Entire CFA L1 FSA (Financial Statement Analysis) in 75 minutes — Mind Map Revision Before Exam

Main ideas / lessons (organized by chapter/topic)

1) Financial Statement Analysis (FSA) overview & structure

• The instructor begins revision for CFA Level 1 Topic: Financial Statement Analysis (FSA).
• FSA is organized into multiple “major chapters” summarized using mind maps.
• First reading (intro chapter):
  • Covers basic terms and definitions.
  • Explains the process/steps of financial statement analysis.
  • Identifies the sources typically used to collect data.

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2) Inventory (mind map + key rules)

A. Inventory basics (meaning & types)

• Inventory = goods/material in the company’s possession.
• Goods can be in many forms (e.g., raw material, finished goods, packaging/spare parts).
• For syllabus classification, inventory includes:
  • Raw material
  • Work in progress
  • Finished goods
• In real-world contexts, items like packaging material and spare parts are often also grouped under inventory.

B. Inventory valuation rules (5 remembered rules)

The instructor emphasizes using a numbered set of rules so students can recall them quickly in exam questions.

1. Purchase cost is relevant for valuation.
2. Conversion cost is relevant (cost to convert raw materials into finished goods).
3. Any other expenses are relevant only until the base location
   • Base location = the first point in time when a good receives its proper classification.
   • Example: for finished goods, base location is when it first becomes finished goods.
4. Waste is not relevant for valuation adjustments
   • Waste is assumed already included in raw material cost.
   • Applies to both:
     • Normal waste
     • Abnormal waste
5. Fixed overhead: only allocated portion is relevant
   • Fixed overhead is allocated based on expected output (allocation rate based on expected production capacity).

C. Inventory management methods

• Methods discussed:
  • FIFO
  • LIFO
  • Weighted average
  • Specific identification (not emphasized in the syllabus; for unique items like jewelry)
• Measurement systems:
  • Periodic: compute stock and COGS only at period end
  • Perpetual: update COGS continuously with each transaction

Key practical insights:

• FIFO: same result under periodic vs perpetual (so IFRS doesn’t worry about the periodic/perpetual distinction; IFRS also doesn’t allow LIFO).
• LIFO: periodic vs perpetual matters, so classification is relevant.
• Weighted average: periodic vs perpetual is theoretically possible but practically not useful for the intended concept; periodic/perpetual distinction is mainly relevant to LIFO.

D. FIFO vs LIFO in an inflationary vs deflationary environment

• Assumption for the “table” in mind map: prices are increasing (inflationary).
• If prices are falling (deflation): relationships reverse.

Main effects in inflation:

• Closing stock:
  • FIFO closing stock higher
  • LIFO closing stock lower
  • Reason: FIFO values closing stock at latest prices
• COGS moves oppositely because:
  • COGS = Opening stock + Purchases − Closing stock
  • If closing stock rises, COGS falls.
• Profits (inverse relation to COGS):
  • Lower COGS → higher profits
• Taxes & cash:
  • Taxes are directly tied to profits
  • Cash is inversely related to taxes (more tax → less cash remaining)

E. Exam strategy for inventory

• Don’t treat FSA inventory as “pure theory”.
• Many “theory-looking” questions test understanding of numericals logic.
  • Example given: company shifts FIFO → LIFO in inflation and question asks impact on ratios (e.g., current ratio) without giving numbers.
• Advice:
  • Spend extra time (about 20 seconds) to think calmly and translate theory into numerical logic.

F. LIFO reserve (US GAAP disclosure)

• LIFO reserve is required under US GAAP (disclosed in notes).
• Definition:
  • LIFO reserve = Inventory (FIFO) − Inventory (LIFO)
• Purpose (analyst perspective):
  • Analysts can’t observe transactions; the reserve helps separate operational differences from reporting choices.

Useful analytical relationships:

• Change in LIFO reserve = closing − opening
• Impact guidance:
  • Change in cost = negative of change in LIFO reserve
  • Change in profits = change in LIFO reserve × (1 − tax)

G. LIFO liquidation (and why it inflates profits)

• LIFO liquidation = reduction of LIFO reserve.
• Two causes:
  1. Price falling (instructor says ignore; outside management control)
  2. Quantity in stock falling
     • Means fewer units remain at older LIFO layers being replaced
     • Leads to artificially inflated profits
• Important clarification:
  • This is not necessarily manipulation; it can be an automatic byproduct of LIFO accounting.
  • Analysts may adjust profits, but companies aren’t “fraudulently” changing results—standards produce the effect.

H. Inventory reporting rules (IFRS vs US GAAP)

IFRS (and general non-commodity logic):

• Report inventory at lower of cost and NRV
• NRV = expected selling price − selling costs − costs of completion/modification
• Write-up rule:
  • Allowed only as recovery of previous write-downs
  • Not allowed to treat increases as profit outright if no prior loss exists.

US GAAP:

• Report at lower of cost and market value
• “Market value” may be used as replacement value
• “Market value” has a range constraint:
  • Must lie between NRV and NRV minus expected profit margin
• Write-up not allowed (as a general rule).

Commodity exception (gold/oil/agri products with active markets):

• Use fair value based on market prices observed in the market.
• For commodities:
  • Write-up / write-down unrestricted.
• IFRS and US GAAP agree on this commodity exception concept.

Q&A notes included in subtitles - Replacement cost ≈ market value when used in questions. - If fair value is provided without “market value”/“replacement value,” fair value can be interpreted as market price or selling price depending on what’s implied. - A clarification question: why US GAAP write-down not allowed—answer points back to the range limitation for market value.

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3) Long-term assets (Property/Plant/Equipment & Intangibles) — initial recognition to derecognition

A. Asset categories & terminology

• Long-term assets split into:
  • Tangible assets → under newer standards referred to as PP&E (Property, Plant, and Equipment)
  • Intangible assets
• Chapter has six sections, with emphasis on initial recognition.

B. Initial recognition (acquisition methods)

Methods and measurement basis (assumed similar rules for PP&E and intangibles):

1. Purchase → transaction price
2. Business combination → fair value
3. Exchange → fair value of:
   • either asset given or received, whichever can be estimated more accurately
4. Lease → mentioned as covered elsewhere (long-term liabilities)

C. Self-constructed assets

• PP&E self-constructed:
  • Capitalize costs until the asset is finished
  • Costs reported as Capital Work in Progress (CWIP)
  • Rationale:
    • PP&E is used to generate revenue later
    • CWIP currently produces zero earnings, so it’s shown separately.
• Intangible self-constructed:
  • Similar separation concept (assets under development are not producing income yet).

D. Research vs development (IFRS) and US GAAP differences

IFRS:

• Research → expense immediately
• Development → capitalize if feasibility is established
• Development capitalization:
  • Report as intangible asset under development
• Key distinction:
  • Feasibility ≠ profitability; it means real-world viability and market/usage potential.

US GAAP:

• R&D both expensed (general rule)
• But exceptions for software:
  • Software for sale: research expensed; development capitalized (aligned with IFRS pattern)
  • Software for own use:
    • replaces “free” terminology due to confusion with trial/free periods
    • research expensed/capitalized under the appropriate own-use logic
    • development capitalized as intangible asset under development

E. Goodwill (only purchased is recognized)

• Self-generated goodwill:
  • Not reported
  • Reason: no reliable way to measure it
• Purchased goodwill:
  • Recognized when acquiring a business:
  • Goodwill = Purchase consideration − Fair value of net assets
  • Hidden “missing asset” rationale: the “extra payment” reflects goodwill not shown on target’s balance sheet.

F. Depreciation / amortization (methods + role)

• Depreciation/amortization = allocating cost over asset’s life.
• Methods mentioned:
  • Straight-line
  • WDB
  • Double declining balance
  • Units of production
• Component-based depreciation discussed conceptually.
• Depreciation often isn’t directly tested, but is used indirectly in other computations.

G. Additional expenses: expense vs capitalize (management choice)

• For additional expenses:
  • Can be expensed or capitalized
  • Presented as a management choice in practice (though exam expects understanding of the concept)
• Impact:
  • Expensing → affects profits immediately
  • Capitalizing → creates asset then depreciate over time

H. Revaluation (IFRS only)

• IFRS allows two models:
  • Cost model (historical cost − depreciation)
  • Revaluation model (fair value)
• Treatment:
  • If asset value increases:
    • report in income statement if it reverses prior losses
    • otherwise in revaluation surplus
  • If decreases:
    • offset revaluation surplus first
    • remainder to income statement

I. Impairment (highly testable; two-step process)

IFRS:

• Step 1 (test):
  • Asset is impaired if carrying value > recoverable value
• Step 2 (measure loss):
  • Recoverable value = higher of:
    • Value in use (future cash flows from using the asset)
    • NRV (net realizable value from selling)
  • Impairment loss = carrying value − recoverable value

US GAAP:

• Step 1 uses a different threshold:
  • carrying value > undiscounted cash flows
• Step 2:
  • impairment loss = carrying value − fair value

Goodwill impairment:

• Step 1: compare carrying value vs fair value
• Step 2: carrying value − fair value
• Same overall idea under IFRS and US GAAP (as described).

Reversal of impairment loss:

• IFRS allows reversal
• US GAAP generally does not, except:
  • if classified as available for sale after the asset is no longer being used

J. Derecognition

• Remove asset via:
  • sale, business combination, exchange, lease, scrap
• Determine profit/loss on derecognition:
  • Compare proceeds received with the asset’s carrying value on statements.

Differences summary explicitly stated

• Tangible vs intangible differences mostly in initial recognition
• Differences between IFRS vs US GAAP mainly:
  1. Self-constructed intangibles (software-type rules)
  2. Impairment rules (and reversals)
• Revaluation is IFRS-only per instructor.

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4) Taxes (deferred taxes, temporary vs permanent differences, IFRS vs US GAAP)

A. Core terminology

• Accounting vs tax concepts:
  • Accounting: pre-tax income, tax expense, carrying/book value
  • Tax: taxable income, tax payable, tax base of an asset

B. Why accounting/tax differ

• Financial reporting aims to disclose information
• Tax law aims to collect tax
• Differences can be:
  • Temporary/timing differences → reverse over time → create deferred tax
  • Permanent differences → don’t reverse → cause effective vs statutory mismatch

C. Deferred tax logic (timing differences)

Simplified rule:

• If tax expense > tax payable → create deferred tax liability (DTL)
• If tax payable > tax expense → create deferred tax asset (DTA)

Additional analytical form:

• DTL formula: (book value − tax base) × tax rate
• Use future rates if available.

D. Income statement vs balance sheet effect

• DTL accumulated across years → balance sheet
• Change in DTL in the current year → income statement

E. Permanent differences and effective tax rate disclosure

• Effective tax rate = tax expense / pre-tax income
• Statutory tax rate = tax rate from tax law
• Permanent differences create gaps; disclosure is required to avoid users misinterpreting tax avoidance/fraud.

F. IFRS vs US GAAP differences (deferred tax presentation)

• IFRS:
  • deferred tax is non-current
  • report on net basis
• US GAAP:
  • may be current or non-current
  • report asset and liability separately
• Future tax rate:
  • IFRS/US GAAP differ in “enacted” vs “substantially enacted” usage (as described in Q&A)

G. Valuation allowance (US GAAP specific idea)

• If a deferred tax asset decreases:
  • reduction is recorded via valuation allowance
• Rationale:
  • future benefit depends on having future profits
• IFRS is different because IFRS net presentation reduces need for separate valuation allowance in the same way (as instructor explains).

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5) Long-term liabilities: Lease and Pension

A. Lease types (lessee accounting focus)

• Lease types:
  • Operating lease
  • Financial lease (a “capital lease” in many curricula)

Financial lease recognition trigger (5 conditions) If any one is met, classify as financial lease:

1. Lease term life ≈ remaining useful life of asset
2. Present value of lease payments ≈ fair value of asset today
3. Ownership transfers to lessee at lease end automatically
4. Bargain purchase option exists (discounted purchase only for lessee)
5. Lessor has no further meaningful use of the asset (often links to sales-type leases)

Financial lease (lessee vs lessor treatment):

• Lessee:
  • Recognize PV of rentals as both:
    • asset
    • liability
  • Asset depreciated
  • Liability increases with interest and decreases with rental payments
• Lessor:
  • Recognize a lease receivable (not the physical leased asset)
  • Interest income accumulates; rental receipts reduce the receivable

Operating lease (simplified):

• Lessee: rent is expense
• Lessor: rent is income
• Asset stays with lessor → lessor depreciates

IFRS vs US GAAP nuance on long-term operating lease (as described):

• IFRS: treated simply (asset remains with lessor; rent expense)
• US GAAP: requires linking depreciation with liability reduction annually (depreciation equals reduction in liability).

Sales-type lease:

• Lessors are manufacturers/dealers
• Treated like financial lease plus:
  • recognize PV of rentals as revenue at the initial sale.

B. Pension plans

• Two types:
  • Defined contribution:
    • employer contributes, employee manages investment decisions
  • Defined benefit:
    • employer manages investments and bears retirement payment obligation
• Defined benefit creates:
  • Liability = Projected Benefit Obligation (PBO)
  • Asset = plan investments = plan assets
• Income statement components (as described):
  • service cost (increase in liability with more service)
  • retrospective changes (past service cost)
  • interest income/expense
• OCI (IFRS):
  • actuarial gains/losses
• US GAAP exception described:
  • past service cost treatment differs (treated in OCI under US GAAP in the instructor’s summary).

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6) How other FSA chapters are “applications” (ratio analysis & cash flow)

• For revision, the instructor says:
  • cash flow statement and ratio analysis are not revised deeply via mind maps
  • they become easy only if the student is comfortable with the rest of FSA, because questions connect back to inventory/assets/taxes etc.
• Cash flow statement (indirect method) notes are sufficient.
• Ratios: notes are formula summaries.

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7) Income statement, EPS, and balance sheet mind maps (presentation focus)

A. Income statement (structure)

• Starts with:
  • Revenue from operations and other sources
• Expenses:
  • cost of goods sold, depreciation, employee expenses, other expenses
• Compute:
  • Income from continuing operations
• Then adjustments:
  • discontinued operations (operations no longer supported, but still producing warranty/obligation-related income/expense)
  • exceptional items (unusual and/or infrequent items)
• Then:
  • pre-tax income
  • subtract tax expense (current + deferred) to get net income
• Dividends reduce equity; remaining portion transfers to retained earnings.

B. Earnings per share (EPS)

1. Basic EPS
   • EPS = earnings attributable to common shareholders / weighted average shares
   • Weighted average rules:
     • New issue or repurchase: weight based on the transaction date
     • Bonus issue/reverse split: weight based on the date of the original shares
2. Diluted EPS
   • Based on potential securities that might convert to common shares.
   • Purpose: avoid panic since conversion could lower EPS.
   • Dilutive vs anti-dilutive securities:
     • Dilutive reduces EPS on conversion
     • Anti-dilutive increases EPS on conversion
   • Diluted EPS computed by combining effects of all dilutive securities (exam complexity typically up to two).
   • Method depends on security type.