325CASESCase 9-1SandvikOne of the accounting development pattern that was introduced in Chapter 2was the macroeconomic development model. Under this frame work accounting practices are designed to enhance national macroeconomic goals. A nationalpolicy advocating stable employment byavoiding major swings in business cycleswould sanction accounting practicesthat smooth income. Similarly, nationalpolicies supporting growth in certainindustries would sanction rapid writeoffsof fixed assets to encourage capitalformation. Sweden is a good example ofthis reporting pattern. Assets may berevalued upwards if they are deemed tohave enduring value, the tax law permitsshorter asset lives, and ceiling tests fordepreciation charges include the higherof 130 percent declining balance methodor 20 percent straight line. Companiesare also permitted to allocate a portion ofpre-tax earnings to special tax equalizationreserves which are not available fordividends until reversed.Reproduced below are the parentcompany financial statements of Sandvikfor the years 2006 and 2007 and selectednotes. Sandvik is a global high technologycompany headquartered in Sweden,with advanced products and well-knownbrands. Its core areas of competenceinclude high speed tools for metalworking, machinery, tools and servicesfor rock excavation, and specialty steels.The company states that it applies allIFRS and IFRIC interpretations approvedby the EU to the extent possible withinthe framework of the Swedish AnnualAccounts Act and considering the closetie between financial reporting and taxation.

Examine the data presented andanswer the following questions.1.What advantages and disadvantagesarise for firms that chose toemploy the Swedish system of specialreserves?2.What are the potential benefits ofthe system of special reserves to theSwedish government?3.In what way does the existence ofthe Swedish reserve system affectthe ability of a financial analyst toevaluate a Swedish firm vis-a-vis anon-Swedish firm?4.In what way does the use ofreserves affect Sandviks financialstatements for the year 2007?How does this compare with theeffect of reserves in the previousyear?5.Show the accounting entry used tocreate the 2007Appropriationsfigurein the income statement.6.If you were to unwind the effect ofreserves for 2007, how wouldSandviks key profitability ratios,such as return on sales and returnon assets change?326Chapter 9 International Financial Statement AnalysisAmounts in SEK M 2007 2006Revenue Note 2 20682 17932Cost of sales and services-16111-13646Gross profit4571 4286Selling expenses-621-577Administrative expenses-1982-1719Research and development costs Note 4-1019-778Other operating income Note 5 488 455Other operating expenses Note 6-916-1344Operating profitNote 3, 7, 8 521 323Income from shares in group companies Note 9 5997 9264Income from shares in associated companies Note 9 5 1Income from investments held as non-current assets Note 9 0Interest income and similar items Note 9 638 657Interest expenses and similar items Note 9-1165-898Profit after financial items5996 9347Appropriations Note 10 3063 305Income tax expense Note 11-745-29Profit for the year8314 9623Parent Company Income StatementParent Company Balance SheetAmounts in SEK M 2007 2006ASSETSNon-current assetsIntangible assetsPatents and similar rights Note 14 26 51Total 26 51Property, plant and equipmentLand and buildings Note 14 484 473Plant and machinery Note 14 3624 3492Equipment, tools and installations Note 14 305 309Construction in progress and advancepayments Note 14 1352 974Total 5765 5248Financial assetsShares in group companies Note 15 13762 11723Advances to group companies 48 34Investmments in associated companies Note 16 4 4Advances to associated companies 0Other investments 1 1Non-current receivables Note 18 20 23(continued)Chapter 9 International Financial Statement Analysis327Parent Company Balance Sheet(Continued)Amounts in SEK M 2007 2006Deferred tax assets Note 11 22 17Total 13857 11802Total non-current assets19648 17101Current assetsInventoriesNote 19 6242 4599Current receivablesTrade receivables 1255 1150Due from group companies 16311 15846Due from associated companies 131 474Income tax receivables Note 11 393 16Other receivables Note 18 518 456Prepaid expenses and accrued income 679 423Total 19287 18365Cash and cash equivalents6 19Total current assets25535 22983TOTAL ASSETS45183 40084EQUITY AND LIABILITIESEquityNon-distributable equityShare capital 1424 1424Legal reserve 1611 1611Total 3035 3035Distributable equityProfit brought forward 1552 1637Profit for the year 8314 9623Total 9866 11260Total equityNote 20 12901 14295Untaxed reservesAccelerated depreciation Note 21 2430Tax allocation reserves Note 22 639Other untaxed reserves Note 22 19 15Total 19 3084ProvisionsProvisions for pensions and similar obligations Note 23 108 106Provisions for taxes Note 11 55 42Other provisions Note 24 154 127Total 317 275Non-current interest-bearing liabilitiesLoans from financial institutions Note 25 1718 1669Loans from group companies Note 25 30 3Other liabilities Note 25 10131 2511Total 11879 4183(continued)328Chapter 9 International Financial Statement AnalysisNoncurrent noninterest-bearing liabilitiesOther liabilities 9Total 9Current interest-bearing liabilitiesLoans from group companies 10902 12766Other liabilities 1080 1324Total 11982 14090Current noninterest-bearing liabilitiesAdvance payments from customers 159 53Accounts payable 1721 1734Due to group companies 3655 27Due to associated companies 82 125Other liabilities 136 205Accrued expenses and deferred income Note 28 2332 2004Total 8085 4148TOTAL EQUITY AND LIABILITIES 45183 40084Pledged assets Note 29 Contingent liabilities Note 29 16068 11929Parent Company Balance Sheet(Continued)Note 10. AppropriationsParent Company2007 2006Accelerated depreciation 2429-143Changes in tax allocation reserves 638 437Changes in other untaxed reserves-4 11Total 3063 305Note 11. Income taxReported in Income StatementGroupParentCompanyIncome tax expense2007 2006 2007 2006Current tax-4396-3135-829-115Adjustment of taxes attributable to prior years 229-16 67 64Total current tax expense-4167-3151-762-51Deferred taxes relating to temporary differencesand unused tax losses 763 145 17 22Total tax expense-3404-3006-745-29Chapter 9 International Financial Statement Analysis329The Groups tax expense for the year wasSEK 3,404 M (3.006) or 26.2% (27.0) of theprofit after financial items.The adjustment of taxes attributableto prior years mainly relates to favorabletax litigation resolutions andadvance rulings in Sweden and reversalof tax provisions upon finalization of taxaudits of foreign subsidiaries.Reconciliation of the Groups taxexpenseThe Groups weighted averagetax based on the tax rates in each country,is 29. 6% (27.0). The nominal tax rate inSweden is 28.0% (28.0).Reconciliation of the Groupsweighted average tax rate, based on thetax rates in each country, and the Groupsactual tax expense:Reconciliation of the Parent Companys taxexpenseThe Parent Companys effectivetax rate of 8.2% (0.8) is less than the nominaltax rate in Sweden, mainly due totax-exempt dividend income from subsidiariesand associated companies:2007 2006Group SEK M % SEK M %Profit after financial items 12997 11113Weighted average tax based on eachcountrys tax rate-3849-29.6-3001-27.0Tax effect of:Non-deductible expenses-195-1.5-179-1.6Tax exempt income 199 1.5 244 2.2Adjustments relating to prior year 229 1.8-16-0.1Effects of unused tax losses, net 75 0.6-22-0.2Other 137 1.1-32-0.3Total reported tax expense-3404-26.2-3006-27.0Reconciliation of the Parent Companysnominal tax rate and actual taxexpense:2007 2006Parent CompanySEK M % SEK M %Profit before tax 9059 9652Tax based on the nominal tax rate for theParent Company-2537-28.0-2703-28.0Tax effects of:Non-deductible expenses-33-0.4-59-0.6Tax-exempt income 1758 19.4 2669 27.6Adjustments relating to prior years 67 0.7 64 0.7Total reported tax expense-745-8.2 29-0.3330Chapter 9 International Financial Statement Analysis2007 2006GroupDeferredtax assetsDeferredtaxliabilities NetDeferredtax assetsDeferredtaxliabilities NetIntangible assets 34-666-632 39-282-243Property, plant,and equipment 96-965-869 195-1573-1378Financial non-current assets 58-2 56 26-31-5Inventories 1445-62 1383 1034-30 1004Receivables 66-335-269 95-237-142Interest-bearing liabilities 325-263 62 549-184 365Noninterest-bearingliabilities 513-761-248 393-444-51Group2007 2006Deferred tax relating to hedging reserve 31 34Total 31 34Parent Company2007 2006Current tax relating to taxable groupcontributions 843-95Total 843-95Tax items recognized directly in equityReported in the balance sheetDeferred tax assets and liabilitiesThedeferred tax assets and liabilities reportedin the balance sheet are attributable to thefollowing assets and liabilities (liabilitiesshown with a minus sign):2007 2006GroupDeferredtax assetsDeferredtaxliabilities NetDeferredtax assetsDeferredtaxliabilities NetOther 19-49-30 20-261 241Unused tax losses 84–84– — –Total 2640-3103-463 2351-3042-691Offsetting within companies-1317 1317– -1031 1013–Total deferred tax assetsand liabilities 1323-1786-463 1338-2029-691Parent CompanyProperty, plantand equipment– -37-37– -38-38Chapter 9 International Financial Statement Analysis331Note 21. Parent Companys Accelerated DepreciationLand andbuildingsPlant andmachineryEquipment, toolsand installationsPatents andsimilar rights TotalBalance at 1 January 2006 1 2075 182 29 2287Accelerated depreciation for the year 0 127 13 3 143Balance at 31 December 2006 1 2202 195 32 2430Balance at 1 January 2007 1 2202 195 32 2430Accelerated depreciation for the year-1-2202-195-32-2430Balance at December 2007– — — — –Note 22. Parent Companys Other Untaxed Reserves2007 2006Tax allocation reservesAppropriated at 2002 tax assessment–435Appropriated at 2004 tax assessment–204Balance at 31 December–639Other untaxed reserves 19 15325CASESCase 9-1SandvikOne of the accounting development patternsthat was introduced in Chapter 2was the macroeconomic developmentmodel. Under this framework accountingpractices are designed to enhancenational macroeconomic goals. A nationalpolicy advocating stable employment byavoiding major swings in business cycleswould sanction accounting practicesthat smooth income. Similarly, nationalpolicies supporting growth in certainindustries would sanction rapid writeoffsof fixed assets to encourage capitalformation. Sweden is a good example ofthis reporting pattern. Assets may berevalued upwards if they are deemed tohave enduring value, the tax law permitsshorter asset lives, and ceiling tests fordepreciation charges include the higherof 130 percent declining balance methodor 20 percent straight line. Companiesare also permitted to allocate a portion ofpre-tax earnings to special tax equalizationreserves which are not available fordividends until reversed.Reproduced below are the parentcompany financial statements of Sandvikfor the years 2006 and 2007 and selectednotes. Sandvik is a global high technologycompany headquartered in Sweden,with advanced products and well-knownbrands. Its core areas of competenceinclude high speed tools for metalworking, machinery, tools and servicesfor rock excavation, and specialty steels.The company states that it applies allIFRS and IFRIC interpretations approvedby the EU to the extent possible withinthe framework of the Swedish AnnualAccounts Act and considering the closetie between financial reporting and taxation.Examine the data presented andanswer the following questions.1.What advantages and disadvantagesarise for firms that chose toemploy the Swedish system of specialreserves?2.What are the potential benefits ofthe system of special reserves to theSwedish government?3.In what way does the existence ofthe Swedish reserve system affectthe ability of a financial analyst toevaluate a Swedish firm vis-a-vis anon-Swedish firm?4.In what way does the use ofreserves affect Sandviks financialstatements for the year 2007?How does this compare with theeffect of reserves in the previousyear?5.Show the accounting entry used tocreate the 2007Appropriationsfigurein the income statement.6.If you were to unwind the effect ofreserves for 2007, how wouldSandviks key profitability ratios,such as return on sales and returnon assets change?326Chapter 9 International Financial Statement AnalysisAmounts in SEK M 2007 2006Revenue Note 2 20682 17932Cost of sales and services-16111-13646Gross profit4571 4286Selling expenses-621-577Administrative expenses-1982-1719Research and development costs Note 4-1019-778Other operating income Note 5 488 455Other operating expenses Note 6-916-1344Operating profitNote 3, 7, 8 521 323Income from shares in group companies Note 9 5997 9264Income from shares in associated companies Note 9 5 1Income from investments held as non-current assets Note 9 0Interest income and similar items Note 9 638 657Interest expenses and similar items Note 9-1165-898Profit after financial items5996 9347Appropriations Note 10 3063 305Income tax expense Note 11-745-29Profit for the year8314 9623Parent Company Income StatementParent Company Balance SheetAmounts in SEK M 2007 2006ASSETSNon-current assetsIntangible assetsPatents and similar rights Note 14 26 51Total 26 51Property, plant and equipmentLand and buildings Note 14 484 473Plant and machinery Note 14 3624 3492Equipment, tools and installations Note 14 305 309Construction in progress and advancepayments Note 14 1352 974Total 5765 5248Financial assetsShares in group companies Note 15 13762 11723Advances to group companies 48 34Investmments in associated companies Note 16 4 4Advances to associated companies 0Other investments 1 1Non-current receivables Note 18 20 23(continued)Chapter 9 International Financial Statement Analysis327Parent Company Balance Sheet(Continued)Amounts in SEK M 2007 2006Deferred tax assets Note 11 22 17Total 13857 11802Total non-current assets19648 17101Current assetsInventoriesNote 19 6242 4599Current receivablesTrade receivables 1255 1150Due from group companies 16311 15846Due from associated companies 131 474Income tax receivables Note 11 393 16Other receivables Note 18 518 456Prepaid expenses and accrued income 679 423Total 19287 18365Cash and cash equivalents6 19Total current assets25535 22983TOTAL ASSETS45183 40084EQUITY AND LIABILITIESEquityNon-distributable equityShare capital 1424 1424Legal reserve 1611 1611Total 3035 3035Distributable equityProfit brought forward 1552 1637Profit for the year 8314 9623Total 9866 11260Total equityNote 20 12901 14295Untaxed reservesAccelerated depreciation Note 21 2430Tax allocation reserves Note 22 639Other untaxed reserves Note 22 19 15Total 19 3084ProvisionsProvisions for pensions and similar obligations Note 23 108 106Provisions for taxes Note 11 55 42Other provisions Note 24 154 127Total 317 275Non-current interest-bearing liabilitiesLoans from financial institutions Note 25 1718 1669Loans from group companies Note 25 30 3Other liabilities Note 25 10131 2511Total 11879 4183(continued)328Chapter 9 International Financial Statement AnalysisNoncurrent noninterest-bearing liabilitiesOther liabilities 9Total 9Current interest-bearing liabilitiesLoans from group companies 10902 12766Other liabilities 1080 1324Total 11982 14090Current noninterest-bearing liabilitiesAdvance payments from customers 159 53Accounts payable 1721 1734Due to group companies 3655 27Due to associated companies 82 125Other liabilities 136 205Accrued expenses and deferred income Note 28 2332 2004Total 8085 4148TOTAL EQUITY AND LIABILITIES 45183 40084Pledged assets Note 29 Contingent liabilities Note 29 16068 11929Parent Company Balance Sheet(Continued)Note 10. AppropriationsParent Company2007 2006Accelerated depreciation 2429-143Changes in tax allocation reserves 638 437Changes in other untaxed reserves-4 11Total 3063 305Note 11. Income taxReported in Income StatementGroupParentCompanyIncome tax expense2007 2006 2007 2006Current tax-4396-3135-829-115Adjustment of taxes attributable to prior years 229-16 67 64Total current tax expense-4167-3151-762-51Deferred taxes relating to temporary differencesand unused tax losses 763 145 17 22Total tax expense-3404-3006-745-29Chapter 9 International Financial Statement Analysis329The Groups tax expense for the year wasSEK 3,404 M (3.006) or 26.2% (27.0) of theprofit after financial items.The adjustment of taxes attributableto prior years mainly relates to favorabletax litigation resolutions andadvance rulings in Sweden and reversalof tax provisions upon finalization of taxaudits of foreign subsidiaries.Reconciliation of the Groups taxexpenseThe Groups weighted averagetax based on the tax rates in each country,is 29. 6% (27.0). The nominal tax rate inSweden is 28.0% (28.0).Reconciliation of the Groupsweighted average tax rate, based on thetax rates in each country, and the Groupsactual tax expense:Reconciliation of the Parent Companys taxexpenseThe Parent Companys effectivetax rate of 8.2% (0.8) is less than the nominaltax rate in Sweden, mainly due totax-exempt dividend income from subsidiariesand associated companies:2007 2006Group SEK M % SEK M %Profit after financial items 12997 11113Weighted average tax based on eachcountrys tax rate-3849-29.6-3001-27.0Tax effect of:Non-deductible expenses-195-1.5-179-1.6Tax exempt income 199 1.5 244 2.2Adjustments relating to prior year 229 1.8-16-0.1Effects of unused tax losses, net 75 0.6-22-0.2Other 137 1.1-32-0.3Total reported tax expense-3404-26.2-3006-27.0Reconciliation of the Parent Companysnominal tax rate and actual taxexpense:2007 2006Parent CompanySEK M % SEK M %Profit before tax 9059 9652Tax based on the nominal tax rate for theParent Company-2537-28.0-2703-28.0Tax effects of:Non-deductible expenses-33-0.4-59-0.6Tax-exempt income 1758 19.4 2669 27.6Adjustments relating to prior years 67 0.7 64 0.7Total reported tax expense-745-8.2 29-0.3330Chapter 9 International Financial Statement Analysis2007 2006GroupDeferredtax assetsDeferredtaxliabilities NetDeferredtax assetsDeferredtaxliabilities NetIntangible assets 34-666-632 39-282-243Property, plant,and equipment 96-965-869 195-1573-1378Financial non-current assets 58-2 56 26-31-5Inventories 1445-62 1383 1034-30 1004Receivables 66-335-269 95-237-142Interest-bearing liabilities 325-263 62 549-184 365Noninterest-bearingliabilities 513-761-248 393-444-51Group2007 2006Deferred tax relating to hedging reserve 31 34Total 31 34Parent Company2007 2006Current tax relating to taxable groupcontributions 843-95Total 843-95Tax items recognized directly in equityReported in the balance sheetDeferred tax assets and liabilitiesThedeferred tax assets and liabilities reportedin the balance sheet are attributable to thefollowing assets and liabilities (liabilitiesshown with a minus sign):2007 2006GroupDeferredtax assetsDeferredtaxliabilities NetDeferredtax assetsDeferredtaxliabilities NetOther 19-49-30 20-261 241Unused tax losses 84–84– — –Total 2640-3103-463 2351-3042-691Offsetting within companies-1317 1317– -1031 1013–Total deferred tax assetsand liabilities 1323-1786-463 1338-2029-691Parent CompanyProperty, plantand equipment– -37-37– -38-38Chapter 9 International Financial Statement Analysis331Note 21. Parent Companys Accelerated DepreciationLand andbuildingsPlant andmachineryEquipment, toolsand installationsPatents andsimilar rights TotalBalance at 1 January 2006 1 2075 182 29 2287Accelerated depreciation for the year 0 127 13 3 143Balance at 31 December 2006 1 2202 195 32 2430Balance at 1 January 2007 1 2202 195 32 2430Accelerated depreciation for the year-1-2202-195-32-2430Balance at December 2007– — — — –Note 22. Parent Companys Other Untaxed Reserves2007 2006Tax allocation reservesAppropriated at 2002 tax assessment–435Appropriated at 2004 tax assessment–204Balance at 31 December–639Other untaxed reserves 19 15