Financial Accounting And Reporting Accounting Essay

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UK-based GlaxoSmithKline is one of the world's leading pharmaceutical research companies. The company was created out of the merger between GlaxoWellcome and SmithKline Beecham in 2000. GSK is engaged in the research and development the pharmaceutical products, manufacturing and marketing the vaccines, over-the-counter (OTC) medicine and health-related consumer products. The financial statements of the company have been prepared in accordance with the Companies Act 1985, Article 4 of the IAS Regulation and International Accounting Standards (IAS) and IFRS as issued by the International Accounting Standards Board. The functional currency of statements is Sterling. Financial year of the company starts from 1st January to 31 December.


The graph illustrates the development of GSK share price between January 2006 and December 2008, with price (in pence) and volume (in millions) shown on the vertical axis and time on the horizontal axis.

As can be seen, the share price plummeted from 1500p to 1250p in three years. The first major down fall came in May 2007 when the share price dropped down from 1450p to 1000p in March 2008. The reason for this is that in May 2007, an article in the New England Journal of Medicine suggested that there may be cardiovascular risk associated withAvandia, GSK'S second largest product. Doctors were reluctant to prescribeAvandiafor new patients. Sales ofAvandiadropped significantly and this had a negative impact on share price.

In the following six months, share price of GSK started rising and reached to the level of 1320p on September 2008. This is caused by GSK's development in major restructuring programme and Expansion of Japanese business.

Thereafter, share price crashed to 995p on October 2008. The reason of this crashed could be the effect of global recession. As seen in the next graph that London stock market is showing a decreasing trend in that period. However, GSK is moving in-line with the pharmaceutical and biotechnology industry. Overall the graph shows a steady negative development in the share price of GSK.


There are different methods to evaluate the performance of the company. Comparison is one of the tools to evaluate the performance. Comparison can be different type such as comparison with the industry ratio of that company as we can see the performance of GSK in the above graph, GSK performance was in-line with the pharmaceutical industry. We can compare the ratio of other similar companies with the interested company and compare like with like. We can also check the performance of the company with common size statement which is converting the all figure in percentage and can have the percentage increase or decrease in results. The methodology we will use is ratio analysis. We will compare the previous year ratio with latest year and have a good idea of company performance. We will use this methodology and to make my comparison effective, I will consider 3 year results.



We will discuss the financial performance of the company in the light of above findings. Comparison of financial performance is the key and ratio plays a vital role as a powerful tool.

Profitability ratios:

I explored the income statement first and found the gross profit margin. Gross profit margin basically measures the profit in percentage made from buying and selling of products before any other expenses are taken. Company's gross profit margin has fallen from 78.43% to 73.66% since 2006 to 2008. This has happened because cost of sales has increased in 2008 which reduced the gross profit. The reason is this that selling price may have been trying to lowered, or cost of goods sold may have increased due to inflation but decision taken not to increase selling price. Major restructuring (started in 2007) may have played some part in this decline if we take cost of sales after deduction of major reconstruction expense.

Company's operating profit is showing a decreasing trend because company spend lot of money on R&D. Operating profit of the company was 33.62% in 2006, in 2007 it shows the slight decrease and in 2008 it reached to 29.32%. This ratio measures the profitability made from trading before interest and tax are taken in consideration. Company spent more money in 2008 on selling and administration cost than previous years. By reducing the selling and administration expense, we can enhance operating profit.

Return on capital employed (ROCE) is one of the most important ratio because it examines the return to all providers of the long-term finance and efficiency of the whole business. I used the capital employed as shareholders equity plus long-term borrowing and got the 45.5% in 2007 and 30.8% in 2008. Basically, it means that if we invested anything in 2007 then we made 45.5% profit and in 2008 this percentage declined to 30.8%. The reason for this decline was increase in long-term borrowing and decrease in operating profit. The ROCE figures given by GSK are different than my calculation but still those figures are showing a declining trend.

Return on equity (ROE), which is the relationship between profit of the company and its equity. Ordinary shareholders are the real owners of the company and they are more interested in the profitability of the company. The performance of the company should be judged on the basis of return on capital of the company. GSK's ROE increased from 55.3% in 2007 and reached to 59.4% in 2008, which is a good signal for shareholder as well as for new investors. Asset turnover ratio of the company was 1.36 in 2007 and reached to 1.05 in 2008 but still it is on good level because it means that every pound investment we will generate 1.05p. So, overall profitability of the business is showing a balanced picture.

Liquidity ratio is one of the most important ratios to know the ability of a business to meet its current obligations as and when they become due. Current ratio examines that how many times current assets cover current liabilities. GSK's current ratio increased from 1.3 in 2007 to 1.7 in 2008. It means that GSK has enough assets to cover its liabilities. However, sometimes even if the ratio is favourable, the business may be in financial trouble because of more inventories and work in process which are not easily convertible into cash, and, therefore may have less cash to pay off current liabilities. A current ratio of 2: 1 indicates a highly solvent position and GSK's figures are near to that. Acid test ratio serves as a supplement to the current ratio in analysing liquidity. GSK's acid test ratio increased from 1.02 to 1.3 in 2008 and generally 1:1 indicates highly solvent position and GSK's figures are more than that.

Gearing ratio explain the amount of business funded by borrowed funds. The more company borrow, the more interest they pay. Borrowing is a risky option because company has to pay the interest whether the investment is a success or not. Even they are making a loss. Company's gearing ratio increased from 24.4% to 65.76% in 2008. This shows two things. Firstly, this company is highly geared. Secondly, gearing could be an option to increase the earning per share. Company with a high gearing ratio is in a risky condition if interest rates are going up. However, too much debt is risky if the liquidity position of the company is low but liquidity position of the company is sound.

GSK's interest cover plummeted from 17 times to 8 times. This ratio measures how easily the company can pay its interest out of its profit. Interest cover looks the short-term riskiness of the business. Any increase in interest rates would put them down in a financially delicate condition, and profit would inevitably suffer.

Investment ratio used for examination of financial statements from the investor's point of view. Some shareholders are more interested in dividend per share that a company actually pays out on per share. GSK's dividend per share skyrocketed from 48p to 57p on 2006 to 2008. Increase in dividend per share may attract those shareholders who are more interested in cash return. Moreover, dividend yield measures that how much a company pays out in dividends each year relative to its share price and GSK's dividend yield is showing an increasing trend. Dividend yield was 3.57% in 2006 and reached to 4.44% in 2008, which is a good sign for the existing shareholders as well as it attracts the new investors. Dividend cover is the amount of times that a business could pay the planned dividend out of this year profit. This shows that how safe this dividend is and how much we will get next year even if the profit falls. GSK's dividend cover for 2008 is 2.0 times. This means that the company's profit attributable to shareholders was two times the number of dividend paid out. High dividend cover shows the better ability to maintain the dividend if the profit drops.

IAS 33 requires that all listed companies should reveal the basic and diluted earnings per share, on all the period for which the income statement is given. According to income statement of GSK, basic earnings per share of the company have fallen from 95.5p to 88.6p among 2006 to 2008. However, these figures would be calculated on after deduction of major reconstruction expense. If we would like to see the figures of basic EPS before deduction of major reconstruction expense than things are different. Basic EPS has been showing an increasing trend from 2006 to 2008, and Basic EPS reached to 104.7p in 2008. It means that each share earns 104.7p. Diluted earnings per share has increased and reached to 104.1p. Diluted earnings per share mean that earning in the future may be spread over a large number of ordinary shares. Because of major restructuring program diluted EPS shows the negative trend but before deduction it is showing a positive trend. These ratios attract the new investors to invest in the company.

<[>Price /earnings ratio is extensively used stock market indicator. It speaks about the market price of the share with its earning. We used earnings after deduction of major expense. The P/E ratio indicates the expected future growth of the company. The P/E of GSK has plummeted from 14.1 to 12.3 among 2006 to 2008. There could be two reasons for this decline. Either too much increase in earnings per share or too much decrease in price per share. We can see the substantial decline in earnings per share for last three years but the price per share has also decreased with greater percentage as compare to earnings. The reason for decline in price per share could be the global recession and major reconstruction for the earnings per share.

Efficiency ratios measures how effectively a business uses and controls its assets. These ratiostrim down riskfor lenders and investors and facilitate owners, managers and consultants to boost productivity and business profits.GSK's debtor days, creditor days and inventory turnover period are showing an increasing trend and according to my calculation there is no funding gap. Number of Inventory turnovers per year plummeted to 1.7 to 1.6 times. An increasingtrend in number of Inventory turnovers per yearindicates a risk in the company's inability to sell its products. However, a decreasingnumber of Inventory turnovers per year may represent under-investment in inventory.

To answer the question, the problem that any user might face with respect to analysis and evaluation of financial statements, first of all we need to understand who the users of financial statement are? Investors, brokers, supplier, customers, lenders, employees, public and Govt are the potential users of financial statements. Investors/brokers need to know the exact position of the company because the money they invested whether making a good profit or they can get more profit from investing somewhere else. Suppliers analyse the financial statement to know business viability, is business able to pay for credit purchases. Lender, employees, public and government have the similar reasons to know the exact position of the business.

These users might face different problem when they analyse and evaluate the financial statements, few of them are general problems such as language problem and difference in financial culture. Whereas, other problems like valuation of asset, biases in accounting data, format of financial statement and currency exchange rates can conceal the true picture of the company. For analysts and investors these problems are essential to know because if they would not clear about these differences they could take wrong decision. If they would not go to international market, they might miss important opportunities for investment.

Language creates very apparent problem for international companies because words that exist in different languages sometimes means sometimes different. Difference in language such as creditors (UK) for account payable and accrued liabilities (US), or debtors (UK) for accounts receivable (US). Moreover, inventory (UK) for stock (US). Some other difference like UK term "fixed asset" called as non-current assets for IASB and same term for US is property plant and equipment. These kinds of differences arise when the translator is hired to translate the financial statement. As GSK using IFRS and their terms can be different from German, French or even US. So user might face problem at the time of analysing. Nevertheless, language problems are comparatively easy and can be avoided.

Difference in financial culture is the important problem which can be caused of misleading. Different countries have different social, cultural and economical backgrounds. German culture is the best example for that where it is tradition for companies to have a high gearing ratio. Bankers trying to give more money to sound businesses and highly geared ratio company is consider safe in Germany as compare to normal or less geared company. So the highly geared business like GSK consider the safe business for German users, it might not consider as safe for the users of other countries where highly geared companies are dangerous.

Accounting differences consist of number of accounting policies and practises, which can have a twisting result on ratio analysis. Difference in accounting policies and practises such as valuation of asset on historic cost or on market price can utterly change the position of net assets. As GSK value their assets on historic cost that can misguide the users where accounting policies of valuation of asset is different than this.

Depreciation method can also be a problem for user of financial statement. Different companies follow different depreciation method like reducing balance method or striate line method. Particularly, GSK follows the strait line method of depreciation for investment properties. Without knowing this, international user might face problem in respect of analysing and evaluating the financial statement.

GSK follows IFRS according to that intangible assets like goodwill whether purchased from third party or in-house develop are capitalize but cannot be amortized without regulatory approval. Under US GAAP payments made for these products and charged to the income statements whether these are in the process of development. Moreover, under IFRS, intangible assets are amortized over their approximated useful life apart from brands where the exact useful life cannot be predicted. However, under US GAAP, before implementation of SFAS 142 in 2002 all intangible assets including goodwill and brands were amortized over a limited life. After implementation of SFAS 142 assets which have indefinite life were no longer amortized. This change shows that before implementation of SFAS 142, amortization used to get charged to assets like brands which have indefinite life.

Pension and other post retirement benefit liabilities have also different accounting treatments and can be risky for users. If we compare this according to IFRS and US GAAP the main difference is the method of recognition of actuarial gain or losses. GSK recognise actuarial gain or losses in year in which they crop up as according to IFRS. However, US GAAP uses 10% corridor approach and overdue actuarial gain or losses are amortized. For that reason, pension liability calculated under US GAAP is smaller than IFRS. Restructuring cost, marketable securities, stock based compensation and derivative instruments are all have some different methods of calculation according to different accounting policies and standards.


Eventually, we can see the graph showed the steady negative development in the share price of company. Most of the ratios we calculated were decreasing in 2008. It shows that company faced a crucial time and company performance was not good that time. However, in that crucial time GSK tried their best to not even maintain but satisfy their shareholder by increasing in their dividend per share. If we see the earnings per share before deduction of major restructure program, we can see the increase in earnings per share in that hard time. High gearing ratio is a question mark because some users (German) feels it is a good indicator while others not. However, liquidity position of the company is sound so than high gearing ratio would not be too much risky option. This is complex topic and user of financial statement needs profound knowledge of standards to understand this complexity. These standards have been changing from year to year. So, the point to understand that there can be no general rules when comparing two companies with different accounting standards, best way to look at each single accounting policy of each part of financial statement, and to build rational understanding. GSK was facing a tough time but despite of all that its performance was not too bad they tried to maintain the balance position and we could hope that in future (completion of major restructuring) their performance would be better.


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