International Financial Reporting Standards_guide.pdf

Chapter 3 Presentation of Financial Statements (IAS 1) 27
■ Company goals. Actual ratios can be compared with company objectives to determine
if the objectives are being attained.
■ Industry norms (cross-sectional analysis). A company can be compared with others in
its industry by relating its financial ratios to industry norms or a subset of the companies
in an industry. When industry norms are used to make judgments, care must be
taken, because of the following:
– Many ratios are industry specific, but not all ratios are important to all industries.
– Differences in corporate strategies can affect certain financial ratios. (It is a good
practice to compare the financial ratios of a company with those of its major competitors.
Typically, the analyst should be wary of companies whose financial ratios are
too far above or below industry norms.)
■ Economic conditions. Financial ratios tend to improve when the economy is strong
and to weaken during recessions. Therefore, financial ratios should be examined in
light of the phase of the economy’s business cycle.
■ Trend (time-series analysis). The trend of a ratio, which shows whether it is improving
or deteriorating, is as important as its current absolute level.
3.6.11 The more aggressive the accounting methods, the lower the quality of earnings; the
lower the quality of earnings, the higher the risk assessment; the higher the risk assessment,
the lower the value of the company being analyzed (see table 3.2).
3.6.12 Table 3.3 provides an overview of some of the ratios that can be calculated using
each of the classification areas discussed in 3.6.7.
3.6.13 When performing an analysis for specific purposes, various elements from different
ratio classification groupings can be combined, as seen in table 3.4.
TABLE 3.2 Manipulation of Earnings via Accounting Methods that Distort the Principles of IFRS
Financial statement item
Aggressive treatment
(bending the intention of IFRS)
“Conservative” treatment
Revenue Aggressive accruals Installment sales or cost recovery
Inventory FIFO-IFRS treatment LIFO (where allowed—not allowed per
IFRS anymore)
Depreciation
Straight line (usual under IFRS) with
higher salvage value
Accelerated-consumption-pattern
methods (lower salvage value)
Warranties or bad debts High estimates Low estimates
Amortization period Longer or increasing Shorter or decreasing
Discretionary expenses Deferred Incurred
Contingencies Footnote only Accrue
Management compensation Accounting earnings as basis Economic earnings as basis
Prior period adjustments Frequent Infrequent
Change in auditors Frequent Infrequent
Costs Capitalize Expense