Concept 49: Steps in the Preparation of Direct and Indirect Cash Flow Statements