Finance and Accounting - GlaxoSmithKline Plc - Case Study Example

Finance and Accounting Report – GlaxoSmithKline plc Table of contents Introduction 3 Part A Three most significant types of non-current (fixed) assets owned by GlaxoSmithΚline plc 3 1.1 Non-current assets, characteristics and types 3 1.2 Non-current assets in GlaxoSmithΚline plc. 5 Part B Problems that GlaxoSmithΚline plc. is likely to have to deal with in order to measure the fair value of its non-current assets 5 2.1 Instability of markets 6 2.2 Fair value measurement is related to market and not to entity 7 2.3 Fair value measurement need to incorporate estimations for future income and discount rates 7 Part C Is the IASB’s approach to fair value measurement actually practical for companies with non-current assets that are not actively traded on broad and deep markets? 8 Conclusion 10 References 10 Bibliography 12 Appendix 12 Introduction In the context of the modern market the evaluation of business performance can be quite difficult a fact that has been related to the instability of interests and exchange rates (Barth, 2007). In practice, the performance of a firm can be measured using different approaches. The reference to business assets can be one approach of this kind. In this study emphasis is given to a particular type of business assets: the non-current assets, especially in regard to their measurement using fair value. Fair value measurement, as a financial reporting approach, has been promoted by IASB as a method for generating financial reports that reflect the actual market trends (KPMG, 2011). However, fair value measurement is not always effective. In fact, this type of measurement cannot be used for all types of a firm’s financial data; for example, the use of fair value measurement for non-current assets has been found to be quite limited (KPMG, 2011). The terms under which non-current assets can be measured using fair value are explored in this study. The case of a firm operating in the pharmaceutical industry has been used as an example. GlaxoSmithKline plc has been chosen for this study based on the following facts: the firm is a leader in the global pharmaceutical industry and its financial statements/ reports are available in its website. In this way, the problems that could appear if trying to identify organizational reports and statements are eliminated. Part A Three most significant types of non-current (fixed) assets owned by GlaxoSmithΚline plc 1.1 Non-current assets, characteristics and types In each business two, main, types of assets can be identified: a) the current assets which serve current needs of the business and b) the non-current assets that respond to long-term needs of a business. According to Richards the non-current assets are those that ‘a business plans to keep and use for longer than one year’ (2008, p.236). In opposition, the assets that are likely to be used by a business in the short term, and no more than a year, can be characterized as current assets (Richards, 2008). For Horngren et al. (2012) the time period for using the current assets can be over a year but such case appears only in businesses that have a longer ‘operating cycle’ (p.187). The term ‘operating cycle’ (Horngren et al., 2012, p.187) indicates the time period necessary for a business in order ‘to acquire its products/ services, to sell them and to collect cash’ (Horngren et al., 2012, p.187). Non-current assets can be of various types. The most common category of non-current assets is known as ‘fixed assets’ (Horngren et al., 2012, p.187). This category can include the ‘plant, equipment, furniture and buildings’ (Horngren et al., 2012, p.187) of a business. Investments are also considered as non-current assets (Horngren et al., 2012). Porter and Norton (2010) note that non-current assets can be divided into three categories: ‘a) plant/ equipment, b) investment and c) intangible assets’ (p.66). In the above study reference is made to ‘franchise agreements’ (Porter and Norton, 2010, p.66) as a common example of non-current assets. The above categorization of non-current assets is similar to that included in the study of Flynn and Koornhof (2005). For the above researchers non-current assets are of two types: ‘tangible and intangible’ (Flynn and Koornhof, 2005, p.3). Not all types of non-assets necessarily exist in each business. In fact, among the above categories only one, i.e. plant/ equipment, is likely to appear in all businesses. This phenomenon can be considered as expected on the basis that it is impossible for a business to conduct its operations without the support, even at low level, of fixed assets, meaning especially the equipment (Pinson, 2008). 1.2 Non-current assets in GlaxoSmithΚline plc. According to the views developed in the literature in regard to non-current assets, as these views are presented in section 1.1 above, the list of the non-current assets of GSK would include the following elements: a) plants/ equipments; this category refers to the buildings of the business worldwide and the equipment used in daily business operations; b) investments; in this category, emphasis is given to the capital that the firm has invested on shares/ bonds and other similar financial titles and c) intangible assets of the business; this category would incorporate various elements, such as: c1) brand name, c2) drug patents, c3) licenses for drug research and c4) licenses that the firm has provided to third-parties as of the production of its drugs, especially in regard to drugs that are covered by relevant patent. The non-current assets of GSK are indicatively presented in the table included in Figure 1 (Appendix). In this study emphasis is given to three of the firm’s non-current assets: ‘a) Property/ plant/ equipment, b) Investments in associates and joint venture and c) patents, as included in the category Other intangible assets’ (GSK, Investors, 2013 Annual Report, p.133). Part B Problems that GlaxoSmithΚline plc. (GSK) is likely to have to deal with in order to measure the fair value of its non-current assets The measurement of the fair value of non-current assets has been related to a series of problems. GSK is expected to face these problems if trying to measure the fair value of its non-current assets. It should be noted that in the firm’s 2013 Annual Report reference is made to the alignment of the firm’s Financial Reports with the rules of IASB, as included in IFRS (GSK, Investors, 2013 Annual Report, p.129). However, as also explained below the use of fair value measurement in regard to the non-current assets of the business has been avoided. 2.1 Instability of markets Traditionally the concept of fair value has been used for showing a value that could be fair taking into consideration current market status. This means that fair value is directly related to market performance (Caprio, 2012). However, markets tend to be characterized by turbulences, a fact that leads to unexpected changes on the market prices of products and services (Caprio, 2012). In this context, fair value ‘can be differentiated from the market value’ (Caprio, 2012, p.425). For GSK the above fact would result to the following implication: if being measured using the fair value, the non-current assets of GSK would be found to have value lower than their actual value, i.e. their market value. In regard to the three types of the firm’s non-current assets chosen for this study, the following analysis could be made: a) plant/ equipment; global market is quite instable. In this environment, the value of the firm’s plant/ equipment cannot be standardized, a fact that would make the use of fair value measurement for these entities as non applicable; b) investments; for this type of non-current assets of GSK a similar analysis could be made. More specifically, the firm’s investments internationally are likely to be changed continuously, as of their value. It would be impossible for the firm’s managers to estimate the future performance of these investments, as such information is required in fair value measurement; c) patents; the firm’s patents are not available to third parties with the following exception: in poor countries the firm has allowed the production of certain of its drugs by local producers but this scheme is limited as of its duration and geographical area. In addition, this scheme is not based on profit, a fact that would not allow the application of fair value measurement, as this approach require the reference to future income/ discount rates. 2.2 Fair value measurement is related to market and not to entity The supporters of fair value tend to emphasize on the objectivity that fair value can secures when being used in financial reporting (Zhou, 2011). More specifically its potential to be ‘time-adjusted’ (Zhou, 2011, p.339) seems to be the most important advantage of fair value. However, fair value is a ‘market – based rather than an entity specific measurement’ (IAS, 2014, par.1). This means that this type of measurement could be used for entities that are traded in many markets. Entities that do not meet this requirement could not be measured using this approach; non-current assets are entities that belong in this category. Towards this direction, GSK would face important difficulties in applying the fair value measurement in regard to its non-current assets, meaning especially the three types of non-current assets reviewed in this study, at the level that these assets are not traded in markets. For avoiding relevant risks, the firm has decided to adopt the acquisition accounting method for measuring the value of its assets, both current and non-current, and liabilities (GSK, 2013 Annual Report, p.137). 2.3 Fair value measurement need to incorporate estimations for future income and discount rates As already noted, fair value measurement has to offer figures that are adjusted to current market trends (Acharya and Richardson, 2009). However, fair value measurement should also help business owners/ managers to check whether the value of their capital, as invested in the firm, would be reduced in the near future (Acharya and Richardson, 2009). In other words, the fair value measurement refers not just to the present but also to the future. For this reason, the specific approach requires the reference to ‘future cash flows and discount rates’ (Acharya and Richardson, 2009, p.217). The estimation of these figures, even in stable markets, cannot be accurate, a fact that sets the credibility of the fair value measurement in risk (Acharya and Richardson, 2009). GSK would also expect to face such problem if the use of the above process in the measurement of the firm’s non-current assets would be decided. More specifically: a) for its property/ plant/ equipment the firm has adopted depreciation; the level of depreciation in regard to these assets of the firm is reviewed annually (GSK, 2013 Annual Report, p.138, Figure 2, Appendix); b) for their intangible assets, including their patents, the firm has employed a ‘straight-line basis’ (GSK, 2013 Annual Report, p.139), according to which value is estimated on the basis of a specific period; in GSK this period has been set to 20 years (2013 Annual Report, p.139). Again, for this type of non-current assets, the firm has adopted the method of annual review, for measuring value (2013 Annual Report, p.139); c) In regard to the investments related to joint ventures, the measurement of value is made based on the following two criteria: ‘a) the acquisition cost and b) the profit made after acquisition’ (2013 Annual Report, p.139). No reference is made to future profits as of these investments, a fact denoting the non use of fair value measurement in this type of non-current asset. Part C Is the IASB’s approach to fair value measurement actually practical for companies with non-current assets that are not actively traded on broad and deep markets? The non-current assets of a company are used along with the company’s other elements, such as current assets and liabilities, for measuring the firm’s financial performance (Mohammadi and Malek, 2012). Indeed, when calculating a firm’s financial ratios all parts of a business, at least those reflected in figures, have to be employed (Mohammadi and Malek, 2012). Based on the above, the measurement of value of a firm’s non-current assets needs to be carefully developed so that valid figures are produced. Also, such measurement has to be practical, i.e. applicable in practice (Biondi, 2011). Otherwise, the completion of the relevant process would be impossible while the data generated would be false, a fact that could lead to severe misleading in regard to a firm’s performance (Zhou, 2011). Christensen and Nicolaev (2011) refer to the practice of British and Germany firms to avoid using fair value as a measurement approach for their fixed assets (Christensen and Nicolaev, 2011). A similar view is promoted in the study of Herrmann et al. (2006) where reference is made to the problems related to the use of fair value measurement for plant and equipment of businesses. Non-current assets are not traded in broad markets. For this reason, the limitations of fair value measurement which refer to the non-current assets of businesses could apply in other business entities, such as current assets. At the same time, Hitz (2007) explained that the results of fair value measurement are rather difficult to be checked, as of their validity; this problem tends to occur since the specific approach is well supported in theory but its applicability in practice has many implications and risks (Hitz, 2007). In any case, the description of fair value measurement, as provided by IFRS, verifies the non-relevance of this approach to entities that are not traded in markets. Indeed, according to IFRS the fair value leads to ‘market-based measurement’ (IFRS, 2014, par.1). So, this approach would be not applicable for entities that are not part of the market, meaning those entities that are not traded in markets worldwide. Conclusion The analysis of the implications of fair value measurement, especially in regard to the non-current assets of GSK, leads to the following assumptions: a) fair value measurement could help the firm to improve its market position, especially since the above method is based on present data; b) the practical applicability of fair value measurement is quite limited, as also revealed through the relevant literature. Thus, GSK could not be particularly benefited by using this approach in measuring the value of its non-current assets and c) the fair value measurement refers, necessarily, to estimations for future income and discount rates; this characteristic of fair value measurement has further contributed in the limitation of this method’s applicability. In any case, the review of GSK’s financial statements, as followed by explanatory text, has verified the firm’s preference for traditional accounting methods, and especially the acquisition accounting method (GSK, 2013 Annual Report, p.137). In fact, in the firm’s 2013 Annual Report it is explained that the fair value measurement has been used, along with other standards suggested by IASB, in the development of the firm’s financial statements but without any particular impact (GSK, 2013 Annual Report, p.136); it is derived that the figures included in these statements have been produced using the acquisition accounting method and that that use of fair value measurement has been quite limited, without any impact on the relevant findings. References Acharya, V. and Richardson, M., 2009. Restoring Financial Stability: How to Repair a Failed System. Hoboken: John Wiley & Sons. Barth, M., 2007. Research, Standard Setting, and Global Financial Reporting. Hanover: Now Publishers Inc. Biondi, Y., 2011. The pure logic of accounting: A critique of the fair value revolution, Accounting, Economics, and Law, 1(1), pp.2-46 Caprio, G., 2012. Handbook of Key Global Financial Markets, Institutions, and Infrastructure. London: Academic Press. Christensen, H. B. and Nicolaev, V., 2011. Does fair value accounting for non-financial assets pass the market test? Review of Accounting Studies, 18(3), pp. 734-775. Flynn, D. and Koornhof, C., 2005. Fundamental Accounting. Cape Town: Juta and Company Ltd. GlaxoSmithCline plc, 2014a. Organizational website. Available at [Accessed 6 November 2014] GlaxoSmithCline plc, 2014b. Investors. Available at [Accessed 6 November 2014] GlaxoSmithCline plc, 2014c. Corporate Reporting. Available at [Accessed 6 November 2014] Herrmann, D., Saudagaran, S. and Thomas, W., 2006. The quality of fair value measures for property, plant, and equipment, Accounting Forum, 30(1), pp. 43-59. Hitz, J. M., 2007. The decision-usefulness of fair value accounting – a theoretical perspective, European Accounting Review, 16(2), pp. 323-362. Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D. and Tan, R., 2012. Financial Accounting. Melbourne: Pearson Higher Education AU. IAS Plus, 2014. International Financial Reporting Standards. Organizational website. Available at [Accessed 6 November 2014] KPMG, 2011. First Impressions: Fair value measurement. Organizational Report, June 2011, pp.1-46. Available at [Accessed 6 November 2014] Mohammadi, M. and Malek, A., 2012. An empirical study of financial performance evaluation of a Malaysian manufacturing company. Academica Science Journal, 1(1), pp.95-102. Pinson, L., 2008. Anatomy of a Business Plan: A Step-by-step Guide to Building the Business and Securing Your Companys Future. Tustin, CA: Aka Associates. Porter, G. and Norton, C., 2010. Financial Accounting: The Impact on Decision Makers. Belmont: Cengage Learning. Richards, M., 2008. FCS Financial Management. Cape Town: Pearson South Africa. Zhou, Q., 2011. Applied Economics, Business and Development: International Symposium, ISAEBD 2011, Dalian, China, August 6-7, 2011, Proceedings. London: Springer Science & Business Media. Bibliography Chea, A., 2011. Fair Value Accounting: Its Impacts on Financial Reporting and How It Can Be Enhanced to Provide More Clarity and Reliability of Information for Users of Financial Statements. International Journal of Business and Social Science, 2(20), pp.12-19. Duhovnic, M., 2007. The problems of fair value in small emerging markets economies. Journal of Economics and business, 10(2), pp.61-81. Frattini, G., 2007. Improving Business Reporting: New Rules, New Opportunities, New Trends. Milano: Giuffrè Editore Jarolim, N. and Oppinger, K., 2012. Fair Value Accounting in Times of Financial Crisis. ACRN Journal of Finance and Risk Perspectives, 1(1), pp.67-90. Kaur, J., 2013. The Fairness of the Fair Value Concept. International Journal of Business and Commerce, 3(3), pp.1-10. Sooriyakumaran L. and Prof. Velnampy T., 2013. Disclosures and impacts of impairment of non-current assets in the financial statements: A study on listed manufacturing companies in Colombo Stock Exchange (CSE) in Sri Lanka. Merit Research Journal of Accounting, Auditing, Economics and Finance, 1(6), pp.122-133 Walton, P., 2012. The Routledge Companion to Fair Value and Financial Reporting. London: Routledge. Appendix Figure 1 – Non-current assets of GSK, as described in the firm’s balance sheet (GSK, Investors, 2013 Annual Report, p.133) Figure 2 – Depreciation for the firm’s property/ plant and equipment (GSK, Investors, 2013 Annual Report, p.138) Read More