Finding Differences in Financial Statements - Essay Example

Finding Differences Finding Differences Introduction Financial reporting of a business concern’s operations and activities is important since it enables shareholders, potential investors, creditors, analysts, and other financial, regulatory and governmental institutions to understand, evaluate and analyze the financial performance of a company. For the purpose of reporting financial performance and accounts of a business entity, there are various financial reporting frameworks. The differences found among different financial reporting frameworks are of various types and at times are of such significance that they may completely result in differing interpretations. This report presents a comprehensive review of financial statements of three companies, which are operating in US, UK and France respectively and follow the financial reporting frameworks applicable in the said countries. Following is a brief overview of the companies selected in this report for identifying differences in their financial reporting: Caterpillar Incorporation Caterpillar Incorporation is a US based company headquartered in Peoria. The company is engaged in the business of manufacturing and selling machinery and equipments related to construction industry (Yahoo Finance, 2013). Glaxo Smith Kline PLC Glaxo Smith Kline PLC is a leading pharmaceutical company headquartered in Brentford. The company manufactures and sells pharmaceutical products worldwide (Yahoo Finance, 2013). L’Oreal S.A. L’Oreal S.A. is a French company, headquartered in Paris, which manufactures and sells cosmetics, body care and fashion related products for both men and women (Yahoo Finance, 2013). Comparison of Financial Statements, Reporting and Accounting Treatment The three companies considered in this report, as stated earlier, are based in three different countries which have different financial reporting frameworks applicable for financial reporting of corporate entities. In the United States of America, corporate entities are required to report their financial statements in accordance with the principles and guidance presented under U.S. GAAP. The framework provided in U.S. GAAP is thus the primary accounting or financial reporting framework in the US. On the other hand, in the United Kingdom, business entities are required to report their financial statements in accordance with the principles and guidance presented under International Financial Reporting Standards (IFRS). The standards provided under IFRS are collectively regarded as the financial reporting framework to which business entities operating in the UK adhere. Lastly, in France, French GAAP are used by corporate entities to prepare their respective sets of financial statements (Nobes et al., 2008; Radebaugh & Gray, 2008). In short, the comparison of three companies’ financial reporting framework reveals that each company is following a different financial reporting framework, which is summarized as follows: Company Name Country of Operation Financial Reporting Framework Caterpillar Incorporation United States of America United States Generally Acceptable Accounting Principles (U.S. GAAP) Glaxo Smith Kline PLC United Kingdom International Financial Reporting Standards (IFRS) L’Oreal S. A. France French Generally Acceptable Accounting Principles (French GAAP) Source: (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011) Due to the difference in financial reporting frameworks of the companies selected in this report, there are a number of differences in their financial statements’ structure and other reporting and valuation related matters. These differences are discussed in the following sections. Differences in Financial Statements Structure While considering the overall structure of the three selected companies’ financial statements, following differences have been noted in each part of the financial statements: Income Statement All three companies have different names for income statement; in Caterpillar’s financial statements, it is named as “Results of Operations”, in Glaxo Smith Kline’s case it is named as “Consolidated Income Statement” and in L’Oreal’s case it is named as “Compared Income Statements”. Apart from this, the layout of income statements for all three companies is different. As for instance, in case of Caterpillar, which follows U.S. GAAP, there are eight main sections, which are “sales and revenue”, “operating costs”, “operating profit”, “consolidated profit before taxes”, “profit of consolidated and affiliated companies”, “profit”, “profit per common share” and “cash dividends declared per common share” (Caterpillar Incorporation, 2011). On the other hand, in case of Glaxo Smith Kline, which follows IFRS, there are four main sections, namely “operating profit”, “profit before taxation”, “profit after taxation for the year” and “earnings per share” (Glaxo Smith Kline PLC, 2011). Lastly, in case of L’Oreal, which follows French GAAP, the compared income statement is categorised into seven main sections, namely “operating revenue”, “operating expenses”, “operating profit”, “net financial income”, “profit before tax and exceptional items”, “exceptional items” and “net profit” (LOreal S.A., 2011). Apart from these differences in income statements of the three companies, there are classification differences as well, which are due to the differences in reporting requirements specified under the respective financial reporting frameworks. As for instance, in Glaxo Smith Kline’s case, the income statement includes determination of gross profit as well which is not found in the income statements of Caterpillar and L’Oreal. Apart from this, under U.S. GAAP, Caterpillar has shown greater segregation and detail of income statement items as compared to the income statements of Glaxo Smith Kline and L’Oreal. Unlike Caterpillar’s and Glaxo Smith Kline’s income statements, there are no earnings per share or profit per common share determined in L’Oreal’s income statement (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Balance Sheet The balance sheets of the three companies under consideration also have different structures and presentation styles. First of all, the titles used to identify balance sheets are different; the titles are “Consolidated Financial Position”, “Consolidated Balance Sheet” and “Compared Balance Sheets” for Caterpillar, Glaxo Smith Kline and L’Oreal respectively. In addition to this, although balance sheets are presented in a comparable format by each company, but the number of years covered are different. Caterpillar’s and L’Oreal’s balance sheets cover three financial years, whereas for Glaxo Smith Kline, only two financial years are covered in the balance sheet. The balance sheets of all three companies are presented in statement form and assets are placed first; however, Caterpillar has placed current assets prior to non-current assets unlike Glaxo Smith Kline and L’Oreal. On the other hand, L’Oreal has shown assets other than current and non-current assets, which include prepaid expenses and unrealized exchange losses. This difference in reporting of these assets, if followed by Glaxo Smith Kline and Caterpillar, would result in a change in their respective financial ratios, such as liquidity ratios, return on assets, ROCE, etc. It is also important to note that the order of presenting current and non-current assets is also different. As for instance, Caterpillar’s balance sheet shows current assets first and then non-current assets; on the other hand, the balance sheets of L’Oreal and Glaxo Smith Kline show non-current assets first and current assets afterwards. As far as liabilities and equity portion of the balance sheet is concerned, Caterpillar and Glaxo Smith Kline have shown liabilities first and then equity and the liabilities section is classified into current and non-current liabilities. On the other hand, L’Oreal has shown equity first and then liabilities and no classification of liabilities into current or non-current are shown in the balance sheet. In addition, it can also be noted that the balance sheet of caterpillar is more detailed than that of the other two companies (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Cash Flow Statement There are no major differences in the cash flow statements of the three companies. However, while looking at the three cash flow statements it is observed that Caterpillar and Glaxo Smith Kline have presented more detailed statements than L’Oreal (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Statement of Changes in Equity Similar is the case with statements of changes in equity for the three companies, that is there is no major difference in structure and presentation of changes in equity statement but Caterpillar’s and Glaxo Smith Kline’s statements are more detailed than L’Oreal’s. Moreover, it is pertinent to note that L’Oreal’s statement of changes in equity is accompanied with additional information presented at the end of statement. This additional information is aimed at explaining various items of statement of changes in equity. Other companies have discussed this information in notes accompanying the financial statements (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Notes to the Financial Statements The fifth major section of the financial statements of all three companies is note to the financial statements. This section includes disclosures and information pertaining to treatment, reporting and classification of items presented in the preceding sections of the financial statements and also policies and accounting frameworks which are used by the companies in preparing financial statements. The notes to the financial statements for all companies generally include similar items and disclosures which are required to be made under their respective financial reporting frameworks. While going through the contents of notes to the financial statements of the three companies, it is observed that there is a difference in reporting style among all three companies. As for instance, L’Oreal has very briefly mentioned that what financial reporting framework is followed while preparing these set of financial statements. On the other hand, Caterpillar and Glaxo Smith Kline have mentioned the basis of preparation of financial statements, but in a different manner (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Differences in Valuation of Long Term Assets Caterpillar makes use of historical costs in presenting the book values of its long term assets, whereas Glaxo Smith Kline makes use of revalued amounts as the book values of non-current assets (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011). However, the basic concept of fair value measurement is same in U.S. GAAP and IFRS and therefore the overall application of fair value measurement is similar for Caterpillar and Glaxo Smith Kline (Ernst & Young, 2011). L’Oreal recognizes its long term assets at acquisition costs and reviews the values of assets in use on annual basis. This review includes comparison of book value with market value of assets and for investments and advances the review is the comparison of current and future profitability of investments. Upon identifying any difference in the values of long term assets, the company accounts for that change by recognizing impairment or revaluation in the assets’ book value (LOreal S.A., 2011). It is pertinent to mention here that French GAAP does not require corporate entities operating in France to update their assets’ value through revaluation on regular basis. Moreover, the revaluation of intangible assets is also an area of difference. Under U.S. GAAP and IFRS, intangible assets are required to be re-valued regularly; however, in French GAAP intangible assets are not re-valued (KPMG, 2003). Differences in Inventory Valuation There are differences noted in the inventory valuation methods used by the three companies (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Before going into details of the differences noted, it is pertinent to reiterate what has been reported by the companies. Company Name Inventory Valuation Disclosure Caterpillar Incorporation “Inventories are stated at the lower of cost or market. Cost is principally determined using the last-in, first-out (LIFO) method.” (Caterpillar Incorporation, 2011, p.A 12) Glaxo Smith Kline PLC “Inventories are included in the financial statements at the lower of cost (including raw materials, direct labour, other direct costs and related production overheads) and net realisable value. Cost is generally determined on a first in, first out basis. Pre-launch inventory is held as an asset when there is a high probability of regulatory approval for the product. Before that point a provision is made against the carrying value to its recoverable amount; the provision is then reversed at the point when a high probability of regulatory approval is determined.” (Glaxo Smith Kline PLC, 2011, p.145) L’Oreal S. A. “Inventories are valued using the weighted average cost method. A provision for impairment of obsolete and slow-moving inventories is recognised by reference to their probable net realisable value, which is measured on the basis of historical and forecast data.” (LOreal S.A., 2011, p.153) These disclosures show that Caterpillar and Glaxo Smith Kline have a comparatively similar method of valuing their inventories, apart from the fact that former uses last in, first out (LIFO) method and the later uses first in, first out (FIFO) method for determining costs of their respective inventories. No such method is used by L’Oreal to determine cost for inventories; in fact the company makes use of weighted average cost method to value its inventories (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Differences in Depreciation Methods Applied The depreciation methods used by the three companies are presented in the notes to financial statements. These notes identify the methods used by the companies for depreciating their non-current assets over their useful lives. The notes related to depreciation are reiterated as follows: Company Name Inventory Valuation Disclosure Caterpillar Incorporation “Depreciation of plant and equipment is computed principally using accelerated methods. Depreciation on equipment leased to others, primarily for Financial Products, is computed using the straight-line method over the term of the lease. The depreciable basis is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term.” (Caterpillar Incorporation, 2011, p.A 12) Glaxo Smith Kline PLC “Depreciation is calculated to write off the cost less residual value of PP&E, excluding freehold land, using the straight-line basis over the expected useful life. Residual values and lives are reviewed, and where appropriate adjusted, annually.” (Glaxo Smith Kline PLC, 2011, p.144) L’Oreal S. A. “Both straight-line and declining-balance depreciation is calculated over the actual useful lives of the assets concerned. Exceptionally, industrial machinery and equipment is depreciated using the straight-line method over a period of ten years, with all additional depreciation classified as accelerated tax-driven depreciation.” (LOreal S.A., 2011, p.153) It can be noted in above table that there are more or less similar depreciation policies of the selected companies; however, the methods used for depreciating non-current assets are different, which are accelerated method and straight line method for Caterpillar, straight line method for Glaxo Smith Kline and straight line method and declining balance method for L’Oreal (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Use of Estimates in Preparing Financial Statements Another difference is related to the use of estimates in the preparation of financial statements. The three companies make estimates in accordance with their respective financial reporting frameworks in relation to residual values of assets on lease, determination of goodwill of the business, determining amounts of impairments, liabilities for warranties, and other matters (Caterpillar Incorporation, 2011; Glaxo Smith Kline PLC, 2011; LOreal S.A., 2011). Summary The review of financial statements and accompanying notes to them for the three companies selected in this report has revealed that due to the differences in financial reporting frameworks adopted by the said companies, there are differences in the structure and layout of financial statements and also in accounting treatments, policies and reporting manners. However, as far as financial statements of Caterpillar Incorporation and Glaxo Smith Kline PLC are concerned, there are fewer differences noted in comparison with the financial statements of L’Oreal S.A. List of References Caterpillar Incorporation, 2011. Form 10-K. Financial Statements. Peoria: Caterpillar Incorporation. Ernst & Young, 2011. Fair value measurement guidance coverges. IFRS Developments, (2). Glaxo Smith Kline PLC, 2011. Annual Report 2011. Financial Statements. Brentford: Glaxo Smith Kline PLC. KPMG, 2003. Implementing IFRS, Extract from: IFRS compared with US GAAP and French GAAP. KPMG International. LOreal S.A., 2011. Registration Document 2011. Financial Statements. Paris: LOreal S.A. Nobes, C., Parker, R.B. & Parker, R.R.H., 2008. Comparative International Accounting. New York: Prentice Hall/Financial Times. Radebaugh, L.H. & Gray, S.J., 2008. International Accounting and Multinational Enterprises. New York: John Wiley & Sons Ltd. Yahoo Finance, 2013. Caterpillar Inc. (CAT) - NYSE. [Online] Available at: http://finance.yahoo.com/q/pr?s=CAT+Profile [Accessed 10 March 2013]. Yahoo Finance, 2013. GlaxoSmithKline plc (GSK) - NYSE. [Online] Available at: http://finance.yahoo.com/q/pr?s=GSK+Profile [Accessed 10 March 2013]. Yahoo Finance, 2013. LOreal SA (OR.PA) -Paris. [Online] Available at: http://finance.yahoo.com/q/pr?s=OR.PA+Profile [Accessed 10 March 2013]. Read More