Financial Accounting and Reporting
Barry Elliott and Jamie Elliott · 2011 · 929 pages
A 31-chapter UK university textbook on IFRS financial reporting, not a trading book. The only two chapters worth an investor's time are the ratio pyramid in chapter 27 and the corporate-failure scoring models in chapter 28.
The one idea
The book's real subject is how a set of financial statements gets built under international accounting standards, from cash-basis accounting through consolidated group accounts to foreign exchange translation. Most of its 31 chapters are aimed at accounting students learning to prepare statements, not at investors trying to read them.
Buried inside chapter 27, though, is a genuinely useful idea: a pyramid of six ratios that decomposes a company's operating return on equity into its constituent drivers. Operating return on equity splits into the financial leverage multiplier and return on capital employed (ROCE); ROCE itself splits into asset turnover and operating margin. Because it is a pyramid, a reader can see exactly which lever moved when a headline ratio changes, rather than treating each ratio as a standalone number.
Chapter 28 extends this into failure prediction: Altman's Z-score, Taffler's Z-score, Company Watch's H-score, and a qualitative A-score, each with published (or partly published) formulas, coefficients, and pass/fail benchmarks drawn from real company data.
What it actually teaches
The chapter 27-28 material works as a five-step read on a set of accounts, moving from the top-line return down to a failure check.
START AT THE APEX RATIO
Operating return on equity (operating profit before tax as a percentage of shareholders' equity) sits at the top of the pyramid. The book's worked example is JD Wetherspoon plc: this ratio rose from 22.6% in 2002 to 23.5% in 2003.
SPLIT IT INTO LEVERAGE AND ROCE
Operating return on equity is the product of the financial leverage multiplier (capital employed divided by shareholders' equity) and ROCE (operating profit divided by capital employed). For Wetherspoon the leverage multiplier moved from 2.53 to 2.56 times and ROCE from 8.95% to 9.19%, meaning the improvement came from both more debt and better use of assets.
SPLIT ROCE INTO TURNOVER AND MARGIN
ROCE further decomposes into asset turnover (revenue divided by capital employed) times operating margin (operating profit as a percentage of revenue). Wetherspoon's asset turnover improved from 0.77 to 0.9 times even as net margin fell from 11.66% to 10.26%, which is the detail the headline ratio alone hides.
CHECK LIQUIDITY SEPARATELY
The sixth key ratio, current assets divided by current liabilities, does not feed the profitability pyramid; it is a standalone liquidity check. There is no universal target (the book explicitly rejects the 2:1 rule of thumb); compare against the industry, since the book notes UK brewers commonly run below 0.5:1.
RUN A FAILURE SCORE
Altman's original Z-score is Z = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.999X5, built from working capital, retained earnings, EBIT, market cap and sales, each divided by total assets (except X4, market cap over book debt). A score above 3.0 (later revised to 2.7) signals safety; below 1.8 signals high failure risk. Taffler's Z-score uses a different four-ratio blend with a 0.2 pass line, and Company Watch's H-score runs 0 to 100 with a danger zone below 25.
What it looks like Monday morning
A reader who works through chapters 27 and 28 comes away able to pull a company's operating margin, asset turnover, and leverage multiplier apart into a one-page pyramid instead of eyeballing a single P/E or current ratio in isolation. The next earnings release gets read as: which of the five drivers actually moved, and did leverage do the work that operations should have done.
The same reader can also run a back-of-envelope Altman Z-score on a holding using nothing but the balance sheet and income statement, and treat a reading under 1.8 (or the revised 2.7 cutoff) as a prompt to dig into the footnotes rather than a verdict on its own.
| Ratio | 2003 | 2002 |
|---|---|---|
| Operating return on equity | 23.5% | 22.6% |
| Financial leverage multiplier | 2.56x | 2.53x |
| Return on capital employed | 9.19% | 8.95% |
| Asset turnover | 0.9x | 0.77x |
| Net profit margin | 10.26% | 11.66% |
| Current ratio | 0.31:1 | 0.31:1 |
The headline return rose only because rising leverage and asset turnover outran a falling net margin, a pattern the single top-line ratio alone would have hidden.
The user should be aware that a ratio is not saying anything about the trends of its individual components.Barry Elliott and Jamie Elliott, Financial Accounting and Reporting
Where it fails
- It is a textbook, not an investing book. Every chapter closes with Objectives, Summary, Review questions, Exercises and References aimed at examinable coursework. The publisher pairs it with an Instructor's Manual and MyAccountingLab study plan. An investor has to skip roughly 25 of the 31 chapters (cash flow basics, consolidation mechanics, foreign currency translation, employee benefits) to reach the two chapters that actually help with reading a stock's accounts.
- The standards it cites have moved on since 2011. The 14th edition documents IAS 17 for leases and IAS 39 for financial instruments as current law. IAS 17 was replaced by IFRS 16 in 2016, moving nearly all operating leases onto the balance sheet, and IAS 39 was replaced by IFRS 9 in 2018. A reader applying this edition's lease or financial-instrument rules to a company's current filings will misread the balance sheet.
- It is built for UK company accounts, with US treatment as an afterthought. The regulatory chapters run through the Financial Reporting Council, the Companies Act, and the ASB in detail; worked examples are drawn from UK-listed names like JD Wetherspoon and the Kier Group. US GAAP appears mainly as a comparison point in the standards-convergence chapters, not as a parallel worked track.
- One of the three named failure-prediction scores can't actually be run from the book. The text gives Altman's full Z-score coefficients and Taffler's ratio weightings (53%, 13%, 18%, 16%), but states outright that the Zeta model's coefficients 'have not been published' and that Taffler's exact equation is also unpublished, meaning a reader is limited in practice to Altman's original formula unless they subscribe to a commercial service.
- The ratio worked examples show improving numbers, not failing ones. The central JD Wetherspoon walkthrough is a company whose operating return on equity is rising. The book explains how to read a deteriorating set of ratios in the abstract (falling gross margin, growing overdraft) but never runs a full company through the pyramid and the Z-score simultaneously to show a name that actually crossed into the danger zone.
Who it is for
Buy it if
You are studying for an accounting or finance qualification and need a rigorous, exercise-backed reference for how IFRS financial statements are built and read, with chapters 27 and 28 doubling as a genuinely useful ratio and failure-prediction primer for company analysis.
Skip it if
You want a trading or investing edge, a quick read, or up-to-date lease and financial-instrument accounting. This is a 929-page university textbook current to 2011 standards; buy a ratio-analysis or credit-analysis book instead if the pyramid and Z-score section is all you need.
As an Amazon Associate I earn from qualifying purchases. It costs you nothing extra, and it does not change what gets recommended or what the verdict says.