Global Financial Reporting and Analysis

(1)

1

Global Financial Reporting and Analysis

1.2. International Differences

International Differences – Culture (Hofstede, 1980) Four basic dimensions of culture

1. Large versus small power distance: Hierarchy in organisations and institutions

 Power distance is the extent to which the members of a society accept that power in institutions and organisations is distributed unequally.

 People in societies that have large power distance accept a hierarchical order in which everybody has a place which needs no further justification.

 Malaysia is ranked first, while Austria is ranked last. Australia is around the middle.

 The fundamental issue addressed by this dimension is how society handles inequalities among people when they occur.

2. Strong versus weak uncertainty avoidance: Dealing with ambiguity

 Uncertainty avoidance is the degree to which the members of a society feels uncomfortable with uncertainty and ambiguity.

 Societies with strong uncertainty avoidance maintain rigid codes of belief and behaviour and are intolerant towards deviant persons and ideas.

 Weak uncertainty avoidance societies have a more relaxed atmosphere in which practice counts more than principles and deviance is more easily tolerated.

 Greece is ranked first, while Singapore is ranked last. Australia is around the middle.

 An issue addressed by this dimension is how a society reacts to the fact that time runs only one way and that the future is unknown: whether it tries to control the future or lets it happen.

3. Masculinity versus femininity: Personal preferences

 Masculinity stands for a preference in society for achievement, heroism, assertiveness and material success.

 Its opposite, femininity, stands for a preference for relationships, modesty, caring for the weak and the quality of life.

 Japan is ranked first, while Sweden is ranked last. Australia is more masculine.

4. Individualism versus collectivism: Degree of interdependence

 Individualism means a preference for a loosely knit social framework in society wherein individuals are supposed to take care of themselves and their immediate families only.

 The fundamental issue addressed by this dimension is the degree of interdependence that a society maintains among individuals.

 United States is ranked first, while Guatemala is ranked last. Australia is more individualistic.

International Differences – Culture (Other Dimensions)

 Long‐term Orientation

 Humane Orientation

 Assertiveness

 Gender Egalitarianism

 Performance Orientation

 Gray (1988) developed the following pairs of contrasting ‘accounting values’:

 Professionalism versus statutory control (relates to authority and enforcement);

 Uniformity versus flexibility (relates to measurement and disclosure);

 Conservatism versus optimism;

 Secrecy versus transparency International Differences – Legal Systems

 Common Law v Code Law

 Differences? (case law v statute)

 Impact on Accounting rules?

 Financial reporting practices?

 Principles based versus Rules based

 True and fair view versus Accounting Standards

(3)

20 Reasons for harmonisation

 Preparers of Financial Statements

 Company

 Accountants

 Users of Financial Statements

 Investors

 Financial analysts

 Regulators

 Government

Which parties stand to gain from the international harmonisation of accounting? What have they done to achieve it?

Benefits of accounting information What have they done?

Preparers - Cheaper – preparers only need to prepare 1 FS

- Skills – transferable across nations

- Lobbying government - Donated to the IASB

Users - Comparable - Lobbying government

Regulators - Comparable - Donated to the IASB

 The pressure for international harmonization comes from those who use, regulate and prepare financial statements.

 Investors and financial analysts need to be able to understand the financial statements of foreign companies whose shares they might wish to buy.

 They would like to be sure that statements from different countries are reliable and comparable, or at least to be clear about the nature and magnitude of the differences.

 They also need confidence in the soundness of the auditing.

 For this reason, various intergovernmental transnational bodies are interested, among other things, in protecting investors within their spheres of influence.

 Also, in cases where foreign shares are quoted on a stock exchange, that stock exchange or its regulator may demand financial statements that are consistent with domestic practices or IFRS.

 In addition, those companies that wish to issue new shares more widely than on their domestic markets will see the advantages of harmonized practices in the promotion of their issues.

 International credit grantors such as the World Bank also face the difficulties of international comparison.

 These pressures will also be felt by companies that do not operate multinationally.

 However, for multinationals, the advantages of harmonization are much more important.

 The great effort of financial accountants to prepare and consolidate financial statements is much simplified if statements from all round the world are prepared on the same basis.

 Similarly, the task of preparing comparable internal information for the appraisal of the performance of subsidiaries in different countries is made much easier.

 Many aspects of investment appraisal, performance evaluation and other decision-making uses of management accounting information benefit from harmonization. The appraisal of foreign companies for potential takeovers is also greatly facilitated. Multinational companies also find it easier to transfer accounting staff from one country to another.

 Above all, if accounting can be made more comparable and reliable, the cost of capital should be brought down by reducing the risk for investors.

 A third group involved in harmonization are the international accountancy firms.

 They support harmonization partly because it is good for their large clients.

 Also, the tax authorities throughout the world have their work greatly complicated, when assessing foreign incomes, by differences in the measurement of profit in different countries.

 Governments in developing countries might find it easier to understand and control the

operations of multinationals if financial reporting were more uniform, particularly as this would imply greater disclosure in some cases.

(4)

34 International Financial Analysis (IFA)

 IFRS – standardisation of Accounting Standards

 Remaining issues:

1. Foreign language and foreign currency 2. Reliability of financial information 3. Ratios in international analysis

4. Financial analysis and the capital market IFA – 1. Foreign Language and Currency

 Common disclaimers

 The English text is a translation of the German original. If the texts differ, the German report takes precedence (Carl Zeiss Annual Report 2011)

 Clariant International Ltd published Annual Reports in English and German. The English version is legally binding.

 “Convenience translations”

 Foreign currency translations

 Presentation issues not transactions Foreign language

 Some companies publish annual reports in more than one language.

 It is common for listed Chinese and Japanese companies to publish reports in English.

 Sometimes, these ‘convenience translations’ are not exact translations of the originals.

Foreign currency

 That is, annual reports are presented in different currencies.

 Some companies publish ‘convenience currency translations’.

 For example, some Japanese companies publish their financial statements in US dollars as well as Japanese yen. Generally, they use the spot rate at the balance sheet date, but some use the average for the year.

 Of course, the great majority of companies show figures in one currency only.

 So, analysts have to make their own choices of rates at which to translate numbers in order to make international comparisons.

IFA – 2. Reliability of Information

 Financial information from different jurisdictions

 Legal system

 Enforcement

 Minority shareholders’ rights Is financial information reliable?

 A key issue in international financial analysis is whether or not the information in financial reports is equally reliable in different jurisdictions.

 When laws and standards are weak or their enforcement is lacking, this gives managers opportunities to mask their firm’s economic performance, either upwards or downwards, by overstating earnings and assets in order to conceal unfavourable circumstances or by understating them in order to create reserves that will cushion future costs.

 Investor protection laws are important in this respect.

 These enable shareholders to hold managers accountable for their actions, at least by forcing them to communicate poor results fully in current earnings.

 In highly competitive circumstances, it is not surprising that managers might try to defer loss recognition to future periods, because in the long run this will shift the consequences on to subsequent generations of managers beyond their own tenure.

(5)

35

 So, strong investor protection tends to make earnings lower, because losses have to be recognized immediately whereas gains are recognized only when they are realized.

 The protection of minority shareholders can also have an impact on the quality of reported financial results.

 In firms with closely held shares, the interests of the managers and the majority shareholders are likely to be aligned and the shareholders will not necessarily rely on financial reporting in order to monitor the managers, as they have access to sources of information within the firm.

 Also, if the managers and controlling owners are able to dominate the firm, they will have incentives to conceal their own benefits, especially if these have a negative effect on the minority shareholders and other parties.

 Indeed, such managers are likely to use earnings management to conceal the firm’s performance from outsiders, especially by overstating earnings in a way that hides unfavourable losses that would prompt outside interference.

IFA – 3. Ratios

 Effect of different accounting rules on ratios

 “Options” – LIFO, capitalisation of development costs

 ROA, ROE, EBIT, EBITDA, Leverage, Gearing

 Debt covenants

 Ratio calculations by companies

 “Key performance indicators” published by companies

 Non-GAAP measures

Ratio analysis in an international context

 Whenever an international accounting difference is mentioned, one important question to think about is: why does this matter? One answer might be the effect on ratios.

 For example, the use of LIFO for inventory valuation can have a large effect on balance sheets.

The significance of this can be gauged by calculating the effect on profitability (return on assets) ratios, gearing/leverage ratios or liquidity ratios.

 Many companies try to help analysts by publishing ratios and ‘key performance indicators’. Often, companies also disclose ‘non‐GAAP’ measures of earnings and other accounting numbers.

 However, there are no internationally (or even nationally) agreed definitions of any of these things. Therefore, users of financial statements need to be especially careful when making international comparisons.

IFA – 4. Financial Analysis and the Capital Market

 Cross‐listed firms

 Voluntary disclosures

 Potential investors

 Interpretation of financial information

 “value relevance”

 Perceived ‘international differences’

 Still applicable?

Financial analysis and the capital market

 Choi and Levich (1990) reported that companies made many voluntary disclosures in order to assist cross‐border analysts.

 In the end, though, they suggested that some investors avoided certain foreign countries because of difficulties in interpreting the financial statements.

 An alternative to that extreme approach is to adjust accounting data to a common benchmark.

A few companies provide data adjusted for presentation (e.g. Japanese convenience translations) or for measurement issues (e.g. reconciliations to US GAAP).

(6)

36

 The relevance of financial disclosures, and corporate earnings in particular, to share price movements appeared to vary from one stock market to another.

 Research by Joos and Lang (1994) considered the effect of the EU accounting Directives on the relationship between earnings and stock prices, investigating other indicators as well, such as return on equity, the price to earnings multiple and the book to market ratio.

 All these authors report no evidence of convergence in the value relevance of earnings and other accounting numbers after the implementation of the Directives into national legislation.

 The value relevance of accounting information (the extent to which financial statements are useful to investors in understanding share prices) has also been linked to institutional conditions in the jurisdiction in which the reporting entity is based.

 In this context, before the switch to IFRS, Ali and Hwang (2000) suggested that analysts should look for the ‘usual culprits’ when asking whether financial disclosures are likely to be less relevant to investors in a particular country.

 Timeliness and conservatism are two of the key properties of accounting numbers that have been thought to differ between accounting regimes (Pope and Walker, 1999).

 Timeliness is the extent to which current accounting income incorporates economic income, which can be proxied by the change in market value of equity. Conservatism is defined as the extent to which losses are recognized more quickly than gains, i.e. that unrealized decreases in asset value are written off immediately whereas unrealized gains are not recognized.

 Foreign firms that cross-list in the USA show more evidence of earnings management, and less evidence of the timely recognition of losses, than their counterparts in the USA.

IFRS – the Conceptual Framework Purpose?

 Standard‐Setters

 Guide for setting accounting standards

 Definitions and purposes of financial reporting

 Preparers

 Interpretation of accounting standards

 Choice of options

 Accounting policies

 Latest Exposure Draft (ED) – December 2015

 Since May 2016, the Board is redeliberating and aims to finalise the revised Conceptual Framework in early 2017 (IFRS website)

 “Summary of Tentative Decisions” – June 2017

 Revised Conceptual Framework to be published around the end of 2017

 Objective of GPFR

 Give useful information to various users in order to improve their financial decisions IASB/FASB Quality

(7)

59

Political Lobbying of the IASB Article: Hansen (2011)

 What is the paper about (i.e. research question)?

 What characteristics of lobbyists and lobbying behaviour are associated with lobbying success?

 Hypotheses regarding the associations between attributes of lobbyists and their lobbying activity, and their lobbying success.

 Who are the lobbyists? Where are they from?

 Lobbyists: all parties who submit a comment letter in response to IASB exposure drafts.

 Hypotheses?

 Information hypothesis: Lobbying success is positively associated with the ability of lobbyists to transfer information to the IASB.

 The association between lobbying success and the information contained in lobbyists’

comment letters will be weaker for less credible lobbyists.

 Viability hypothesis: Lobbying success is positively associated with the ability of the lobbyist to impact the viability of the IASB.

 A primary factor in lobbyist success is the ability to contribute to the financial and operational viability of the regulator.

 Findings?

 Information hypothesis: I find that the association between each lobbyist’s desired position and his/her outcome is positively related to the quality of information included in their comment letter. This positive relationship, however, hinges on the credibility of the lobbyist.

 Information hypothesis: I find no evidence that lobbying success is associated with the number of board members from the lobbyist’s home country. However, additional testing indicates that board members are more likely to voice a dissenting vote when the final standard is contrary to the preferences of lobbyists from their home country.

 Viability hypothesis: I also find that lobbying success is positively associated with contributions to the IASCF and with the size of the capital market in the lobbyist’s home country. I interpret these relationships to indicate that lobbying success is associated with the ability of lobbyists to impact the viability of the IASB.

 Implications (the ‘so what’ question)?

 Information hypothesis dominates the viability hypothesis when lobbying is most crucial (i.e.

when lobbyists disagree with the standard-setters’ original position).

Global Financial Reporting and Analysis