721ISSUES IN ACCOUNTING EDUCATIONVol. 22, No. 4November 2007pp. 721–733Making the Right Comparisons:Novartis AGElaine Henry and Ya-Wen YangABSTRACT: This case introduces the concept of convergence between InternationalFinancial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Princi-ples (GAAP). The scenario involves a securities analyst’s evaluation of Novartis AG’sfinancial performance under IFRS and U.S. GAAP, and provides an opportunity to ex-amine the issues giving rise to differences under the two sets of standards. Based onthe company’s 20-F disclosure, the case uses the reconciliation footnotes to recast thecompany’s IFRS financial statements to U.S. GAAP. The analytical skill of adjustingfinancial statements is useful beyond the IFRS-to-U.S. GAAP context.Keywords: case study; international accounting; 20-F reconciliation; ratio analysis.INTRODUCTIONArriving in the office on January 19, 2006, Rebecca Robinson opens a brief emailmessage from her boss: ‘‘Novartis reported today. Take a look and let’s meet afterlunch.’’ Rebecca was enjoying her new job working with one of the senior phar-maceutical analysts at a major money management firm and really felt she had learned alot since taking the position a few weeks ago. She understood that her boss was referringto the company’s announcement of its financial results for the year ended December 31,2005.Skimming the bulleted points at the beginning of the company’s earnings announce-ment, Rebecca noted that the company had increased sales by 14 percent and net incomeby 10 percent. Although the diluted EPS of $2.62 was lower than the analyst’s forecasted$2.70, the company’s performance looked strong. Compared to other pharmaceutical com-panies announcing earnings this week, Novartis’s growth in sales and profits was muchhigher. For example, U.S.-based Pfizer had reported a slight decrease in sales and a declinein net income. Aware that Novartis is a Swiss company and reports its financial statementsusing International Financial Reporting Standards (IFRS), Rebecca wondered whether dif-ferences in accounting standards might affect comparisons of profitability. Of course, withthe convergence between IFRS and U.S. GAAP, it seemed likely that the differences wereminimal. Nonetheless, Rebecca decided to examine these differences before her afternoonmeeting.Elaine Henry is an Assistant Professor and Ya-wen Yang is an Assistant Professor, both atthe University of Miami.We appreciate helpful comments from Bruce Behn, Steve Lin, Diana Falsetta, participants at the 2007 MidyearMeeting of the International Accounting Section of the American Accounting Association, the editor, and twoanonymous reviewers.722 Henry and YangIssues in Accounting Education, November 2007THE EARNINGS ANNOUNCEMENTNovartis’s equity trades on the New York Stock Exchange and thus is subject to therequirements of the Securities and Exchange Commission (SEC). The SEC, in accordancewith the Securities Exchange Act of 1934, requires companies with publicly traded secu-rities to file annual financial reports, interim financial reports, and announcements of majorevents of importance to shareholders. (The SEC does not require foreign issuers such asNovartis to file interim reports; however, whenever such companies issue interim financialreports in their home markets, they also file the reports with the SEC.) It is a typical practice,though not a requirement, for companies to issue a press release announcing their financialresults shortly after an accounting period ends, with the formal SEC filing following withinthe required time frame. These earnings announcements are filed with the SEC, on Form8-K for U.S. companies and on Form 6-K for non-U.S. companies. The formal SEC filingsof companies’ annual financial reports are made using Form 10-K for U.S. companies andForm 20-F for non-U.S. companies.Novartis announced its performance for the year 2005 in a press release January 19,2006, and filed a Form 6-K with the SEC, attaching the press release. The followingheadline and bullet points appear in that press release. As is customary with earningsannouncements, Novartis emphasizes the positive aspects of its performance:Novartis delivers strong performance with record results in 2005●Group full-year net sales up 14% in USD (⫹13% lc [local currency]) thanks to dynamicexpansion of Novartis Pharmaceuticals and Sandoz, the latter supported by acquisitions●Pharmaceuticals continues to gain market share, net sales rise 10% (⫹9% lc) based onexcellent performances from strategic products●Group operating income rises 10%, while Pharmaceuticals advances 12% through pro-ductivity gains and the operating margin rises 0.7 percentage points to 29.7%●Net income up 10% to USD 6.1 billion and EPS rises 11% to USD 2.63 per share.(Source: Novartis Investor Relations Release)BACKGROUNDThe Pharmaceutical IndustryMost major pharmaceutical companies were founded in the late 19th and early 20thcenturies.1The industry remained relatively small until a long period of scientific advance-ments began in the 1970s. Today, the largest pharmaceutical companies are among the mostprofitable and productive in the world. In 2005, global pharmaceutical sales were $565billion, a 7 percent increase over 2004, according to data from IMS Health Inc., a marketresearch and consulting firm. Sales growth can be largely attributed to increased averagelife expectancy, rising wealth, and the launch of innovative new products; however, growthis expected to decelerate as more brand-name drugs will lose patent protection from 2007through 2010, and the industry will face intense generic competition and price erosion.Many pharmaceutical companies responded to the competition and economic pressureswith mergers and acquisitions. Some branded drug companies purchased generic drug man-ufacturers as a result of generic competition, while many small biotech and R&D intensive1Industry background obtained from Standard & Poor’s (2006).Making the Right Comparisons: Novartis AG 723Issues in Accounting Education, November 2007companies merged with large pharmaceutical companies to capitalize on the synergy be-tween the companies. Such consolidation allows companies to share research expertise,marketing capability, and product portfolios.The CompanyIn 1758, Geigy, the oldest of Novartis’s predecessor companies, began operations inBasel, Switzerland.2In 1970, Geigy merged with