In this video, we walk through 5 FAR practice questions teaching about understanding the items of Form 10-Q Part I and Form 10-K Part II. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
Also be sure to watch one of our free webinars on the 6 “key ingredients” to an extremely effective & efficient CPA study process here…
The Items of Form 10-Q Part I and Form 10-K Part II
When analyzing the financial health of a company, two critical documents often come into play: the Form 10-Q and the Form 10-K. Both forms are required filings for publicly traded companies and provide investors, regulators, and analysts with key information about the company’s financial condition, performance, and risks. While the 10-Q is filed quarterly and provides a snapshot of short-term performance, the 10-K is an annual filing that offers a comprehensive overview of the company’s operations and financial position over the entire fiscal year.
In this post, we’ll focus on specific sections of both forms that you need to know for the FAR CPA exam: Part I, Items 1, 2, and 3 of the 10-Q, and Part II, Items 7, 7A, and 8 of the 10-K. These items are particularly important because they disclose essential financial data, management insights, and risk factors that directly impact how a company is evaluated by stakeholders.
Form 10-Q Part I: Items 1, 2, and 3
The Form 10-Q is filed quarterly and consists of several parts. However, Part I, Items 1, 2, and 3 focus on the most critical aspects of financial reporting and analysis. Let’s break these down:
Item 1: Financial Statements
The first item in Part I of the 10-Q is the financial statements. These typically include:
- Balance Sheets (for the current quarter and the corresponding quarter from the previous year).
- Income Statements (detailing revenues, expenses, and net income).
- Statements of Cash Flows (showing the cash inflows and outflows from operating, investing, and financing activities).
It’s important to note that the financial statements in the 10-Q are unaudited, unlike those in the 10-K. However, they still provide valuable insights into the company’s short-term financial condition and performance. Investors use these quarterly statements to track a company’s progress, compare it to previous quarters, and identify trends or warning signs early on.
Item 2: Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
Item 2 covers the MD&A, where management provides a narrative analysis of the company’s financial performance. This section is crucial because it offers context and explanations for the figures reported in the financial statements. Rather than just presenting numbers, management discusses the reasons behind changes in revenue, expenses, and profitability. They also talk about broader trends affecting the business, such as changes in consumer demand, economic conditions, or industry developments.
The MD&A in the 10-Q focuses on short-term trends and developments. It compares the current quarter’s results with the same quarter from the previous year or the previous quarter, highlighting significant changes. This information is vital for stakeholders looking to understand how the company is performing in the near term.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Item 3 requires companies to disclose their exposure to various market risks. These can include:
- Interest rate risk
- Foreign currency exchange risk
- Commodity price risk
This section helps investors understand the potential risks the company faces that could affect its financial performance. While the disclosure in the 10-Q is often more focused on short-term fluctuations and new risks, it’s still a critical component for assessing the company’s risk profile.
Form 10-K Part II: Items 7, 7A, and 8
The Form 10-K is an annual report that offers a much more detailed and audited look into the company’s performance over the entire fiscal year. The sections we’ll focus on—Part II, Items 7, 7A, and 8—are some of the most important for anyone evaluating a company’s long-term financial health.
Item 7: Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
Similar to the 10-Q, the 10-K includes an MD&A section. However, the scope of the MD&A in the 10-K is far more comprehensive. Instead of focusing on quarterly performance, this section analyzes the company’s financial results over the entire fiscal year.
In the 10-K MD&A, management discusses long-term strategies, market conditions, risks, and other significant factors that impacted the company’s performance throughout the year. This section provides valuable insight into the company’s business model, growth potential, and ability to manage risks.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
Item 7A is dedicated to providing an in-depth analysis of the company’s exposure to market risks. These include the same risks disclosed in the 10-Q—such as interest rate risk, currency risk, and commodity price risk—but in much more detail.
The 10-K requires companies to provide both quantitative and qualitative disclosures. Quantitative disclosures might include sensitivity analysis, which shows how changes in interest rates or currency exchange rates could impact the company’s financial results. Qualitative disclosures, on the other hand, explain how the company manages these risks.
Item 8: Financial Statements
Finally, Item 8 of the 10-K includes the company’s audited financial statements. These financials are subject to stricter regulatory standards and auditing requirements, making them more reliable than the unaudited statements in the 10-Q. The financial statements included here cover the entire fiscal year and provide a full picture of the company’s financial health.
Key Takeaways
Understanding these sections of the 10-Q and 10-K is critical for anyone analyzing a company’s financial performance.
- In the 10-Q, Part I, Items 1, 2, and 3 give a snapshot of quarterly financial performance, management’s short-term analysis, and disclosures about market risk.
- In the 10-K, Part II, Items 7, 7A, and 8 provide a more in-depth, annual view, with a comprehensive MD&A, detailed market risk analysis, and audited financial statements.
