International Accounting, Chapter 9 ch 09

International Accounting, 6/e

Frederick D.S. Choi

Gary K. Meek

Chapter 9: International Financial

Statement Analysis

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

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.

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

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.

Steps in Examining Foreign

Accounting Practices



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.

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.

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

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.

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).

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.

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 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

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.

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.

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. 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

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