Understanding Company Financial Statements
a book by RH Parker
- members of a company are its owners (shareholders if a public company)
- annual report from the board of directors (agents) to the members
- audit: give an opinion to members on whether accounts show a fair and accurate view
- GAAP is prevalent in UK/US and anglo-saxon countries. EU has IASB
- GAAP accounts are not tax accounts, depreciation can be accelerated for tax to incentivize investment
- cash is not earning due to accrual accounting
US/UK GAAP objective is "fair and true" financial statements while tax might allow accelerated depreciation to incentivize investment, which is not prudent. Slower depreciation in GAAP also leads to deferred tax. In contrast, German accounting must follow tax accounting.
Revenue Recognition Rule - unearned revenue - lifo: less tax - fifo bigger inventory
- FAS123R: stock grant needs to be expensed in IS
- Impairment of Goodwill: exceptional adj to net income or buried in the SG&A
- earnings recognized in different tax jurisdictions can lead to any tax rate incl negative. -FASB142 goodwill depreciation is no longer done, ASC350 goodwill tested annually for impairment
Analysis of Statements:
- revenue growth
- expense growth
- operating income growth
- Cash growth
- Debt growth
Definitions proposed by the author:
- Payable turnover = net sales / avg(acct payable)
- Inventory turnover = COGS / avg(total inventory)
- Receivable turnover = revenue / avg(acct receivable)
- cash cycle = payable turnover + inventory turnover- receivable turnover
Alternatives of ROIC:
Author proposes the definitions below, without describing when one would be preferable to the other:
- ROIC = (net income-dividends)/(total capital)
- ROIC = nopat / adj assets
- nopat = net operating earning before amz, interest, after tax
- adj asset = asset - cash - (current liab - st debt and accrued liab)
International Financial Reporting & Analysis
a book by David Alexander, Anne Britton, Ann Jorissen
- shareholder-oriented accounting countries: US, UK, NL, Sweden, Australia, Canada
- Creditor-oriented accounting countries: Germany, France, Belgium, Italy, Spain, Portugal
Creditor-oriented accounts are more conservative. Shareholder accounts try to be more accurate/fair.
- Common law countries: England, Wales, US, Australia, Canada, Ireland, NZ, Singapore
- Code Law countries: Scotland, France, Germany, Belgium, NL, Portugal, Spain, JP
Code law countries' accounting practice follows the law prescriptions. Common law countries comply with the views of a professional body.
Accounting and taxation: Germany has Massgegeblichkeit Prinzip: Steurbilans = Handelsbilans.
- independent countries: Denmark, Ireland, UK, NL, CZ, PL
- dependent countries: Ge, Fr, Be, I
- power distance (professionalism vs statutory control, secrecy vs transparency)
- uncertainty avoidance (uniformity vs flexibility, conservatism vs optimism)
Credit financing means internal access and less disclosure.
Leases is shown on BS in UK/US but not in France Consolidation rules were formalized in the late 20th century for the EU.
Accounting Theory usually follows basic principles but can be normative/positive as for the Rochester School.
Assumption: - accrual basis - going concern Qualitative Characteristics: - understandable - relevant - material - reliable
- Cashflow statements IAS7 required by IFRS only since 92
- Leases IAS17 , Capitalize leases has economic consequences
- Currency: IAS21 functional vs presentation currency
- Pension: IAS 19
- Intangible/Goodwill: IAS38
Comparative International Accounting
A book by Christopher Nobes and Robert Parker
IFRS allows convergence in EU, while US and UK had a GAAP, there is no anglo-saxon group, with UK GAAP more similar to German than US.
- Europe decided to converge as part of their plan to have freedom of movement of capital, goods and persons
- Eastern blocks: command economy, standard statement of account, accounting degenerated to bookkeeping due to low accountability w.r. to productivity/profitability. Countries had more reliance to credit like Germany even pre-communism.
- Japan was following German accounting with Japan-specific adaptations. Accountants are low status
- China went from command-style accounts to GAAP to list on US exchange or IFRS.
- NL wanted to take into account inflation whereas Germans did not want to.
IAS21 is the result of a decision to converge to US GAAP FAS52 even though the framework is inconsistent. FAS52 was very controversial due to its inconsistency. It replaced FAS8 which was consistent but prescribed the major balance sheet movements due to different fx dates used by the temporal method to be recognized in comprehensive income. IAS21 uses the closing rate for BS translation, but with the oddity that IS is using average period fx (hoping to get back the same IS as in the foreign currency), even for depreciation. FAS8 as per the ivory tower recommendation by Lorensen 72, had some internal consistency but gave numbers too big, FAS52 numbers just don't relate properly.
"The fundamental problem is that exchange rate moves are linked to price changes. As accounting ignores the latter, any measurement of the former creates difficulties".
A cleaner method is to measure only the net equity of the subsidiary and include it in BS instead of consolidating the accounts, but that goes against the rule on consolidating.
An extreme case for this is Polly Peck a 40y old fashion brand that was bought in 1980 by a Cypriot and rose from a market capitalization of GBP 300k to 1.7bn in 10 years. It then collapsed in 1990 among rumours of accounting fraud, having invested in bank deposits in Turkey which led the company to paint a rosy picture of accrual profits on its deposits while it was losing money due to the Turkish Lira devaluation.
IAS21 prescribes to switch to the parent currency if the currency has hyperinflation, defined as inflation greater than 100% in 3 years.
Focus On Value
a book on firm valuation by James Grant. The goal of valuation (for management decisions or for external investors) is:
- assess whether the company generates a good return on existing assets
- examine risk to value relation in a Cost of Capital framework
- invest positively for economic profit growth
- understand the magnitude of external influence
- reconcile market with fundamental expectations of economic profit growth
Few frameworks are used internally:
- Economic Value Added
- Risk Adjusted ROCE
- Shareholder Value Added