GSK Annual Report 2002

110 GlaxoSmithKline Notes to the financial statements
32 Financial instruments and related disclosures
Policies
Discussion of the Group’s objectives and policies for the
management of financial instruments and associated risks is
included under ‘Treasury Policies’ in the Operating and financial
review and prospects on page 62.
Investments
The Group holds a number of equity investments, frequently in
entities where the Group has entered into research collaborations.
The Group seeks to realise the value in these investments, which
in part the research collaboration helps to create, and therefore
certain of these investments are regarded as available for sale and
are accounted for as current asset investments. For the purposes
of US GAAP all the current asset investments are classified as
available for sale.
In 2002, GlaxoSmithKline hedged part of the equity value of its
holdings in its largest equity investment, Quest Diagnostics, Inc.
through a series of variable sale forward contracts. These contracts
(the ‘equity collar’) are structured in five series, each over one
million Quest shares and mature between 2006 and 2008.
The Group has liquid investments, representing funds surplus to
immediate operating requirements, which are accounted for as
current asset investments. For the purposes of US GAAP the
investments are classified as available for sale. The proceeds from
sale of investments classified as available for sale (under US GAAP)
in the year ended 31st December 2002 were £162 million. The
proceeds include the roll-over of liquid funds on short-term deposit.
The gross gains and losses reflected in the consolidated profit and
loss account in respect of investments classified as available for sale
(under US GAAP) were £44 million and £1 million, respectively.
Foreign exchange risk management
The Group has entered into forward foreign exchange contracts
in order to swap liquid assets and borrowings into the currencies
required for Group purposes. At 31st December 2002 the Group
had outstanding contracts to sell or purchase foreign currency
having a total notional principal amount of £1,937 million
(2001 – £7,312 million). The majority of contracts are for periods
of 12 months or less.
At the end of the year the Group had a number of currency swaps
in place in respect of medium-term debt instruments.
Borrowings denominated in, or swapped into, foreign currencies
which match investments in overseas Group assets are treated as
a hedge against the relevant net assets and exchange gains or
losses are recorded in reserves.
Interest rate risk management
To manage the fixed/floating interest rate profile of debt, the Group
had several interest rate swaps outstanding with commercial banks
at 31st December 2002.
Concentrations of credit risk and credit exposures of
financial instruments
The Group does not believe it is exposed to major concentrations
of credit risk. The Group is exposed to credit-related losses in the
event of non-performance by counterparties to financial
instruments, but does not expect any counterparties to fail to meet
their obligations. The Group applies Board-approved limits to the
amount of credit exposure to any one counterparty and employs
strict minimum credit worthiness criteria as to the choice of
counterparty.
Fair value of financial assets and liabilities
The table on page 111 presents the carrying amounts under UK
GAAP and the fair values of the Group’s financial assets and
liabilities at 31st December 2002 and 31st December 2001.
Debtors and creditors due within one year have been excluded.
The fair values of the financial assets and liabilities are included
at the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced
or liquidation sale. The following methods and assumptions were
used to estimate the fair values:
• Equity investments – market value based on quoted market
prices in the case of listed investments; market value by
reference to quoted prices for similar companies or recent
financing information in the case of material unlisted
investments
• Cash at bank – approximates to the carrying amount
• Liquid investments – based on quoted market prices for similar
companies or recent financing information in the case of
marketable securities; approximates to the carrying amount
in the case of time deposits because of their short maturity
• Short-term loans and overdrafts – approximates to the carrying
amount because of the short maturity of these instruments
• Medium-term loans – market value based on quoted market
prices in the case of the Eurobonds and other fixed rate
borrowings; approximates to the carrying amount in the case
of floating rate bank loans and other loans
• Forward exchange contracts – based on market prices and
exchange rates at the balance sheet date
• Currency swaps – based on market valuations at the balance
sheet date
• Equity collar - fair value is determined based on an option
pricing model
• Interest rate instruments – based on market valuations at the
balance sheet date
• Debtors and creditors – approximates to the carrying amount
• Provisions – approximates to the carrying amount
• Auction rate preference stock - approximates to the carrying
amount in the case of floating rate instruments
• Flexible auction market preferred stock - based on market
valuations at the balance sheet date.
Fair value of investments in own shares
The Group had at 31st December 2002 investments in own shares
of £2,826 million (2001 – £2,936 million) with a fair value of
£2,161 million (2001 – £3,229 million). The difference between
the carrying amount and the fair value represents an unrealised
loss of £665 million. This valuation shortfall is not considered to
represent a permanent diminution in value in the context of the
length of the future period over which the related share options
may be exercised. Accordingly no provision has been made. These
investments are excluded from financial instrument disclosure. The
fair value is the market value based on quoted market price.
The shares represent purchases by Employee Share Ownership
Trusts to satisfy future exercises of options and awards under
employee incentive schemes. The purchases are matched against
options at pre-determined exercise prices and the gain or loss to
be recognised is measured against exercise price rather than
market value.