Jack Stone is in a real quandary. He has only two weeks in which to make a final

Question

Jack Stone is in a real quandary. He has only two weeks in which to make a final recommendation on the acquisition of Matterhorn, a Swiss manufacturer of high-quality mountain climbing equipment. Matterhorn is a Swiss corporation, with a large percentage of the stock owned by Hans Groberg and his family. Hans started the business 30 years ago and is anxious to sell so he can retire. He has two sons and a daughter who manage various Matterhorn subsidiaries, but none of them is anxious to take over the business. Since beginning the business, some of the stock has been sold to nonfamily members, so Hans’s personal holdings are less than 15 percent. However, his control over Matterhorn has never been questioned by other shareholders. The banks have provided substantial financing for Matterhorn and control most of the proxy votes of other shareholders at the annual meetings.

Part of Jack’s dilemma is that he has no idea what to offer Matterhorn shareholders for their stock. The Swiss company law requires that financial statements be prepared, but the information disclosed is rather limited. Jack computed a price-earnings ratio for Matterhorn and discovered that it was four times that of a similar company in the United States, and he suspects that Matterhorn’s earnings were understated in comparison with U.S. GAAP. On the balance sheet, he noticed that certain fixed assets were carried at a value of one Swiss franc, even though their insured value was several million Swiss francs. In talking with a CPA who had experience in Switzerland, Jack found out that hidden reserves, which tend to understate the value of assets and overstate expenses, were allowed. Jack tried to get Matterhorn’s accountant to show him how the hidden reserves really affected the books, but the accountant was hesitant to do so.

Another problem is trying to get a picture of the whole corporation. Matterhorn’s financial statements—such as they are—contain the results of only the parent. Jack knows that at least 10 subsidiaries controlled by Hans’s children were not consolidated with Matterhorn’s operations. Jack has tried to get copies of the financial statements of the subsidiaries and a summary of intercompany transactions but still has not received a response.

Explanation / Answer

Hi,

Please find the answers as follows:

Part A:

One of the major problems faced by Jack is lack of proper financial information to perform an appropriate investment analysis. In the absence of such information, he is not able to arrive at the price at which he should purchase Matterhorn. A proper financial analysis can be performed with the use of correct and reliable information in the financial statements which is not available in the given case.

His complexities are further increased by the difference in the accounting principles governed by U.S. GAAP and the principles applicable to companies in Switzerland.

Part B:

Consolidation is tricky because of difference in accounting principles under U.S. GAAP and standards and principles followed by US companies. Secondly. financial statements for subsidiary companies are not available. Proper information on intercompany transactions is also not available making the consolidation difficult and tricky.

Part C:

There was a difference in the way earnings were calculated for Matterhorn. Earnings were understated as per US GAAP. Hidden reserves were established to increase the value of expenses and reduce net income to lower taxes. This issue resulted in understatement of earnings while they were actually not as per US GAAP.

Part D:

Many policies such as creation of hidden reserves resulting in understatement of expenses and overstatement of assets are allowed. Such policies are generally not allowed under the accounting systems followed by companies in other countries. In some countries, such activities are considered as unethical and not in the best interest of the investors and other stakeholders. These could be some of the reasons as to why Swiss are so conservative and secretive in their accounting.

Thanks.

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