Implications for Financial Analysis of Alternative

The goal of global convergence has been advanced by adopting IFRS in many countries outside the US as the required financial reporting standard. However, several differences exist between US GAAP and IFRS that affect how companies report their financial statement. The following are the significant differences between US GAAP and IFRS.

$$ \begin{array}{l|l|l}
\text{Basis for Comparison} & \text{US GAAP} & \text{IFRS} \\ \hline
\text{Developed by} & \text{FASB} & \text{IASB} \\ \hline
\text{Basis} & \text{Rules} & \text{Principles} \\ \hline
{\text{Inventory write-down} \\ \text{reversal} } & \text{Prohibited} & {\text{Permissible if certain} \\ \text{conditions are met} } \\ \hline
\text{Valuation of inventory} & { \text{LIFO, FIFO, and} \\ \text{Weighted Average} \\ \text{Method}} & { \text{Weighted Average Method} \\ \text{and FIFO.} } \\ \hline
\text{Development cost} & \text{Expensed} & {\text{Capitalized if it meets the} \\ \text{criteria for capitalization.} } \\ \hline
\text{Interest paid} & {\text{Cash flows from} \\ \text{operating activities}} & {\text{Cash flows from operating} \\ \text{or Cash flows from} \\ \text{financing activities} } \\ \end{array} $$

Analysts comparing two companies that use different accounting standards must be aware of areas where accounting standards have not converged since reconciliation disclosures between IFRS and US GAAP are not required. It is often difficult to make the specific adjustments necessary to achieve comparability between financial statements prepared under different accounting standards without sufficient information.

Comparative financial measures generated under different accounting standards must be interpreted carefully by analysts, and significant developments in financial reporting standards need to be monitored, as these factors can affect company performance and security valuations in essential ways.

Monitoring Developments in Financial Reporting Standards

Analysts should monitor developments in financial reporting standards from a user perspective, not a preparer’s perspective (like accountants). They need to understand the effect of these developments on financial reports. Analysts can stay informed about developments in financial reporting standards by keeping tabs on actions of standard setters, new products and transactions, and company disclosures of critical estimates and accounting policies.

New Types of Transactions or Products

There can be unusual or unique components to new products and types of transactions that are not explicitly outlined in the financial reporting standards. An economic event, such as a new business (e.g., fintech) or a new financial instrument, typically brings about new products or transactions. In addition to reviewing financial reports, analysts can monitor business journals and capital markets for new products and transactions.

When one company introduces something new, others in the industry tend to follow. To comprehend these novelties, it’s crucial to understand their business purpose.

Evolving Standards

The delays between new product development and regulatory action make standard setters and regulators unlikely to identify new products and transactions. Nevertheless, monitoring the actions of these authorities is essential because regulatory changes can impact companies’ financial reports and hence valuations. Market participants may ignore financial statement details when valuing a company’s securities. In this case, more explicit identification could affect company securities’ value. Further, it appears that management pays more attention to and is more rigorous in calculating/estimating items that appear in the financial statements than those in the notes.

The FASB and IASB publish information on proposed future standard changes and new standards on their websites. The input of financial analysts, especially those who regularly use financial statements, is used by the FASB and IASB when creating or changing standards. CFA Institute actively supports improvements to financial reporting. In addition to drafting comment letters and position papers, volunteer members of the CFA Institute serve on various liaison committees that meet regularly to recommend proposed standards to FASB and IASB.

Question

Analysts are advised to monitor developments in financial reporting standards primarily from a:

1. Preparer’s perspective to ensure accurate implementation.
2. Legal perspective to avoid regulatory discrepancies.
3. User perspective to understand their impact on financial reports.

Solution

C is correct. Analysts monitor the development of financial reporting standards from a user perspective.

A and B are incorrect. Accountants monitor developments in financial reporting standards from a preparer’s perspective.