solution manual chapter 9 financial issues

8/10/2019 Solution Manual Chapter 9 Financial Issues

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Chapter 09 - Analysis of Foreign Financial Statements

CHAPTER 9ANALYSIS OF FOREIGN FINANCIAL STATEMENTS

Chapter Outline

I. Reasons to analyze financial statements of foreign companies include: making foreign portfolio investment decisions,

making foreign merger and acquisition decisions,

making credit decisions about foreign customers,

evaluating foreign suppliers, and

benchmarking against foreign competitors.

II. There are several problems an analyst might encounter in analyzing foreign financialstatements, including:

finding and obtaining financial information about a foreign company,

understanding the language in which the financial statements are presented, the currency used in presenting monetary amounts,

terminology differences that result in uncertainty as to the information provided,

differences in format that lead to confusion and missing information,

lack of adequate disclosures,

financial statements are not made available on a timely basis,

accounting differences that hinder crosscountry comparisons, and

differences in business environments that might make ratio comparisons meaninglesseven if accounting differences are eliminated.

III. !ome of the potential problems can be removed by companies through their preparation ofconvenience translations in which language, currency, and perhaps even accountingprinciples have been restated for the convenience of foreign readers.

I". # significant number of investors find that differences in accounting practices acrosscountries hinder their financial analysis and affect their investment decisions. !omeanalysts cope with this problem by restating foreign financial statements to a familiarbasis, such as $.!. %##&.

#. #nother coping mechanism is to base analysis on a measure of performance fromwhich many accounting issues have been removed, such as '(IT)#.

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". #nalysts should e*ercise care in interpreting ratios calculated for foreign companies.+hat is considered to be a good or bad value for a ratio in one country may not be inanother country.

#. inancial ratios can differ across countries as a result of differences in accountingprinciples.

(. inancial ratios also can differ across countries as a result of differences in business

and economic environments. -ptimally, an analyst will develop an understanding ofthe accounting and business environments of the countries whose companies theywish to analyze.

"I. To facilitate crosscountry comparisons of financial information, foreign company financialstatements can be restated in terms of a preferred %##& through the use of areconciliation worksheet in which debitcredit entries summarizing the differences in %##&are used to ad/ust the original reported amounts.

#. #ll income differences also affect stockholders0 equity through retained earnings.(. In addition to ad/ustments resulting from differences in %##&, an ad/ustment also will

be needed for the deferred ta* effect of the aggregate difference in preta* income.

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Answers to uestions

1. Investors can diversify their risk by including shares of foreign companies in their investmentportfolio. 2orrelations in the returns 3increases and decreases in stock prices4 earnedacross stock markets are relatively low. The high degree of independence across capitalmarkets affords investors diversification opportunities.

5. ord might want to include the following companies in a benchmarking study:$.!. 6 %eneral 7otors, 2hrysler8apan 6 9onda, Toyota, issan, !ubaru%ermany 6 )aimler, (7+, "olkswagen, #udi;orea 6 9yundai, ;iarance 6 Renault, &eugeot


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Timeliness is also a function of how often companies must prepare financial statements.+hereas the $.!., 2anada, and the $.;. require publication of quarterly reports, the'uropean $nion requires only semiannual reporting, and annual reporting only is the normin many countries.

B. The advantage of using a measure such as '(IT)# to compare profitability of companies

across countries is that differences in accounting for interest 3I4, ta*es 3T4, depreciation 3)4,and amortization 3#4 across countries do not affect the profitability measure. Thedisadvantage is that these e*penses might be important in evaluating profitability and indetermining the value of the firm.

1C. The different features that might be DtranslatedE in a convenience translation are: Fanguage,

2urrency, and

%##&.The most common type of convenience translation is a language translation only. '*hibitsB


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E!!e"t o! "onser#atis$ on Return on E%uit&'

Return on 'quity G et Income H

#verage Total 'quity

(ase "ase'Year ) Year * Year )+ Year ,+ Year -+

(eginning equity 1,CCC 1,=CC 1,BCC 5,BCC =,BCC

#nnual income 1CC 1CC 1CC 1CC 1CC

o dividends

'nding equity 1,1CC 1,>CC 5,CCC ,CCC

et Income 1CC 1CC 1CC 1CC 1CC

#verage Total 'quity 1,C>C 1,=>C 1,B>C 5,B>C =,B>C

B.>5 ?.BC >.1


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1


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Solutions to E4er"ises an/ Pro0le$s

)5 Ar"ot Co$pan& 6Cal"ulatin7 ratios !ro$ Lo"al GAAP an/ .5S5 GAAP state$ents8

Ratio For$ulaLo"alGAAP a5)5

.5S5GAAP a5, 05 3 2i!!5

2urrent ratio 2# B,@@A B,B??

2F 5,BAC


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,5 China Petroleu$ Che$i"al Corporation 6Sinope"8 6Co$parison o! ROE un/er/i!!erent a""ountin7 rules8

A""ountin7 Rules

PRC IFRS .5S5 GAAP

&rofit, 5CC? >C,??= >>,=CA >=,A?5Total equity, 15=,A@> 5?5,5B@ 5?5,5B@

Total equity, 15 51>,?5< 555,AC< 555,AC>C 5=5,>>C

IFRS:PRC .5S5:PRC .5S5:IFRS

a. difference in profit B.= A.


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;5 SA( Miller PLC 6Sto", !tatement of changes in shareholders0 equity, provides the followinginformation about the D7erger relief reserve.E

Merger relief reserveIn accordance with section 131 of The Companies Act 1985, the group recordedthe US$3,395 miion e!cess of "aue attri#uted to the shares issued asconsideration for ier %rewing Compan& o"er the nomina "aue of thoseshares as a merger reief reser"e in the &ear ended 31 arch '((3)

Thus, Dmerger relief reserveE appears to be Dadditional paidin capital in e*cess ofpar valueE resulting from the issuance of shares to effect a business combination.

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-5 (a0"o"< International 6Re!or$attin7 o! 0alan"e sheet8

(a0"o"< International

(alan"e Sheet

As at ;) Mar"h ,++>

Assets ?$

2ash

Receivables B.5 No#artis Group 6ShareB0ase/ "o$pensation8

a5 The amount of e*pense related to sharebased compensation under IR! was $!) >million less than would have been recognized under $.!. %##&. The entry to ad/ust toa $.!. %##& basis would be as follows:

)r. '*pense 3P '*p " -I, !'4 O> million 2r. &aidin capital 3P !'4 O> million

In addition, $!) 1A? million that was recognized as equity under IR! would have beenrecognized as a liability under $.!. %##&. The entry to ad/ust to $.!. %##& would havebeen:

)r. &aidin capital 3 !'4 O1A? million2r. Fongtem liabilities 3P F4 O1A? million

The company does not provide information whether this ad/ustment affects currentliabilities, longterm liabilities, or some combination of the two. This solution assumes

that it affects longterm liabilities only.

The difference in accounting for sharebased compensation causes income and equityto be smaller and liabilities to larger under $.!. %##&. There is no effect on assets.

b. Ratio 3under $.!. %##& rather than IR!4 $nder $.!. %##&2urrent ratio 32#2F4 o effectK)ebt to equity ratio 3TFT!'4 S 9igher Total asset turnover 3salesaverage T#4 o effect&rofit margin 3Isales4 !maller Return on equity 3Iaverage !'4 FargerKK

where: G no effect, G decrease, S G increase

K The company does not provide sufficient information to determine whether thead/ustment to $.!. %##& affects current liabilities, longterm liabilities, or both.

#ssuming only longterm liabilities are affected, there would be no effect on the currentratio.KK (oth net income and average stockholders0 equity are smaller under $.!. %##&. (utthe decrease in stockholders0 equity is much larger than the decrease in equity: $!)1A1 million vs. $!) > milliion. #s a result, return on equity is larger under $.!. %##&.

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5 Ga$$a Hol/in7s ND 6Pro#isions8

a5 &ercentage growth inIncome before ta*: >),3L3=C.? 6 >.C4>.CM.&ercentage growth in net income: );9++3L35A.C 6 C.54C.5M.

These are e*tremely high percentage changes.

05 &rovisions are estimated, accrued liabilitiesJ recognition of a provision increasesliabilities and e*penses. Increasing a provision causes a decrease in net income.

"5 &rovisions are increased at the time that 3a4 an accrued liability is recognized 3increaseprovision, increase e*pense4. 3ote: !ome companies will intentionally overstate aprovision to create Dhidden reservesE of income that can be reported in a later year.4&rovisions are decreased when 3b4 the liability provided for is paid 3decrease provision,decrease cash4, or 3c4 the accrued liability is determined to have been overstated andthe provision is reversed 3decrease provision, increase revenue4. Reversing thepreviously recognized provision 3releasing Dhidden reservesE to income4 is a methodused in income smoothing, sometimes known as Dcookie /ar accounting.E The ending

balance in provisions increases when 3a4 U 3b4 P 3c4, and decreases when 3a4 V 3b4 P 3c4.

/5Cal"ulation o! "han7e in other pro#isions ,++ ,++* ,++-

'nding balance in other provisions 5?.<


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)+5 Neopost SA 62e#elop$ent "osts8

a5 Cal"ulation o! a#era7e e4pe"te/ use!ul li!e o! /e#elop$ent "osts

2e#elop$ent "osts ,++> ,++

(eginning gross value =@.<


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2apitalization of development costs results in a slightly higher profit margin in both 5CC?and 5CC@.

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05 Esti$ate sustaina0le in"o$e

(abcock reports profit for the year 5CC@ of X=>.5, but this includes several items that arenonrecurring 3and therefore not part of sustainable income4 and are given specialpresentation in the income statement.

irst, the loss for the year from discontinued operations is reported separately fromDprofit for the year from continuing operations.E (y definition, this loss is not going torecur and would be e*cluded from the estimate of sustainable income.

!econd, amortization of intangibles and e*ceptional items are reported in a separatecolumn of the income statement, which suggests that these are Dspecial itemsE 3the labelDe*ceptionalE reinforces this supposition4. To determine whether these Dspecial itemsEare nonrecurring and therefore should be e*cluded from the estimation of sustainableincome, it is useful to read the relevant note 6 Dote >. -perating e*ceptional items andacquired intangible amortisation.E

ote > indicates that the total amount of Dspecial itemsE of X>.> is comprised of the

following:Intangible amortization e*pense X3?.14et gain related to pensions .>

There is no indication that the intangible amortization e*pense is unique to 5CC@ and willnot recur. There is limited information on the net gain related to pensions 3ote >indicates it is related to a Dliability limitation e*erciseE4. %iven that it is labeled anDe*ceptional item,E it appears that this is a nonrecurring gain. Reorganization costs alsoare described as De*ceptionalE and appear to be nonrecurring.

(ased on the presentation of information on the income statement and the information inote >, the following would be a reasonable estimate of sustainable income for 5CC@:

&rofit for the year X=>.5#dd: Foss for the year from discontinued operations C.A&rofit for the year from continuing operations X=?.C!ubtract: et gain related to pensions 3


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)-5 Ar"ot Co$pan& 6Restate$ent o! !inan"ial state$ents Year )8

Re"on"ilin7 Entries

L1M Inventory indirect costs)r. Inventories ?C

2r. 2ost of goods sold ?C

L5M Revaluation of property, plant, and equipment)r. Revaluation reserve 5CC

2r. &roperty, plant, and equipment 5CC

L

2r. Interest e*pense 1>

L=M )eferred charges)r. -perating e*penses 3preopstartup costs4 5=

2r. )eferred charges 5=

L?M %overnment grants)r. Revenue


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orTotal asset turnover C.=< C.= C.A@

Times interest earned 1=.?B 1?.=.@ 5?.


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or


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)*5 Ar"ot Co$pan& 6Restate$ent o! !inan"ial state$ents Year ,8

Re"on"ilin7 Entries

L1M Inventory indirect costs)r. 2ost of goods sold =1

Inventories 1B2r. Retained earnings, 11Y5 ?C

L5M Revaluation of property, plant, and equipment)r. Revaluation reserve 5CC

2r. &roperty, plant, and equipment 1?C -perating e*penses 3depreciation4 =C

L

L=M )eferred charges)r. -perating e*penses 3preopstartup costs4 1A

Retained earnings, 11Y5 5=2r. )eferred charges


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or

Times interest earned 5>.B 5@.?

et profit margin 5?.@ 5>.B

-perating profit margin


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or


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Case 9B) Swiss"o$ AG

Re"on"ilin7 A/ust$ents

2e0it Cre/it

a. &roperty, plant and equipment >=)epreciation and amortization >

Interest e*pense 1

c. )epreciation and amortization >

&roperty, plant and equipment >

d. -ther noncurrent assets =@>

)epreciation and amortization 1AA

%oods and services purchased C

'quity in net loss of affiliate >C

Total BA5 BA5

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orA=

-ther operating e*penses 5,CBC 5,CBC

)epreciation and amortization 1,@ a 1,B c

1AA d

Restructuring charges 1,@5? 5C> b 1,>51

Total operatin7 e4penses 9+* 9-,

Operatin7 in"o$e ;)- 9)

Interest e*pense 3=5A4 1< a 3=1>4

inancial income 5> 5>

In"o$e 6loss8 0e!ore in"o$e ta4esan/ e%uit& in net loss o! a!!iliate/"o$panies 698 ;+)

Income ta* e*pense 1 1

In"o$e 6loss8 0e!ore e%uit& in netloss o! a!!iliate/ "o$panies 69+8 ;++

'quity in net loss of affiliated companies 34 >C e 35@>4

Net in"o$e 6loss8 6-)*8 ,*

Consoli/ate/ Ret Earnin7s State$ent

Retaine/ earnin7s ):):9> 6)*)8 =? a )

5B< d

et loss 3=1>4 5>

&rofit distribution declared 31,5A54 31,5A542onversion of loan payable to equity


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6)8 6,8 6;8 6-8

ReconcilingAdjustments

IFRSs 2e0it Cre/it Note.5S5

GAAP

Consoli/ate/ (alan"e SheetAssets

Current assets

2ash and cash equivalents 5>? 5>?

!ecurities available for sale >1 >1

Trade accounts receivable 5,C>5 5,C>5

Inventories 1?B 1?B

-ther current assets < >= a 11,?CB

1C@ b

> c

Investments 1,5C e 1,5AA

-ther noncurrent assets 55C =@> d ?B>

Total nonB"urrent assets ),9)) );*9,

Total assets )*->; ))*-

Lia0ilities an/ sharehol/ers@ e%uit&

Current lia0ilities

!hortterm debt 1,1@A 1,1@A

Trade accounts payable AAB AAB

#ccrued pension cost @AB @AB

-ther current liabilities 5,51< 5,51

solution manual chapter 9 financial issues

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