Critical evaluation of the quality and usefulness of the company’s financial reporting
GlaxoSmithKline plc operates on a global basis, primarily through subsidiary companies established in the markets that are traded. Entities that the Group has the power to control the operating and financial policies are accounted for as subsidiaries. Where the Group has the ability to exercise joint control, the entities are accounted for as joint ventures, and “where the Group has the ability to exercise significant influence”, they are accounted for as associates.
The results and assets and liabilities of associates and joint ventures are incorporated into the consolidated financial statements using the equity method of accounting. “Business combinations are accounted for using the acquisition accounting method”. Identifiable assets, liabilities, and contingent liabilities acquired are measured at fair value at the acquisition date (Bragg, Nach & Barry 2009).
An Analysis of the Accounting Policies of GlaxoSmithKline
When there is an indication that the assets of the company may be impaired, the carrying value of all non-current assets is reviewed. The intangible assets and intangible assets with indefinite valuable lives, which are not available for use, are examined for impairment every year. A provision of impairment is charged against the statement of the annual income for the respective year. The impairment of goodwill cannot be reversed.
Only impairment losses on non-current assets can be reversed when a change in the estimates occurs (Bragg, Nach & Barry 2009). The recoverable amounts are established to the extent that the reversed recoverable value does not surpass the carrying amounts when depreciation is netted. To estimate impairment, the higher of fair value, less expenditure to sell, and the value in use as calculated by examining risk-adjusted future cash flows are used. An appropriate interest rate is used to discount these estimates. Thus, the future cash flows are intrinsically judgmental (Bragg, Nach & Barry 2009).
In the financial statements, the impairment is charged to the cost of sales, which according to the year 2010 annual reports was reflected as follows: 31 million (2010-142 million), R&D 89 million (2010-46 million), SG&A 70 Million (2010-17 million), and incorporating 131 million (2010-57 million) arising from key reform program. Subsequent reviews of impaired assets result in a reversal of impairments (GSK 2010). This is where the conditions that caused the original impairments are no longer applicable.
The reversals are attributed to sales costs (Bragg, Nach & Barry 2009). Either the fair value, fewer costs model or value in use are used to assess the recoverable value of other money generating units. The formula of determining value in use is summing up the terminal value of the money generating unit (goodwill allocated) to present the net value of risk-adjusted in the pre-tax cash flows. The impairment test shows the recoverable amounts being less the carrying value.
This is repeated with a pre-tax rate of reduction and pre-tax flows for determining the existence of impairment in addition to determining its magnitude. Goodwill is estimated at cost fewer impairments and is considered to have an indefinite useful life. It is tested every year for impairment (GSK 2010). The recoverable amounts are established to the extent that the reversed recoverable value does not surpass the carrying amounts when depreciation is netted.
As indicated in appendices I, the Impairment losses are recognized in the annual income statement deemed as operating income in addition to the amount reserved for implements, reclassified as fair value provision. Primarily, impairment originates from significant reductions in fair value of the venture equity below the cost of acquisition, consequent to which a further reduction in fair value is directly incorporated in the statement of income. Impairment of goodwill is not reserved, which contrasts related companies in the industry (Bragg, Nach & Barry 2009).
The resolution to rationalize facilities whose estimation is based on the value in the use of fair value, less selling cost results in impairment losses. The net present value is risk-adjusted, and cash flows (post-tax) relevant to the cash-generating unit or relevant asset to the project are used to determine the value in use. A discount rate is applied at a rate of Group post-tax weighted average cost of capital (WACC). For example, during the 2011 financial year, a WACC of 8% was used. In the event that a pre-tax cash flow computation is anticipated to give rise to totally different results, where an impairment is revealed, the pre-tax discount rate and pre-tax cash flows would be performed (GSK 2011).
The Principle Risks To the Company and How They Are Managed
Instruments of managing risks
GSK applies several instruments to finance its operations. It also uses derivative financial instruments to manage various risks. The derivatives majorly comprise foreign currency contracts, currency and interest rate swaps. Currency swaps are used to swap borrowings and assets (liquid) to legal tenders necessary for the Group’s management of exposure risks emanating from fluctuation of interest rates and foreign exchange rates.
GSK reports its financial results in Sterling and its dividends are issued in Sterling, which exposes it to high fluctuation risks. The Corporate Treasury manages and monitors its external and internal risks on finances by the use of a range of financial instruments to finance the operations. It uses derivative fiscal instruments to control risks that are occasioned by variations in the interest and foreign rates (Bragg, Nach & Barry 2009).
Financial Risks that the group faces
Various “jurisdictions compel both actual and potential duties on the Group to remediate polluted sites” (GSK 2011). The company faces potential risks due to its numerous sites which can pose environmental pollution if care is not taken. This means that the company is likely to incur huge expenses to manage happening of environmental degradation. The repercussions in the event that the company fails to undertake its environmental management properly, is significant since it can cause serious negative impact on its financial results.
According to IFRS, particular financial instruments that change in terms of market value, should be reported in the financial reports, even before the recognitions of losses or gains. This may have significant impact on a particular year’s statement of income. Another risk may arise because of volatility of inter-company inventory, which results from the deferred taxation – this is dependent on the reporting entity itself rather than the whole group (GSK 2011).
Hedging instruments
Income statement movements are mainly caused by hedging instruments, relating to US legal provisions, in addition to trade receivable and payable. The hedging instruments offer economic hedges. In the appendices II, the respective provisions are not related to financial instruments, but rather offer economic hedging. As such, they are not incorporated in the table. The combination of the hedging sensitivity instruments and the provisions would have been of no significance had they been included.
The group experienced both current derivative and non-current financial instruments, whose measurement during 2010 and 2011 financial years was based on fair value (155 million-2010-190 million 2011). Most of these amounts are associated with swap interest rates and foreign exchange contracts that are recognized as accounting hedges. Adjustments in cash flow hedges in comprehensive income statement are recognized to the extent that the hedge remains effective.
Portions that are ineffective are recognized in loss or profit instantly. Other amounts that are deferred in comprehensive incomes are reclassified to the statement of income once they impact either profit or loss. The same way is used to give an account of net investment hedges as cash flow hedges. Fluctuations of the fair value, in regard to hedged liabilities or assets for fair value of derivatives that are designed as fair value hedges, are all recorded in the income statement.
However, changes in the fair value of any of the derivative instruments that fail to qualify for hedge accounting, gain an immediate recognition in the income statement. Estimation of financial instruments’ fair value, which do not have active market are based on the assumptions and methods such as liquid investments. In this method, the principal value in the case of non marketable securities results from their short reprising period nature. The other alternative is referring to the discounted cash flows in the underlying net assets (Patel 2006).
Hedge accounting
Derivative instruments of finance are classified as being held-for-trading and are recorded at their fair value in the balance sheet. On the other hand, derivatives that have been designated as instrument of hedging are classified on commencement as cash flow hedges – the net investment hedges/ fair value hedges. Portions that are ineffective are recognized in loss or profit instantly. The quantity deferred in other comprehensive income can be reclassified under the income statement in the event of the hedged item affecting the profit or the loss.
The same method that is used to account for the cash flow hedges is also used to account for the net investment hedges. Any adjustments in the derivatives’ fair value, which are built like the fair value hedges, are accounted for in the statement of income, together with the any variation in the fair value of the hedged assets or liability. The changes in the fair value of several derivative instruments that fail to qualify for purpose of hedge accounting are recognized in the income statement (Bragg, Nach & Barry 2009).
Exposure of foreign currency transaction that arises from internal and external trade flows is not hedged. Exposure in a foreign country operating subsidiaries transaction is reduced by matching the domestic currency earnings with the domestic currency prices. The international trading transactions are, therefore, matched and the Group manages inter-company terms of payment – this reduces the risk of foreign currency. In cases of exceptional foreign currency, cash flows could be hedged in a selective manner in the supervision of the TGM and Corporate Treasury. These hedging instruments offer economic hedges, while the associated provisions are not the instruments of finance, thus, they cannot be included in financial statements (GSK 2011).
Accounting policies that recognize post-employment benefits
The provision of pension has been defined under the benefit schemes, which is calculated with the help of projected unit credit method. It is spread over a period, upon which benefits are expected consequential from the employees’ services, in consistence with the advice of professional actuaries. The obligations of pensions are determined with the present value estimated with cash flow discounted at the rates that reflect the high corporate bonds.
The pension scheme property is estimated at fair value at the date of balance sheet. The actual gains and differences among anticipated and actual returns of the assets and the effect of actuarial assumption are recognized in the statement of income annually. The Groups has a defined contribution plan that is charged to the income statement that is incurred. The cost of post-employment liabilities is calculated the same way as the benefit scheme, and spread over the duration that benefits are to be derived from employees’ services, based on the actuaries (King 2066).
Employees get incentives and awards that are shared from the scheme.
The cost of pension services and other post employment benefits get charged under the income statement in line with IAS 19 on Employment Benefits over a period of employees’ services and the cost are assessed by a selected management. The assumption comprise of future earnings and benefits. Projected units have been used to account for the pension cost. In specific countries, the benefits are given at unfunded grounds and in others they are administered by company trustees (Bragg, Nach & Barry 2009).
Conclusion
GlaxoSmithKline plc has ensured compliance with IASB requirements in its financial reporting and disclosure. The comprehensive income statements, the statements of financial position, statement of cash flows, as well as all other accounting policies and notes have been reported professionally, and have indeed increased the usefulness and quality of the company’s financial reports. In particular, the financial statements have been prepared in accordance with the requirements under IFSR, which have been issued by IASB. As a result, the users of these financial reports can get to know the true and fair value, together with the underplaying assumptions of these reports. This has increased their usefulness (Patel 2006).
Appendices I
Other investments
Appendices II
Foreign exchange sensitivity
References
Bragg S, Nach, R & Barry J 2009, Wiley GAAP Codification Enhanced, John Wiley and Sons, New York.
GSK 2011, Company annual reports. Web.
GSK 2010,Company annual reports. Web.
King A 2006, Fair value financial reporting: meeting the new FASB Requirements, John Wiley & Sons, New York.
Patel A 2006, Fair value financial reporting, John Wiley & Sons, New York.