COST ACCOUNTING SYSTEM 9
A cost accounting system can be described as a system that records,examines and allocates costs to the services and products that areoffered to patients, such as procedures, tests, medications, room andboard. Firms that do not have a cost accounting system tend to userudimentary methods like the ratio-of-cost-to-charge to allocatecosts. GlaxoSmithKline (GSK) is a research-based healthcareorganization that operates in two segments, including pharmaceuticalsand consumer healthcare (Nisen & Rockhold, 2013 Ryssdal, 2016).Powell and Hodges (2008) assert that healthcare organizations usuallyutilize three forms of accounting approaches, which include accrualbasis, cash basis, and fund accounting. GlaxoSmithKline recognizesrevenue when it supplies services and goods or makes them availableto clients against the orders it has received. In this regards, thecompany utilizes the accrual basis form of accounting system. Powelland Hodges (2008) assert that the accrual basis system attempts toaccumulate revenue and expenses to the appropriate period in which acompany earns them. This means that a company must effectively recordmonthly financial records whether the firm has received cash or paidcash (Rogowski, Grosse, Schmidtke, & Marckmann, 2014). Thus, itis imperative to critically assess the cost accounting systememployed by GlaxoSmithKline to understand how accounting systemsoperate and support the structures and strategic approaches of afirm.
Challenges facing the company
The company classifies liquid investments and other investmentsexisting-for-sale reserves, which means that these investments areprimarily recorded at fair value price and then reevaluated atconsequent reporting periods to effective value. In addition, theaccrual basis allows a company to match expenses and revenuesregardless of when a company makes or receive payments. In thisregards, the company faces challenges especially in recordingexpenses and ensuring transparency and compliance. In recordingexpenses, the firm uses an expense report, which lessens the numberof checks especially when recording employee expenses. However, theuse of expense reports put additional burden to the accounting teamespecially in recording and tracking expenses. In this regards, thecompany faces a great challenge when it comes to reporting workers’expenses. When workers are submitting expenses, they usuallyattribute a date in which the expenses were not incurred or paymentsmade. This means that the expense report has a date when the employeesent the receipt instead of when payments were made or expensesincurred. As such, the accounting team faces challenges inassociating expenses to the appropriate period, as well as, inreconciling payments. The firm engages in research activities, whichmeans that it usually experiences challenges in allocating funds tothe research activities.
The company has also faced challenges in terms of reducing the amountof time spent away from the business, reducing training costs, andreliance on costly equipment (Christodoulou, Clubb, & Mcleay,2016). Some of the products that are subjected to cost accountinginclude prescription medication, consumer health products, andvaccines. The company also manufactures products for severaltherapeutic categories and in broad spaces (Nisen & Rockhold,2013). Losses in patent protection for different drugs are expectedin the next 3 to 5 years but there are numerous other new productsthat will offset these losses. The company’s cost accounting systemcoupled with other approaches such as risk management, goodgovernance, dedicated business models, and ethical behavior hasallowed the improvement of the firm’s standing. For example, in2014, GSK had a group turnover of £23billion and a total operatingprofit of £3.6 billion (GlaxoSmithKline 2015). The firm’simprovements and positive growth shows that despite the challengesfaced in enhancing cost structures and accounting, the firm hascultivated a flexible, effective, and comprehensive system.
GSK has also been using data-driven methodologies to carry out costaccounting. The data-driven methodology according to the companyallows it to establish areas of concerns, as well as, identity areasof improvements (GlaxoSmithKline, 2015). However, the company facesnumerous challenges in incorporating and structuring the approachsuch as huge costs, low priority, and management challenges. In fact,the approach is highly costly in terms of compliance andtransparency, but effective hence, only big companies can manage toutilize it effectively. This has made several other healthorganizations to put-off revision of their old methodologies. Normalhospital cost management systems usually utilize a combination ofrelative value units (RVU) as well as ratio cost changes (RCC) inorder to allocate costs (Christodoulou et al., 2016). Electronicmedical records (EMR) are increasing the amount of data that isavailable to an organization. However, old techniques and costaccounting systems fail to utilize the richness of data to offer anaccurate view of costs. Today, the company has extensively usedtechnology to shape and structure its activity-based cost system,which has allowed it to identify and seek to resolve challenges.
Pros and Cons
The main advantage of the accrual basis is its accuracy in providingfinancial statements. The accrual basis allows a company to producemore accurate financial statements that include enhanced presentationof actual situations than its main rival. The accrual basis allows afirm to record expenses and revenue at the same period regardless ofwhen payments were made or expenses incurred thus, it cultivatesmore appropriate and accurate gauges of firms’ performance in anyperiod. A firm assign costs to a product that requires certainactivities in order to be produced (Reference for Business, 2016).The accrual method allows a company to compare and communicatefinancial aspects easily and effectively since it communicates theactivities, which occurred during a specific period. For instance,GlaxoSmithKline records earned revenue during a month in the incomestatement (GlaxoSmithKline, 2015). Although the company might notereceive payment until the subsequent month, the accrual basis allowsusers of financial information to see that the firm engaged in anincome-generating activities during the month. In fact, the accrualmethod has allowed the company to communicate its financial positioneffectively and easily. Most importantly is the fact that the methodallows a firm to double check all entries since it utilizes thedouble entry approach where credits must equal debits. In thisregards, Rogowski et al. (2014) opine that the accrual method is avery effective approach especially for firms involved in numeroustransactions and activities. In addition, this costing technique iseasy to interpret the costs for internal management. Therefore, itenables benchmarking, as well as, a huge understanding of the totalcosts. The method allows a company to review all transactionseffectively irrespective they generated revenue or not since certainemployees were engaged in the activity and they need to be paid.However, the system has several drawbacks to a company especially inits application and maintenance. Based on GlaxoSmithKline history andaccounting systems, the system requires substantial resources toimplement and run. The implementation of the accrual approachrequires highly trained accountants, which means that the method iscostly to run. Moreover, the approach fails to offer appropriatesituations on cash flows since the method does not offer an immediatesituation of cash flows. This implies that it is a huge disadvantageto healthcare organization especially with the rising cost ofmedication and as firms try to reduce their costs of operations(Kaplan & Anderson, 2013). This means that firms fail to gaugetheir cash flows effectively when using the accrual basis as well asencounter challenges sometimes in hiring highly trained accountants.
Financial Management Improvement
GlaxoSmithKline uses accounting information for improving financialmanagement and this is evident in the accounting system adopted bythe company. Exchanging information between the finance andproduction departments has been instrumental in controlling costs andensuring that the firm meets its production. This implies thatleaders in the accounting department are able to use the collectedinformation to improve financial management and enhance closecoordination between different departments (Klann et al., 2015Reference for Business, 2016). All the information that accountantsproduce need to be readily and timely understood by other managers sothat the firm can realize cost reductions and enhance effectivemanagement. In 2011, GSK begun a strategy aimed at improving andsimplifying operational and financial information across the entirefirm (GlaxoSmithKline, 2015). The strategy has shaped the company’sgrowth and allowed the implementation of sound managementaccountancy. The strategy has allowed the firm to entrenchprinciples of sound management accountancy within the organization sothat information can easily be shared and implemented.
The initiative has given management accountants the ability toincreasingly participate and get involved with the operational sideof the business. Moreover, this has enhanced the capacity of theproduction departments to come up with timely and effectivedecisions. For example, studies have shown that the initiative washighly efficient for the standard setting process that is done yearly(Christodoulou et al., 2016). Moreover, since clear managementdecisions can be leveraged, it implies that the production andaccounting teams could easily identify different key products andminimize the costs by 9% to 15% every year (GlaxoSmithKline, 2015).GSK managers have been deeply committed to reducing waste and costs,driving improvement, and enhancing the robustness of the entiremanufacturing process. They have attained this while maintaining thelargest quality in the line of production. The processes affect thedaily operation of the firm while reducing costs.
Christodoulou, D., Clubb, C., & Mcleay, S. (2016). A structuralaccounting framework for estimating the expected rate of return onequity. Abacus, 52(1), 176-210.
GlaxoSmithKline. (2015). Strategic report 2014. GlaxoSmithKline.Retrieved 10 June 2016 fromwww.gsk.com/media/606188/strategic-report-2014.pdf
Kaplan, R., & Anderson, S. R. (2013). Time-DrivenActivity-Based Costing: A Simpler and More Powerful Path to HigherProfits. Harvard: Harvard Business Press
Klann, R. C., Beuren, I. M., & Hein, N. (2015). Canonicalrelationship between performance indicators based on Brazil, US andIFRS accounting standards of Brazilian and United Kingdomcompanies. Journal of Accounting and Taxation, 7(1),1.
Nisen, P., & Rockhold, F. (2013). Access to patient-level datafrom GlaxoSmithKline clinical trials. New England Journal ofMedicine, 369(5), 475-478.
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Rogowski, W. H., Grosse, S. D., Schmidtke, J., & Marckmann, G.(2014). Criteria for fairly allocating scarce health-care resourcesto genetic tests: which matter most&quest. EuropeanJournal of Human Genetics, 22(1), 25-31.
Ryssdal, K. (2016). GlaxoSmithKline CEO on why drugs cost so much.Retrieved June 10, 2016, fromhttp://www.marketplace.org/2016/05/10/health-care/corner-office/glaxosmithkline-ceo-says-things-have-change