Accounting classification differences

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Accounting Classification Differences
While accounting quality is primarily a firm-specific concept, a related concern arises when you wish to compare two firms that use different accounting classifications for the same economic item. For example, consider two luxury goods retailers, Coach and Tiffany. Coach includes shipping and handling expense (for shipping products to retail locations and to customers) in selling, general, and administrative expenses, while Tiffany includes it in cost of goods sold. This creates a source of difference in their gross margins. If the amounts of shipping and handling expense are disclosed, then analysts can adjust SG&A and cost of goods sold. If the amounts are not disclosed, the analyst must take the difference into account when making profitability comparisons.

The account classification issue is exacerbated when comparing firms in different countries. Exhibit 6.10 presents the 2009 consolidated income statement of the Finnish company Stora Enso, prepared in accordance with IFRS. Stora Enso is a global paper, packaging, and wood products company that produces newsprint and book paper, magazine paper, fine paper, consumer board, industrial packaging, and wood products. Stora Enso’s sales totaled EUR 8.9 billion in 2009. The company has approximately 27,000 employees in more than 35 countries worldwide

Typical of the financial statements for a non-U.S. company, Stora Enso classifies expenses by source instead of function. For example, a U.S. paper company includes as operating expenses cost of goods sold, SG&A (selling, general, and administrative) expenses, possibly some other gains and losses, restructuring charges, and impairments. Wages and salary costs and depreciation costs are allocated to cost of goods sold and SG&A expenses. Cost of goods sold includes the costs allocated to inventory sold that period, such as wages and depreciation (that is, manufacturing overhead) costs, as well as materials costs. Wages, salaries, and depreciation not related to production appear in SG&A. In contrast, Stora Enso does not make those allocations. For example, ‘‘Personnel expenses’’ are listed, but one does not know the portion of those expenses that would be included in inventory and therefore included in cost of goods sold in the U.S. company. Likewise, Stora Enso reports ‘‘Depreciation, amortisation, and impairment charge,’’ which is different from what is done in the U.S. reporting approach. Instead of cost of goods sold, Stora Enso reports ‘‘Materials and services’’ and ‘‘Changes in inventories of finished goods and work in progress.’’ An analyst estimating cost of goods sold would have to include these two accounts, an estimated portion of personnel expenses to be included in inventory, and an estimated portion of depreciation to be included in inventory.

When you can easily and unambiguously reclassify accounts, the reclassified data should serve as the basis for analysis. If the reclassifications require numerous assumptions, you should make them as precisely as possible or avoid making them and note the differences in account classification for further reference when interpreting the financial statement analysis

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