- CFA Exams
- 2023 Level II
- Topic 3. Financial Statement Analysis
- Learning Module 15. Evaluating Quality of Financial Reports
- Subject 6. Balance Sheet Quality
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Subject 6. Balance Sheet Quality PDF Download
High financial reporting quality: completeness, unbiased measurement, and clear presentation.
High financial results quality: an optimal amount of leverage, adequate liquidity, and economically successful asset allocation.
A balance sheet with significant amounts of off-balance-sheet debt would lack the completeness aspect of financial reporting quality. Here are a couple of examples.
Off-balance-sheet (OBS) financing is an attempt to borrow money in such a way that liabilities are kept off a firm's balance sheet and the associated interest expense off its income statement. The classic example is leases. Generally lessees prefer leases to be classified as operating leases. They do not have to recognize the asset and loan on their balance sheet although they still receive all of the benefit of using the asset. Therefore operating leases result in higher profitability ratios and reduce reported leverage for lessees.
Business combinations are accomplished when one entity (investor) acquires "control" over the net assets of another entity. Any excess of cost over fair value of net assets acquired is recorded as goodwill. Goodwill is not amortized, but is tested annually for impairment. There is considerable discretion in conducting the impairment test. Analysts should look carefully at changes in reported goodwill.
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