2023 Curriculum CFA Program Level I Financial Reporting and Analysis
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. 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 high- or 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 Section 4 describes basic principles and selected applications related to the recognition of expenses. Section 5 covers non-recurring items and non-operating items. Section 6 explains the calculation of earnings per share. Section 7 introduces income statement analysis, and Section 8 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.
The member should be able to:
This reading has presented the elements of income statement analysis. The income statement presents information on the financial results of a company’s business activities over a period of time; it communicates how much revenue the company generated during a period and what costs it incurred in connection with generating that revenue. A company’s net income and its components (e.g., gross margin, operating earnings, and pretax earnings) are critical inputs into both the equity and credit analysis processes. Equity analysts are interested in earnings because equity markets often reward relatively high- or low-earnings growth companies with above-average or below-average valuations, respectively. 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 income statements more than the other financial statements.
Key points to this reading include the following:
What is the difference between an income statement and a balance sheet?
The income statement lays out the accounting period in the header, such as “...for the year ended Dec. 31, 2019.” Meanwhile, balance sheets cover a point in time, i.e. the end of the accounting period.
What is the importance of comparative financial statements?
These comparative statements also helps us to compare the financial performance of the company over number of years. This, in turn, helps to determine trends, accounting errors, and more. It helps in comparing individual line items in all the statements. Also, it helps in comparing the proportions of various items over multiple reporting periods.
Why is the accounting period useful in investing?
The accounting period is useful in investing because potential shareholders analyze a company’s performance through its financial statements that are based on a fixed accounting period.
What is the purpose of income statement in financial statements?
In addition to the balance sheet and cash flow statement, the income statement is also part of the financial statements prepared by all organizations. The purpose of an income statement is to provide financial information to investors, creditors, and readers, whether the company is profitable during the financial year.
Why is comparative income statement important?
A comparative income statement presents the results of multiple accounting periods in separate columns. The intent of this format is to allow the reader to compare the results of multiple historical periods, thereby giving a view of how a business is performing over time.
Why is it so important to compare a firm's financial statements with those of competitors?
A comparative analysis allows owners owners to compare their company's financial ratio information to that of a competing company. This provides information on a competing company's operational and financial performance.
Why is the time period covered in an income statement significant?
Income statements covering longer periods such as a year provide information about how business expenses and revenue balance out over time. For this reason, banks usually ask for longer-term statements, often requiring a series of annual documents showing business activity over multiple years.