BTPLC Annual Report 2006 - Consolidated financial statements

These are the group’s first consolidated financial statements prepared in accordance with EU-adopted IFRS.
The accounting policies set out on pages 65 to 72 have been applied in preparing the financial statements for the year ended 31 March 2006, the comparative information for the year ended 31 March 2005 and the preparation of an opening balance sheet at 1 April 2004, the group’s date of transition. IAS 39, ‘Financial Instruments: Recognition and Measurement’ and IAS 32, ‘Financial Instruments: Disclosure and Presentation’ have not been applied to the comparative periods because the group has taken a transitional exemption and adopted these standards prospectively from 1 April 2005.
In preparing its opening IFRS balance sheet, the group has made adjustments to amounts previously reported in its financial statements under UK GAAP. IFRS and UK GAAP are not directly comparable. An explanation of how the transition from previous UK GAAP to IFRS has affected the group’s financial position is set out below.

		31 March 2005		1 April 2004
	Notes	£m		£m

Total equity under UK GAAP		3,901		3,112

Adjustments to equity to conform with IFRS (net of deferred tax):
Employee benefits	a	(4,092	)	(4,390	)
Share based payments	b	7		–
Goodwill and other intangibles	c	16		–
Dividends	d	551		454
Leases	e	(288	)	(215	)

Total reduction in equity		(3,806	)	(4,151	)

Total equity (deficit) under IFRS		95		(1,039	)

		2005
	Notes	£m

Profit for the year under UK GAAP		1,821

Adjustments to profit to conform with IFRS (net of deferred tax):
Employee benefits	a	86
Share based payments	b	(21	)
Goodwill and other intangibles	c	16
Leases	e	(73	)

Total adjustment to profit for the year		8

Profit for the year under IFRS		1,829

Under IAS 7 ‘Cash Flow Statements’ movements in cash and cash equivalents are reconciled. Under UK GAAP movements in cash balances only are reconciled. The change in the presentation of the cash flow statement under IAS 7 has no impact on the cash flow generated by the group.

Effect of IAS 32 and IAS 39 transitional adjustment (note f)

	31 March 2005		Transition adjustment		1 April 2005
	£m		£m		£m

Non current assets
Derivative financial instruments	18		5		23

Current assets
Trade and other receivables	4,269		(275	)	3,994
Derivative financial instruments	143		31		174
Loans and receivables	2,003		45		2,048
Available-for-sale investments	1,149		2		1,151

Current liabilities
Trade and other payables	(6,763	)	861		(5,902	)
Derivative financial instruments	(375	)	(321	)	(696	)
Loans and other borrowings	(4,261	)	(111	)	(4,372	)

Non current liabilities
Loans and other borrowings	(7,744	)	(194	)	(7,938	)
Deferred tax liabilities	(1,715	)	272		(1,443	)
Derivative financial instruments	(472	)	(524	)	(996	)

Reserves	(387	)	(209	)	(596	)

First Time adoption exemptions applied
IFRS 1, ‘First-time Adoption of International Financial Reporting Standards’ sets out the transitional rules which must be applied when IFRS is applied for the first time. The group is required to select accounting policies in accordance with IFRS valid at its first IFRS reporting date and apply those policies retrospectively. The standard sets out certain mandatory exceptions to retrospective application and certain optional exemptions. The exemptions adopted by the group are as set out below.

Business combinations: the group has elected not to apply IFRS 3, ‘Business Combinations’ retrospectively to business combinations that occurred before the date of transition (1 April 2004).
Employee benefits: the group has elected to recognise all cumulative actuarial gains and losses from employee benefits schemes at the date of transition. All subsequent actuarial gains and losses have been recognised in full in the period in which they occur in the statement of recognised income and expense in accordance with IAS 19, ‘Employee Benefits’ (as amended on 16 December 2004).
Share based payments: the group has elected to apply IFRS 2, ‘Share Based Payment’ retrospectively to all equity instruments granted after 7 November 2002 and which were not fully vested as at 1 January 2005.
Cumulative translation differences: the group has elected to reset the foreign currency translation reserve to zero at the transition date. Any gains and losses on subsequent disposals of foreign operations will exclude any translation differences arising prior to the date.
Financial instruments: the group has chosen to utilise the exemption from the requirements to restate comparative information for IAS 32, ‘Financial Instruments: Disclosure and Presentation’ and IAS 39, ‘Financial Instruments: Recognition and Measurement’, and hence these standards have been applied prospectively as of 1 April 2005.

NOTES TO EXPLAIN THE EFFECTS OF IFRS IN THE FINANCIAL STATEMENTS
(a)	Employee benefits

Under UK GAAP, the group previously measured pension commitments and other related post-retirement benefits in accordance with SSAP 24, ‘Accounting for Pension Costs’ with additional disclosures provided in accordance with FRS 17, ‘Retirement Benefits’. Under IFRS the group measures pension commitments and other related post-retirement benefits in accordance with IAS 19, ‘Employee Benefits’.
     Under IAS 19 the income statement charge is split between an operating charge and a net finance charge. The net finance charge relates to the unwinding of the discount applied to the liabilities of the scheme offset by the expected return on the assets of the scheme, based on conditions prevailing at the start of the year. Actuarial gains and losses are recognised immediately in reserves.
     Under SSAP 24, the asset on the balance sheet represented the timing differences between the pension charge recognised in the profit and loss account and the payments made to the pension scheme. Under IAS 19, the liability on the balance sheet represents the deficit in the pension scheme. The scheme assets are valued at market value and the liabilities are discounted using a high quality corporate bond rate.
     Under SSAP 24, pension charges for the year ended 31 March 2005 were £465 million, including a charge for the amortisation of the SSAP 24 deficit in the BTPS, and an interest credit relating to the balance sheet prepayment. Under IAS 19 the total charges for the year ended 31 March 2005 were £342 million, split between an operating charge and net finance income. Accordingly, for the year ended 31 March 2005 there is an additional £75 million charge to operating profit and £198 million of net finance income has been recognised under IAS 19. A related deferred tax charge of £37 million has also been recognised. The net effect has been an increase in profit of £86 million.
     A pension liability has been recognised at 31 March 2005 of £4,807 million and a deferred tax asset of £1,434 million, offset by the reversal of provisions of £44 million for 31 March 2005. The pension prepayment on the UK GAAP balance sheet of £1,118 million has also been reversed, including the associated deferred tax liability. The net effect has been a reduction in equity at 31 March 2005 of £4,092 million.
     A pension liability has been recognised at 1 April 2004 of £5,136 million and a deferred tax asset of £1,541 million, offset by the reversal of provisions of £36 million. The pension prepayment of £1,172 million has also been reversed, including the associated deferred tax liability. The net effect has been a reduction in equity at 1 April 2004 of £4,390 million.

(b)

Share based payment

Under UK GAAP an expense was recognised for the award of share options and shares based on their intrinsic value (the difference between the exercise price and the market value at the date of the award). The majority of BT’s share based payments are made under all employee ‘Save As You Earn’ plans which were exempt under UK GAAP and the intrinsic value of many of the senior management schemes is nil.
     Under IFRS 2, ‘Share Based Payment’, an expense is recognised in the income statement for all share based payments (both awards of options and awards of shares). This expense is based on the fair value at the date of grant of the award, using an option pricing model, and is charged to the income statement over the related performance period.
     The adoption of IFRS 2 has resulted in an increased operating charge for the year ended 31 March 2005 of £28 million. A related deferred tax benefit of £7 million, has also been recognised, with the net effect being a decrease in profit of £21 million.
     The credit entry for the share based payments is recognised directly in reserves as the awards are equity settled. The net effect has been an increase in equity of £7 million at 31 March 2005.

(c)

Goodwill and other intangible assets

UK GAAP required goodwill to be amortised over its expected useful economic life. Under IFRS 3, ‘Business Combinations’, goodwill is no longer amortised but held at its carrying value on the balance sheet and tested annually for impairment. In addition, IAS 38, ‘Intangible Assets’ requires other intangible assets arising on acquisitions after the transition date to be separately identified and amortised over their useful economic life, often a shorter period than previously used for goodwill. As a result, intangible assets such as customer relationships and trademarks, need to be separately valued and recognised on business combinations, and then amortised over their useful economic lives.
The UK GAAP goodwill amortisation charge in the year to 31 March 2005 of £16 million has been reversed. The other intangible assets arising from acquisitions since 1 April, 2004 are being amortised over their estimated useful economic lives.
Computer software that is not an integral part of the associated hardware is classified as an intangible asset under IAS 38. Under UK GAAP, the group’s policy was to categorise all capitalised software as tangible fixed assets. This has resulted in a balance sheet reclassification of £615 million as at 31 March 2005, but has had no impact on profit or equity.

(d)

Dividends

Under UK GAAP, the dividend charge was recognised in the profit and loss account in the period to which it related. Under IAS 10, ‘Events After The Balance Sheet Date’, dividends are not recognised in the income statement but directly in reserves. In addition, the final dividend is recognised only when it has been declared and approved by the company in a general meeting.
The final dividend liabilities for the 2005 and 2004 financial years of £551 million and £454 million, respectively have been reversed at 31 March 2005 and 1 April 2004 as the associated dividends had not been approved at those dates.

(e)

Leases

Under IAS 17 ‘Leases’ there is a requirement to view leases of land separately from leases of buildings. Furthermore, there is a requirement to recognise operating lease charges as an expense on a straight line basis. As a result, the building elements of a small number of properties have been reclassified from operating leases under UK GAAP to finance leases under IFRS, and lease rentals under the group’s 2001 sale and operating leaseback transaction are recognised on a straight line basis under IFRS.
For those properties reclassified as finance leases, profit before tax for the year ended 31 March 2005 has been reduced by approximately £3 million as a result of the recognition of depreciation and finance lease interest charges, and the removal of the UK GAAP operating lease charges. Recognising the operating lease charges, on a straight line basis has further reduced the profit before tax for the year ended 31 March, by £101 million. A deferred tax benefit of £31 million has also been recognised, with the net effect being a £73 million reduction in profit.
Those properties reclassified as finance leases have been capitalised and are included within property, plant and equipment at the lower of the present value of the minimum lease payments or the fair value of the lease asset, which was £93 million at 1 April 2004 and £90 million at 31 March 2005, respectively. The associated finance lease obligation has also been recognised, being £105 million and £107 million at 1 April 2004 and 31 March 2005, respectively. The excess of the sales proceeds over the previous carrying value has deferred, and is being recognised in the income statement over the lease term. The deferred gain included in deferred income at 1 April 2004 and 31 March 2005 was £44 million and £42 million respectively. Where the operating lease rentals are recognised on a straight line basis, the difference between the amounts recognised in the income statement and the lease payments is included in other creditors, and amounted to £251 million and £352 million at 1 April 2004 and 31 March 2005, respectively. A deferred tax liability of £100 million and £123 million at 1 April 2004 and 31 March 2005 has been recognised. The net effect of the above has been a reduction in equity of £215 million and £288 million at 1 April 2004 and 31 March 2005, respectively.

(f)

Financial instruments

Under UK GAAP, the group previously measured financial assets and liabilities in accordance with the principles of FRS 4, ‘Capital Instruments’, FRS 5, ‘Reporting the Substance of Transactions’ and SSAP 20, ‘Foreign Currency Translation’. Current asset investments were recognised at the lower of cost and net realisable value. Debt instruments were stated at the amount of the net proceeds adjusted to amortise any discount over the term of the debt. Debt and current asset investments were further adjusted for the effect of the currency element of swaps and forward contracts used as a hedge against these instruments. The group also provided disclosures in accordance with FRS 13, ‘Derivatives and Other Financial Instruments: Disclosures’ setting out the objectives, policies and strategies for holding or issuing financial instruments, and the fair value of financial instruments held at the balance sheet date.
     IAS 39 requires all derivative financial instruments to be recorded at fair value on the balance sheet. The fair value of derivative financial instruments recognised on the balance sheet on transition at 1 April, 2005 was a net liability of £1.5 billion. This fair value included a net liability of £0.7 billion which was previously recognised under UK GAAP, reflecting the currency element of financial instruments and accrued interest associated with derivatives. The additional net liability of £0.8 billion arising on transition resulted in a corresponding net decrease to equity. Future market interest rate and currency movements will give rise to adjustments to these fair values. Where hedge accounting cannot be applied under the prescriptive rules of IAS 39, changes in fair values of derivative financial instruments will impact the income statement.
     In addition, the majority of the gains and losses associated with terminated derivative financial instruments that were deferred under UK GAAP have been reclassified to reserves in accordance with the transitional rules of IFRS 1, resulting in an additional net increase to equity of £0.3 billion.
     Certain financial assets and financial liabilities are required to be recorded at amortised cost under IAS 39. Under UK GAAP, the majority of this amortised cost value was reflected on the balance sheet but elements were separately recorded in current assets and current liabilities. These amounts have been reclassified on transition to either financial assets or loans and borrowings to recognise the respective instruments at amortised cost.
     The adjustments described above, on adoption of IAS 32 and IAS 39, have resulted in an overall reduction in total equity as at 1 April, 2005 of £481 million (£209 million net of deferred taxation).

(g)

Other adjustments and reclassifications

There are a number of other minor adjustments and reclassifications which include:

–

The group’s share of results of associates and joint ventures is presented net of tax and finance expense on the face of the income statement. Previously under UK GAAP the group’s share of associates and joint ventures’ interest and tax was included in the relevant interest and tax line of the income statement.

–	Liquid investments with maturities of less than three months at acquisition are classified within cash and cash equivalents under IAS 7, ‘Cash Flow Statements’ rather than as current asset investments under UK GAAP.

–

Cash flow statements prepared in accordance with IAS 7, ‘Cash Flow Statements’ have a different presentational format. Although the underlying cash flows remain the same as previously reported, the cash flow statement reflects movements in cash and cash equivalents. In addition, certain leases are non classified as finance leases which had previously been treated as operating leases.

–

Under UK GAAP, loans and borrowings and current asset investments were held at foreign currency rates prescribed in the hedging instrument where hedging had been applied in accordance with the group’s accounting policies. Under IAS 21, ‘The Effects of Changes in Foreign Exchanges Rates’, such forward rate adjustments are required to be disclosed separately and have therefore been reclassified. On adoption of IAS 39 from 1 April, 2005, such forward rate adjustments form part of the overall fair value of derivative financial instruments.

–	Foreign exchange gains and losses on certain intercompany loans are recognised in the income statement. Under UK GAAP these amounts were recognised in reserves.

–	Profits on the sale of property fixed assets are classified within other operating income on the face of the income statement. Under UK GAAP, these amounts had previously been disclosed after operating profit.

–

The group has historically recognised revenue arising from calls to our premium rate numbers on a gross basis, with amounts paid to service providers recorded separately within operating costs. In light of the transition to IFRS and changing market practice we have reviewed the presentation of these arrangements. We have decided to change our presentation to a net basis for these calls where we provide basic transmission and connectivity only. For those calls where we add value by providing interactivity and a more significant and valuable part of the service, the associated revenue will continue to be reported on a gross basis. Whilst reducing revenue and operating costs, this change has had no impact on reported profit, cash flows or the balance sheet. The impact on revenue and operating costs was £194 million for the year ended 31 March 2005.

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