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Chapter 17
International Financial Statement Analysis
FASB, IASB, and IAAER Project on Financial Reporting
Questions addressed in this project include Should the performance (income) statement be
the primary focus of financial reporting? How should the performance statement
complement the other financial statements? How should the cash flow statement be used? What information should be presented in the
performance statement? Is one approach applicable to all countries?
International Accounting Differences and Financial Statement Analysis
The key question How do differences in accounting affect earnings
and cash flow assessments? These assessments are important to
Investors Corporations concerned with foreign direct
investment Many companies are listing on international
exchanges (London, New York)
Stock Market Comparisons
Accounting Diversity and Economic Environments
International Accounting Differences and Financial Statement Analysis
A tendency exists to looks at earnings from a home country perspective This tendency may ignore accounting differences
A need exists to better understand foreign accounting principles in the context in which they are derived
International comparability is important in considering alternative investments
Major Differences in Accounting Principles Around the World
Inventory measurement Generally based on
“lower of cost or market” with market defined as either Net realizable value Replacement cost
LIFO is permitted for tax purposes in U.S. and Japan, but not in the EU
Construction contracts Wide usage of
percentage-of-completion method
Completed contract method – Switzerland, China, Japan
Major Differences in Accounting Principles Around the World
Measurement basis used Historical cost is used in
the U.S., Brazil, Switzerland, China, and Japan.
More flexible approach with some restatements to market value or replacement cost – U.K., Holland
Depreciation accounting Useful economic life
concept – U.S. and EU Accelerated methods –
France, Germany, Switzerland, Japan
Major Differences in Accounting Principles Around the World
R&D costs Expensed immediately in
Anglo-American and Germanic countries
Brazil has a more flexible approach
Some countries allow capitalizing the borrowed cost of assets
Retirement benefits Generally accounted for
on the basis of accrued and/or projected benefits payable to employees
Pay-as-you-go approach in Brazil and China
Major Differences in Accounting Principles Around the World
Taxation Accounting income
strongly influenced by the tax system in France, Germany, Brazil, Switzerland
Business Combinations Varies with allowance of
pooling-of-interests Purchase method is
generally required Goodwill is amortized in
Brazil, China, and Japan Goodwill impairment
tests are used in U.S., U.K.
Major Differences in Accounting Principles Around the World
Intangibles Generally are capitalized and subject to
amortization or impairment tests Exception – Switzerland
Foreign Currency Translation Choice between average or closing rate Generally flexible; actual or average rate allowed
Big Question: Do these differences matter?
A Global Perspective on Earnings Management
How do Anglo-American earnings compare with continental Europe and Japan?
Continental Europe Gray (1980) compared French and German companies to
British companies Insert Exhibit 5.8, 5.9 French and German earnings are more conservative than
British earnings Weetman and Gray (1991) found that
Netherlands was less conservative that Sweden, U.K. Swedish methods were more conservative than U.S. GAAP
A Global Perspective on Earnings Management
Japan Earnings are relatively understated compared to the U.S.
(33.9%, according to Aron (1991) Historically high PE ratios were deflated by adjustments for
reserves, consolidation practices, depreciation, cross-holdings, and differences in capitalization (Morgan Stanley)
Higher levels of gearing (leverage) and short-term payables are tolerated because of long-term relationships with bankers and suppliers
Emphasis tends to be on long-term growth rather than instant profitability
Factors Influencing Measurement Differences
U.S. and U.K. Stock market is the dominant influence
Information needs of investors encourage a more “optimistic” view of earnings and higher share prices
Accounting principles are flexible Accounting profession is independent Tax rules have a limited influence Cultural values motivate a less conservative
approach to measurement
Factors Influencing Measurement Differences
Continental Europe and Japan Taxation and sources of finance are influential Tradition of commercial codes and accounting
plans Tendency to report lower earnings for tax
purposes
Factors Influencing Measurement Differences
Continental Europe and Japan Users of financial information may be more
concerned with balance sheet information Black and White (2003) findings
Balance sheet info is more informative in Germany, Japan Income statement is more relative in the U.S.
Professional influence is low due to legal requirements related to accounting
Cultural values motivate a more conservative approach
Global Accounting Convergence
IASB sets IFRS Goal is to develop comparable international standards with
low cost to MNEs Provides a model for developing countries More uniform standards have been developed to aid in
capital raisings and stock exchange listings Core standards program with IOSCO was completed in
1998 May 2000 – IOSCO endorsed IFRS EU will adopt IFRS in 2005
Will the U.S. accept IFRS?