CFA 2018 level 2 schweser notes book 2

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Getting Started Flyer
Table of Contents
Page List
Book 2: Financial Reporting and Analysis and Corporate Finance
Readings and Learning Outcome Statements
Intercorporate Investments
1. LOS 16.a: Describe the classification, measurement, and disclosure under
International Financial Reporting Standards (IFRS) for 1) investments in
financial assets, 2) investments in associates, 3) joint ventures, 4) business
combinations, and 5) special purpose and variable interest entities.
2. LOS 16.b: Distinguish between IFRS and US GAAP in the classification,
measurement, and disclosure of investments in financial assets,
investments in associates, joint ventures, business combinations, and
special purpose and variable interest entities.
3. LOS 16.c: Analyze how different methods used to account for
intercorporate investments affect financial statements and ratios.
4. Key Concepts
1. LOS 16.a
2. LOS 16.b
3. LOS 16.c
5. Concept Checkers

1. Answers – Concept Checkers
6. Challenge Problems
1. Answers – Challenge Problems
7. Employee Compensation: Post-Employment and Share-Based
1. LOS 17.a: Describe the types of post-employment benefit plans and
implications for financial reports.
2. LOS 17.b: Explain and calculate measures of a defined benefit pension
obligation (i.e., present value of the defined benefit obligation and
projected benefit obligation) and net pension liability (or asset).
3. LOS 17.c: Describe the components of a company’s defined benefit pension
costs.
4. LOS 17.d: Explain and calculate the effect of a defined benefit plan’s
assumptions on the defined benefit obligation and periodic pension cost.
5. LOS 17.e: Explain and calculate how adjusting for items of pension and
other post-employment benefits that are reported in the notes to the
financial statements affects financial statements and ratios.
6. LOS 17.f: Interpret pension plan note disclosures including cash flow
related information.
7. LOS 17.g: Explain issues associated with accounting for share-based


compensation.
8. LOS 17.h: Explain how accounting for stock grants and stock options affects
financial statements, and the importance of companies’ assumptions in
valuing these grants and options.
9. Key Concepts
1. LOS 17.a
2. LOS 17.b
3. LOS 17.c
4. LOS 17.d

5. LOS 17.e
6. LOS 17.f
7. LOS 17.g
8. LOS 17.h
10. Concept Checkers
1. Answers – Concept Checkers
11. Challenge Problems
1. Answers – Challenge Problems
8. Multinational Operations
1. LOS 18.a: Distinguish among presentation (reporting) currency, functional
currency, and local currency.
2. LOS 18.b: Describe foreign currency transaction exposure, including
accounting for and disclosures about foreign currency transaction gains
and losses.
3. LOS 18.c: Analyze how changes in exchange rates affect the translated sales
of the subsidiary and parent company.
4. LOS 18.d: Compare the current rate method and the temporal method,
evaluate how each affects the parent company’s balance sheet and income
statement, and determine which method is appropriate in various
scenarios.
5. LOS 18.e: Calculate the translation effects and evaluate the translation of a
subsidiary’s balance sheet and income statement into the parent
company’s presentation currency.
6. LOS 18.f: Analyze how the current rate method and the temporal method
affect financial statements and ratios.
7. LOS 18.g: Analyze how alternative translation methods for subsidiaries
operating in hyperinflationary economies affect financial statements and
ratios.
8. LOS 18.h: Describe how multinational operations affect a company’s
effective tax rate.

9. LOS 18.i: Explain how changes in the components of sales affect the
sustainability of sales growth.
10. LOS 18.j: Analyze how currency fluctuations potentially affect financial
results, given a company’s countries of operation.
11. Key Concepts


1. LOS 18.a
2. LOS 18.b
3. LOS 18.c
4. LOS 18.d
5. LOS 18.e
6. LOS 18.f
7. LOS 18.g
8. LOS 18.h
9. LOS 18.i
10. LOS 18.j
12. Concept Checkers
1. Answers – Concept Checkers
13. Challenge Problems
1. Answers – Challenge Problems
9. Evaluating Quality of Financial Reports
1. LOS 19.a: Demonstrate the use of a conceptual framework for assessing
the quality of a company’s financial reports.
2. LOS 19.b: Explain potential problems that affect the quality of financial
reports.
3. LOS 19.c: Describe how to evaluate the quality of a company’s financial
reports.; LOS 19.d: Evaluate the quality of a company’s financial reports.
4. LOS 19.f: Describe indicators of earnings quality.
5. LOS 19.e: Describe the concept of sustainable (persistent) earnings.

6. LOS 19.g: Explain mean reversion in earnings and how the accruals
component of earnings affects the speed of mean reversion.
7. LOS 19.h: Evaluate the earnings quality of a company.
8. LOS 19.i: Describe indicators of cash flow quality.
9. LOS 19.j: Evaluate the cash flow quality of a company.
10. LOS 19.k: Describe indicators of balance sheet quality.
11. LOS 19.l: Evaluate the balance sheet quality of a company.
12. LOS 19.m: Describe sources of information about risk.
13. Key Concepts
1. LOS 19.a
2. LOS 19.b
3. LOS 19.c
4. LOS 19.d
5. LOS 19.e
6. LOS 19.f
7. LOS 19.g
8. LOS 19.h
9. LOS 19.i
10. LOS 19.j
11. LOS 19.k
12. LOS 19.l


13. LOS 19.m
14. Concept Checkers
1. Answers – Concept Checkers
10. Integration of Financial Statement Analysis Techniques
1. LOS 20.a: Demonstrate the use of a framework for the analysis of financial
statements, given a particular problem, question, or purpose (e.g., valuing
equity based on comparables, critiquing a credit rating, obtaining a

comprehensive picture of financial leverage, evaluating the perspectives
given in management’s discussion of financial results).
2. LOS 20.b: Identify financial reporting choices and biases that affect the
quality and comparability of companies’ financial statements and explain
how such biases may affect financial decisions.
3. LOS 20.e: Analyze and interpret how balance sheet modifications, earnings
normalization, and cash flow statement related modifications affect a
company’s financial statements, financial ratios, and overall financial
condition.
4. LOS 20.c: Evaluate the quality of a company’s financial data, and
recommend appropriate adjustments to improve quality and comparability
with similar companies, including adjustments for differences in accounting
standards, methods, and assumptions.
5. LOS 20.d: Evaluate how a given change in accounting standards, methods,
or assumptions affects financial statements and ratios.
6. Key Concepts
1. LOS 20.a
2. LOS 20.b
3. LOS 20.c
4. LOS 20.d
5. LOS 20.e
7. Concept Checkers
1. Answers – Concept Checkers
11. Self-Test: Ethical and Professional Standards
1. Self-Test Answers: Ethical and Professional Standards
12. Capital Budgeting
1. LOS 21.a: Calculate the yearly cash flows of expansion and replacement
capital projects and evaluate how the choice of depreciation method
affects those cash flows.
2. LOS 21.b: Explain how inflation affects capital budgeting analysis.

3. LOS 21.c: Evaluate capital projects and determine the optimal capital
project in situations of 1) mutually exclusive projects with unequal lives,
using either the least common multiple of lives approach or the equivalent
annual annuity approach, and 2) capital rationing.
4. LOS 21.d: Explain how sensitivity analysis, scenario analysis, and Monte
Carlo simulation can be used to assess the stand-alone risk of a capital
project.


5. LOS 21.e: Explain and calculate the discount rate, based on market risk
methods, to use in valuing a capital project.
6. LOS 21.f: Describe types of real options and evaluate a capital project using
real options.
7. LOS 21.g: Describe common capital budgeting pitfalls.
8. LOS 21.h: Calculate and interpret accounting income and economic income
in the context of capital budgeting.
9. LOS 21.i: Distinguish among the economic profit, residual income, and
claims valuation models for capital budgeting and evaluate a capital project
using each.
10. Key Concepts
1. LOS 21.a
2. LOS 21.b
3. LOS 21.c
4. LOS 21.d
5. LOS 21.e
6. LOS 21.f
7. LOS 21.g
8. LOS 21.h
9. LOS 21.i
11. Concept Checkers

1. Answers – Concept Checkers
12. Challenge Problems
1. Answers – Challenge Problems
13. Capital Structure
1. LOS 22.a: Explain the Modigliani–Miller propositions regarding capital
structure, including the effects of leverage, taxes, financial distress, agency
costs, and asymmetric information on a company’s cost of equity, cost of
capital, and optimal capital structure.
2. LOS 22.b: Describe target capital structure and explain why a company’s
actual capital structure may fluctuate around its target.
3. LOS 22.c: Describe the role of debt ratings in capital structure policy.
4. LOS 22.d: Explain factors an analyst should consider in evaluating the effect
of capital structure policy on valuation.
5. LOS 22.e: Describe international differences in the use of financial leverage,
factors that explain these differences, and implications of these differences
for investment analysis.
6. Key Concepts
1. LOS 22.a
2. LOS 22.b
3. LOS 22.c
4. LOS 22.d
5. LOS 22.e
7. Concept Checkers


1. Answers – Concept Checkers
8. Challenge Problems
1. Answers – Challenge Problems
14. Dividends and Share Repurchases: Analysis
1. LOS 23.a: Describe the expected effect of regular cash dividends, extra

dividends, liquidating dividends, stock dividends, stock splits, and reverse
stock splits on shareholders' wealth and a company's financial ratios.
2. LOS 23.b: Compare theories of dividend policy and explain implications of
each for share value given a description of a corporate dividend action.
3. LOS 23.c: Describe types of information (signals) that dividend initiations,
increases, decreases, and omissions may convey.
4. LOS 23.d: Explain how clientele effects and agency costs may affect a
company’s payout policy.
5. LOS 23.e: Explain factors that affect dividend policy in practice.
6. LOS 23.f: Calculate and interpret the effective tax rate on a given currency
unit of corporate earnings under double taxation, dividend imputation, and
split-rate tax systems.
7. LOS 23.g: Compare stable dividend, constant dividend payout ratio, and
residual dividend payout policies, and calculate the dividend under each
policy.
8. LOS 23.h: Compare share repurchase methods.
9. LOS 23.i: Calculate and compare the effect of a share repurchaseshare
repurchase on earnings per share when 1) the repurchase is financed with
the company's surplus cash and 2) the company uses debt to finance the
repurchase.
10. LOS 23.j: Calculate the effect of a share repurchase on book value per
share.
11. LOS 23.k: Explain the choice between paying cash dividends and
repurchasing shares.
12. LOS 23.l: Describe broad trends in corporate payout policies.
13. LOS 23.m: Calculate and interpret dividend coverage ratios based on 1) net
income and 2) free cash flow.
14. LOS 23.n: Identify characteristics of companies that may not be able to
sustain their cash dividend.
15. Key Concepts

1. LOS 23.a
2. LOS 23.b
3. LOS 23.c
4. LOS 23.d
5. LOS 23.e
6. LOS 23.f
7. LOS 23.g
8. LOS 23.h
9. LOS 23.i


10. LOS 23.j
11. LOS 23.k
12. LOS 23.l
13. LOS 23.m
14. LOS 23.n
16. Concept Checkers
1. Answers – Concept Checkers
17. Challenge Problems
1. Answers – Challenge Problems
15. Corporate Performance, Governance, and Business Ethics
1. LOS 24.a: Compare interests of key stakeholder groups and explain the
purpose of a stakeholder impact analysis.
2. LOS 24.b: Discuss problems that can arise in principal–agent relationships
and mechanisms that may mitigate such problems.
3. LOS 24.c: Discuss roots of unethical behavior and how managers might
ensure that ethical issues are considered in business decision making.
4. LOS 24.d: Compare the Friedman doctrine, Utilitarianism, Kantian Ethics,
and Rights and Justice Theories as approaches to ethical decision making.
5. Key Concepts

1. LOS 24.a
2. LOS 24.b
3. LOS 24.c
4. LOS 24.d
6. Concept Checkers
1. Answers – Concept Checkers
16. Corporate Governance
1. LOS 25.a: Describe objectives and core attributes of an effective corporate
governance system and evaluate whether a company’s corporate
governance has those attributes.
2. LOS 25.b: Compare major business forms and describe the conflicts of
interest associated with each.
3. LOS 25.c: Explain conflicts that arise in agency relationships, including
manager–shareholder conflicts and director–shareholder conflicts.
4. LOS 25.d: Describe responsibilities of the board of directors and explain
qualifications and core competencies that an investment analyst should
look for in the board of directors.
5. LOS 25.e: Explain effective corporate governance practice as it relates to
the board of directors and evaluate strengths and weaknesses of a
company’s corporate governance practice.
6. LOS 25.f: Describe elements of a company’s statement of corporate
governance policies that investment analysts should assess.
7. LOS 25.g: Describe environmental, social, and governance risk exposures;
8. LOS 25.h : Explain the valuation implications of corporate governance.
9. Key Concepts


1. LOS 25.a
2. LOS 25.b
3. LOS 25.c

4. LOS 25.d
5. LOS 25.e
6. LOS 25.f
7. LOS 25.g
8. LOS 25.h
10. Concept Checkers
1. Answers – Concept Checkers
11. Challenge Problems
1. Answers – Challenge Problems
17. Mergers and Acquisitions
1. LOS 26.a: Classify merger and acquisition (M&A) activities based on forms
of integration and relatedness of business activities.
2. LOS 26.b: Explain common motivations behind M&A activity.
3. LOS 26.c: Explain bootstrapping of earnings per share (EPS) and calculate a
company’s post-merger EPS.
4. LOS 26.d: Explain, based on industry life cycles, the relation between
merger motivations and types of mergers.
5. LOS 26.e: Contrast merger transaction characteristics by form of
acquisition, method of payment, and attitude of target management.
6. LOS 26.f: Distinguish among pre-offer and post-offer takeover defense
mechanisms.
7. LOS 26.g: Calculate and interpret the Herfindahl–Hirschman Index and
evaluate the likelihood of an antitrust challenge for a given business
combination.
8. LOS 26.i: Calculate free cash flows for a target company and estimate the
company’s intrinsic value based on discounted cash flow analysis.
9. LOS 26.j: Estimate the value of a target company using comparable
company and comparable transaction analyses.
10. LOS 26.h: Compare the discounted cash flow, comparable company, and
comparable transaction analyses for valuing a target company, including

the advantages and disadvantages of each.
11. LOS 26.k: Evaluate a takeover bid and calculate the estimated postacquisition value of an acquirer and the gains accrued to the target
shareholders versus the acquirer shareholders.
12. LOS 26.l: Explain how price and payment method affect the distribution of
risks and benefits in M&A transactions.
13. LOS 26.m: Describe characteristics of M&A transactions that create value.
14. LOS 26.n: Distinguish among equity carve-outs, spin-offs, split-offs, and
liquidation.
15. LOS 26.o: Explain common reasons for restructuring.
16. Key Concepts


1. LOS 26.a
2. LOS 26.b
3. LOS 26.c
4. LOS 26.d
5. LOS 26.e
6. LOS 26.f
7. LOS 26.g
8. LOS 26.h
9. LOS 26.i
10. LOS 26.j
11. LOS 26.k
12. LOS 26.l
13. LOS 26.m
14. LOS 26.n
15. LOS 26.o
17. Concept Checkers
1. Answers – Concept Checkers
18. Challenge Problems

1. Answers – Challenge Problems
18. Self-Test: Corporate Finance
1. Self-Test Answers: Corporate Finance
19. Formulas
20. Copyright


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BOOK 2 – FINANCIAL REPORTING AND ANALYSIS
AND CORPORATE FINANCE
Readings and Learning Outcome Statements
Study Session 5 – Financial Reporting and Analysis: Intercorporate Investments,
Post-Employment and Share-Based Compensation, and Multinational Operations
Study Session 6 – Financial Reporting and Analysis: Quality of Financial Reports
and Financial Statement Analysis
Self-Test – Financial Reporting and Analysis
Study Session 7 – Corporate Finance
Study Session 8 – Corporate Finance: Financing and Control Issues
Self-Test – Corporate Finance
Formulas


READINGS AND LEARNING OUTCOME STATEMENTS
READINGS
The following material is a review of the Financial Reporting and Analysis, and
Corporate Finance principles designed to address the learning outcome statements
set forth by CFA Institute.

STUDY SESSION 5
Reading Assignments
Financial Reporting and Analysis, CFA Program Curriculum, Volume 2, Level II (CFA
Institute, 2017)
16. Intercorporate Investments (page 1)
17. Employee Compensation: Post-Employment and Share-Based (page 37)
18. Multinational Operations (page 63)

STUDY SESSION 6

Reading Assignments
Financial Reporting and Analysis, CFA Program Curriculum, Volume 2, Level II (CFA
Institute, 2017)
19. Evaluating Quality of Financial Reports (page 102)
20. Integration of Financial Statement Analysis Techniques (page 128)

STUDY SESSION 7
Reading Assignments
Corporate Finance, CFA Program Curriculum, Volume 3, Level II (CFA Institute,
2017)
21. Capital Budgeting (page 160)
22. Capital Structure (page 208)
23. Dividends and Share Repurchases: Analysis (page 227)


STUDY SESSION 8
Reading Assignments
Corporate Finance, CFA Program Curriculum, Volume 3, Level II (CFA Institute,
2017)
24. Corporate Performance, Governance, and Business Ethics (page 259)
25. Corporate Governance (page 270)
26. Mergers and Acquisitions (page 289)

LEARNING OUTCOME STATEMENTS (LOS)
The CFA Institute Learning Outcome Statements are listed below. These are
repeated in each topic review; however, the order may have been changed in order
to get a better fit with the flow of the review.

STUDY SESSION 5
The topical coverage corresponds with the following CFA Institute assigned

reading:
16. Intercorporate Investments
The candidate should be able to:
a. describe the classification, measurement, and disclosure under International
Financial Reporting Standards (IFRS) for 1) investments in financial assets,
2) investments in associates, 3) joint ventures, 4) business combinations,
and 5) special purpose and variable interest entities. (page 1)
b. distinguish between IFRS and US GAAP in the classification, measurement,
and disclosure of investments in financial assets, investments in associates,
joint ventures, business combinations, and special purpose and variable
interest entities. (page 1)
c. analyze how different methods used to account for intercorporate
investments affect financial statements and ratios. (page 25)
The topical coverage corresponds with the following CFA Institute assigned
reading:
17. Employee Compensation: Post-Employment and Share-Based
The candidate should be able to:


a. describe the types of post-employment benefit plans and implications for
financial reports. (page 37)
b. explain and calculate measures of a defined benefit pension obligation (i.e.,
present value of the defined benefit obligation and projected benefit
obligation) and net pension liability (or asset). (page 38)
c. describe the components of a company’s defined benefit pension costs.
(page 42)
d. explain and calculate the effect of a defined benefit plan’s assumptions on
the defined benefit obligation and periodic pension cost. (page 47)
e. explain and calculate how adjusting for items of pension and other postemployment benefits that are reported in the notes to the financial
statements affects financial statements and ratios. (page 50)

f. Interpret pension plan note disclosures including cash flow related
information. (page 51)
g. explain issues associated with accounting for share-based compensation.
(page 53)
h. explain how accounting for stock grants and stock options affects financial
statements, and the importance of companies’ assumptions in valuing these
grants and options. (page 53)
The topical coverage corresponds with the following CFA Institute assigned
reading:
18. Multinational Operations
The candidate should be able to:
a. distinguish among presentation (reporting) currency, functional currency,
and local currency. (page 63)
b. describe foreign currency transaction exposure, including accounting for
and disclosures about foreign currency transaction gains and losses.
(page 64)
c. analyze how changes in exchange rates affect the translated sales of the
subsidiary and parent company. (page 65)
d. compare the current rate method and the temporal method, evaluate how
each affects the parent company’s balance sheet and income statement,
and determine which method is appropriate in various scenarios. (page 65)
e. calculate the translation effects and evaluate the translation of a
subsidiary’s balance sheet and income statement into the parent company’s
presentation currency. (page 71)
f. analyze how the current rate method and the temporal method affect
financial statements and ratios. (page 79)


g. analyze how alternative translation methods for subsidiaries operating in
hyperinflationary economies affect financial statements and ratios.

(page 83)
h. describe how multinational operations affect a company’s effective tax rate.
(page 86)
i. explain how changes in the components of sales affect the sustainability of
sales growth. (page 87)
j. analyze how currency fluctuations potentially affect financial results, given a
company’s countries of operation. (page 88)

STUDY SESSION 6
The topical coverage corresponds with the following CFA Institute assigned
reading:
19. Evaluating Quality of Financial Reports
The candidate should be able to:
a. demonstrate the use of a conceptual framework for assessing the quality of
a company’s financial reports. (page 102)
b. explain potential problems that affect the quality of financial reports.
(page 103)
c. describe how to evaluate the quality of a company’s financial reports.
(page 106)
d. evaluate the quality of a company’s financial reports. (page 106)
e. describe the concept of sustainable (persistent) earnings. (page 109)
f. describe indicators of earnings quality. (page 109)
g. explain mean reversion in earnings and how the accruals component of
earnings affects the speed of mean reversion. (page 111)
h. evaluate the earnings quality of a company. (page 111)
i. describe indicators of cash flow quality. (page 114)
j. evaluate the cash flow quality of a company. (page 114)
k. describe indicators of balance sheet quality. page 115)
l. evaluate the balance sheet quality of a company. (page 115)
m. describe sources of information about risk. (page 116)

The topical coverage corresponds with the following CFA Institute assigned
reading:
20. Integration of Financial Statement Analysis Techniques
The candidate should be able to: