Level 1 CFA® Exam:
Comparison of Financial Statements & Adjustments

Last updated: December 09, 2022

Investments

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When comparing two companies with substantial investments in their books, check whether they treat investments similarly. If one of the companies classified financial assets as measured at fair value through profit & loss and the other as measured at fair value through other comprehensive income, you might have to adjust numbers for one company, so that they are corresponding to each other. It is because:

  • for financial assets measured at fair value through profit & loss – the unrealized gains and losses are included in net income in the profit & loss statement,
  • for financial assets measured at fair value through other comprehensive income – the unrealized gains and losses go directly to equity omitting the profit & loss statement.
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Inventory & COGS

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The basic difference for inventory and COGS may occur when one company uses the LIFO method (allowed only under U.S. GAAP) and the other uses the FIFO method. Fortunately, U.S. GAAP requires that companies using the LIFO method present the so-called LIFO reserve. LIFO reserve can easily be used to adjust both inventory and COGS from LIFO to FIFO:

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COGS FIFO vs COGS LIFO
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\(COGS_{FIFO}=COGS_{LIFO}-\text{ increase in LIFO reserve}\)

  • \(COGS\) - cost of goods sold
  • \(LIFO\) - Last-In, First-Out
  • \(FIFO\) - First-In, First-Out

LIFO method is allowed under U.S. GAAP only (it is not permitted under IFRS).

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Inventory FIFO vs Inventory LIFO
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\(\text{inventory}_{FIFO}=\text{inventory}_{LIFO}+\text{ LIFO reserve}\)

  • \(LIFO\) - Last-In, First-Out
  • \(FIFO\) - First-In, First-Out

LIFO method is allowed under U.S. GAAP only (it is not permitted under IFRS).

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Net Income FIFO vs Net Income LIFO
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\(NI_{FIFO}=NI_{LIFO}+\text{ increase in LIFO reserve}\times{(1-T)}\)

  • \(NI\) - net income
  • \(LIFO\) - Last-In, First-Out
  • \(FIFO\) - First-In, First-Out
  • \(T\) - tax rate

LIFO method is allowed under U.S. GAAP only (it is not permitted under IFRS).

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Retained Earnings FIFO vs Retained Earnings LIFO
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\(RE_{FIFO}=RE_{LIFO}+\text{ LIFO reserve}\times{(1-T)}\)

  • \(RE\) - retained earnings
  • \(LIFO\) - Last-In, First-Out
  • \(FIFO\) - First-In, First-Out
  • \(T\) - tax rate

LIFO method is allowed under U.S. GAAP only (it is not permitted under IFRS).

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PP&E

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Differences between companies may arise from choices made by their managements and are related to:

  • method of depreciation (the straight-line method vs accelerated methods vs the units of production method),
  • estimation of salvage values and expected useful lives of the assets.

Note: Based on financial statements and information they provide, only general information about PP&E-related subjects can be deduced. It’s because the disclosure required by accounting standards is not very broad. However, even with only some basic data, we are still able to draw interesting conclusions.

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Level 1 CFA Exam Takeaways: Comparison of Financial Statements & Adjustments

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  1. When comparing two companies with substantial investments in their books, check whether they treat investments similarly.
  2. The basic difference for inventory and COGS may occur when one company uses the LIFO method (allowed only under U.S. GAAP) and the other uses the FIFO method.
  3. Differences between companies may arise from choices made by their managements and are related to: method of depreciation and estimation of salvage values and expected useful lives of the assets.
  4. Goodwill is not amortized but it should be tested for impairment at least annually.
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