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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 projects 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 financial statement 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 that competes 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 and development costs. You should seek the professors 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. You should 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 US GAAP 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 earnings forecasts 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 SECs website at www.sec.gov. Most companies have their annual reports available on their web sites.

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 would contribute to an analysis of the companys financial prospects. You can be guided by the Doupnik and Perera textbook model-- Three Steps of Financial Statement Analysis: 1. Accounting analysisreflection of economic reality (e.g. inconsistent standards, estimation errors and intentional manipulation) 2. Financial analysis (cash flow, profitability and risk analysis) 3. Prospective analysisusing 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 important disclosure 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 changes since 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 firms operations.

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 are from different countries, do you see evidence of country differences? E. The US firm has a Management Discussion and Analysis. What does the IFRS firm have that 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 the income 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 influence accounting 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 at times 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 librarys data bases can be helpful-- You can do a search on ABI Inform and other 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 firms 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 flow compare 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?

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 possibly identify 2 or 3 items and use this in interpreting the ratios. Analyzing the financial statementsyour 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 analysis Leverage 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 Bradstreets Industry Norms and Key Business Ratios, Yahoo Finance, Standard and Poors Industry Reports, Value Line Investment Surveys and various Moodys 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 GAAP differences? 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 firms 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

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 do not 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, & Moodys) 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 months or 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 not much 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 calculated the 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. Since there 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 by the 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 the outlook 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

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 companys operations? In what lines of business does the firm operate? What is the companys 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 firms 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 the firm? 9) How does R&D fit into the firms strategy? Questions related to the industry: 1. Does the industry consist of many firms? A few firms? 2. Who are some of the companys 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!

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 Monday after 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 should use 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 GAAP difference from IFRS that would impact reported net income for an in-depth accounting analysis, including consideration of the firms operations. The accounting analysis presentation should be at least 60% of the presentation. The maximum time for each teams 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, and managements 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 and concise 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.

(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 firms most recent 10K filed with the SEC and IFRS firms 20F 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 students 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 industry standards. 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 in firm 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 companys year do not necessarily represent the actual activity for those quarters, 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 company expects 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 1st and 2nd quarter of another year introduces another set of problems. The sum of those 4

quarters does not represent what the financial statements would be if those 4 quarters represented the firms fiscal year. You essentially trade off one set of problems (differences in economic climate) for another. Do not attempt to do this adjustment. If you have 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.

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 ______ 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 ______ Attends team meetings ______ Comes prepared to team meetings and is willing to contribute ______ Performs agreed upon tasks ______ Shows respect for peers and their views

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______ Other(explain)_____________________________________________________________ _______ 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)_____________________________________________________________ _______ 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, international company 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 recent industry-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; enables customized viewing and output to retrieve company reports and financials into software applications such as Word, Excel or Adobe, and enables accurate crossborder 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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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 analyst reports. IFRS comparison exhibit (illustration) Accounting policy 1.Inventory US INC. Fin Inc. Comments 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 trend for 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 firms investment prospects. Using ABI Inform or Google may help you find such articles. Dont worry if you can not find something that is obvious. Readings #5 and 9 that I handed out in the beginning of the semester may be helpful.

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Team IFRS firm (study): Industry: US Firm: Ratio Analysis table 1 Ratios 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 Year ended 2008 US firm 2007 US firm IFRS firm (study): 2008 IFRS firm (study): 2007 Pos. Neg.

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IFRS benchmark firm: benchmark firm Ratio Analysis table 2 Ratios 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 2008 IFRS firm 2007 IFRS firm IFRS firm 2008 IFRS firm 2007 Pos. Neg.

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