Implications for Financial Analysis of Differing Financial Reporting Systems

The recent adoption of IFRS in many countries, especially in the EU, has advanced the objective of achieving global convergence of financial reporting standards. There are, however, still significant differences remaining in global financial reporting, most noticeably between IFRS and US GAAP.

These differences have significant implications for the interpretation of financial analysis that is generated from financial statements prepared using different financial reporting systems. As a result, effective monitoring of developments in financial reporting standards is now more important than ever before.

Implications for Financial Analysis Caused by differing Financial Reporting Systems

Reconciliation schedules and disclosures relating to significant differences between reporting standards have historically been useful in comparing financial statements created using different standards. This boosts the faith of users of financial statements in the results of the financial analysis conducted on financial statements prepared under different standards.

In recent times, the requirement for reconciliation schedules and disclosures to be provided has been relaxed. For example, in 2007, the US Securities & Exchange Commission eliminated the requirement for reconciliation reporting on foreign private issuers that did not prepare their financial statements under US GAAP.

Financial statements prepared using different accounting standards may no longer provide the user with sufficient information to enable them to make the specific adjustments that are necessary for the achievement of comparability. It is, therefore, critical that sufficient caution be exercised when interpreting comparative financial measures that are produced under different accounting standards. Analysts should also make every effort to be aware of areas where accounting standards have not converged. In addition, they must continuously monitor developments in financial reporting standards.

Importance of Monitoring Developments in Financial Reporting Standards

Financial reporting standards are evolving rapidly. It is, therefore, important for analysts to closely monitor developments in these standards and continuously assess their implications for security analysis and valuation. This monitoring can occur in three main areas:

• new products or transactions: companies may discuss new products and transactions in their financial reports. It is also possible for new products and transactions to be identified through the monitoring of business journals and capital markets. Alternatively, such information may also be obtained directly from a company’s management. Strictly speaking, the obtained information will be useful if it provides insight into the economic purpose, financial statement reporting, significant estimates, judgments applied in reporting, and the future cash flow implications of the new product or transaction;

• actions of standard setters and other groups representing users of financial statements, such as the CFA Institute: users of financial statements may improve their investment decision-making by keeping abreast with the current financial reporting standards. Ideally, they should contribute to the improvement of financial reporting by sharing their perspectives. In fact, standard-setting bodies always invite comments from users of financial statements on proposed changes. For example, the IASB and FASB usually seek input from users of financial statements whenever a new standard is proposed. Any changes in standards can affect a company’s financial reports and its valuations, especially if the changes involve more explicit identification of matters affecting asset/liability valuation or financial performance;

• company disclosures regarding critical accounting policies and estimates: financial reporting standards restrict alternatives. Nevertheless, they allow companies to maintain flexibility in matching their accounting methods with their underlying economic fundamentals. Companies may, therefore, use estimates and choose among alternative accounting policies. Under IFRS and US GAAP, companies are required to disclose the accounting policies and estimates they selected.  These details should be included in the notes accompanying financial statements. Companies can also discuss the policies that their managements deem to be important in the management’s discussions and analyses.

Question

Which of the following accurately represents a recent change that now makes it harder to compare financial statements that have been prepared using different accounting standards?

1. Reconciliation schedules and disclosures are no longer required.
2. New products and transactions are being discussed in financial reports.
3. Standard-setters are seeking input from users of financial statements whenever a new standard is proposed.

Solution

The correct answer is A.

With reconciliation schedules and disclosures no longer required, financial statements prepared using different accounting standards may no longer provide the user with sufficient information to enable them make the specific adjustments necessary for the achievement of comparability.

B is incorrect because the disclosure of new products and transactions in financial reports is an area that analysts should monitor closely and which will assist in comparing financial statements.

C is incorrect because, by sharing their perspectives, users of financial statements can contribute to the improvement of financial reporting and thereby facilitate better comparison of financial statements.