Accounting in Multinational Enterprises – Lectures
Knowledge clip 1.1 – financial statement analysis
Financial accounting:
• Framework for business analysis and valuation
• Equity security and credit analysis
Who are the users of ‘financial statements’?
• Shareholders
• Banks/ creditors main focus IFRS
• Customers/ suppliers
• Employees
• Government (regulators, tax authorities)
• ‘Society’ (e.g., NGOs)
Financial reporting entails the disclosure of financial (and related) information about a
company’s financial performance in a certain period. Financial statements are the chief
instrument to do that.
,Financial reporting and capital markets:
Key takeaways:
• Financial accounting is more than just journal entries.
▪ It provides valuable information to capital markets
• Yet financial statement analysis is needed to understand the information conveyed,
as there is often no clear ‘right’ or ‘wrong’ in accounting
• Financial statement analysis looks at the accounting choices made in financial
statements as well as any incentives managers have in making these choices
▪ The objective is to uncover relevant information contained in financial
statements
Knowledge clip 1.2 – Key themes
Financial reporting; depicting business activities:
• Financial statements measure and summarize the economic consequences of
business activities
▪ To be reported on an annual, semi-annual and/ or quarterly basis
• Financial statements comprise:
▪ Income statements
o Statements of comprehensive income
▪ Balance sheet
o Statement of financial position
▪ Cash flow statement
▪ Statement of changes in equity
▪ Notes
,We focus on two major themes – or influences on financial reporting:
1. Accrual accounting and discretion
2. Managers’ influence on financial statements
Other factors that affect financial reporting?
• Accounting conventions and standards (‘local dialects’)
▪ European listed firms are required to apply IFRS (‘international Financial
Reporting Standards’)
• Auditing and the regulatory framework
Key takeaway: there is no ‘objective truth’ in accounting
Accrual accounting and discretion:
• IFRS defines the following financial statement elements:
▪ Revenues, expenses
▪ Assets, liabilities, equity
• Financial reports are prepared using accrual accounting
▪ Transactions are recorded when they occur, rather than at the time of a cash
flow
o For example, revenue recognition, depreciation
• Hence
▪ Net income = cash flow + accruals (discretion)
Accrual accounting means that there is a trade-off due to:
• Accounting estimates
▪ What is the right number?
• Flexibility in standards
▪ How much discretion to ‘choose’ a number?
• ‘Imperfect’ rules
▪ Do the rules (still) reflect the current environment?
• Managers’ incentive
▪ Do they want to present the ‘right’ number?
, • Example
▪ Provisions are recognized at management’s best estimate, if the firm expects
a cash outflow from a past event that is ‘more likely than not’
▪ E-Z, Inc. is subject to a lawsuit. If lost, a large fine will become due. Should its
management recognize a provision? If so, which amount?
• A mor realistic example
▪ In 1992, Stella Liebeck bought a cup of coffee at a McDonald’s drive-thru and
spilled it on her lap. She sued McDonald’s, alleging the coffee was not just
“hot”, but dangerously hot
▪ Would you recognize a provision in this case? If so, which amount?
o A jury awarded her nearly $3 million in punitive damages, as she
suffered third-degree burns, requiring skin grafting and making her
partially disabled for two years.
Managers’ influence on financial statements:
• Management has superior knowledge of a firm’s business:
▪ By way of accounting, it can communicate this knowledge to investors
▪ For example
o Useful lives of assets: How long do machines/ equipment last?
o Revenue recognition: When is a particular stream of revenue
‘earned’?
• However, there are certain incentives to ‘distort’ accounting numbers
▪ For example
o Management compensation
o Debt contracts
• As a result, there is a trade-off surrounding management discretion
Knowledge clip 1.3 – Non-GAAP measures
Non-GAAP measures:
• Accounting standards prescribe only the minimum amount of information that firms
need to disclose
• Management may present additional financial measures it considers relevant for
investors, so-called Non-GAAP measures
▪ GAAP = Generally Accepted Accounting Principles
• Often it is unclear though what these measures exactly entail:
▪ EBITDA = Earnings Before Interest, Taxation, Depreciation & Amortization
o Also known as ‘Earnings Before Bad Stuff’
▪ ‘Adjusted income’, etcetera
Non-GAAP measures; Apple, inc.:
• Accounting standards require that revenue from iPhone sales is split over two years
due to providing ‘free’ software upgrades for 24 months
• Assume that iPhone costs $1,000 and the customer pays cash
• Apple needs to assess how much of the price relates to
Knowledge clip 1.1 – financial statement analysis
Financial accounting:
• Framework for business analysis and valuation
• Equity security and credit analysis
Who are the users of ‘financial statements’?
• Shareholders
• Banks/ creditors main focus IFRS
• Customers/ suppliers
• Employees
• Government (regulators, tax authorities)
• ‘Society’ (e.g., NGOs)
Financial reporting entails the disclosure of financial (and related) information about a
company’s financial performance in a certain period. Financial statements are the chief
instrument to do that.
,Financial reporting and capital markets:
Key takeaways:
• Financial accounting is more than just journal entries.
▪ It provides valuable information to capital markets
• Yet financial statement analysis is needed to understand the information conveyed,
as there is often no clear ‘right’ or ‘wrong’ in accounting
• Financial statement analysis looks at the accounting choices made in financial
statements as well as any incentives managers have in making these choices
▪ The objective is to uncover relevant information contained in financial
statements
Knowledge clip 1.2 – Key themes
Financial reporting; depicting business activities:
• Financial statements measure and summarize the economic consequences of
business activities
▪ To be reported on an annual, semi-annual and/ or quarterly basis
• Financial statements comprise:
▪ Income statements
o Statements of comprehensive income
▪ Balance sheet
o Statement of financial position
▪ Cash flow statement
▪ Statement of changes in equity
▪ Notes
,We focus on two major themes – or influences on financial reporting:
1. Accrual accounting and discretion
2. Managers’ influence on financial statements
Other factors that affect financial reporting?
• Accounting conventions and standards (‘local dialects’)
▪ European listed firms are required to apply IFRS (‘international Financial
Reporting Standards’)
• Auditing and the regulatory framework
Key takeaway: there is no ‘objective truth’ in accounting
Accrual accounting and discretion:
• IFRS defines the following financial statement elements:
▪ Revenues, expenses
▪ Assets, liabilities, equity
• Financial reports are prepared using accrual accounting
▪ Transactions are recorded when they occur, rather than at the time of a cash
flow
o For example, revenue recognition, depreciation
• Hence
▪ Net income = cash flow + accruals (discretion)
Accrual accounting means that there is a trade-off due to:
• Accounting estimates
▪ What is the right number?
• Flexibility in standards
▪ How much discretion to ‘choose’ a number?
• ‘Imperfect’ rules
▪ Do the rules (still) reflect the current environment?
• Managers’ incentive
▪ Do they want to present the ‘right’ number?
, • Example
▪ Provisions are recognized at management’s best estimate, if the firm expects
a cash outflow from a past event that is ‘more likely than not’
▪ E-Z, Inc. is subject to a lawsuit. If lost, a large fine will become due. Should its
management recognize a provision? If so, which amount?
• A mor realistic example
▪ In 1992, Stella Liebeck bought a cup of coffee at a McDonald’s drive-thru and
spilled it on her lap. She sued McDonald’s, alleging the coffee was not just
“hot”, but dangerously hot
▪ Would you recognize a provision in this case? If so, which amount?
o A jury awarded her nearly $3 million in punitive damages, as she
suffered third-degree burns, requiring skin grafting and making her
partially disabled for two years.
Managers’ influence on financial statements:
• Management has superior knowledge of a firm’s business:
▪ By way of accounting, it can communicate this knowledge to investors
▪ For example
o Useful lives of assets: How long do machines/ equipment last?
o Revenue recognition: When is a particular stream of revenue
‘earned’?
• However, there are certain incentives to ‘distort’ accounting numbers
▪ For example
o Management compensation
o Debt contracts
• As a result, there is a trade-off surrounding management discretion
Knowledge clip 1.3 – Non-GAAP measures
Non-GAAP measures:
• Accounting standards prescribe only the minimum amount of information that firms
need to disclose
• Management may present additional financial measures it considers relevant for
investors, so-called Non-GAAP measures
▪ GAAP = Generally Accepted Accounting Principles
• Often it is unclear though what these measures exactly entail:
▪ EBITDA = Earnings Before Interest, Taxation, Depreciation & Amortization
o Also known as ‘Earnings Before Bad Stuff’
▪ ‘Adjusted income’, etcetera
Non-GAAP measures; Apple, inc.:
• Accounting standards require that revenue from iPhone sales is split over two years
due to providing ‘free’ software upgrades for 24 months
• Assume that iPhone costs $1,000 and the customer pays cash
• Apple needs to assess how much of the price relates to
