27th May 2005 07:01
Lloyds TSB Group PLC26 May 2005 LLOYDS TSB GROUP PLC TRANSITION TO IFRS RESTATEMENT OF 2004 FINANCIAL INFORMATION FROM UK GAAP AND IMPLEMENTATION OF FRS 27 CONTENTS PageIntroduction 1Overview 2Consolidated IFRS income statements 7Consolidated IFRS balance sheets 8Summarised IFRS segmental information 10Changes in accounting policies : key differences from UK GAAP 11Special purpose audit report 18 Appendices1. Basis of preparation 202. Provisional IFRS accounting policies 22 FORWARD LOOKING STATEMENTS This document contains forward looking statements with respect to the business,strategy and plans of the Lloyds TSB Group and its current goals andexpectations relating to its future financial condition and performance.Statements that are not historical facts, including statements about Lloyds TSBGroup's or management's beliefs and expectations, are forward lookingstatements. By their nature, forward looking statements involve risk anduncertainty because they relate to events and depend on circumstances that willoccur in the future. Lloyds TSB Group's actual future results may differmaterially from the results expressed or implied in these forward lookingstatements as a result of a variety of factors, including UK domestic and globaleconomic and business conditions, risks concerning borrower credit quality,market related risks such as interest rate risk and exchange rate risk in itsbanking businesses and equity risk in its insurance businesses, inherent risksregarding changing demographic developments, catastrophic weather and similarcontingencies outside Lloyds TSB Group's control, any adverse experience ininherent operational risks, any unexpected developments in regulation orregulatory actions, changes in customer preferences, competition, industryconsolidation, acquisitions and other factors. For more information on theseand other factors, please refer to Lloyds TSB Group's Registration Statement onForm 20-F filed with the US Securities and Exchange Commission and to anysubsequent reports furnished by Lloyds TSB Group to the US Securities andExchange Commission or to the London Stock Exchange. The forward lookingstatements contained in this document are made as of the date hereof, and LloydsTSB Group undertakes no obligation to update any of its forward lookingstatements. LLOYDS TSB GROUP - TRANSITION TO IFRS INTRODUCTION Up to 31 December 2004, the Group prepared its financial statements inaccordance with UK Generally Accepted Accounting Principles ('UK GAAP'). On 1January 2005, the Group, in common with other listed entities within theEuropean Union ('EU'), implemented International Financial Reporting Standards('IFRS'). This document sets out the impact of these changes upon the Group'sfinancial position and reconciles the restated comparatives to previouslypublished 2004 UK GAAP financial information. In addition, in accordance withan undertaking given to the UK Accounting Standards Board during 2004, the Grouphas adopted the requirements of the UK Financial Reporting Standard ('FRS') 27 "Life Assurance", which has the effect of changing the accounting for certainScottish Widows insurance contracts. Comparative information for 2004 has been restated to take into account therequirements of all of the standards except for IAS 32 "Financial Instruments:Disclosure and Presentation", IAS 39 "Financial Instruments: Recognition andMeasurement" and IFRS 4 "Insurance Contracts". These three standards have beenimplemented with effect from 1 January 2005 and the opening balance sheet atthis date has been adjusted accordingly. In accordance with the requirements ofIFRS, 2004 comparative information has not been restated for the effects of FRS27. Provisional accounting policies that the Group proposes to adopt in thepreparation of its 2005 half-year and full-year results are also provided.These provisional accounting policies are in accordance with all standards andrelated interpretations that have been endorsed for use by the EU, and with allextant accounting standards and interpretations issued by the IASB. Further standards and interpretations may be issued that could be applicable forfinancial years ending in 2005 or later but with the option for earlieradoption. The Group's first annual IFRS financial statements may, therefore, beprepared in accordance with different accounting policies to those used in thisdocument and, as a result, the financial information in this document could besubject to change. Page 1 LLOYDS TSB GROUP - TRANSITION TO IFRS OVERVIEW From 1 January 2005, the Group has been using IFRS as its primary financialreporting framework. Although the move to IFRS significantly changes the timingof earnings recognition in financial results, it is important to note that thereis no IFRS impact on business fundamentals and cash flows, the development ofour organic growth strategies, or the Group's capital management policies.Whilst IFRS implementation is likely to result in greater earnings volatility inthe future, the Group will endeavour to ensure that comparable underlyingbusiness performance and trends are clearly identified on an ongoing basis. 2004 EARNINGS RESTATEMENT In accordance with the requirements of IFRS, revised results for 2004 includeonly those adjustments for standards implemented with effect from 1 January 2004(i.e. they exclude adjustments for standards which have been implemented witheffect from 1 January 2005). The key changes to the 2004 profit and lossaccount arising as a result of IFRS are: • Profit before tax increased by £2 million to £3,495 million. • Profit attributable to equity shareholders decreased by £29 million,or 1 per cent, to £2,392 million. • Earnings per share decreased by 1 per cent to 42.8 pence. The changes to earnings reflect the accounting treatment of goodwill, leasing,employee share option schemes and certain aspects relating to the Group'sinsurance businesses. 1 JANUARY 2005 - BALANCE SHEET RESTATEMENT The key changes as a result of adopting IFRS and FRS 27, compared with theGroup's balance sheet on 31 December 2004 under UK GAAP, are: • Shareholders' equity reduced by £405 million to £9,572 million. • Total assets increased by £12,154 million to £291,997 million. • Total capital ratio increased to 10.1 per cent and tier 1 capitalratio decreased to 8.2 per cent, compared to 10.0 per cent and 8.9 per centrespectively under UK GAAP at 31 December 2004. The most significant changes to the Group's balance sheet reflect changes inlife assurance and dividend accounting; and the grossing up of certain lending,deposit and derivative balances. 2005 EARNINGS IMPACT Current indications are that the overall impact of the adoption of IFRS,excluding the volatility introduced by the requirements of IAS 39 and FRS 27,will be to reduce the Group's 2005 reported earnings per share by approximately6 per cent. On a similar basis, profit attributable to shareholders andearnings per share, before goodwill amortisation, are expected to be reduced byapproximately 7 per cent. Key changes reflect the introduction of the use of effective interest rates, thereclassification of certain securities from equity to debt, and the impact ofdiscounting on levels of loan loss impairment. Page 2 LLOYDS TSB GROUP - TRANSITION TO IFRS Income statement 2004 Increase UK GAAP IFRS* (Decrease) £m £m £mTotal income, net of claims 9,343 9,679 336Operating expenses (4,917) (5,297) 380Trading surplus 4,426 4,382 (44)Profit before tax 3,493 3,495 2Profit attributable to shareholders 2,421 2,392 (29)Earnings per share (pence) 43.3p 42.8pPost-tax return on averageshareholders' equity (%) 24.3% 22.6% Profit before tax under IFRS for the year ended 31 December 2004, at £3,495million, was broadly unchanged from that previously reported under UK GAAP. Theeffect of IFRS 3 which requires that goodwill is no longer amortised but issubject to an annual impairment test, and the beneficial impact of changes inthe accounting treatment for certain aspects of Scottish Widows' business, inparticular the unit trust operations, where up-front commissions are now spreadover the life of the related transactions, were largely offset by changes inlease accounting, which result in a greater proportion of profit being deferred,and an increased charge in respect of employee share option schemes. Profitattributable to shareholders and earnings per share were 1 per cent lower at£2,392 million and 42.8 pence respectively, reflecting an increase in thedeferred tax provision in Scottish Widows. Excluding the impact of goodwill,profit before tax was £42 million, or 1 per cent, lower. Although the effect of the adoption of IFRS upon the Group's profit before taxand earnings in 2004 is not significant, the requirement to consolidate theresults of our life assurance business on a line-by-line basis rather than as asingle line item has resulted in a substantial increase in total income, with acompensating increase in insurance claims. Going forward, in order to provide aclearer representation of business performance, insurance claims will bededucted from total income. A summarised analysis of the changes that have been made is set out below. Movement in Movement in total income, profit before net of claims tax 2004 2004 £m £mConsolidation of life assurance 405 (4) business and other entitiesAccounting for leasing business (19) (32)Employee benefits (39) (25)Unit trust income recognition 31 31Cessation of goodwill amortisation - 44Other adjustments (42) (12) 336 2 Page 3 LLOYDS TSB GROUP - TRANSITION TO IFRS Balance sheet and shareholders' equity The overall effect of the adoption of IFRS upon the Group's balance sheet is setout below. Shareholders' equity has reduced by £405 million, or 4 per cent,compared to the position at 31 December 2004 under UK GAAP, while total assetshave increased by £12.2 billion, or 4 per cent. 31 December 2004 1 January 2005 Increase UK GAAP IFRS* (Decrease) £m £m £mBalance sheetShareholders' equity 9,977 9,572 (405)Net assets per share (pence) 176 169Total assets 279,843 291,997 12,154 Risk asset ratios % %Total capital 10.0 10.1Tier 1 capital 8.9 8.2 The principal cause of the reduction in shareholders' equity arises from changesin accounting for certain aspects of the Group's life assurance businesses.IFRS 4 introduces a definition of an insurance contract which differs from thatunder UK GAAP. For contracts meeting this new definition IFRS permits thecontinued use of UK GAAP, however investment contracts not meeting the reviseddefinition must be accounted for as financial instruments under IAS 39. As aresult, the value of in-force business previously recognised in respect of theseinvestment contracts can no longer be carried on the Group's balance sheet.This resulted in a reduction in shareholders' equity at 1 January 2005 of £836million. For those contracts meeting the new definition of insurance business, the Grouphas amended its previous UK GAAP accounting policy to comply with therequirements of FRS 27. As a result, the value of in-force business relating tothese contracts no longer includes the benefit of future investment margins, andalso includes the realistic valuation of options and guarantees within thewith-profits fund; this has resulted in a further reduction in shareholders'equity at 1 January 2005 of £230 million. Other factors that led to a reduction in shareholders' equity are: • The accounting treatment of derivative contracts. All derivatives,including those entered into for risk management and balance sheet managementpurposes, must now be carried in the Group's balance sheet at fair value. TheGroup has established a number of hedging relationships which comply with therequirements of IAS 39 in order to mitigate income statement volatility,however, the initial fair value adjustment has resulted in a reduction inshareholders' equity of £192 million. * Includes IAS 32, IAS 39 and IFRS 4, together with the impact of FRS 27. Page 4 LLOYDS TSB GROUP - TRANSITION TO IFRS • Changes in the accounting treatment of leases, which have the effectof deferring the timing of income recognition on finance leases and acceleratingdepreciation on some operating lease assets. This has led to a reduction inshareholders' equity of £268 million. • Changes in provisioning methodology used in the calculation of loanloss impairment to reflect the impact of discounting on expected cash flows fromimpaired lending. This reduced shareholders' equity by £221 million. These reductions in shareholders' equity have been largely offset by the effectof moving from an accruals to a payments basis of accounting for dividends whichincreased shareholders' equity by £1,315 million. A summarised analysis of the changes that have been made is set out below. Movement in shareholders' equity £m Changes to insurance accounting3/4 arising from IFRS 4 (836)3/4 arising from FRS 27 (230) (1,066)Accounting for derivatives (192)Accounting for leasing business (268)Impairment (221)Dividends 1,315Other 27 (405) Total assets at 1 January 2005 increased by £12.2 billion, compared to the 31December 2004 UK GAAP position. The increase principally reflects a £10.2billion grossing up of lending, deposit and derivative balances which under UKGAAP could be offset against each other. The consolidation of Open EndedInvestment Companies, unit trusts and other entities, and changes to theaccounting for the Group's insurance business increased assets by £2.6 billion.The Group's risk-weighted assets were broadly unchanged. The total capitalratio at 1 January 2005 was 10.1 per cent, broadly unchanged from 31 December2004 whilst, largely as a result of the IFRS 4 and FRS 27 related reduction inthe value of in-force insurance business, the tier 1 capital ratio reducedfrom 8.9 per cent to 8.2 per cent. Page 5 LLOYDS TSB GROUP - TRANSITION TO IFRS 2005 impact The effect of the full implementation of IFRS and FRS 27 on the Group's 2005earnings will depend upon a number of factors such as business mix, rate ofgrowth and market conditions. The increased use of fair values is likely tolead to greater volatility, particularly in the results of the Group's lifeassurance businesses. Excluding this volatility, the application of effectiveinterest rates, the reclassification of certain securities issued by the Groupfrom minority interests to debt, and the impact of discounting on levels of loanloss impairment, are likely to result in some reduction in profits. Current indications are that the overall impact will be to reduce the Group'sreported earnings per share (before volatility), compared with those that wouldhave been reported under UK GAAP, by approximately 6 per cent. Excludinggoodwill amortisation, earnings per share (before volatility) are expected toreduce by 7 per cent. Profit before tax (before volatility) is expected to beapproximately 8 per cent lower, additionally reflecting the inclusion of couponpayments on preferred securities now being treated as an interest expense ratherthan minority interests. This likely reduction in earnings in 2005 is almostentirely due to changes in the timing of income and expense recognition in theGroup's financial statements. Page 6 LLOYDS TSB GROUP - TRANSITION TO IFRS CONSOLIDATED IFRS INCOME STATEMENTS Year ended Half-year ended 31 December 2004 30 June 2004 31 December 2004 £m £m £mInterest income 10,707 4,907 5,800Interest expense (5,597) (2,389) (3,208)Net interest income 5,110 2,518 2,592Insurance premium income 6,070 2,843 3,227Fees and commissions receivable 3,054 1,448 1,606Fees and commissions payable (844) (424) (420)Net fee and commission income 2,210 1,024 1,186Net trading income 5,036 816 4,220Other operating income 875 445 430Total income 19,301 7,646 11,655Insurance claims (9,622) (3,074) (6,548)Total income, net of insurance claims 9,679 4,572 5,107Administrative expenses (4,659) (2,230) (2,429)Depreciation (638) (319) (319)Total operating expenses (5,297) (2,549) (2,748)Trading surplus 4,382 2,023 2,359Impairment losses on loans and advances (866) (442) (424)Operating profit 3,516 1,581 1,935Loss on disposal of businesses (21) (13) (8)Profit before tax 3,495 1,568 1,927Taxation (1,036) (442) (594)Profit for the year 2,459 1,126 1,333 Profit attributable to minority interests 67 32 35Profit attributable to equity shareholders 2,392 1,094 1,298 2,459 1,126 1,333 Basic earnings per share 42.8p 19.6p 23.2p Diluted earnings per share 42.5p 19.5p 23.0p Page 7 LLOYDS TSB GROUP - TRANSITION TO IFRS CONSOLIDATED IFRS BALANCE SHEETS 1 January 31 December 30 June 1 January 2005 2004 2004 2004 £m £m £m £mAssetsCash and balances at central banks 1,078 1,078 892 1,195Items in the course of collection from banks 1,462 1,462 1,879 1,447Treasury bills and other eligible bills 92 142 539Trading securities 10,645Derivative financial instruments 9,263Other financial assets at fair value 46,208 through profit or lossLoans and advances to banks 31,851 31,848 34,305 22,142Loans and advances to customers 161,162 155,318 142,209 136,113Debt securities 43,485 44,007 45,885Equity shares 27,323 25,362 25,625Available-for-sale financial assets 14,593Investment property 3,776 3,776 3,501 3,551Interests in joint ventures 53 53 53 54Goodwill 2,469 2,469 2,507 2,513Value of in-force business 1,890 2,913 2,955 2,879Intangible assets 28 28 43 41Deferred tax asset - - - 54Fixed assets 4,180 4,180 4,062 3,944Other assets 3,339 8,960 8,370 7,495Total assets 291,997 282,985 270,287 253,477 Page 8 LLOYDS TSB GROUP - TRANSITION TO IFRS CONSOLIDATED IFRS BALANCE SHEETS (continued) 1 January 31 December 30 June 1 January 2005 2004 2004 2004 £m £m £m £mEquity and liabilitiesDeposits from banks 39,723 39,723 37,569 23,947Customer accounts 126,349 119,811 116,357 114,501Items in course of transmission to banks 631 631 765 626Derivative financial instruments 10,334 and other trading liabilitiesLiabilities to customers under investment contracts 16,361Debt securities in issue 28,728 28,770 28,564 27,458Insurance contract liabilities 36,725 52,289 49,349 49,028Unallocated surplus within insurance business 426 1,362 410 339Other liabilities 8,476 14,866 13,171 12,310Deferred tax liabilities 15 214 12 -Other provisions 270 211 153 216Retirement benefit obligations 3,075 3,075 3,116 3,172Subordinated liabilities:- Undated loan capital 6,613 5,852 5,850 5,959- Dated loan capital 4,598 4,400 3,933 4,495 11,211 10,252 9,783 10,454Other long-term borrowings 20Total liabilities 282,344 271,204 259,249 242,051 EquityShare capital 1,399 1,419 1,419 1,418Share premium account 1,145 1,145 1,144 1,136Other reserves 371 343 343 343Retained profits 6,657 8,243 7,512 7,747Shareholders' equity 9,572 11,150 10,418 10,644Minority interests 81 631 620 782Total equity 9,653 11,781 11,038 11,426Total equity and liabilities 291,997 282,985 270,287 253,477 Page 9 LLOYDS TSB GROUP - TRANSITION TO IFRS SUMMARISED IFRS SEGMENTAL INFORMATION Year ended 31 December 2004 Wholesale Insurance and Central UK Retail and International Group Banking Investments Banking Items Total £m £m £m £m £m Net interest income 3,228 283 2,006 (407) 5,110Other income 1,696 10,745 1,558 45 14,044Total income 4,924 11,028 3,564 (362) 19,154Insurance claims - (9,622) - - (9,622)Total income, net of insurance claims 4,924 1,406 3,564 (362) 9,532Operating expenses (2,609) (622) (2,078) 12 (5,297)Trading surplus (deficit) 2,315 784 1,486 (350) 4,235Impairment losses on loans and advances (676) 3 (193) - (866)Profit (loss) before tax* 1,639 787 1,293 (350) 3,369Volatility - 147 - - 147Loss on sale of businesses - - (21) - (21)Profit (loss) before tax 1,639 934 1,272 (350) 3,495 * excluding volatility and loss on sale of businesses Half-year ended 30 June 2004 Insurance and Central UK Retail and International Group Banking Investments Banking Items Total £m £m £m £m £m Net interest income 1,602 134 983 (201) 2,518Other income 794 3,617 751 26 5,188Total income 2,396 3,751 1,734 (175) 7,706Insurance claims - (3,074) - - (3,074)Total income, net of insurance claims 2,396 677 1,734 (175) 4,632Operating expenses (1,252) (301) (1,018) 22 (2,549)Trading surplus (deficit) 1,144 376 716 (153) 2,083Impairment losses on loans and advances (344) - (98) - (442)Profit (loss) before tax* 800 376 618 (153) 1,641Volatility - (60) - - (60)Loss on sale of businesses - - (13) - (13)Profit (loss) before tax 800 316 605 (153) 1,568 * excluding volatility and loss on sale of businesses In addition to the restatements required to reflect the implementation of IFRS,the segmental analysis has also been restated to reflect changes in the wayearnings on capital and certain costs have been allocated. Page 10 LLOYDS TSB GROUP - TRANSITION TO IFRS CHANGES IN ACCOUNTING POLICIES: KEY DIFFERENCES FROM UK GAAP The changes in financial information noted above are as a result of the Groupchanging its accounting policies to comply with the requirements of IFRS and theUK accounting standard FRS 27. Significant changes to the Group's previous UKGAAP accounting policies are set out below. Accounting policy changes effective from 1 January 2004 and which impact 2004comparatives: Consolidation (IAS 27 and SIC-12) IFRS requires line-by-line consolidation for all items of income andexpenditure; consequently, the Group is no longer permitted to report theresults and balances of the life assurance business as one line items. Insteadthese amounts are broken down into their constituent parts and allocated to theappropriate lines. As a result, in the income statement premiums receivablefrom policyholders and the returns on policyholder investments are now shownwithin total income, and a deduction is included for the related insuranceclaims expense. Although this represents a significant presentational change,there is no overall impact upon the Group's profitability. A furtherpresentational change concerns the treatment within the income statement ofmovements in the value of in-force business. Under UK GAAP, movements in the value of in-force business, together with theother components of the embedded value, were presented in the profit and lossaccount grossed up at the underlying rate of corporation tax. Under IAS 12movements in the value of in-force business will now be presented net of tax;there is no impact upon attributable profits. Additional impacts of IAS 12include changes to the measurement of the Scottish Widows' deferred tax assetsand liabilities, and the inclusion of tax payable on the policyholders'investment returns within the tax charge. IFRS also requires consolidation of several entities that the Group was notrequired to consolidate under UK GAAP including companies supporting the Group'ssecuritisation conduits, which facilitate customers' own securitisations, andOpen Ended Investment Companies (OEICs) and unit trusts where the Group, throughthe Scottish Widows life funds, has a controlling interest. These changes have reduced the Group's profit before tax for the year ended 31December 2004 by £4 million and increased shareholders' equity at 31 December2004 by £13 million. Leasing (IAS 17) IFRS requires income from finance leases to be credited to the income statementto give a constant pre-tax rate of return on the net investment in the lease; UK GAAP required a constant post-tax rate of return. In addition, IFRS requiresdepreciation on operating lease assets to be charged on the same basis as forother tangible fixed assets, which for the Group is a straight-line basis.Under UK GAAP depreciation was charged so as to give a constant rate of returnon the leased asset. The effect of these changes is to reduce profit before tax for the year ended 31December 2004 by £32 million and reduce shareholders' equity at 31 December2004 by £268 million. Page 11 LLOYDS TSB GROUP - TRANSITION TO IFRS Employee benefits (IFRS 2, IAS 19) IFRS 2 requires that a cost is recognised in the financial statements for alloptions granted under executive and employee Save-As-You-Earn ('SAYE')share-option schemes. The total cost recognised represents the fair value ofthe options (determined using an option valuation model) at the grant date, asadjusted for the expected number of forfeitures and, for executive schemes, thenumber of options for which the non-market performance target will not be met.The resulting cost is spread on a straight line basis over the period tovesting. This results in an increase in the cost recognised in the Group'sincome statement. The Group has applied the requirements of FRS 17, Retirement Benefits, in its UK GAAP financial statements since 2002. The requirements of that standard arebroadly similar to those of IAS 19, Employee Benefits; the application of IAS 19has therefore had no significant impact on the Group's profit before tax for theyear ended 31 December 2004. The Group has elected to apply the corridorapproach to determine the treatment of actuarial gains and losses arising duringthe year as permitted under IAS 19. This means that to the extent that thecumulative gains or losses remain within a corridor, defined as the greater of10 per cent of the scheme assets or liabilities, they are not reflected in theaccounts. If the cumulative gains or losses exceed the corridor, the excess ischarged or credited to the income statement on a straight line basis over theaverage remaining service lives of those employees who are members of theschemes. The effect of this has been to derecognise the actuarial lossescharged to reserves in 2004 under UK GAAP in the restated figures. The overall effect of the changes in accounting for employee benefits is toreduce profit before tax for the year ended 31 December 2004 by £25 million,principally representing the additional cost of the Group's SAYE share optionschemes. Shareholders' equity at 31 December 2004 increased by £95 millionlargely as a result of the reversal of the actuarial losses charged againstreserves in 2004 under UK GAAP. Capitalisation of software (IAS 38) Under UK GAAP the Group's accounting policy has been that only software costsrelating to separable new systems have been capitalised within tangible fixedassets. Under IFRS, both external and directly related internal costs relatingto enhancements that lead to additional system functionality are also nowcapitalised. The effect of this change is to reduce profit before tax for the year ended 31December 2004 by £12 million, as the effect of additional software capitalisedduring the year under IFRS, treated as an intangible asset, is more than offsetby an increased amortisation charge reflecting the impact of additional softwarecapitalised as at 1 January 2004. Shareholders' equity at 31 December 2004 isincreased by £19 million equivalent to the post tax value of the additionalsoftware capitalised at that date. Investment management fees (IAS 18) Under IFRS the Group will move from immediate recognition of up-front feesreceived for investment management services to recognising them on astraight-line basis over the estimated lives of the investment contracts. Page 12 LLOYDS TSB GROUP - TRANSITION TO IFRS The effect of this change has been to increase the Group's profit before tax forthe year ended 31 December 2004 by £31 million. Shareholders' equity at 31December 2004 is reduced by £37 million. Goodwill (IFRS 3 and IAS 36) Under UK GAAP the Group's accounting policy has been to amortise goodwillarising on acquisitions after 1 January 1998, with the exception of goodwillwhich arose on the acquisition of Scottish Widows. Under IFRS all goodwillrecognised in the UK GAAP balance sheet at 1 January 2004 is carried forwardwithout adjustment in the balance sheet and is now subject to impairment testingannually, or more frequently if events or circumstances indicate that it mightbe impaired. The effect of this change is to increase profit before tax for the year ended 31December 2004 by £44 million and shareholders' equity at 31 December 2004 by£41 million. Dividends (IAS 10) Under IFRS equity dividends declared after the balance sheet date may not beincluded as a liability at the balance sheet date. The effect of this change isto increase shareholders' equity at 31 December 2004 by £1,315 million, theamount of the 2004 final dividend. Depreciation (IAS 16) IFRS requires property, plant and equipment to be depreciated from the date ofacquisition. Under UK GAAP, long leasehold and freehold properties have beendepreciated only since 1 January 2000 and therefore it is necessary to adjusttheir carrying values to reflect the depreciation that would have been chargedfrom the date of acquisition to 1 January 2000. The effect of this change is to reduce shareholders' equity at 31 December 2004by £47 million; the impact on the Group's profit before tax for the year ended31 December 2004 is not significant. Claims equalisation provision (IAS 37) The claims equalisation provision in respect of the Group's general insurancebusiness, established under law to minimise volatility in incurred claims, isnot permitted under IFRS. The effect of this change has been to increase the Group's profit before tax forthe year ended 31 December 2004 by £10 million. Shareholders' equity at 31December 2004 increased by £43 million. Accounting policy changes effective from 1 January 2005 and which do not affect2004 comparatives: Fees integral to effective yield (IAS 18, IAS 39) Fees and commissions that are an integral part of the effective yield on afinancial instrument, and direct incremental costs associated with itsorigination, are included in the calculation of the effective interest rate andrecognised over the expected life of the instrument, or a shorter period ifappropriate. The effective interest rate is the rate that exactly discounts theexpected future cash receipts or payments over the expected life of thefinancial instrument to the net carrying value of the instrument. Page 13 LLOYDS TSB GROUP - TRANSITION TO IFRS As a result the recognition of up-front fees and costs that were recognised whenreceived, or incurred, under UK GAAP, for example those related to loanorigination, are now deferred and the recognition of fee income typicallycharged at the end of an agreement, for example early redemption charges onmortgages, brought forward. The effect of this change has been to increase shareholders' equity at 1 January2005 by £22 million. Loan impairment (IAS 39) IFRS adopts an incurred loss model for impairment losses on loans and providesguidance on the measurement of impairment. A provision is raised for losses inrespect of exposures that are known to be impaired. The required provision iscalculated by comparing the book value of the loans with the net present valueof the expected future cash flows from the loans discounted at their effectiveinterest rates or, as a practical expedient for variable rate loans, usingobservable market prices. Exposures found not to be impaired are placed intopools of similar assets with similar risk characteristics to be collectivelyassessed for losses that have been incurred, but are not yet identified. Forsuch exposures, the required provision is estimated on the basis of historicalloss experience for assets with credit risk characteristics similar to those inthe collective pool, adjusted based on current observable data. As thediscounting effect on the provisions unwinds, the resulting income is reflectedwithin net interest income. Although many of these principles are similar to those followed by the Groupunder UK GAAP, the requirement to discount the expected cash flows at theoriginal effective interest rate when determining the provisioning requirementhas resulted in an increase in provisions of £314 million at 1 January 2005,which, after tax, has resulted in a reduction in shareholders' equity of £221million. This is not a reflection of any change in credit quality as there hasbeen no change in the level of expected cash recoveries. Netting (IAS 32) IFRS prohibits financial assets and financial liabilities from being offsetunless there is a legal right of set-off and the asset and liability are inpractice normally settled on a net basis. In the banking business, this willresult in the grossing-up on the balance sheet of certain assets and liabilitiessubject to set-off arrangements that were presented net under UK GAAP. As a result of this change, at 1 January 2005 balance sheet footings have beenincreased by £10.2 billion principally reflecting the grossing up of corporateloans and deposits and inter-bank derivative balances, which although subject toset-off arrangements, will not be settled on a net basis. Derivatives, hedging and investment securities (IAS 39) The Group enters into derivative contracts for both trading purposes and tohedge exposures arising from within the banking book. Under UK GAAP tradingderivatives were carried at fair value but hedging derivatives were accountedfor on the same basis as the underlying hedged item, mainly on an accrualsbasis. IAS 39 requires that all derivative contracts are carried at fair valueon the Group's balance sheet and movements in their fair value are reflected inthe income statement; this results in a mismatch between the accounting and theunderlying economics where the Group has hedged its economic risk resulting fromthe different treatment of the derivative and the underlying hedged position. Page 14 LLOYDS TSB GROUP - TRANSITION TO IFRS The Group has not changed the way it hedges its economic exposures as a resultof the implementation of IFRS, but the Group seeks to mitigate the resultingincome statement volatility by the application of hedge accounting. The Groupuses two of the permitted kinds of hedge accounting: fair value and cash flowhedge accounting. The Group makes greater use of fair value hedge accountingwhich seeks to match, in the income statement, changes in the fair value of thehedged risk with the changes in the fair value of the related derivatives. Cashflow hedge accounting is being used to a lesser extent; adjustments reflectingthe movements in the fair values of the derivatives concerned are made to aseparate reserve in equity and recycled to the income statement when the hedgedcash flows affect income. IFRS contains detailed requirements for designation and documentation of hedgerelationships and testing their effectiveness. To the extent that a hedge isineffective, the impact is immediately reflected in the income statement.Although the Group intends to mitigate the volatility arising from therequirement to fair value all derivatives as far as possible, this will be asource of increased volatility in the income statement in 2005 and beyond. Anadjustment has been made at 1 January 2005 to measure all derivatives at theirfair value and to reflect the establishment as at that date of compliant hedgingrelationships. The overall effect has been to reduce shareholders' equity by£192 million. Under UK GAAP debt securities held for continuing use in the business wereclassified as investment securities and carried in the balance sheet at costless any provisions for permanent diminution in value. IAS 39 introducesstrict requirements to be met before debt securities can be carried at amortisedcost and the Group has determined that it does not meet these. Accordingly debtsecurities previously classified as investment securities have been reclassifiedas available-for-sale and valued at their fair values at 1 January 2005. Equityshares may not be carried at cost under IAS 39 and these have also beenreclassified as available-for-sale. The effect of this reclassification hasbeen to increase shareholders' equity at 1 January 2005 by £28 million. Going forward, movements in the fair values of these available-for-salesecurities will be reflected in equity and the cumulative gain or loss recycledthrough the income statement upon disposal or impairment. Insurance (IFRS 4, IAS 39) IFRS 4, which introduces a revised definition of an insurance contract, appliesto insurance contracts as well as investment contracts with discretionaryparticipation features. Such investment contracts entitle the holder to receiveadditional discretionary benefits (bonuses) depending on performance and arereferred to as participating investment contracts. Investment contracts that are not within the scope of IFRS 4 are accounted foras financial instruments under IAS 39. The principal effects of this change onthe accounting for non-participating investment contracts is the removal of thatportion of the embedded value which represents the value of in-force businessrelating to those contracts, the recognition of an asset for deferredacquisition costs, and the deferral of up-front fees received for investmentmanagement services; deferred acquisition costs and deferred up-front fees areamortised over the period of the provision of investment management services. Page 15 LLOYDS TSB GROUP - TRANSITION TO IFRS For those contracts within the scope of IFRS 4, accounting practices are largelyunchanged except for the modifications introduced by FRS 27 which is dealt withseparately below. The effect of this change is to reduce shareholders' equity at 1 January 2005 by£836 million. Accounting for insurance business is an area which is currently subject toreview by the IASB and further changes are expected in the future, although theexact timing and form that these changes may take remains uncertain. Life assurance (FRS 27) Following the implementation of FRS 27, the Group excludes from the value ofin-force business recognised in the balance sheet any amounts that reflectfuture investment margins and measures the liabilities of the Scottish WidowsWith-Profits Fund in accordance with the realistic capital regime of theFinancial Services Authority. This basis includes a realistic valuation ofguarantees and options embedded within products written by the With-ProfitsFund. The principal effect of these new requirements is on the measurement ofthe in-force business, as the valuation of the With-Profits Fund on a realisticbasis reduces the expected income to the shareholder from that fund. Changes inthe valuation are reflected in the income statement and because this is marketrelated it is inherently volatile. The effect of these changes has been to reduce shareholders' equity at 1 January2005 by £230 million. Equity to debt reclassification (IAS 32) The classification of the majority of the Group's capital and subordinated debtinstruments will continue to follow their UK GAAP treatment, however, thelimited voting ordinary shares will be reclassified as debt. This is becauseunder the terms of the agreement with the four Lloyds TSB Foundations, which arethe holders of the limited voting ordinary shares, the Group is committed tomaking an annual payment, equivalent to 1 per cent of the consolidated pre-taxprofit, averaged over three years. In addition, the Group's preferredsecurities, which were treated as non-equity minority interests under UK GAAP,will be reclassified as debt because the coupon payment is not discretionary.Distributions on these securities will be shown as interest expense rather thanas minority interests. The effect of these reclassifications is to reduce shareholders' equity by £20million and minority interests by £550 million at 1 January 2005; long-termborrowings increase by £570 million. Derecognition of financial liabilities (IAS 39) Under IFRS a financial liability may only be removed from the balance sheetafter it has been settled, it has expired or alternatively the debtor has beenlegally released from the liability, either by process of law or by thecreditor. Upon adoption of IFRS, certain financial liabilities in respect ofwhich amounts had been released to the profit and loss account under UK GAAP onthe basis that the likelihood of their settlement was remote have beenremeasured as at 1 January 2005 to reflect the entire legal obligation. Page 16 LLOYDS TSB GROUP - TRANSITION TO IFRS At 1 January 2005 the effect of the remeasurement is to increase liabilities by£184 million which, after tax, has resulted in a reduction in shareholders'equity of £131 million. Helen A WeirGroup Finance Director26 May 2005 The financial information presented contains details of the transitionaladjustments required to restate the Group's financial information under IFRS.Future presentation of restated financial information may be in a differentformat. The transitional adjustments presented have been calculated on thebasis of the specific facts of the transaction and should not be used asindicators of future adjustments between UK GAAP and IFRS that will be required. Page 17 LLOYDS TSB GROUP - TRANSITION TO IFRS SPECIAL PURPOSE AUDIT REPORT OF PRICEWATERHOUSECOOPERS LLP TO LLOYDS TSB GROUPPLC (THE 'COMPANY') ON ITS INTERNATIONAL FINANCIAL REPORTING STANDARDS ('IFRS') FINANCIAL INFORMATION We have audited the accompanying consolidated IFRS balance sheets of Lloyds TSBGroup plc and its subsidiaries (the 'Group') as at 1 January 2004 and 31December 2004, the related consolidated IFRS income statement for the year ended31 December 2004, the 1 January 2005 balance sheet and transition adjustmentsrelating to the adoption of IAS 32, IAS 39 and IFRS 4 set out on pages 7, 8 and9 and the associated IFRS 1 reconciliations and consolidated IFRS statement ofchanges in equity for the year ended 31 December 2004 set out on pages 35 to 42prepared in accordance with the basis of preparation and the provisionalaccounting policies set out on pages 20 to 34 (hereinafter referred to as the 'IFRS financial information'). In addition to the above noted opening and year end balance sheets, full yearincome statement and associated IFRS reconciliations, included with thefinancial information set out on pages 7, 8 and 9 are the half-year balancesheet, half-year income statements and associated IFRS reconciliations. We havenot audited the half-year balance sheet, half-year income statements andassociated IFRS reconciliations and these are not covered by this opinion and donot form part of the above defined IFRS financial information. The IFRS financial information has been prepared by the Group as part of itstransition to IFRS and to establish the financial position, and results ofoperations of the Group to provide the comparative financial informationexpected to be included in the first complete set of consolidated IFRS financialstatements of the Group for the year ended 31 December 2005. Respective responsibilities of Directors and PricewaterhouseCoopers LLP The Directors of the Company are responsible for the preparation of theconsolidated IFRS financial information which has been prepared as part of theGroup's transition to IFRS. Our responsibilities, as independent auditors, areestablished in the United Kingdom by the Auditing Practices Board, ourprofession's ethical guidance and the terms of our engagement. Under the termsof engagement we are required to report to you our opinion as to whether theIFRS financial information has been prepared, in all material respects, inaccordance with the basis of preparation and provisional accounting policies setout on pages 22 to 34. This report, including the opinion, has been prepared for, and only for, theCompany for the purposes of assisting with the Group's transition to IFRS andfor no other purpose. To the fullest extent permitted by law, we do not, ingiving this opinion, accept or assume responsibility for any other purpose or toany other person to whom this report is shown or into whose hands it may comesave where expressly agreed by our prior consent in writing. We read the other information contained in this document and consider itsimplications for our report if we become aware of any apparent misstatements ormaterial inconsistencies with the above defined IFRS financial information. Page 18 LLOYDS TSB GROUP - TRANSITION TO IFRS Basis of audit opinion We conducted our audit in accordance with Auditing Standards issued by the UKAuditing Practices Board. An audit includes examination, on a test basis, ofevidence relevant to the amounts and disclosures in the IFRS financialinformation. It also includes an assessment of the significant estimates andjudgements made by the directors in the preparation of the IFRS financialinformation, and of whether the accounting policies are appropriate to theGroup's circumstances and adequately disclosed. We planned and performed our audit so as to obtain all the information andexplanations which we considered necessary in order to provide us withsufficient evidence to give reasonable assurance that the IFRS financialinformation is free from material misstatement, whether caused by fraud or otherirregularity or error. In forming our opinion we also evaluated the overalladequacy of the presentation of information in the IFRS financial information. Emphasis of matter Without qualifying our opinion, we draw your attention to the fact that the IFRSfinancial information may require adjustment before its inclusion as comparativeinformation in the Group's first set of IFRS financial statements for the yearended 31 December 2005. This is because Standards currently in issue andadopted by the EU are subject to interpretation issued from time to time by theInternational Financial Reporting Interpretations Committee (IFRIC) and furtherStandards may be issued by the International Accounting Standards Board (IASB)that will be adopted for financial years beginning on or after 1 January 2005. Additionally, without qualifying our opinion, IFRS is currently being applied inthe United Kingdom and in a large number of other countries simultaneously forthe first time. Furthermore, due to a number of new and revised Standardsincluded within the body of Standards that comprise IFRS, there is not yet asignificant body of established practice on which to draw in forming opinionsregarding interpretation and application. Accordingly, practice is continuingto evolve. At this preliminary stage, therefore, the full financial effect ofreporting under IFRS as it will be applied and reported on in the Group's firstIFRS financial statements for the year ended 31 December 2005 may be subject tochange. Opinion In our opinion, the accompanying IFRS financial information comprising theconsolidated IFRS balance sheets as at 1 January 2004 and 31 December 2004, therelated consolidated IFRS income statement for the year ended 31 December 2004,the 1 January 2005 balance sheet and transition adjustments relating to theadoption of IAS 32, IAS 39 and IFRS 4, set out on pages 7, 8 and 9 and theassociated IFRS 1 reconciliations and consolidated IFRS statement of changes inequity for the year ended 31 December 2004 set out on pages 35 to 42, have beenprepared, in all material respects, in accordance with the basis of preparationand the provisional accounting policies set out on pages 20 to 34, whichdescribe how IFRS have been applied under IFRS 1 and the policies expected to beadopted when the directors of the Company prepare the first complete set of IFRSfinancial statements of the Group for the year ended 31 December 2005. PricewaterhouseCoopers LLPChartered AccountantsSouthampton26 May 2005 Page 19 LLOYDS TSB GROUP - TRANSITION TO IFRS Appendix 1 BASIS OF PREPARATION The financial information has been prepared under the historical costconvention, as modified by the revaluation of investment properties,available-for-sale financial assets, financial assets at fair value throughRelated Shares:
Lloyds