Summary Class notes - International Financial Management

- International Financial Management
- -
- 2015 - 2016
- Rijksuniversiteit Groningen (Rijksuniversiteit Groningen, Groningen)
- International Business and Management
262 Flashcards & Notes
6 Students
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Summary - Class notes - International Financial Management

  • 1450738800 Week 1: Worldwide Accounting Diversity & Analysis of Foreign Financial Statements (Chapters 1&2)

  • What are the two major types of legal systems used around the world?
    Common Law and Code Law (page 8).
  • What are the five items as being commonly accepted as factors influencing a country's financial reporting practices?
    1. legal system 2. taxation 3. providers of financing 4.inflation and 5. political and economic ties (page 8).
  • What are the characteristics of Common law?
    Common law began in England and is primarily found in the English-speaking countries of the world. Common law countries rely on a limited amount of statute law, which is the interpreted by the courts. Courts decisions establish precedents, thereby developing case law that supplements the statutes (page 8).
  • What are the characteristics of Code law?
    Code law is mostly followed in non-English-speaking countries. Code law countries tend to have relatively more statute or codified governing a wider range of human activity (page 8).
  • What are the differences in accounting law between code law and common law countries?
    In code law countries, the accounting law tends to be rather general, does not provide much detail regarding specific accounting practices, and may provide no guidance at all in certain areas. In common law countries, where there is likely to be a non-legislative organization developing accounting standards, much more detailed rules are developed (page 8-9).
  • What does a country's legal system have to do with accounting?
    Code law countries generally have corporation law that establishes the basic legal parameters governing business enterprises. The corporation law often stipulates which financial statements must be published in accordance with a prescribed format. In countries with a tradition of common law, although a corporation law laying the basic framework for accounting might exist, specific accounting rules are established by the profession or by an independent nongovernmental body representing a variety of constituencies (page 8).
  • How does taxation influence accounting diversity?
    In some countries published financial statements form the basis for taxation, whereas in other countries, financial statements are adjusted for tax purposes and submitted to the government separately from the reports send to stockholders. Common and Code law countries have different approaches on taxation, which causes diversity (page 9).
  • How do providers of financing influence accounting diversity?
    The major providers of financing for business enterprises are family members, banks, governments, and shareholders. In those countries in which company financing is dominated by families, banks, or the state, there will be less pressure for public accountability and information disclosure. Banks and the state will often be represented on the board of directors and will therefore be able to obtain information necessary for decision making from inside the company. As companies become more dependent on financing from the general populace through the public offering of shares of stock, the demand for more information made available outside the company becomes greater. It simply is not feasible for the company to allow the hundreds, thousands, millions of shareholders aces to internal accounting records. The information needs of those financial statements users can be satisfied only through extensive disclosures in accounting reports (page 10).
  • How does inflation influence accounting diversity and how can it be addressed?
    Countries experiencing chronic high rates of inflation have found it necessary to adopt accounting rules that required the inflation adjustment of historical cost amounts (page 10). However, inflation has been successfully brought under control in most countries by adopting adjusting accounting records. Adjusting accounting records for inflation results in a write-up of assets and therefore related depreciation and amortization expenses (page 10).
  • For who is adjusting income for inflation especially important?
    Adjusting income for inflation is especially important in those countries in which accounting statements serve as the basis for taxation; otherwise, companies will be paying taxes on fictitious profits (page 10).
  • How do political and economic ties cause accounting diversity?
    Accounting is a technology that can be relatively easily borrowed from or imposed on another country. For example, through previous colonialism, both England and France have transferred their accounting frameworks (page 10).
  • How can a preparation of consolidated financial statements cause any problem for a company?
    The diversity in accounting practice across countries causes problems that can be quite serious for some parties. One problem, for example, relates to the preparation of consolidated financial statements by companies with foreign operations. Each subsidiary incorporated in the country in which it is located is required to prepare financial statements in accordance with local regulations. These regulations usually require companies to keep books in local currency using local accounting principles. Translating these financial statements can be time consuming and can cause certain errors (page 11).
  • How does access to foreign capital markets cause problems regarding accountant diversity?
    If a company desires to obtain capital by selling stock or borrowing money in a foreign country, it might be required to present a set of financial statements prepared in accordance with the accounting standards in the country in which the capital is being obtain, which can be time-consuming and expensive (page 11).
  • How can the lack of comparability of financial statements between companies be a problem for companies?
    Lack of comparability can significantly affect analysis of foreign financial statements for making investment and lending decisions.  The job of deciding which foreign companies to invest in is complicated by the fact that foreign companies can use different accounting principles, and that those rules differ from country to country. It is therefore very difficult if not impossible for a potential investor to directly compare the financial position and performance of, for example, an automobile manufacturer in Germany (Volkswagen), Japan (Nissan), and the United States (Ford) because these three countries have different financial accounting and reporting standards. Foreign acquisitions are also influenced by this (page 12).
  • How can a lack of high-quality accounting information influence accounting diversity?
    There is a lack of high-quality accounting standards in some parts of the world. For example, when a country has a lack of accounting transparency. Disclosure influences behavior and improves management, particularly risk management (page 13).
  • What is harmonization?
    Harmonization is the process of reducing accounting differences across countries (page 13).
  • What is the Fair Presentation/ Full Disclosure Model (also known as the Anglo-Saxon or Anglo-American model) and where is it mostly used?
    This model describes the approach used in the United Kingdom and the United States, where accounting is oriented toward the decision needs of large numbers of investors and creditors. Most of the countries follow a common law legal system that use this model (page 14).
  • What is the Legal Compliance Model and where is it mostly used?
    The Legal Compliance Model originates in the code law countries of Continental Europe; it is also known as the Continental European model. It is used by most of Europe, Japan and other code law countries. Companies in this group usually are tied quite closely to banks that serve as the primary suppliers of financing. Because these are code law countries, accounting is legalistic and is designed to provide information for taxation or government-planning purposes (page 14).
  • What is The Inflation-Adjusted Model and where is did it originated?
    This model was found primarily in South America. It resembles the Continental European model in its legalistic tax, and government-planning orientation. It distinguishes itself, however, through the extensive use of adjustments for inflation (page 14).
  • What does Nobes's Judgmental Classification of Financial Reporting Systems tell us?
    It shows us how the financial reporting systems in 14 developed countries relate to one another. The terms micro-based and macro-uniform describe the Anglo-Saxon and Continental European models, respectively. Each of these classes is divided into two subclasses that are further divided into families. The importance of this hierarchical model is that it shows the comparative distances between countries and could be used as a blueprint for determining where financial statement comparability is likely to be greater. For example, comparisons of financial statements between the U.S. and Canada (which are in the same family) are likely to be more valid than comparisons between the U.S. and the United Kingdom ( which are not in the same family) (page 15).
  • What are the four cultural dimensions of Hofstede?
    1. individualism 2. power distance 3. uncertainty avoidance 4. masculinity (page 17).
  • What does individualism refer to in Hofstede's cultural dimensions?
    Individualism refers to a preference for a loosely knit social fabric rather than a tightly knit social fabric (collectivism) (page 17).
  • What does power distance refer to in Hofstede's cultural dimensions?
    Power distance refers to the extent to which hierarchy and unequal power distribution in institutions and organizations are accepted (page 17).
  • What does uncertainty avoidance refer to in Hofstede's cultural dimensions?
    Uncertainty avoidance refers to the degree to which individuals feel uncomfortable with uncertainty and ambiguity (page 17).
  • What does masculinity refer to in Hofstede's cultural dimensions?
    Masculinity refers to an emphasis on traditional masculine values of performance and achievement rather than feminine values of relationships, caring, and nurturing (page 17).
  • What does long-term orientation, a fifth extra dimension, refer to in Hofstede's cultural dimensions?
    Long-term orientation stands for the "fostering of virtues oriented towards future rewards, in particular perseverance and thrift" (page 17).
  • What are Gray's four accounting values?
    1. Professionalism 2. Uniformity 3. Conservatism and 4. Secrecy (page 17).
  • How does Gray describe Professionalism vs Statutory Control?
    A preference for the exercise of individual professional judgment and the maintenance of professional self-regulation as opposed to compliance with prescriptive legal requirements and statutory control (page 17).
  • How does Gray describe Uniformity versus Flexibility?
    A preference for the enforcement of uniform accounting practices between companies and for the consistent use of such practices over time as opposed to flexibility in accordance with the perceived circumstances of individual companies (page 17).
  • How does Gray describe Conservatism versus Optimism?
    A preference for cautious approach to measurement so as to cope with the uncertainty of future events as opposed to a more optimistic, laissez-faire, risk taking approach (page 17).
  • How does Gray describe Secrecy versus Transparency?
    A preference for confidentiality and the restriction of disclosure of information about the business only to those who are closely involved with its management and financing as opposed to a more transparent, open and publicly accountable approach (page 17).
  • According to Gray how does culture affect accounting systems (indirectly)
    Through its influence on accounting values and through its institutional consequences (page 19).
  • How can religion influence accounting?
    Religion pays an important role in defining national culture in many parts of the world and can have a significant effect on business practice. Under Islam, for example, the Koran provides guidance with respect to issues such as making charitable contributions and charging interest on loans. In some countries banking companies operate under Shariah law (page 19-20).
  • What does Nobes argue that the major reason for international differences is in financial reporting?
    Difference in the purpose of what is being reported. Specifically, whether or not a country has strong equity financing system with large numbers of outside shareholders will determine the nature of financial reporting in a country (page 21).
  • Describe the Class A accounting systems in Nobes' model
    Class A accounting systems are found in countries with strong equity-outside shareholder financing, which are less conservative, disclosure is extensive, and accounting practice differs from tax rules. Class A corresponds to what may be called Anglo-Saxon accounting (page 21).
  • Describe the Class B accounting systems in Nobes' model
    Class B accounting systems are found in countries with weak equity-outside shareholders financing systems. measurement is more conservative, disclosure is not as extensive, and accounting practice more closely follows tax rules. Class B corresponds to Continental European accounting (page 21).
  • What are the six categories of differences that occur in accounting diversity?
    1. Differences in the financial statements included in an annual report 2. Differences in the format used to present individual financial statements. 3. Differences in the level of detail provided in the financial statements. 4. Terminology differences. 5. Disclosure differences. 6. Recognition and measurement differences (page 23).
  • What does recognition and measurement refer to in international accounting principles?
    Recognition refers to the decision of whether an item should be reported in the financial statements. Measurement refers to the determination of the amount to be reported. For example, national accounting standards establish whether costs associated with acquiring the use of a resource should be recognized as an asset on the balance sheet. If so, then guidance must be provided with respect to both the initial measurement of the asset and measurement at subsequent balance sheet dates (page 33).
  • How does U.S. GAAP requires PPE to be carried on the balance sheet?
    U.S. GAAP requires PPE to be carried on the balance sheet at historical cost less accumulated depreciation. If an asset is impaired, that is, its carrying value exceeds the amount of cash expected to result from use of the asset, it must be written down to fair value (page 34).
  • How does IFRS requires PPE to be carried on the balance sheet?
    Under IFRS, publicly traded companies in the European Union are free to choose between two different methods for valuing their assets. PPE may be carried on the balance sheet at historical cost or at revalued amounts (page 34).
  • What are the three values at which assets can be reported on the balance sheet, regarding property, plant, and equipment (PPE).
    1. Historical cost (HC). 2. Historical cost adjusted for changes in the general purchasing power (GPP) of the currency. 3. Fair value (FV). The latter two are the main methods to apply (page 34).
  • What does financial statement analysis consist of?
    1. Accounting analysis 2. Financial analysis 3. Prospective analysis (page 47).
  • What is accounting analysis and what are the three common sources of distortion in financial statements regarding accounting analysis?
    Accounting analysis begins with an evaluation of the extent to which a company's financial statements reflect economic reality and involves identifying  and adjusting distortions in financial statements. The three common mistakes are: 1. Accounting standards that are inconsistent with economic reality 2. Estimation errors made by managers in applying accounting standards 3. the intentional manipulation of financial statements by managers, often referred to as earnings management (page 47).
  • What is financial analysis and what does it consist of?
    Financial analysis involves the use of adjusted financial statement information to conduct: 1. Cash flow analysis, the analysis of how a company generate sand uses cash 2. Profitability analysis, with a focus on return on invested capital and 3. Risk analysis, including an evaluation of liquidity and solvency to assess a company's ability to meet its obligations (page 47).
  • What is prospective analysis?
    Prospective analysis involves combining the results of accounting analysis and financial analysis, along with an analysis of the business environment and company strategy, to forecast future financial statement information, especially cash flows and income (page 47).
  • What is the benefit of foreign portfolio investment?
    Investors can reduce portfolio risks by diversifying internationally (page 48).
  • Can you give a few reasons why it is useful to analyze foreign financial statements?
    For foreign portfolio investments, international mergers and acquisitions opportunities, making credit decisions about foreign customers, evaluating the financial health of foreign suppliers and benchmarking against global competitors (page 49).
  • What are the potential problems in analyzing foreign financial statements?
    1. Data accessibility, foreign companies may not be as easy to obtain as those for domestic companies. 2. Language, financial statements will most likely be in the local language 3. Currency, some statements require a translation from one currency to another (placing ratio's in statements can make this issue easier) 4. Terminology, even if a foreign company has translated its financial statements into English for the convenience of English-speaking analysts, confusion can arise because of the terminology used (this issue has mostly been handled) 5. Format, the format of financial statements can vary across countries. 6. Extent of disclosure, amounts and types of disclosure differ across countries (page 56). 7. Timeliness, the usefulness of the accounting information is in part of its function of its timeliness, that is, how soon after the end of the fiscal year the information is made available to the public (page 49 -56).
  • How do differences in accounting principles influence financial statements and how does this affect investors?
    Differences can affect accounting principles as every accounting principle differs in their statement (see picture). Because of these different methods, investors get to read different financial values that affects their decision making. Choi and Levich have addressed this issue and shown that investors are indeed affected by the difference in statements (page 57-59).
  • How do international ratio analysis differ between countries and can be seen as misleading?
    The use of ratio analysis can be misleading because of environmental differences across countries. Through a comparison of financial ratios in Japan, Korea, and the United States, Choi (researcher) has shown that substantial differences exist that are not attributable solely to differences in accounting methods. For example, when calculating the debt ratio there is a difference between Japanese firms and other firms, partly explained because of the high debt ratios from the reliance on bank financing that was partly a function of low levels of personal savings at the end of WWII. In addition, relatively low interest rates on bank rates of bank loans made debt financing attractive. Foreign investors would be concerned, in comparison to local investors, who are used to the difference in ratio. Analysis must therefore be careful in comparing ratios across countries (page 60-61).
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What are the six categories of differences that occur in accounting diversity?
1. Differences in the financial statements included in an annual report 2. Differences in the format used to present individual financial statements. 3. Differences in the level of detail provided in the financial statements. 4. Terminology differences. 5. Disclosure differences. 6. Recognition and measurement differences (page 23).
According to Shapiro (1984) what are the three different approaches to determine the subsidiary's financial structure?
1. Conform to the parent company's norm. 2. Conform to the local norm of the country where the subsidiary operates. 3.Vary judiciously to capitalize on opportunities to lower taxes, reducing financing costs and risks, and take advantage of various market imperfections. Since the parent company is responsible, legally and/or morally, for its subsidiary's financial obligations, it has to decide the subsidiary's financial structure considering the latter's effect on the parent's overall financial structure. The subsidiary, however, should be allowed to take advantage of any favorable financing opportunities available in the host country, because that is consistent with the goal of minimizing the overall cost of capital of the parent. If necessary, the parent can adjust its own financial structure to bring about the optimal overall financial structure.
 (read on page 366-368 how each approach fully effects a MNC).
How do foreign investors face different market share prices, what is also called a 'pricing-to-market (PTM) phenomenon?
While companies have incentives to internationalize their ownership structure to lower the cost of capital and increase their market values, they may be concerned, at the same time, with possible loss of corporate control to foreigners. Consequently, governments in both developed and developing countries sometimes impose restrictions on the maximum percentage ownership of local firms by foreigners. Because the constraint is effective in limiting desired foreign ownership, foreign and domestic investors may face different market share prices. Shares can exhibit a dual pricing or PTM phenomenon due to legal restrictions imposed to foreigners (page 362-363) (read the Nestlé case on page 363-364 to get a better understanding of this 'phenomenon').
Despite the potential benefits, not every company seeks overseas listings because of the costs, name four:
1. It can be costly to meet the disclosure and listing requirements imposed by the foreign exchange and regulatory authorities. 2. Controlling insiders may find it difficult to continue to derive private benefits once the company is cross-listed on foreign exchanges. 3. Once a company's stock is traded in overseas markets, there can be volatility spillover from those markets. 4. Once a company's stock is made available to foreigners, they might acquire a controlling interest and challenge the domestic control of the company.
Generally speaking, a company can benefit from cross-border listings of its shares in the following ways:
1. The company can expand its potential investor base, which will lead to a higher stock price and a lower cost of capital. 2. Cross-listing creates a secondary market for the company's shares, which facilitates raising new capital in foreign markets. 3. Cross-listing can enhance the liquidity of the company's stock. 4. Cross-listing enhances the visibility of the company's name and its products in foreign marketplaces. 5. Cross-listed shares may be used as the "acquisition currency" for taking over foreign companies. 6. Cross-listing may improve the company's corporate governance and transparency (page 358).
Does the cost of capital differ among countries?
Yes, research have shown that there is a positive relationship between cost of capital and home bias, that is the higher the home bias the higher the cost of capital (page 351-353).
How do you calculate Beta, mainly to use it in the CAPM?
See formula. Where Cov (Ri, Rm) is the covariance of future returns between security i and the market portfolio and Var(Rm) is the variance of returns of the market portfolio (page 350).
What does the Capital Asset Pricing Model (CAPM) stand for (see equation)?
CAPM states that the equilibrium expected rate of return on a stock (or more generally any security) is a linear function of the systematic risk inherent in the security (see equation). Where Rf is the risk-free interest rate and Rm is the expected return on the market portfolio, the market-value-weighted portfolio of all assets. Beta (Bi), is a measure of systematic risk inherent in security i. Systematic risk is the nondiversifiable market risk of an asset. The CAPM equation shows that the expected return of security i, Ri, increased in Bi, the greater the market risk, the greater the expected return (page 350, see also page 351 for an example).
What does the equation say?
When a firm has both debt and equity in its capital structure, its financing cost can be represented by the weighted average  cost of capital. It can be computed by weighting the after-tax borrowing cost of the firm and the cost of equity capital, using the capital structure ratio as the weight (page 349).
What does 'cost of capital' mean?
The cost of capital is the minimum rate of return an investment project must generate in orde to pay its financing costs. If the return on a investment project is equal to the cost of capital, undertaking the project will leave the firm's value unaffected (page 348).