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International Accounting, 6/e

Frederick D.S. Choi

Gary K. Meek

Chapter 7: International Financial Statement Analysis

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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误区 to avoid when conducting cross-country ratio analysis?

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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.

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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记者 Lobbyists游说者 Regulators主管部门 Financial press财经媒体

Information Availability 信息有效性 Business strategy analysis is especially difficult in some

countries due to a lack of reliable information about macroeconomic developments.

Governments in develop countries are sometimes accused of被指控犯罪 publishing faulty or misleading economic statistics.

The situation is much worse in many emerging economies. For example, one reason the 1994/95 Mexican currency crisis货币危机 was a surprise was that the government concealed隐匿 information about its shrinking foreign reserves and exploding money supply. Some countries delay publishing statistics when the numbers are unfavorable, or even falsify篡改 their economic figures.

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Obtaining industry information is also difficult in many countries and the quantity and quality of company information varies greatly 差别很大 .

The availability of company-specific information has been strikingly low 非常缺乏 in many developing economies.

Recently, many large companies that list and raise capital in overseas markets have been expanding their disclosures and have voluntarily switched to globally recognized accounting principles such as International Financial Reporting Standards.

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Recommendations建议 for Analysis

Data constraints数据约束 make it difficult to perform business strategy analyses using traditional research methods

The World Wide Web全球资讯网 also offers quick access to information that recently was unavailable or difficult to obtain. Exhibit 9-1 presents a sampling of freely available Web resources that can be used to learn about country risks and travel conditions.

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Country information can also be found in “international briefings 国际简报” publications distributed by large accounting firms, banks, and brokerages经纪行 .

The International Federation of Stock Exchanges国际证卷交易所联会 (FIBV, http://www, fibv. com) and the Federation of European Stock Exchanges (FESE, http://www, fese.be) publish highly informative international newsletters 实时通讯 , and Accountancy, The Economist, Financial Analysts Journal, and Euromoney magazines provide many articles highly relevant for international financial analysis.

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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(Foreign Exchange外汇 ) risk need to be evaluated.

Information sources may be limited or unreliable.

ACCOUNTING ANALYSIS

The purpose of accounting analysis is to assess the extent to which a firm's reported results reflect economic reality.

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异常值 . Adjust for accounting measurements that distort失真

the underlying economics经济基础 of a firm’s transactions交易事项 .

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INTERNATIONAL FINANCIAL ANALYSIS The goal of financial analysis is to evaluate a firm's

current and past performance, and to judge whether its performance can be sustained. Ratio analysis and cash flow analysis are important tools in financial analysis.

A summary of commonly used financial ratios appears in Exhibit 9-2.

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Cash flow analysis focuses on the cash flow statement, which provides information about a firm's cash inflows and outflows, classified among operating, investing and financing activities, and disclosures about periodic noncash investing and financing activities.

Analysts can use cash flow analysis to address处理 many questions about the firm's performance and management.

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For example, has the firm generated positive cash flows from operations? How have cash flow components changed across time relation to changes in income statement components, sales, and cost of sales in particular?

What have been the cash flow consequences of management decisions about financial policy, dividend policy, and investment?

When used in conjunction with连同起来 the income statement, cash flow information also informs analysts about the validity有效期 of the going concern assumption, a firm's liquidity and management's use of measurement options to manage earnings.

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

countries make performance comparisons业绩比较 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定位 ; i.e., creditor vs. shareholder.

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

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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主观概率分布

Auditing differences affect the credibility of reported numbers owing to由于 differences in: the information content of the auditors report the source of auditing standards the enforcement执行 of auditing standards auditor liability责任 to third parties auditor qualifications auditor certification procedures auditor independence

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Coping Mechanisms应对机制 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.

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Coping Mechanisms (contin)

For disclosure differences: Undertake company visitations访问 . 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).

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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诚实 of the attest 证明function is in doubt.

Assess a higher risk premium for audit risk.

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Prospective未来 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复杂的因素 : Fluctuating exchange rates 自由波动汇率 make it difficult

to forecast a firm’s future costs and revenues when sales/purchases are invoiced 开发票 in foreign currencies.

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

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合并 appropriate corporate valuations.

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Pitfalls误区 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.

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Examples of environmental differences: Government systems

UK and U.S. governments are more laissez-faire自由放任 ; i.e., ensure free markets. Self-regulation自动调节 is encouraged.

German and Japanese governments are more active in orchestrating精心安排 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代表 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.

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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一致 . 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.

FINANCIAL STATEMENT ANALYSIS AND AUDITING The Attest Function验证职能 Independent auditors perform the attest

function in financial reporting. As competent outside experts they review financial information provided by a firm's management and then attest to its reliability, fairness and other aspects of quality.

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Investors and other readers of financial statements have a big stake赌注 the attestation of professional auditors. They can make decisions with better expected outcomes if they have relatively better information available.

The public is also better served. Incomplete, unreliable or even misleading financial information may well have a negative effect on capital formation processes within an economy. .

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The Audit Report

The auditors‘ attestation is typically communicated传达 to financial statement readers by way of an audit report.

Do auditors in all countries employ identical完全相同的 reporting formats?

Next is a taxonomy of audit reporting requirements in a sample of countries.

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United Kingdom

The auditor's report discloses the responsibilities of company directors and the scope of the audit; basis of opinion and statement of opinion. The balance sheet, income statement and related notes must be covered by statute; auditing standards extend this coverage to the cash flow statement.

The auditors' opinion must state whether the financial statements give a true and fair view and that the statements comply with statutory requirements.

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Auditors must state that they have read other information contained in the audit report, including the corporate governance statement, and describe implications for the audit report if the auditors become aware of any inconsistencies不一致 .

The scope section also explains the auditor's responsibilities in relation to the separate directors‘ report, the accounting records, information and explanations required, and rules regarding the disclosure of directors' remuneration.

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United States

A standard three paragraph report identifies the company and the principal financial statements being audited (scope) and states the responsibilities of management and the auditor.

The auditor must indicate whether or not the audit complied with generally accepted auditing standards.

The auditor must express an opinion as to whether the financial statements are presented fairly in accordance with GAAP and whether GAAP has been consistently observed in relation to reports in previous years.

If an opinion cannot be expressed this must be stated.

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Sweden The Swedish Companies Act requires the auditor

statements about: 1. The preparation of the annual report is in

accordance with the Act. 2. The adoption of the balance sheet and income

statement. 3. The proposal建议 included in the

administration report for disposition处置 of the unappropriated earnings 未分配利润 or deficit.

4. The discharge from the liability of members of the board of directors董事会 and the managing director总经理 .

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Germany The German Commercial Code specifies that the

auditor's report contain a description of the process and result of the audit, including management's report, a forecast of future developments, a statement of compliance with legal regulation and a statement describing the company's risk management system.

The auditor must provide a summary of the content, type and volume of the audit in the Bestaetigungsvmerk稽核员 , an evaluation of the audit results, and statements as to whether or not the financial statements and managemnt's report present a true and fair view.

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Diversity of Audit Opinions

UK

In our opinion, the financial statements give a true and fair view of the state of affairs of the company and of the group as at 31 December 20X8 and of the profit and cash flows of the group for the year then ended and have been properly prepared in accordance with the Companies Act 1985.

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U.S.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Time Warner at December 31,20X7 and 20X8, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31,20X8 in conformity相符 with U.S. GAAP

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Sweden

The annual accounts and the consolidated accounts have been prepared in accordance with the Annual Accounts Act and, thereby, give a true and fair view of the Company's and the Group's financial position and results of operations in accordance with generally accepted accounting principles in Sweden.

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Switzerland

In our opinion, the accounting records and financial statements and the proposed appropriation of available earnings comply with Swiss law and the company's articles of incorporation.

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Norway

The financial statements of Norsk Hydro are prepared in accordance with the law and regulations and present fairly ... the financial position of the Company ... in accordance with accounting principles generally accepted in Norway.

In our opinion, such consolidated financial statements.., present fairly.., in conformity with U.S. GAAP.

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Internal Auditing

A sound external audit of a reporting entity's financial statements is a necessary condition to assure the credibility of managements communications with external parties.

However, it is not sufficient. The effectiveness of a firm‘s internal control system is equally important as it provides a more timely system of“checks and balances相互制衡 " than can be provided by a firm's outside auditors.

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Professional Organization Professional focus for internal auditing is

provided by the Institute of Internal Auditors (IIA), which is headquartered总部 in the United States and has an international membership. Established in 1941, IIA is committed to:

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Providing, on an international scale, comprehensive professional development activities, standards for the practice of internal auditing, and certification

Researching, disseminating宣传 , and promoting to its members and to the public throughout the world, knowledge and information concerning internal auditing, including internal control and related subjects

Establishing meetings worldwide in order to educate members and others as to the practice of internal auditing as it exists in various countries throughout the world

Bringing together internal auditors and promoting education in the field of internal auditing

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The professional examination and certification activites of IlA leads to qualification as a Certified Internal Auditor (CIA).The CIA designation is the only globally-accepted certification for internal auditors.

At present, the IIA boasts a membership approaching 130,000 from 165 countries.

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Evolving Role of Internal Auditing In an environment of global competition,

managers today are looking to internal auditors for expertise that transcends traditional control functions. The major international public accounting firm of PricewaterhouseCoopers 普华永道会计师事务所 offers ten imperatives命令 to internal auditors to improve their value to companies operating in a post-Enron world. They are:

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1. Sharpen dialog with top management and directors in order to clearly establish the value-added objectives of internal audit(i.e., strategic issues, risk management and protection of company assets).

2. Realign改组 to meet key stakeholders' expectations(stockholders, executive management, external auditors and market regulators).

3. Think and act strategically. 4. Expand audit coverage审计范围 to include

"tone set at the top," the conduct of executive management in protecting the company.

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5. Assess and strengthen expertise for complex business auditing.

6. Leverage technology in high-risk areas. 7. Focus on enterprise risk management

capabilities. 8. Make the audit process dynamic. 9. Strengthen quality assurance processes. 10. Measure the enhanced performance

against expectations of shareholders.

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