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International Accounting, 6e
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 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?
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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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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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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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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.
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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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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 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 salespurchases 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 PE ratios also vary from country to country complicating appropriate corporate valuations.
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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; 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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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.
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Chapter Exhibits
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Exhibit 9-4 contin
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Exhibit 9-11 contin
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Exhibit 9-12 contin