International Accounting, 6/e
Frederick D.S. Choi
Gary K. Meek
Chapter 9: International Financial
Statement Analysis
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Learning Objectives
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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?
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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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International Business
Strategy 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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International Business
Strategy Analysis (contin)
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Difficulties in undertaking an IB business
strategy analysis
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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
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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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How Does Diversity in
International Accounting Impact
Financial Statement Analysis?
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Measurement differences within and between
countries make performance comparisons difficult.
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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)
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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
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For measurement differences:
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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)
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For disclosure differences:
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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)
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For audit differences:
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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
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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
country complicating appropriate corporate valuations.
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Pitfalls in Conducting
International Ratio Analysis
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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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Pitfalls in Conducting International
Ratio Analysis (contin)
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Examples of environmental differences:
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Government systems
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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
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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)
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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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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)
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