International Accounting Differences

INTERNATIONAL ACCOUNTING DIFFERENCES

International accounting differences pose a number of problems from a financial analysis perspective:

1. In attempting to value a foreign corporation, there is a tendency to look at earnings and other

financial data from a home country perspective - leads to the potential of overlooking the

effects of accounting differences.

2. An awareness of international differences suggests the need to become familiar with foreign

accounting principles in order to better understand earnings data in the context in which such

measures are derived.

3. Issues of international comparability and accounting harmonization become highlighted in the

context of considering alternative investment opportunities.

Module 1 – International Financial Statement Analysis Page 2

MAJOR DIFFERENCES IN ACCOUNTING PRINCIPLES AROUND THE WORLD

1. Conservative application of historical cost generally required in Germanic, Latin, and Asian

countries

2. More flexible approach to valuation in the UK and the Netherlands

3. Depreciation in the Anglo-Saxon and Nordic countries is based on useful economic life

compared to tax rule factors in Germanic, Latin, and Asian countries

4. Inventory measurement is generally based on the principle of "lower of cost or market" but with

some variation as to the meaning of market

5. Construction contracts are generally accounted for by using the percentage of completion

method in Anglo-Saxon and Germanic countries

6. Research and development costs are usually expensed immediately in the Anglo-American and

Germanic countries

7. Retirement benefits usually based on accrued or projected benefits with pay-as-you-go common

in Latin and Asian countries

8. Strong tax influence on accounting in Germanic, Latin and Asian countries

9. Treatment of business combinations varies but more flexible approach to goodwill in Anglo-

Saxon, Nordic and Germanic countries

10. Intangibles – generally a flexible approach for capitalization

11. Foreign currency transactions – generally flexible approach with actual or average rates

QUANTITATIVE ANALYSIS OF ACCOUNTING PRINCIPLE DIFFERENCES

1. See "conservatism" index

a. Using US vs. UK GAAP, a value greater than one implies greater US conservatism

b. A value of less than one implies less US conservatism

c. A value equal to one indicates neutrality

2. Can easily be computed for British firms that list in the US because they are required to provide

a reconciliation to US GAAP

a. Form 20-F contains a reconciliation of British earnings to US earnings with a

quantification of each accounting policy

b. Form 20-F is also required for firms that sponsor an American Depository Receipt (ADR)

which is traded on a US national stock exchange (e.g., NASDAQ)

3. A comparable income base between US and UK firms is difficult to establish due to the

treatment of extraordinary items, though this problem has recently been virtually eliminated

4. A study by Weetman and Gray (1998) show that earnings by UK firms are more conservative

under US than UK GAAP

a. Major study factors are goodwill amortization and deferred tax – exhibit 5.6

b. The most important factor is goodwill but the study is now dated because recent US

FASBs eliminated goodwill amortization

c. The index of conservatism can be applied to income as a whole or to individual items to

see which has the greatest impact

d. See exhibit 5.7; the largest category of British firms had profit 10% or more above US

profit

Module 1 – International Financial Statement Analysis Page 3

RATIO ANALYSIS

Ratios of key items on the financial statements are calculated to determine such things as rate of return,

riskiness, and the ability to pay debts (liquidity).

Two popular ratios that provide the investor with information as to the rates of return on a particular

investment are earnings per share and return on investment. Earnings per share give the investor an

indication of the earnings attributable to each share of stock and are calculated as:

=

Net income accruing to common stock

Total shares of common stock outstanding

Return on investment indicates how efficiently capital has been employed by the company. Investment

may be defined as total assets or owner's equity.

=

Net income

Owner sequity

=

Net income

Total assets

The ratios used to indicate liquidity and risk are the current ratio and the debt-to-equity ratio. The

current ratio indicates the company's ability to pay its short-term creditors with its most liquid assets,

the current assets.

=

Current assets

Current liabilites

The debt-to-equity ratio provides the investor with another indicator of the relative risk of this

investment.

=

Total liabilities

Owner s equity

Asset turnover is a financial ratio that measures the efficiency of a company's use of its assets in

generating sales revenue or sales income to the company.

=

Sales

Average Total Assets

"Sales is the value of "Net Sales" or "Sales" from the company's income statement

"Average Total Assets" is the average of the values of "Total Assets" from the company's balance sheet

in the beginning and the end of the fiscal period

Module 1 – International Financial