The Accounting Concepts and Process: The Financial Accounting - Research Paper Example

Introduction This project is divided into two parts. The first part analyzes the Glaxo Smith Kline’s (GSK’s) annual report 2010 in relation to the accounting concepts and process if the Group fulfils the requirements of accounting policies. The financial accounting is the process of preparing and operating accounting information system and disclosing the prepared financial information to the stakeholders of the business. GSK is a UK based MNC which its presence in the pharmaceuticals and consumer health care. The GSK group prepares its consolidated statements in accordance with the IFRS and the company’s financial statements follow the guidelines of UK GAAP. The second part includes the main uses and types of users of accounting information. It has been analyzed if the Group has provided sufficient and relevant information to enable the users to form an opinion about the Group’s financial health. The main area of investigation from its annual report has been the notes to financial statements as this present the policies and standards applied in the accounts’ preparation. Part 1 Accounting Concepts & Process There are many types of businesses in the world where all the businesses regularly need basic financial information about their operations. The function of keeping the records of that information and providing this financial information to the owners and other stakeholders is the prime objective of accounting. The financial information of an enterprise is essential for the accountability of its business. Therefore accounting serves as a link between the decision makers and business activities. The financial accounting is a process of preparation of financial statements and providing these statements to the external user such as shareholders, banks and creditors, fund managers, and regulators (Needles, Powers & Crosson, 2010, p.7). The preparation of financial statements involves some basic steps which are, 1. Analysis of transactions from vouchers or other source documents. 2. Journal entries 3. Posting to ledger accounts 4. Trial balance preparation and then adjusted for accrual entries. 5. Final statements preparation from adjusted trial balance. 6. Closure of temporary accounts. The financial statements mainly include Income Statement, Balance Sheet, Cash flow statement and Notes to the statements. Glaxo Smithkline (GSK) in its most recent annual report of 2010 has disclosed the consolidated financial and notes to the financial statements (Glaxo Smith Kline, 2011, p.104-108). The consolidated statements include the combined accounting figures of all group companies for the financial year. The income statement gives the financial performance of the company. The balance sheet provides the financial position and cash flow statement gives the cash flow from operating, financing and investing activities. Presenting the cash flow statement is not required by law but it is a requirement for companies other than ‘small’ companies to prepare the cash flow statement under FRS1, professional accounting standard (Stittle, 2003, p.39). The consolidated statement of changes in equity explains how the shareholders’ funds have changed over the reporting period. The notes to the financial statements are the most important tool in analyzing the financial statements because these explain the principles and basis on which the transactions in the accounts have been recorded. GSK in its notes to financial statements has included the presentation basis, accounting principles and policies related to consolidation, business combinations, foreign currency translation, revenue and expenditure recognition, R&D, provision for environmental and legal expenditure, pensions and various post-employment benefits, employee share plans, fixed assets, intangible assets including goodwill, asset impairment, investments in associates and JVs, current assets and derivative financial instruments. It has mentioned accounting judgements and estimates regarding turnover, taxation, provisions, tangible and intangible assets. GSK has also included new accounting requirements, exchange rates, segment information on the geographical basis and product line basis, restructuring programmes and their costs, other operating income, employee cost, financial income and costs, net debt etc (Glaxo Smith Kline, 2011, p.109-159). The basic accounting concepts are: 1. Going Concern concept: It is a presumption that the company will remain operational in the foreseeable future. GSK in its Directors’ responsibilities’ statement disclosed that the company has adequate resources for its operational existence in foreseeable future and thus they have prepared the financial statements on the basis of going concern (Glaxo Smith Kline, 2011, p.186). 2. Money Measurement concept: Those transactions that can be expressed in monetary terms are recorded. Intangible assets such as goodwill and patents are recorded after computing their monetary values. The items in GSK’s financial statements are expressed in money terms. The intangible assets include the costs of acquisition from third parties. The goodwill is also recorded in monetary terms. 3. Cost concept: This means that the asset should be recorded at the cost and if management feels to revalue them then the change in value is taken to the accounts. Depreciation is charged at the end of the period. GSK prepares its financial statements using historical cost concept. 4. Accruals Concept: The time of expenses incurred and revenues earned are irrelevant. They are considered the moment they become due irrespective of when they are paid or earned (Tyagi & Tyagi, 2003, p.7-8). The qualitative characteristics given by IASB which make the financial statements useful to the readers are: 1. Relevance/Materiality: The information disclosed should be material, relevant, updated and useful to the user. 2. Reliability: The information must be free from any material error, biases and in conformity with the ‘faithful presentation’. Sometimes the relevance and reliability present the case of conflict for example, relevance might require adoption of current subjective costs whereas reliability might favour more objective costs such as historic costs. In such situations IASB favours relevance. Also prudence must be exercised in estimation. 3. Comparability: Information must be comparable across all accounting periods. This also requires proper disclosures to the users appreciating the significance of transactions. However, the accounting policies must be reviewed if a reliable and relevant alternative exists. 4. Understanding: The information must be presented in such a manner it is understood by the user clearly. It should not be very simple so as to become meaningless (Kirk, 2008, p.8). To ensure the understanding of annual reports by the users, a set of accounting principles also known as GAAP have been developed. The consolidated financial statements of GSK are prepared in accordance with IAS regulation International Accounting Standards, Companies Act 2006, and IFRS. The financial statements of the parent company are prepared according to UK GAAP and UK accounting presentation (Glaxo Smith Kline, 2011, p.109-110). The independent auditor’s report for the Group’s financial statements has stated that the financial statements of the Group give a true and fair view of its affairs and have been prepared in accordance with IFRS as adopted by EU and as per the statutory requirements (Glaxo Smith Kline, 2011, p.103). Part 2 Key Users of Financial Statements The people who use financial accounting information for decision-making are: Management: The management of the business is responsible for operating the business with the goal of profitability and liquidity. This includes managers from various departments such as finance, accounting, investment, marketing, human resource, operations and productions, and information systems. The management has to analyze data from the points of view of creditors and investors. It should be concerned with the financial position of the company to meet the liabilities as well as the future earnings prospects. Direct Financial Interest: Those user groups which have direct financial interest in the company’s financial health are creditors, shareholders, portfolio/fund managers, brokerage firms and investment banks. They depend on reported information such as annual reports to analyze the risk and return from the company and take decisions. Many corporations in addition to annual reports also report their quarterly performance. GSK reports its quarterly earnings, share price analysis and Annual General Meetings’ information (GlaxoSmithKline Plc, 2011). GSK in its annual report has provided a summary of its 2010 operating performance and financial highlights. It has also shown the last five years’ key performance indicators such as turnover, EPS, Free Cash Flow, total shareholder return etc. Indirect Financial Interest: Those entities which have an indirect financial interest in the company’s reporting are tax authorities, regulatory agencies, customers, labour unions, audit firms and economic planner (Needles, Powers & Crosson, 2010, p.10-11). Uses of Accounting Information The uses of annual reports depend upon the type of user analyzing it. Following are the uses of the annual reports: Capital Structure: The management uses the accounting information to determine the capital structure of the firm as the proportion of short-term debt and long-term debt as well as the proportion of equity. Asset Structure: The management is interested in knowing the asset structure of the firm such as the cash, receivables, inventory, investments, and long-term assets. Business Strategy: The accounting information helps the senior managers of the firm in determining the short-run strategy and long-run policies. To balance the liquidity and profitability of the firm is a challenge for the management because the highly liquid assets are least profitable and liquid assets are required in the form of working capital. Well managed accounting system will help the management to take timely decisions. Ratio Analysis: The investors and creditors are interested in knowing the financial health of the firm through income statement. They analyze the income statement by looking at the margin ratios such as gross profit margin, operating profit margin and net profit margin. These ratios help in analyzing the cost structure of the business as to whether the business’ costs are mostly product-related or operating or non-operating. The ratio analysis of the balance sheet involves the liquidity analysis and financial risk analysis through the current ratio, quick ratio and debt ratios. Other ratios which help in analysing the firm are efficiency ratios such as turnover ratios, per employee earnings ratios, and price multiples. The price multiples are used in making investment decisions. The investors analyze the past trends and current position of the firm to project its future prospects. The fund managers analyze the data provided by the firms to give an investment recommendation on the firms’ stocks (McConnon & French, 2006, p.1-2). Raising Capital: The existing shareholders, creditors and potential investors help in raising the capital needed. The creditors extend the credit based on the viability of the firm in terms of risk. They check the level of already existing debt and equity. They also analyze the operating cash flows which exhibit the firm’s ability to meet its obligations. Many institutional creditors such as banks require the firm to conform to the covenants mentioned in the credit documents which usually put restrictions on the debt-raising and other ratios that represent risk to them. The firms raise capital by offering shares to public through IPOs and FPOs. The investors analyze the firm’s accounting information before taking decision to invest. Employees’ Interest: The firm’s employees seek to know the ability of the firm in increasing compensation in future (Gibson, 2010, p.203). Regulatory Requirements: The regulatory authorities such as FRC and SEC require fair and transparent disclosure of financial information and comply with the reporting requirements. The standards that govern the financial statements preparation and disclosures are IFRS and GAAP. They analyze from the notes to the financial statements if the firm has complied with the standards and other requirements. The Government analyzes the financial statements to ensure the compliance with anti-trust law and tax purposes. Future Prospects: The users of financial statements analyze the MD&A where the senior executive of the firm discusses about the future goals and prospects of the firm. GSK has mentioned in its annual report 2010 that the disclosure committee along with the management, internal auditors, and the Board work in alliance to ensure the quality of company’s accounting and financial reporting (Glaxo Smith Kline, 2011, p.76). Conclusion This project is presented in two parts where the first part discusses the accounting concepts and process and if GSK fulfils the requirements of accounting policies. The financial accounting is the process of preparing and operating accounting information system and disclosing the prepared financial information to the stakeholders of the business. The GSK group prepares its consolidated statements in accordance with the IFRS and other statutory requirements. Based on the opinion of the independent auditor, the company has provided a true and fair view of its operations. The second part includes the main uses and types of users of accounting information and if the Group has provided sufficient and relevant information to enable the users to form an opinion about the Group’s financial health. The main area of investigation from its annual report has been the notes to financial statements as this present the policies and standards applied in the accounts’ preparation. The Group has provided in detail the basis of accounting and policies adopted. References Gibson, C.H. (2010). Financial Reporting & Analysis: Using Financial Accounting Information. Cengage Learning. Glaxo Smith Kline. (2011). GSK Annual Report 2010. [Pdf]. Available at: http://www.gsk.com/investors/reps10/GSK-Annual-Report-2010.pdf. [Accessed on November 16, 2011]. GlaxoSmithKline Plc. (2011). Investors – GlaxoSmithKline. [Online]. Available at: http://www.gsk.com/investors/. [Accessed on November 16, 2011]. Kirk, R. (2008). IFRS: a quick reference guide. Butterworth-Heinemann. McConnon, J.C. & French, F.M. (2006). Ratio Analysis. [Pdf]. Available at: http://www.umext.maine.edu/onlinepubs/pdfpubs/3002.pdf. [Accessed on November 16, 2011]. Needles, B.E. Powers, M. & Crosson, S.V. (2010). Principles of Accounting. Cengage Learning. Stittle, J. (2003). Annual reports: delivering your corporate message to stakeholders. Gower Publishing, Ltd. Tyagi, C.L. & Tyagi, M. (2003). Financial And Management Accounting 2 Vols. Set. Atlantic Publishers & Dist. Bibliography Dick, W. & Missionier-Piera, F. (2010). Financial Reporting Under IFRS: A Topic Based Approach. John Wiley and Sons. Marriott, P. Edwards, J.R. & Mellett, H.J. (2002). Introduction to Accounting. SAGE. Pierce, A. & Brennan, N. (2003). Principles and practice of group accounts: a European perspective. Cengage Learning EMEA. Stickney, C.P. Weil, R.L. Schipper, K. & Francis, J. (2009). Financial accounting: an introduction to concepts, methods, and uses. Cengage Learning. Read More