ifrs2nd ed financial statement project r10 a

7/31/2019 IFRS2nd Ed Financial Statement Project r10 A

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IFRS Team Project-- financial statement disclosures and financial statement analysis

Spring 2010

Wayne G. Bremser, PhD, Professor of Accountancy

Second edition

PROJECT LEARNING OBJECTIVES:

The project’s primary objective is to enhance students’ depth of understanding of IFRS

financial statements. Student teams are required to compare annual reports and major

accounting policies of a U.S. firm and a foreign firm that uses IFRS. These two firms must

be in the same industry. A second objective is to enhance student competencies in financialstatement analysis techniques and extend them to IFRS firms.

COMPANY SELECTION

Your team will select a European firm to study IFRS in depth. For comparison with US

GAAP purposes, you will also select a publicly traded U.S. company in that industry thatcompetes with the European firm in some market segments. You will select a IFRS

comparison firm in the same industry to be used as benchmark for analyzing the financial

statements (a high performing IFRS competitor). Try to select a firm that has research anddevelopment costs.

You should seek the professor’s approval before proceeding with a detailed analysis.

• Select European firms that filed a SEC 20F reconciliation with U.S. GAAP in 2006

and 2005. See the 20F list on the course website and the list of firms to be excluded. Youshould select a firm that had a net income difference of at least 10% in one of those years.

In selecting the IFRS firms, there are advantages to identifying interesting accounting policy comparisons. Several areas of potentially significant IFRS differences from USGAAP exist. You will want to have some of them in the IFRS firm you select.

• It is helpful if the company you select is not too diversified across industry

segments as this makes the identification of a competitor or industry benchmark difficult.• Companies that have engaged in significant merger, acquisition or divestiture

activity are a challenge to analyze.

• Select a company that has operated at a profit in at least 3 of 5 of the most recent

years. There are advantages to selecting firms that have at least three analysts’ earningsforecasts available and the average rating should be hold or better. There are advantages to

selecting a US firm that is an industry leader in the USA.

• Financial statements and the 20F can be downloaded from the SEC's Edgar Database found on the SEC’s website at www.sec.gov. Most companies have their annual

reports available on their web sites.

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ANALYSIS MODEL

The goal of financial statement analysis is to answer specific questions. For example,should you invest in the company or not? If you own the stock, should you sell? For

purposes of this project, you may or may not choose to make an investment

recommendation. At a minimum, your analysis should result in insights that wouldcontribute to an analysis of the company’s financial prospects.

You can be guided by the Doupnik and Perera textbook model-- Three Steps of FinancialStatement Analysis:

1. Accounting analysis—reflection of economic reality (e.g. inconsistent standards,

estimation errors and intentional manipulation)

2. Financial analysis (cash flow, profitability and risk analysis)3. Prospective analysis—using accounting analysis and financial analysis, along with

business environment analysis and company strategy, to forecast future cash flow and

income.

ACCOUNTING ANALYSIS

1. Reading and studying the financial statements and footnotes

Read the auditors’ reports.Identify significant transactions – major acquisitions, discontinuance or disposal of

business segment, unresolved litigation, major write-downs of receivables or inventories,

etc. Read the financial statements and footnotes.

2. Compare the IFRS financial statements with the US GAAP statements.

(1) For the IFRS firm, use the 20F reconciliation to:

A. Identify accounting differences affecting net income of the most recent year ending

before November 15, 2007. Discuss each of these accounting differences and importantdisclosure differences. Is it possible to reconcile these differences in subsequent periods

using IFRS disclosures if the IFRS firm does not provide the reconciliation? Explain your

answer by referring to relevant notes to financial statements (use number references).

B. Determine the dollar amount of the difference between IFRS net income and U.S.

GAAP net income for each year during the past 2- 5 years (depending on when the firm

adopted IFRS) that 20F reconciliations were available. Is there a trend?

C. Compare the IFRS and US GAAP financial statements for the most recent year. What

are the major differences in accounting policies and disclosure? Were there any changessince the last 20F filing? Prepare an IFRS comparison exhibit (see appendix) to

summarize your findings. You should select at least one significant US GAAP difference

from IFRS that would impact reported net income for your IFRS firm and do in-depth

accounting analysis, including consideration of the firm’s operations.

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D. You will email the IFRS comparison exhibit to the class and the professor so that you

can see whether the IFRS differences from US GAAP are similar. If the IFRS firms arefrom different countries, do you see evidence of country differences?

E. The US firm has a Management Discussion and Analysis. What does the IFRS firm havethat is comparable such as a management review? Which firm has the most comprehensive

review?

F. Overall, how would you rate the disclosure (transparency) of the IFRS firm as compared

to the US firm?

3. Evaluate the adoption of IFRS. Was there early adoption? What was the impact on theincome statement and balance sheet? List the material differences and amounts.

4. Assess earnings quality

Earnings quality may be affected by a number of strategies managers use to influenceaccounting numbers. Can you identify any issues related to four major strategies?

o Overstating operating performance

o Taking a bath

o Creating hidden reserves

o Employing off-balance-sheet financing

Since the financial statements are audited, this can be a challenge.

Use the earnings management indicator model discussed in class. The model is an indicator

which could direct you to take a closer look at what the firm might have done.

The model is based on research by Jansen et al. supported by a study covering 1974-2005.

Since there is good reason to believe that most public firms use earnings management attimes to some extent, the concern might be whether they getting too aggressive and

possibly crossing the line into the red space-- financial fraud. While this model is based on

the ROA analysis model, it is different. Thus, you should not view it as a substitute for ROA analysis, which is used to gain insights into operating management.

The Villanova library’s data bases can be helpful-- You can do a search on ABI Inform andother data bases to attempt to find these issues for a firm. Financial writers in Business

Week, Forbes, Fortune, Wall Street Journal, etc. sometimes question accounting practices

in their coverage of a firm’s investment prospects.The S & P and Value Line data bases may be helpful.

The statement of cash flow can provide insights. How does the trend in operating cash flowcompare to the trend in earnings?

Has the firm changed accounting methods or estimates that affect comparability over time?Can you identify any assets that are of questionable value such as goodwill or receivables?

If so, why are they questionable? Keep in mind the economic environment at the balance

sheet date.Do the footnotes indicate any future or contingent obligations that appear to some

characteristics of liabilities?

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FINANCIAL ANALYSIS

Your financial analysis should cover the most recent 2 years for the IFRS firm, and you

may want to do a quarterly update. Your textbook recommends adjusting IFRS statements

to US GAAP. However, this is not required; and it is tricky to do. You can possiblyidentify 2 or 3 items and use this in interpreting the ratios.

Analyzing the financial statements—your class presentation should focus on the most

important aspects of the following:

Comparisons across time

Comparisons within the financial statements: common-size statements and ratio analysis

Profitability ratios-- ROA analysisLeverage ratios— ROA versus ROE

Asset turnover ratios

Cash flow analysis

What is R&D as a % of sales?How does total market value compare with book value?

Ratio analysis table 1(see appendix) of key ratios should be prepared presenting two

(most recent) years of data for your firm and the US comparison firm. You need to

interpret what the ratios imply about the company's performance. The performance of your chosen IFRS firm and US firm should be compared to each other as competitors. Industry

ratios are often used as benchmarks and the data to compute additional ratios can be found

in: Yahoo finance, MSN or Reuters.com. Dun and Bradstreet’s Industry Norms and Key

Business Ratios, Yahoo Finance, Standard and Poors’ Industry Reports, Value LineInvestment Surveys and various Moody’s publications. The problem is that the industry

ratios are based on US GAAP firms. A major question that you should address in your

presentation is, how meaningful is this comparison, given IFRS and US GAAPdifferences?

Ratio analysis table 2 (see appendix) of key ratios should be prepared presenting two(most recent) years of data for your firm and an IFRS comparison firm in the same

industry. The IFRS competitor firm is to be used as benchmark for analyzing the financial

statements. You should take a best in class approach and select a high performing IFRS

competitor. Is this a better comparison than the US firm?

A ratio calculator excel file is available on WebCT. You can use published ratios for your

firms from library data sources (see appendix) internet sources in the table or you can

calculate them. When a firm’s ratios have changed significantly from one year to the next,you need to consider the cause of the change. If ratios differ significantly between the

firms and the industry benchmark, you should think about reasons for the differences. In

many instances it may not be possible to pin down an exact cause. In that case, you might:

(a) list alternative explanations for the difference, (b) list questions you would ask to try to

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identify the cause, and/or (c) list data you would need in order to reach a conclusion. Make

a check on key ratios (ROA, ROE, sales growth, EPS growth) on internet site or data base

calculations before using them. Small differences can be tolerated. Some internet sites donot provide the formulas used to compute the ratios reported. There is often more than one

way to compute a given ratio. You must be comfortable about the formulas used for

industry ratios and for your company are consistent. Even in the hard copy sources (Dunn& Bradstreet, Robert Morris, S & P, Value Line, & Moody’s’) referenced earlier, there are

differences in ratio formulas. Internet sources may compute ratios based on the most

recent 12 months (combining quarterly data). They may refer to this as trailing 12 monthsor TTM. Your ratio analysis table should be based on audited annual financial statements.

For certain ratios, industry data may not be available. For those ratios only time-series

(trend) analysis will be possible. In addition, you should discuss any unique accounting

issues that apply to the industry and the specific firm. If the ratios that you calculate are notmuch different than published ratios for your firm, you can feel comfortable using

published ratios for the firm that you are choosing for a benchmark. If not, there may be

two or three ratios that need to be calculated for your benchmark firm. It can be argued that

the most important thing is that the ratios for your firm and the benchmark be calculatedthe same way.

If you do a quarterly update, you should examine the quarterly earnings reports published

subsequent to the year-end statements to determine if there have been significant changes

and do a comparison with a benchmark. Focus on sales, return on sales, and EPS. Sincethere are seasonal effects for most firms, compare them to the same quarter the prior year

and quarterly trend for the most recent 12 months compared to the preceding 12 month

period.

Use graphs in your presentation for key items. For example, you might show EPS,

operating cash flow and sales trends for your firm and the benchmark competitor on the

same graph.

5. For your IFRS firm, the US firm and the IFRS comparison firm, compare “net cash from

operating activities per share” with earnings per share for all years that IFRS was used bythe European firm. Use an excel graph (minimum 3 years) and compute percent change

year to year. Does this provide any insight?

PROSPECTIVE ANALYSIS

Since the project is focusing on IFRS accounting, this analysis will be limited. Your

analysis in this section should be extensive enough to arrive at conclusions about theoutlook for the IFRS firm and the usefulness of IFRS financial statements versus US

GAAP. How would the quality of financial reporting be affected by a change to IFRS for

the US firm? Are there reasons to believe that earnings quality would be lower?

1 .Assessing the business environment— many of the following questions will be relevant

to your analysis. You do not have to include all of them in your presentation. You can get

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information from data sources in the Bartley virtual library, financial press articles, or

Bloomberg in the trading room.

Questions related to the firm and its strategies:

1) What is the nature of the company’s operations? In what lines of business does thefirm operate? What is the company’s industry?

2) Is the firm diversified with respect to:

a. Products b. Geographic segments. Where does the firm do business?

c. Customer base

3) What are the firm’s major products and services?

4) Are its products mature or new? What percentage of the firms sales are from new products?

5) Does the company have new products in the pipeline?

6) What share of the market does the company have?

7) What strategy is being employed to generate profits? Is it restructuring, downsizing,diversifying, in a growth phase, etc?

8) Who are the major players? Competition? How is global competition affecting thefirm?

9) How does R&D fit into the firm’s strategy?

Questions related to the industry:

1. Does the industry consist of many firms? A few firms?

2. Who are some of the company’s major competitors in the industry? How is

global competition affecting the industry?3. How does the firm fit into the industry? Is it a giant? A niche player?

4. What is the level of competitiveness within in the industry?

5. What is the industry growth profile? Is the industry in decline? In a growth phase?

6. What is the regulatory environment?

7. What is the importance of technological change and innovation?

Predicting future earnings and/or cash flow

What do analysts predict for earnings?Does your financial statement analysis provide insights that would cause you to agree or

disagree?

Note: The above questions are for guidance. You do not have to answer al of them in your

presentation. Focus on key issues!

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DELIVERABLES:

1. Prior to your presentation:A copy of the IFRS comparison exhibit , comparing the IFRS and US GAAP financial

statements for the most recent year should be emailed to the professor and the class, using

“reply all” on one of my recent emails to the class. The due date is the second Mondayafter we return from mid-term break (see schedule). Also email a link to the financial

statements for the most recent year (firm website or SEC.gov Edgar database) that you will

be using for the US and IFRS firms. Your email should indicate the page numbers where

the financials are located for each document.

Ratio analysis tables 1 and 2 for all teams should be emailed to the professor and the

class at least 5 days before the first presentation is scheduled.

2. Class presentation:

Your team will present report focusing on the most interesting aspects that provide the

greatest insights into IFRS and conclusions about the firm will be presented. You shoulduse a class handout of the ratio analysis tables 1 and 2, and an IFRS comparison exhibit.

Other handouts can be used. You should select at least one significant US GAAPdifference from IFRS that would impact reported net income for an in-depth accounting

analysis, including consideration of the firm’s operations. The accounting analysis

presentation should be at least 60% of the presentation. The maximum time for each team’s presentations (including Q & A) is 30 minutes. Be creative!

The teams should present views about the disclosure (transparency) of the IFRS firm as

compared to the US firm.

You must provide to the professor by 9:00AM on the day you present the following (slide

under my office door):(1) A hard copy of your power point slides (3 slides per page) and your class handout

(2) A hard copy of your ratio analysis tables and IFRS comparison exhibit and a copy of your conclusions.

3. The following must be submitted by all teams no later than the second to last class in the

semester.

(1) Your written summary and conclusions report listing all team members on the cover

with the statement asserting that, “all team members have read the US and IFRS financial

statements for the most recent year and related notes, the auditors’ report, andmanagement’s discussion and analysis (or equivalent for IFRS)”. The page limit is

approximately 4 pages, and you should attach your ratio analysis tables and IFRS

comparison exhibit. You should realize that professionals are more likely to read clear andconcise reports. The report should present a basis for your conclusions. The conclusions

will be the most important and should clearly address the issues in this project.

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(2) Submit a CD (virus free) or a USB drive containing the power point slides, Ratio

analysis tables, IFRS comparison exhibit, and a word file of your report. The CD must also

include a file that has the USA firm’s most recent 10K filed with the SEC and IFRS firm’s20F for 2005, 2006, and the most recent IFRS statements. You can include other evidence

of research or technology usage such as copies of articles or links to websites.

(3) Peer evaluation forms of team members.

GRADING

The team presentation and written report will be graded on the basis of the project

objectives and the requirements stated above. A presentation evaluation form will be

provided to the class at least one week before the presentations begin. Professional

accountants will be invited to attend the presentations and provide input into the grading

process. A high quality senior level presentation is required. This is a competitive

environment and your team grade is based on my ranking of team performance. Some

aspects of team projects can be graded on an individual basis such as a student’s presentation and preparedness in the team project presentation to the class. See the course

syllabus for the peer evaluation policy.

Notes:

A few more detailed points follow:

1. List references for material you include in the project as you would in a research paper.

2. As far as the timing of reports. It may be that the fiscal year end of your company does

not match the fiscal year end of the competitor or the aggregation date for the industrystandards. If a 10K is filed four weeks or earlier before your presentation you should

use the most recent 10K. Thus, a May 15 2009 filing should be used. If you use an older

filing due to a fiscal year being January, June, etc., you should review the most recent

quarterly earnings data (to provide an update on whether the earnings outlook has changed.Use key figures from a source such as MSN or Standard and Poors, but you do not have to

look at 10Q SEC filings. Thus, this does not mean that you should attempt to “roll up” the

quarterly financial data so that times periods align. This would help eliminate difference infirm performance due to shifts in economic and industry condition. Unfortunately, the

“rolling up” of quarterly data is not as simple as it may at first appear. Quarterly financial

data contains even more estimates and assumptions than annual data. Data for the first 3

quarters of a company’s year do not necessarily represent the actual activity for thosequarters, as certain things must be estimated on an annualized basis. For example, tax

expense in the first quarter does not necessarily represent the taxes on the income earned

during the first quarter. Rather it represents one quarter of the total taxes that the companyexpects to incur that year. Each quarter as more information becomes available about how

the year is likely to shake out, the estimate is refined. But prior quarters’ figures are not

automatically revised. So combining the 3rd and 4th quarter of one fiscal year with the 1stand 2nd quarter of another year introduces another set of problems. The sum of those 4

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quarters does not represent what the financial statements would be if those 4 quarters

represented the firm’s fiscal year. You essentially trade off one set of problems

(differences in economic climate) for another. Do not attempt to do this adjustment. If youhave a time discrepancy between your firm and your comparator data, you might discuss in

the write up the fact that differing year-ends make the numbers not directly comparable and

speak to what has happened in the economy or industry in the intervening time periods.

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PEER--TEAM EVALUATION Team #______

Rate each team member (including yourself) on a scale of 1(unsatisfactory) to 5 (excellent),

where 3 is satisfactory. This form should be folded in half and submitted no later than

the last day of class. Your name

________________________________________________

Team member ________________________________________________

Rating

______ Attends team meetings

______ Comes prepared to team meetings and is willing to contribute

______ Performs agreed upon tasks

______ Shows respect for peers and their views

______ Other(explain)_____________________________________________________________

_______

Team member ________________________________________________ Rating





______ Other(explain)_____________________________________________________________

_______






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______

Other(explain)_____________________________________________________________

_______






______

Other(explain)_____________________________________________________________ _______

Comments:

Appendix:

Email

Value Line Investment Survey

Designed to help investors analyze and select stocks by performing a broad range of functions including sorting, filtering (screening), graphing and reporting on individual

stocks and groups of stocks.

Market Insight (S&P) [Details]

Provides full-text access to the S&P Industry Surveys, the Executive Compensation

database, Global Reports Library which contains full-color, online, internationalcompany source documents including annual reports, annual report summaries,

financials, interims, and IPO prospectuses for 13,000 companies around the world,

and the GICS Sub-Industry Financial Highlights Report which provides recentindustry-level valuation, profitability, performance and financial risk data.

Mergent Online [Details]

Provides research to 15 years of detailed financial statements for international and

U.S. companies included in the Moody's (now Mergent) Manuals; enablescustomized viewing and output to retrieve company reports and financials into

software applications such as Word, Excel or Adobe, and enables accurate cross-

border searches using a variety of financial and text variables.Mergent WebReports [Details]

Features the full text of all of Mergent / Moody's Corporate Manuals from 1909 to

the present. Once you enter the database select the option for "Corporate

Manuals" and begin your search.

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mailto:[email protected]

http://ezproxy.villanova.edu/login?URL=http://www.valueline.com/secure/vlrc/research.html

http://ezproxy.villanova.edu/login?URL=http://umi.compustat.com/

http://library.villanova.edu/Research/Resource?id=901&subject_id=114&type_id=42

http://ezproxy.villanova.edu/login?URL=http://www.mergentonline.com/compsearch.asp


http://ezproxy.villanova.edu/login?URL=http://ezproxy.villanova.edu/login?URL=http://webreports.mergent.com/


mailto:[email protected]

http://ezproxy.villanova.edu/login?URL=http://www.valueline.com/secure/vlrc/research.html

http://ezproxy.villanova.edu/login?URL=http://umi.compustat.com/


http://ezproxy.villanova.edu/login?URL=http://www.mergentonline.com/compsearch.asp


http://ezproxy.villanova.edu/login?URL=http://ezproxy.villanova.edu/login?URL=http://webreports.mergent.com/




Morningstar Investment Research Center [Details]

Best known for performance and financial data on mutual funds, Morningstar

Investment Research Center is also a great source for company data and analystreports.

IFRS comparison exhibit (illustration)

Accounting policy US INC. Fin Inc. Comments

1.Inventory LIFO FIFO Fin Inc.

would have higher assets; higher earnings (most years)

Clarifications:

For the quarterly update, focus on sales, return on sales, and EPS. Since there are seasonal

effects for most firms, compare them to the same quarter the prior year and quarterly trendfor the most recent 12 months compared to the preceding 12 month period.

Earnings quality-- financial writers in Business Week. Forbes, Fortune, Wall Street

Journal, etc. sometimes question accounting practices in their coverage of a firm’s

investment prospects. Using ABI Inform or Google may help you find such articles. Don’t

worry if you can not find something that is obvious. Readings #5 and 9 that I handed out inthe beginning of the semester may be helpful.

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http://ezproxy.villanova.edu/login?URL=http://library.morningstar.com/


http://ezproxy.villanova.edu/login?URL=http://library.morningstar.com/




Team

IFRS firm (study):

Industry:

US Firm:

Year

ended

Ratio Analysis table 1 2008 2007 2008 2007

Ratios US firm US firmIFRS firm(study):

IFRS firm(study): Pos. Neg.

Liquidity:

Current Ratio

Quick Ratio

Receivables turnover

Inventory turnover

Profitability:

Return on Sales- EBIT

Return on Sales

Asset turnover

Return on Total Assets

Sales Growth (vs prior yr)

Earnings per share

Earnings per share growth

R&D as a % of sales

Valuation:

Price-earnings ratio

Market value/book value

Financial Leverage:

Return on Equity

Debt to Equity Ratio

Times Interest Earned

Cash Flow:

Operating Cash Flow per share

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IFRS benchmark firm:

benchmark firm

Ratio Analysis table 2 2008 2007 2008 2007

Ratios IFRS firm IFRS firm IFRS firm IFRS firm Pos. Neg.

Liquidity:

Current Ratio

Quick Ratio

Receivables turnover

Inventory turnover

Profitability:

Return on Sales- EBIT

Return on Sales

Asset turnover

Return on Total Assets

Sales Growth (vs prior yr)

Earnings per share

Earnings per share growth

R&D as a % of sales

Valuation:

Price-earnings ratio

Market value/book value

Financial Leverage:

Return on Equity

Debt to Equity Ratio

Times Interest Earned

Cash Flow:

Operating Cash Flow per share

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ifrs2nd ed financial statement project r10 a

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