International Accounting, 6/e

Choi/Meek, 6/e 1

International Accounting, 6/e

Frederick D.S. Choi

Gary K. Meek

Chapter 9: International Financial Statement Analysis

Choi/Meek, 6/e 2

Learning Objectives What is a logical approach to analyzing foreign financial

statements? Why is it difficult to undertake an international business strategy

analysis? What are some steps to examining foreign accounting practices? How do cross-country variations in accounting measurements,

disclosure practices, and auditing standards impact one’s analysis of foreign financial statements?

How can you cope with differences in national accounting measurement practices?

What does international prospective analysis entail and why is it difficult to perform in an international setting?

What are some pitfalls to avoid when conducting cross-country ratio analysis?

Choi/Meek, 6/e 3

What is a Logical Approach to Analyzing Foreign Financial Statements?

Undertake a business strategy analysis. Conduct an analysis of a firm’s financial

reporting practices. Conduct a financial analysis using ratio and

cash flow data. Do a prospective analysis.

Choi/Meek, 6/e 4

International Business Strategy Analysis Strategy analysis = getting to know a company and its

competition in relation to its economic environment. Information gathering includes recourse to

Annual reports Company staff, financial analysts, and other financial

professionals World Wide Web Trade groups Competitors Reporters Lobbyists Regulators Financial press

Choi/Meek, 6/e 5

International Business Strategy Analysis (contin)

Difficulties in undertaking an IB business strategy analysis Profit drivers and business risks may be country

specific. National business and legal environments differ. Environmental risks such as changing process

and FX risk need to be evaluated. Information sources may be limited or unreliable.

Choi/Meek, 6/e 6

Steps in Examining Foreign Accounting Practices

Identify key accounting policies. Assess a firm’s accounting flexibility. Evaluate the firm’s accounting strategy. Evaluate the quality of its financial

disclosures. Identify reporting outliers. Adjust for accounting measurements that

distort the underlying economics of a firm’s transactions.

Choi/Meek, 6/e 7

How Does Diversity in International Accounting Impact Financial Statement Analysis? Measurement differences within and between

countries make performance comparisons difficult. Measurement differences may relate to measurement

options permitted by GAAP. Measurement differences may be due to differences in

management discretion. Measurement difference may be due to differences in

financial statement orientation; i.e., creditor vs. shareholder.

Measurement differences may relate to the objectives of financial statements; i.e., oriented toward more macro decisions vs. micro decisions.

Choi/Meek, 6/e 8

How Does Diversity in International Accounting Impact Financial Statement Analysis? (contin) Differences in corporate transparency make it difficult:

to comprehend what measurement rules are being followed to estimate future performance metrics to value forecasted numbers because of large variances of these

subjective probability distributions Auditing differences affect the credibility of reported numbers

owing to differences in: the information content of the auditors report the source of auditing standards the enforcement of auditing standards auditor liability to third parties auditor qualifications auditor certification procedures auditor independence

Choi/Meek, 6/e 9

Coping Mechanisms

For measurement differences: Adopt a mutual fund (passive) approach to

investing. Restate foreign GAAP to domestic GAAP. Restate foreign GAAP to IFRS. Rely on non-accounting data using a dividend

discount model or cash flow data. Immerse yourself in the language, currency and

GAAP of the country you are investing in; i.e., develop a multiple-principles capability.

Choi/Meek, 6/e 10

Coping Mechanisms (contin)

For disclosure differences: Undertake company visitations. Attend company road shows. Alter investment classifications from speculative

grade (poor disclosure) to investment grade (good disclosure).

Alter investment strategies from active investing (good disclosure) to passive or non-investing (poor disclosure).

Choi/Meek, 6/e 11

Coping Mechanisms (contin)

For audit differences: Research the auditing environment in the country

being analyzed. Institutional investors ask for a second audit

opinion or engage a recognized audit firm when confidence in the integrity of the attest function is in doubt.

Assess a higher risk premium for audit risk.

Choi/Meek, 6/e 12

Prospective Analysis Prospective analysis: forecasting a firm’s prospects based on

an assessment of a firm’s business strategy, accounting policy, and its financial analysis, and arriving at an estimate of the firm’s value.

Complicating factors: Fluctuating exchange rates make it difficult to forecast a firm’s

future costs and revenues when sales/purchases are invoiced in foreign currencies.

National variations in measurement, disclosure, and auditing practices including national enforcement regimes add to the difficulty of achieving forecast accuracy.

National variations in pricing risk make it difficult to select an appropriate discount rate for valuation purposes.

Valuation multiples such as P/E ratios also vary from country to country complicating appropriate corporate valuations.

Choi/Meek, 6/e 13

Pitfalls in Conducting International Ratio Analysis All of the difficulties mentioned previously in

conducting business strategy, accounting, and financial analysis.

A lack of understanding of the political, legal and business environment that affects the analysis of financial ratios generated in that environment.

Choi/Meek, 6/e 14

Pitfalls in Conducting International Ratio Analysis (contin)

Examples of environmental differences: Government systems

UK and U.S. governments are more laissez-faire; i.e., ensure free markets. Self-regulation is encouraged.

German and Japanese governments are more active in orchestrating growth. Government has a major role in market regulation.

Legal systems UK and U.S. governments are common law countries where

standard-setting is delegated to professional bodies and standards oriented toward investor decisions.

Germany and Japan are code law countries. Government active in standard setting with pronouncements oriented toward societal rights.

Choi/Meek, 6/e 15

Pitfalls in Conducting International Ratio Analysis (contin)

Fiscal systems UK and U.S. make a distinction between financial reporting

and tax reporting. Emphasis on consolidated reporting. Germany and Japan exhibit a degree of tax-book

conformity. Parent company financial statements are important.

Capital markets UK and U.S. markets oriented more toward equity

investors. They’re more equity-oriented with significant individual ownership. Earnings tend to have an optimistic bias.

German and Japanese markets traditionally oriented toward creditors. Earnings tend to have a more conservative bias with more smoothing opportunities.

Choi/Meek, 6/e 16

Chapter Exhibits

Choi/Meek, 6/e 17

Chapter Exhibits (contin)

Choi/Meek, 6/e 18


Choi/Meek, 6/e 19


Choi/Meek, 6/e 20

Exhibit 9-4 (contin)

Choi/Meek, 6/e 21


Choi/Meek, 6/e 22


Choi/Meek, 6/e 23


Choi/Meek, 6/e 24


Choi/Meek, 6/e 25


Choi/Meek, 6/e 26


Choi/Meek, 6/e 27


Choi/Meek, 6/e 28


Choi/Meek, 6/e 29


Choi/Meek, 6/e 30


Choi/Meek, 6/e 31


International Accounting, 6/e

Documents

Transcript of International Accounting, 6/e