A critical insight into the financial statements of GlaxoSmithKline GSK

Category: Accounting

In preparing financial statements, companies have to make a decision on which information to include in the financial statements, when to include it and how to present the information in a way that is useful to users. Most national accounting bodies and particularly the International Accounting Standards Board(IASB) have come up with a generally accepted set of principles based on which financial statements that aim to give a true and fair view ought to adhere. The principles cover almost every aspect of financial reporting however this report is aimed at the qualitative characteristics of financial reporting.

This report takes a critical look at the financial statements of GlaxoSmithKline(GSK) a major pharmaceutical company for the year ended 31st December 2008 and how the information presented in the statements conform to or digress from the qualitative benchmarks of financial statements that aim to give a true and fair view.

The statements are taken in turn and the information presented analysed on the basis of its:

Relevance: the ability of the information to influence the economic decisions of users

Reliability: the information is complete and faithful representation

Comparability: similarities and differences year on year and with similar companies are analysed. For the purposes of this report the financial statements of Smith&Nephew(S&N) a company specialising in medical devices is compared with GSK

Understandability: The significance of the information presented can be perceived

The statements to be analysed in turn are:

The Consolidated Statement of Comprehensive Income

The Consolidated Statement of Financial Position

The Consolidated Statement of Changes in Equity

Non-current Assets

Consolidated Statement of Comprehensive Income

The financial statements of GSK group has been prepared as stated in the notes to the accounts in accordance with the Companies Act 1985, International Accounting Standards(IAS) and International financial reporting standards(IFRS). The aim in this section is to comment whether the information presented in the consolidated income statement are relevant, reliable, comparable and understandable and also to detect any material misstatements or omissions where applicable.

Relevance

As stated above information is said to be relevant if it has the ability to influence the economic decisions of users and is provided in time to influence those decisions. Relevant information must have a predictive or confirmatory value or both. GSK in making the decisions of what information to include and how to include it has demonstrated this quality in the inclusion of its restructuring costs in the income statements. Particularly important to this quality is the separation of the performance of the group before and after the inclusion of the restructuring costs in the income statement, to show the effect of its incidence on the performance of the group. This way, users are able to evaluate or assess current and future performance of GSK. Also, it enables users to confirm or correct any past evaluations that they have made about GSK. Suffice to state that the presentation of the performance of the group as a single entity in a consolidated statement gives credence to GSK's adherence to providing users with information that is relevant. Research and development expenditure has been written off in the income statement and capitalised when deserved. This enables users to perceive which projects GSK has invested in and the magnitude of the investment for users to make decisions on the future performance and potential viability of GSK. Other relevant information is of course Turnover and gross profit which gives an indication of the extent to which management of GSK has used the resources in their control to generate revenue. Also important particularly to the owners of GSK who are by default the principal intended recipients of the financial statements is the inclusion of profit after tax. This is arguably the most relevant information to users as it shows the profitability of GSK. Items such as finance costs and the associated disclosures are also relevant to users as they give any indication of how much is owed lenders of GSK.

Reliability

The information provided in financial statements ought to be reliable. The quality of reliability requires information presented to be neutral, free from material error, complete, prudently estimated and faithfully represented. To the extent that GSK has adhered to IFRS and IAS determines whether the information presented is reliable as the reliability of the information depends to a large extent on the methods adopted by GSK. The neutrality of the information presented is difficult to ascertain however based on the independent auditors' report it is safe to state that GSK has exercised neutrality and prudence in presenting the financial information for 2008. In requiring financial statements to represent faithfully what it purports to represent and to be neutral, there is an implication that the information is complete and free from error within the bounds of materiality. Since the major requirements of users is for the financial performance and position of entities it is my opinion, therefore, that the financial statements of GSK group are reliable to the extent that they have adopted IAS and IFRS in preparing it. Instances where GSK has demonstrated reliability is in exercising prudence by adopting IAS 37 in the treatment of legal disputes and restructuring costs which goes to the core of prudence and materiality. Another example is the treatment of R&D expenditure which could have been capitalised thereby overstating profits and assets but was written off as incurred and capitalised when deserved in accordance with standard thereby enhancing reliability.

Comparability

Comparability implies consistency throughout the reporting entity within each accounting period and from one period to the next. Consistency is very important in ensuring comparability of financial statements. For consistency to exist and to be properly ascertained there has to be adequate disclosures in the financial statements. GSK has demonstrated this with the disclosure of the accounting policies that it has adopted in preparing the financial statements of 2008. Once again it is difficult to do a meaningful comparison without the full statements and disclosures of previous years to see whether there had been material departures from previously adopted policies. That notwithstanding a comparison with S&W revealed that GSK has displayed some consistency with the treatment of research and development costs. Both companies write off R&D expenditure as incurred and capitalise when deserved in accordance with IAS 38 Also in accordance with IAS 37 both companies consolidate their financial statements to represent the economic substance of their association with their subsidiaries and associates. The disclosure of the performance of 2007 and 2006 on the face of the statement also aids comparison to the extent that it informs users of the improvement that GSK has made over the three year period. Also important especially to shareholders is the disclosure of the EPS on the face of statement which can be used to compare with S&W's to ascertain whether the performance of GSK is acceptable and within industry standards.

Understandability

The understandability of financial statements depends on the way in which the effects of transactions are characterised, aggregated and classified. The presentation of the information and the capabilities of users also help in the understandability of financial reports. Information provided in the statements ought to be simple, clear and effective. Similar items have to be presented together and distinguished from dissimilar items to facilitate analysis by users. The statements have to be accompanied by notes to form an integrated whole, with the notes amplifying and explaining the statements. GSK has demonstrated this with a simple and clear income statement and an elaborate set of notes explaining the incidence and effect of transactions in the statements. Fundamental to the understanding of the income statement is the presentation of it; the headings used and the items that appear under each heading. Good presentation involves:

recognising only gains and losses in the statement

classifying components by reference to a combination of function and the nature of the item

distinguishing amounts that are affected in different ways by changes in economic conditions or business activity

identifying separately items that are unusual in amount or incidence, items that have special characteristics and items that are related primarily to the profits of future rather than current accounting periods.

Meeting the presentational criteria above as proposed by the IASB avoids cluttering of the income statement with excessive detail and obscuring the message thereby enhancing the understanding of the statement. GSK has shown this in the income statement under item (i) by recognising only gains and losses, under item (ii) by classifying components of cost by reference to function as in the amalgamation of selling, general and administration expenditure, under item (iii) by reporting segmental information in the notes and under item (iv) by disclosing the effect of unusual items like the restructuring expenditure.

Consolidated Statement of Financial Position

The users of financial statements are most concerned about the types and amounts of assets and liabilities held and the relationship between them, and in the function of the various assets. The statement of financial position therefore needs to convey information that is relevant for user decision-making, that can be objectively relied on, that is consistent and understandable.

Relevance

The relevance of the information in the statement of financial position depends on the extent to which users are able to use the information to predict or confirm the financial state of a business. In the case of GSK the values of total resources owned and owed by shareholders has been shown in the statements. Most importantly to the quality of relevance is the disclosure of Minority interest in the statement to distinguish what is actually owned by owners of GSK and what is owned by others in reporting the substance of GSK's association with its subsidiary and associate companies. Disclosures such as the amounts of long-term borrowing and the accompanied elaborate explanation to show the capital structure of the company also helps users to predict for example the financial gearing of GSK making it relevant information for users. The disclosure of current assets and current liabilities is also relevant in the sense that it enables users of the information to know to what extent GSK is liquid. Other relevant information on the statement of financial position is the inclusion of provisions for legal disputes, restructuring and employee related costs. These costs have a material effect on the nature and focus of GSK, therefore merit inclusion in the statements hence relevant to users. Overall enough relevant information has been disclosed in the statement of financial position of GSK to warrant a true and fair view.

Reliability

Once again, the extent to which GSK has complied with IAS and IFRS enhances the reliability of the Statement of Financial Position. To a large extent the financial statements of GSK are reliable however there appears to be a deviation in the treatment of financing costs attributable to Property, Plant and equipment. Under IAS 23 'Borrowing Costs', financing costs directly attributable to specific assets under the standard have to be capitalised. GSK has not shown or displayed adherence to this standard or has not disclosed enough information to indicate why they have departed from the standard. If GSK has chosen not to capitalise finance costs as a general organisational policy then that ought to have been disclosed in the notes and made clear to users. It is therefore my opinion that the statement of financial position does not represent faithfully what it purports to represent as per the treatment of financing costs, suffice to state that faithful representation need to be understood in the context of the Statement as a whole. However, GSK has exercise prudence in making provisions for bad and doubtful debts as well as adequate disclosures for the depreciation of non-current assets enhancing the reliability of the statements.

Comparability

Comparability generally implies consistency throughout the reporting entity from one period to the next. It also implies the accounting policies adopted by different entities and by companies from period to period. Whereas GSK did not particularly state how inventory was valued and the basis on which it was valued S&W valued its inventory according to IAS2. Both companies displayed consistency and adequate disclosure in their treatment of their investments in associate interests. Both companies accounted for the value of associate interest using the equity method of accounting. Likewise provisions for legal disputes were also provided for on the basis of IAS 36. It is clear that both GSK and S&W have prepared their financial statements in similar ways and to a large extent with the same accounting standards. Therefore as far as comparability of financial statements is concerned both companies have displayed the requisite standards to give a true and fair view.

Understandability

As stated above under the statement of comprehensive income it is fair to comment that GSK has prepared its financial statements in accordance with standards of presentation, classification and aggregation to enhance user understanding of the reports. The arrangement of items by elements enhances the clarity of the statements and ease of understanding. The statement of financial position expresses the ownership of the business in terms of providers of resources the business and the resources under the control of the business. Any user with a reasonable knowledge of finance can readily, based on the presentation of the statement of financial position, perceive the state of the business. Due to the itemised nature of the statement and the definitions of items users are easily able to identify the resources of the business and the providers of those resources.