Bài giảng môn Kế toán, kiểm toán - Chapter 10: Analysis of foreign financial statements

Chapter 10:Analysis of ForeignFinancial StatementsChapter TopicsOverview of financial statement analysisReasons for analyzing foreign financial statementsPotential problems in analyzing foreign financial statementsPossible solutions to problems associated with analyzing foreign financial statementsRestating foreign financial statements to U.S. GAAP illustrated10-2Learning ObjectivesDiscuss reasons to analyze financial statements of foreign companiesDescribe potential problems in analyzing foreign financial statementsProvide possible solutions to problems associated with analyzing foreign financial statementsDemonstrate an approach for restating foreign financial statements to U.S. generally accepted accounting principles (GAAP)10-3Overview of Financial Statement AnalysisAccounting analysisReflection of economic reality Sources of distortion in financial statements:(e.g. inconsistent standards, estimation errors and intentional manipulation)Financial analysis Cash flow, profitability and risk analysisProspective analysisCombining results of accounting analysis and financial analysis, along with business environment analysis and company strategy, to forecast future cash flow and income10-4Foreign portfolio investmentInvestors can diversify some risk by investing internationallyWhile stock returns in many countries are positively correlated with U.S. returns, these correlations are far from perfectInternational investors, including managers of international mutual funds, rely on foreign financial statementsReasons to Analyze Foreign Financial Statements10-5Reasons to Analyze Foreign Financial StatementsInternational Mergers and AcquisitionsThe frequency and size of international corporate mergers has increased in recent yearsExamples include Ambev/Anheuser-Busch; BP/Amoco; and acquisitions by Ford Motor such as Volvo (of Sweden), who, in 2010, reached a deal to sell Volvo to China’s Zhejiang Geely Holding GroupThe purchaser of an international company needs to analyze the target company’s financial statements for determining how much to pay10-6Reasons to Analyze Foreign Financial StatementsOther reasonsMaking credit decisions about foreign customerEvaluating the financial health of foreign suppliersBenchmarking against global competitors10-7Potential Problems in Analyzing Foreign Financial StatementsData accessibilityRelative to the U.S., financial information is difficult to obtain in many countriesWhile databases of foreign financial statements do exist, these can contain errors and present in a variety of formatsThese databases also do not contain complete disclosure notesAnother approach is to obtain a copy of the foreign company’s annual reportAnnual Reports.com provides reports for companies listed on U.S., U.K., Canada and Australia stock exchanges by name, ticker symbol, stock exchange and industry10-8Potential Problems in Analyzing Foreign Financial StatementsLanguageMany international companies do not produce financial statements in EnglishThe financial statement user could hire a translator or develop multilingual capabilitySince English is the language of business, companies in many foreign countries produce “convenience translations” of their financial statements in English10-9Potential Problems in Analyzing Foreign Financial StatementsCurrencyMany international companies produce their financial statements in a currency other than the U.S. dollarThese can be converted to U.S. dollars by translating all balances at the exchange rate at the end of the current yearIn order to avoid distortions, the current exchange rate should be used for all previous yearsAnalysis using ratios is not distorted by different currencies10-10Potential Problems in Analyzing Foreign Financial StatementsTerminologyDifferences in terminology exist between countries using the same languageFor example, “inventory” in the U.S. used to be called “stocks” in the U.KIn cases of convenience translations, sometimes these include terminology unfamiliar to English speakersKnowledge of the business and accounting environment, as well as a careful reading of the notes to the financial statements can help alleviate problems in understanding odd terminologyMuch of the U.S. and U.K. differences were removed in 2005 when the U.K. adopted IFRS10-11Potential Problems in Analyzing Foreign Financial StatementsFormatMost differences are not problematic because the information is given, just in a different placeHowever, other format differences are a problem because the information is not providedIt is common in Europe to not report the amount of cost of goods soldThis prevents an analyst from determining gross profit margin 10-12Potential Problems in Analyzing Foreign Financial StatementsExtent of disclosureDisclosure internationally tends to be limited compared to the U.S. where full disclosure is fundamentalSome of the most serious disclosure limitations are information on segments, asset valuation, foreign operations, interim statements, and reservesLack of disclosure contributes to the significance of format problemsGlobalization of capital markets tends to enhance disclosure as companies attempt to attract investors10-13Potential Problems in Analyzing Foreign Financial StatementsTimelinessAspect of the relevance of informationVaries significantly internationally since filing deadlines differ from country to countryRequirements about the frequency of information also vary internationally from quarterly to annual reportingThere is very little investors can do to overcome these problems10-14Potential Problems in Analyzing Foreign Financial StatementsDifferences in accounting principlesOften result in significantly different income and other financial statement amountsSome of the most troublesome areas are consolidations, fixed asset valuation, depreciation, and goodwillCause some investors to limit the scope of their investmentsSome investors attempt to reframe foreign financial statements to a more familiar GAAPAnother approach is to use a stripped down measure of earnings that excludes items most affected by diversity10-15Potential Problems in Analyzing Foreign Financial StatementsInternational Ratio AnalysisDifferences in culture and economic environments have an impact on the relevance of ratiosA study of companies in Japan, Korea, and the U.S. found significant differences due to business environmentJapanese and Korean companies borrow much more on a short-term basis than U.S. companies, leading to lower current ratiosDebt ratios also tend to be higher in Japan and Korea because of the sources of financingLower profit margins in Japan in 1978, relative to the U.S., can be partly explained by the Japanese companies having their focus on market share as opposed to profits10-16Restating Financial StatementsForm 20-FForeign companies that file non-U.S. GAAP financial statements with the SEC are required to complete a Form 20-F, with the exception of those that use IFRSReconciles net income and stockholders’ equity to U.S. GAAPHowever, there is no requirement to reconcile assets and liabilitiesIn essence, this represents a partial restatement from foreign GAAP to U.S. GAAP10-17Restating Financial StatementsForm 20-FSome ratios, such as return on equity, can be computed as if under U.S. GAAPMost other ratios cannot be computed as if under U.S. GAAPAnalysts can overcome this by performing the restatement of financial statement items10-18Restating Financial StatementsRestatement overview – Step one of twoReformattingInvolves transforming the financial statements into a U.S. formatOne part is transforming terminology differencesPresentation differences are also transformedItem definitions and classifications are transformedRestatement overview – Step two of twoInvolves restating the foreign GAAP amounts to U.S. GAAP amountsEasier when the company files a Form 20-FSometimes, companies will present a similar reconciliation without actually filing the Form 20-F10-19Restating Financial StatementsRestatement overview – Step two of twoNotes to the financial statements are very useful in completing this stepStep one mechanics – ReformattingBegin with a four column worksheet in U.S. GAAP formatColumns are Local GAAP, debits, credits, and U.S. GAAPAmounts are presented in the original currencyPrepare worksheets for income statement, statement of retained earnings, and balance sheetLine items in the worksheet are presented in the terminology of U.S. account titles10-20Restating Financial StatementsStep two mechanics – RestatingAffects the debit and credit columns in the worksheetThe nature of these entries is essentially adjusting and reclassification Some entries affect current net income or beginning retained earnings, while others affect bothEach entry reflects the adjustment needed to reconcile to U.S. GAAP from local GAAP10-21Restating Financial StatementsPartial example -- restated financial statementsAssume that the local GAAP column of the financial statements being restated has already been reformatted into the U.S. GAAP titles and amountsThese amounts include:Sales 2,000 Cash 500Cost of sales 1,100 Inventory 600SG&A expense 200 Deferred liability 50Other income 100 Pension liability 800Retained earnings (beg) 500 Retained earnings (end) 1,30010-22Restating Foreign Financial Statements to U.S. GAAPPartial example -- restated financial statementsUnder U.S. GAAP the current pension liability costs are 40 units higher and the beginning balance in pension liability is 100 units higherThese costs are accounted for as SG&A expenseCash realized of 20 units during the current year is considered a deferred liability under U.S. GAAP and is other income under local GAAP10-23Restating Foreign Financial Statements to U.S. GAAPPartial example -- Income statement Local U.S.U.S. Format GAAP Dr. Cr. GAAPSales 2,000 2,000Cost of sales 1,100 1,100Gross profit 900 900S,G,&A expense 200 40 240Other income 100 20 80Net Income 800 74010-24Restating Foreign Financial Statements to U.S. GAAPPartial example – Retained earnings statement Local U.S.U.S. Format GAAP Dr. Cr. GAAPR/E, beginning 500 100 400Net income 800 740R/E, ending 1,300 1,14010-25Restating Foreign Financial Statements to U.S. GAAPPartial example – Balance sheet Local U.S.U.S. Format GAAP Dr. Cr. GAAPCash 500 500Inventory 600 600 Deferred liability 50 20 70Pension liability 800 100 940 40 ...Retained Earnings 1,300 1,14010-26End of Chapter 1010-27