Chapter 4 Analysis of Financial Statements 974-5c Return on Total Assets
Net income divided by total assets gives us the return on total assets (ROA):
Return on total assets (ROA)! Net incTotal assets__ome
! $117.5__$2,000! 5.9%
Industry average! 9.0%
Allied’s 5.9% return is well below the 9.0% industry average. This is not good—it is
obviously better to have a higher than a lower return on assets. Note, though, that a
low ROA can result from a conscious decision to use a great deal of debt, in which
case high interest expenses will cause net income to be relatively low. That is part of
the reason for Allied’s low ROA. Never forget—you must look at a number of ratios,
see what each suggests, and then look at the overall situation when you judge the
performance of a company and consider what actions it should undertake to
improve.
Return on Total Assets
(ROA)
The ratio of the net income
to total assets.Return on Total Assets
(ROA)
The ratio of the net income
to total assets.These days you must be a good! nancial detective to analyze
! nancial statements, especially when the company operates
overseas. Despite attempts to standardize accounting practices,
there are still many di" erences in! nancial reporting in di" erent
countries; and those di" erences create headaches for investors
making cross-border company comparisons. However, as busi-
nesses become more global and as more foreign companies list
on U.S. stock exchanges, accountants and regulators are realiz-
ing the need for a global convergence of accounting standards.
As a result, the “writing is on the wall” regarding accounting
standards and di" erences are disappearing.
The e" ort to internationalize accounting standards
began in 1973 with the formation of the International
Accounting Standards Committee. However, in 1998, it
became apparent that a full-time rule-making body with
global representation was necessary; so the International
Accounting Standards Board (IASB), with members repre-
senting 9 major countries, was established. The IASB was
charged with the responsibility for creating a set of Interna-
tional Financial Reporting Standards (IFRS).
A survey of senior executives from 85! nancial institutions
worldwide found that 92% of those responding favored a sin-
gle set of international standards. The U.S. SEC has proposed
allowing non-U.S. companies that operate in the United States
to base their reports on IFRS rather than GAAP, and it is consid-
ering requiring U.S. companies to shift to IFRS. Obviously, the
globalization of accounting standards is a huge endeavor—
one that will involve compromises between the IASB and FASB.
The main problem is that U.S. GAAP takes a rules-based
approach, while the IASB insists on using a principles-based
approach. With a rules-based system, companies can tell
whether they are in compliance, but they can also devise ways
to get around a rule and thus subvert its intent. With a princi-
ples-based system, there is more uncertainty about whether
certain borderline procedures will be allowed; but such a sys-
tem makes it easier to prosecute on the basis of intent.
A global accounting structure would enable investors
and practitioners around the world to read and understand
! nancial reports produced anywhere in the world. According
to SEC Chairman Christopher Cox, “Having a set of globally
accepted accounting standards is critical to the rapidly accel-
erating global integration of the world’s capital markets.”
Even the chairman of the U.S. Financial Accounting Stan-
dards Board, Robert Herz, has recommended that a target
date be set for U.S. companies to transition from GAAP to
IFRS. So it seems that the issue is when, not if, all companies
will be playing by the same set of accounting rules.GLOBAL ACCOUNTING STANDARDS: CAN ONE SIZE FIT ALL?
Sources: “All Accountants Soon May Speak the Same Language,” The Wall Street Journal, August 29, 1995, p. A15; “For and Against; Standards
Need Time to Work,” Accountancy Age, June 5, 2003, p. 16; and James Turley (CEO, Ernst & Young), “Mind the GAAP,” The Wall Street Journal,
November 9, 2007, p. A18.