Chapter 5

International Financial Statement Analysis

International Accounting Differences and Financial Statement Analysis

#he

"ey $uestion

%o& do di''erences in accounting a''ect earnings and cash 'lo& assessments ( are the di''erences material in the decision process

#hese

assessments are important to

In)estors Corporations concerned &ith 'oreign direct in)estment

ro&ing number o' companies are listing on international e*changes +,ondon, -e& .or"/

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Stock Market Comparisons

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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International Accounting Differences and Financial Statement Analysis

A

tendency e*ists to loo"s at earnings 'rom a home country perspecti)e ( that may or may not place a high )alue on accounting0

#his tendency may ignore accounting di''erences

need e*ists to better understand 'oreign accounting principles in the conte*t in &hich they are deri)ed International comparability is important in considering alternati)e in)estments
International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Major Differences in Accounting Principles Around the World

In)entory measurement

Construction contracts

enerally based on 1lo&er o' cost or mar"et2 &ith mar"et de'ined as either

-et reali3able )alue Replacement cost

,IF4 is permitted 'or ta* purposes in 50S0 and 6apan, but not in the E5

7ide usage o' percentage-o'completion method ( is this better 8 more accurate9 Completed contract method ( S&it3erland, China, 6apan

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Major Differences in Accounting Principles Around the World

Measurement basis used

;epreciation accounting

%istorical cost is used in the 50S0, !ra3il, S&it3erland, China, and 6apan0 More 'le*ible approach &ith some restatements to mar"et )alue or replacement cost ( 50:0, %olland

5se'ul economic li'e concept ( 50S0 and E5 Accelerated methods ( France, ermany, S&it3erland, 6apan

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Major Differences in Accounting Principles Around the World

R&; costs

Retirement bene'its

E*pensed immediately in Anglo-American and ermanic countries !ra3il has a more 'le*ible approach Some countries allo& capitali3ing the borro&ed cost o' assets

enerally accounted 'or on the basis o' accrued and8or pro<ected bene'its payable to employees =ay-as-you-go approach in !ra3il and China

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Major Differences in Accounting Principles Around the World

#a*ation

!usiness Combinations

Accounting income strongly in'luenced by the ta* system in France, ermany, !ra3il, S&it3erland

>aries &ith allo&ance o' pooling-o'-interests =urchase method is generally re$uired ood&ill is amorti3ed in !ra3il, China, and 6apan ood&ill impairment tests are used in 50S0, 50:0

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Major Differences in Accounting Principles Around the World

Intangibles

enerally are capitali3ed and sub<ect to amorti3ation or impairment tests E*ception ( S&it3erland

Foreign

Currency #ranslation

Choice bet&een a)erage or closing rate enerally 'le*ible? actual or a)erage rate allo&ed

!ig

@uestionA ;o these di''erences matter9

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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he Impact of !"S"#!"$" Accounting Differences# A %uantitati&e 'ook

Inde( of conser&atism )*ray+ ,-./0 , 1 23A 1 3D 4 l 3A l5 Where 3A 6 adjusted earnings )or returns0 )i"e" earnings con&erted to an alternate accounting system0 3D 6 disclosed earnings )firm earnings reported on the home countries accounting system0" herefore+ , 1 2!"S" *AAP 7arnings 1 !"$" *AAP 7arnings 4 l !"S" *AAP 7arnings l5 If inde( &alue 8 ,+ !"$" *AAP earnings are less 9conser&ati&e: or more optimistic4aggressi&e If inde( &alue ; ,+ !"$" *AAP earnings are more 9conser&ati&e: International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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he Impact of !"S"#!"$" Accounting Differences

Example 1 !"$" earnings BCCD million Example 2 !"$" earnings BHD million

!"S" earnings BCDD million

!"S" earnings BCDD million

Inde( C ( ECDD-CDDF8CDD G C0C

Inde( C ( ECDD-HDF8CDD G D0H

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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he Impact of !"S"#!"$" Accounting Differences

It is possible to establish the relati)e e''ect o' indi)idual ad<ustments &ith partial indices o' ad<ustment ( to assess the accounting policy you &ish to e*amine0
=artial inde* o' 1conser)atism2 - 'irst ad<ust to o)erall comparison accounting method #henA analy3e the accounting issue in $uestion C ( Epartial ad<ustment +accounting policy in $uestion/ 8 l 50S0 AA= Earnings l F
International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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he Impact of !"S"#!"$" Accounting Differences

Example Millions o' =ounds 50:0 AA= earnings Ad<ustments 'or 50S0 AA=A ;e'erred ta*ation ood&ill amorti3ation +less o' issue no&/ Ad<usted earnings per 50S0 AA= 4)erall inde* o' Jconser)atismK =artial inde* 'or de'erred ta*ation =artial inde* 'or good&ill CID +C5/ +5/ +CDD/ C0I C ( E-C58CDDF G C0C5 C ( E-58CDDF G C0D5

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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he Impact of !"S"#!"$" Accounting Differences

;i''erences

bet&een methods are illustrated in the Form ID-F report Form ID-F can be used to test ho& conser)ati)e 50S0 and 50:0 AA= are in comparison &ith each other Form ID-F is reliable because it is pro)ided by the company itsel' Research 'indings sho& 50:0 AA= to be less conser)ati)e
International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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A *lo<al Perspecti&e on 7arnings Management

%o& do Anglo-American earnings compare &ith continental Europe and 6apan9 Continental Europe

ray +CHLD/ compared French and erman companies to !ritish companies Insert E*hibit 50L, 50H French and erman earnings are more conser)ati)e than !ritish earnings 7eetman and ray +CHHC/ 'ound that -etherlands &as less conser)ati)e that S&eden, 50:0 S&edish methods &ere more conser)ati)e than 50S0 AA=

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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A *lo<al Perspecti&e on 7arnings Management

6apan

Earnings are relati)ely understated compared to the 50S0 +MM0HN, according to Aron +CHHC/ %istorically high =E ratios &ere de'lated by ad<ustments 'or reser)es, consolidation practices, depreciation, crossholdings, and di''erences in capitali3ation +Morgan Stanley/ %igher le)els o' gearing +le)erage/ and short-term payables are tolerated because o' long-term relationships &ith ban"ers and suppliers Emphasis tends to be on long-term gro&th rather than instant pro'itability

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Factors Influencing Measurement Differences

50S0

and 50:0

Stoc" mar"et is the dominant in'luence

In'ormation needs o' in)estors encourage a more 1optimistic2 )ie& o' earnings and higher share prices

Accounting principles are 'le*ible Accounting pro'ession is independent #a* rules ha)e a limited in'luence Cultural )alues moti)ate a less conser)ati)e approach to measurement

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Factors Influencing Measurement Differences

Continental

Europe and 6apan

#a*ation and sources o' 'inance are in'luential #radition o' commercial codes and accounting plans #endency to report lo&er earnings 'or ta* purposes

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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Factors Influencing Measurement Differences

Continental

Europe and 6apan

5sers o' 'inancial in'ormation may be more concerned &ith balance sheet in'ormation !lac" and 7hite +IDDM/ 'indings

!alance sheet in'o is more in'ormati)e in ermany, 6apan Income statement is more relati)e in the 50S0

=ro'essional in'luence is lo& due to legal re$uirements related to accounting Cultural )alues moti)ate a more conser)ati)e approach

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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*lo<al Accounting Con&ergence

IAS! sets IFRS

oal is to de)elop comparable international standards &ith lo& cost to M-Es =ro)ides a model 'or de)eloping countries More uni'orm standards ha)e been de)eloped to aid in capital raisings and stoc" e*change listings Core standards program &ith I4SC4 &as completed in CHHL May IDDD ( I4SC4 endorsed IFRS E5 &ill adopt IFRS in IDD5 ( &ill nonlisted companies adopt9

7ill the 50S0 accept IFRS9

International Accounting & Multinational Enterprises - Chapter 5 - Radebaugh,

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