© CFA Institute. For candidate use only. Not for distribution.

FINANCIAL
STATEMENT
ANALYSIS AND
CORPORATE
ISSUERS

CFAđ Program Curriculum
2022 ã LEVEL I ã VOLUME 3


© CFA Institute. For candidate use only. Not for distribution.

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ISBN 978-1-950157-44-0 (paper)
ISBN 978-1-950157-68-6 (ebk)
10 9 8 7 6 5 4 3 2 1


© CFA Institute. For candidate use only. Not for distribution.

CONTENTS
How to Use the CFA Program Curriculum  
Background on the CBOK  
Organization of the Curriculum  
Features of the Curriculum  
Designing Your Personal Study Program  
CFA Institute Learning Ecosystem (LES)  
Prep Providers  
Feedback  

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Financial Statement Analysis
Study Session 6


Financial Statement Analysis (2)  

Reading 17

Understanding Income Statements  
Introduction  
Components and Format of the Income Statement  
Revenue Recognition  
General Principles  
Accounting Standards for Revenue Recognition   
Expense Recognition: General Principles  
General Principles  
Issues in Expense Recognition: Doubtful Accounts, Warranties  
Doubtful Accounts  
Warranties  
Issues in Expense Recognition: Depreciation and Amortization  
Implications for Financial Analysts: Expense Recognition  
Non-­Recurring Items and Non-­Operating Items: Discontinued Operations
and Unusual or Infrequent items  
Discontinued Operations  
Unusual or Infrequent Items  
Non-­Recurring Items: Changes in Accounting Policy  
Non-­
Operating Items  
Earnings Per Share and Capital Structure and Basic EPS  
Simple versus Complex Capital Structure  
Basic EPS  
Diluted EPS: the If-­Converted Method  
Diluted EPS When a Company Has Convertible Preferred Stock
Outstanding  

Diluted EPS When a Company Has Convertible Debt Outstanding  
Diluted EPS: the Treasury Stock Method  
Other Issues with Diluted EPS and Changes in EPS  
Changes in EPS  
Common-­Size Analysis of the Income Statement  
Common-­Size Analysis of the Income Statement  
Income Statement Ratios  
indicates an optional segment

3
5
6
6
12
13
14
18
18
22
22
22
23
27
28
28
29
30
33
34
35

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37
38
39
40
43
44
44
45
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© CFA Institute. For candidate use only. Not for distribution.

Comprehensive Income  
Summary  
Practice Problems  
Solutions  

Contents

49
52
55
60

Reading 18


Understanding Balance Sheets  
63
Introduction and Components of the Balance Sheet  
64
Components and Format of the Balance Sheet  
64
Balance Sheet Components  
65
Current and Non-­Current Classification  
67
Liquidity-­
Based Presentation  
68
Current Assets: Cash and Cash Equivalents, Marketable Securities and
Trade Receivables  
69
Current Assets  
69
Current Assets: Inventories and Other Current Assets  
74
Other Current Assets  
74
Current liabilities  
75
Non-­Current Assets: Property, Plant and Equipment and Investment Property  79
Property, Plant, and Equipment  
80
Investment Property  
81
Non-­Current Assets: Intangible Assets  

81
Identifiable Intangibles  
82
Non-­Current Assets: Goodwill  
84
Non-­Current Assets: Financial Assets  
87
Non-­Current Assets: Deferred Tax Assets  
91
Non-­
Current Liabilities  
91
Long-­term Financial Liabilities  
93
Deferred Tax Liabilities  
93
Components of Equity  
94
Components of Equity  
94
Statement of Changes in Equity  
97
Common Size Analysis of Balance Sheet  
98
Common-­Size Analysis of the Balance Sheet  
98
Balance Sheet Ratios  
106
Summary  
108

Practice Problems  
111
Solutions  
116

Reading 19

Understanding Cash Flow Statements  
Introduction  
Classification Of Cash Flows and Non-­Cash Activities  
Classification of Cash Flows and Non-­Cash Activities  

indicates an optional segment

119
120
121
121


Contents

Reading 20

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iii

Cash Flow Statement: Differences Between IFRS and US GAAP  
Cash Flow Statement: Direct and Indirect Methods for Reporting Cash

Flow from Operating Activities  
Cash Flow Statement: Indirect Method Under IFRS  
Cash Flow Statement: Direct Method Under IFRS  
Cash Flow Statement: Direct Method Under US GAAP  
Cash Flow Statement: Indirect Method Under US GAAP  
Linkages of Cash Flow Statement with the Income Statement and Balance
Sheet  
Linkages of the Cash Flow Statement with the Income Statement
and Balance Sheet  
Preparing the Cash Flow Statement: The Direct Method for Operating
Activities  
Operating Activities: Direct Method  
Preparing the Cash Flow Statement: Investing Activities  
Preparing the Cash Flow Statement: Financing Activities  
Long-­Term Debt and Common Stock  
Dividends  
Preparing the Cash Flow Statement: Overall Statement of Cash Flows
Under the Direct Method  
Preparing the Cash Flow Statement: Overall Statement of Cash Flows
Under the Indirect Method  
Conversion of Cash Flows from the Indirect to Direct Method  
Cash Flow Statement Analysis: Evaluation of Sources and Uses of Cash  
Evaluation of the Sources and Uses of Cash  
Cash Flow Statement Analysis: Common Size Analysis  
Cash Flow Statement Analysis: Free Cash Flow to Firm and Free Cash Flow
to Equity  
Cash Flow Statement Analysis: Cash Flow Ratios  
Summary  
Practice Problems  
Solutions  


123

Financial Analysis Techniques  
Introduction  
The Financial Analysis Process  
Analytical Tools and Techniques  
Financial Ratio Analysis  
The Universe of Ratios  
Value, Purposes, and Limitations of Ratio Analysis  
Sources of Ratios  
Common Size Balance Sheets and Income Statements  
Common-­Size Analysis of the Balance Sheet  
Common-­Size Analysis of the Income Statement  
Cross-­Sectional, Trend Analysis & Relationships in Financial Statements  
Trend Analysis  
Relationships among Financial Statements  
The Use of Graphs and Regression Analysis  
Regression Analysis  

175
176
177
181
183
184
186
187
188
189

189
191
192
194
195
197

indicates an optional segment

125
126
129
131
133
135
135
137
138
142
144
144
145
145
146
149
150
150
155
160
162

164
165
171


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© CFA Institute. For candidate use only. Not for distribution.

Contents

Common Ratio Categories & Interpretation and Context  
Interpretation and Context  
Activity Ratios  
Calculation of Activity Ratios  
Interpretation of Activity Ratios  
Liquidity Ratios  
Calculation of Liquidity Ratios  
Interpretation of Liquidity Ratios  
Solvency Ratios  
Calculation of Solvency Ratios  
Interpretation of Solvency Ratios  
Profitability Ratios  
Calculation of Profitability Ratios  
Interpretation of Profitability Ratios  
Integrated Financial Ratio Analysis  
The Overall Ratio Picture: Examples  
DuPont Analysis: The Decomposition of ROE  
Equity Analysis and Valuation Ratios  
Valuation Ratios  

Industry-­Specific Financial Ratios  
Research on Financial Ratios in Credit and Equity Analysis  
Credit Analysis  
The Credit Rating Process  
Historical Research on Ratios in Credit Analysis  
Business and Geographic Segments  
Segment Reporting Requirements  
Segment Ratios  
Model Building and Forecasting  
Summary  
Practice Problems  
Solutions  

197
198
199
199
201
205
206
207
210
211
212
215
215
216
218
219
221

226
226
229
231
232
233
234
234
235
236
238
239
241
247

Study Session 7

Financial Statement Analysis (3)  

251

Reading 21

Inventories  
Introduction  
Cost of inventories  
Inventory valuation methods  
Specific Identification  
First-­In, First-­Out (FIFO)  
Weighted Average Cost  

Last-­In, First-­Out (LIFO)  
Calculations of cost of sales, gross profit, and ending inventory  
Periodic versus perpetual inventory systems  
Comparison of inventory valuation methods  
The LIFO method and LIFO reserve  
LIFO Reserve  

253
254
255
256
257
257
258
258
258
260
263
265
266

indicates an optional segment


Contents

© CFA Institute. For candidate use only. Not for distribution.

LIFO liquidations  
Inventory method changes  

Inventory adjustments  
Evaluation of inventory management: Disclosures & ratios  
Presentation and Disclosure  
Inventory Ratios  
Illustrations of inventory analysis: Adjusting LIFO to FIFO  
Illustrations of inventory analysis: Impacts of writedowns  
Summary  
Practice Problems  
Solutions  
Reading 22

v

266
274
275
282
282
283
284
288
294
297
313

Long-­Lived Assets  
321
Introduction & Acquisition of Property, Plant and Equipment  
322
Introduction  

322
Acquisition of Long-­Lived Assets  
323
Property, Plant, and Equipment  
323
Acquisition of Intangible Assets  
326
Intangible Assets Purchased in Situations Other Than Business
Combinations  
326
Intangible Assets Developed Internally  
327
Intangible Assets Acquired in a Business Combination  
328
Capitalization versus Expensing: Impact on Financial Statements and Ratios  330
Capitalisation of Interest Costs  
335
Capitalisation of Interest and Internal Development Costs  
338
Depreciation of Long-­Lived Assets: Methods and Calculation  
342
Depreciation Methods and Calculation of Depreciation Expense  
343
Amortisation of Long-­Lived Assets: Methods and Calculation  
351
The Revaluation Model  
352
Impairment of Assets  
356
Impairment of Property, Plant, and Equipment  

357
Impairment of Intangible Assets with a Finite Life  
359
Impairment of Intangibles with Indefinite Lives  
359
Impairment of Long-­Lived Assets Held for Sale  
359
Reversals of Impairments of Long-­Lived Assets  
360
Derecognition  
360
Sale of Long-­Lived Assets  
360
Long-­Lived Assets Disposed of Other Than by a Sale  
361
Presentation and Disclosure Requirements  
363
Using Disclosures in Analysis  
370
Investment Property  
374
Summary  
377
Practice Problems  
380
Solutions  
392

indicates an optional segment



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Reading 23

Reading 24

© CFA Institute. For candidate use only. Not for distribution.

Contents

Income Taxes  
Introduction  
Differences Between Accounting Profit and Taxable Income  
Current and Deferred Tax Assets and Liabilities  
Deferred Tax Assets and Liabilities  
Determining the Tax Base of Assets and Liabilities  
Determining the Tax Base of an Asset  
Determining the Tax Base of a Liability  
Changes in Income Tax Rates  
Temporary and Permanent Differences Between Taxable and Accounting
Profit  
Taxable Temporary Differences  
Deductible Temporary Differences  
Examples of Taxable and Deductible Temporary Differences  
Exceptions to the Usual Rules for Temporary Differences  
Business Combinations and Deferred Taxes  
Investments in Subsidiaries, Branches, Associates and Interests in
Joint Ventures  
Unused Tax Losses and Tax Credits  

Recognition and Measurement of Current and Deferred Tax  
Recognition of a Valuation Allowance  
Recognition of Current and Deferred Tax Charged Directly to Equity  
Presentation and Disclosure  
Comparison of IFRS and US GAAP  
Summary  
Practice Problems  
Solutions  

397
398
398
399
400
403
404
405
407
408
409
410
410
412
413
413
413
414
415
415
418

424
426
428
433

Non-­Current (Long-­Term) Liabilities  
435
Introduction  
436
Bonds Payable & Accounting for Bond Issuance  
436
Accounting for Bond Issuance  
436
Accounting for Bond Amortisation, Interest Expense, and Interest Payments  440
Accounting for Bonds at Fair Value  
445
Derecognition of Debt  
448
Debt Covenants  
451
Presentation and Disclosure of Long-­Term Debt  
453
Leases  
456
Examples of Leases  
457
Advantages of Leasing  
457
Lease Classification as Finance or Operating  
457

Financial Reporting of Leases  
459
Lessee Accounting—IFRS  
459
Lessee Accounting—US GAAP  
461
Lessor Accounting  
463
Introduction to Pensions and Other Post-­Employment Benefits  
465
Evaluating Solvency: Leverage and Coverage Ratios  
469

indicates an optional segment


Contents

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vii

Summary  
Practice Problems  
Solutions  

472
475
480


Study Session 8

Financial Statement Analysis (4)  

487

Reading 25

Financial Reporting Quality  
Introduction & Conceptual Overview  
Conceptual Overview  
GAAP, Decision Useful Financial Reporting  
GAAP, Decision-­Useful, but Sustainable?  
Biased Accounting Choices  
Within GAAP, but “Earnings Management”  
Departures from GAAP  
Differentiate between Conservative and Aggressive Accounting  
Conservatism in Accounting Standards  
Bias in the Application of Accounting Standards  
Context for Assessing Financial Reporting Quality: Motivations and
Conditions Conducive to Issuing Low Quality Financial Reports  
Motivations  
Conditions Conducive to Issuing Low-­Quality Financial Reports  
Mechanisms That Discipline Financial Reporting Quality  
Market Regulatory Authorities  
Auditors  
Private Contracting  
Detection of Financial Reporting Quality Issues: Introduction &
Presentation Choices  
Presentation Choices  

Accounting Choices and Estimates and How Accounting Choices and
Estimates Affect Earnings and Balance Sheets  
How Accounting Choices and Estimates Affect Earnings and Balance
Sheets  
How Choices that Affect the Cash Flow Statement  
Choices that Affect Financial Reporting  
Warning Signs  
1) Pay attention to revenue.   
2) Pay attention to signals from inventories.  
3) Pay attention to capitalization policies and deferred costs.  
4) Pay attention to the relationship of cash flow and net income.  
5) Other potential warnings signs.  
Summary  
Practice Problems  
Solutions  

489
490
491
492
493
494
503
503
505
506
507

Applications of Financial Statement Analysis  
Introduction & Evaluating Past Financial Performance  

Application: Evaluating Past Financial Performance  

561
562
563

Reading 26

indicates an optional segment

508
509
509
510
510
512
516
518
519
525
526
537
540
544
544
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546
546
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549

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© CFA Institute. For candidate use only. Not for distribution.

Application: Projecting Future Financial Performance as an Input to
Market Based Valuation  
Projecting Performance: An Input to Market-­Based Valuation  
Projecting Multiple-­Period Performance  
Application: Assessing Credit Risk  
Screening for Potential Equity Investments  
Framework for Analyst Adjustments & Adjustments to Investments &
Adjustments to Inventory  
A Framework for Analyst Adjustments  
Analyst Adjustments Related to Investments  
Analyst Adjustments Related to Inventory  
Adjustments Related to Property, Plant, and Equipment  
Adjustments Related to Goodwill  
Summary  
Practice Problems  
Solutions  

Contents

566
567
572

576
578
581
582
582
582
586
588
590
592
594

Corporate Issuers
Study Session 9

Corporate Issuers (1)  

Reading 27

Introduction to Corporate Governance and Other ESG Considerations   599
Introduction and Overview of Corporate Governance  
600
Corporate Governance Overview  
600
Stakeholder Groups  
602
Stakeholder Groups  
602
Principal–Agent and Other Relationships in Corporate Governance  
605

Shareholder and Manager/Director Relationships  
606
Controlling and Minority Shareholder Relationships  
606
Manager and Board Relationships  
607
Shareholder versus Creditor Interests  
607
Other Stakeholder Conflicts  
608
Overview and Mechanisms of Stakeholder Management  
608
Overview of Stakeholder Management  
609
Mechanisms of Stakeholder Management  
609
Mechanisms to Mitigate Associated Stakeholder Risks  
613
Employee Laws and Contracts  
614
Contractual Agreements with Customers and Suppliers  
615
Laws and Regulations  
615
Company Boards and Committees  
615
Composition of the Board of Directors  
616
Functions and Responsibilities of the Board  
617

Board of Directors Committees  
617
Relevant Factors in Analyzing Corporate Governance and Stakeholder
Management  
620
Market Factors  
620
Non-­
Market Factors  
622
Risks and Benefits of Corporate Governance and Stakeholder Management  623
Risks of Poor Governance and Stakeholder Management  
623
indicates an optional segment

597


Contents

© CFA Institute. For candidate use only. Not for distribution.

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Benefits of Effective Governance and Stakeholder Management  
Factors Relevant to Corporate Governance and Stakeholder Management
Analysis  
Economic Ownership and Voting Control  
Board of Directors Representation  
Remuneration and Company Performance  

Investors in the Company  
Strength of Shareholders’ Rights  
Managing Long-­Term Risks  
Summary of Analyst Considerations  
ESG Considerations for Investors and Analysts  
Introduction to Environmental, Social, and Governance issues  
ESG Investment Strategies  
ESG Investment Approaches  
Catalysts for Growth in ESG Investing  
ESG Market Overview  
ESG Factors in Investment Analysis  
Summary  
Practice Problems  
Solutions  

625

Reading 28

Uses of Capital  
Introduction  
The Capital Allocation Process  
Investment Decision Criteria  
Net Present Value  
Internal Rate of Return  
Corporate Usage of Capital Allocation Methods  
Real Options  
Timing Options  
Sizing Options  
Flexibility Options  

Fundamental Options  
Common Capital Allocation Pitfalls  
Summary  
Practice Problems  
Solutions  

645
645
646
651
651
652
654
656
657
657
657
658
659
660
662
666

Reading 29

Sources of Capital  
Introduction  
Corporate Financing Options  
Internal Financing  
Financial Intermediaries   

Capital Markets  
Other Financing  
Considerations Affecting Financing Choices  
Managing and Measuring Liquidity  
Defining Liquidity Management  
Measuring Liquidity  

669
669
670
671
672
673
676
676
680
681
684

indicates an optional segment

626
627
627
628
629
629
630
630
632

632
633
634
636
637
638
640
642
644


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© CFA Institute. For candidate use only. Not for distribution.

Evaluating Short-­Term Financing Choices  
Summary  
Practice Problems  
Solutions  

Contents

688
691
692
695

GlossaryG-1

indicates an optional segment



© CFA Institute. For candidate use only. Not for distribution.

How to Use the CFA
Program Curriculum
Congratulations on your decision to enter the Chartered Financial Analyst (CFA®)

Program. This exciting and rewarding program of study reflects your desire to become
a serious investment professional. You are embarking on a program noted for its high
ethical standards and the breadth of knowledge, skills, and abilities (competencies) it
develops. Your commitment should be educationally and professionally rewarding.
The credential you seek is respected around the world as a mark of accomplishment and dedication. Each level of the program represents a distinct achievement in
professional development. Successful completion of the program is rewarded with
membership in a prestigious global community of investment professionals. CFA
charterholders are dedicated to life-­long learning and maintaining currency with
the ever-­changing dynamics of a challenging profession. CFA Program enrollment
represents the first step toward a career-­long commitment to professional education.
The CFA exam measures your mastery of the core knowledge, skills, and abilities
required to succeed as an investment professional. These core competencies are the
basis for the Candidate Body of Knowledge (CBOK™). The CBOK consists of four
components:
■■

A broad outline that lists the major CFA Program topic areas (www.cfainstitute.
org/programs/cfa/curriculum/cbok);

■■

Topic area weights that indicate the relative exam weightings of the top-­level

topic areas (www.cfainstitute.org/programs/cfa/curriculum);

■■

Learning outcome statements (LOS) that advise candidates about the specific
knowledge, skills, and abilities they should acquire from readings covering a
topic area (LOS are provided in candidate study sessions and at the beginning
of each reading); and

■■

CFA Program curriculum that candidates receive upon exam registration.

Therefore, the key to your success on the CFA exams is studying and understanding
the CBOK. The following sections provide background on the CBOK, the organization of the curriculum, features of the curriculum, and tips for designing an effective
personal study program.

BACKGROUND ON THE CBOK
CFA Program is grounded in the practice of the investment profession. CFA Institute
performs a continuous practice analysis with investment professionals around the
world to determine the competencies that are relevant to the profession, beginning
with the Global Body of Investment Knowledge (GBIK®). Regional expert panels and
targeted surveys are conducted annually to verify and reinforce the continuous feedback about the GBIK. The practice analysis process ultimately defines the CBOK. The
CBOK reflects the competencies that are generally accepted and applied by investment
professionals. These competencies are used in practice in a generalist context and are
expected to be demonstrated by a recently qualified CFA charterholder.

© 2021 CFA Institute. All rights reserved.

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© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

The CFA Institute staff—in conjunction with the Education Advisory Committee
and Curriculum Level Advisors, who consist of practicing CFA charterholders—designs
the CFA Program curriculum in order to deliver the CBOK to candidates. The exams,
also written by CFA charterholders, are designed to allow you to demonstrate your
mastery of the CBOK as set forth in the CFA Program curriculum. As you structure
your personal study program, you should emphasize mastery of the CBOK and the
practical application of that knowledge. For more information on the practice analysis, CBOK, and development of the CFA Program curriculum, please visit www.
cfainstitute.org.

ORGANIZATION OF THE CURRICULUM
The Level I CFA Program curriculum is organized into 10 topic areas. Each topic area
begins with a brief statement of the material and the depth of knowledge expected.
It is then divided into one or more study sessions. These study sessions should form
the basic structure of your reading and preparation. Each study session includes a
statement of its structure and objective and is further divided into assigned readings.
An outline illustrating the organization of these study sessions can be found at the
front of each volume of the curriculum.
The readings are commissioned by CFA Institute and written by content experts,
including investment professionals and university professors. Each reading includes
LOS and the core material to be studied, often a combination of text, exhibits, and in-­
text examples and questions. End of Reading Questions (EORQs) followed by solutions
help you understand and master the material. The LOS indicate what you should be
able to accomplish after studying the material. The LOS, the core material, and the

EORQs are dependent on each other, with the core material and EORQs providing
context for understanding the scope of the LOS and enabling you to apply a principle
or concept in a variety of scenarios.
The entire readings, including the EORQs, are the basis for all exam questions
and are selected or developed specifically to teach the knowledge, skills, and abilities
reflected in the CBOK.
You should use the LOS to guide and focus your study because each exam question
is based on one or more LOS and the core material and practice problems associated
with the LOS. As a candidate, you are responsible for the entirety of the required
material in a study session.
We encourage you to review the information about the LOS on our website (www.
cfainstitute.org/programs/cfa/curriculum/study-­sessions), including the descriptions
of LOS “command words” on the candidate resources page at www.cfainstitute.org.

FEATURES OF THE CURRICULUM
End of Reading Questions/Solutions  All End of Reading Questions (EORQs) as well
as their solutions are part of the curriculum and are required material for the exam.
In addition to the in-­text examples and questions, these EORQs help demonstrate
practical applications and reinforce your understanding of the concepts presented.
Some of these EORQs are adapted from past CFA exams and/or may serve as a basis
for exam questions.


© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

Glossary   For your convenience, each volume includes a comprehensive Glossary.
Throughout the curriculum, a bolded word in a reading denotes a term defined in
the Glossary.
Note that the digital curriculum that is included in your exam registration fee is

searchable for key words, including Glossary terms.
LOS Self-­Check  We have inserted checkboxes next to each LOS that you can use to
track your progress in mastering the concepts in each reading.
Source Material  The CFA Institute curriculum cites textbooks, journal articles, and
other publications that provide additional context or information about topics covered
in the readings. As a candidate, you are not responsible for familiarity with the original
source materials cited in the curriculum.
Note that some readings may contain a web address or URL. The referenced sites
were live at the time the reading was written or updated but may have been deactivated since then.
 
Some readings in the curriculum cite articles published in the Financial Analysts Journal®,
which is the flagship publication of CFA Institute. Since its launch in 1945, the Financial
Analysts Journal has established itself as the leading practitioner-­oriented journal in the
investment management community. Over the years, it has advanced the knowledge and
understanding of the practice of investment management through the publication of
peer-­reviewed practitioner-­relevant research from leading academics and practitioners.
It has also featured thought-­provoking opinion pieces that advance the common level of
discourse within the investment management profession. Some of the most influential
research in the area of investment management has appeared in the pages of the Financial
Analysts Journal, and several Nobel laureates have contributed articles.
Candidates are not responsible for familiarity with Financial Analysts Journal articles
that are cited in the curriculum. But, as your time and studies allow, we strongly encourage you to begin supplementing your understanding of key investment management
issues by reading this, and other, CFA Institute practice-­oriented publications through
the Research & Analysis webpage (www.cfainstitute.org/en/research).

Errata  The curriculum development process is rigorous and includes multiple rounds
of reviews by content experts. Despite our efforts to produce a curriculum that is free
of errors, there are times when we must make corrections. Curriculum errata are periodically updated and posted by exam level and test date online (www.cfainstitute.org/
en/programs/submit-­errata). If you believe you have found an error in the curriculum,
you can submit your concerns through our curriculum errata reporting process found

at the bottom of the Curriculum Errata webpage.

DESIGNING YOUR PERSONAL STUDY PROGRAM
Create a Schedule  An orderly, systematic approach to exam preparation is critical.
You should dedicate a consistent block of time every week to reading and studying.
Complete all assigned readings and the associated problems and solutions in each study
session. Review the LOS both before and after you study each reading to ensure that

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How to Use the CFA Program Curriculum

you have mastered the applicable content and can demonstrate the knowledge, skills,
and abilities described by the LOS and the assigned reading. Use the LOS self-­check
to track your progress and highlight areas of weakness for later review.
Successful candidates report an average of more than 300 hours preparing for each
exam. Your preparation time will vary based on your prior education and experience,
and you will probably spend more time on some study sessions than on others.
You should allow ample time for both in-­depth study of all topic areas and additional concentration on those topic areas for which you feel the least prepared.

CFA INSTITUTE LEARNING ECOSYSTEM (LES)
As you prepare for your exam, we will email you important exam updates, testing
policies, and study tips. Be sure to read these carefully.
Your exam registration fee includes access to the CFA Program Learning Ecosystem
(LES). This digital learning platform provides access, even offline, to all of the readings
and End of Reading Questions found in the print curriculum organized as a series of

shorter online lessons with associated EORQs. This tool is your one-­stop location for
all study materials, including practice questions and mock exams.
The LES provides the following supplemental study tools:
Structured and Adaptive Study Plans  The LES offers two ways to plan your study
through the curriculum. The first is a structured plan that allows you to move through
the material in the way that you feel best suits your learning. The second is an adaptive
study plan based on the results of an assessment test that uses actual practice questions.
Regardless of your chosen study path, the LES tracks your level of proficiency in
each topic area and presents you with a dashboard of where you stand in terms of
proficiency so that you can allocate your study time efficiently.
Flashcards and Game Center  The LES offers all the Glossary terms as Flashcards and
tracks correct and incorrect answers. Flashcards can be filtered both by curriculum
topic area and by action taken—for example, answered correctly, unanswered, and so
on. These Flashcards provide a flexible way to study Glossary item definitions.
The Game Center provides several engaging ways to interact with the Flashcards in
a game context. Each game tests your knowledge of the Glossary terms a in different
way. Your results are scored and presented, along with a summary of candidates with
high scores on the game, on your Dashboard.
Discussion Board  The Discussion Board within the LES provides a way for you to
interact with other candidates as you pursue your study plan. Discussions can happen
at the level of individual lessons to raise questions about material in those lessons that
you or other candidates can clarify or comment on. Discussions can also be posted at
the level of topics or in the initial Welcome section to connect with other candidates
in your area.
Practice Question Bank  The LES offers access to a question bank of hundreds of
practice questions that are in addition to the End of Reading Questions. These practice
questions, only available on the LES, are intended to help you assess your mastery of
individual topic areas as you progress through your studies. After each practice question, you will receive immediate feedback noting the correct response and indicating
the relevant assigned reading so you can identify areas of weakness for further study.



© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

Mock Exams  The LES also includes access to three-­hour Mock Exams that simulate
the morning and afternoon sessions of the actual CFA exam. These Mock Exams are
intended to be taken after you complete your study of the full curriculum and take
practice questions so you can test your understanding of the curriculum and your
readiness for the exam. If you take these Mock Exams within the LES, you will receive
feedback afterward that notes the correct responses and indicates the relevant assigned
readings so you can assess areas of weakness for further study. We recommend that
you take Mock Exams during the final stages of your preparation for the actual CFA
exam. For more information on the Mock Exams, please visit www.cfainstitute.org.

PREP PROVIDERS
You may choose to seek study support outside CFA Institute in the form of exam prep
providers. After your CFA Program enrollment, you may receive numerous solicitations for exam prep courses and review materials. When considering a prep course,
make sure the provider is committed to following the CFA Institute guidelines and
high standards in its offerings.
Remember, however, that there are no shortcuts to success on the CFA exams;
reading and studying the CFA Program curriculum is the key to success on the exam.
The CFA Program exams reference only the CFA Institute assigned curriculum; no
prep course or review course materials are consulted or referenced.
SUMMARY
Every question on the CFA exam is based on the content contained in the required
readings and on one or more LOS. Frequently, an exam question is based on a specific
example highlighted within a reading or on a specific practice problem and its solution.
To make effective use of the CFA Program curriculum, please remember these key points:

1 All pages of the curriculum are required reading for the exam.

2 All questions, problems, and their solutions are part of the curriculum and are

required study material for the exam. These questions are found at the end of the
readings in the print versions of the curriculum. In the LES, these questions appear
directly after the lesson with which they are associated. The LES provides immediate feedback on your answers and tracks your performance on these questions
throughout your study.

3 We strongly encourage you to use the CFA Program Learning Ecosystem. In

addition to providing access to all the curriculum material, including EORQs, in
the form of shorter, focused lessons, the LES offers structured and adaptive study
planning, a Discussion Board to communicate with other candidates, Flashcards,
a Game Center for study activities, a test bank of practice questions, and online
Mock Exams. Other supplemental study tools, such as eBook and PDF versions
of the print curriculum, and additional candidate resources are available at www.
cfainstitute.org.

4 Using the study planner, create a schedule and commit sufficient study time to
cover the study sessions. You should also plan to review the materials, answer
practice questions, and take Mock Exams.

5 Some of the concepts in the study sessions may be superseded by updated

rulings and/or pronouncements issued after a reading was published. Candidates
are expected to be familiar with the overall analytical framework contained in the
assigned readings. Candidates are not responsible for changes that occur after the
material was written.

xv



xvi

© CFA Institute. For candidate use only. Not for distribution.
How to Use the CFA Program Curriculum

FEEDBACK
At CFA Institute, we are committed to delivering a comprehensive and rigorous curriculum for the development of competent, ethically grounded investment professionals.
We rely on candidate and investment professional comments and feedback as we
work to improve the curriculum, supplemental study tools, and candidate resources.
Please send any comments or feedback to You can be assured
that we will review your suggestions carefully. Ongoing improvements in the curriculum will help you prepare for success on the upcoming exams and for a lifetime of
learning as a serious investment professional.


© CFA Institute. For candidate use only. Not for distribution.

Financial Statement
Analysis

STUDY SESSIONS
Study Session 5
Study Session 6
Study Session 7
Study Session 8

Financial Statement Analysis (1)
Financial Statement Analysis (2)
Financial Statement Analysis (3)
Financial Statement Analysis (4)


TOPIC LEVEL LEARNING OUTCOME
The candidate should be able to demonstrate a thorough knowledge of financial
reporting procedures and the standards that govern financial reporting disclosure.
Emphasis is on basic financial statements and how alternative accounting methods
affect those statements and the analysis of them.
Financial statement analysis is critical in assessing a company’s overall financial
position and associated risks over time. Security and business valuation, credit risk
assessment, and acquisition due diligence all require an understanding of the major
financial statements including general principles and reporting approaches. Because
no set of accounting standards has universal acceptance, companies around the world
may differ in reporting treatment based on their jurisdiction.
Financial statement analysis requires the ability to analyze a company’s reported
results with its economic reality, normalize differences in accounting treatment to make
valid cross company comparisons, identify quality issues that may exist in reported
financial statements, and discern evidence of financial statement manipulation by
management.
© 2021 CFA Institute. All rights reserved.

Note: Changes in accounting
standards as well as new rulings
and/or pronouncements issued
after the publication of the
readings on financial reporting
and analysis may cause some
of the information in these
readings to become dated.
Candidates are not responsible
for anything that occurs after
the readings were published.

In addition, candidates are
expected to be familiar with the
analytical frameworks contained
in the readings, as well as the
implications of alternative
accounting methods for financial
analysis and valuation discussed
in the readings. Candidates are
also responsible for the content
of accounting standards, but not
for the actual reference numbers.
Finally, candidates should be
aware that certain ratios may
be defined and calculated
differently. When alternative
ratio definitions exist and no
specific definition is given,
candidates should use the ratio
definitions emphasized in the
readings.


2

© CFA Institute. For candidate use only. Not for distribution.
Financial Statement Analysis

Candidates should be familiar with the material covered in the following prerequisite reading available in Candidate Resources on the CFA Institute website:
• Financial Reporting Mechanics



© CFA Institute. For candidate use only. Not for distribution.

F inancial S tatement A nalysis

6

STUDY SESSION

Financial Statement Analysis (2)

This study session addresses the three major financial statements—the income

statement, the balance sheet, and the cash flow statement—by examining each in
turn. The purpose, elements of, construction, pertinent ratios, and common-­size
analysis are presented for each major financial statement. The session concludes with
a discussion of financial analysis techniques including the use of ratios to evaluate
corporate financial health.

READING ASSIGNMENTS
Reading 17

Understanding Income Statements
by Elaine Henry, PhD, CFA, and Thomas R.
Robinson, PhD, CFA

Reading 18

Understanding Balance Sheets
by Elaine Henry, PhD, CFA, and Thomas R.

Robinson, PhD, CFA

Reading 19

Understanding Cash Flow Statements
by Elaine Henry, PhD, CFA, Thomas R. Robinson, PhD, CFA,
J. Hennie van Greuning, DCom, CFA, and Michael A.
Broihahn, CPA, CIA, CFA

Reading 20

Financial Analysis Techniques
by Elaine Henry, PhD, CFA, Thomas R. Robinson, PhD, CFA,
and J. Hennie van Greuning, DCom, CFA

© 2021 CFA Institute. All rights reserved.

Note: Changes in accounting
standards as well as new rulings
and/or pronouncements issued
after the publication of the
readings on financial reporting
and analysis may cause some
of the information in these
readings to become dated.
Candidates are not responsible
for anything that occurs after
the readings were published.
In addition, candidates are
expected to be familiar with the

analytical frameworks contained
in the readings, as well as the
implications of alternative
accounting methods for financial
analysis and valuation discussed
in the readings. Candidates are
also responsible for the content
of accounting standards, but not
for the actual reference numbers.
Finally, candidates should be
aware that certain ratios may
be defined and calculated
differently. When alternative
ratio definitions exist and no
specific definition is given,
candidates should use the ratio
definitions emphasized in the
readings.


© CFA Institute. For candidate use only. Not for distribution.


© CFA Institute. For candidate use only. Not for distribution.

READING

17

Understanding Income Statements

by Elaine Henry, PhD, CFA, and Thomas R. Robinson, PhD, CFA
Elaine Henry, PhD, CFA, is at Stevens Institute of Technology (USA). Thomas R. Robinson,
PhD, CFA, is at AACSB International (USA).

LEARNING OUTCOMES
Mastery

The candidate should be able to:
a. describe the components of the income statement and alternative
presentation formats of that statement;

b. describe general principles of revenue recognition and accounting
standards for revenue recognition;
c. calculate revenue given information that might influence the
choice of revenue recognition method;

d. describe general principles of expense recognition, specific
expense recognition applications, and implications of expense
recognition choices for financial analysis;

e. describe the financial reporting treatment and analysis of non-­
recurring items (including discontinued operations, unusual or
infrequent items) and changes in accounting policies;

f. contrast operating and non-­operating components of the income
statement;
g. describe how earnings per share is calculated and calculate
and interpret a company’s earnings per share (both basic and
diluted earnings per share) for both simple and complex capital
structures;

h. contrast dilutive and antidilutive securities and describe the
implications of each for the earnings per share calculation;
i. formulate income statements into common-­size income
statements;

j. evaluate a company’s financial performance using common-­size
income statements and financial ratios based on the income
statement;
k. describe, calculate, and interpret comprehensive income;

l. describe other comprehensive income and identify major types of
items included in it.
© 2019 CFA Institute. All rights reserved.

Note: Changes in accounting
standards as well as new rulings
and/or pronouncements issued
after the publication of the
readings on financial reporting
and analysis may cause some
of the information in these
readings to become dated.
Candidates are not responsible
for anything that occurs after
the readings were published.
In addition, candidates are
expected to be familiar with the
analytical frameworks contained
in the readings, as well as the
implications of alternative

accounting methods for financial
analysis and valuation discussed
in the readings. Candidates are
also responsible for the content
of accounting standards, but not
for the actual reference numbers.
Finally, candidates should be
aware that certain ratios may
be defined and calculated
differently. When alternative
ratio definitions exist and no
specific definition is given,
candidates should use the ratio
definitions emphasized in the
readings.


© CFA Institute. For candidate use only. Not for distribution.
Reading 17 ■ Understanding Income Statements

6

1

2

INTRODUCTION
The income statement presents information on the financial results of a company’s
business activities over a period of time. The income statement communicates how
much revenue the company generated during a period and what costs it incurred in

connection with generating that revenue. The basic equation underlying the income
statement, ignoring gains and losses, is Revenue minus Expenses equals Net income.
The income statement is also sometimes referred to as the “statement of operations,”
“statement of earnings,” or “profit and loss (P&L) statement.” Under both International
Financial Reporting Standards (IFRS) and US generally accepted accounting principles
(US GAAP), the income statement may be presented as a separate statement followed
by a statement of comprehensive income that begins with the profit or loss from the
income statement or as a section of a single statement of comprehensive income.1 This
reading focuses on the income statement, and the term income statement will be used
to describe either the separate statement that reports profit or loss used for earnings
per share calculations or that section of a statement of comprehensive income that
reports the same profit or loss. The reading also includes a discussion of comprehensive
income (profit or loss from the income statement plus other comprehensive income).
Investment analysts intensely scrutinize companies’ income statements. Equity
analysts are interested in them because equity markets often reward relatively highor low-­earnings growth companies with above-­average or below-­average valuations,
respectively, and because inputs into valuation models often include estimates of
earnings. Fixed-­income analysts examine the components of income statements, past
and projected, for information on companies’ abilities to make promised payments on
their debt over the course of the business cycle. Corporate financial announcements
frequently emphasize information reported in income statements, particularly earnings, more than information reported in the other financial statements.
This reading is organized as follows: Section 2 describes the components of the
income statement and its format. Section 3 describes basic principles and selected
applications related to the recognition of revenue, and Sections 4–7 describe basic
principles and selected applications related to the recognition of expenses. Sections
8–10 cover non-­recurring items and non-­operating items. Sections 11–14 explain
the calculation of earnings per share. Sections 15–16 introduce income statement
analysis, and Section 17 explains comprehensive income and its reporting. A summary
of the key points and practice problems in the CFA Institute multiple choice format
complete the reading.


COMPONENTS AND FORMAT OF THE INCOME
STATEMENT
a describe the components of the income statement and alternative presentation
formats of that statement;

1  International Accounting Standard (IAS) 1, Presentation of Financial Statements, establishes the presentation and minimum content requirements of financial statements and guidelines for the structure of
financial statements under IFRS. Under US GAAP, the Financial Accounting Standards Board Accounting
Standards Codification ASC Section 220-­10-­45 [Comprehensive Income–Overall–Other Presentation
Matters] discusses acceptable formats in which to present income, other comprehensive income, and
comprehensive income.


© CFA Institute. For candidate use only. Not for distribution.
Components and Format of the Income Statement

7

Exhibits 1, 2, and 3 show the income statements for Anheuser-­Busch InBev SA/NV (AB
InBev), a multinational beverage company based in Belgium, Molson Coors Brewing
Company (Molson Coors), a US-­based multinational brewing company, and Groupe
Danone (Danone), a French food manufacturer.2 AB InBev and Danone report under
IFRS, and Molson Coors reports under US GAAP. Note that both AB InBev and Molson
Coors show three years’ income statements and list the years in chronological order
with the most recent year listed in the left-­most column. In contrast, Danone shows
two years of income statements and lists the years in chronological order from left
to right with the most recent year in the right-­most column. Different orderings of
chronological information are common.
On the top line of the income statement, companies typically report revenue.
Revenue generally refers to the amount charged for the delivery of goods or services
in the ordinary activities of a business. Revenue may also be called sales or turnover.3

For the year ended 31 December 2017, AB InBev reports $56.44 billion of revenue,
Molson Coors reports $13.47 billion of revenue (labeled “sales”), and Danone reports
€24.68 billion of revenue (labeled “sales”).
Revenue is reported after adjustments (e.g., for cash or volume discounts, or for
other reductions), and the term net revenue is sometimes used to specifically indicate
that the revenue has been adjusted (e.g., for estimated returns). For all three companies in Exhibits 1 through 3, footnotes to their financial statements (not shown here)
state that revenues are stated net of such items as returns, customer rebates, trade
discounts, or volume-­based incentive programs for customers.
In a comparative analysis, an analyst may need to reference information disclosed
elsewhere in companies’ annual reports—typically the notes to the financial statements
and the Management Discussion and Analysis (MD&A)—to identify the appropriately comparable revenue amounts. For example, excise taxes represent a significant
expenditure for brewing companies. On its income statement, Molson Coors reports
$13.47 billion of revenue (labeled “sales”) and $11.00 billion of net revenue (labeled “net
sales”), which equals sales minus $2.47 billion of excise taxes. Unlike Molson Coors, AB
InBev does not show the amount of excise taxes on its income statement. However, in
its disclosures, AB InBev notes that excise taxes (amounting to $15.4 billion in 2017)
have been deducted from the revenue amount shown on its income statement. Thus,
the amount on AB InBev’s income statement labeled “revenue” is more comparable
to the amount on Molson Coors’ income statement labeled “net sales.”
Exhibit 1  Anheuser-­Busch InBev SA/NV Consolidated Income Statement (in Millions of US Dollars)
[Excerpt]
12 Months Ended December 31
2017

2016

2015

Revenue


$56,444

$45,517

$43,604

Cost of sales

(21,386)

(17,803)

(17,137)

Gross profit

35,058

27,715

26,467

Distribution expenses

(5,876)

(4,543)

(4,259)


Sales and marketing expenses

(8,382)

(7,745)

(6,913)

(continued)
2  Following net income, the income statement also presents earnings per share, the amount of earnings
per common share of the company. Earnings per share will be discussed in detail later in this reading,
and the per-­share display has been omitted from these exhibits to focus on the core income statement.
3  Sales is sometimes understood to refer to the sale of goods, whereas revenue can include the sale of
goods or services; however, the terms are often used interchangeably. In some countries, the term “turnover” may be used in place of revenue.