14th Apr 2005 07:00
14 April 2005 ROLLS-ROYCE GROUP plc PREPARATIONS COMPLETED FOR ADOPTION OF IFRS Rolls-Royce, the world-leading power systems company for aerospace, marine andenergy markets, today announced the completion of preparations to adoptInternational Financial Reporting Standards (IFRS). Commenting on the Group's adoption of the new accounting rules, AndrewShilston, Finance Director, said:"Rolls-Royce has followed a consistent and successful strategy for many years.Our business model has proved robust and we are focused on the creation oflong-term value for our shareholders, customers and employees."The adoption of IFRS will have some impact on the presentation of our accountsbut will not change our business model, our strategy, our risk managementprocesses or our cash flows."HighlightsReported earnings per share for 2004 up by 29%, as compared with the figureannounced in February (and underlying eps up by 7%)No change to the Group's guidance on trading performance for 2005. Under IFRS,however, underlying profits for 2005 are expected to be significantly ahead ofcurrent market expectations, which are based on UK Generally AcceptedAccounting PrinciplesNo effect on the Group's trading cash flowsNo effect on the Group's management of its businesses"Underlying profits" to be retained as key measure of operating performance,with some redefinitionA full overview of the impact of IFRS is set out on pages 1 to 16 of theTransition document (part 2), together with a set of restated 2004 financialstatements for comparative purposes (pages 17 to 23). Six appendices to the(unaudited) financial statements describe the Group's summarised accountingpolicies under IFRS ((appendix 1) and provide a numerical breakdown of therestatements for 2004 (appendices 2 to 6).To date, Rolls-Royce has prepared its accounts in compliance with UK GenerallyAccepted Accounting Principles ("UK GAAP"). EU regulations require Rolls-Royceto adopt IFRS in its financial statements from 2005. A study was begun by theGroup in 2002, in conjunction with our auditors KPMG Audit plc, to review whatchanges would be required in order to move from UK GAAP to IFRS. Restatementsof our 2004 results are unaudited, but our auditors have agreed the principlesthat have now been adopted by the Group.There are five principal areas in which the implementation of the newaccounting rules will result in important changes to the financial statementsas compared with past practice.As a consequence of these changes, and other less significant adjustments notedin the attached document, future financial statements will not be readilycomparable with past statements. Setting the restated 2004 Results* againstthose announced in February 2005, the net differences can be summarised asfollows:2004 profit and loss account under IFRS vs. UK GAAPIncrease of ‚£58 million profit before tax (from ‚£306 million to ‚£364 million)Increase of 29 per cent in reported earnings per share (from 12.07pence to15.56 pence)2004 profit and loss account under IFRS vs. UK GAAP - underlying **Increase of ‚£19 million profit before tax (from ‚£345 million to ‚£364 million)Increase of 7 per cent in underlying earnings per share (from 14.50 pence to15.56 pence)2004 year end balance sheet under IFRS vs. UK GAAPReduction of ‚£861 million net assets (from ‚£2,307m to ‚£1,446m)Increase of ‚£69 million net debt (from ‚£80m to ‚£149m)* excluding the impact of IAS 39 Financial Instruments, whichhas been adoptedwith effect from 1.1.05 (see page 2, "Basis of preparation" in the Transitiondocument)**before non-trading items (see page 4 in the Transition document)The five principal areas are affected as follows: 1. Research and Development costsUK GAAP: Research and development costs were in general expensed through theprofit and loss account as and when they were incurred.IFRS (as required by IAS 38): A portion of development costs, as defined byspecified criteria, must be capitalised as intangible assets. Broadly, thesecriteria will apply where the relevant spending can be reliably identified withdevelopment rather than research and is likely to generate future earnings -conditions that will generally be met, on a typical new engine programme, ataround the date of engine certification. Spending will then be capitalisedfrom the date of capitalisation - to be determined in practice by two internalreview boards, covering commercial and technical issues - until the respectiveengine's entry into service. (Spending prior to the threshold date willcontinue to be expensed as incurred.) The resulting asset will be amortised ona straight-line basis over 15 years. It will also be re-assessed each year (inan "impairment test") to ensure that the recorded value is supported by theestimated value of the respective future earnings.Financial impact: An additional (post-tax) net asset of ‚£108 million willappear on the restated ("R") 2004 year-end balance sheet. Research anddevelopment costs expensed through the 2004 (R) profit and loss account willincrease by ‚£6 million, because the amount required to be amortised will exceedby ‚£6 million the amount that was previously expensed and will now be removedfrom the profit and loss account by being capitalised for the year.Sales of original equipmentUK GAAP: Where no linked aftermarket contract existed at the time of theoriginal equipment (OE) sale, all costs of OE sold were expensed through theprofit and loss account as incurred.IFRS (as required by IAS 38): Where no linked aftermarket contract exists butthe Group has contractually agreed to supply aftermarket parts and services tothe purchaser of a new engine, and has a reasonable degree of control over theaftermarket, any production costs in excess of the engine's cash selling pricewill be treated as an investment made with a view to the future value of theengine's aftermarket. IFRS requires this investment, as an intangible asset, tobe capitalised(subject, as in (1) above, to the amount being reliablyquantifiable and expected to generate future earnings). The asset will beamortised on a straight-line basis over a maximum of ten years (subject, as in(1) above, to an impairment test to ensure that the recorded value is supportedby the estimated value of the respective future earnings).Financial impact: An adjustment to net assets of ‚£87 million, after tax, willbe reported on the 2004 (R) balance sheet. This represents the cumulativedeficits, net of past amortisation, incurred on engines sold by the Group since1998. Operating costs recorded in the 2004 (R) profit and loss account willincrease by ‚£10 million, this being the amount by which the requiredamortisation for the year exceeds the engine-sale deficits incurred in 2004that were previously charged to the profit and loss account but will now becapitalised, after off-setting existing provisions.Financial risk and revenue-sharing partnersUK GAAP: Receipts from financial risk and revenue-sharing partners ("RRSPs")were recorded within the profit and loss account as 'other operating income'. Payments to partners, which arose from sales of the respective programmes, werecharged through the profit and loss account and included within 'cost ofsales'.IFRS (as required by IAS 32/39): Investments that are made by financial RRSPs(i.e. as opposed to investments made by industrial partners and any repayableUK government launch investment) are regarded under IFRS as financialinstruments. Thus receipts from financial RRSPs will no longer be treated asoperating income. Instead, they will give rise to a balance sheet liability -which will be set up to reflect the present value of expected future paymentsto these partners. Thereafter, this creditor item will be adjusted to takeaccount of (a) actual payments made; and (b) any change in the present value offuture payments, as a consequence of the imputed finance costs and any alteredrevenue expectations. The net adjustment to the balance sheet item will berecorded in the profit and loss account within 'net finance costs'.Financial impact: A liability of ‚£325 million, after tax, will be reported onthe opening balance sheet for 2005, representing the present value of expectedfuture payments to financial RRSPs under existing agreements. No restatementof 2004 results is required for the introduction of this new policy.Treatment of hedging for foreign exchangeUK GAAP: Financial derivatives, employed to hedge future transactions,particularly in respect of foreign exchange, were "hedge" accounted. That isto say, profit was recorded at the achieved exchange rate, blending togetherany transactions executed at spot rates and the settlement of maturing forwardcontracts held in the hedge book. Unrealised losses and gains on the on-goingcontracts within the hedge book were disclosed within the notes to theaccounts.IFRS (as required by IAS 32/39): The Group will continue to utilise forwardexchange contracts, in the "portfolio" approach that is well suited to itsneeds. It will no longer apply "hedge" accounting, however, which under IFRSwould require the Group to make significant changes to the way in which itoperates its hedging policies. Therefore, operating profits will be reportedwithout the benefit of any off-set from financial derivatives, as thoughtranslated at spot rates only. At the same time, the aggregate value of allthe Group's outstanding derivatives will be shown as one asset on the balancesheet, which will be "marked-to-market" each year, to reflect its fair value. In the profit and loss account, net finance costs will record the net gain orloss on both realised derivative transactions and unrealised, marked-to-marketadjustments. In order to retain a fundamental feature of its past reporting,the Group will exclude the unrealised gains/losses in its calculation of"underlying profits", which will continue to reflect the settlement of foreignexchange cover and other benefits, as in the past.Financial impact: A "hedging reserve" of ‚£719 million, net of tax, will beestablished on the opening balance sheet for 2005, to reflect an unrealisedforeign exchange gain resulting from the marked-to-market valuation of theGroup's derivatives hedge book at that date. This will be released through turnover over a four-year period. Future changes in marked-to-marketvaluations will be passed through the profit and loss account in the year theyarise. No restatement of 2004 results is required for the introduction of thisnew policy.Pensions and other post-retirement benefitsUK GAAP: Pension-funding requirements were determined by triennial actuarialreviews. Pension costs were charged to the profit and loss account asoperating costs in accordance with UK GAAP (ie SSAP 24). Any deficits in thepension schemes' assets as compared with their future liabilities were recordedin the notes to the accounts.IFRS (as required by IAS19, but closely in line with disclosures already madein Notes to the Accounts under FRS17): Any deficit will be recorded as aliability on the balance sheet. Changes in the value of the deficit will betaken through the Statement of Recognised Income and Expenses, which has noimpact on the calculation of earnings per share. A separate annual charge willbe made to the profit and loss account, which will comprise a service cost anda finance cost - though these will be separated, with the service charge goingthrough operating costs and the finance charge through net finance costs. Generally, as for other companies that have a large deficit, the total pensionfund charge to the profit and loss account will under IFRS be lower than underUK GAAP. The change in the accounting treatment of the Group's pensionarrangements will have no impact on their funding.Financial impact: An additional liability of ‚£1,076m, after tax, will bereported on the 2004 (R) balance sheet, with a corresponding reduction to Groupreserves. The charge to the profit and loss account for 2004 (R) will fall by‚£41m, before tax.Finally, four important points should be noted about the impact on the Group of switching to accounts compiled under IFRS:(i) it will have no effect on the Group's trading cash flows;(ii) it will have no impact on how the Group's businesses are managed;(iii) it is expected that the Group's reported profits for 2005 on an underlying basis will be significantly ahead of current market expectations,which are based on UK GAAP;(iv) it is expected that reported profits will in future be significantlymore volatile, principally as a result of the requirement to mark-to-market thevalue of financial instruments.The policies now being adopted by Rolls-Royce are in line with the IFRSexpected to be adopted by the EU formally as of December 31, 2005. Thesestandards still remain subject to further change, which may lead to furtherrefinement of the policies implemented by Rolls-Royce. * * * * * For further information, please contact:Duncan Campbell-Smith -- 020-7227- 9193 (mobile 07774-250811)Director of Corporate CommunicationsPeter Barnes-Wallis -- 020-7227-9141 (mobile 07770-442603) Director of Financial Communicationswww.Rolls-Royce.comENDROLLS-ROYCE GROUP PLCRelated Shares:
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