International Accounting, 6/e

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International Accounting, 6/e

• Frederick D.S. Choi
• Gary K. Meek

Chapter 9 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 ones 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?

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What is a Logical Approach to Analyzing Foreign
Financial Statements?

• Undertake a business strategy analysis.
• Conduct an analysis of a firms 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
• Lobbyists
• Regulators
• Financial press

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

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Steps in Examining Foreign Accounting Practices

• Identify key accounting policies.
• Assess a firms accounting flexibility.
• Evaluate the firms accounting strategy.
• Evaluate the quality of its financial
  disclosures.
• Identify reporting outliers.
• Adjust for accounting measurements that distort
  the underlying economics of a firms
  transactions.

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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.

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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

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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.

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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).

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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 of the attest
  function is in doubt.
• Assess a higher risk premium for audit risk.

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Prospective Analysis

• Prospective analysis forecasting a firms
  prospects based on an assessment of a firms
  business strategy, accounting policy, and its
  financial analysis, and arriving at an estimate
  of the firms value.
• Complicating factors
• Fluctuating exchange rates make it difficult to
  forecast a firms 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.

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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.

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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.

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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. Theyre 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.

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Chapter Exhibits
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Exhibit 9-4 (contin)
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Exhibit 9-4 (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Chapter Exhibits (contin)
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Exhibit 9-11 (contin)
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Chapter Exhibits (contin)
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Exhibit 9-12 (contin)