Compass Group PLC Accounting Policies and Procedures Manual. March 2010 Version 3.0

Transcription

1 Compass Group PLC Accounting Policies and Procedures Manual March 2010 Version 3.0

2 How to use this manual This manual is organised by topic and aims to cover the accounting and financial reporting matters relevant to Compass Group companies as clearly as possible. In addition to accounting, it also covers the procedures and policies the Group requires in other key areas. Each chapter of the accounting section is organised in a common format: 1. Turnover recognition Approval Approved by: Andrew Martin, Group Finance Director March 2005 Version control March 2005h Version 1 of policy issued Key points, summarising the Group s requirements in each area and principal dos and don ts. Default policy, which should be adhered to in the absence of more specific guidance. References to relevant IFRS standards. Guidance on application to specific situations of relevance to Compass and worked examples. Key points Turnover should be recognised as it is earned. The fundamental accounting concepts of accruals and prudence should be followed. 1.1 Disclosed accounting policy Turnover represents the invoiced value, excluding value added tax and similar sales taxes of goods and services supplied to third parties. 1.2 Default policy and process for exceptions Default policy Turnover (or revenue) should be recognised as it is earned Consultation and authorisation process for exceptions Turnover recognition is a matter of applying the principles outlined in this section. Where a commercial situation is particularly complicated Group Finance, Chertsey should be consulted. 1.3 UK GAAP references FRS 5 Reporting the substance of transactions (Application Note G) SSAP 9 Stocks and long-term contracts 1.4 Summary of UK GAAP requirements What is turnover? Turnover is the turnover resulting from exchange transactions as part of a company s operating activities. Other exchange transactions such as the sale of fixed assets, investments or businesses, do not normally give rise to turnover. Note: Although an individual statutory entity s principal activities may indicate that amounts should be recognised as turnover, in some cases, these activities are merely incidental to the Group s activities as whole. In such circumstances, the income is shown as a reduction in cost of sales or as other operating income (rather than turnover), i.e. a different treatment may be appropriate from a group perspective. 1.5 Application guidance This section considers the application of the above guidance to the following types of contracts: management fee contracts fixed cost contracts profit and loss contracts concession contracts vending turnover Consultation and authorisation requirements needed for exceptions. Summary of technical issues and principles.

3 Contacts Group Finance Director Andrew Martin Telephone number +44 (0) Group Financial Controller John Franke Telephone number +44 (0) address Group Treasurer Justin Besley Telephone number +44 (0) address Group Tax Manager David Brassington Telephone number +44 (0) address Peter Frans European Tax and Treasury Manager Telephone number address Group Finance, Chertsey Nigel Palmer Group Technical & Corporate Accounting Manager Telephone number +44 (0) address Kate Dunham Group Financial Planning & Analysis Manager Telephone number +44 (0) address Sarah Sergeant Group Reporting Manager Telephone number +44 (0) address Ben Walters Group Treasury Accountant Telephone number +44 (0) address

4 Contents A B C Executive summary 1. Accounting policies 2. Changes from UK GAAP to IFRS Group requirements Accounting policies Section 1 Revenue recognition 2 Supplier rebates and discounts 3 Contract costs: Bidding and mobilisation (start-up) 4 Contract costs: Client commitments 5 Share-based payments - employee share schemes 6 Material profit or loss items 7 Tax on profits 8 Other taxes 9 Non-current assets held for sale and discontinued operations 10 Goodwill 11 Intangible assets 12 Property, plant and equipment 13 Classification of investments 14 Inventories 15 Long-term contracts 16 Receivables 17 Contingent assets 18 Cash 19 Financial instruments 20 Leases 21 Payables 22 Provisions and contingent liabilities 23 Pensions 24 Government grants 25 Accounting convention and basis of consolidation 26 Acquisition accounting and fair value adjustments 27 Impairment 28 Foreign exchange 29 PFI and similar long term service concession arrangements 30 Other disclosures 31 Intra-group items 32 First-time adoption of IFRS D Period end procedures This document is confidential to Compass Group PLC and should not be made available to anyone outside the Group without the prior written consent of Group Finance, Chertsey. It is the property of Compass Group and must be returned on request. This document will be kept up to date on the Group's intranet where the definitive version of it can be found.

5 A. Executive summary, page 1 of 15 A. Executive summary Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued This manual covers the accounting requirements to be used in preparation of all Group reporting, which includes: monthly management accounts; half year and year end statutory financial reporting; budgets; forecasts; and any other reporting requested by Group Finance, Chertsey. The key points covering Accounting Policies are listed below. Accounting Policies Revenue recognition Revenue (sometimes described as turnover or sales) should be recognised as it is earned. The fundamental accounting concepts of accruals and prudence should be followed. Revenue should be recorded net of any trade discounts, but settlement discounts should be recorded as a Cost of Sale. Supplier rebates and discounts (previously referred to as Purchasing income) Supplier rebates received must be spread across the period to which they relate. Special care should be taken with lump sum receipts to match them against the purchases or period to which they relate. Commercially, up front bonuses given are in expectation of future purchases under a contract suppliers do not give money for nothing. Supplier rebates should be recognised in the income statement when the goods and services associated with them are used. Discounts on capital expenditure should be set against the cost of these items and will reduce the depreciation charge over the life of the asset. With backdated rebates, whilst specific contract terms may provide supporting evidence for the accounting treatment, the evidence that the payment relates to past events rather than future purchases must be persuasive before immediate recognition is allowed. Up front lump sum receipts must not be released immediately to the income statement as a matter of course.

6 A. Executive summary, page 2 of 15 Contract costs: bidding and mobilisation (start-up) All pre contract bidding and mobilisation (start-up) costs must be expensed as incurred unless they fulfil the stringent conditions for capitalising as property, plant and equipment or intangible assets. The initial purchase of glassware, cutlery and kitchen utensils at the start of a contract is to be held on the balance sheet as base stock in property, plant and equipment (or client commitment intangible assets see Group policy on Client Commitments) and written down over the life of the contract (or shorter if a reasonable expectation exists that the contract will terminate early) to residual value. All subsequent expenditure on these items must be charged to the income statement as incurred. Contract costs: Client commitments This policy deals with the accounting for client commitments. These commitments include the various types of investment linked to client contracts. Whilst in the majority of cases we typically conclude that payments to clients made at the time of signing a contract (or which we are contractually committed to make at a later date) should be accounted for as intangible assets, consideration also needs to be given to whether all or part of any investment should be regarded as a direct investment in physical assets (catering facilities) depending on how the agreements are structured. This policy also explains the appropriate depreciation or amortisation policies to be followed. Summary of typical payments/commitments and their treatment; Client commitment intangible asset (signing fee, client investment or key money) Property, plant and equipment Loan or advance to client ~ current or long term other receivables Client incentive payment (e.g. up front sales commission) ~ prepayments Lease premium ~ prepayment Not an asset ~ expense immediately Where physical assets (e.g. a catering facility) are installed as a result of the client commitment, consideration should be given as to whether these are PPE, regardless of legal title. Many factors influence this decision but the substance of the arrangement and whether or not the Group bears the risks and rewards of ownership need to be considered carefully. Ownership or legal title, whilst also relevant, is not the only factor for consideration. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

7 A. Executive summary, page 3 of 15 Share-based payments - Employee share schemes Compass Group accounts for share-based payments in accordance with IFRS 2, under which all share-based payment transactions are recognised in financial statements. Equity-settled transactions are measured at the fair value of the goods and services, or where this cannot be reliably measured, the fair value of the equity instruments granted at the date of grant. Cash-settled payments are measured at the current fair value of the liability at each balance sheet date. Where the terms of a transaction are modified, the measurement basis will change. This may accelerate the timing of booking the expense. The cost of employee share schemes will be determined by Group Finance, Chertsey and communicated to countries, where relevant. Charges for share-based payments are invoiced to employing entities only where it is necessary or appropriate to do so for tax purposes, for example, in order to obtain local tax relief. Such charges will be treated as cost-sharing and will not be included within PBIT for management accounts purposes. For local subsidiary statutory accounts presentation purposes, invoiced sharebased payment charges should be charged to the income statement as part of wages and salaries expense. Where employing companies are required to comply with IFRS 2 (or an equivalent local GAAP financial reporting standard), the income statement expense will be calculated by Group Finance, Chertsey and notified to the entity concerned, taking account of any charges made through cost-sharing. This expense should be recorded as a capital contribution within equity. Material profit or loss items Although IFRS does not recognise the expression exceptional items, it does require that certain types of item of a material nature should be separately disclosed either on the face of the income statement or in the notes. However, the term exceptional items may still be used to describe material items within a set of financial statements provided that it has been clearly defined. All items of a material nature, requiring separate disclosure, should be shown above operating profit regardless of their frequency of occurrence or nature. Material releases of provisions or movements in fair value adjustments originally established against goodwill are part of operating profit but should be disclosed separately for the purposes of Group reporting. Extraordinary items are not allowed under IFRS. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

8 A. Executive summary, page 4 of 15 Tax on profits Corporation tax must be calculated using the tax rates and laws applicable for the accounting period. Only taxes on profit should be charged to tax on ordinary activities. Current tax must be presented separately on the face of the balance sheet. It is charged or credited directly to equity if it relates to items that are also charged or credited to equity. Deferred tax should be recognised in respect of taxable temporary differences that exist at the balance sheet date. IAS 12 uses a balance sheet liability approach that focuses on taxable or deductible temporary differences (differences between the carrying amount of an asset or liability and its tax base). Taxable temporary differences include all timing differences and many permanent differences. Deferred tax is recognised on revaluation gains. Deferred tax assets should be recognised only to the extent that they are recoverable. Discounting of deferred tax balances is not permitted. Deferred tax assets and liabilities may not be offset under IFRS unless they relate to tax payable in the same tax jurisdiction. Other taxes Other taxes should be included in the appropriate category in the income statement (e.g. employment taxes should be included in staff costs). Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

9 A. Executive summary, page 5 of 15 Non-current assets held for sale and discontinued operations A non-current asset (or disposal group) is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. To qualify as held for sale, an asset must be immediately available for sale in its present condition and its sale must be highly probable to be recognised as held for sale. Management must be committed to a plan to sell and actively looking for a buyer. The sale should generally be completed within one year of the date of classification as held for sale. Assets that meet the criteria are measured at the lower of carrying amount and fair value less costs to sell and are not depreciated. Assets and disposal groups held for sale are presented separately on the face of the balance sheet. The related liabilities are also presented separately from other liabilities. The results of discontinued operations are presented separately in the income statement. A discontinued operation is defined as a separate major line of business or geographical area or is a subsidiary acquired exclusively with a view to resale. The results of subsidiaries acquired exclusively with a view to resale are consolidated, but their net results are presented within the single line item for discontinued operations. The post-tax results of discontinued operations and the post-tax gain or loss on sale are shown as a separate combined line item after profit for the year from continuing operations. More detailed analysis is shown within the notes to the financial statements. Goodwill The Group recognises purchased goodwill arising after October 1998 on the balance sheet. Goodwill is not amortised but is subject to an annual impairment review. The value of purchased goodwill recognised is based upon the UK GAAP net book value at the date of transition to IFRS (1 October 2004) less any subsequent impairment charges. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

10 A. Executive summary, page 6 of 15 Intangible assets Intangible fixed assets are capitalised and amortised over their expected useful lives, or subject to an annual impairment review if they have an indefinite useful life. Intangible assets must be recognised, particularly in the context of acquisitions where intangibles such as contracts must be separately identified and valued, rather than being included within the value of goodwill. Under transition rules, intangible assets in relation to acquisitions that took place before 1 October 2004 are not required to be separately identified but remain within the balance of purchased goodwill. Only in closely defined circumstances can internally generated intangible assets such as software development be recognised. Internally generated brands and similar intangible assets are not recognised. Property, plant and equipment Only costs directly incurred in bringing a fixed asset into use can be capitalised. Capital discounts received relating to fixed assets should be deducted from the cost of the asset, and not credited directly to the income statement. Property, plant and equipment should be reviewed for indicators of impairment at every year-end. Depreciation of fixed assets should be charged on a straight-line basis, at a rate that writes off the cost of the asset over its useful economic life to its residual value. Depreciation starts when the asset is available for use; there is no gap allowed between the date that capitalisation of the cost stops and the asset comes into use. Asset lives should be reviewed for appropriateness at every year-end but revised only with the prior approval of the Group Financial Controller. Increasing useful economic lives or residual values in order to increase profits is strictly prohibited. Material changes to these estimates must be supported by sufficient evidence to justify the change. Revisions to useful economic life or residual value can never be applied retrospectively. Computer software should be classified as an intangible asset under IFRS if it is not an integral part of the hardware it resides on. Consumables should not be included in property, plant and equipment. Group policy is not to revalue any property, plant and equipment. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

11 A. Executive summary, page 7 of 15 Classification of investments An entity must be consolidated in the Group accounts if the Group owns a majority of the voting rights after taking into consideration potential voting rights that could be currently exercised at the Group s option. Joint control occurs when a contractual agreement or share of the voting rights ensures that no single venturer is able to control the entity unilaterally. IFRS considers formal written agreements only and takes no account of informal arrangements. The Group uses proportionate consolidation to account for jointly controlled entities. The Group s share of the assets, liabilities, income and expenses of a jointly controlled entity is combined line by line in the Group s financial statements. IFRS (IAS 39) requires that all investments are allocated to one of four categories of financial asset. If classified as available for sale they will be measured at fair value. However, an investment that does not have a quoted market price and whose fair value cannot be reliably measured is still measured at cost. This situation is rare. Inventories Inventory valuations must be net of all purchasing discounts. Sufficient provision must be made against excess, damaged or outdated inventory. Long-term contracts Only in extremely rare circumstances will any of the Group s contracts with clients or customers be accounted for as long-term contracts. The key principle in recognising revenue on long-term contracts is the seller's performance of its contractual obligations. All loss-making contracts, whether or not they are long-term in nature, should be provided for in full, as soon as the loss is anticipated. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

12 A. Executive summary, page 8 of 15 Receivables Full provision must be made against irrecoverable debts. An appropriate partial provision for doubtful debts must be made, based on age and expected recovery. The level of provision against bad and doubtful debts is disclosed in published financial statements prepared under IFRS. No expenditure should be carried forward as an other debtor or prepayment unless: it relates to revenue which will be earned in the future or services to be received in the future, and it will be covered by the profits it generates. Contingent assets Contingent assets cannot be recognised. Retrospective discounts, rebates or reimbursements cannot be recognised until the other party has documented their acceptance of the broad terms of the payment and a reasonable and supportable estimate can be made. Cash The Group s month-end procedures regarding bank reconciliations and cut-off should be strictly applied when accounting for cash. Financial instruments The Group does not undertake trading in derivative financial instruments. Derivative financial instruments are used under the control of the Group Treasury department to manage interest rate and currency risks arising from the Group s operations. No entity may enter into any derivative financial instrument contract without the written consent of the Group Treasurer and the Group Finance Director. This includes put options granted to minority shareholders as part of the acquisition of a business. Speculative use of derivative financial instruments is forbidden. All financial instruments, including derivatives, are shown on the balance sheet at fair value, amortised cost or historical cost. All types of contracts must be reviewed for the existence of embedded derivatives, and these embedded derivatives may require separate recognition from the host contract. Hedge accounting follows very tight controls and rules under IFRS. Hedging requires formal designation and documentation, and testing to prove that the hedge is effective. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

13 A. Executive summary, page 9 of 15 Leases A lease is an arrangement where the Group has the right to use an asset over an agreed period of time. In a lease the payment made for this right is therefore a consequence of the time the asset is available, and dependant on the output or usage levels of the asset. Therefore contingent no minimum arrangements ARE NOT LEASES. Many lease scheme proposals are, on full inspection, finance leases, which mean that the asset leased should be capitalised and depreciated, and the finance creditor is part of the Group s debt. The definition of a finance lease is by reference to the substance of the agreement alone. The land and building elements of each property lease have to be split out. The lease of land is usually treated as an operating lease. Where the buildings element qualifies as a finance lease, the two elements of the lease must be accounted for separately. Where the Group has a lease for equipment installed in client premises, the costs of which are recoverable from the client, in many cases, the primary risks and rewards of ownership belong to the Group. If so, the lease should be accounted for as a finance lease. Lease incentives (refunds, lump sum purchasing rebates, discounts or up-front payment holidays) should be amortised by the lessee over the term of the lease. Lease incentives are not purchasing income. The use of leases for off-balance sheet finance to try to avoid Group capital expenditure controls is not acceptable. Payables Payables and accruals should be determined reliably and prudently. The liability recorded should be the best estimate of the cost required to settle the obligation and must not be excessive. An accrual is made for a liability that is reasonably certain to occur, but where some doubt exists as to the timing or actual amount of the settlement. Only accruals which are justified as a genuine liability at the balance sheet date should be recognised. Dividends should only be accrued for in the period in which they are declared. Holiday pay accruals should be made where there is a cost involved in meeting the accrued benefit to the employee. Liabilities for unpaid balances (for example, unclaimed dividends or client overpayments) may only be released when the statutory time in which payment can be claimed has expired. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

14 A. Executive summary, page 10 of 15 Provisions and contingent liabilities Where a liability arises in the period, provisions must be set up and charged to the income statement. On acquisition of a business, provisions may only be set up if a number of specific conditions are satisfied. Costs may only be charged against provisions if a number of specific conditions are satisfied. Unused amounts of provisions must be reversed through the income statement and cannot be used to absorb costs other than those for which the provision was originally set up. General provisions should not be recognised. Pensions and long-term employee benefits Defined benefit and unfunded pension costs should be charged to the income statement in accordance with the rates advised by an actuary. IAS19 distinguishes various components of the pension charge, namely: current service costs, past service costs, curtailment and settlement charges which are charged to operating profit, interest costs and return on scheme assets which are charged to interest, actuarial gains or losses which are reported in the Statement of Comprehensive Income (previously the Statement of Recognised Income and Expense ( SORIE )) The net present value of the obligation should be recognised immediately on the Group balance sheet, with movements other than the current service cost and finance charge recognised in the Statement of Comprehensive Income. There are restrictions over the circumstances in which a pension plan surplus (which arises if there is an excess of the fair value of plan assets over the present value of the defined benefit obligation) can be recognised as an asset. Defined contribution pension costs are expensed as incurred. Government grants A grant should not be recognised until the conditions for its receipt have been complied with and there is reasonable assurance that it will be received. Grants related to assets may either be deducted from the value of the related asset or carried as deferred income and released through the income statement over the life of the asset. Government grants should be recognised in the income statement so as to match them with the expenditure towards which they are intended to contribute. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

15 A. Executive summary, page 11 of 15 Accounting convention and basis of consolidation Group reporting must be under uniform accounting policies. Subsidiaries that close their ledgers early in order to comply with the Group s reporting timetable must make appropriate adjustments to roll forward their results and balance sheets to the Group s reporting date. The Group has chosen to account for all joint ventures using the proportionate consolidation method. The share of an associate s profit after tax is shown on the face of the income statement as a separate line item, and the tax is not separately disclosed. Minority interests are presented in the consolidated balance sheet within equity separately from the parent shareholders equity. The minority share of profit or loss is disclosed as an allocation of retained profit. Acquisition accounting and fair value adjustments ALL acquisition costs must be written-off to the income statement in the period in which they are incurred and are prohibited from being included in the goodwill calculation. Fair value adjustments arising on acquisitions must be appropriate and justifiable by reference to IFRS, and allocated to specific items in existence at the date of acquisition. Fair value adjustments must apply to the circumstances in existence at the date of acquisition. They must not take account of any reorganisation plans the Group has, nor may they be utilised for items they were not originally intended to cover. Intangible assets acquired through a business combination must be identified and recognised on the balance sheet. This will have implications on the cost of the acquisition and the post-acquisition profits and must be evaluated before the acquisition is approved. Goodwill is subject to an annual impairment review. Negative goodwill is taken as income during the period that the acquisition takes place. A value must be attributed to the contingent liabilities of the acquired business and included in the calculation of goodwill. The value of acquired contingent liabilities is recognised on the balance sheet. Fair value adjustments may only be revised during the hindsight period that extends to twelve calendar months following the date of acquisition. Every effort should be made to record adjustments to fair value during the hindsight period. Changes made within the hindsight period which straddles a year-end, are shown by restating the comparatives and brought forward balances. Therefore it is essential that the initial fair values are as accurate as possible. Fair value adjustments that come to light after the hindsight period must be taken to the income statement. Any fair value adjustments that are not utilised or considered no longer appropriate after the hindsight period are adjusted through the income statement and should be separately disclosed within operating profit if material. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

16 A. Executive summary, page 12 of 15 Acquisition accounting and fair value adjustments (continued) Where an acquisition is carried out in several stages, goodwill must now be calculated at each transaction date until control passes and the acquired entity becomes a subsidiary. Records must be kept of fair values at each stage. Impairment Assets should be recorded at no more than their recoverable amount. Impairment is measured by comparing the carrying value of an asset or cashgenerating unit with the recoverable amount. The recoverable amount represents the higher of fair value less selling costs and value in use. Impairment losses should be shown in operating profit. Impairment losses are allocated to goodwill first, and then to all other assets pro-rata. Impairment tests should be performed annually for goodwill and intangibles with an indefinite useful economic life, or when an indicator of impairment exists. Where indicators of impairment exist, or an asset is impaired this may also indicate that the useful economic life and residual value of an asset should be reviewed. Foreign exchange Exchange differences arising on settled transactions within individual companies should be recognised as part of the profit or loss for the year. Exchange differences on investments in foreign operations and long-term intragroup loans that are part of the Group s net investment in the foreign operation (structural loans) should be taken directly to reserves in Group reporting and are shown in a separate translation reserve. Exchange differences arising on external third party foreign currency borrowings may be taken directly to equity (translation reserve) only if formal hedge accounting treatment has been adopted using the rules set out in IAS 39 and the hedging relationship has been proved to be effective. Exchange differences deferred within the translation reserve are recycled to the income statement when the foreign operation is disposed of. The budget rates issued must be used in Group reporting, except at half year and full year when actual rates must be used. All rates will be notified by Group Finance, Chertsey. There are special rules regarding the hedging of investments in foreign entities via long-term foreign currency loans. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

17 A. Executive summary, page 13 of 15 Private Finance Initiative ( PFI ) contracts Under a PFI contract, the private sector is contracted to supply services traditionally provided by the public sector. Usually, the private sector entity designs, builds and finances a property, e.g. a hospital, prison or office, in order to provide the contracted service. The accounting treatment depends on whether the PFI contract is similar to a lease, involving payments for a property, or whether the contract also includes non-separable service elements. Where the contract includes non-separable service elements, the accounting treatment depends on whether the purchaser or operator includes the property as an asset due to its rights to the risks and rewards of ownership of the property. Any contract that may be of this type should be referred to Group Finance, Chertsey. Other disclosures Certain additional information is required by the Group for statutory disclosure in the Group accounts or for internal management purposes. This information may be outside the reporting entity s ledger system; nevertheless, it is still important and requires the same care in preparation and accountability as income statement, balance sheet or cash flow information. Particular attention must be paid to operating lease disclosure (income statement and commitments) as this influences the Group s cost of borrowing. The total minimum commitment payable under non-cancellable operating leases for one year, two to five years and over five years must be disclosed. The level of bad debt provision against estimated irrecoverable amounts has to be disclosed - see policy on Receivables. The value of inventory write-down (or any reversal of such a write-down) charged to the income statement in the period has to be disclosed - see policy on Inventories. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

18 A. Executive summary, page 14 of 15 Intra-group items As a basic consolidation requirement, all intra-group balances and transactions must be matched and cancelled in Group accounts. This can only be done if all entities: separate intra-group items, account for them in the correct period, report using the correct exchange rates, regularly ensure that intra-group balances are agreed with the other party, and do not deviate from these agreed balances when reporting to Group. It is the responsibility of the entities concerned to agree their mutual balance and transaction reporting to the Group. Group Finance, Chertsey cannot get involved in disputes at any point in the reporting cycle. Many intra-group relationships have been reviewed and assessed to comply with tax regulations and to reduce tax risk. These must not be amended without the express authorisation of the Group Tax Manager or the Group Finance Director. Instructions regarding documentation, payment schedules or other matters must be adhered to in order to protect the Group s tax position. Under IFRS, a number of entities (which were previously treated as subsidiaries) are classified as joint ventures and are therefore proportionately consolidated. Balances and transactions with joint ventures are still treated as intra-group and must be matched to the extent of the Group s shareholding and cancelled in Group reporting.

19 A. Executive summary, page 15 of 15 First time adoption All Group reporting will be under IFRS from 1 October Whilst first-time adoption of IFRS has now been completed by the Group, this policy is retained for reference purposes and to provide guidance for any subsidiary that chooses to adopt IFRS for local statutory reporting purposes at a future date. IFRS 1 applies when an entity adopts IFRS for the first time by an explicit and unreserved statement of compliance with IFRS. In general an entity must comply with each IFRS effective at the reporting date for its first IFRS financial statements. In particular, within the opening (transition) balance sheet an entity must: Recognise all assets and liabilities whose recognition is required by IFRS. Not recognise items as asset or liabilities if IFRS do not permit such recognition. Reclassify items that are a different type of asset, liability or component of equity under IFRS than under previous GAAP. Apply IFRS in measuring all assets and liabilities. IFRS 1 grants limited exemptions from these requirements and prohibits the retrospective application of IFRS in some areas. IFRS 1 requires disclosures that explain how the transition from previous GAAP to IFRS affected the entity s reported financial position, financial performance and cash flows All UK-based companies (regardless of reporting responsibility) are to continue to prepare their statutory accounts in accordance with UK GAAP until informed otherwise. Companies in other countries should agree their statutory reporting framework with the country finance director. Period end procedures Accounting periods should close on the last calendar day of the relevant month unless separate arrangements have been agreed with Group Finance, Chertsey. Adequate cut-off procedures for revenues, costs, receivables, payables, inventories and cash should be in place to ensure those transactions up to and including the accounting period close are included within the accounts, and transactions after this date are excluded. Compass Group PLC Accounting policies and procedures manual version 3.0, March 2010

20 B. Group requirements Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Contents B.1 Purpose of this manual 1 B.2 Scope 1 B.3 Applicability 1 B.4 Implementation guidance 2 B.5 Role and responsibilities of Group Finance and Business Unit Finance 2 B.6 General approach to authorisation/approval 2 B.7 Applicability of compliance requirements 2 B.8 Importance of accounting records and contemporaneous documentation 3 B.9 Document retention 3 B.10 Confidentiality 3 B.1 Purpose of this manual This is the Group-wide accounting policies and procedures manual. It has been prepared to address the following areas: a single reference source on compliance with IFRS reporting for all areas of the business; to enable all Compass businesses to report under a single, clearly described set of policies; an introduction for people new to Compass Group reporting which explains the procedures and policies to be followed in reporting to Group; and to describe conditions or events which require separate notification to or guidance from Group Finance. B.2 Scope This manual covers the accounting requirements to be used in preparation of all Group reporting, which includes: monthly management accounts; half-year and year-end statutory financial reporting; budgets and plan years; forecasts; and any other reporting requested by Group Finance, Chertsey or the Country Finance Director. Each policy follows a common format (see How to use this manual on the inside cover). Suggestions for further areas to be covered or where greater clarity is required should be addressed to Group Finance, Chertsey for consideration as the manual is updated and expanded. B.3 Applicability Not all Group entities circumstances will require all of the policies included here. Some, for example on financial instruments, will only apply to very few entities, mainly at the Group centre. Others, for example on foreign 1

21 B. Group requirements, Page 2 of 3 exchange, include sections applicable to individual reporting entities and other sections that relate to the Group consolidated accounts. The manual does not address external disclosure requirements or issues which are dealt with solely at a Group level unless specifically relevant to the discussion. Neither does it address local accounting and reporting requirements. Where there are local reporting or filing requirements in addition to those of the Group, appropriate policies should be adopted which comply with those requirements. B.4 Implementation guidance The accounting policies in this section should be applied to all Group forecasts, budgets and actual results for the 2005/6 financial year onwards and to the restatement of the 2004/5 financial year for IFRS comparative purposes. B.5 Role and responsibilities of Group Finance and business unit finance The design of the framework of policies and procedures included in this manual is the responsibility of Group Finance. Implementation of the policies, together with the design and operation of a local control framework is, however, the responsibility of local financial management. Group Finance and the Group Risk Management function are a source of help and consultation on these, but are not a substitute for effective local management and control. B.6 General approach to authorisation/approval Local entities should implement an authorisation and approval framework appropriate to their business. Local frameworks should always comply with the Group frameworks for the appropriate area (e.g. capital investment, management incentives) included here or published elsewhere in the Group. Consultation is encouraged, and written authorisation from Group Finance, Chertsey, is always required for exceptions to the Group policies. B.7 Applicability of compliance requirements The policies in this manual are to be applied to all Group reporting for all items material to the entity. This includes all management and statutory reporting, budgets and forecasts. Policies and procedures adopted at country or entity level must be consistent with those in this manual. Departure from these policies is in general only permitted with the advance written approval of the Group Finance Director. More information is given in each of the policies. It is your responsibility to read, understand and apply the policies described. If you have any questions, please contact John Franke, Group Financial Controller, or Nigel Palmer, Group Technical & Corporate Accounting Manager. It is not acceptable for audit adjustments to be required because the principles explained in this manual have not been applied in a reporting entity.

22 B. Group requirements, Page 3 of 3 B.8 Importance of accounting records and contemporaneous documentation The basis for all accurate reporting must be the maintenance of each entity s accounting records. These should allow an accurate view of the business at any point in time. There must be properly planned controls over access, segregation of duties, a clear audit trail for all transactions and entries, and secure backups of data taken. Responsibility must be taken for timely updating of accounting records to enable the Group s reporting timetable to be met. Contemporaneous records should be maintained. They are a requirement for many local taxation authorities and an important piece of evidence in the audit process as they provide a record of events, issues and judgements at the time they occurred. In addition, accurate and timely record-keeping allows the month-end reporting process to become more efficient and effective as a result. B.9 Document retention It is important that supporting documentation be collected at the time of a transaction. Accounting records and supporting documents should be retained in accordance with local legal and fiscal requirements, but for not less than six years. Annual financial statements and documents around acquisitions and similar significant transactions should be kept permanently. Records should generally be retained only as long as they are needed for commercial or legal purposes. Local company policy on this matter should consider: (a) (b) (c) (d) economic considerations (e.g., the cost of staff, equipment, space and supplies); legal and related requirements (e.g., specific retention periods required by law, audit considerations and enforceability of contracts); actual or potential demand for copies and historical value (e.g., policy decisions, precedents, and archives); and the Group minimum period for record retention specified above. The retention period starts from the beginning of the following financial year. Local procedures should exist to authorise disposal of books and records at the end of each retention period. B.10 Confidentiality This manual is available in printed form or through the Finance section of the Group s intranet, Mercury. It has been prepared exclusively for Compass Group reporting and should not be made available outside the Group without written permission from Group Finance, Chertsey.

23 C. Accounting policies Accounting policies contents Section 1 Revenue recognition 2 Supplier rebates and discounts 3 Contract costs: Bidding and mobilisation (start-up) 4 Contract costs: Client commitments 5 Share-based payments - employee share schemes 6 Material profit or loss items 7 Tax on profits 8 Other taxes 9 Non-current assets held for sale and discontinued operations 10 Goodwill 11 Intangible assets 12 Property, plant and equipment 13 Classification of investments 14 Inventories 15 Long-term contracts 16 Receivables 17 Contingent assets 18 Cash 19 Financial instruments 20 Leases 21 Payables 22 Provisions and contingent liabilities 23 Pensions 24 Government grants 25 Accounting convention and basis of consolidation 26 Acquisition accounting and fair value adjustments 27 Impairment 28 Foreign exchange 29 PFI and similar long term service concession arrangements 30 Other disclosures 31 Intra-group items 32 First-time adoption of IFRS

24 Detailed Contents C Accounting policies Section 1 Revenue recognition 1.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 1.3 IFRS references 1.4 Summary of IFRS requirements What is revenue? When should revenue be recognised? How much revenue should be recognised? Payments in advance Acting as principal or agent 1.5 Application guidance Management fee contracts (cost plus) Fixed price contracts Profit and loss contracts Concession contracts Vending revenue Design and build contracts Luncheon vouchers and electronic payment cards Agent or principal? 2 Supplier rebates and discounts 2.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 2.3 IFRS references 2.4 Summary of IFRS requirements Basic principles Supplier rebates and discounts recognition 2.5 Application guidance Consumables and food stocks Net pricing Separate discount payment ( sheltered income ) Volume-related discounts ( overriders ) Lump sum receipts Advertising support Capital discounts Supplier rebates and discounts passed to the client

25 3 Contract costs; bidding and mobilisation (start-up) 3.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 3.3 IFRS references 3.4 Summary of IFRS requirements Principals governing recognition of an asset Property, plant and equipment assets 3.5 Application guidance Summary Start up costs Pre-contract costs Pre-contract costs capitalisation; decision guidance Base stock policy for short life assets 4 Client commitments 4.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 4.3 IFRS references 4.4 Summary of IFRS requirements Principles governing recognition as an asset 4.5 Application guidance Tangible assets, property, plant and equipment Signing-on fee intangible asset Client incentive prepayments Lease prepayments and premiums Client loans Asset write down period Extended buy back clause exception Base stock policy for short life items 5 Share-based payments - employee share schemes 5.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 5.3 IFRS references 5.4 Summary of IFRS requirements Recognition and measurement 5.5 Application guidance Charges to employing companies for share-based payments relating to their employees Responsibility for calculation of charges for share-based payments Accounting for income statement expense by employing companies Share-based bonus payments Group accounting treatment for share-based payments Other share-based payments

26 6 Material profit or loss items 6.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 6.3 IFRS references 6.4 Summary of IFRS requirements Basic principles Tax Summary of reporting classification requirements Changes to estimates and correction of errors 6.5 Application guidance Profits or losses on disposal of fixed assets Provisions for fundamental restructuring or sale/termination Provisions Other material profit or loss items Subsequent amendments to fair value adjustments 7 Tax on profits 7.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 7.3 IFRS references 7.4 Summary of IFRS requirements Current tax Deferred tax Deferred tax - identification of temporary differences Deferred tax - definition of tax basis Reconciliation of tax on profit on ordinary activities 7.5 Application guidance Record keeping Entries to the tax account Recognition of deferred tax assets Deferred tax on pre-1998 deductible goodwill Corporation tax provision Tax payments Intra-group transactions Group relief or equivalent intragroup tax payments Tax on profit on ordinary activities Hybrid taxes Reconciliation of tax on ordinary profits Withholding taxes Examples of deferred tax calculations

27 8 Other taxes 8.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 8.3 IFRS references 8.4 Summary of IFRS requirements 8.5 Application guidance Hybrid taxes Examples 8 Non-current assets held for sale and discontinued operations 9.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 9.3 IFRS references 9.4 Summary of IFRS requirements Classification of non-current assets (or disposal groups) as held for sale Measurement of non-current assets (or disposal group) held for sale Recognition of impairment losses and reversals Changes to a plan of sale Discontinued operations 9.5 Application guidance Probability of sale Disposal of a headquarters building Disposal group and discontinued operations 10 Goodwill 10.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 10.3 IFRS references 10.4 Summary of IFRS requirements Purchased goodwill Impairment reviews Calculation of gain or loss on disposal 10.5 Application guidance Acquisition versus asset purchase Treatment of goodwill on disposal of a business 11 Intangible assets 11.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 11.3 IFRS references 11.4 Summary of IFRS requirements Other intangible assets Amortisation Impairment reviews 11.5 Application guidance When should an intangible asset be recognised? Useful economic life for amortisation of intangible assets

28 12 Property, plant and equipment 12.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 12.3 IFRS references 12.4 Summary of IFRS requirements Capitalisation of costs Alternative valuation rules Depreciation Disposals Impairment Disclosure 12.5 Application guidance Capitalisation of costs Depreciation Useful economic life Useful economic life of Information Technology assets Revaluation Disposals 13 Classification of investments 13.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 13.3 IFRS references 13.4 Summary of IFRS requirements Definition of parent and subsidiary relationship Other definitions 13.5 Application guidance Subsidiary undertakings Joint ventures Associated undertakings Consolidation method Date of acquisition Examples 14 Inventories 14.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 14.3 IFRS references 14.4 Summary of IFRS requirements 14.5 Application guidance Determining cost Purchase discounts Lower of cost and net realisable value Inventory write downs

29 15 Long-term contracts 15.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 15.3 IFRS references 15.4 Summary of IFRS requirements Basic principles for revenue and profit Loss-making contracts 15.5 Application guidance Examples of long-term contracts 16 Receivables 16.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 16.3 IFRS references 16.4 Summary of IFRS requirements Classification of receivables Amounts falling due after more than one year IFRS7 Disclosure requirements 16.5 Application guidance Trade receivables Making provisions for bad and doubtful debts Prepayments 17 Contingent assets 17.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 17.3 IFRS references 17.4 Summary of IFRS requirements 17.5 Application guidance Specific examples 18 Cash 18.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 18.3 IFRS references 18.4 Summary of IFRS requirements 18.5 Application guidance

30 19 Financial instruments 19.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 19.3 IFRS references 19.4 Summary of IFRS requirements Definitions Financial instruments and derivatives Capital instruments Disclosure 19.5 Application guidance Debt and borrowings Derivatives 20 Leases 20.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 20.3 IFRS references 20.4 Summary of IFRS requirements Determining whether an arrangement contains a lease Determining whether a lease is finance or operating 20.5 Application guidance Determining whether an arrangement contains a lease Finance leases Operating leases Property leases Third party agreements Hire purchase contracts Sale and leaseback agreements 21 Payables 21.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 21.3 IFRS references 21.4 Summary of IFRS requirements Classification of payables 21.5 Application guidance Accruals Trade payable schemes

31 22 Provisions and contingent liabilities 22.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 22.3 IFRS references 22.4 Summary of IFRS requirements Provisions Contingent liabilities Does a provision exist? Provisions compared with other liabilities Applicability 22.5 Application guidance Establishment of provisions Movements in provisions Types of provisions Pensions and other post employment benefits Insurance Onerous contracts Onerous leases Legal and other claims Restructuring Environmental Major refit and repair costs Executory contracts Contract termination; employee costs Appendix Discounting of provisions 23 Pensions and long term employee benefits 23.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 23.3 IFRS references 23.4 Summary of IFRS requirements Defined contribution schemes Defined benefit schemes Other long-term employee benefits 23.5 Application guidance Treatment as a defined contribution scheme Defined benefit scheme

32 24 Government grants 24.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 24.3 IFRS references 24.4 Summary of IFRS requirements Government grants - basic principle General recognition criteria Repayment of grant 24.5 Application guidance 25 Accounting convention and basis of consolidation 25.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 25.3 IFRS references 25.4 Summary of IFRS requirements Minority interests Intra-group transactions Consistency between parent and subsidiary undertakings Changes in membership of a group Acquisition of a subsidiary undertaking 26 Acquisition accounting and fair value adjustments 26.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 26.3 IFRS references 26.4 Summary of IFRS requirements Accounting for acquisitions Fair value of identifiable assets and liabilities Fair value of cost of acquisition Changes in stake Minority interests Change of control Internal acquisitions and reorganisations 26.5 Application guidance Purchase consideration Deferred and contingent consideration Date of control Acquisition costs Fair value adjustments Intangible assets Hindsight period Changes in stake : investment becoming a subsidiary Changes in stake :associate becoming a subsidiary Acquisition of a minority interest Reflecting acquisitions in Group reporting

33 27 Impairment of assets 27.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 27.3 IFRS references 27.4 Summary of IFRS requirements Summary Scope When to test for impairment Example indicators of impairment Calculating impairment Recognising impairment Reversal of a past impairment loss 27.5 Application guidance - how to carry out an impairment test Identify the assets to be tested Expected future cash flows The growth rate used The discount rate to use Calculating the value in use Impairment tests required under local GAAP 28 Foreign exchange 28.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 28.3 IFRS references 28.4 Summary of IFRS requirements Definitions Foreign exchange differences Individual companies Consolidated accounts Equity investments financed by foreign borrowings 28.5 Application guidance Summary Individual company reporting Consolidated reporting Intra-group accounts - treatment of exchange differences Hyper-inflationary areas Special cases 29 Private finance initiative ( PFI ) contracts 29.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 29.3 IFRS references 29.4 Summary of IFRS requirements Basic principles Purchaser recognises the property as an asset on its balance sheet Operator recognises the property as an asset on its balance sheet 29.5 Application guidance

34 30 Other disclosures 30.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 30.3 IFRS references 30.4 Summary of IFRS requirements 30.5 Application guidance Contingent liabilities Capital commitments Operating lease commitments Analysis of rentals in the income statement Disclosure of gross payments under finance leases Staff numbers and staff costs Post balance sheet events Appendix Treasury guidance on contract bonds, guarantees and indemnities 31 Intra-group items 31.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 31.3 IFRS references 31.4 Summary of IFRS requirements 31.5 Application guidance Common intra-group partners Agreeing and reporting intra-group balances Offsetting intra-group balances 32 First-time adoption of IFRS 32.1 Disclosed accounting policy Default policy Consultation and authorisation process for exceptions 32.3 IFRS references 32.4 Summary of IFRS requirements Accounting policies Business combinations Fair value or revaluation as deemed cost Employee benefits Cumulative translation differences Assets and liabilities of subsidiaries, associates and joint ventures Designation of previously recognised financial instruments Share-based payment transaction Leases Financial instruments Estimates Assets held for sale and discontinued operations Exemption from requirements to restate comparatives Reconciliations

35 1. Revenue recognition Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Key points Revenue (or turnover or sales) should be recognised as it is earned. The fundamental accounting concepts of accruals and prudence should be followed. Revenue should be recorded net of any trade discounts and settlement discounts (under IFRS there is greater emphasis on recognising revenue as the fair value of the cash amount due). Where extended settlement periods are offered to clients (usually greater than one year) the revenue recognised should be the discounted value of the cash to be received, with the discount being shown as interest income over the period of the settlement. 1.1 Disclosed accounting policy Revenue is recognised in the period in which services are provided in accordance with the terms of the contractual relationships with third parties. Revenue represents the fair value of consideration received or receivable for goods and services provided in the normal course of business, excluding trade discounts, value added tax and similar sales taxes. Management fee contracts Revenue from management fee contracts comprises the total of sales made to customers, the subsidy charged to clients, together with the management fee charged to clients. Fixed price contracts Revenue from fixed price contracts is recognised in proportion to the volume of services that the Group is contracted to supply in each period. Inter-segment sales There is minimal intra-group trading between the reported business segments. Where such trading does take place it is on similar terms and conditions to those available to third parties. 1.2 Default policy and process for exceptions Default policy Revenue (or turnover or sales) should be recognised as it is earned Consultation and authorisation process for exceptions Revenue recognition is a matter of applying the principles outlined in this section. Where a commercial situation is particularly complicated Group Finance, Chertsey should be consulted. 1.3 IFRS references IAS 18 Revenue

36 Revenue recognition, page 2 of Summary of IFRS requirements What is revenue? Revenue is the result of exchange transactions as part of a company s operating activities. Other exchange transactions, such as the sale of fixed assets, investments or businesses, do not normally give rise to revenue. Note: Although an individual statutory entity s principal activities may indicate that amounts should be recognised as revenue, in some cases, these activities are merely incidental to the Group s activities as whole. In such circumstances, the income is shown as a reduction in cost of sales or as other operating income (rather than revenue), i.e. a different treatment may be appropriate from a Group perspective When should revenue be recognised? Revenue should be recognised as it is earned. Earning revenue involves the performance of the contractual obligations with the customer that leads to the right to get paid. Economically this gives rise to either an asset (a debtor or cash), or a reduction in a liability (deferred income). In many situations there are complications that can arise. For example; Where the contract with the customer includes several types of goods and services, it can be difficult to separate these out and account for them individually. Does revenue accrue throughout the performance of the contract (or at stages within the contract) or is revenue earned at the end of the contract? To the extent that different revenue streams can be identified within a client contract, they should be separately accounted for and the revenue recognised as appropriate to that revenue stream. Invoicing and payment for these revenue streams may be grouped together for commercial reasons, but accounting for revenue should be separated where material. Where there is a question over the timing of the recognition of revenue the following considerations are relevant: If performance of the contract involves supplying goods (such as food) the revenue is earned when the goods have been supplied and the customer has accepted them. If performance of the contract involves supplying a service over a certain time (e.g. cleaning, building maintenance) the performance of this activity accrues evenly over the term of the contract. Where a contract involves the completion of separate stages it may be appropriate to recognise revenue at the completion of each stage. Some considerations in these circumstances are: Can the stages be viewed as separate pieces of work with value in their own right? Could a stage be completed by a third party as a separate piece of work? If the contract was terminated before completion would the client view the work completed to date as satisfactory or

37 Revenue recognition, page 3 of 11 1 would they view the work as unusable unless all the stages were completed? Unbundling a contract in this manner into separate stages should always be considered before adopting long-term contract accounting. Revenue recognition is not dependant on when client invoices are approved or sent out, though usually these coincide. Long-term contracts Long-term contracts, which are expected to arise very rarely within the Group, are dealt with in a separate policy (see Long-term contracts) How much revenue should be recognised? Revenue should be measured at the fair value of the right to consideration. This is normally the price specified in the contractual arrangement, net of trade discounts, value added tax and similar sales taxes. Early settlement discounts should also be deducted from revenue as IFRS places greater emphasis on the cash amount receivable from the client. Where there is a significant risk that there will be default on the amount of consideration due and the effect is material, an adjustment to the price specified in the contractual arrangement will be necessary to arrive at the amount of revenue to be recognised. Subsequent adjustments to a debtor balance that result from changes in the time value of money and credit risk (for example a bad debt provision) should not be included within revenue, but should be treated as an expense Payments in advance Revenue must be earned through the performance of the contracted task. It cannot be recognised at the point the payment is received from the customer if that is in advance of the point where it is earned and, therefore, revenue recognition does not follow the receipt of cash from a client or customer. Some situations within the Group where the issue of payments in advance occur are: Contracts with stage payments such as design and build contracts (section 1.5.6); Sale of luncheon vouchers (section 1.5.7); and Sale of electronic payment cards (section 1.5.7) Acting as principal or agent There are sometimes situations where it is not clear if the Group should recognise the gross revenue and costs of a transaction (acting as principal) or whether a commission or margin on the net of the selling price less costs should be recognised (acting as agent). The following issues should be considered when deciding whether the Group is an agent or principal in a transaction: Does the Group take responsibility for and bear the risks relating to, the stock, labour and overheads incurred in performing the service? Can the Group set the sales price of the goods, and who takes the credit risk should the customer not pay? Where the seller has not disclosed that it is acting as agent, it is generally presumed that it is acting as principal.

38 Revenue recognition, page 4 of Application guidance This section considers the application of the above guidance to the following types of contracts: management fee (or cost plus) contracts including managed volume contracts fixed price contracts profit and loss contracts concession contracts vending revenue design and build contracts luncheon vouchers agent or principal? purchasing for third parties support services contracts Management fee contracts (cost plus) The Group provides the agreed services, and invoices the client an amount based on costs incurred plus a management fee. There is often an issue of agency versus principal (substance over form) to be determined before the correct accounting for these contracts can be decided. More commonly, the Group acts as principal and takes on the risks of employing staff, purchasing food and incurring overheads involved in running the contract. In this case the Group recognises revenue equivalent to the total costs incurred plus the management fee: Revenue from variable costs such as food and consumables are recognised when these are supplied to the customer. Receipts from unit customers should be recognised as revenue as they are received if these are retained by the Group. If these are receipts are retained by the client but netted against the value of the client invoice they should be shown as a payment in advance until the date of the client invoice. Where the management fee varies by volume this should be recognised in line with revenue from the customers. Fixed overhead and staff costs that can be recharged should be recognised as revenue on a straight-line basis over the course of the financial year. Variable overhead and staff costs that can be recharged should be recognised as revenue as incurred. If the management fee is fixed this too should be recognised on a straight-line basis In practical terms usually a client invoice is prepared monthly from which the revenue derived from the in unit customer is deducted. This client invoice therefore covers the client subsidy and the Group s management

39 Revenue recognition, page 5 of 11 1 fee and together with the in unit customer revenue forms the Group s total revenue. Example: Group acts as principal Management fee contracts (1) The Group has a management fee contract whereby it can invoice the client a management fee based upon a 10% mark up on all normal unit costs. All normal unit costs such as food, consumables, overheads and staff costs are also recharged to the client. The Group retains customer receipts and deducts them from the client invoice. The client is invoiced at the end of every month. The overall effect is that the Group recognises revenue equivalent to all normal in unit costs plus a 10% mark up. Normal costs in this context are the expected running costs of the contract and have been agreed in advance with the client. The Group should recognise revenue on the following basis: Sales made in the unit to customers are recognised as revenue as they are made. The revenue is recorded net of sales tax. The Group also recognises 10% of all food, consumable and other variable costs as revenue in line with when these variable costs are incurred (usually when supplied to the customer). This is invoiced to the client at the end of every month. Fixed overhead and staff costs plus 10% mark up are recognised as revenue on a straight-line basis over the financial year. This is invoiced to the client at the end of every month. Any abnormal costs incurred by the Group such as industrial action leading to one-off staff costs or wastage from over ordering, are not rechargeable under the terms of the contract, and therefore must not be recorded as revenue. Management fee contracts (2) As above, although the client is entitled to retain cash received from the customers that is banked by the Group. The client is invoiced a higher amount and the customer receipts are netted off against this invoice as partial settlement. The cash receipts are at all times held by the Group. In this situation the recognition of revenue should not change. The cash from customers should be treated as an advance payment on behalf of the client, and at the month end when the client is invoiced the advance payment credit in the accounts should be offset against the invoice value in trade debtors. The accounting entries for the cash received from customers are: Dr Cash 5 Cr Payments in advance 5 Dr Accrued income 5 Cr Revenue 5 At the time the purchase is made by a customer in the canteen. Dr Trade Debtors 5 Cr Accrued income 5 Invoice issued to client at month end. Dr Payments in advance 5 Cr Trade debtors 5 The cash received from the customer is offset against the invoice to the client.* *The above entries ignore the recharge of overheads and staff costs to the client, and the 10% management fee that the Group applies to all of these costs.

40 Revenue recognition, page 6 of 11 1 Revenue derived from recharging costs under this type of contract should not be netted off against those costs in the accounts. This would not give an accurate picture of the revenue the Group earns or the costs it incurs. Managed volume contracts In managed volume contracts the Group operates a similar arrangement to a management fee contract but does not take on the risks associated with employing the staff, purchasing the food or incurring overheads. In these situations the Group is acting as agent and therefore it is the management fee only element of the contract that is recognised as revenue by the Group. Example: Group acting as agent Managed volume ~ Group as agent (1) The Group has a contract where it provides the management of the catering facilities at a client site. All the food and consumables are purchased and paid for directly by the client. The Group receives a fee for providing the management of the client s foodservice activities. The Group s revenue in this case is the fee it receives. In operating the facility, it is acting as agent for the client, who contracts directly with the suppliers. It would be inappropriate to gross up revenue and cost of sales to reflect the costs of the food and consumables, as they are neither invoiced by, nor a cost to, the Group. Managed volume (as opposed to a selfoperated contract) can be monitored for operating purposes, but should not be reflected in financial reporting. Managed volume ~ Group as agent & principal (2) The Group does not employ the labour used within the contract and this cost is retained by the client. The risks associated with employment are attributable to the client. All food, consumable and overhead costs are incurred by the Group and are recharged to the client along with the management fee. This is a hybrid principal AND agency situation for the Group, and the revenue recognised should be equivalent to the cost of normal food, consumable and overheads plus the management fee. The cost of labour does not form part of the client invoice. Managed volume ~ Group as principal (3) The client employs the labour used within the contract and then invoices the Group. The risks associated with employment are attributable to the Group. All food, consumable and overhead costs are incurred by the Group and are recharged to the client along with the management fee. The labour cost is also incurred by the Group through the client invoice, and a charge for labour is included in the Group s invoice to the client. This may not equal the cost for labour invoiced from the client in situations where an abnormal labour cost was incurred. The revenue recognised by the Group should be the cost of normal food, consumable, labour and overheads plus the management fee. This type of situation is uncommon in the Group and occurs in the UK in some PFI healthcare contracts.

41 Revenue recognition, page 7 of Fixed price contracts In these contracts the client pays a fixed amount for an agreed range of services provided over a fixed period of time. Revenue recognition should follow the performance of these services by the Group. Fixed price contracts may have a tiered revenue clause depending on the volume of demand from the client. Revenue should be accrued for in line with these tiered volume levels based on the forecast volume for the relevant period. Any excess of revenue over invoiced amounts would be carried on the balance sheet as accrued income, but would have to be revised as forecast levels change Profit and loss contracts The Group has control of the offer and pricing in these types of contracts. Revenue is derived from the customers and should be recognised as sales are made Concession contracts Similar to above, although the Group has to pay a revenue based fee to the client. Again, revenue should be recognised as sales to customers are made. The revenue-based fee should be recognised as a separate overhead cost. It is advantageous to the Group s financial position for this fee not to be described as a property rental charge. Every effort should be made to achieve this position, including liaison with Group Finance as required Vending revenue Vending machine revenue is recognised as sales are made from the machines. Often the logistical problems of visiting every vending machine and recording sales at the period end make it difficult to accurately report all revenue in the correct period. Group policy is that reported revenue should be the most accurate possible estimate that management can make at the reporting date Design and build contracts No design and build contract of any size may be entered into without prior Group approval. Where they are approved, design and build contracts should be accounted for as short-term contracts. The revenue should not be recognised until the design and build contract has been completed and signed off to the client s satisfaction. It may be possible (see section above) to justify unbundling separate stages from the overall contract and recognise revenue as these stages are completed. Payments received in advance should be accounted for as deferred income. Revenue recognition should be separated from the receipt of cash. If at any stage the forecast outcome of a contract is that it will make a loss, this loss must be accrued for immediately.

42 Revenue recognition, page 8 of 11 1 Example: Design and build contracts The Group is contracted to build a site to service an oil refinery. The site is to contain accommodation and canteen facilities. The Group has agreed a price of 2,000,000 for the site, split into two stages the accommodation block and the canteen site (each valued at 1,000,000 in the contract). The accommodation block will be built first and will take four months, followed by the canteen site taking a further four months. The client is to pay the Group in three instalments of 250,000 up front, 500,000 after completion of the first stage, and 1,250,000 at completion of the contract. The contract can be split into two stages, because each stage is a separate piece of work with a value in its own right. The commercial substance of the contract is that it consists of two distinct parts with their own value and each capable of being completed by separate parties. Therefore the revenue from stage one (completing the accommodation block) can be recognised when this is completed. Because the contract can be split into two separate stages and revenue is recognised for each stage, the costs recognised should follow this treatment. The costs for each stage should therefore be charged to the income statement as that stage is completed. The accounting entries for the contract revenue are: Dr Cash 250,000 Cr Deferred income 250,000 For the up front receipt. Dr Accrued income 250,000 Cr Revenue 1,000,000 Dr Cash 500,000 Dr Deferred income 250,000 For the completion of stage one, and receipt of the second stage payment. Dr Cash 1,250,000 Cr Revenue 1,000,000 Cr Accrued income 250,000 For the completion of stage two, and the final payment from the client. Where it is not possible to identify separate revenue earning stages within the overall contract, and it is believed that the activity falls into two or more financial years; and the revenue and profit from the contract (or group of contracts if the business is involved in more than one) has a material effect on the Group s accounts, Group Finance, Chertsey should be consulted as to the possibility of accounting for these contracts as long-term contracts Luncheon vouchers and electronic payment cards Where the Group sells luncheon vouchers or allows customers to pay for electronic credit on a card in advance, the revenue recognition treatment does not follow the receipt of the cash. The revenue that can be recognised at the point of the receipt of cash is the cash received less the fair value of the voucher or credit purchased. This fair value is the value the voucher or electronic credit can be redeemed for in a future purchase. In some common situations where the Group issues vouchers, the accounting treatment would be:

43 Revenue recognition, page 9 of 11 1 Examples: Vouchers 1 Vouchers/electronic credits are sold in advance and can be redeemed in a Compass operated restaurant at face value; revenue should not be recognised until the customer has purchased goods from the restaurant, and used their vouchers/credits as consideration. Dr Cash 10 Cr Deferred income 10 For the initial cash receipt. Dr Deferred income 10 Cr Revenue 10 For the purchase by the customer 2 Vouchers are sold that are redeemable at Group owned units or third party sites that accept these vouchers; there is a commission earned by the Group, as the vouchers are not redeemed at full face value by the retailer. The Group should recognise this commission at the point of sale, but also recognise a liability due on redemption of the voucher. Dr Cash 10 Cr Revenue 1 Cr Accruals 9 This is also a situation where the Group is acting as an agent (see section above) and therefore should not recognise the gross amount of the sale as revenue, or the cost to the retailer as a cost of sale. When the retailer is reimbursed the accounting entry is: Dr Accruals 9 Cr Cash 9 If the voucher is redeemed in one of the Group s operations the accounting entry is: Dr Accruals 9 Cr Revenue 9 The amount of outstanding vouchers and credits at the year-end should be reviewed. An estimate based upon historical trends of the amount of vouchers or credits that will not be redeemed should be made and this should be taken to revenue. For example, in the two situations above historically 10% of vouchers are never redeemed. Therefore at the year-end if the vouchers were still outstanding the following entry would be made: Dr Deferred income/accruals 1 Cr Revenue 1 On expiry of the vouchers, the remaining unused credit should also be taken to revenue. The exception for this is if the Group has a practice of honouring expired vouchers, in which case the deferred income should be retained as a creditor.

44 Revenue recognition, page 10 of Agent or principal? There are situations within the Group where questions of principal versus agent arise. These include managed volume (see section above), prepaid vouchers redeemable at third party sites (see section above) purchasing for third parties, facilities management, and retail sales (such as lottery tickets and mobile phone cards). Purchasing for third parties In some cases, the Group uses its purchasing operations to provide services to third parties. Depending on the nature of the contract with the third party and with the Group s supplier, the Group can be acting as principal or agent. Examples: Purchasing for third parties 1 The Group utilises its expertise to negotiate purchasing arrangements for a third party foodservice company. The Group purchases the items in its own name from the supplier, thus benefiting from its existing volume purchase discount arrangements. It then invoices these costs to its third party client, at the discounted price plus a margin (in effect, a commission). The Group is acting as principal in this transaction. It contracts directly with the supplier, pays for the goods and reinvoices them to its client. In doing so, it bears credit risk on the amounts due from its client. The Group should recognise the full amount billed to its client as revenue, with the payments to the supplier being treated as a cost of sale. 2 The Group utilises its expertise to negotiate purchasing arrangements for a third party foodservice company. The Group s involvement is limited to arranging the terms of the purchase. The purchase contract is directly between the third party and the supplier. The Group invoices the third party a commission for the negotiation services performed. The Group is acting as agent for the third party in this transaction. It does not contract directly with the supplier, nor is it involved in the payments for the goods purchased. The Group should only recognise the commission it invoices to the client as revenue.

45 Revenue recognition, page 11 of 11 1 Support services contracts Example: Support services contracts The Group enters into a contract to manage the support services supplied to a client by third party sub-contractors. The Group will order the goods or service from the sub-contractor for the client and will manage the delivery of those services to the client by determining the level of service provided and supervising the delivery of that service. The sub-contractor contract remains with the client. The sub-contractor will invoice the client but these invoices will be processed and paid by the Group. The Group will raise sales invoices to pass such charges and costs onto the client along with any direct costs and a management fee based on the savings achieved. The following factors are relevant in assessing the accounting treatment: The Group will pay the sub-contractor invoices and then raise invoices to the client to include pre-agreed amounts in respect of Group staff and sub-contractor charges plus an additional amount for management fees which vary dependent on service levels. As the Group manages and directs the levels and types of staffing from the subcontractor but can only invoice a pre-agreed amount, it must manage the risk of exposures to increased costs (or be more efficient to still achieve the same service levels). The Group will suffer the credit risk on invoices to clients. The Group has the management relationship with the client and hence will be able significantly to influence the sub-contractor and supplier relationships (even though legal contracts may not initially transfer). Physically, cash will move between the client and the Group, not directly to the subcontractor. If the sub-contractor does not perform, the Group will receive complaints and will need to manage the situation. The client will deem the Group to be the principal in the arrangement. The Group is exposed to all the risks involved in running the contract and is taking credit risk on the client invoice value and therefore it is acting as principal in the transaction. Reported revenue should be based on the gross amount receivable. Performance bonuses under support service contracts In some cases there may be performance bonuses due under support services contracts for things such as the achievement of health and safety targets. These bonuses should be recognised as earned, with consideration given to the type of target and the time period it is relevant to. Example: Performance bonuses under support service contracts The Group enters into a support services contract at a hospital to provide cleaning, maintenance and porterage services. Every quarter there is a performance bonus paid out if the Group achieves specified health and safety objectives. The performance bonus should only be recognised as revenue at the end of each quarter.

46 2. Supplier rebates and discounts Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Supplier rebates and discounts received must be spread across the period to which they relate. Special care should be taken with lump sum receipts to match them against the purchases or period to which they relate. Commercially, up front bonuses given are in expectation of future purchases under a contract suppliers do not give money for nothing. Supplier rebates and discounts should be recognised in the income statement when the goods and services associated with them are used. Discounts on capital expenditure should be set against the cost of these items and will reduce the depreciation charge over the life of the asset. With backdated rebates, whilst specific contract terms may provide supporting evidence for the accounting treatment, the evidence that the payment relates to past events rather than future purchases must be persuasive before immediate recognition is allowed. Up front lump sum receipts must not be released immediately to the income statement as a matter of course. 2.1 Disclosed accounting policy Rebates and other amounts received from suppliers include agreed discounts from suppliers list prices, value and volume-related rebates. Income from value and volume-related rebates is recognised based on actual purchases in the period as a proportion of total purchases made over the rebate period. Agreed discounts relating to inventories are credited to the income statement as the goods are consumed. Rebates relating to items purchased but still held at the balance sheet date are deducted from the carrying value of these items so that the cost of inventories is recorded net of applicable rebates. Rebates received in respect of plant and equipment are deducted from the costs capitalised. 2.2 Default policy and process for exceptions Default policy Supplier rebates and discounts are recognised as either: a reduction in cost of sales; a reduction in the capital cost of an asset where amounts are a contribution towards capital expenditure; or a reduction in the carrying value of inventories, where amounts relate to the cost of food or other consumables and where those items remain on hand.

47 Supplier rebates and discounts, page 2 of 9 2 Supplier rebates and discounts should be recognised over the period to which they relate, and should only be recognised when it is virtually certain that the amounts will be received. Supplier rebates and discounts should never be recognised as revenue Consultation and authorisation process for exceptions The principles set out in this section must be followed when determining the correct accounting treatment for supplier rebates and discounts. Responsibility for the accounting treatment of supplier rebates and discounts remains with the Finance Director of the operation concerned. Where doubt exists as to the correct accounting treatment Compass International Purchasing, Foodbuy (for transactions negotiated or routed through them) or Group Finance, Chertsey should be consulted. 2.3 IFRS references Framework for the preparation and presentation of financial statements IAS 2 Inventories IAS 8 Accounting policies, changes in accounting estimates and errors IAS 37 Provisions, contingent liabilities and contingent assets 2.4 Summary of IFRS requirements Basic principles Supplier rebates and discounts generally take the form of rebates, bonuses, reductions in the purchase price of goods, commissions or advertising and marketing support received from suppliers. Such income may be settled by the supplier in a number of ways (e.g. cash, credit notes or goods), and the timing of receipt of such income can vary (e.g. being received up front, over a fixed time period in instalments or retrospectively). There is no specific accounting standard regarding supplier rebates and discounts. Rather, recognition is driven by several fundamental accounting concepts, notably accruals, which requires that the income received be recognised across the period to which it relates and prudence. Examples of this would be: Receiving an agreed value direct as purchases are made; Spreading a lump sum ( signing bonus ) over the life of the contract; Spreading a lump sum ( marketing support ) for advertising; Retrospective discounts on past quantities purchased; or Reimbursements for set up costs by a new supplier, which should be spread over the life of the agreed contract. Commercially, the supplier has only made this payment in expectation of future benefit from the new contract, and the income recognition should reflect this. Contingent assets/reimbursements Reimbursements, for example agreed retrospective rebates or for a particular advertising campaign paid for by the Group, should be recognised only when it is virtually certain that they will be received. (See policy on Contingent assets).

48 Supplier rebates and discounts, page 3 of Supplier rebates and discounts recognition Supplier rebates and discounts are recognised as a reduction to cost of sales, rather than as revenue, as they relates to an arrangement between a purchaser and a supplier, rather than directly from transactions with a customer. If the income is attributable to the volume or value of units sold or purchased, the amount of funding recognised should be calculated, based on the sales or purchase data, and recognised upon the event triggering the funding or as soon as practicable thereafter. HFM account: IS21100 IS21200 The amount recognised should take account of whether any triggering events or conditions attaching to the receipt of such funding (or any subsequent repayment to the supplier) have been fulfilled. Where stocks remain on hand, the discount received or receivable relating to those items should be deducted from the carrying value. 2.5 Application guidance The various types of supplier rebates and discounts commonly encountered, together with the appropriate accounting treatment, are summarised below. Supplier rebates Net prices received as purchased Consumables and food stocks Separate discount received on all purchases (sheltered income) Tiered volume discounts ( overriders ) Lump sum payments Capital items Issues to consider: Upfront payments Backdated rebates Payment to break old arrangements Contracts with no fixed term. Discount already reflected in price paid COS and stock shown at net amount COS and stock shown at net amount based on expected volumes Default policy is to spread - rare exceptions to consider carefully Deduct from cost of asset Further detail on each of these follows Consumables and food inventories

49 Supplier rebates and discounts, page 4 of 9 2 These items are charged to the income statement as they are used by the Group, and items purchased but still held at the balance sheet date are classified as inventories. As set out in the section on Inventories, the valuation of stock must include all associated purchasing discounts. The amount charged to the income statement should reflect the discounts earned by the Group on the consumables and inventories used in the reporting period Net pricing Where a supplier uses net pricing, any discount is factored in to the initial price paid by the Group. Purchases and inventories are therefore automatically recorded at the net cost to the Group, and no further accounting entries are necessary Separate discount payment ( sheltered income ) For commercial purposes it is often the case that the cost of goods and services passed onto the unit level is at gross cost, i.e. before purchasing discounts. Therefore the purchase discount is accounted for at a different level in the country (as purchasing income) and is sheltered from the unit. Based upon the value of the discounts earned over the reporting period, an adjustment along the following lines would have to be made centrally: Dr Cr Cr Accrued income (debtors) Purchasing income Inventories (balance sheet) The income associated with the goods/services used are credited to cost of sales in the income statement whilst the income associated with goods purchased but not used is credited to inventories in the balance sheet. HFM account: BS22120 IS21100 BS21100 The level of accrued income within debtors must be carefully monitored and revised in light of the actual discounts received in a particular period, once these have been agreed with the supplier. Differences between accrued income balances and the amounts agreed with suppliers should be taken to purchasing income in the income statement. Example: Simple purchase discount A supplier contract is signed with a new supplier, commencing on 1 January. The supplier s list price per unit is 10 each, but the Group has negotiated a discount of 1 per unit regardless of volume. The discount is payable annually on 31 December. The Group purchases 500,000 units in the nine months to the year-end and has 100,000 on hand at this date. Dr Accrued income 500,000 Cr Inventories 100,000 Cr Cost of sales 400, Volume-related discounts ( overriders ) Volume overriders are typically tiered discounts where the level of discount depends on volumes purchased from the supplier. Where the Group s reporting period differs from the period over which the level of discounts received is determined, a forecast of the volumes to be consumed over the contract period should be used to calculate the levels of discount earned. This should be accounted for in the inventories valuation and the income statement. Evidence for the volumes estimated should come from;

50 Supplier rebates and discounts, page 5 of 9 2 Historical levels of product volume, seasonal fluctuations of product volume, and year to date levels of consumption Example: Tiered discounts (1) A supplier contract is signed with a new supplier, commencing on 1 January. The supplier s list price per unit is 10 each, but the Group has negotiated a discount of 1 per unit but the discount per unit goes up to 2 per unit on all units purchased if the volume exceeds 600,000 during a calendar year of the contract. In the nine months to 30 September the Group had purchased 500,000 units (of which 100,000 are in stock at the year end) and therefore is on course to exceed the 600,000 level in the calendar year. Seasonal factors are minimal, and post year-end the volumes purchased have remained consistent with the first nine months. The following accounting entries should be made at the year-end; Dr Accrued income 1,000,000 Cr Inventories 200,000 Cr Cost of sales 800,000 Example: Tiered discounts (2) The facts are the same as example 1 above, except that the overrider discount level is 650,000 units. There would have to be persuasive evidence that the overrider level would be reached in the calendar year of the supplier contract. The income could only be recognised if it is virtually certain to be realised and evidence from the period after the year-end would be critical in supporting any overrider discount booked at the year-end Lump sum receipts Lump sums received at the start of the supply contract Commonly, supplier contracts allow for the payment of a lump sum to the Group in return for agreeing the supply contract. This lump sum receipt is in addition to the purchase discounts agreed within the supply contract. The commercial substance of lump sum receipts must be carefully considered, and where the receipt is in return for signing the supply contract, or in expectation of future purchases, the lump sum should be released to the income statement over the life of the contract. Where the lump sum receipt is non refundable and is not dependent upon the volume of goods supplied, the release to the income statement should be on a straight-line basis over the life of the contract. There are very few circumstances in which it is correct to take a lump sum receipt to the income statement straight away. Even if a lump sum is non-refundable this is unlikely to be the correct accounting treatment. Commercially, the supplier has only made the payment in expectation of receiving a future benefit from it. The accounting principle of substance over form will usually show that the lump sum is an inducement payment for signing the supply contract and therefore should be taken over the life of the contract.

51 Supplier rebates and discounts, page 6 of 9 2 Example: Up front payment A supplier contract is signed with a new supplier, commencing on 1 January. The length of the agreement is three years and the supplier has paid the Group 1,200,000 as an up front lump sum payment. In the first nine months to 30 September, the up front payment should be accounted for as: Dr Cash 1,200,000 Cr Deferred income 1,200,000 Dr Deferred income 300,000 Cr Purchasing income 300,000 Back-dated lump sum rebates Lump sum receipts are sometimes described as back-dated rebates where the supplier has been used for a period of time before the supply contract has been agreed (or the old contract renegotiated). Care should be taken in assessing the accounting treatment for such items. In rare cases, taking the lump sum over the life of the contract may not be the most appropriate treatment, because the substance of the lump sum might be that it is a back-dated discount on goods supplied before the supply contract was finalised or that it relates to a legitimate rebate for supplier non-performance before the new/amended contract was agreed. Alternatively the lump sum may in substance be an inducement to sign the supply contract in which case it should be spread over the life of the contract). Group Finance, Chertsey should be consulted if any uncertainty exists. For back-dated rebates, reference should also be made to the policy on Contingent assets to determine when these should be recognised. Some factors that should be considered when deciding the correct treatment of a back-dated lump sum receipt are: Has the level of the lump sum been determined by reference to the volume of goods supplied in the back-dated period to which these amounts relate? At the date to which the payment dates back, were negotiations in place over the supply contract and was it acknowledged by the supplier that the final discounts agreed in the contract would be back dated? Is the lump sum linked to any circumstances outside of the backdated period? Where the supply contract is a re-negotiation of a previous deal with the same supplier, is the lump sum in place of the discounts that would have been earned under the old supply contract?

52 Supplier rebates and discounts, page 7 of 9 2 Examples: back-dated lump sums 1 A supplier contract is signed with a supplier on 1 January, but the supplier has been used informally for six months prior to the signing of the contract. Negotiations on the supply agreement started at the time the supplier was first used (1 July). The Group purchased 250,000 units during this period at the standard list price. The Group and the supplier have agreed that the Supplier will make a non-refundable back-dated payment to the Group equivalent to the discount subsequently agreed of 1 per unit. The supplier is making a back-dated payment for units purchased before the agreement came into force. The amount paid is based on the number of units purchased in the back-dated period, and there are no contractual terms relating to future events or targets that affect this payment. The Group should treat this receipt as a reduction in cost of sales. 2 As above but negotiations began in December, and the back-dated payment is covered by a penalty clause in the contract that states that if the contract is terminated early by the Group the lump sum is repayable. On balance it is difficult to argue that this receipt is related to back-dated purchases. When the Group began using the supplier there was no expectation of receiving a purchasing discount as negotiations did not start until five months later. Additionally the lump sum is potentially refundable to the supplier based upon a future event, and therefore cannot be said to be relating to back-dated purchases. The nature of the lump sum is as an inducement for the Group to sign the supplier agreement. The lump sum should be released to the income statement over the life of the contract. Compensation for breaking an existing supply contract Where the Group moves to an alternative supplier there may be a payment from the new supplier to compensate the Group for any penalties it has incurred in breaking an existing supply contract with another supplier. The Group may have lost discounts it had accrued from the original supplier or had to pay a penalty for breaching the supply contract. The treatment of the payment from the new supplier will depend on the commercial substance of the transaction and each case will have to be looked at individually. Determining the length of a contract when accounting for lump sums There may be situations where the length of a contract for the purposes of recognising income from lump sums is not clear. Contracts may have no fixed duration, may assume an annual renewal or could have earlier termination dates at the option of either the Group or the supplier. Commercial substance takes precedence over legal form, and in these situations this may allow a release of a lump sum over a shorter period than the term of the supply contract. Where the commercial reality of a contract is that it will be terminated or re-negotiated by one party or the other before the end of the contract, a lump sum receipt relating to that contract should be spread over the expected period the contract will apply to. The evidence required to back up this accounting treatment must ensure that the term assigned to the supply agreement for accounting purposes is virtually certain to be the maximum time that the contract is in force for.

53 Supplier rebates and discounts, page 8 of 9 2 There is no direct guidance in IFRS on the recognition or de-recognition of deferred income, but the principle of IAS 37 (see policies on Provisions and Contingent Liabilities and on Contingent assets) is that a liability should be recognised if it is probable, while an asset should not be recognised until it is virtually certain (an asset that is merely probable is an unrecognised contingent asset). When this principle is applied to the recognition of income and de-recognition of deferred income, it is clear that the evidence required to take a shorter time scale for accounting purposes than the legal form of the contract must be very persuasive and lead to virtual certainty Advertising support On occasion, funding will be received from suppliers for specific advertising or marketing promotions. Where the reimbursement relates to specific costs incurred for a particular campaign or promotion, the reimbursement should be matched to the expenditure. In other cases, a supplier will pay a general amount for marketing support, which may be paid upfront or across the life of a contract. Such general amounts should be spread over the life of the contract as described above. Examples: Advertising support 1 A supplier agrees to pay the Group 20,000 in advance of a significant advertising campaign, as a contribution towards advertising the supplier s new product. The 20,000 should be held as deferred income on the balance sheet and credited to the income statement, as a reduction in the cost, as the advertising expenditure is incurred. 2 As above, but 10,000 is repayable to the supplier if volumes purchased are less than 10,000 units in the six months following the advertising campaign. The 20,000 contribution is recognised as above. A separate provision should be made for the 10,000 repayable if it is probable that the volume target will not be reached Capital discounts Capital discounts should not be credited in full directly to the income statement. Capital discounts should be assigned directly to the asset(s) they relate to so that the correct depreciation charge and profit or loss on disposal of the asset can be determined. Discounts on capital expenditure should be set against the gross cost of the asset acquired to give a lower cost of the asset to the Group. Where for commercial or practical reasons the gross cost of the asset is incurred at unit level, an adjustment at a higher level to the fixed asset register should be made to record the correct net cost of the asset to the Group. The capital item is then depreciated at its net cost to the Group, and the benefit of the discount realised through lower depreciation charges. It is not, however, always possible to assign capital discounts directly to the asset(s) they relate to, particularly for tiered / overrider rebates where significant quantities of similar assets are purchased. In these instances it may be more practical either to:

54 Supplier rebates and discounts, page 9 of 9 2 (a) (b) assign the capital discount as a one line adjustment to the asset register for assets purchased in that year; or capitalise a standard cost for the asset, based on the expected net cost of the asset after deducting expected capital discounts and then making a one line adjustment to the asset register only if the net costs charged are different to the actual costs paid. In the former case, the level of disposals should be reviewed carefully: if, for example, a significant quantity of assets purchased in one year was disposed of, it would be appropriate to release a proportion of that year s capital rebate as part of the calculation of profit or loss on disposal. Examples: Capital discounts Based on budgeted purchases of vending machines, the Group estimates that it will receive a rebate of 400,000. The Group estimates it will purchase 500 machines, each with a list price of 10,000. At the end of the year, the Group has purchased 460 machines, and receives a retrospective rebate, based on volumes, of 322,000. Vending machines are capitalised as fixed assets by the Group and, in this example, are depreciated over six years. Contributions towards capital expenditure should be recognised as a reduction in the cost of the relevant capital item once the expenditure which gives rise to the rebate has been incurred. Two practical approaches could be adopted: 1 Standard cost The estimated rebate of 400,000 equates to 800 per machine. The standard cost of each machine is therefore 9,200. As each machine is purchased, the double entry is: Dr Tangible fixed assets 9,200 Dr Accrued income/standard cost clearing account 800 Cr Cash 10,000 At the end of the year, 460 machines have been purchased and the balance sheet shows Additions to tangible fixed assets 4,232,000 Accrued income 368,000. On receipt of the actual rebate of 322,000, the accounting is: Dr Cash 322,000 Cr Accrued income 368,000 Dr Tangible fixed assets 46,000 The debit to fixed assets brings the additions to their true cost to the Group, and should be depreciated over the same period as the machines. Total additions are thus 4,278,000. In a full year, depreciation on these assets would amount to 713, Annual adjustment Alternatively, an adjustment could be made at the year-end when a better estimate of the actual rebate to be received for full year purchases. On purchase, the machines would be capitalised at their full cash cost of 10,000, with a subsequent reduction of 322,000 for the rebate. Total additions will be 4,278,000. In a full year, depreciation on these assets would amount to 713,000 In both cases, the cost of the asset and relevant depreciation charge are reduced by the rebate received and the income statement effect is the same Supplier rebates and discounts passed to the client Supplier rebates and discounts passed on to the client should be reflected as an increase to cost of sales and not as a reduction in revenue.

55 3. Contract costs: Bidding and mobilisation (start-up) Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued All pre contract bidding and mobilisation (start-up) costs must be expensed as incurred unless they fulfil the stringent conditions for capitalising as property, plant and equipment or intangible assets. The initial purchase of glassware, cutlery and kitchen utensils at the start of a contract is to be held on the balance sheet as base stock in property, plant and equipment (or client commitment intangible assets see Group policy on Client Commitments) and written down over the life of the contract (or shorter if a reasonable expectation exists that the contract will terminate early) to residual value. All subsequent expenditure on these items must be charged to the income statement as incurred. 3.1 Disclosed accounting policy There is no externally disclosed accounting policy for pre-contract costs. 3.2 Default policy and process for exceptions Default policy All pre contract bidding and mobilisation (start-up) costs must be expensed as incurred unless they fulfil the conditions for capitalisation as property, plant and equipment or intangible assets Consultation and authorisation process for exceptions: Exceptions to the default policy or more specific application detail below must be authorised in writing by the Group Financial Controller. 3.3 IFRS references Framework for the preparation and presentation of financial statements IAS 38 Intangible Assets 3.4 Summary of IFRS requirements Principles governing recognition as an asset IAS 38 forbids the capitalisation of start-up costs unless the expenditure is included within the cost of an item of property, plant or equipment in accordance with IAS 16. Items specifically excluded from capitalisation are the establishment costs of a new legal entity, pre-opening costs of a new facility or business, start-up costs when the new business or facility opens, training, advertising and promotional activities and relocation or reorganisation costs Property, plant and equipment assets The costs associated with a start-up or commissioning period should be included in the cost of property, plant & equipment, only where the asset is available for use but incapable of operating at normal levels without such a start-up or commissioning period. There is no justification for capitalising costs relating to start-up periods where the asset is available for use but not yet operating at normal levels, for example because of a lack of demand. Training costs cannot be capitalised. See policy on Property, plant and equipment.

56 Contract costs: Bidding and mobilisation (start-up), page 2 of Application guidance Summary The correct treatment of different types of expense is given below. Type of cost Sales and marketing department costs Sales commissions Investment in client premises Signing-on bonus/ key money Pre-contract costs Security deposits for utilities Equipment Consulting/surveys relating to fixed assets Training costs Initial purchase of crockery, utensils and similar items Initial trading losses Research and development Charge to income statement Charge to income statement See Contract costs - Client commitments policy. See Contract costs - Client commitments policy. May capitalise only if meeting the very strict conditions set out below. Otherwise, charge to income statement Carry on balance sheet as prepayments Capitalise in line with Group policy Costs may be capitalised in line with Group policy, only from the point when a suitable asset has been identified i.e. site selection costs may not be capitalised. Charge to income statement See below Charge to income statement Group policy is to charge to income statement Start-up costs Start-up costs are costs arising from one-time activities such as: Opening a new facility or operation Introducing a new product or service Conducting business in a new territory Conducting business with a new class of customer Initiating a new process in an existing facility. Broadly, start-up costs should be treated consistently with similar costs incurred as part of on-going activities, i.e. they should be expensed as incurred. Costs may only be deferred and carried forward on the balance sheet where they meet the criteria for recognition as assets under a relevant accounting standard Pre-contract costs The capitalisation of pre-contract costs and subsequent amortisation over the life of the contract is permitted, but only if certain specific criteria are met, being Only costs arising after the award of the contract is virtually certain (and not reliant on regulatory or third party consent) may be capitalised. The contract must yield sufficient future cash flow to cover the costs.

57 Contract costs: Bidding and mobilisation (start-up), page 3 of 5 3 Only costs that are directly attributable to the contract, separately identifiable and reliably measured may be capitalised. Costs previously expensed may not be subsequently capitalised when the contract is awarded even within the same financial period. These conditions fulfil the criteria in the IFRS Framework and IAS 38 for recognition as an intangible asset as the expense is directly linked to future economic benefits and is capable of accurate measurement. Items to be considered would include the costs of tendering for and securing contracts for the design, construction, manufacture or operation of assets or for the provision of services or a combination of assets and services. The rules regarding capitalisation of such costs are set out below. Status Right to bid for contract granted Three bidders still in contention for contract Preferred-bidder status granted and contract virtually certain Treatment of costs by supplier Charge to income statement Charge to income statement Defer directly attributable costs as intangible assets and amortise over life of contract. Do not re-capitalise costs previously expensed. In the case of most Group contracts, there are only low levels of costs involved, particularly as regular staff costs are excluded. However, in larger scale contracts, for example remote site or worldwide supplier agreements, the amount of organisation required may involve higher costs. Whether the benefit of fulfilling the necessary criteria would be sufficiently material to warrant the cost of collection and identification would need to be established in any case where this treatment is considered Pre-contract cost capitalisation: decision guidance Contract status Tender is still in competition with others Tender has been unsuccessful Contract is not yet virtually certain i.e. there are remaining third party consents or contract is contingent on external events Contract becomes virtually certain but projected cash flows will not cover precontract costs Contract becomes virtually certain and projected cash flows will cover pre-contract costs Contract enters start-up phase Treatment of costs All costs expensed through income statement All costs expensed through income statement All costs expensed through income statement All costs should be expensed through income statement Directly attributable, separately identifiable and reliably measured costs related directly to securing the specific contract from the date that the contract becomes virtually certain to be capitalised and amortised over the period of the contract. Costs incurred before this date may not be capitalised even if incurred in the same financial year. Costs arising from this point should be expensed through income statement

58 Contract costs: Bidding and mobilisation (start-up), page 4 of Base stock policy for short life items Short life items are defined as items of equipment that require on going renewal and replacement throughout a contract s life. They are typically small value items with a durable nature, i.e. typically last up to three or four years, although their physical life is significantly shorter than the life of the contract. These items typically include glassware, cutlery and crockery. The initial expense on short life items at the start of a contract should be held as base stock on balance sheet within property, plant and equipment (or client commitment intangible assets see Group policy on Client Commitments). This should be depreciated over an appropriate period, often contract life, unless they are part of a client commitment in which case the guidance given on asset lives in section above should be followed. The balance must be depreciated fully or to its residual value over this time period. All replacement items must be charged to the income statement as the cost is incurred Examples: Pre-contract costs Company C becomes aware of a number of catering contract opportunities with a substantial education authority in an area where Company C currently has no education contracts Stage Stage 1 - Company C recruits dedicated sales personnel with detailed knowledge of this specific market and produces new promotional brochures to target the new area. Stage 2 - Company C is short listed for a competitive tender for catering at a group of ten schools for five years. The sales staff engage in detailed research, meetings and preparation of tender documents. Stage 3 - Company C is awarded the contract by the education authority but the consent of the local authority is outstanding. Stage 4 - Clearance is obtained from all necessary authorities. Cash flow projections show good cash generation that will cover any costs capitalised. Stage 5 - Company C opens a new regional office to deal with education contracts - premises are leased, equipment purchased and staff employed. Stage 6 - Company C makes a payment to the education authority for the purchase of kitchen equipment, taking advantage of the education authority s lower tax rates in the local tax regime. The contract says that if the contract is terminated early, the education authority will repay a proportion of this cost (calculated on a straight line basis) to Company C. Treatment of costs All sales and marketing costs are charged to the income statement as incurred. All costs are charged to the income statement as incurred. All costs are charged to the income statement as incurred. Directly attributable, separately identifiable and reliably measured costs related to securing the specific contract from the date that the contract becomes virtually certain, to be capitalised and amortised over the period of the contract. Expenses before this date may not be capitalised even if incurred in the same financial year. Legal fees related to the contract, premises surveys and design consultancy dating from this point may be capitalised - regular staff costs and overheads may not. Equipment that complies with the capitalisation criteria (see section on Property, plant and equipment) would be capitalised as fixed assets and depreciated. Other expenses are charged to the income statement as overheads. The client commitment is capitalised either as PPE or an intangible depending on the terms of the contract.

59 Contract costs: Bidding and mobilisation (start-up), page 5 of 5 3 Stage 7 - Company C purchases restaurant fittings and furniture for the contract and retains ownership of these assets. Stage 8 - Company C takes over employment of the staff, purchases uniforms and undertakes staff training. Stage 9 - Another operator of four contracts in the area is looking to sell the business and retire. Company C acquires this business. The assets are capitalised and depreciated over the life of the contract in accordance with Group policy. The contract is now in start-up phase - all costs are charged to the income statement as unit costs. Account for as an acquisition. Any difference between the amounts paid for the business and the fair value of the net assets acquired (including intangible assets) is capitalised as goodwill.

60 4. Contract costs - Client commitments Approval Approved by: Introduction Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued This policy deals with the accounting for client commitments. These commitments include the various types of investment linked to client contracts. Whilst in the majority of cases we typically conclude that payments to clients made at the time of signing a contract (or which we are contractually committed to make at a later date) should be accounted for as intangible assets, consideration also needs to be given to whether all or part of any investment should be regarded as a direct investment in physical assets (catering facilities) depending on how the agreements are structured. This policy also explains the appropriate depreciation or amortisation policies to be followed. Summary of typical payments / commitments and their treatment; Client commitment intangible asset (signing fee, client investment or key money) Property, plant and equipment Loan or advance to client ~ current or long term other receivables Client incentive payment (e.g. up front sales commission) ~ prepayments Lease premium ~ prepayment Not an asset ~ expense immediately Where physical assets (e.g. a catering facility) are installed as a result of the client commitment, consideration should be given as to whether these are PPE, regardless of legal title. Many factors influence this decision but the substance of the arrangement and whether or not the Group bears the risks and rewards of ownership need to be considered carefully. Ownership or legal title, whilst also relevant, is not the only factor for consideration. This policy is to be applied prospectively. 4.1 Disclosed accounting policy There is no externally disclosed accounting policy for client commitments. 4.2 Default policy and process for exceptions Default policy Client commitment costs will usually fulfil the conditions for capitalisation as either tangible or intangible fixed assets. In certain cases it may be appropriate to treat as loans or prepayments within other receivables. If asset recognition rules are not met, client commitment expenditure must be expensed as incurred Consultation and authorisation process for exceptions: Exceptions to the default policy or more specific application detail below must be authorised in writing by the Group Financial Controller.

61 Contract costs: Client commitments, page 2 of IFRS references Framework for the preparation and presentation of financial statements IAS 38 Intangible Assets IAS 16 Property, plant and equipment IFRIC 4 Determining whether an arrangement contains a lease Summary of IFRS requirements Principles governing recognition as an asset Assets are defined as "rights or other access to future economic benefits controlled by an entity as a result of past transactions or events". An asset is recognised in financial statements only if there is sufficient evidence that the asset has been created (including, where appropriate, that a future inflow of benefit will occur) and it can be measured with sufficient reliability. Expenditure should be written off in the period in which it arises unless its relationship to future economic benefits can be established with reasonable certainty. 4.5 Application guidance In the process of gaining or renewing a contract, the Group often either commits a sum upfront or over future periods to the client. These upfront client commitments fall into several categories. The flow chart that follows documents the steps to be taken to classify a client commitment. This is followed by additional guidance about the decisions and the possible outcomes to consider before arriving at the correct accounting treatment. This is often a complex situation and the flow chart and additional guidance set out the general principles to be considered in determining the correct accounting treatment to be adopted. This policy does not attempt to provide a set of rules to cover every eventuality and Group Finance, Chertsey should be consulted where there is doubt over the correct accounting treatment to be followed. A client commitment may contain different elements of all the possible outcomes listed in this section. Where it is relevant, the commitment should be separated into its various elements and each accounted for separately. It is best practice for all contracts authorising a client commitment where the client holds legal title or exercises control over the assets (e.g. they are situated at the client s site) to contain a buy-back* clause to enable the Group to recover any remaining unamortised value of the commitment in the event of early contract termination. * The term buy-back is used throughout this policy and refers to any contract terms that protect the Group s investment. The contract language may not use the phrase buy-back.

62 Contract costs: Client commitments, page 3 of 12 4 Client commitment accounting decision tree Does the contractual commitment meet the definition of an asset? YES NO Expense in the period incurred through the income statement Is the money paid to the client repayable, i.e. a loan? NO YES Loan; show in other receivables and reduce balance as loan is repaid Is the arrangement a lease? NO YES Lease prepayment; show in prepayments and expense over term of lease Is the asset legally or contractually protected? Key judgements (1) YES NO Client incentive prepayment or advance sales commissions; show in sundry receivables and release straightline over term of contract (check regularly for recoverability, i.e. that contract is profitable after the release adjustment is included) If the commitment is funding physical assets should these assets be shown as PPE? Key judgements (2) Plant, property and equipment; account for as normal PPE NO YES Client commitment intangible asset: (client investment or signing-on fee) Capitalise entire commitment and accrue for unspent portion. Do not net-off asset and accrual. Where there is significant uncertainty about the level of spend to be incurred under the contract, the commitment may be capitalised in tranches as that spend is incurred. Amortise straight-line over term of contract starting no later than the commencement of revenue generating activities.

63 Contract costs: Client commitments, page 4 of 12 4 Key judgements (1) Legal or contractual protection; Legal or contractual protection in the context of client commitments arises from two sources; The contract protects the investment; normally this is represented by a buy-back clause in the contract Legal title to the assets purchased through the commitment is retained by the Group For example a client investment or signing-on fee must be protected by a buy-back clause in the contract in order to qualify as an intangible asset. Absence of buy-back clause protection does not prohibit recognition of the asset (it may still be shown in sundry receivables), but it fails the criteria required to be recognised as an intangible asset. (2) PPE versus intangible asset (in situations where the client commitment is funding physical assets). We anticipate that this decision is made once at the start of a contract and not on an asset by asset basis; Risks; Who bears the risks of ownership of the assets acquired? Who funds replacement, insurance and maintenance costs especially where these are abnormal? Rewards; Who derives the economic rewards (revenue & profit) from the asset? Where assets have a residual value at the end of the contract who benefits from this? Control; Who controls the use of the assets, and who controls physical access to the assets? Can the Group remove the assets at the end of the contract? Control may not rest with whoever holds legal title if a different party exercises day to day direction over the use of the asset. Legal title; The possession of legal title does not automatically dictate that the assets are PPE of the Group or the client, for example legal title is looked through when accounting for finance leases. It is however a strong indicator and others factors would have to be highly persuasive in order to override legal title. Contract life; Is the contract life similar to the life of the assets being acquired? Here a distinction should be made between the intention to create a facility of a long standing nature, and shorter lives of many of the individual assets make up parts of the facility. Contract life should be considered against the overall facility life which in the case of a building will be for a considerable period. Buy-back clause; Is the unamortised value in the buy-back clause (if it exists) broadly similar to the NBV of the physical assets if they were treated as PPE and depreciated over their normal UEL? If Group does, then strong indicator asset is PPE. If Group does, then strong indicator asset is PPE. If Group does, then indicator asset is PPE. If Group does, then strong indicator asset is PPE. Contract life equal to or greater than the life of the physical assets is an indicator the assets are PPE. Buy-back amortisation similar to NBV is an indicator the assets are PPE. If Client does, then strong indicator asset is intangible If Client does, then strong indicator asset is intangible If Client does, then indicator asset is intangible If Client does, record as an intangible asset, unless there are factors overriding the legal title. Contract life shorter than the life of the physical assets is an indicator the assets are intangible. Buy-back amortisation dissimilar to NBV is an indicator the assets are intangible The decision should be made on the balance of the above factors. Exceptionally, it may be appropriate to separate a client commitment into tangible and intangible components and account for these separately.

64 Contract costs: Client commitments, page 5 of 12 4 A summary of the treatment of typical client commitments; Description Classification Measurement & recognition Income statement impact An investment in the client relationship characterised by a legal agreement that identifies and protects the asset Client commitment intangible asset (Client investment, signing-on fee or key money) Recognised at the point at which both parties have committed to the arrangement. Measured at total value of the commitment, or tranche of commitment if in separate distinct phases. Accrual recognised in client commitment accrual account in HFM for unspent amount (cash flow effect will be capex not working capital). Amortise on a straight-line basis over the life of the contract. Begin amortisation no later than the commencement of revenue generating activities.* Physical assets funded by the Group and used directly in Group operations PPE Recognised as the cash is spent on the assets. Measured at cost less depreciation (see PPE policy 11) Depreciate over the shorter of physical life or contract term* An investment in the client relationship that is not separable from existing operations or identified by a legal agreement. Sundry receivables client incentive prepayment Recognised at the point at which both parties have committed to the arrangement. Measured at total value of the commitment, or tranche of commitment if in separate distinct phases. Accrual recognised in working capital for unspent amount. Amortise on a straight-line basis over the life of the contract. Begin amortising when revenue generating activities begin.* A lease premium prepayment arises where the relationship is that of landlord tenant and an up front premium is paid by the Group to secure the site Sundry receivables Recognised at the point at which both parties have committed to the arrangement. Write-off prepayment on a straight-line basis over the life of the lease Any client commitment that is effectively a loan under the terms of the contract, i.e. set repayment schedule, interest charged. Sundry receivables loan Recognised at the point at which cash leaves the control of the Group. Cash repaid reduces receivable balance no income statement impact (unless loan is interest bearing.) There is no reasonable certainty that a future right or access to economic benefits has arisen from the expenditure Expense Measurement is based on the costs incurred (i.e. cash spend and accrued costs) in the period Charge through the income statement in the period incurred. * The write-off of the asset to the income statement may be impacted by the terms of any buy-back clause in the agreement. The effects of a buy-back clause are discussed in below.

65 Contract costs: Client commitments, page 6 of Client commitment intangible asset (Client investment, signing-on fee or key money) This is an investment in the client relationship and represents the most common accounting treatment for client commitments. There are different forms of client commitment intangible assets, the most common of which are investments made through the purchase of catering assets on behalf of clients, signing-on fees (or key money) paid direct to a client (who uses the funding at its own discretion) or other expenditures relating to the contract as agreed by the client. Such funding represents an investment in the contract, not the underlying assets that may have been purchased with the funding. In each case the terms of the client contract support the treatment of the investment as an intangible asset (i.e. the asset is protected by a contractual or legal right). This is necessary in order to pass the IFRS intangible asset recognition test which requires that an intangible asset is both identifiable and measurable. The implications of this are that; The commitment must be capitalised and accrued in full at the time the agreement is made. The asset represents the client relationship and therefore timing differences to the cash spend are not relevant. An exception to the above is when the commitment is made in separate distinct tranches. For example, where part of the commitment is to fund a separate revenue generating facility in year three of the contract, the asset created through this separate tranche should be recognised when it is created and not at inception. An exception may also be made where there is significant uncertainty about the level of spend that has been committed to under the contract. Amortisation of the intangible should be on a straight-line basis over the term of the arrangement and should commence no later than when revenue generating activities begin. Client investments, signing-on fees and key money not protected by a buy-back clause do not meet the definition of an intangible asset. They may however qualify as a client incentive prepayment and be shown in sundry receivables. Where the Group makes a payment to a client as a client commitment intangible then this expenditure is shown as an intangible asset and is treated as capital expenditure for balance sheet and cash flow purposes. Where direct reimbursement of the client commitment intangible is received from the client in accordance with the contract terms, this is treated as Revenue and not a credit to the asset. Alternatively, where the client commitment is described in the contract as a loan, it should be accounted for as a loan receivable and not as Revenue. Repayments in this case will reduce the outstanding loan receivable.

66 Contract costs: Client commitments, page 7 of 12 4 Example: Signing-on fees The Group has successfully tendered for the contract to operate food service in the corporate boxes at a prestigious sporting venue for the next three years. At the start of the contract the Group must make a commitment to the client to pay a signing-on fee of 3 million, payable in three instalments at the start of each year of the contract. Although the contract is run on a profit basis the offer is packaged within the clients overall business and, in substance, the corporate hospitality has been outsourced to the Group. At the start of the contract the Group has made an irrevocable commitment to the client to pay a signing-on fee of 3m. The Group should record this as Dr Intangible asset signing-on fee Cr Cash Cr Client commitment accrual in HFM ~ part of capex 3m 1m 2m The Group recognises the entire signing-on fee as an intangible asset and the accrual to reflect the staggered cash flows. The accrual should not be netted off against the intangible asset, but is shown separately within payables. The amortisation charge is 1m per year. The relationship is not considered to be a lease arrangement because the Group s offer is integrated within the client s corporate hospitality offer. The Group is a service provider and not a tenant Property, plant and equipment Investments should be classified as property, plant and equipment regardless of legal title if the Group bears / enjoys the risks and rewards of ownership of the assets purchased through a client commitment. In certain situations, despite the fact that assets are situated at a client site and the client has legal title, it is appropriate to show these assets as PPE. The Group may have effective day to day control and sole use of the asset for its entire physical life. All economic benefits that flow from the asset effectively flow to the Group as it is used in revenue generating activities. A buy back clause may protect Group s interest in the residual value of the physical assets at the end of the contract. The Group may also bear the majority of the risks of ownership, such as responsibility for insurance, maintenance and replacement including exposure to abnormal or unforeseen costs. Where these circumstances exist they may be persuasive enough to indicate that the correct accounting treatment is to show the assets as PPE. Assets should be capitalised as they are purchased. Depreciation should commence at the point at which the asset is ready for use this may be before the asset is actually brought into use. The depreciation charge should write-down the carrying value of the asset to its residual value over the useful economic life of the asset (the shorter of either the physical life of the asset or the term of the contract). See below for guidance on appropriate accounting to be followed in situations where a buy-back clause is present in the contract. Section 12 Property, plant and equipment, contains more detailed guidance on the recognition, measurement and depreciation of tangible assets Client incentive prepayments These should be accounted for as prepayments (within working capital) and represent a client asset that does not meet the definition of an intangible asset (and is not a lease premium or a loan). These assets therefore are not separable, i.e. they are not capable of being separated from other Group activity and sold on, or protected by a specific clause in the client contract. Client investments, signing-on fees and key money not protected

67 Contract costs: Client commitments, page 8 of 12 4 in the contract by a buy-back clause do not qualify as intangible assets but if they meet the definition of an asset should be classified as a prepayment. These assets must be expensed on a straight-line basis over the contract life to which they relate. Example (1): Sales commissions The Group has successfully tendered for a new contract and has agreed to pay the client an amount equivalent to 15% of turnover at the sites it operates on behalf of the client. This arrangement is entirely contingent with no minimum guaranteed amount. The Group has agreed to pay five years worth of estimated sales commissions to the client at the beginning of the contract. The payment should be recognised as a client incentive prepayment. Because the amount ultimately paid to the client will depend entirely on turnover the arrangement is not a lease. The Group should write down the initial prepayment over the five year period it relates to and book any difference with the amount of actual sales commission incurred as an expense as it arises. Example (2): Client incentive prepayments The Group has successfully tendered for a new contract; however local law states that the employees of the units that operate the contract are entitled to redundancy pay even though they will be re-employed by the Group. Local business practice is for the incoming contractor to pay the redundancy pay. This is not covered by any legal agreement between the new client and the Group and is an informal practice. The payment made to the unit staff does not qualify as an intangible asset. It cannot be separated and it is not protected by the legal agreement between the client and the Group. The payment does form part of the investment made by the Group in the client contract because the Group could not commence trading at the units without making it and it is recovered within the contract price. It is therefore an asset because it gives the Group the right to future economic benefits from the contract. Show the payment as a client incentive prepayment and release the cost on a straight-line basis over the course of the contract Lease prepayments/premiums These payments are made to secure the use of a specific site for a period of time. The arrangement must meet the definition of a lease set out in Section 20 Leases. In lease arrangements the relationship is not one of client and service provider but that of landlord and tenant as the Group is able to control the business it conducts from the site and has a high degree of freedom over the type of operation it runs at the site. If the conclusion is that a lease has been created the commitment is a lease premium and should be accounted for as a prepayment. The lease premium should be expensed over the life of the lease arrangement.

68 Contract costs: Client commitments, page 9 of 12 4 The following indicators help define the distinction between lease arrangements and other forms of client commitment investment; Client commitment Relationship is that of service provider client The contract specifies the style, branding or pricing of the offer to some degree, or there is an expectation that the operation will conform to an overall offer controlled by the client. The operation is integrated into the client s overall facility and offer. The commitment is to be settled by a single or few lump sum payments separated by time periods greater than 3 months. The commitment is protected by a buy-back clause ~ strong indicator that a signing-on fee intangible is created Lease arrangement Relationship is that of landlord tenant The Group has greater autonomy over the style, branding and pricing of its offer. The operation is a stand-alone business. The commitment is settled by a number of regular payments often separated by shorter time periods. The commitment is not protected by a buy-back clause; most lease arrangements do not permit the repayment of the premium paid if they terminate early. Commitments made with staggered cash flows are generally indicative of a lease arrangement as opposed to a signing-on fee. This is because the staggering of cash flows usually indicates that the payment is for the time that the site is made available, and not an intangible asset invested in the client relationship. However a staggered cash flow is not always associated with a leasing situation. It could be perfectly feasible to have a client contract containing an annual commitment to a signing-on fee. Where this is the case a liability has been created for the element of the signingon fee that remains unpaid. This should be recognised along with the intangible asset. Integration into the client s offer or service provision is a strong indication that the commitment is an intangible asset signing-on fee, and that the Group is being contracted to provide food services at the site. However, where the Group is not subject to any restrictions over its ability to control and operate the site, the payment or commitment may well represent a lease premium and/or rental payment for use of the site. Such circumstances should be clear from the wording of the contract Client loan The cash transferred to the client is defined as a loan in the contract. The correct treatment is to classify as an other receivable within working capital. The recovery of the loan from the client must not be treated as revenue but as the recovery of a loan. Loan arrangements include fixed repayment instalments independent of the contract revenue streams. In addition any interest charge added under the contract terms is a definite indicator that a loan is in place. Where the Group makes a payment to a client as a 'Client loan' then this expenditure is held within loans receivable and is treated as working capital for balance sheet and cash flow purposes. Reimbursement received from the client in accordance with the contract terms will reduce the outstanding balance of the loan receivable. Such loan repayments are NOT accounted for as Revenue. There is no need to mark to market these loans as they fall under the loans & receivables category under IAS 39 and therefore should be held at amortised cost. Due to the highly specific nature of these loans implied interest rates should equal whatever interest rate is specified on the loan under the terms of the contract, including 0% if the loan is non-interest bearing.

69 Contract costs: Client commitments, page 10 of Asset write down period The default write down policy for all client commitment assets (whether intangibles. PPE or prepayments / receivables) is that the asset must be written off; over the shorter of the contract term, or if applicable, the physical life of the asset (facility) funded through the commitment. Assets treated as PPE under a client commitment can either be capitalised and depreciated individually or aggregated into a facility asset in which case the physical life of the overall facility can be substituted for individual asset lives. In this situation a base stock policy with replacement cost of short life assets being expensed as incurred should be used Extended buy-back clause exception In circumstances where there is an extended buy-back amortisation period in the contract (i.e. the buy-back amortisation period is longer than the length of the contract) then; the client commitment asset can be written off over the extended buy-back period, provided that it can be clearly demonstrated, through a thorough contract review process (see * below), that the carrying value of the asset is never greater than its net realisable value, and prior approval has been obtained from the Group Financial Controller for this accounting treatment. The expectation when the contract commences, is that at the end of the initial contract period, the underlying assets will retain value such that it will not be necessary to completely replace them in order to operate an extended contract. The contract review process may be carried out as part of a general review of the entire contract portfolio which, as a minimum, should take place annually with the objective of ensuring that the carrying value of contract assets is less than or equal to its net realisable value and must consider; *Extended buy-back clause exception; contract review process 1. Asset carrying value for a specific contract can never exceed the unamortised value of the buy-back clause. 2. The review process should identify contracts either performing below initial expectations or making a loss and where necessary the carrying value of the assets invested in the contract must be justified by a value in use calculation. 3. The review process must take into account of the most likely commercial outcome from the relationship with the client, i.e. whether the residual commitment asset will be recovered through improved pricing or a smaller commitment investment in any contract renewal period. If the contract is not expected to be renewed the recoverability of the asset must be clearly demonstrated. The most likely commercial outcome from the contract may change over time. 4. The review process must consider the client s credit worthiness and ability to continue as a going concern. 5. Where the client commitment asset has been assessed as PPE under no circumstances can the exception be used to extend the write-down period beyond the physical life of the PPE.

70 Contract costs: Client commitments, page 11 of 12 4 *Often client commitments are protected by a buy-back clause (in fact this is strongly recommended as best commercial practice). These clauses set out an amortisation schedule controlling the recoverable amount due back to the Group over the life of the contract should it terminate early. Extended buy-back clauses run for a period longer than the contract. In addition, where an extended buy-back amortisation period has been applied to an existing contract, a formal review should take place when that contract is either renewed or extended, to confirm that the underlying assets retain value at that date consistent with the remainder of the extended buy-back period. Example: Buy-back clause (1) The Group has won a contract with a new client and has committed to pay 0.5m to fit out new restaurant and kitchen facility at the client s site. Legal title to the physical assets will belong to the client and the contract life is 10 years. The facility being built has an estimated physical life of approximately 10 years at which point it will be worth nothing. The Group is responsible for replacing and maintaining all the assets within the facility. There is a buy-back clause in the contract that amortises the commitment over a 10 year period on a straight-line basis. These assets are PPE. The Group will operate the facility over its entire estimated physical life. The Group will generate all the rewards from its use (profits), and is responsible for the risk from its use (the repair and replacement cost of the assets). Contract life is similar to the facility life and the same as the buy-back schedule. These factors outweigh legal title being retained by the client. The facility is effectively the Group s PPE and only in remote circumstances (i.e. the contract terminating early) would the client enforce control but even in these circumstances the NBV of the asset is protected by the buy back clause. The entire cost of the facility should be capitalised as PPE and depreciated over 10 years. The entity adopts the base stock policy for short life assets (such as microwaves, cutlery, glassware, etc) and therefore the cost of these initial items can be included in the overall facility asset created. Replacement short life assets should be expensed in the period in which the cost is incurred. Example: Buy-back clause (2) The facts are as above however; The contract life is only for 5 years. On balance the asset created is a client commitment intangible asset because the Group s use of the facility is for half of its physical life and this is combined with lack of legal title. There will be considerable residual value left in the physical assets at the end of the 5 year contract. The intangible asset can be amortised over 10 years (i.e. the period the buy-back protection clause). The contract must be reviewed annually for indicators of impairment because the amortisation period is greater than the contract term. This review must consider the most likely commercial outcome from the relationship with the client and whether this supports the carrying value of the asset. Example: Buy-back clause (3) The facts are as (1) above however; The buy-back schedule lasts for 15 years. On balance the asset created is PPE for the reasons given in (1) above. The asset should be depreciated to a residual value of zero over 10 years. Even though the buy back period lasts for 15 years the physical life of the facility is 10 years at which point it will be worth nothing. The extended buy-back clause cannot override this.

71 Contract costs: Client commitments, page 12 of 12 4 Example: Buy-back clause (4) The facts are as (1) above however; The buy back schedule lasts for 15 years. The physical life of the assets funded significantly exceeds 10 years The asset created is a client commitment intangible and can be written down over 15 years. The physical life of the assets is significantly longer than the contract and therefore, subject to regular contract reviews to demonstrate recoverability, the client commitment intangible can be written down over 15 years Base stock policy for short life items Short life items are defined as items of equipment that require on going renewal and replacement throughout a contract s life. They are typically small value items with a durable nature, i.e. typically last up to three or four years, although their physical life is significantly shorter than the life of the contract. These items typically include glassware, cutlery & crockery. The initial expense on short life items at the start of a contract should be held as base stock on the balance sheet. This will be classified either as a client commitment intangible asset or as property, plant and equipment (where it has been established that the Group bears / enjoys the risks and rewards of ownership of these assets). The accounting treatment will reflect the asset classification determined to be appropriate for the overall client investment for each contract. Short life assets should be amortised / depreciated over an appropriate period, often the contract life. All replacement items must be charged to the income statement as the cost is incurred.

72 5. Share-based payments - employee share schemes Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Compass Group accounts for share-based payments in accordance with IFRS 2, under which all share-based payment transactions are recognised in financial statements. Equity-settled transactions are measured at the fair value of the goods and services, or where this cannot be reliably measured, the fair value of the equity instruments granted at the date of grant. Cash-settled payments are measured at the current fair value of the liability at each balance sheet date. Where the terms of a transaction are modified, the measurement basis will change. This may accelerate the timing of booking the expense. The cost of employee share schemes will be determined by Group Finance, Chertsey and communicated to countries, where relevant. Charges for share-based payments are invoiced to employing entities only where it is necessary or appropriate to do so for tax purposes, for example, in order to obtain local tax relief. Such charges will be treated as cost-sharing and will not be included within PBIT for management accounts purposes. For local subsidiary statutory accounts presentation purposes, invoiced sharebased payment charges should be charged to the income statement as part of wages and salaries expense. Where employing companies are required to comply with IFRS 2 (or an equivalent local GAAP financial reporting standard), the income statement expense will be calculated by Group Finance, Chertsey and notified to the entity concerned, taking account of any charges made through cost-sharing. This expense should be recorded as a capital contribution within equity. 5.1 Disclosed accounting policy The Group issues equity-settled and cash-settled share-based payments to certain employees. Equity-settled share-based payments are measured at fair value (excluding the effect of non market-based vesting conditions) at the date of grant. The fair value determined at the grant date of the equitysettled share-based payments is expensed on a straight-line basis over the vesting period, based on the Group s estimate of the shares that will eventually vest and adjusted for the effect of non market-based vesting conditions. Fair value is measured using either the Binomial Distribution or Black- Scholes option pricing models as is most appropriate for each scheme. The expected life used in the models has been adjusted, based on management s best estimate, for the effects of exercise restrictions and behavioural considerations. For cash-settled share-based payments, a liability equal to the portion of the goods or services received is recognised at the current fair value determined at each balance sheet date. Compass Group PLC - Accounting policies and procedures manual 3.0, March 2010

73 Share-based payments, page 2 of Default policy and process for exceptions Default policy The income statement charge for employee share schemes, and other share-based payments, will be determined by Group Finance, Chertsey, based on the detailed accounting rules set out in IFRS 2. Where recharged, these costs should be booked to the income statement by the entities concerned. Entities should also reflect an IFRS 2 expense in their local statutory accounts where this is required under local GAAP Consultation and authorisation process for exceptions Any variance from recording the notified charges or expense requires the written approval of the Group Financial Controller. 5.3 IFRS references IFRS 2 Share-based Payment IFRS 2 was amended in June 2009 to clarify its scope and the accounting for group cash-settled share-based payment transactions in the separate financial statements of the entity receiving the goods and services when the entity has no obligation to settle the share-based payment transaction. The amendments also incorporated guidance previously contained in IFRIC 8 and IFRIC 11 which were both withdrawn. 5.4 Summary of IFRS requirements Entities often grant shares or share options to directors and other employees, as part of their remuneration package, or to other parties, for example as part of an acquisition payment. The cost of such equity instruments must be recognised within the income statement based on the difference between the fair value of the shares at the date of grant and, where relevant, the option price. Fair value is determined using an option-pricing model. The expense is normally charged to the income statement on a straight-line basis over the vesting period. In the case of options or other shares granted to directors and other employees, adjustments are made to the fair value to reflect the nonachievement of non-market based vesting conditions (such as the length of service). Market-based conditions (such as the attainment of a specific share price target) are reflected in the fair value of the instruments at the date of grant and are not subsequently adjusted for experience. Once share options or other share arrangements have vested (that is, when all of the vesting conditions, such as length of service and achievement of Group Free Cash Flow or EPS growth targets, have been met), the expense cannot be reversed through the income statement even if the options are not subsequently exercised by the employee. Extensive disclosures must be provided regarding such schemes, including the inputs and assumptions used in the option-pricing model and also details of any Compass Group shares held by the Group (in trusts or otherwise) to fund such schemes. An entity might modify existing share-based payment transaction terms and conditions. The cancellation or settlement of an option is treated as an acceleration of vesting, and the additional expense that would have been recognised over the remaining vesting period is recognised immediately.

74 Share-based payments, page 3 of 8 5 If new equity instruments are granted to employees that are identified as replacements for cancelled instruments, then the entity will recognise the incremental fair value granted as an expense over the remaining vesting period. The outstanding expense in relation to the cancelled instruments will continue to be recognised over the original vesting period. The cancellation of a share-based payment arrangement by an employee (including share-save options) is treated in the same way as a cancellation by an employer Recognition and measurement There are complex accounting rules regarding the calculation of income statement charges. These have not been reproduced here, but are summarised below. Scenario New shares to be issued on exercise Existing shares purchased in market by trust ESOP trust subscribes for new shares on date of grant Company committed to buying existing shares in market at future date Minimum profit and loss account charge Fair value of shares on date of grant less exercise price Fair value of shares on date of grant less exercise price Fair value of shares on date of grant less exercise price Fair value of shares on date of grant less exercise price The charge for employee equity instruments, awarded as part of a remuneration package, should be recognised within the wages and salaries cost for the year. The full fair value of share-based bonus payments must be expensed to the income statement over the period in which the bonus is earned. Where share bonus awards are subject to doubling after the completion of a further period of service, then the expense relating to the doubling element should be spread on a straight-line basis over that additional period of service. In the event that the doubling element of the award does not vest (for example, because the additional period of service is not completed by a leaver), then the accrued expense may be written back to the income statement. Other share-based payments should be recognised within the appropriate categories to which they relate.

75 Share-based payments, page 4 of Application guidance Charges to employing companies for share-based payments relating to their employees Charges for share-based payments (other than in relation to share bonus schemes) will only be invoiced to the employing companies where it is appropriate to do so for tax purposes. These will be invoiced as part of cost-sharing arrangements and are not charged to PBIT for management reporting purposes. All such charges must be expensed through the income statement for statutory reporting purposes and reflected within the wages and salaries expense. Businesses are expected to account for the cash equivalent cost of share bonus scheme awards made to their employees, but not for the option value (see section below), unless this has been invoiced under costsharing arrangements. All charges invoiced under cost-sharing arrangements must be expensed through the income statement in the year that they are invoiced using HFM account IS Cost-sharing charges for Group Head Office costs will include the applicable element of share-based payment charges relating to Head Office employees. These need not be separately identified for reporting purposes Responsibility for calculation of charges for share-based payments Group Finance, Chertsey will calculate the IFRS 2 cost of the various share schemes when options are granted. The following schemes fall within the scope of this exercise: a) Executive and management share options b) Share-save options c) Long-term incentive plan ( LTIP ) d) Share-based bonus payments e) Share investment plan ( SIP ) If there is a requirement to calculate charges for share-based payments under a local GAAP that is not consistent with IFRS 2 (e.g. US GAAP), then the local country is responsible to determining the charges to be recorded in the local statutory accounts Accounting for income statement expense by employing companies Where an entity s local statutory financial statements are required to comply with IFRS 2 (or an equivalent local GAAP financial reporting standard (for example: UK GAAP standard FRS 20), the share-based payment expense will be calculated by Group Finance, Chertsey and notified to the entity concerned. This expense will not be invoiced but should be recorded for reporting purposes as a capital contribution within equity. The expense will be calculated using the following principles. In the case of options which vest immediately, the IFRS 2 option charge must be recorded immediately in the income statement. Where the options vest at the end of

76 Share-based payments, page 5 of 8 5 a period of service, the charge should be apportioned on a straight-line basis over that time period. IFRS 2 sets out a number of complex rules that may cause the IFRS expense to vary. The expense is calculated allowing for an expected number of leavers. These estimates are updated on an annual basis to allow for actual experience up to the point where the service period ends and the options vest. If an employee transfers between employing companies, the transferring company continues to account for any expense up to the date of transfer. Any remaining expense for unexpired options arising after the date of transfer (and experience adjustments recognised after that date) will be expensed by the new employing company. If an employee withdraws from an option scheme but does not leave Group employment, this is treated as a cancellation and all costs relating to that option must be charged to the income statement immediately. The following examples provide guidance on how the expense will be calculated by Group Finance, Chertsey Examples: Share-based payment expense 1 An employee is awarded an option over 1,500 shares. The option price is 3.00 and is exercisable in three years time if the employee is still employed by the Group. The value of the option grant is invoiced as 900. The expense of 900 will be spread equally over the three years until the option vests giving an annual expense of 300 in relation to the option grant to this employee. 2 As in 1 above, but at the end of the three years the share price is 2.80 so the employee does not exercise the share option. The employee continues to have the right to exercise the option during the option exercise period. There is no change to the 900 expense that has already been recorded in the income statement. Once an option vests the income statement expense is never reversed even if the option is never exercised. 3 As in 1 above, but the employee leaves after one year and so will not be able to exercise the share option. The employing entity must notify the Group Rewards Office at Chertsey that the employee has left. The 900 IFRS expense continues to be charged to the income statement over the vesting period by the employing entity as the original calculation already takes account of the expected level of leavers. The overall expense is adjusted to reflect actual leavers on an annual basis. 4 As in 1 above, but after two years the employee transfers to work for another Group entity. The original employing entity should continue to charge the IFRS expense to the income statement up to the date of transfer and the new employing company will record any expense over the remainder of the three-year vesting period. 5 As in 1 above, but the option only vests if a Group Free Cash Flow Target is achieved over a three-year period. At the end of the period, this condition is not met. The options do not vest and therefore lapse. The IFRS 2 expense is reversed and credited back to the income statement. 6 An employee joins a Group share-save scheme requiring minimum savings over five years. At the start of the scheme, the value of the options available is valued at 1,000. After two years, the employee decides they can no longer afford the

77 Share-based payments, page 6 of 8 5 subscriptions and withdraws from the share-save scheme, having their savings returned to them. The employee remains employed with the Group. The value of the options available at the end of the five-year term is 1,000. This expense should be charged to the income statement equally over the time until the options vest (five years). However, the employee cancels their participation after two years. Under IFRS, this means that the whole expense for the cancelled option (the remaining 600) must be charged immediately to the income statement. This is not reversed at any stage Share-based bonus payments Share-based bonus payments may have two components. a basic award which vests immediately although delivery is deferred to a future date a doubling award which only vests after an additional period of service has been completed. For each component there are two elements to the expense that must be recorded:- a) The equivalent cash cost of the basic award which must be charged to the income statement by the employing company in the year in which the bonus is earned. The equivalent cash cost of the doubling award (that will only vest after a qualifying period) should also be expensed to the income statement but on a straight-line basis over the qualifying period in question. b) The IFRS 2 option expense for the share bonus payments will be calculated by Group Finance, Chertsey. Where this is recharged to the employing company under cost-sharing arrangements, this charge must be expensed to the income statement immediately. Any expense relating to the basic award (that vests immediately) will be recognised in the year in which the bonus is earned, and that relating to the doubling award will be recorded on a straight-line basis over the qualifying service period. If an employee transfers between employing companies, the original employing company remains responsible for recording any remaining cash equivalent cost of the bonus award. In addition, the accrual for the cash equivalent element of the bonus entitlement should be retained by the original employing company. When the shares are called for by the employee, the cash equivalent cost of the bonus payment (i.e. calculated using the prevailing grant date share price and exchange rate) will be recharged to the original employing company, which holds the share bonus accrual. Any difference between this value and the actual cost incurred to acquire shares for delivery to the employee is accounted for centrally as an equity movement. The cash equivalent cost of share bonus payments is recorded as wages and salaries as for cash bonus payments. All recharges or expenses recorded by employing companies for share-based payments under cost sharing arrangements must be reported below PBIT using HFM account IS61170.

78 Share-based payments, page 7 of 8 5 Examples: Share-based bonus payments 1 An employee is awarded 500 shares as a bonus payment for the year. This represents a cash equivalent of 1,500 at 3.00 per share being the grant date price. In addition an IFRS expense of 500 is invoiced by Chertsey under cost-sharing arrangements. The cash equivalent cost of the shares ( = 1,500) and the IFRS expense of 500 must be charged to the income statement for statutory purposes in the year to which the bonus relates. For management reporting purposes, the cash equivalent cost is treated as PBIT whereas the IFRS expense of 500 is reported as cost sharing below PBIT. 2 As 1 above, but the employee is entitled to a doubling award of a further 500 shares after completing a further three-year period of service. In addition a further IFRS expense of 500 is invoiced by Chertsey for the doubling award under cost-sharing arrangements. The cash equivalent cost of the doubling shares ( = 1,500) must be charged to the income statement on a straight-line basis over the three-year qualifying period as part of PBIT. The IFRS 2 expense should be charged to the income statement in the year in which it is invoiced as a cost-sharing expense. The charge from Chertsey will allow for spreading over the service qualification period. 3 As 2 above, but the employee transfers to another employing company within the Group after one year of the additional three-year service period. The cash-equivalent accruals of 1,500 for the basic award and 500 for the doubling award are retained by the original employing company, which should also record the remaining cash equivalent expense for the doubling award during the remaining 2 year service period. 4 As 2 above, but the employee resigns and leaves the Group after one year of the additional three-year service period. A cash payment is made to the employee of 1,500 in respect of the basic share award and the doubling award is forfeited. 500 already accrued for the cash-equivalent of the doubling award is credited back to the income statement immediately. If any IFRS charges have been made by Chertsey under cost-sharing arrangements, these will be credited in the following year Accounting for shares released under the Long term Incentive Plan Normally, shares in Compass Group PLC, released under the LTIP, are subscribed for at current market value by an Employee Trust, which in turn distributes the shares to those employees entitled to them. The Trust will then recharge the market value of the shares released under the Plan to the employing companies. If the employing company has already accounted for the share-based payment expense under IFRS 2 rules, then it must treat this cost as a distribution to the ultimate parent company, Compass Group PLC (unless that company has previously invoiced the relevant share-based expense to the employing company). This distribution should be recorded in the local statutory accounts as a movement to retained earnings and reported on HFM using accounts IS92111 and IS92112 as appropriate. The amount of the distribution is reduced to allow for any share-based payment expense previously invoiced by Compass Group PLC. Any share-based payment expense previously recorded under IFRS 2 (or the equivalent local financial reporting standard) may be transferred from the Share-based Payment Reserve to Retained Earnings.

79 Share-based payments, page 8 of IFRS 2 expense for Share Investment Plans ( SIP ) Whether an expense should be recorded for SIP s depends on the terms of the plan. Normally, any such expense will be immaterial and can be disregarded unless the terms of the plan provide for the company to offer free shares or discounts against the current market share price to participants Group accounting treatment for share-based payments Compass Group will record the expense for share-based payments as wages and salaries using HFM account IS Other share based payments There are very few other circumstances where Compass Group shares are used to pay for goods or services. If such circumstances arise, refer to Group Finance, Chertsey for accounting information.

80 6. Material profit or loss items Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Although IFRS does not recognise the expression exceptional items, it does require that certain types of item of a material nature should be separately disclosed either on the face of the income statement or in the notes. However, the term exceptional items may still be used to describe material items within a set of financial statements provided that it has been clearly defined. All items of a material nature, requiring separate disclosure, should be shown above operating profit regardless of their frequency of occurrence or nature. Material releases of provisions or movements in fair value adjustments originally established against goodwill are part of operating profit but should be disclosed separately for the purposes of Group reporting. Extraordinary items are not allowed under IFRS. 6.1 Disclosed accounting policy Exceptional items Exceptional items are disclosed and described separately in the financial statements where it is necessary to do so to provide further understanding of the financial performance of the Group. They are material items of income or expense that have been shown separately due to their nature or amount. 6.2 Default policy and process for exceptions Default policy Items of an unusual and material nature should be charged to operating profit. Details of any amounts considered requiring separate disclosure in the income statement or notes must be notified to and approved by Group Finance, Chertsey Consultation and authorisation process for exceptions No amounts are to be reported as Exceptional items using accounts IS67100, IS67200, IS67300 or IS67400 without the prior written approval of the Group Reporting Manager. 6.3 IFRS references IAS 1 Presentation of financial statements IAS 8 Accounting policies, changes in accounting estimates and errors

81 Material profit or loss items, page 2 of Summary of IFRS requirements Basic principles Certain profit or loss items by their size or frequency or nature may require separate disclosure within operating profit either on the face income statement or in the notes. IAS 1 lists the following items as potentially requiring separate disclosure; write-downs of stock or impairments of tangible fixed assets (in addition there are detailed disclosure requirements regarding impairments of goodwill and other assets), restructuring activities and reversals of any restructuring provisions, disposals of tangible fixed assets, disposals of investments, discontinued operations, litigation settlements, releases of provisions. As explained below an item must be material to the Group and not solely to the reporting entity. All items of this nature must be referred to the Group Financial Controller before classification is decided upon Tax Any special circumstances that affect the overall tax charge or credit for the period, or that may affect those of future periods, should be disclosed in a note to the accounts and the individual effects quantified. See the policy on Tax on profits for further details Summary of reporting classification requirements Nature of item Bad debt expense, and subsequent recovery of a bad debt Inventory write-down Depreciation and amortisation Reporting treatment Report in HFM account IS45311 Change in provision for impairment of receivables Report in HFM account IS46110 Other overheads Report in the following HFM accounts as appropriate: IS42131 Amortisation / impairment - owned property plant & equipment or IS42132 Amortisation / impairment - leased property plant & equipment or IS42121 Amortisation / impairment - owned other intangibles or IS42122 Amortisation / impairment leased other intangibles Goodwill impairment Report in HFM account IS42111 Amortisation / impairment Goodwill Normal operating results of a business being closed, and qualifying as a discontinued operation Report results under the normal captions. The Group would report these figures separately as discontinued activities, by transferring the entity within the entity structure. See policy on Non current asset held for resale and discontinued operations.

82 Material profit or loss items, page 3 of 5 6 Nature of item Write-down of plant and equipment for impairment Release of a provision for legal claims Release of previously booked fair value adjustments, outside of the hindsight period. Correction of fundamental error in previous years financial statements Losses on termination of an operation arising from asset writedowns, unavoidable staff costs and other closure cost Provision for sale of a business, including expected operating losses from the balance sheet date to date of sale Profit/loss on disposal of an intangible asset Profit/loss on disposal of property plant and equipment Profit/loss on disposal of an investment Profit/loss on disposal of a subsidiary undertaking Costs of a fundamental reorganisation of a business, and related provisions. Reporting treatment Report on appropriate account in HFM section IS42131 Amortisation / impairment - owned property plant & equipment. If material, notify Group Finance, Chertsey for consideration of separate disclosure in Group accounts. Report in HFM account IS44620 Legal fees, licensing, compliance and insurance Report in HFM account IS46110 Other overheads but identify separately in MAP pack quality of profits reporting as material releases require separate disclosure. Inform Group Finance, Chertsey in advance of doing so. See below. Prior period adjustments to reserves are not permitted. This may, if material to the Group, have to be disclosed separately in the Group accounts. Refer to Group Finance, Chertsey for guidance and reporting details. The provision will be taken into account in calculating the Group profit or loss on disposal. Report in HFM account IS42230 Gain or loss on sale of other investments Report in HFM account IS42210 Gain or loss on sale of intangible assets Report in HFM account IS42220 Gain or loss on sale of property, plant & equipment Report in HFM account IS42230 Gain or loss on sale of other investments Report in HFM account IS67100 Sale of a discontinued business or IS67200 Sale of an exited business This may, if material to the Group, have to be disclosed separately in the Group accounts. Refer to Group Finance, Chertsey for guidance and reporting details Changes to estimates and correction of errors Under IFRS there are many instances where estimates are used in order to measure assets and liabilities at fair value. Changes to estimates are to be reflected in the current year s results and in accounting entries going forwards. Changes in estimates do not affect prior year results or opening balances. The income statement impact should be shown in the current year and future years if appropriate. An exception to this is revision of provisional estimates of fair value adjustments made in the hindsight period after an acquisition; see the policy on Acquisitions and fair values. The hindsight period under IFRS extends for 12 months following the date of acquisition, however any adjustment made in the financial year following the acquisition is dealt with by restating the prior period. Any proposal to do so must be notified to and approved by the Group Financial Controller. Any material errors must be notified to Group Finance, Chertsey and the Country Finance Director. Prior years should be restated as far back as possible to eliminate the error, and the error should not affect the profit or loss of the current year. Errors must be material to the Group; immaterial

83 Material profit or loss items, page 4 of 5 6 errors should be put through the current year s results, and not adjusted for in reserves. 6.5 Application guidance Profits or losses on disposal of fixed assets IFRS requires that profits or losses arising on the disposal of fixed assets are reported within operating profit, even if material to the Group. Where material to the Group these are disclosed separately within the income statement or notes to the accounts. It is important that all profits or losses on disposal, even if immaterial, are recorded in the correct account in HFM as this is taken into account by the automatic cash flow calculation. HFM account: IS42220 Any profits or losses which may be material to the entity should be notified to Group Finance, Chertsey Provisions for a fundamental restructuring or sale/termination See separate policy on Provisions for details of when a provision is required. Operating losses In contrast to an actual profit or loss on disposal of an operation or business, provisions for restructuring or closure will include expected operating losses from the balance sheet date to the date of sale or termination. The creation or release of the provisions and the actual profits and losses as they occur should each be analysed as continuing or discontinued, depending upon the classification of the operation for the period for which the financial statements are being prepared. See policy on Non current assets held for resale and discontinued operations. Example: Restructuring provision In 200X, an entity is demonstrably committed to a termination plan for a chain of restaurants. A provision of 20m was made in 200X for operating losses up to the date of disposal ( 5m) and for the loss on disposal ( 15m). This provision is shown separately on the face of the 200X income statement as a material item requiring separate disclosure. In 200Y, the trading losses are reported in HFM under the normal headings but flagged as discontinued operations. In the Group s financial statements on the face of the income statement the discontinued operation s results are aggregated into one line along with the release of the 5m provision made in 200X. A note to the accounts will show the results of the discontinued operation under the normal headings. The actual loss on disposal and the related release of the provision for 15m are recognised as a material item requiring separate disclosure within operating profit either on the face of the income statement or in a note to the accounts Provisions The increase or release of provisions must be shown separately on the correct line in HFM reporting and may not be included or set against other lines in the income statement Other material profit or loss items Abnormal operating conditions or start up losses do not automatically give rise to items requiring separate disclosure in Group reporting. The item must be material by its size or by its nature to be reported as such. Many

84 Material profit or loss items, page 5 of 5 6 unusual operating conditions are simply unexpected and would not qualify for separate disclosure. Examples: Abnormal operating conditions 1 A strike causes the closure of a number of sites for two weeks. The catering operations have no sales but still incur costs of 100,000 which are not recoverable from the client. The costs incurred are not material by nature or size in the Group context, but will need to be explained in reporting the adverse variance to budget. 2 Following a review of overheads, one-off costs are incurred of 50m in order to reduce overheads by a similar amount in future years. The costs are included in operating profit and because they are material to the Group they are disclosed separately either on the face of the income statement or in the notes Subsequent amendments to fair value adjustments The assessment of fair values of assets and liabilities on acquisition must be completed by, at the latest, twelve months after the acquisition. Amendments to these fair values may still be needed, however. Because, at this point, no further goodwill adjustments can be made, the effect of such amendments must be reflected in the income statement. If material, they will require separate disclosure. Example: Subsequent amendments to fair value provisions A major acquisition was made several years ago and provisions of 40m set up to cover specific legal risks as part of the fair value exercise. Following a judgement in the year, these are no longer required. The provision release will be treated as an item requiring separate disclosure within operating profit by virtue of its size.

85 7. Tax on profits Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Corporation tax must be calculated using the tax rates and laws applicable for the accounting period. Only taxes on profit should be charged to tax on ordinary activities. Current tax must be presented separately on the face of the balance sheet. It is charged or credited directly to equity if it relates to items that are also charged or credited to equity. Deferred tax should be recognised in respect of taxable temporary differences that exist at the balance sheet date. IAS 12 uses a balance sheet liability approach that focuses on taxable or deductible temporary differences (differences between the carrying amount of an asset or liability and its tax base). Taxable temporary differences include all timing differences and many permanent differences. Deferred tax is recognised on revaluation gains. Deferred tax assets should be recognised only to the extent that they are recoverable. Discounting of deferred tax balances is not permitted. Deferred tax assets and liabilities may not be offset under IFRS unless they relate to tax payable in the same tax jurisdiction. 7.1 Disclosed accounting policy Income tax expense comprises current and deferred tax. Tax is recognised in the Income Statement except where it relates to items taken directly to equity, in which case it is recognised in equity. Current tax is the expected tax payable on the taxable income for the period, using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Such assets and liabilities are not recognised if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the taxable profit nor the accounting profit. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and associates, and interest in joint ventures, except where the Group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that

86 Tax on profits, page 2 of 12 7 sufficient taxable profits will be available to allow all or part of the asset to be recovered. Deferred tax is calculated at the tax rates that are expected to apply in the period when the liability is settled or the asset realised. Deferred tax assets and liabilities are offset against each other when they relate to income taxes levied by the same tax jurisdiction and the Group intends to settle its current tax asset and liabilities on a net basis. 7.2 Default policy and process for exceptions Default policy Compass Group entities should maintain accurate records and processes that allow the timely reporting of tax liabilities to the taxation authorities and through Group reporting. The tax charge in the income statement should include only taxes arising on profits, whether the tax is current, deferred or the attributable share of a joint venture undertaking s tax charge. The attributable share of an associated undertaking s tax charge does not form part of the tax charge. It is added to the attributable profit or loss before taxation and disclosed as a single line item within the income statement. Other taxes are dealt with in a separate policy. Corporation tax must be calculated using the tax rates and laws applicable for the accounting period. Deferred tax should be recognised in respect of taxable temporary differences that have originated but not reversed by the balance sheet date at the rate expected to be applicable at the date of reversal. Deferred tax assets should be recognised to the extent that it is probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Evidence to support the assertion that taxable profits will be available will need to be provided to the Group Tax Department. Any deferred tax assets that are not thought to be recoverable should be reported as unprovided deferred tax. Discounting of deferred tax balances is not permitted by IFRS and must not be applied locally in Group reporting Consultation and authorisation process for exceptions Where it is unclear whether a tax is a tax on profits, the Group Tax Department should be consulted. Any deviation from the above policy must be agreed in writing by the Group Tax Manager and the Group Finance Director. 7.3 IFRS references IAS 12 Income taxes SIC 21 Income Taxes - Recovery of Revalued Non-Depreciable Assets SIC 25 Income Taxes Changes in the Tax Status of an Entity or its Shareholders 7.4 Summary of IFRS requirements Current tax Current tax should be recognised in the income statement for the period, except to the extent that it is attributable to a gain or loss that has been

87 Tax on profits, page 3 of 12 7 recognised directly in equity using the new IAS 1 Consolidated Statement of Comprehensive Income (previously the Statement of Recognised Income and Expenditure (SORIE)). It should include current tax and deferred tax, including the Group s share of any joint venture s tax where that entity s results are consolidated using the proportionate consolidation method. The Group s share of any associated undertaking s tax charge is netted against the Group s share of associated undertaking s profit before taxation and shown as a single line item within the income statement. Other taxes are dealt with separately. Where a gain or loss has been recognised directly in the Statement of Comprehensive Income, the tax relating to that gain or loss should also be recognised directly in that statement. Any tax charged other than to the income statement should be recorded in the other line in the tax account. As noted below, all entries in excess of 100,000 in the other line should be accompanied by a full explanation to the Group Tax Department. IFRS does not recognise the concept of exceptional items; it does, however, require the separate disclosure of items of income and expense that are material. Any tax relating to such items is still included in the tax line within the income statement. Current tax should be measured using tax rates and laws that have been enacted or substantively enacted by the balance sheet date. The effect of any withholding tax suffered should be taken into account as part of the tax charge Deferred tax Full provision should be made for deferred tax assets and liabilities arising from taxable temporary differences between the carrying amount of an asset or liability and its tax base. Deferred tax assets should be recognised to the extent that it is regarded as more likely than not that they will be recovered - that is, there are likely to be sufficient taxable profits to allow all or part of the asset to be recovered. Any deferred tax assets that are not thought to be recoverable should be reported as unprovided deferred tax. Deferred tax must be calculated at the average rates that are expected to apply in future when the taxable temporary differences reverse, based on rates and laws in place at the balance sheet date. Discounting of deferred tax balances is not permitted by IFRS and must not be applied locally in Group reporting. Deferred tax assets and liabilities may only be offset within the balance sheet where they relate to tax payable in the same tax jurisdiction and are expected to be settled on a net basis.

88 Tax on profits, page 4 of 12 7 Temporary difference where deferred tax required Accelerated capital allowances Temporary difference where deferred tax not provided Remittance of a subsidiary, associate or JV's earnings would cause tax to be payable, but no commitment has been made to remit such earnings and the Group can control distribution. Accruals for pension costs and other post-retirement benefits that will be deductible for tax purposes only when paid Elimination of unrealised intra-group profits on consolidation Gain on sale of an asset, not yet rolled over into replacement assets Revalued fixed assets whether or not there is a commitment to sell the asset Other short-term timing differences Deferred tax - identification of temporary differences The basic approach is as follows: i) Identify tax base of each asset / liability ii) iii) iv) Compute the temporary difference by comparing it to the carrying value Apply recognition criteria and any initial exemptions Apply local tax rate v) Compare opening and closing balances vi) Decide where the movement should be recognised (income statement, equity or, on a business combination, goodwill) Deferred Tax Definition of tax basis Assets The amount that will be deductible for tax purposes against any taxable economic benefits that will flow to the enterprise when it recovers the carrying amount of the asset. If these economic benefits will not be taxable, the tax base is equal to its carrying amount. Liabilities It s carrying amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount less any amount of revenue that will not be taxable in future periods Reconciliation of tax on profit on ordinary activities Information is needed in the Group accounts about factors affecting current and future tax charges. A key element of this is a requirement to disclose a reconciliation of the total tax charge (both current and deferred) for the period to the charge that would arise if the profits reported in the financial

89 Tax on profits, page 5 of 12 7 statements were charged at a standard rate of tax. This reconciliation is completed centrally by the Group tax team. 7.5 Application guidance Record keeping Compass Group entities should maintain accurate records and processes that allow the timely reporting of tax liabilities to the taxation authorities and through Group reporting. Records should be retained for a period of time in accordance with local legislative requirements, but in any case for a minimum of two years, in order to help check prior year balances Entries to the tax account Amounts in excess of 100,000 entered in the lines of the tax account used to report those items which are taken directly to equity, must be fully explained to the Group tax team. These lines should only be used very rarely, for example, where the double entry must be reported in the new IAS 1 Statement of Comprehensive Income (previously the Statement of Recognised Income and Expense ( SORIE ) (for example, foreign exchange, actuarial gains and losses on post-retirement employee benefits). Group policy is to enter payments for group relief or equivalent intra-group tax payments through the cash line of HFM Recognition of deferred tax assets Generally, deferred tax assets should be recognised only when it is probable that, on the basis of all available evidence, it can be regarded as more likely than not that future taxable profits will arise in order to allow deduction of the underlying timing differences. HFM account: BS34000 Cust1; RESTAXFX RESTAXPEN RESTAXOTH HFM account: BS34000 Cust1; CASHMTO Where a company has a history of tax losses it is generally prohibited from using an estimate of future earnings to support a conclusion that realisation of an existing deferred tax asset is probable. Accordingly, there needs to be persuasive and reliable evidence of a return to profitability in the future (for example, significant new contracts) if those losses are to be recognised as a deferred tax asset. Forecasts should be prepared to assess future taxable profits, but, given the inherent uncertainty of such projections, losses should only be recognised as deferred tax assets where recovery is anticipated in the next accounting period. In this context it should, however, be noted that deferred tax assets can always be recognised if an entity has provided for deferred tax liabilities which are of a type that, on reversal, generate a taxable profit against which the deferred tax asset can then be deducted (i.e. in the same period). If any doubt remains regarding the recognition of deferred tax assets, Compass Group entities should consult the Group Tax Department. For worked examples of some situations, see the examples at the end of this section Deferred tax on pre-1998 deductible goodwill Under IFRS, goodwill already written off to reserves that is deductible for local tax purposes will give rise to a deferred tax asset. This is calculated based on the difference between the carrying amount (zero) and the tax basis (the anticipated remaining future tax deductions). The current tax

90 Tax on profits, page 6 of 12 7 deduction available should be identified separately and charged to equity where it will be offset against the unwinding of the deferred tax asset. All deferred tax balances should be reported gross. Discounting is not permitted by IFRS Corporation tax provision The current year corporation tax provision made by Compass Group entities should correspond to the draft tax returns prepared at the year- end. Prior year adjustments (which are shown within the tax charge and recognised in the current year) can be made to bring amounts previously provided into line with the returns submitted to the local authorities. Liabilities should only be shown to the extent that the entity has not yet paid the amounts shown as due on the relevant tax returns. Assets should only be recognised to the extent that tax has been paid in excess of the amounts shown as due on the relevant tax returns. When further payments or repayments are agreed with the local authorities, the additional amounts due should be recorded as prior year adjustments to tax in the current year only after the agreement has been reached. Provisions against tax risks should only be made locally after discussion with the Group Tax Department. Entities should not provide for possible tax payments in excess of tax liabilities submitted to, or subsequently agreed with, the local authorities, unless required to under local GAAP. If an entity considers that additional tax may become payable in respect of certain transactions or returns, the circumstances and amount of the possible liability (if in excess of 100,000) should be notified to the Group Tax Department, and the best estimate of the amount payable, provided for. Current tax becoming due after more than 12 months should be separately identified. As it is rare for tax to be due after more than 12 months, any such balances should be explained to the Group Tax Department. HFM account: BS34000 Cust1; PLPYTRADE OR PLCYTRADE Tax payments No payments of corporate income tax of more than 1 million are to be made without the prior approval of the Group Tax Department Intra-group transactions As described in the Intra-group section, any loans, dividends or reorganisations of a value in excess of 1m must be cleared by the Group Tax Department at least four weeks in advance of the transaction Group relief or equivalent intra-group tax payments Group policy is to enter payments and receipts for group relief through the intra-group transfers line of the tax account. In the period in which a profit or loss arises, the corresponding tax charge or credit should be booked locally as normal. The tax should be shown as payable/receivable from the tax authorities until notification is received from the Group Tax Department that the amounts will be covered by intragroup arrangements. HFM account: BS34000 Cust1; IGMOV The year following the year of profit/loss, the payable/receivable should be transferred from the tax account to the intra-group account. Adjustments of this sort are posted through the intra-group transfers line of the tax account. However, in order to ensure that the intra-group balances reconcile, these entries should only be made following notification from the Group Tax Department and with the agreement of the other Group entity.

91 Tax on profits, page 7 of 12 7 If no notification of group relief has been received from the Group Tax Department, the entity must contact the Group Tax Department prior to adjusting the tax payable/intra-group balances this way Tax on profit on ordinary activities The tax charge in the income statement should only include taxes arising on profits. In some circumstances, in may not be clear whether the tax is a tax on profits. In such situations, the Compass Group entity should seek further guidance from the Group Tax Department. Detail on Other taxes is included separately Hybrid taxes Hybrid taxes are taxes such as Japanese inhabitants tax which consist of a profit-based part and a non profit-based part. The profit-based part should be included in the tax charge on profit. The non-profit based part should not form part of the tax charge but should be charged to the appropriate part of the income statement as described in the policy on Other taxes Reconciliation of tax on profit on ordinary activities Group policy is to reconcile the Total tax charge on ordinary activities to the statutory local tax rate. Prior year items are therefore included as reconciling items. All items having a material impact on the tax charge (if it causes a change in the tax charge in excess of 1%) must be separately identified. Group policy is to show the reconciling items as a percentage of the profit on ordinary activities before tax, unless such disclosure would produce absurd results (e.g. infinite or zero percentages) Withholding taxes Withholding taxes may arise on payments of dividends, royalties, franchise fees, management fees or interest payments. It is the responsibility of the country making the intra-group payment to determine the withholding tax obligation on any given payment. Dividends paid and proposed, interest and other payments must be accounted for gross of withholding tax. Incoming dividends, interest or other receipts must be accounted for at the full value including the withholding tax deducted by the payer. Any withholding tax that cannot be recovered should be taken into account as part of the tax charge in the income statement.

92 Tax on profits, page 8 of 12 7 Where it is confirmed that withholding tax applies, then the accounting is as follows: Example: Dividends Company A declares and pays a dividend of 1,000. Company A deducts 20% withholding tax. Company B receives 800 but can reclaim only half of the withholding tax. Six months later, company B receives payment of 100 from the relevant tax authority. Company A a) In Company A s accounts: Dr Dividend payable 1,000 Cr Intra-group - Company B 800 Cr Withholding tax authority 200 On declaration of the dividend On declaration of the dividend, and subject to Group Tax Department clearance, Company A must notify company B of the declaration, in order that company B can set up the receivable per (c) below. b) In Company A s accounts Dr Intra-group - Company B 800 Dr Withholding tax authority 200 Cr Cash 1,000 On payment of the dividend Company B c) In Company B s accounts Dr Intra-group - Company A 800 Dr Withholding tax authority 100 Dr P&L account - tax charge 100 Cr Dividend income 1,000 On notification of the declaration of the dividend d) In Company B s accounts Dr Cash 800 Cr Intra-group Company A 800 On receipt of the dividend e) In Company B s accounts Dr Cash 100 Cr Withholding tax authority 100 On recovery of the withholding tax. In all cases, the responsibility for the correct withholding tax rate remains with the company making the payments. However, for amounts accruing throughout the period (for example royalties, franchise fees, management fees and interest payments) the responsibilities for agreeing intra-group charges lies with the recipient company. At least four weeks in advance of the end of a reporting period, the recipient company must notify and agree the accrual for the period with the paying company (and the Group Tax Department). The paying company should respond with confirmation of the liability and advise the recipient of the local withholding tax requirements.

93 Tax on profits, page 9 of Examples of deferred tax calculations Example 1: Tax-deductible goodwill acquired as part of a business combination Goodwill is acquired as part of a business combination for 100 and we expect to receive future tax deductions for this amount evenly spread over 10 years. The local tax rate is 40%. At inception the temporary difference is 0. Calculation of deferred tax at inception Carrying value 100 Tax basis 100 Temporary difference 0 No deferred tax is set up at inception. Calculation of deferred tax at end of year 1 Carrying value (no amortisation charge under IFRS) 100 Tax basis (1 year of tax deductions have been claimed) 90 Temporary difference 10 Provide deferred tax liability on temporary difference of 10 at local tax rate. Dr Deferred tax (part of tax charge) 4 Cr Deferred tax (balance sheet) 4 Example 2: Non tax-deductible intangible asset acquired as part of a business combination An intangible asset is acquired as part of a business combination for 100 and no future tax deductions are expected. The asset will be amortised over five years. The local tax rate is 40%. At inception the temporary difference is 100. Calculation of deferred tax at inception Carrying value 100 Tax basis 0 Temporary difference 100 A deferred tax liability is set up at inception on the temporary difference of 100 at the local tax rate. Goodwill will be adjusted accordingly. Dr Goodwill 40 Cr Deferred tax (balance sheet) 40 Calculation of deferred tax at end of year 1 Carrying value (amortisation charge of 20 have been recorded) 80 Tax basis 0 Temporary difference 80 Provide deferred tax liability on the temporary difference of 80 at tax rate (reducing the deferred tax liability to 326). Dr Deferred tax (balance sheet) 8 Cr Deferred tax (part of tax charge) 8

94 Tax on profits, page 10 of 12 7 Example 3: Intangible restructuring Subsidiary A sells an intangible asset (not previously recognised in A s accounts) to Subsidiary B for 100. Tax deductions on the transfer value of 100 are available in subsidiary B, spread evenly over 10 years. The local tax rate is 40%. Calculation of deferred tax at inception Carrying value (Group) 0 Tax basis 100 Temporary difference A deferred tax asset is set up at inception with a credit to income statement tax account, anticipating the future tax benefits. Dr Deferred tax (balance sheet) 40 Cr Deferred tax (part of tax charge) 40 Calculation of deferred tax at end of year 1 Carrying value (Group) 0 Tax basis (10 of tax deductions have been claimed) 90 Temporary difference - 90 The temporary difference is reduced to 90 and the reduction in deferred tax to 36 is taken through equity. Dr Retained earnings 4 Cr Deferred tax (balance sheet) 4 The overall impact of the IAS 12 treatment is to eliminate the reduction to the overall income statement tax rate that would apply under UK GAAP.

95 Tax on profits, page 11 of 12 7 Example 4: Share options (equity settled) Ten thousand share options with an option price of 2.00, the current share price, are granted. The fair value is calculated as 3,000. This accounting charge will be spread in the income statement over the three-year vesting period. A local tax deduction is available on exercise, based on the intrinsic value at that date (that is, the profit over the option price). The local tax rate is 40%. Calculation of deferred tax at inception Carrying value 0 Tax basis (Current share price = option price) 0 Temporary difference 0 There is no deferred tax at the date of grant. At the end of year 1, the market share price is The 1,000 income statement charge has been posted to the share based payment reserve and so there is no carrying value on the balance sheet attributable to these options. Calculation of deferred tax at end of year 1 Carrying value 0 Tax basis ( 0.50x10,000x1/3years) 1,666 Temporary difference - 1,666 Deferred tax asset -666 Provide for a deferred tax asset on the temporary difference of 1,666 at the local tax rate. (IFRS assumes that there will be no further change in the value of the share price up to the date of exercise). Of this, tax on 1,000 (the cumulative accounting charge) may be credited to the income statement and the remainder is posted to equity (share-based payment reserve). Dr Deferred tax (balance sheet) 666 Cr Deferred tax (part of tax charge)(1,000x40%) 400 Cr Share-based payment reserve 266 At the end of year 2, the market share price is Calculation of deferred tax at end of year 2 Carrying value 0 Tax basis ( 1.00x10,000x2/3years) 6,667 Temporary difference - 6,667 Deferred tax asset -2,667 Less : deferred tax at start of year Deferred tax for year -2,001 Dr Deferred tax (balance sheet) 2,001 Cr Deferred tax (part of tax charge)(1,000x40%) 400 Cr Share-based payment reserve 1,601

96 At the end of year 3, the market share price is 2.80 and the options are exercised. The deferred tax entries from the previous two years are reversed and replaced by the corporation tax deduction based on the actual value at the date of exercise. Dr Share-based payment reserve ( ) 1,867 Dr Deferred tax (part of tax charge)( ) 800 Cr Deferred tax (balance sheet) 2,667 Being reversal of deferred tax entries made in years 1 and 2 Dr Corporation tax (balance sheet) ( 0.80x10,000x40%) 3,200 Cr Corporation tax (part of tax charge)(3,000x40%) 1,200 Cr Share-based payment reserve 2,000 Being corporation tax effect of exercise of options Note that the end result is :- 3,000 has been expensed in the income statement - this is the fair value calculated at inception 1,200 of tax credit has been recognised in the income statement - this is limited to the option charge in the income statement ( 3,000) at local tax rate (40%) 2,000 of tax credit has been recognised in equity (the remaining part of the local tax deduction on final exercise price) Example 5: Rollover relief A company sells an asset in P11 200X for 1,200, realising a gain on disposal of 200, which is also the capital gain for tax purposes. The company expects to purchase a new asset in P3 in 200Y that will satisfy the tax requirements for rolling over the gain. The local tax rate is 40%. Calculation of deferred tax on asset sale Carrying value 0 Tax basis (capital gain) Temporary difference 200 The gain has not been included in the current tax computation because it is expected to be rolled over. So a deferred tax liability is set up at the local tax rate Dr Deferred tax (part of tax charge) 80 Cr Deferred tax (balance sheet) 80 In 200Y, the company reinvests the proceeds and buys an asset that fulfils the criteria for rollover relief for 1,200. This creates 1,200 of tax allowances that will be received in future periods. There are two possible tax bases and the deferred tax position will depend on whether management intend to either - use the asset in the business; - or, sell the asset thereby crystallising the tax liability that has been rolled over. If the asset will be used in the business: Calculation of deferred tax on purchase of Asset 2 Carrying value 1200 Tax basis 1200 Temporary difference 0 Release the deferred tax liability if management s intention is to use Asset 2. Dr Deferred tax (balance sheet) 80 Cr Deferred tax (part of tax charge) 80 If the asset is intended to be sold: Calculation of deferred tax on purchase of Asset 2 Carrying value 1200 Tax basis 1000 Temporary difference 200 Retain the deferred tax liability previously set up if management s intention is to sell Asset 2.

97 8. Other taxes Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Other taxes should be included in the appropriate category in the income statement (e.g. employment taxes should be included within staff costs). 8.1 Disclosed accounting policy Revenue is recognised in the period in which services are provided in accordance with the terms of the contractual relationships with third parties. Revenue represents the fair value of the consideration received or receivable for goods and services provided in the normal course of business, excluding discounts, value added tax and similar sales taxes. There is no specific disclosed accounting policy for other taxes. 8.2 Default policy and process for exceptions Default policy Only taxes on profit should be included in the tax charge for the year. Other taxes should be included in the appropriate category in the income statement (for example, property taxes should be included within administrative expenses) Consultation and authorisation process for exceptions Any deviation from the above policy must be agreed in writing by the Group Financial Controller. 8.3 IFRS references IAS 18 Revenue 8.4 Summary of IFRS requirements There is no detailed accounting guidance on other taxes, other than VAT or sales taxes. Broadly, taxes other than corporation tax should be included within the appropriate income or expense line, in so far as they are a true cost or income to the entity. Sales and purchases are generally recorded net of VAT and other sales taxes if such taxes are recoverable or reimbursable from/to a third party. 8.5 Application guidance Hybrid taxes Hybrid taxes are taxes such as Japanese inhabitants tax which consist of a profit-based part and a non profit-based part. The profit-based part should be included in the tax charge on profit. The non-profit based part should not form part of the tax charge but should be charged to the appropriate part of the income statement.

98 Other taxes, page 2 of Examples Type of tax Value added tax and other sales taxes Employment taxes Banking transaction taxes Interest and penalties on late or incorrect tax payments and interest received on overdue tax refunds Payments or receipts in respect of disposal transaction indemnities The treatment of payments or receipts of tax representing adjustments to the purchase price of businesses acquired will depend upon the date at which the asset/liability is identified. Exclude from revenue, purchases and capital expenditure, unless not recoverable Include within staff costs Recognition of refunds is dealt with in the policy on Contingent assets. Include within bank charges Include within interest payable or receivable Include within the calculation of the profit or loss on disposal, even where the payment is in relation to a tax indemnity. However, the treatment of any such payment or receipt should be confirmed with the Group Tax Department in advance of booking the payments. Amounts identified on acquisition, or in the twelve months following should be recorded as adjustments to the fair value of the tax balances acquired, with a corresponding adjustment to goodwill. Payments will then be set against the fair value tax asset as usual. Amounts identified in accounting periods more than one year after the year of acquisition should be charged or credited to the income statement. Withholding tax Add back to the relevant dividends or interest receivable, where deducted by the payer. Any withholding tax that is not recoverable should be included in the corporation tax charge for the year. See section on Tax on profits for more detail.

99 9. Non-current assets held for sale and discontinued operations Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued A non-current asset (or disposal group) is classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. To qualify as held for sale, an asset must be immediately available for sale in its present condition and its sale must be highly probable to be recognised as held for sale. Management must be committed to a plan to sell and actively looking for a buyer. The sale should generally be completed within one year of the date of classification as held for sale. Assets that meet the criteria are measured at the lower of carrying amount and fair value less costs to sell and are not depreciated. Assets and disposal groups held for sale are presented separately on the face of the balance sheet. The related liabilities are also presented separately from other liabilities. The results of discontinued operations are presented separately in the income statement. A discontinued operation is defined as a separate major line of business or geographical area or is a subsidiary acquired exclusively with a view to resale. The results of subsidiaries acquired exclusively with a view to resale are consolidated, but their net results are presented within the single line item for discontinued operations. The post-tax results of discontinued operations and the post-tax gain or loss on sale are shown as a separate combined line item after profit for the year from continuing operations. More detailed analysis is shown within the notes to the financial statements. 9.1 Disclosed accounting policy Assets held for sale Non-current assets and disposal groups are classified as held for sale if the carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable, management is committed to a sale plan, the asset is available for immediate sale in its present condition and the sale is expected to be completed within one year from the date of classification. These assets are measured at the lower of carrying value and fair value less costs to sell. 9.2 Default policy and process for exceptions Default policy A non-current asset (or disposal group) shall be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. The asset must be immediately available for sale in its present condition and its sale must be highly probable to be recognised as held for sale. Management must be

100 Non-current assets held for sale and discontinued operations page 2 of 6 9 committed to a plan to sell and actively looking for a buyer. The sale should generally be completed within one year of the date of classification. A discontinued operation is a major line of business or geographical area of operations or is a subsidiary acquired exclusively with a view to resale. The post-tax results of discontinued operations and the post-tax gain or loss on sale are shown as a separate line item after profit for the year from continuing operations. Assets classified as held for sale and the assets in a disposal group that is classified as held for sale are presented separately from other assets in the balance sheet and the liabilities of a disposal group are presented separately from other liabilities. Assets that meet the criteria are measured at the lower of carrying amount and fair value less costs to sell. Depreciation on such assets will cease with effect from the date that they are classified as held for sale Consultation and authorisation process for exceptions Any cases where it is thought that these rules will apply should be discussed with Group Finance, Chertsey particularly where further clarification is required, or the disposal is complex in nature. Where it appears that assets or disposal groups qualify for this categorisation, the Group Financial Controller must be notified in writing. Exceptions to the rules identifying non-current assets held for sale and discontinuing operations would be extremely unlikely and would be referred to the Group Financial Controller. 9.3 IFRS references IFRS 5 Non-current Assets held for Sale and Discontinued Operations 9.4 Summary of IFRS requirements Classification of non-current assets (or disposal groups) as held for sale A non-current asset (or disposal group) shall be classified as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. It must be available for immediate sale in its present condition, subject only to terms that are usual and customary for sale of such assets (or disposal group) and its sale must be highly probable. For a sale to be highly probable the appropriate level of management must be committed to a plan to sell the assets (or disposal group) and an active programme to locate a buyer and complete the plan must be underway. The asset (or disposal group) must be marketed at a price that is reasonable in relation to its current fair value. The sale should be expected to qualify for recognition as a completed sale within one year from the date of classification. Significant changes to the plan or its withdrawal should be unlikely. Events or circumstances beyond the entity s control may extend the period to complete the sale beyond one year, provided that the entity remains committed to its plan to sell the asset (or disposal group).

101 Non-current assets held for sale and discontinued operations page 3 of 6 9 Accounting for non-current assets held for sale and discontinued operations Does the asset (or disposal group) meet the definition of held for sale? Balance sheet: Continue showing assets and related liabilities in their normal place within the balance sheet NO YES Does the asset (or disposal group) meet the definition of a discontinued operation? NO YES Balance sheet: Held for sale at carrying value or fair value less costs to sell Income Statement: Report within continuing operations Balance sheet: Held for sale at carrying value or fair value less costs to sell Income Statement: Single line entry - discontinued operations Measurement of non-current assets (or disposal group) held for sale Assets or disposal groups that meet the criteria are measured at the lower of its carrying amount and fair value less costs to sell. When the sale is expected to occur beyond one year, the entity shall measure the costs to sell at their present value, where material. Any increase in the present value of the costs to sell that arises from the passage of time shall be presented in profit or loss as a financing item. Immediately before the initial classification of the assets (or disposal group) as held for sale, the carrying amounts of the asset (or all of the assets and liabilities in the group) shall be measured in accordance with each applicable International Financial Reporting Standard Recognition of impairment losses and reversals An entity shall recognise an impairment loss for any initial or subsequent write-down of the asset (or disposal group) to fair value less costs to sell, to the extent that it has not been previously recognised. An entity shall recognise a gain for any subsequent increase in fair value less costs to sell, but not in excess of the cumulative impairment loss previously recognised.

102 Non-current assets held for sale and discontinued operations page 4 of 6 9 A gain or loss not previously recognised by the date of sale shall be recognised at that time. A non-current asset shall not be depreciated while it is classified as held for sale. Interest and other expenses attributable to the liabilities of a disposal group classified as held for sale shall continue to be recognised Changes to a plan of sale If the criteria for classification as held for sale (set out in above) are no longer met, then the entity shall stop classifying the asset (or disposal group) as held for sale. The non-current asset (or disposal group assets and liabilities), previously held for sale, shall be measured at the lower of: a) Its carrying amount before it was classified as held for sale, adjusted for any depreciation, amortisation or revaluation that would have been recognised in the intervening period, and b) Its recoverable amount at the date of the subsequent decision not to sell Discontinued operations A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and: a) represents a major line or business or geographical area of operations, b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations, or c) is a subsidiary acquired exclusively with a view to resale. 9.5 Application guidance Probability of sale Assets or disposal groups should only be classified as held for sale if the disposal is highly probable and meets the criteria set out in section In practice, this means that the probability of a sale within a year is at least 80%. Assets and disposal groups must not be at risk of moving between classifications without fundamental changes in circumstances. So, simply investigating the market, speculative enquiries or initial approaches from a potential buyer, no matter the level of authorisation, are not sufficient grounds for reclassification unless the highly probable level of certainty is reached Disposal of a headquarters building Example 1: Sale of a headquarters building A Group entity is committed to plan to sell its headquarters building. The decision has been made at a board meeting, alternative premises identified, the staff notified and a selling agent has been instructed. (a) The Group entity intends to transfer the building to a buyer after it vacates the building. The building can be vacated within a period that is usual and customary for sale of such assets.

103 Non-current assets held for sale and discontinued operations page 5 of 6 9 The criteria of being available for immediate sale would be met when the above actions had been committed. The building would be classified as held for sale and no longer depreciated. It should be appropriately valued at the lower of its net book value and the expected sale price less selling costs. Expenses related to the ongoing occupation of the building do not qualify as discontinued operations and so will continue to be recorded in the income statement as continuing operations. (b) The Group entity will continue to use the building until construction of a new headquarters building is completed. The Group entity does not intend to transfer the existing building to a buyer until after the construction of the new building is completed (and it vacates the existing building). The delay in the timing of the transfer of the existing building imposed by the seller demonstrates that it is not immediately available for sale. The available for immediate sale criteria would not be met until construction of the new building is completed, even if a firm purchase commitment for the future transfer of the existing building is obtained earlier. Therefore, the building is not classified as held for sale until the new building is ready for occupation Disposal group and discontinued operations Example 2: Disposal group and discontinued operations The Group is committed to a plan to sell a disposal group (a portfolio of branded hotels and restaurants) that represents a significant portion of its operations. An announcement was made on 1 July 200X that the business will be sold through an auction process, which is now underway. Initial interest from potential buyers suggests that it is highly probable that the sale will be completed. It is unlikely that any significant changes will be made to the disposal plan or that the businesses will be withdrawn from sale. Completion of the sale is expected within one year. The criteria of being available for immediate sale is met and the assets are classified as held for sale at the year-end (30 September 200X). The disposal group qualifies as a discontinued operation as at 30 September 200X as it represents a major line of business or geographical area of operations. Accordingly the results of its operations are presented as a single amount on the face of the income statement described as profit for the year from discontinued operation. Example 3: Impairment of non-current assets held for sale The facts are the same as in example 2 above. The disposal group is made up of: Goodwill 7 Property, plant and equipment 150 Inventory 10 Payables (57) Net carrying value 110 Obsolete inventory with a value of 1 has been identified. Fair value less selling costs of the disposal group is estimated at 100. Under IFRS 5, the assets of the disposal group must be measured at the lower of their carrying amount and fair value less costs to sell. This is considered in two stages:

104 Non-current assets held for sale and discontinued operations page 6 of 6 9 i) On the date that the disposal group qualifies as held for sale, the obsolete stocks of 1 are written down immediately before classifying the disposal group as held for sale. ii) There is an impairment loss of 9 on comparing the fair value less selling costs of 100 against the current carrying value of 109. This impairment loss is allocated between the various assets of the disposal group in the following order. First, the impairment loss writes off the goodwill (7 in this example), and then the residual loss of 2 is allocated between the other non-current assets pro-rata - in this case, taken off the value of property, plant and equipment. Consequently no further impairment is allocated against inventory. The value of the disposal group after these adjustments is therefore: Goodwill - Property, plant and equipment 148 Inventory 9 Payables (57) Net carrying value 100 Example 4: Disposal group completion of sale The sale of the disposal group in example 3 is completed on 31 December 200X and net proceeds of 95 are received, which compares with the current carrying amount of 100. The remaining loss of 5m is recognised at the date of completion (31 December 200X). This is reported on the face of the income statement within the single line item for results of discontinued operations. Example 5: Disposal group changes to a plan of sale The Group completes the sale of the hotels from example 2 on 31 December 200X, but decides to withdraw the restaurants from the auction process and to retain these. The restaurants cease to be classified as held for sale with immediate effect. Non-current assets that cease to be classified as held for sale should be measured at the lower of: i) their carrying amount before they were classified as held for sale, adjusted for any depreciation that would have been recognised had they not been classified as held for sale, and ii) their recoverable amount at the date of the subsequent decision not to sell. The recoverable amount is the higher of fair value less costs to sell and value in use. Any required adjustment to the carrying amount of a non-current asset that ceases to be classified as held for sale should be included within income from continuing operations for the period and in the same income statement caption used to present any gain or loss recognised in relation to remeasuring non-current assets held for sale which do not meet the definition of a discontinued operation. If an entity ceases to classify a component as held for sale, the results of the component previously presented in discontinued operations should be reclassified and included in income from continuing operations for all periods presented. In this example the results of the restaurants would have been presented under discontinued operations in the accounts for the year to 30 September 200X, but would be presented under continuing operations in the following year with the comparative figures amended. The balance sheet presentation requirements for assets (or disposal groups) classified as held for sale at the end of the reporting period do not apply retrospectively. Consequently, the balance sheet as at 30 September 200X is not restated when the following years accounts are drawn up and the assets of the restaurants, that are now retained, remain within assets held for sale at that date.

105 10. Goodwill Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued The Group recognises purchased goodwill arising after October 1998 on the balance sheet. Goodwill is not amortised but is subject to an annual impairment review. The value of purchased goodwill recognised is based upon the UK GAAP net book value at the date of transition to IFRS (1 October 2004) plus additions for new acquisitions less any subsequent impairment charges Disclosed accounting policy Goodwill Goodwill arising on consolidation represents the excess of the cost of acquisition over the fair value of the Group s share of the identifiable assets and liabilities of the acquired subsidiary, associate or joint venture at the date of acquisition. Goodwill is tested annually for impairment and is carried at cost less any accumulated impairment losses. Goodwill is allocated to cash-generating units ( CGU ) for the purpose of impairment testing. A CGU is identified at the lowest aggregation of assets that generate largely independent cash flows, and that which is looked at by management for monitoring and managing the business. This is generally the total business for a country. However, in some instances, where there are distinct separately managed business activities within a country, particularly if they fall within different secondary business segments, the CGU is identified at this lower level. If the recoverable amount of the cash-generating unit is less than the carrying amount, an impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the unit and then to the other assets of the unit pro-rata on the basis of the carrying amount of each asset in the unit. Any impairment is immediately recognised in the income statement and an impairment loss recognised for goodwill is not subsequently reversed. On disposal, the attributable amount of goodwill is included in the determination of the gain or loss on disposal. Goodwill arising on acquisitions before the date of transition to IFRS has been retained at the previous UK GAAP amounts subject to being tested for impairment at that date. Goodwill written off to reserves under UK GAAP prior to 1998 has not been reinstated and is not included in determining any subsequent gain or loss on disposal.

106 Goodwill, page 2 of Default policy and process for exceptions Default policy Goodwill arising on acquisition is recognised as an asset, is not amortised and is reviewed for impairment annually. Goodwill arising between 1998 and the date of transition to IFRS (1 October 2004) is retained at the previous UK GAAP level subject to any impairment charges recognised at the transition date. Any impairment is charged immediately to the income statement and is not reversible. Goodwill has to be taken into account when determining the profit or loss on disposal of a Group entity. Internally generated goodwill is not recognised Consultation and authorisation process for exceptions Exceptions to the default policy or more specific application detail below must be authorised by the Group Financial Controller IFRS references IFRS 3 Business Combinations IAS 21 Effect of changes in foreign exchange rates IAS 36 Impairment of Assets 10.4 Summary of IFRS requirements Purchased goodwill should be capitalised. Internally generated goodwill should not be capitalised Purchased goodwill Initial recognition Purchased goodwill is the difference between the cost of an acquired entity and the aggregate of the fair values of that entity's identifiable assets, liabilities and contingent liabilities. Cost of acquisition Cash paid, the fair value* of other purchase consideration given by the acquirer, and the fair value of any contingent consideration, LESS Fair value* of identifiable assets and liabilities and fair value of intangible assets and fair value of contingent liabilities assumed Fair value of assets and liabilities where it is probable that future economic benefits or outflow of resources will arise and whose fair value can be measured reliably. Fair value of intangible assets; see section 25 for details on the types of intangible assets that may be present in an acquisition. Fair value of contingent liabilities, which are recognised only if their value can be measured reliably = Goodwill Defined as future economic benefits arising from assets that are not capable of being individually identified and separately recognised. *Fair value The amount at which an asset or liability could be exchanged in an arm's length transaction between informed and willing parties, other than in a forced or liquidation sale More information on determination of goodwill and intangible assets including the calculation of fair value adjustments is included in the Group policy on Acquisitions and Fair Value Accounting.

107 Goodwill, page 3 of 4 10 Goodwill should be held in the functional currency of the foreign operation acquired and therefore re-translated at period ends. The goodwill is treated as an asset of the foreign operation. Negative goodwill Negative goodwill is highly unlikely to arise and IFRS 3 requires that the fair value adjustments be reassessed if it appears to do so. If any negative goodwill remains after the reassessment, it is immediately recognised in the income statement Impairment reviews Goodwill is not amortised but must be reviewed annually for any indication of impairment. See the Group policy on Impairment for detailed rules regarding the impairment of goodwill Calculation of gain or loss on disposal Goodwill that has been capitalised as an asset must be taken into the calculation of gain or loss on disposal when a business is sold Application guidance Acquisition versus asset purchase There may be instances where there is doubt as to whether an acquisition has occurred or simply the purchase of a substantial asset or group of assets. Acquisitions may give rise to goodwill, whereas the purchase of assets does not; the purchase price is taken as the cost of the asset(s) purchased. The purchase of an asset is not accompanied by the elements that contribute towards a business such as existing contracts or staff. An acquisition may simply be for a contract or bundle of contracts which constitutes a business activity and, in the absence of capitalising them as other intangibles (e.g. Acquired customer contracts ), the difference between the price and the fair value of the assets should be classed as goodwill. An asset purchase will not have the accompanying integrated business activity. Where there is doubt over the distinction between the purchase of a separate business and a purchase of assets the following factors should be considered: Does the consideration include the purchase of a trading name with the implied reputation and goodwill attached? Stripping out the value of the contracts an entity currently holds, does the entity have any residual value attributable to its trading name, reputation, regional or market presence, goodwill, customer or supplier base, staff or operating premises? Do the staff that have transferred with the entity contain management or sales staff capable of continuing and expanding the entity s business in their own right (regardless of future reorganisation plans and synergies the Group may have)? Has there been a transfer of infrastructure (i.e. distribution, support functions, personnel) with the acquisition?

108 Goodwill, page 4 of 4 10 It is likely that even within what appears to be a straight forward acquisition of a contract(s) there exists an element of contract intangible and goodwill in the purchase price. See Group policy on Acquisition accounting and fair value adjustments for more guidance on contract related intangible valuation Treatment of goodwill on disposal of a business Prior to 1998 goodwill on acquisitions was written off to reserves, and, under UK GAAP, was shown as part of equity, classified as retained earnings. Under IFRS this ceases to exist and is not shown separately. If a business acquired before 1998 is disposed of, goodwill previously written off to equity is not taken into account when calculating the gain or loss on disposal. Where the business disposed of was purchased after 1998, (and therefore the goodwill acquired is shown at cost less impairment on the balance sheet), the remaining NBV of the goodwill is taken to the income statement as part of the gain or loss on disposal. Goodwill previously impaired through the income statement is not reinstated on disposal of the business and has no impact upon the gain or loss recorded on disposal.

109 11. Intangible assets Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Intangible fixed assets are capitalised and amortised over their expected useful lives, or are subject to an annual impairment review if they have an indefinite useful life. Intangible assets must be recognised, particularly in the context of acquisitions where intangibles such as contracts must be separately identified and valued, rather than being included within the value of goodwill. Under transition rules, intangible assets in relation to acquisitions that took place before 1 October 2004 are not required to be separately identified but remain within the balance of purchased goodwill. Only in closely defined circumstances can internally generated intangible assets such as software development be recognised. Internally generated brands and similar intangible assets are not recognised Disclosed accounting policy Intangible assets Intangible assets acquired separately are capitalised at cost or, if acquired as part of a business combination, are capitalised at fair value as at the date of the acquisition. Internally-generated intangible assets are not capitalised. Amortisation is charged on a straight-line basis on assets over their expected useful lives. The following rates are applied for the Group: Contract-related intangible assets: the life of the contract; and Computer software: 6% to 33% per annum. The typical life of contract-related intangibles is 2-20 years. Contract related intangible assets raising on the acquisition of a business are recognised at fair value and amortised over the life of the contract. Underlying operating profit and underlying earnings per share exclude the amortisation of contract-related intangible assets arising on the acquisition of a business as it is not considered relevant to the underlying trading performance of the Group Default policy and process for exceptions Default policy Intangible assets comprise such items as development costs, concessions, patents, brand names, trademarks, software, customer contracts, client investments and websites. Purchased intangibles are capitalised at cost. Only certain categories of internally generated intangible assets may be recognised. These include computer software and websites. In addition, certain criteria must be fulfilled: An identifiable asset must be created that it is probable will generate future economic benefits.

110 Intangible assets, page 2 of 5 11 Development costs must be reliably measured. Internally generated brands and similar intangible assets are not recognised. The cost incurred in developing these must be written off through the income statement. Other intangible fixed assets may be present within acquired entities, either recognised already on their balance sheets, or unrecognised because the entity developed these assets internally. These must be separately identified and valued as part of the acquisition accounting process. Intangible assets that have a finite life are amortised on a straight-line basis over their useful lives. Intangible assets that have infinite lives are not amortised, but are subject to annual impairment reviews Consultation and authorisation process for exceptions Capitalisation of internally generated intangible assets or valuation of intangible assets must be referred to Group Finance, Chertsey for advice on method and basis. Exceptions to the default policy or more specific application detail below must be authorised by the Group Financial Controller IFRS references IAS 36 Impairment of assets IAS 38 Intangible Assets IFRS 3 Business Combinations SIC 32 Intangible Assets Web Site costs 11.4 Summary of IFRS requirements Purchased intangible assets should be capitalised. Internally developed intangible assets should be capitalised only in certain circumstances Other intangible assets Initial recognition An intangible asset acquired as part of the acquisition of a business should be capitalised separately from goodwill at fair value, if its value can be measured reliably on initial recognition. If its value cannot be measured reliably, it should be included within the amount of the purchase price attributed to goodwill Amortisation Amortisation is only applied to intangible assets that have finite useful lives. The basis for estimating the useful life should be prudent Impairment reviews Where an intangible asset has an indefinite life, it is not amortised but must be reviewed annually for any indication of impairment. See the policy on Impairment for detailed rules regarding the impairment of assets.

111 Intangible assets, page 3 of Application guidance When should an intangible asset be recognised? An intangible asset must be capable of being identified (in contrast to goodwill, the components of which cannot be individually identified). It is identifiable if it is separable (for example, capable of being sold, such as ownership of a purchased trademark), or arises from contractual or other legal rights, even if those rights cannot be separated from the entity (for example, exclusive franchise rights to use a brand) In addition, the cost of the asset must be measured reliably and future economic benefits be expected to flow as a consequence of ownership. Intangible assets are most often expected to arise either as the purchase of specific rights or software or in the context of acquiring a business. Internally generated intangible assets are generally not recognised because there are problems in deciding if the asset is identifiable from the rest of the entity s operations and if it will give rise to separate economic benefits the cost of developing the asset cannot be determined reliably and separated from the entity s other operational costs. The most usual example of an internally generated asset being capitalised is software development. Example: Development of a new software application The Group develops a new software application for recording sales and stock levels in a number of its operating units. The following costs are incurred in bringing the system to the point where it is ready for use: 000 Purchase of software from supplier 75 Consultancy costs in developing application for the Group 125 Three years licensing fees for use of the application 500 Group staff costs (wages and other directly related costs) for project team 100 Project team training in developing the application 10 Unit staff training in use of the application 125 Indirect overheads attributable to the project team 10 Installation costs in the units 200 IT director s time spent overseeing the project 15 Hardware for the units and Head Office site 750 Abnormal costs relating to a design error 50 Total 1,960 The amount that can be capitalised is 1,710,000. The following costs should not be capitalised for the reasons specified: Unit staff training 125,000 Indirect overheads 10,000 IT director s time 15,000 Start up costs should be treated in the same way as similar costs incurred as the part of the entity s ongoing activities. Costs are not directly attributable to the production of the asset. A director necessarily has responsibilities broader than a single management task, so a director's remuneration cannot arise incrementally in consequence of the construction of an asset.

112 Intangible assets, page 4 of 5 11 Abnormal costs caused by an error 50,000 Staff costs 50,000 Not directly attributable to bringing the asset into working condition for its intended use. Further analysis of the Group staff costs identifies that 50,000 is for two full time personnel working on the project (and who s roles have been backfilled by other people), 30,000 relates to part time costs of ten people, each working approximately 10% of their time on the project and 20,000 relates to travel, car and mobile phone costs of the various employees. 50,000 being the costs of the two full time employees should be capitalised as part of the project. However, the part time costs are merely an allocation of time and it is difficult to show that they are directly attributable to the asset hence they should be expensed. In addition, the expenses of 20,000 may relate to any of the employees and hence are not necessarily directly attributable. In the absence of detailed analysis splitting the costs between the two full time employees and the ten part time individuals, these costs should also be expensed No research expenditure may be capitalised. The capitalisation of internally generated brands, customer lists and similar items is specifically forbidden by IAS Useful economic life for amortisation of intangible assets The useful economic life of an intangible asset may vary depending on the exact circumstances of an acquisition and the nature of the asset concerned. Prudence suggests that it is unlikely that the useful life of a new strategic software application would exceed eight years.

113 Intangible assets, page 5 of 5 11 Examples: Useful economic life of an intangible asset 1 The Group newly acquires the right to use a brand for seven years in a territory. There is evidence that use of the brand will generate economic benefits. The value of the intangible asset is the price paid for the right to use the brand. The asset should be amortised over the seven years that the Group has the right to use it. If the Group decides to stop using the brand before the end of the period, the remaining balance should be written off. 2 The Group purchases software to cover unit reporting. The computer hardware on which the software runs is separate and is amortised over five years. It is estimated that the software will be in use for at least three years before an improved replacement is developed. The software is separate from the hardware and so it should be capitalised as an intangible asset and amortised over its expected useful life of three years. 3 The Group purchases EPOS machines including new point-of-sale software. The software can only be run on these machines and the machines only operate with this software. The software is not separate from the hardware and so the total cost must be capitalised as a tangible fixed asset and depreciated over the expected useful life in accordance with the section on Property, plant and equipment. 4 The Group acquires a number of contracts that are expected to be profitable as part of an acquisition. A value has been determined for the right to operate these contracts and has been capitalised as an intangible asset. These contracts have an average life of three years. The intangible asset should be amortised on a straight-line basis over three years. 5 The Group develops a new software application for recording sales and inventory levels in a number of its operating units and has capitalised a total of 1,710,000. This represents a strategic business application that is expected to remain operational for a number of years. The expected period that the sales and inventory levels software application will remain in use should be considered carefully on a prudent basis and should not exceed eight years. The software application should be amortised on a straight-line basis over the expected useful life.

114 12. Property, plant and equipment Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Only costs directly incurred in bringing an item of property, plant and equipment into use can be capitalised. Capital discounts received relating to property, plant and equipment should be deducted from the cost of the asset, and not credited directly to the income statement. Property, plant and equipment should be reviewed for indicators of impairment at every year-end. Depreciation of property, plant and equipment should be charged on a straightline basis, at a rate that writes off the cost of the asset over its useful economic life to its residual value. Depreciation starts when the asset is available for use; there is no gap allowed between the date that capitalisation of the cost stops and the asset comes into use. Asset lives should be reviewed for appropriateness at every year-end but may be revised only with the prior approval of the Group Financial Controller. Increasing useful economic lives or residual values in order to increase profits is strictly prohibited. Material changes to these estimates must be supported by sufficient evidence to justify the change. Revisions to useful economic life or residual value can never be applied retrospectively. Computer software should be classified as an intangible asset under IFRS if it is not an integral part of the hardware it resides on. Consumables should not be included in property, plant and equipment. Group policy is not to revalue any items of property, plant and equipment Disclosed accounting policy All tangible fixed assets are reviewed for impairment when there are indications that the carrying value may not be recoverable. Freehold land is not depreciated. All other property, plant and equipment assets are carried at cost less accumulated depreciation and any recognised impairment in value. Depreciation is provided on a straight-line basis over the anticipated useful lives of the assets. The following rates applied for the Group: Freehold buildings and long-term leasehold property: 2% per annum Short-term leasehold property: the life of the lease Plant and machinery: 8% to 33% per annum Fixtures and fittings: 8% to 33% per annum. When assets are sold, the difference between sales proceeds and the carrying amount of the assets is dealt with in the income statement.

115 Property, plant and equipment, page 2 of Default policy and process for exceptions Default policy Capitalisation There is no set Group level on the capitalisation limit, but a suitable capitalisation level for either an individual asset or group of assets is 1,000 or local currency equivalent, with an expected useful life of more than eighteen months. Small items (e.g. chairs) may be capitalised where they form part of a larger asset (e.g. a canteen fit out). Consumables should not be included in tangible fixed assets. Common sense should be used to align capitalisation limits to local tax rules where applicable. The recommended 1,000 level for capitalisation is for guidance only and a lower level may be used if that is more appropriate for local purposes. Entities should avoid having different capitalisation and depreciation policies for local and Group reporting wherever possible. If the market value or value in use of an item of property, plant and equipment is below its carrying value then that asset is impaired (see policy on Impairment). Depreciation Depreciation should be charged over the useful economic life of the asset, in line with Group policy. It should be charged on a straight-line basis. Useful economic life There is no Group policy set for useful economic lives for different categories of assets. However the maximum lives as set out in the Group s disclosed policy (section 12.1 above) must be followed. Information technology assets should normally be depreciated over three years. Revaluation Property, plant and equipment should not be revalued. Disposals Profits or losses on disposal of property, plant and equipment should be included in the appropriate code in HFM the judgement as to whether they are material enough to require separate disclosure as in the Group accounts will be made by Group Finance, Chertsey. Disposals are disclosed as a separate part of operating profit in the Group accounts where they represent routine adjustments to depreciation on disposals. HFM account: IS42220 Significant profits on major disposals (principally of land, often where no cost is associated with the asset), must be referred to the Group Financial Controller before proceeding with the transaction to determine the appropriate accounting presentation for financial reporting and management purposes. See also separate policy on Material profit or loss items Consultation and authorisation process for exceptions Changes to useful economic lives or residual values must be authorised by the Group Financial Controller.

116 Property, plant and equipment, page 3 of Capitalisation and depreciation questions should be referred to Group Finance, Chertsey IFRS references IAS 16 Property, plant and equipment IAS 36 Impairment of assets 12.4 Summary of IFRS requirements Property, plant and equipment are tangible items that are held for use in the production or supply of goods or services, or for administrative purposes and are expected to be used during more than one period Capitalisation of costs Initial cost The amount to be included in respect of any fixed asset is its purchase price or production cost: Purchase price is the actual price paid plus any expenses incidental to the acquisition. Production cost is: the purchase price of raw materials; and other incremental costs incurred in the production of the asset that are directly attributable to bringing the asset into working condition for its intended use.

117 Property, plant and equipment, page 4 of Directly attributable costs where capitalisation permitted Purchase price less purchasing discounts and rebates. Labour costs of own employees arising directly from the construction of the asset. Note there is no explicit requirement for own labour costs to be incremental although they must arise directly from the construction of the specific asset (but see additional guidance below). Interest costs attributable to the acquisition, construction or production of qualifying assets (which necessarily take a substantial period of time to get ready for their intended use or sale.) Stamp duty, import duties, non-refundable purchase tax, site preparation and clearance costs, initial delivery and handling costs, installation costs and professional fees Cost of provisions needed to dismantle the asset and/or restore the site at the end of its useful economic life (discounted to present value if effect is material) Software that is an integral part of the hardware it resides on, such as the operating system. Application software, databases and websites are now generally classified as intangible assets because they are not embedded in the hardware they reside on. Start-up costs such as a commitment to purchase tangible fixed assets at a client site (see separate policy on Start up costs). Base stock such as the initial purchase of crockery and utensils at the start of a contract (replacements cannot be capitalised). Costs where capitalisation is generally not appropriate Site or product selection costs, including the costs of planning permission. Administration and general costs. Interest and finance costs where development activity has been suspended for an extended period of time. Operating losses as a result of the suspension of a business activity while the asset is constructed. Directors remuneration. Marketing or advertising costs to increase demand for use of the asset. Start-up costs such as staff training costs which would be expensed if incurred in an on-going contract. Abnormal costs such as design errors, industrial disputes, idle capacity wasted materials, labour or other resources and production delays. Costs of relocating or reorganising part of an entity s operations.

118 Property, plant and equipment, page 5 of Subsequent expenditure Subsequent expenditure to ensure that a property, plant and equipment asset maintains its previously assessed standard of performance, for example servicing costs, should be recognised in the income statement as it is incurred. Subsequent expenditure should be capitalised in the following circumstances. Circumstance Where the subsequent expenditure provides an enhancement of the economic benefits of the tangible fixed asset in excess of the previously assessed standard of performance Where a component of a property, plant and equipment asset that has been treated separately for depreciation purposes is replaced or restored, provided that the asset it replaces is written off. Examples Adding a conference suite to a hotel Adding a floor or a wing to an office building Re-equipping the kitchen of a restaurant Replacing a lift Alternative valuation rules Financial reporting standards permit companies to choose a policy of revaluation for particular classes of fixed assets. Compass does not revalue property, plant and equipment assets, however Depreciation Depreciation should be charged on all property, plant and equipment assets (other than non-depreciable land), to write off the asset systematically over its useful economic life. The useful economic life of an asset is the period over which the entity will derive economic benefit from the asset. Depreciation should commence when the asset is available for use. This will mean that there is a no gap between when the asset is ready for use and when it is brought into use. The amount depreciated is the cost less residual value. The residual value is the expected value of the asset at the end of its economic life for the business. Depreciation should be charged to the income statement on a systematic basis (Compass uses the straight-line method) over the useful economic life, by a method that reflects as fairly as possible the pattern of consumption of benefits of the asset. Both useful economic life and residual value (if material) should be reviewed each financial year and revised if expectations have changed significantly. Changes in useful economic life or residual value Increasing useful economic lives or residual values in order to increase profits is strictly prohibited. Material changes to these estimates must be supported by sufficient evidence to justify the change.

119 Property, plant and equipment, page 6 of Residual value is the current market value of the asset, in the condition it is expected to be in at the end of its useful economic life. Where an estimate of useful economic life or residual value is changed, this does not constitute a change of accounting policy. The carrying amount of the fixed asset is depreciated using the remainder of the revised useful economic life or residual value, beginning in the period in which the change is made. Depreciation charged in previous years cannot be written back. Asset lives should be revised only with the approval of the Group Financial Controller. Depreciation charged in previous periods cannot be reversed Disposals Profits or losses on disposal of fixed assets should be included in operating profit, and are separately identified in the Group s reporting system Impairment See separate policy on Impairment of assets. HFM account: IS Disclosure There are significant disclosure requirements regarding tangible fixed assets. Any non-compliance with Group accounting policy or with the requirements of the Group reporting pack should be notified to Group Finance, Chertsey Application guidance Capitalisation of costs Where a fixed asset is purchased, the cost that should be capitalised is the purchase price plus any costs incurred in the purchase. These could include non-recoverable taxes, stamp duty, import duty, delivery and installation costs, and professional fees. In some instances these purchasing costs may form a substantial part of the total costs capitalised, and this is acceptable provided the carrying value of the assets is justified. All purchasing discounts relating to the asset must be set against the purchase cost. If an asset is leased under a finance lease the cost that should be capitalised is the lower of the asset s fair value or the present value of the minimum lease payments. Leased assets should be classified as such in the balance sheet to distinguish them from owned assets. Assets developed or constructed internally Where an asset is constructed or developed in-house the costs that should be capitalised are the costs directly related to bringing the asset to a state where it is ready for use. Labour costs of employees directly involved in the development or construction of the asset should be capitalised - see additional guidance below. However other costs can only be capitalised if they are incremental to the development or construction of the asset.

120 Property, plant and equipment, page 7 of Examples: Property department personnel costs 1 An entity has a property department that deals with all property and site related issues. It employs eight people and salary and other expenses directly attributable to the cost centre are 500,000 per year. These costs are not necessarily directly attributable to the construction of an asset and will partly be related to ongoing maintenance of properties and sites and partly related to new sites. With no specific method of separating the two types of cost, they should be expensed as incurred. 2 As above, except a time recording system is used when each member of the department completes a fortnightly time report allocating their hours between specific new sites and various other activities. Time analysis identifies that 150,000 of salary costs relate specifically to the development and construction of new properties or sites. 150,000 of the costs should be capitalised provided a clear trail between the time reports and the capitalised figure can be determined with the remaining 350,000 expensed in the period. Labour costs are therefore treated differently from other costs; labour costs can be capitalised even if they are not incremental to the construction of the asset. All other costs must be incremental and directly attributable to the construction of the asset. Costs that cannot be capitalised include: Administration, marketing and general overhead expenses; Site selection costs; Abnormal costs caused by design error, material wastage, industrial disputes, etc; Operating losses as a result of suspending normal trading activities; Directors remuneration; and Staff training in the use of the asset (although staff training for the purpose of developing the asset should be capitalised). Where an asset is constructed that brings an immediate obligation to dismantle or make good the site at the end of its useful economic life, the provision created should be capitalised as part of the cost of the asset. The accounting entries would be: Dr Cost of asset Cr Environmental provision x x See the policy on Provisions and contingent liabilities for more detail. When to stop capitalising When an asset has been constructed internally, or it has been purchased but requires a commissioning period, capitalisation of costs should cease when the asset is substantially ready for use. Whether the asset is then put into immediate use, or where activity builds up gradually over time, is not relevant; costs incurred in these periods must not be capitalised. Delays due to regulatory approval (e.g. Health and Safety inspection) do not exempt the asset from being ready for use.

121 Property, plant and equipment, page 8 of The asset should be depreciated from the date that it is ready for use. Example: When to stop capitalising A company is having a new office block built and the Group has won the contract to provide the staff restaurant. The Group has fitted out the kitchen and restaurant areas and incurred costs of 0.5m which it is allowed to capitalise. The kitchen is completed several months before the office block is completed, and therefore there is a gap between the completion of the kitchen and when it is put to use. The Group incurs costs during the period of inactivity such as staff training, routine cleaning and maintenance, but it is not allowed to capitalise these because the asset is already ready for use. Finance costs Interest costs attributable to the acquisition, construction or production of qualifying assets should be capitalised. Qualifying assets are those which necessarily take a substantial period of time to get ready for their intended use or sale. It is anticipated that such circumstances will apply only exceptionally to Compass activities. Capitalisation of software applications Software installed on hardware at the time of purchase of the hardware such as an operating system should be added to the cost of the hardware and written off over the useful life of the hardware. The software must be an integral part of the hardware (without which the hardware would be unusable) for it to be classified as a tangible fixed asset. Internally developed systems, or improvements to purchased applications, may be capitalised as intangible assets provided they meet the rules set out above. They must also pass the requirement that the value in use (or market value, which is extremely unlikely to exist) of the application exceeds the carrying value. Website development costs should not be capitalised unless the website is capable of generating turnover directly, and the cost capitalised can be justified by this value in use. See the policy on Intangible assets for more details. Subsequent expenditure Often expenditure is incurred on an asset throughout its useful economic lifetime. Where this expenditure does not add any significant future economic benefit to the asset s continued use this expenditure must be written off as incurred. Maintenance costs must be expensed. If the future economic benefits of the asset are enhanced as a result of the costs incurred, they should be capitalised. The rules above apply where the expenditure is incurred internally, and the value in use or fair value of the asset must be greater than increased carrying value (see policy on Impairment of assets). Situations where it is acceptable to capitalise subsequent expenditure on an asset include: The performance of the asset is improved; or The useful economic life of the asset is extended past the date originally used to calculate the depreciation charge.

122 Property, plant and equipment, page 9 of A repair cost to an asset in order to return it to working order should not be capitalised unless it meets either of these criteria. With some assets the useful economic life of the asset can be extended provided a major refit occurs at a certain point in its life. The cost of the major refit can only be capitalised if the period up to the time of the refit was originally taken as the useful economic life of the asset for depreciation purposes. If the extended lifetime of the asset (after refit) was used to determine the original depreciation charge then the cost of the refit must be taken to the income and expenditure account as it is incurred. The decision must be made as to whether the cost of refit works should be capitalised or expensed as incurred is made at beginning of the asset s life when its useful economic life is estimated. Example: Subsequent expenditure A vending machine is purchased from a supplier for 5,500, and an additional 500 is spent installing it at a client s premises. The vending machine under normal circumstances has a useful economic life of four years, but if a major refit and servicing is performed during year four this life can be extended to six years. The business has historically always carried out this refit during year four of their vending machines lives. The cost of the refit is 1,500. The vending machine should be capitalised at a cost of 6,000, ignoring the cost of the refit. The business can choose the following treatments for the depreciation of the machine: Option 1 (preferred treatment): assume useful economic life is four years. Capitalise the cost of the refit during year four and depreciate this cost over the remaining life of the machine. The income statement charges are: Year 1 1,500 Year 2 1,500 Year 3 1,500 Year 4 1,000 Year 5 1,000 Year 6 1,000 Option 2 (allowable): depreciate the machine over six years, and take the cost of the refit to the income statement as incurred. The income statement charges are: Year 1 1,000 Year 2 1,000 Year 3 1,000 Year 4 2,500 Year 5 1,000 Year 6 1,000 The business cannot choose to depreciate the machine over six years, and capitalise the cost of the refit as well. This treatment does not reflect the consumption of the economic value of the machine correctly, because little economic value will be reflected in the first three years of its life, while value consumed in the last three years of its life is excessive. In reality the machine loses most of its economic value over the first four years and Option 1 best reflects this in the accounts.

123 Property, plant and equipment, page 10 of Depreciation Depreciation should be charged against the cost of an asset so that it is written off to its residual value at the end of its useful economic life. Depreciation should be charged to reflect the consumption of economic benefit to the Group, and not to reflect the decline of market value of the asset. Group policy is to charge depreciation on a straight-line basis. Depreciation should commence when the asset is ready for use. Example: When to start depreciating A company is having a new office block built and the Group has won the contract to provide the staff restaurant. The Group has fitted out the kitchen and restaurant areas and incurred costs of 0.5m which it is allowed to capitalise. The kitchen is completed several months before the office block is completed, and therefore there is a gap between the completion of the kitchen and when it is put to use. IFRS requires that the kitchen is depreciated from the date that it is ready to use, and not the date when it is put to use. At each year-end the useful economic life of an asset and its residual value should be reviewed. Residual value should now be assessed on current prices for the asset being reviewed in the condition it is expected to be in at the end of its useful economic life; If the estimate of the useful economic life or the residual value of an asset increases the depreciation charge in the current and subsequent years should be at the lower amount to reflect these changes. Asset lives should only be revised with the authorisation of the Group Financial Controller. Under no circumstances can excess depreciation charged in prior years be credited back to the income statement in the year. Where the residual value or the useful economic life is considered to have decreased, the depreciation charge should increase to reflect these circumstances. The asset should also be considered for impairment testing (see policy on Impairment). If the asset is impaired then the full depreciation charge is recorded immediately. When reviewing assets for useful economic life and residual value Group materiality should be borne in mind, and assets grouped wherever possible. In addition the review should also concentrate on assets with a substantial residual value that is liable to change, or to assets where the useful economic life is subjective and liable to change. The majority of fixed assets in the Group will require only a high-level review at the year-end. The example below illustrates the principle surrounding residual value, but in isolation is immaterial at Group level; Example: Residual Value The Group purchases a fleet of 25 vans for 15,000 each and initially decides that at the end of their useful economic life to the Group of 5 years these vans will have a residual value of 2,000 each. During year three it is apparent that the market price of second hand vans has fallen from that originally estimated, and therefore the residual value for each van is reduced to 1,000 each. The reduction in residual value is spread over the depreciation charged in years three, four and five.

124 Property, plant and equipment, page 11 of The depreciation charged in each year is; Year 1 65,000 Year 2 65,000 Year 3 73,333 Year 4 73,333 Year 5 73, Useful economic life There is no Group policy set for useful economic lives for different categories of assets. However the maximum lives as set out in the Group s disclosed policy must be followed. The estimation of useful economic life should take into account the following factors: Physical deterioration of the asset. Obsolescence of the asset. Time limits on the use of the asset (e.g. lease terms, contract life where asset is directly linked to servicing the contract). Consistency of lives with those of similar assets within the business. Where assets are directly attributable to a contract, the useful economic life of the assets owned by the Group cannot be longer than the term of the contract. The term of the contract for this purpose should have regard for the commercial reality of the expected term of the contract and this may be shorter than the legal term of the contract. Where the client contract contains a Net Book Value buy-back clause at the end of the contract, this represents evidence of the residual value of the assets and should be taken into account when depreciating the asset over the term of the contract. Example: New contract useful economic life The group enters into a new catering contract for a period of five years. Initial capital costs are 750,000. After three years, there is a scheduled contract review upon which either Compass or the client can terminate the contract. Normally contracts are re-negotiated at this interim stage. 750,000 should be capitalised and amortised over three years, being the shorter of the contract period and the date at which the client could choose to exit the contract. However, where, for example, either party to a five year contract has a two-month notice period which is not expected to be exercised; the life of the contract should be taken as five years, not two months. If the classification of a lease (either for an asset or for premises in which the asset is permanently installed) has not taken account of any periods beyond a scheduled contract review or point where there is an option to break, then the useful economic life of the related asset should be this same shorter period.

125 Property, plant and equipment, page 12 of Useful economic life of Information Technology assets Information technology assets are not only subject to physical obsolescence but also technological obsolescence. For this reason the useful economic life of hardware should not normally exceed 3 years. Where there is a major computer installation and there is strong valid evidence to justify the view that these assets will be used for a longer period and not become technologically obsolescent, then exceptionally it may be possible to consider extending the useful economic life for such equipment to 5 years. Most software should be categorised as intangible assets unless it is integral to operation of the related hardware (see section ). The useful economic life for integral software capitalised as property, plant and equipment should follow that of the related hardware. The time limits on the use of hardware assets (as explained in section above) will always override the assessment of useful economic life resulting from the view taken of physical and technological obsolescence Revaluation Group policy is not to revalue tangible fixed assets Disposals Profits or losses on disposal of property, plant and equipment assets should be included in operating profit. They are disclosed as a separate part of operating profit in the Group accounts where they represent routine adjustments to depreciation on disposals. The authorisation levels for disposals are set out in the Group Approvals Manual, which has been circulated separately. Significant profits on major disposals (principally of land, often where no cost is associated with the asset), must be referred to the Group Financial Controller before proceeding with the transaction to determine the appropriate accounting presentation for financial reporting and management purposes. Disposals should be recognised when the Group has lost control of the asset. For plant and equipment, this will be when the asset is sold or scrapped. On demobilisation of contracts, the assets located in the facility to be vacated should be reviewed. In some cases, the assets will be removed and reassigned to other contracts. Frequently, however, the assets remain in the client s premises or the concession facility, with compensation for them forming part of the transfer payment from the new contractor. In these cases, a disposal of the assets should be recorded at the point the contract is demobilised. Any element of the transfer payment from the new contractor relating to these assets should be recorded as proceeds on disposal. The fixed asset register should also be reviewed to ensure no assets relating to the former contract retain a value. For disposals of land and property, recognition will be on legal completion of the sale. A conditional contract, or exchange of contracts, is not sufficient.

126 Property, plant and equipment, page 13 of Example: Property disposal A Group company is in discussions to sell a property to a third party. It no longer occupies the building and has exchanged contracts with the purchaser. At the balance sheet date, several conditions remain: i) local municipal consent is required (a formality, but yet to occur); and ii) the purchaser needs to obtain financing from its bank. Until these conditions are resolved, the sale will not legally complete. The disposal of the asset should not be recorded at the balance sheet date as the sale has not legally completed. Various conditions remaining outstanding which, until fulfilled, mean that the sale is not legally enforceable. In rare circumstances, however, property can be disposed of with no sale agreement. This can occur, for example, with compulsory purchase orders where land is requisitioned by government. Example: Compulsory purchase orders The government has decided to construct a new road and, as a result, it has issued compulsory purchase orders (CPOs) against the Group to acquire certain strips of land required for the construction. Once the CPO has been issued, the government can occupy the land and commence construction. Legal title will pass from the Group to the government at some later stage. In addition, the Group will receive compensation from the government at a later stage once a value for the land has been agreed. In general, the stages of the process are as follows: 1. The government decide where they want to build the road. 2. Locate the owners of the land. 3. Serve initial notice to acquire. 4. Objections and proposals period which can take years. 5. Order to make the road is confirmed. 6. Notice of Entry issued - contract between government and landowner price not necessarily included at this point. This empowers the government to go onto the land and start building the road. 7. It can be many years before the title to the land actually transfers. 8. In some instances an advanced payment agreement is issued from the government which usually represents 90% of what the government believes it will ultimately have to pay (land valuation). 9. Once title has been proved and all financial compensations agreed then land title is transferred and the balance of monies is paid to the landowner (10% plus compensation for loss of business). This will include interest from the date the government took possession of the land.

127 Property, plant and equipment, page 14 of The point at which the income and disposal should be recognised is when control of the land has effectively passed to the government, even though this may be before transfer of title. Whilst income could be recognised at the notice of entry point (as from this point the government can access the land and the Group has fulfilled its part of the disposal contract), the lack of a valuation at this point makes recognition difficult. An appropriate time to recognise the income will be when a valuation has been received, as this valuation will normally be the guaranteed minimum receivable under the CPO. The cost of disposal should also be recorded in the same period. Any interest subsequently receivable on the proceeds should be classified as interest and not included as part of the profit or loss on disposal.

128 13. Classification of investments Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued An entity must be consolidated in the Group accounts if the Group owns a majority of the voting rights after taking into consideration potential voting rights that could be currently exercised at the Group s option. Joint control occurs when a contractual agreement or share of the voting rights ensures that no single venturer is able to control the entity unilaterally. IFRS considers formal written agreements only and takes no account of informal arrangements. The Group uses proportionate consolidation to account for jointly controlled entities. The Group s share of the assets, liabilities, income and expenses of a jointly controlled entity is combined line by line in the Group s financial statements. IFRS (IAS 39) requires that all investments are allocated to one of four categories of financial asset. If classified as available for sale they will be measured at fair value. However, an investment that does not have a quoted market price and whose fair value cannot be reliably measured is still measured at cost. This situation is rare Disclosed accounting policy Subsidiaries are entities over which the Group has the power to govern the financial and operating policies. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing control. Joint ventures are entities in which the Group holds an interest on a longterm basis and which are jointly controlled by the Group and other venturers under a contractual agreement. The Group s share is accounted for using the proportionate consolidation method. The consolidated income statement and balance sheet include the Group s share of the assets, liabilities, income and expenses. Associates are undertakings that are not subsidiaries or joint ventures over which the Group has significant influence and can participate in financial and operating policy decisions. Investments in associated undertakings are accounted for using the equity method. The consolidated income statement includes the Group s share of the profit after tax of the associated undertakings. Investments in associates include goodwill identified on acquisition and are carried in the Group balance sheet at cost plus postacquisition changes in the Group s share of the net assets of the associate, less any impairment in value. Where necessary, adjustments are made to the financial statements of subsidiaries, associates and joint ventures to bring the accounting policies used in line with those used by the Group. The results of subsidiaries, associates or joint ventures acquired or disposed of during the period are included in the consolidated income statement from the effective date of acquisition or up to the effective date of disposal, as appropriate.

129 Classification of investments, page 2 of Default policy and process for exceptions Default policy An entity should be fully consolidated in the Group accounts if the Group holds the majority voting rights or currently has the capability of obtaining it through any shareholder agreement. An entity should be proportionately consolidated in the Group accounts if: the Group has contractually agreed to share control over an economic activity. Joint Control is demonstrated through contractual agreement so that no single investor in the entity is in a position to control the activity unilaterally. The Group s rights must be capable of demonstration and clearly documented for this treatment to be acceptable. The consolidation method for new entities should be reviewed and confirmed by the Group Financial Controller Consultation and authorisation process for exceptions Exclusion from consolidation Businesses where control is only intended to be temporary may be excluded from consolidation and shown under current asset investments as businesses held for resale (see policy on Non-current Assets Held for Sale and Discontinued Operations). There must be evidence that the subsidiary is acquired with the intention to dispose of it within 12 months and that management is actively seeking a buyer. Each case must be referred to Group Finance, Chertsey and be approved by the Group Financial Controller before this treatment is adopted. Any other subsidiary that is being excluded from consolidation must also be approved by the Group Financial Controller.

130 Classification of investments, page 3 of IFRS references IAS 27 Consolidated and Separate Financial Statements IAS 28 Investment in Associates IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Presentation IAS 39 Financial Instruments: Recognition and Measurement IFRS 7 Financial Instruments: Disclosures 13.4 Summary of IFRS requirements Definition of parent and subsidiary relationship Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than half of the voting power of an entity. Control also exists when the parent owns half or less of the voting rights of an entity when there is: power over more than half of the voting rights by virtue of an agreement with other investors; power to govern the financial and operating policies of the entity under a statute or an agreement; power to appoint or remove the majority of the members of the board or equivalent governing body and control of the entity is by that board or body; or power to cast the majority of votes at meeting of the board of directors or equivalent governing body and control of the entity is by that board or body. The existence and effect of potential voting rights that are currently exercisable or convertible (share warrants, call option, debt or equity instruments), are considered when assessing whether an entity has the control or joint control of the voting rights. Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until a future date or until the occurrence of a future event. Put options (where the third party has the option to require the Group to purchase additional shares in the entity) cannot be considered as exercisable rights. Management s intentions are not relevant in considering the impact of potential voting rights Other definitions The term investor below refers to a Compass Group PLC holding company. An associate is an entity over which the investor has significant influence defined as the power to participate in the financial and operating policy decisions of the investee but where the investor does not exercise either control or joint control. A venturer is a party to a joint venture and has joint control (defined as a contractually agreed sharing of control over an economic activity) that exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control. Jointly controlled operations occur when two or more venturers combine their operations, resources and expertise rather than establish a

131 Classification of investments, page 4 of 8 13 corporation partnership or other entity that is separate from the venturers themselves. Each venturer will recognise the assets that it controls and the liabilities that it incurs as well as the expenses that it incurs and the share of income that it earns from the sale of goods or services. Jointly controlled assets involve the joint ownership of assets for the purpose of a joint venture, but do not involve the establishment of a corporation, partnership or other entity. Each venturer will recognise its share of the jointly controlled assets and the liabilities that it incurs and its share of any liabilities incurred jointly. It will also recognise any expenses it incurs, its share of expenses incurred by the joint venture and its share of income that the joint venture earns from the sale of goods or services. Other participating investments shall be accounted for in accordance with IAS 39. They are classified as financial assets and must be allocated to one of four available categories. Compass Group policy is to classify such investments as available for sale. They need to be held on a long-term basis for a purpose other than selling for a short-term profit. For further information, see the policy on Financial Instruments. The investments should be measured at their fair value, except for investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured. These are valued at cost. The decision stages to follow in order to determine the classification of an investment are outlined below: Does investor have long term significant influence? No Other participating investment Yes Has investor sole control? No Does investor exercise joint control with another No Associate Yes Yes Subsidiary Joint venture

132 Classification of investments, page 5 of 8 13 Type of investment Nature of relationship Key elements of relationship Accounting treatment Subsidiary Investor controls investee Own (or potentially own) directly or indirectly more than half of the voting rights Full consolidation Minority interest recognised Joint venture Investor controls investee jointly Under a contractual arrangement, two or more investors together control a venture Proportionate consolidation No minority interest recognised Joint controlled operations or assets THIS IS RARE Investors control operations or assets jointly Investor extends its own trade through the joint arrangement Each investor accounts for its own assets, liabilities expenses income and cash flows Associate Exercise of a significant influence A long-term substantial minority shareholding which enables the investor to be actively involved, and influential in policy decisions Net equity method Simple investment Passive participating interest An insubstantial interest giving the investor limited influence, or a short-term interest, in an investee. Cost or fair value (depends if fair value can be reliably measured) The investment in a subsidiary in the holding company s own books is subject to local GAAP requirements. However, where these mirror IFRS, the investment should be held at cost and not re-translated if originally purchased in a foreign currency. These investments are classified as available for sale where the fair value cannot be reliably determined.

133 Classification of investments, page 6 of Application guidance Subsidiary undertakings Any undertaking where the Group controls more than 50% of the voting rights that allow the Group to exercise sole control should be consolidated as a subsidiary. Major operational and financial decisions should be taken by simple majority and should not require a unanimous vote. Major operational and financial decisions include the appointment of key managers, decisions regarding capital investment, the declaration of dividends and the adoption of budgets and forecasts. Any other shareholders should not hold a right of veto. Written agreements such as a technical assistance agreement, a management service agreement or a power of attorney providing extensive powers to management may not be considered if they don t provide effective power over the board and its final decisions. Shares held by a nominee may be considered when looking at the shareholdings and control over voting rights. Call options that are currently exercisable and warrants should be considered when determining the proportion of voting rights controlled Joint ventures Any undertaking which the Group controls jointly with other shareholders. The Group may own more or less than 50% of the shares. A jointly controlled entity should be consolidated using the proportionate consolidation method. Joint control may be shown by either: voting rights which are equally allocated between the partners in the entity where major decisions are taken by simple majority; voting rights which are not equally allocated but where major decisions require unanimous consent. Options currently exercisable and warrants should be considered when determining the proportion of voting rights controlled. Under the Group s accounting policy joint ventures should be accounted for using the proportionate consolidation method. The investor should combine its share of each of the assets, liabilities, income and expenses of the joint venture entity with the similar items in its own financial statements (balance sheet and income statement) on a line by line basis Associated undertakings An undertaking over which the Group does not exercise control but does exercise a significant influence should be classified as an associate and consolidated using the net equity method. Significant influence is presumed if the Group controls at least 20% of the voting rights but does not exercise control. Significant influence is evidenced if the Group is represented on the board of directors, and participates in the policy-making process or similar activities. Options currently exercisable and warrants should be considered when determining the proportion of voting rights controlled.

134 Classification of investments, page 7 of 8 13 An associate should be accounted for under the net equity method as follows: The investor's consolidated income statement should include the investor's share of its associate s profit after tax, immediately after Group operating profit as investment income. In the balance sheet the investor's share of the net assets of its associates should be included and separately disclosed as other investments. Goodwill arising on the investor's acquisition of its associates, less any amortisation or write-down pre September 2004 should be included in the value of the investment. Amortisation of that goodwill is not permitted under IFRS Consolidation method See policy on Accounting convention and basis of consolidation section Date of acquisition The date of acquisition or disposal is the date when control passes. This may not be the same as the legal contract completion date. See the Acquisition accounting section for further information.

135 Classification of investments, page 8 of Examples Examples: Classification of investments 1 Compass controls 60% of the voting rights of Company A and major decisions require a simple majority. Consolidate 100% but show minority share of 40%. 2 Compass controls 65% of the voting rights in Company B but major decisions require the consent of all shareholders. Proportionately consolidate the 65% Group share, without any minority interest. 3. Compass controls 40% of the voting rights in Company C but major decisions require the consent of all shareholders. Proportionately consolidate the 40% Group share, without any minority interest. 4. Compass controls 49% of the voting rights in Company D and major decisions require simple majority. However, Compass could currently exercise a call option giving 2% of shareholding and give the Group 51% of voting rights. Consolidate 100% but show minority share of 51% until the call option is exercised. 5. Compass controls 50% of the voting rights in Company E and major decisions require simple majority. Compass signed a management service agreement and has a fee of 2% of turnover. Proportionately consolidate for 50% group share, without any minority interest. 6. Compass controls 49% of the voting rights in Company F, has a seat on the Board and is involved in the decision making processes of the Company. Account for as an associate under the net equity method. 7. Compass holds 10% of the voting rights in Company G, a trading partner, and has no automatic right to Board representation. Company G is not listed on a stock exchange and its fair value cannot be reliably measured. The investment is intended to be held for more than three years. Account for Company G as a fixed asset investment valued at cost but provide for any permanent diminution in value. 8. Compass holds 10% of the voting rights in Company H, a trading partner, and has no automatic right to Board representation. Company H is listed on a stock exchange and fair value can be reliably measured. The investment is intended to be held for more than three years. Account for Company H as a fixed asset investment, valued at market price at the balance sheet date. Changes in valuation are taken to equity and reported in the statement of changes in equity until the investment is sold. Then the cumulative gain or loss should be recognised through the income statement. 9. As the result of an acquisition, Compass holds a number of shares in X plc, a company listed on the London Stock Exchange, which represents 6% of X plc. It is not expected that these shares will be held for the long term. Classify in current asset investments, valued at market price at the balance sheet date. Changes in valuation are booked through the income statement.

136 14. Inventories Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Inventory valuations must be net of all purchasing discounts. Sufficient provision must be made against excess, damaged or outdated inventory Disclosed accounting policy Inventories are valued at the lower of cost and net realisable value. Cost is calculated using either the weighted average price or the first in, first out method as appropriate to the circumstances. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses Default policy and process for exceptions Default policy Inventories should be recorded at the lower of cost and net realisable value. Cost is arrived at after deducting all purchasing discounts. Net realisable value should be assessed after making appropriate provision for excess, damaged or obsolete inventory Consultation and authorisation process for exceptions Exceptions to the default policy or more specific application detail below must be authorised in writing by the Group Financial Controller IFRS references IAS 2 Inventories 14.4 Summary of IFRS requirements Inventories are stated at the lower of cost and net realisable value. The costs of purchase comprise the purchase price, import duties and other taxes (other than those subsequently recoverable from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase. Net realisable value is the actual or estimated selling price (net of trade but before settlement discounts), after deduction of all further costs to completion and of costs of marketing, selling and distribution. Long-term contracts are discussed in a separate policy and rarely arise in the Group.

137 Inventories, page 2 of 3 14 In particular: inventory should be valued using a first in, first out or weighted average valuation; all purchasing discounts must be deducted in reaching the cost; the difference between deferred payment terms and normal credit terms must be treated as an interest cost and not part of the inventory cost; all intra-group mark-ups must be eliminated to arrive at the cost to the Group; any outdated or damaged inventory must not be included; and slow moving inventories and excess quantities should be reviewed and provisions made if necessary. The level of inventory provisions must be monitored by the reporting Country Finance Director and the overall value of inventory must be capable of substantiation. Inventories must be accurately and regularly counted, and variances from book values investigated (see Period end procedures). There is a requirement under IAS 2 to separately disclose any writedown of inventory recognised as an expense in the period Application guidance Determining cost The two methods of determining costs which are acceptable Group policy are: (a) (b) first in first out (i.e. the earliest purchased inventory is the first to be disposed of, and the inventory on hand is the most recent purchase); or weighted average price, which is determined by dividing the total cost of units by their number to arrive at a weighted average price. Inventories may not be recorded at latest invoice price since the result does not normally represent cost. In most parts of the Group, however, inventory is held for a very short period and latest invoice price will be an acceptable valuation method, on the basis that price fluctuations during the inventory holding period have been so insignificant that the result is a reasonable approximation of cost. In parts of the Group where this is not the case, for example because significant inventories of frozen or non-perishable items are held for logistical reasons, or inventories are non-food, this approximation may not be appropriate. The cost of inventory may include items such as raw materials, import duties, transport and handling costs and other directly attributable costs, but not storage, wastage or selling costs.

138 Inventories, page 3 of Purchase discounts Purchase discounts and supplier rebates should be deducted from the inventory valuation to ensure it is stated at the cost to the Group. This applies regardless of whether a higher price (inter-unit pricing) is used internally. Example: Purchase discounts Product A s cost is charged as follows Full list price (charged to unit) 55 Local supplier discount (12) National discount (6) Overriding discount (2) Net cost 35 The cost to be used in valuing Product A in Group reporting is 35, as this is the cost to the Group in buying the product. This cost may be recorded at unit level, by recalculating the cost of inventory at a level above unit level, or by calculating the estimated provision needed to give the correct value. Any calculation of an estimate should be rigorous, detailed and capable of being verified Lower of cost and net realisable value In assessing the lower of cost and net realisable value, appropriate provisions should be made against obsolete or excess inventory which is not expected to be sold, together with slow-moving inventory. Examples: Inventory provision 1 Two months supply of Product B is in store in a central warehouse. Product B s remaining shelf life is one month, during which one month s worth of Product B is expected to be used. A provision for 50% of the value of Product B should be made. 2 Two year s supply of Product C is in store in a central warehouse. Product C is a cleaning material with an indefinite shelf life and is still currently marketed and used. No provision is necessary against the value of Product C. However, the circumstances surrounding the build up of such an exceptional level of inventory should be investigated and measures put in place to prevent a recurrence Inventory write downs Write-downs of inventory recognised as an expense in the period have to be separately disclosed and should be recorded in HFM.

139 15. Long-term contracts Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Only in extremely rare circumstances will any of the Group s contracts with clients or customers be accounted for as long-term contracts. The key principle in recognising revenue on long-term contracts is the seller's performance of its contractual obligations. All loss-making contracts, whether or not they are long-term in nature, should be provided for in full, as soon as the loss is anticipated Disclosed accounting policy There is no disclosed accounting policy for long-term contracts Default policy and process for exceptions Default policy Only in extremely rare circumstances, will any of the Group s contracts be accounted for as long-term contracts. Loss-making contracts should be provided for in full, as soon as the loss is anticipated. Any loss-making contracts should be notified to Group Finance, Chertsey. On profitable contracts, revenue and profits recognised should reflect the proportion of contractual performance completed, thus following the normal revenue recognition rules as set out in the policy on Revenue recognition Consultation and authorisation process for exceptions Agreement to treat any contracts as long-term contracts should be received in writing from the Group Financial Controller. Any exceptions to the default policy or more specific application detail below must be authorised by the Group Financial Controller IFRS references IAS 11 Construction contracts IAS 18 Revenue 15.4 Summary of IFRS requirements Basic principles IAS 11 deals specifically with asset construction contracts but IAS 18 uses the same principles in determining revenue recognition. A contractual arrangement should be accounted for as two or more separate transactions where the commercial substance is that the individual components operate independently of each other ( unbundling ). More detail is given on unbundling of contracts in the Revenue Recognition section. Unbundling of a contract for accounting purposes is always preferable to adopting long-term contract accounting.

140 Long-term contracts, page 2 of for revenue and profit Where the outcome of a long-term contract can be assessed with reasonable certainty, the attributable profit should be recognised in the income and expenditure account by including in revenue the proportion of the total contract appropriate to the stage of completion of the contract and transferring to cost of sales, those costs incurred in reaching this stage of completion. Where the outcome cannot be assessed with reasonable certainty, no profit should be recognised. An appropriate proportion of revenue should be recognised, using a zero estimate of profit Loss-making contracts All foreseeable (and unavoidable) losses on contracts entered into before the balance sheet date should be provided in full, even if work has not commenced Application guidance Examples of long-term contracts Scenario Contract 1: Work performed to date 200,000 Payments on account received from customer 150,000 Costs incurred to date on work performed 140,000. Contract 2: Work performed to date 500,000 Payments on account received from customer 600,000 Costs incurred to date 400,000, of which 350,000 has been transferred to cost of sales Contract 3: Work performed to date 500,000. Payments on account received from customer 400,000. Costs incurred to date and transferred to cost of sales 500,000. Further costs anticipated for work performed to date 50,000 Treatment Recognise 200,000 as turnover, and 140,000 as cost of sales. Amounts recoverable on contracts of 50,000 ( 200,000 less 150,000 received to date) included within debtors. Recognise 500,000 as turnover, and 350,000 as cost of sales. Excess of payments on account over turnover 100,000 should be offset firstly against any debit balances on this contract (i.e the additional costs of 50,000), with the remaining 50,000 included within creditors as Payments on account. Recognise turnover of 500,000 and cost of sales of 550,000 ( 500,000 plus additional cost of 50,000). Provision for contract losses of 50,000 included within accruals. Amounts recoverable on contracts of 100,000 ( 500,000 less 400,000 received to date) included within debtors. Balance sheet amounts are not offset.

141 16. Receivables Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Full provision must be made against irrecoverable debts. An appropriate partial provision for doubtful debts must be made, based on age and expected recovery. The level of provision against bad and doubtful debts is disclosed in published financial statements prepared under IFRS. No expenditure should be carried forward as an other receivable or prepayment unless: it relates to revenue which will be earned in the future, or services to be received in the future, and it will be covered by the profits it generates Disclosed accounting policy The Group has no specific externally disclosed accounting policy for receivables Default policy and process for exceptions Default policy Receivables should not be carried at more than their recoverable amount. See below for further guidance. The entity s policy for bad debt provisions should be approved by the Country Finance Director Consultation and authorisation process for exceptions Any entity which is not making regular provisions for overdue debts or is carrying forward expenditure other than as permitted by this document must justify its policy to the Group Financial Controller IFRS references Framework for the preparation and presentation of financial statements From 1 October 2007 IFRS 7 Financial Instruments: Disclosures 16.4 Summary of IFRS requirements IFRS requires that amounts recognised as assets be determined reliably and, where there is uncertainty, prudently (i.e. a degree of caution has been applied in exercising judgement and making the necessary estimates). This implies that receivables should not be carried above the amount which is recoverable and that costs should not be carried forward as prepayments unless they will be matched against, and more than covered by, the future revenues to which they relate. Note that under IFRS the level of provision against bad and doubtful debts is disclosed.

142 Receivables, page 2 of Classification of debtors The various categories of debtors include Category Trade receivables Other receivables Prepayments Includes Amounts invoiced to customers, accrued sales for goods delivered but not billed, contract retentions (e.g. for certain design and build contracts) and supplier debit balances, less provision for bad debts and provision for credit notes and rebates. Where supplier debit balance is settled through netting against the payable balance, it should be shown against the supplier balance within trade payables. Appropriate provision should be made for bad and doubtful debts. Net credit balances owed to customers should be reclassified as trade creditors for the purposes of Group reporting if the total amount is significant in the context of the local entity s receivables or payables. Amounts owed to Group companies should not be classified as trade receivables but should be shown as intragroup balances (see policy on Intragroup items). Receivables arising from non-trading activities, such as the proceeds from fixed asset sales, insurance reimbursements and refundable deposits. Advances or payments on account towards property, plant and equipment should be included in property, plant and equipment. Property, plant and equipment which is intended for sale or is in the process of being sold should not be included in this category. Only once the sale has legally completed should it be recognised, with any proceeds receivable being recorded as an other receivable. Interest receivable should be accrued for as earned. In certain circumstances and with certain safeguards, costs can be carried forward and charged in the income statement to match the revenue they generate. Prepayments represent amounts paid in advance of benefits to be received (e.g. rent paid in advance). No expenditure should be deferred unless: it relates to revenue that will be earned in the future, or services to be received in the future, and it will be covered by the profits it generates Amounts falling due after more than one year Receivables due after more than one year must be disclosed separately. When reporting to the Group at P6 and P12, debtors must be reviewed to ensure correct disclosure IFRS 7 Disclosure requirements IFRS 7 requires additional pieces of disclosure surrounding receivables classed as financial instruments (these are trade or other receivables); An aging analysis of all receivables past due but not impaired i.e. provided for (past due usually being anything beyond the term defined in the client contract). A reconciliation of the bad debt provision from opening to closing balance. An aging analysis of all impaired receivables i.e. those that have been provided for. In addition a description of collateral held as security must be provided.

143 Receivables, page 3 of Application guidance Trade receivables Credit sales should only be made after credit approval procedures have been satisfactorily completed. Sales invoices should be raised promptly, accurately and in accordance with contract terms and conditions and all debts should be collected promptly in accordance with the contract terms and conditions. Debts that are not recoverable should be identified and full provision made. An appropriate partial provision for doubtful debts must be made, based on age and expected recovery (see guidance below). Debt factoring or offering receivables as security is strictly forbidden under Group policy Making provisions for bad and doubtful debts It is recognised that different countries and markets have different payment practices and therefore it is not appropriate to specify a single policy on provisioning to cover all countries. An entity s provisioning policy should be approved by the Country Finance Director. Where the provisioning policy differs significantly from the guidance below the Group Financial Controller should be informed. All entities must recognise the risks arising from carrying out business on credit - it is not realistic to assume that all debts will eventually be paid. Specific provision: Provisions should be recorded against specific receivable balances where circumstances indicate that the balance is not fully recoverable. When reviewing specific provisions, the factors to be considered include the following: how overdue the debt is; progress of resolution of any disputed amounts; the type of client (for example, a public authority, lead contractor); current market and trading conditions; past history of the client (but this must be balanced by the other considerations); any existing guarantees or security for the debt. Full provision: Indications that a debt should be fully provided for include the age of the balance, the client ceasing to trade, legal proceedings and insolvency or similar arrangements. These indications are for guidance only and local business practices may determine that other factors are taken into account when deciding on specific provisions. In addition, knowledge of the specific circumstances surrounding legal proceedings may enable a Country Finance Director to conclude that full provision is not required. Debt write-offs should be authorised at a senior level within the entity. Even after full provision has been made, the status of the client should be monitored to ensure that any amounts that can be recovered are collected.

144 Receivables, page 4 of 5 16 General provision: In addition to provisions against specific receivable balances, it is normally appropriate for an entity to carry a general provision against receivables to reflect the risks inherent in the overall balance. Such a general provision could be based on: a flat rate percentage of the overall balance: e.g. % of total receivables (net of sales tax, which is generally recoverable in the event of default by the client). or the degree to which the balance is overdue: or e.g. Days overdue >120 Provision % % % % % % another appropriate method. In all cases, amounts specifically provided for would be deducted from the calculated amount. The entity s historical experience may help in deriving the appropriate formula. The method of provision, percentage chosen and any changes should be approved by the Country Finance Director and should be applied consistently from period to period Prepayments No expenditure should be carried forward unless: it relates specifically to revenue that will be earned in the future, or services to be received in the future, and it will be covered by the profits it generates. Even where prepayments are carried forward, the period in which the benefits are to be received must be short enough that the recovery of the costs is probable. Any balance carried in prepayments that is no longer justified or recoverable must be written off. Some specific situations are: Situation Advertising costs These usually cannot be identified with specific revenue and thus these expenses should not be carried forward beyond the date that the advertisement is run. Marketing materials The cost of tangible marketing materials may normally be carried forward to the time that the material is first used (i.e. when first despatched to the point of sale) providing recovery of cost is reasonably assured. Once despatch to units has occurred, there is no direct control over these materials and so expensing the costs at that time is required. Costs relating to surplus stocks of marketing materials must be expensed.

145 Receivables, page 5 of 5 16 Crockery, cutlery, glassware, cooking utensils, uniforms and similar items Where these items have been received but are held in a central depot and have not been brought into use then those items should be treated as stock. Where usage has commenced it is not appropriate to hold those costs on the balance sheet as a prepayment or within stock and the costs should be expensed to the income statement. For the avoidance of doubt, consumables such as cleaning materials, plastic or paper items should always be expensed once they have been issued from stock. For permitted accounting on initial purchases of crockery and similar items for a new contract see section on Start-up costs, bidding costs and other pre-contract costs. Pre-contract costs See Start-up costs, bidding costs and other pre-contract costs. Contract termination costs Costs incurred in cancelling an onerous contract, even when apparently linked to obtaining another profitable contract, should not be deferred, because they are not directly related to the generation of future profits.

146 17. Contingent assets Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Contingent assets cannot be recognised. Retrospective discounts, rebates or reimbursements cannot be recognised until the other party has documented their acceptance of the broad terms of the payment and a reasonable and supportable estimate can be made Disclosed accounting policy The Group has no specific externally disclosed accounting policy for contingent assets Default policy and process for exceptions Default policy A contingent asset cannot be recognised. Only when the realisation of profit is virtually certain (and the asset is no longer contingent) can it be recognised Consultation and authorisation process for exceptions Exceptions to the default policy must be authorised by the Group Financial Controller. For more specific application detail contact Group Finance, Chertsey IFRS references IAS 37 Provisions, contingent liabilities and contingent assets 17.4 Summary of IFRS requirements A contingent asset is a possible asset arising from past events whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity s control. It is not recognised as an asset because this may result in the recognition of profit which may never be realised. When, however, the realisation of the profit is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.

147 Contingent assets, page 2 of Application guidance Examples of contingent assets which may be encountered in practice include the following. Example Insurance refunds receivable Retrospective discounts from suppliers Sales tax or other tax refunds receivable Contract variations An insurance receipt should not be recognised unless it is virtually certain. In practice, this can lead to a mismatch, with costs being incurred, or a provision for an obligation being established in one period, but the recognition for the insurance receipt not accounted for until a later date. Virtual certainty in the case of an insurance debtor should be taken to be, as a minimum: (a) (b) written acknowledgement from the insurer of: (i) (ii) the existence of cover and its applicability to the claim; and the basis of calculating the amount of the claim; and a reasonable and supportable estimate of the size of the claim can be made, which in many cases would require the company s insurance broker to be involved. This provides certainty in respect of the existence of cover and the basis of calculating the claim, rather than necessarily confirming the amount itself. Recognition of insurance recoveries prior to the receipt of payment from the insurers requires the specific approval of the Group Financial Controller. Retrospective discounts cannot be recognised until: (a) (a) agreement has been reached and documented with the supplier about: (i) (ii) the period and products covered by the discount; the structure of the discount arrangement (fixed amount, per unit amount, etc); and either the quantities to which the discount will be applied have been agreed by the supplier or a reasonable and supportable analysis can be prepared which demonstrates the quantities purchased to which the discount would apply. An intention to seek a retrospective discount or an agreement from the supplier to enter into discussions intended to lead to such a discount would not, in themselves, permit recognition of an asset. These should not be recognised until either: (a) (a) settlement of the claim has been received; or an agreement to the claim in principle has been received from the relevant tax authority and a reasonable (and supportable) estimate of the likely refund can be made. No receivable should be recognised if neither of these points has been reached. Variations ( extras ) which are not contemplated in a client contract should not be recognised until the client agrees that additional amounts can be billed and a reasonable and supportable estimate of these can be made. The intention to seek additional payments which are not explicitly addressed in the terms of the client contract, even where the business has incurred additional costs which it believes should be recovered from the client, is not sufficient in itself to recognise an asset.

148 Contingent assets, page 3 of Specific examples Example: Retrospective supplier rebates A company, in reviewing its arrangements with its suppliers, has concluded that it has been overcharged in respect of previous periods. Its view has been supported by a study by an industry specialist who has noted that the prices the company has previously paid are above those paid by companies of a comparable size. Whilst the company has informed its suppliers of its conclusions and desire both to renegotiate prices and seek a rebate for prior periods, and the suppliers concerned have agreed to meet the company to discuss the issue, no agreement, either on the principle or the quantities or amounts involved, has been reached. Recognition of any asset in respect of this rebate at this point would be premature as there is no certainty as to existence, amount or timing. No asset should be accounted for until the suppliers have agreed to the principle, period and calculation basis of the discount and a reasonable and supportable estimate of the amount can be made. Examples: Sales tax claim 1 A company has made a claim to the appropriate local government authority to recover sales tax on cold food sold in hospitals, which in fact should not be subject to sales tax and hence should not have been paid over to the government authority in the first place. The claim made totals 500,000. At year end, the claim has been submitted to the local government authority but no further correspondence has been entered into. At year end, no asset should be recognised as there is no certainty that an amount will be recovered. 2 As above, except that by year end a letter has been received from the local government authority acknowledging the claim and agreeing that it is valid in principle, subject to final agreement of the amount repayable. As the principle has been agreed, provided a reasonable estimate of the amount recoverable can be made (based upon previous experience of similar claims and/or advice from appropriate professional advisors) then a debtor may be recognised to reflect the amount considered to be reasonably certain of recovery.

149 18. Cash Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued The Group s month-end procedures regarding bank reconciliations and cut-off should be strictly applied when accounting for cash Disclosed accounting policy Cash and cash equivalents Cash and cash equivalents comprise cash at bank and in hand and short term deposits with an original maturity of three months or less 18.2 Default policy and process for exceptions Default policy Cash should include cash floats, bank deposits, cheques and other deposits or payments which are repayable / payable on demand. Within a legal entity cash and overdrafts repayable on demand should be offset if they are held with the same bank and there is a right of set off. The Period-end procedures for cut-off should be applied strictly and consistently. Loans and overdraft facilities To ensure compliance with the Group s financial covenants companies are not permitted to arrange local credit facilities without the prior approval of Group Treasury. Where approval is given credit facilities will be made available through the in-country cash management arrangements and must be agreed with the Country Cash Manager. Where local cash management arrangements do not exist such facilities must be arranged through Group Treasury, who will advise on the local banking relationships, and agree the need for and form of any support Consultation and authorisation process for exceptions Exceptions to the default policy or more specific application detail below must be authorised by the Group Finance Director IFRS references Companies Act 1985 IAS 7 Cash flow statements 18.4 Summary of IFRS requirements Cash, cheques, postal orders and other amounts repayable on demand, held in the ordinary course of collection should be included within cash. Other, longer-term deposits and finance facilities should be included with current or long-term investments or liabilities as appropriate. Deposits repayable within 24 hours without penalty to the principal sum should be included in cash.

150 Cash, page 2 of Application guidance Cash takings up to the accounting close date that have not been banked should be recorded as cash in hand. Amounts should be treated as withdrawn from the bank when cheques are released rather than when they are presented; therefore unpresented cheques and unbanked receipts should be deducted from / included in cash as appropriate. For unbanked receipts to be included as cash, there must be evidence at the time which demonstrates that the cheque was in the Group s control at the balance sheet date, and that the cheque was not post-dated. Where cheques are drawn in settlement of liabilities but are not released to the creditors until a later date, the payment entries should be reversed for month-end and year-end reporting. If bank accounts with both debit and credit balances are maintained at the same bank and there is a right of set-off, the net amount should be shown under cash at bank or bank overdrafts as appropriate. Where a right of setoff does not exist, the assets and liabilities should both be shown at their full amount in the balance sheet, regardless of whether the balances are with the same bank or different banks. Where companies in a group remit funds to a central treasury company, balances should be disclosed as amounts owed by group undertakings, not as cash at bank. Credit card transactions should be recorded as cash when the funds are credited to the Group s bank account by the credit card processor. Examples: Cash 1 Cheque payments A cheque run has been processed on the last day of the period and amounted to 45 million. The system automatically debits trade creditors and credits cash to reflect the processing of the transaction. 30 million of these cheques were posted to suppliers before the end of the day but 15 million were held back. The 30 million has correctly been deducted from cash, reflecting the fact that control of the cheque instrument has now physically passed from the Group. The 15 million of cheques held back should be added back to cash and creditors as the Group has retained control and could (if it chose) destroy or withhold the cheques. 2 Cheque receipts Cheques received and deposited at the bank before a period-end should be reflected as cash, with the corresponding debtor credited. Cheques dated and received just prior to the period end may not have been lodged at the bank. Whilst, technically, the debtor balance due from the payee is only extinguished when the cheque is cleared, Group policy is to recognise cheques as cash once received by the company. Hence, it is appropriate to record the cheque as cash when there is persuasive evidence that the Group has received the cheque (and that cheque is dated on or at an earlier date to the receipt date). Appropriate evidence of receipt prior to the period-end must be available. This treatment is subject to there being persuasive evidence that cheques in general are banked on a timely basis after being received.

151 Cash, page 3 of 3 18 Examples: Cash 3 BACS, CHAPS or other electronic funds payments Prior to year-end, management have instructed their bank to make BACS payments of 10 million. Due to the processing cycle, these payments will not leave the company s bank account until after the period-end, at which point the transfer to the recipient s bank account occurs instantaneously. The Group records the reduction in cash only when payment leaves its bank account. For this instruction, 10 million should not be deducted from cash until after the period end and the liability should remain at that date also, as up to that point the instruction could be withdrawn. 4 BACS, CHAPS or other electronic funds receipts Just before year-end, the company receives notification from a customer that it has made a BACS transfer of 2 million in settlement of certain outstanding sales invoices. As at year-end, the funds have not been received into a Group bank account. The BACS instruction is given by the customer and hence the customer has control of the process until the instant the cash is cleared in the Group s bank account. The debtor balance due from the payee is only extinguished when the money has cleared in the Group s bank account. It is only appropriate to record the 2 million BACS receipt as cash when it has cleared in the Group s bank account.

152 19. Financial instruments Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued The Group does not undertake trading in derivative financial instruments. Derivative financial instruments are used under the control of the Group Treasury department to manage interest rate and currency risks arising from the Group s operations. No entity may enter into any derivative financial instrument contract without the written consent of the Group Treasurer and the Group Finance Director. This includes put options granted to minority shareholders as part of the acquisition of a business. Speculative use of derivative financial instruments is forbidden. All financial instruments, including derivatives, are shown on the balance sheet at fair value, amortised cost or historical cost. All types of contracts must be reviewed for the existence of embedded derivatives, and these embedded derivatives may require separate recognition from the host contract. Hedge accounting follows very tight controls and rules under IFRS. Hedging requires formal designation and documentation, and testing to prove that the hedge is effective Disclosed accounting policy Financial instruments Financial assets and financial liabilities are recognised on the Group s balance sheet when the Group becomes a party to the contractual provisions of the instrument. Financial assets and liabilities, including derivative financial instruments, denominated in foreign currencies are translated into sterling at period-end exchange rates. Gains and losses are dealt with through the income statement, unless hedge accounting treatment is available. Derivative financial instruments and hedge accounting The Group uses derivative financial instruments such as foreign currency contracts and interest rate swaps to hedge its risks associated with changes in foreign exchange rates and interest rates. Such derivative financial instruments are initially measured at fair value on the contract date, and are re-measured to fair value at subsequent reporting dates. The use of financial derivatives is governed by the Group s policies approved by the board of directors that provide written principles on the use of financial derivatives consistent with the Group s risk management strategy. The Group does not use derivative financial instruments for speculative purposes. The fair value of forward exchange contracts is calculated by reference to current forward exchange rates for contracts with similar maturity profiles. The fair value of interest rate swaps is determined by reference to market values for similar instruments.

153 Financial instruments, page 2 of For the purpose of hedge accounting, hedges are classified as either fair value hedges when they hedge the exposure to changes in the fair value of a recognised asset or liability; or cash flow hedges where they hedge exposure to variability in cash flows that is either attributable to a particular risk associated with a recognised asset or liability or a forecasted transaction. In relation to fair value hedges (interest rate swaps) which meet the conditions for hedge accounting, any gain or loss from re-measuring the hedging instrument at fair value is recognised immediately in the income statement. Any gain or loss on the hedged item attributable to the hedged risk is adjusted against the carrying amount of the hedged item and recognised in the income statement. Where the adjustment is to the carrying amount of a hedged interest-bearing financial instrument, the adjustment is amortised to the net profit and loss such that it is fully amortised by maturity. When fair value hedge accounting is discontinued, any adjustment to the carrying amount of the hedged item for the designated risk for interestbearing financial instruments is amortised to profit or loss, with amortisation commencing no later than when the hedged item ceases to be adjusted. The Group s policy is to convert a proportion of its floating rate debt to fixed rates. The Group designates these as cash flow hedges of interest rate risk. In relation to cash flow hedges (forward foreign exchange contracts) to hedge firm commitments which meet the conditions for hedge accounting, the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised directly in equity and the ineffective portion is recognised in net profit or loss. When the hedged firm commitment results in the recognition of an asset or liability, then at the time the asset or liability is recognised, the associated gains or losses that had previously been recognised in equity are included in the initial measurement of the acquisition cost of other carrying amount of the asset or liability. For all other cash flow hedges, the gains or losses that are recognised in equity are transferred to the income statement in the same period in which the hedged firm commitment affects the net profit and loss, for example when the future sale actually occurs. For derivative financial instruments that do not qualify for hedge accounting, any gains or losses arising from changes in fair value are taken directly to the income statement in the period. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. At that point in time, any cumulative gain or loss on the hedging instrument recognised in equity is kept in equity until the forecasted transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in equity is transferred to the income statement in the period.

154 Financial instruments, page 3 of Default policy and process for exceptions Default policy Derivative financial instruments are used under the control of the Group Treasury department to manage interest rate and currency risks arising from the Group s operations. No entity may enter into any derivative or forward currency contract without the written consent of the Group Treasurer Consultation and authorisation process for exceptions Any proposed exceptions from the above policy must be authorised by the Group Finance Director in writing IFRS references IAS 21 The effects of changes in foreign exchange rates IAS 32 Financial instruments: Presentation IAS 39 Financial instruments: Recognition and Measurement IFRS 7 Financial instruments: Disclosures 19.4 Summary of IFRS requirements Definitions Financial instrument A contract that generates both a financial asset for one entity and a financial liability or equity instrument for another entity. Financial instruments include primary financial instruments (such as bonds, receivables, payables and shares) and derivative financial instruments. Financial asset Any asset that is : cash; a contractual right to receive cash or another financial asset from another entity; a contractual right to exchange financial instruments with another entity under conditions that are potentially favourable; or an equity instrument of another entity. See policies on cash, contingent assets and receivables for further detail. Financial liability Equity instrument Any liability that is a contractual obligation: to deliver cash or another financial asset to another entity; or to exchange financial instruments with another entity under conditions that is potentially unfavourable. See policies on payables and provisions for further detail. Evidence of an ownership interest in an entity, i.e. a residual interest in the assets of the entity after deducting all of its liabilities. Examples are not only equity shares, but also some non-equity shares, as well as warrants and options to purchase equity shares in the issuing entity. Derivative instrument financial A financial instrument that derives its value from the price or rate of some underlying item such as equities, bonds, commodities, interest rates, exchange rates and stock market and other indices. Examples include futures, options, forward contracts, interest rate and currency swaps, interest rate caps, collars and floors, commitments to purchase shares or bonds, note issuance facilities and letters of credit.

155 Financial instruments, page 4 of Capital instrument All instruments issued by reporting entities to raise finance, including: shares; debentures; loans and debt instruments; or options and warrants that give the holder the right to subscribe for or obtain capital instruments Financial instruments and derivatives Derivative financial instruments are dealt with by Group Finance, Chertsey and the accounting for these is not therefore relevant to business units IFRS requires that all financial instruments are recognised and valued on the balance sheet. The table below summarises the various categories that IFRS requires financial instruments to be placed in. It also summarises the accounting treatment for each category. Financial instruments should be recognised on the balance sheet at the date that the entity becomes contractually committed to the instrument.

156 19 Financial instruments, page 5 of 15 Financial Assets Classification Definition Initial Measurement Subsequent Measurement Treatment of movement in value Fair value through profit or loss/ Held for Trading Including financial assets held for trading (i.e. acquired or incurred with the intention of selling or receiving settlement in the near future) designated as such upon recognition Excluding; equity instruments where it is not possible to determine the fair value Fair value Fair value Taken to income statement Held to maturity investments Including financial assets with fixed payment maturity dates positive intention to hold to maturity and a history of having held similar assets to maturity Excluding those designated as being in another category derivatives, equities and puttable options Fair value plus transaction costs Amortised cost Amortised cost movements taken to income statement Impairment changes taken to income statement Loans and receivables Including financial assets with fixed payments and that are not quoted on an active market Excluding those designated as being in another category those where the intention is to sell them in the short term derivatives, equities and puttable options Fair value plus transaction costs Amortised cost Amortised cost movements taken to income statement Impairment changes taken to income statement Available for sale financial assets Including financial assets classified as such equity instruments where fair value is difficult to determine any financial asset not included in the other categories Excluding derivatives Fair value plus transaction costs Fair value Equity instruments where fv difficult to determine = at cost Taken directly to equity Impairment changes taken to income statement, including previous amounts recognised in equity 19

157 19 Financial instruments, page 6 of 15 Financial Liabilities Classification Definition Initial Measurement Subsequent Measurement Treatment of movement in value Fair value through profit or loss Including financial liabilities held for trading (i.e. acquired or incurred with the intention of selling or settling in the near future). derivatives, unless part of a designated and effective hedge. designated as such upon recognition Fair value Fair value Taken to income statement Other financial liabilities (Measured at amortised cost using effective interest method) Including financial liabilities not categorised as above e.g debt, trade payables and certain accruals. Fair value plus transaction costs Amortised cost Amortised cost movements taken to income statement Impairment changes taken to income statement 19

158 Hedge Accounting Financial instruments, page 7 of Under IFRS hedging of financial instruments is a complex area and requires onerous documentation, designation and effectiveness testing procedures. Group Finance, Chertsey must be informed of, and authorise any transactions of this nature before the transaction is entered into. Hedge accounting requirements In order to obtain hedge accounting treatment under IAS 39, the following procedures must be followed: a) Designation and documentation At the inception of the hedge there must be formal designation and documentation of the hedging relationship and the entity s risk management objectives and strategy for undertaking the hedge. This will include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging instrument s effectiveness in offsetting the exposure to changes in the hedged item s fair value or cash flows attributable to the hedged risk. The hedge must be expected to be highly effective and any forecast transaction that is the subject of the hedge must be highly probable. b) Effectiveness testing The hedge must be assessed on an ongoing basis and determined to have been highly effective throughout the financial reporting periods for which the hedge was designated, both prospectively and retrospectively. Testing is achieved through the use of appropriate techniques such as ratio analysis ( the dollar offset test ) or regression. All effectiveness testing will be performed by Group Finance in Chertsey. There are three types of hedging arrangement allowable under IAS 39: Fair Value Hedge: this is the hedge of a movement in the fair value of the hedged item (for example a hedge against the contracted cost of a future stock purchase, see below). The fair value of the hedging instrument is shown on the balance sheet, and the movements are taken to the income statement in order to match against the change in value of the hedged item which is also taken to profit and loss. Cash Flow Hedge: this is a hedge against a change in the value of future cash flows which impact the income statement. The fair value of the hedging instrument is shown on the balance sheet, and the movements are taken to equity. When the hedged cash flow occurs and affects the income statement, the accumulated movement in equity on the hedging instrument is recycled to the income statement in order to hedge the effect. Net Investment Hedge: this is a hedge against the exchange gain or loss on the net assets of foreign entities. The hedging instrument (usually a foreign currency debt or forward exchange contract) is fair valued and its movement taken to equity to match the gain or loss on translation of the net assets of the foreign operation. On disposal of the foreign operation, the cumulative exchange gain or loss is recycled through the income statement and included as part of the gain or loss on sale. Fair value hedges may lead to assets or liabilities that would normally be held at cost, being valued to take into account the gain or loss attributable

159 Financial instruments, page 8 of to the hedged risk on the balance sheet. It may also lead to the recognition of an asset or liability not previously recognised such as an unrecognised firm commitment (see below). It may also mean that where normally the movement in fair value of the hedged item is taken to equity (e.g. an available for sale financial asset) it will now be taken to the income statement. Cash flow and net investment hedges defer any income statement gain or loss on the effective portion of the hedging instrument until the date when the hedged item affects profit or loss. Often the need for formal hedge accounting can be avoided where there is a natural hedge in place by designating financial instruments as fair value through profit or loss. Forward exchange contracts Under a forward exchange contract, a company agrees to buy or sell a specified amount of foreign currency at a specified rate on a given future date. For forward exchange contracts, the following treatments are appropriate: Type of transaction 1. Forward entered into at date of a matched transaction e.g. a forward to sell 100,000 in 60 days when a company sells goods for 100,000 receivable in 60 days time Both the receivable and the forward are classified as financial instruments held for trading. The Group has a choice of designating the forward as a formal hedge for the foreign currency receivable, or doing nothing. Because the hedged risk is foreign exchange risk a fair value or cash flow hedge could be designated. Treatment The sale and receivable are recorded at spot rate on the transaction date. Fair value hedging treatment At each period end or at the date of settlement the receivable is retranslated at the period end rate and the forward contract is recognised on the balance sheet at fair value. Gains or losses on the movement in value of the receivable or forward are taken to the income statement. Cash flow hedging treatment The movement on the fair value of the forward is taken to equity, and the receivable is still revalued at period ends. The gain or loss taken to equity on the forward is recycled to the income statement to offset the exchange movement in the receivable. Doing nothing In this example there is no overall difference between the fair value hedge, the cash flow hedge, or doing nothing. The receivable and the forward will be revalued at each period end, and the gains and losses taken to the income statement.

160 Financial instruments, page 9 of Forward to hedge future transactions e.g. a contracted future purchase of inventory in a foreign currency. The contract to purchase inventory represents an unrecognised firm commitment*, and is therefore available to hedge. The hedge could be either a fair value or cash flow hedge because it is taking out a hedge against foreign exchange risk. 3. Forwards to hedge existing monetary assets and liabilities, e.g. a forward to fix the value of a foreign currency loan Fair value hedging treatment The unrecognised firm commitment and the forward should be valued at fair value at each period end. The fair value of the firm commitment is netted against the value of the inventory when received. The inventory and the payable should be recorded at spot rate on the transaction date. The result is that the inventory will be recorded at the rate fixed by the forward. The foreign currency payable should be retranslated at each period end. The forward should continue to be fair valued at each period end and upon settlement. The benefit of establishing the hedging relationship between the firm commitment and the forward is that movements in the fair value of the forward (taken out for economic reasons to fix the price of the stock) will be offset by movements in the fair value of the firm commitment. Cash flow hedging treatment The firm commitment would not be fair valued. The trade payable would be translated at spot rate on the transaction date, and would be revalued until settlement. The fair value movements on the forward are taken to equity. These movements are recycled from equity in order to match the translation gains or losses from the retranslation of the payable. Upon settlement of the payable, the residual value in equity is recycled to the income statement. The forward could be designated a fair value hedge, and therefore movements on the fair value would be taken to the income statement to offset revaluation movements of the loan. However it is likely that there would be little difference between designating the hedging relationship and doing nothing in this situation, because both the loan and the forward would be revalued at each period end and the movement taken to the income statement.

161 Financial instruments, page 10 of Forwards to hedge investments in foreign entities (consolidated accounts) Under IAS 21 exchange movements in the value of the net assets of the foreign entities are taken to equity. Where a forward is taken out in order to hedge this risk and the forward is designated as a net investment hedge, and movements in its fair value are taken to equity, where the hedge is effective. Upon disposal of the foreign entity IAS 21 requires that the cumulative foreign exchange movements on the entity are included in the gain or loss on disposal calculation. Hedge accounting rules also mean that the movement in the fair value of the forward is recycled to the income statement at the date of disposal, and included in the profit or loss on disposal. * Unrecognised firm commitments are binding commitments to buy or sell goods or services at a specified price on specified future dates. Where they are in the normal course of the entity s sale, purchase or usage requirements they are outside the scope of IAS 39 and DO NOT require measurement and recognition on the balance sheet. Example 2 above brings the unrecognised firm commitment onto the balance sheet only under the fair value hedging rules which require the underlying (the commitment) to be fair valued in this situation. Interest rate swaps Interest rate swaps are recognised on the balance sheet at fair value. Movements in fair value are taken to the income statement unless cash flow hedging is successfully designated. Minority interest put options The Group has put options held by certain minority interest partners who can require the Group to buy out their holding at a determinable price and date. Because the option is controlled by the minority partner, a financial liability must be created to reflect the fair value of the put option. The debit entry created by recognising these types of financial liability must be taken to equity. The debit cannot be recognised as goodwill at this stage because it represents in part the minority partners goodwill and therefore does not meet the definition of an asset under IFRS rules. Fixed price put options should be categorised as other financial liabilities, and therefore held at amortised cost in the balance sheet. Put options where the price is based on a multiple of earnings must be fair valued at the balance sheet date based on the earnings multiplier, and this will expose the Group to movements in this fair value which must be taken to the income statement. Because of the additional risk that the Group is exposed to from put options, any future acquisitions where the use of a put option is being considered must be referred to and approved by the Group Finance Director. Where this approval is received, Group Finance Chertsey must agree the accounting entries for the put option. Embedded derivatives These are derivatives embedded within a host contract. Embedded derivatives may be present in all types of contracts including; operating

162 Financial instruments, page 11 of and finance leases, purchases, sales, concession rental, contract hire, and debt instruments. Clauses within these contracts that may give rise to an embedded derivative include reference to interest rates, financial instrument prices/ indices, commodity prices, foreign exchange rates and inflation indexes. Under IFRS embedded derivatives may require separate recognition and measurement from the host contract unless the derivative is closely related to the host contract or the host contract is accounted for at fair value itself as a financial asset held at fair value through profit and loss. Clauses in the host contract which qualify as closely related include; The currency of the contract is in the functional currency of one of the parties to the contract; The currency of the contract is that in which the goods/services are routinely traded in commercial transactions around the world; Any underlying index used to determine the price of the goods/services being traded is closely linked to those goods/services. This may include an inflation-linked index for instance. An embedded derivative is not closely related if it changes the nature of the risks inherent within the contract from those normally associated with the type of contract under consideration. An embedded derivative that requires separate measurement and recognition must be shown at fair value on the balance sheet, and movements in this fair value must be taken to the income statement. Where it is suspected that an embedded derivative exists that requires separate recognition and measurement from a host contract Group Finance, Chertsey should be consulted regarding the accounting treatment Capital instruments Debt or other capital instruments should be recorded initially at the amount of the net proceeds. Net proceeds are the fair value of the consideration received on the issue of a capital instrument after deduction of issue costs. Issue costs are the direct costs incurred in connection with the issue of the capital instrument. Other costs are to be charged as expenses when incurred. The finance costs of debt should be allocated to periods over the term of the debt at a constant rate on the carrying amount. All finance costs should be charged to the income statement. The carrying amount of debt should be increased by the finance cost in respect of the reporting period and reduced by payments made. Accrued finance costs are usually included in accruals rather than in the carrying amount of debt, but should be taken into account when calculating finance costs and gains and losses arising on repurchase or early settlement.

163 Financial instruments, page 12 of Disclosure IFRS 7 governs numerical and narrative disclosures around interest rate risk, foreign currency risk, market price risk and hedging. The required information to prepare these disclosures is included in the Group reporting package (HFM) and is not reproduced here Application guidance Under IFRS, financial instruments are included on the balance sheet at their fair value, amortised cost or historical cost. The specific principles relating to debt and derivatives are set out below Debt and borrowings Debt and borrowings classified as Other financial liabilities (measured at amortised cost using the effective interest rate method) are initially recorded at the fair value of the debt (usually the cash received) less premiums, discounts, and front-end fees. Amounts should be amortised through the interest line in the income statement over the life of the debt, at a constant rate on the carrying amount of the debt (the effective interest rate method). Examples A bank loan is raised for 10,000,000. The loan has a fixed term of five years. Costs and front-end fees are charged at 250,000. How should these costs be accounted for? As in example 1, but after 3 years the loan is repaid and replaced with a new 12,000,000, five year loan with costs and front-end fees of 300,000. What is the accounting for the unamortised costs of 100,000 remaining on the initial loan? Correct treatment The loan should initially be stated at the net proceeds of 9,750,000. The cost of 250,000 should be charged to interest in the income statement at a constant rate on the carrying amount of the debt (or on a straightline basis if not materially different) over the life of the loan The remaining unamortised costs of 100,000 should be written off through interest in the income statement when the original loan is replaced. The fees on the new loan should be amortised through the income statement line as before, at a constant rate on the carrying amount of the debt Derivatives The majority of the Group s derivative financial instruments are held centrally by Group Treasury. Only in exceptional circumstances, and with written authorisation from the Group Treasurer, will derivatives be held at local level. Interest rate swaps Interest rate swaps are valued and included in the Group s balance sheet at each reporting date. Valuations may be obtained from banks or through the use of specialised IAS 39 accounting software programmes. The fair value of an interest rate swap represents the net present value of all future cash flows. Where interest rates are variable, then the future payments are assessed by reference to the relevant future interest rate yield curve. Interest received or paid on interest rate swaps are recorded in interest payable or receivable in the income statement. Outstanding cash receipts or payments are included in interest receivables or accruals at the period end.

164 Financial instruments, page 13 of The fair value gains or losses on the interest rate swaps are recorded on the balance sheet as either assets or liabilities. Movements on the fair value of the swap will either be taken to the income statement, or to equity if cash flow hedging is successfully designated. HFM account: IS71161 IS71161 IS71161 Example A swap has been entered into with the following characteristics: 2 years to run. On a notional principal of 10,000,000, the Group receives a fixed rate of 5.0% and pays interest at a market floating rate plus 0.25%. Market floating rate for the next 6 months is 3.0%. At the balance sheet date, the swap has a market value of 275,000. Correct treatment Interest receivable on the swap will be accrued for the next six months (until the next rate fixing) of 14,583 per month (10m x ( )% /12 months). The market value of the swap is shown as an asset in account BS17000 Derivatives receivable interest rate swaps due >1 year. The other side of the fair value of the swap is recorded in the income statement or equity if a cash flow hedge is successfully designated. HFM account: BS17000 Forward foreign exchange contracts Where Group companies are involved in foreign currency transactions they should contact Group Treasury, Chertsey for advice on structuring these transactions. Where the use of forward foreign exchange contracts has been approved by Group Treasury and the Country Director, the fair value of the forward is shown on the balance sheet and movements to this fair value taken to the income statement unless cash flow or net investment hedging has been successfully designated. Where the entity is hedging a net position from highly probable forecast sales and purchases in a foreign currency, the forward contract should again be accounted for separately from the transactions it is hedging. The forward contract is fair valued at settlement date and at each period end in between. The exchange gains or losses incurred should be included within profit and loss. HFM account: IS45331 Receivables and payables arising from the transactions being hedged are retranslated at the period-end rate. It is possible to designate a hedge of a net position by allocating the forward to a specific net amount. A cash flow hedge can be used to defer fair value movements on the forward from impacting the income statement until the designated portion of the foreign currency sales or purchases are transacted. This could be beneficial in removing volatility from the income statement from changes in fair value of the forward over period ends (especially period six and twelve when the Group reports externally). In many situations however the overall effect of taking the fair value of the forward to the income statement will match the gains or losses from foreign currency sales and purchases without the need to apply hedge accounting. Where the currency sales and purchases are part of on-going trading activities, a series of forwards with a spread of settlement dates

165 Financial instruments, page 14 of will normally hedge these transactions without the need to use hedge accounting. Forwards may also be taken out to hedge net investments in foreign subsidiaries. Where net investment hedging is successfully designated exchange gains and losses on the forwards are taken to equity (translation reserve) to match the exchange gain or loss arising on the hedged foreign net assets in the Group accounts. HFM account: BS75400 For guidance on accounting for any other form of financial asset or liability, contact Group Finance, Chertsey. Embedded Derivatives Contracts should be reviewed for clauses that contain reference to unusual indices, currencies, interest rates and other factors, not usually associated with the contract. If a clause is present that changes or introduces a risk exposure not usually associated with the type of contract being reviewed, then an embedded derivative may be present that needs to be separately identified and measured on the balance sheet. Examples A Group entity enters a concession lease agreement in the UK where an annual rent of 100,000 is agreed. In addition the contract also sets an additional rent equal to 5% of the site s turnover. The site is expected to turnover approximately 1,000,000 per year, giving a total expected rent of 150,000*. A Group entity enters into a contract to purchase food and beverage supplies for twelve months at an agreed price. The contract allows for tiered purchasing discounts based upon the volume of goods purchased by the Group entity*. A Group entity enters into a contract to purchase food and beverage supplies for the next twelve months at set prices. The contract allows the price to be adjusted by the local inflation rate of the supplier six months into the contract*. Correct treatment An embedded derivative is present because the rental cost is linked to the site turnover. However the embedded derivative is closely related to the host contract under guidance given by IAS 39, because rental value and site turnover are related items. Therefore the embedded derivative should not be separately identified and measured on the balance sheet. An embedded derivative is present because the contract prices are linked to the volume of goods purchased However the embedded derivative is closely related to the host contract because this type of clause is extremely common in purchasing agreements. Therefore the embedded derivative should not be separately identified and measured on the balance sheet. An embedded derivative is present because the contract prices are linked to the local inflation index. However the embedded derivative is closely related to the host contract under the guidance given by IAS 39 because the exposure to price increases on food and beverage inventories is directly linked to local inflation. Therefore the embedded derivative should not be separately identified and measured on the balance sheet.

166 Financial instruments, page 15 of A Group entity borrows cash from the bank. The interest rate and term of the loan are both fixed. The contract allows for the loan to be extended, but at a floating interest rate linked to LIBOR at the time of the extension An embedded derivative is present because the contract allows the length of the loan term to be extended. However the embedded derivative is closely related to the host contract under the guidance given by IAS 39 because the exposure to the change in interest rates during the extension period is linked to the market interest rate at that time. Therefore the embedded derivative should not be separately identified and measured on the balance sheet. * These host contracts are outside the scope of IAS 39 unless they are designated as the underlying in a fair value hedge. This is because the contracts are in the normal course of the entity s sale, purchase or usage requirements.

167 20. Leases Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued A lease is an arrangement where the Group has the right to use an asset over an agreed period of time. In a lease the payment made for this right is therefore a consequence of the time the asset is available, and not dependant on the output or usage levels of the asset. Therefore contingent no minimum arrangements ARE NOT LEASES. Many lease scheme proposals are, on full inspection, finance leases, which mean that the asset leased should be capitalised and depreciated, and the finance creditor is part of the Group s debt. The definition of a finance lease is by reference to the substance of the agreement alone. The land and building elements of each property lease have to be split out. The lease of land is usually treated as an operating lease. Where the buildings element qualifies as a finance lease, the two elements of the lease must be accounted for separately. Where the Group has a lease for equipment installed in client premises, the costs of which are recoverable from the client, in many cases, the primary risks and rewards of ownership belong to the Group. If so, the lease should be accounted for as a finance lease. Lease incentives (refunds, lump sum purchasing rebates, discounts or up-front payment holidays) should be amortised by the lessee over the term of the lease. Lease incentives are not purchasing income. The use of leases for off-balance sheet finance to try to avoid Group capital expenditure controls is not acceptable Disclosed accounting policy Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Assets held under finance leases are recognised as assets of the Group at their fair value or, if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The corresponding liability to the lessor is included in the balance sheet as a finance lease obligation. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income. Payments made under operating leases are charged to income on a straight-line basis over the period of the lease. Any incentives to enter into an operating lease are also spread on a straight-line basis over the lease term Default policy and process for exceptions Default policy Where a lease transfers substantially all of the risks and rewards of ownership of the asset to the lessee it should be classified as a finance lease and treated in accordance with the guidance below.

168 Leases, page 2 of Other leases are treated as operating leases Consultation and authorisation process for exceptions Any question over whether a lease should be treated as a finance lease or an operating lease should be referred to Group Finance, Chertsey for review before the lease is signed. Please refer to the Group Approvals Manual for the approval limits for operating and finance lease arrangements IFRS references IAS 17 Leases SIC 15 Operating leases - incentives IFRIC 4 Determining whether an arrangement contains a lease 20.4 Summary of IFRS requirements Determining whether an arrangement contains a lease A lease arrangement exists where the following occurs; A specific asset or asset type (if replacement or substitute assets are acceptable) is required in the fulfilment of the arrangement. The asset may be explicitly or implicitly identified in the arrangement if there is no economic or practical alternative for the supplier to fulfil the arrangement other than to supply the asset, and Where the right to use the asset is demonstrated by the ability to operate or control the use of the asset or to restrict the physical access to the asset and benefit more than an insignificant amount from the output of the asset. An arrangement is a lease only if the payments (or part of the payments) made by the purchaser (potential lessee) are for the time the asset is available for. Arrangements where payment is entirely contingent upon the volume of output or level of usage (i.e. contingent no minimum agreements) ARE NOT leases. This overrides legal form of the agreement which may refer to a contingent no minimum arrangement as a lease. An arrangement must be assessed at inception to determine whether a lease exists or not. The arrangement should be reassessed in situations where there is a change in contractual terms, the arrangement is renewed or there is a substantial change to the asset. An arrangement does not have to take the legal form of a lease to fall within scope of the lease accounting rules. It is possible within an arrangement such as with a sub-contractor for a lease arrangement to exist (see section ). In this situation the lease element of the arrangement should be separated and accounted for under the guidelines contained in this section. The reverse could also be true; an arrangement that refers to the term lease may not actually be one, particularly in arrangements that are entirely contingent with no minimum guaranteed rent. Short-term hire costs are not leases. Any asset hired for less than one month falls into this category. Assets hired for between one and six

169 Leases, page 3 of months should be assessed as to whether they are required on an ongoing basis in the business, while any hire extended beyond six months can be assumed to be a lease Determining whether a lease is finance or operating Where a lease exists the next step is to determine whether it is a finance lease or an operating lease. The key difference between a finance lease and an operating lease is that a finance lease transfers substantially all of the risks and rewards of ownership of the asset to the lessee. An overall evaluation should be based on all the evidence taken together at the inception of the lease. Factors to be considered include: the term of the lease compared to the useful economic life of the asset, the responsibility for insurance, repair and maintenance of the asset, whether legal title passes to the lessee at the end of the lease, or there is an option to transfer title at below market value at the end of the lease, the present value of the minimum lease payments (including any initial payment) amounts to substantially all the fair value of the asset, the leased assets are of a specialised nature and could not be leased to another party without major modifications, if the lease were terminated early, are the potential losses borne by the lessee (finance lease) or lessor (operating lease), any gain or loss from the change in fair value of the asset is attributable to the lessee (finance lease) or lessor (operating lease). At the start of a finance lease, both the leased asset and the related lease obligation should be recorded in the balance sheet at its fair value (market value or purchase price), or if lower the present value of the minimum lease payments. The difference between the cost of the asset and the total payable under the leasing contract is the finance cost. The asset is depreciated over the shorter of the lease term or the estimated useful life of the asset as determined in the Group policy on Property, Plant and Equipment. The financing cost should be charged against interest cost in the income statement so as to produce a constant periodic rate of charge on the remaining balance of the obligation for each accounting period. Rentals payable under an operating lease should be charged on a straightline basis over the lease term even if the payments are not made on that basis, unless another systematic and rational basis is more appropriate. Lease incentives offered by the lessor such as upfront cash payments or rental free periods should be taken as adjustments to the cost of the lease over its entire term. See also the Group Approvals Policy, circulated separately.

170 Leases, page 4 of For finance leases, the Group consolidated accounts must include the reconciliation between the total of future minimum lease payments and their present value falling due in yearly increments up to five years and in more than five years. Situations where the Group is the lessor are expected to be extremely rare and, where they arise, Group Finance, Chertsey should be consulted Application guidance Determining whether an arrangement contains a lease An arrangement does not have to take the legal form of a lease for there to be one present. IFRIC 4 outlines two tests to determine whether a lease exists and these are outlined in section 20.4 above. Where the Group makes an arrangement with a supplier for a range of services there may within this be a lease if the arrangement explicitly or implicitly refers to a certain asset or asset type, and the arrangement confers the right to use or restrict access to, and benefit from the asset. Example: Determining whether an arrangement contains a lease (1) The Group enters into a support services contract and sub-contracts the cleaning element of the contract. The sub-contractor is responsible for the entire cleaning operation and must supply their own equipment, labour and cleaning products. There is a question as to whether within this arrangement the Group has leased the cleaning equipment from the sub- contractor and will have to recognise part of the payment to the sub-contractor as a lease payment along with the accounting and disclosure requirements this involves. The contract is for a generalised cleaning service, and there is no mention of the equipment the sub-contractor must use to carry out its duties either explicitly or implicitly. The subcontractor has various alternatives in the course of supplying their services. The arrangement does not contain a lease. Example: Determining whether an arrangement contains a lease (2) The facts are as above, though the client is a highly specialised manufacturing plant and the only method of cleaning involves a particular specialist piece of cleaning equipment that the sub-contractor is able to supply. The Group is entering into a lease arrangement with the sub-contractor for the use of the specialised cleaning equipment the sub-contractor has to supply to carry out their duties. Part of the sub-contractor s fee relates to the supply of this equipment and should be separated, accounted for and disclosed as a lease. The usual tests must be applied to determine whether this is a finance or operating lease. In addition for an arrangement to be a lease the consideration payable under the arrangement must contain an element that is only linked to the passage of time. If the consideration payable is entirely contingent upon the usage or level of output of the asset then this arrangement is not a lease. Example: Determining whether an arrangement contains a lease (3) The Group enters into an arrangement to supply the food service at a sports stadium for three years. The contract is on a profit and loss basis and the Group has to pay the stadium owner 10% of revenue as a fee for trading there. The contract refers to the fee as the rental cost

171 Leases, page 5 of Because the fee is entirely contingent on the volume of sales made from the food outlets at the stadium the consideration payable is not a time related payment. If there were no sales made then there would be no consideration payable. The arrangement does not contain a lease Finance leases Balance sheet At the start of a finance lease, both the leased asset and the related lease obligation should be recorded in the balance sheet at the lower of the asset s fair value or the present value of the minimum lease payments. In most cases, the fair value of the asset is a close approximation of the present value of the minimum lease payments. Where the leased asset is also offered on a cash sale basis, the cash price might be a suitable measure of the present value, so long as it is realistic. Alternatively, the contract terms or rates quoted by finance houses may indicate a suitable discount rate which may be used to calculate a present value. Leased assets should be distinguished from owned assets by using the appropriate classification codes in HFM. Leased assets should be depreciated over the shorter of the lease term and their estimated useful lives (see Group policy on Property, plant and equipment). In determining the lease term, it is appropriate to extend it beyond the agreed minimum where: there is a secondary period for which the lessee has the option to continue the lease which it is reasonably certain at the start of the lease that it will exercise; or there is a bargain purchase option (for example, a hire purchase contract) which it is reasonably certain at the inception of the lease that the lessee will exercise. Income statement The finance charge on a finance lease is the difference between the total minimum lease payments and their present value at the beginning of the lease. This should be allocated over the term of the lease, so as to produce a constant rate of interest (or a reasonable approximation to it) on the remaining balance of the lease obligation. This is achieved by splitting each rental payment into a finance charge and a capital repayment. Two appropriate methods for this are often used in practice: actuarial method; or Often, the information necessary to adopt this basis is provided by the lessor. Alternatively, spreadsheets generally have suitable functions for such calculations to be performed sum of digits method; This generally produces a good approximation of the results obtained by the actuarial method, but is easier to apply. Example: Finance lease sum of digits method An asset is leased under a finance lease for a three-year period, with 12 quarterly rental payments; the total finance charge amounts to 10,000.

172 Leases, page 6 of (a) If rentals are paid quarterly in arrears The digit assigned for the first period will be 12 and, for the last period, 1. Period Quarter Digit Finance Charge allocation Year ,000 X 12/78 1, ,000 X 11/78 1, ,000 X 10/78 1, ,000 X 9/78 1,154 Year ,000 X 8/78 1, ,000 X 7/ ,000 X 6/ ,000 X 5/ Year ,000 X 4/ ,000 X 3/ ,000 X 2/ ,000 X 1/ (b) If rentals are paid in advance 78 10,000 Since there is no capital outstanding during the final quarter of the last year, there is no finance charge allocation to that quarter. Consequently, the digit for the last period will be zero and for the first period, 11. The sum of the digits becomes Operating leases Rentals payable under an operating lease should be charged on a straightline basis over the lease term, even if the payments are not made on that basis, unless another systematic and rational basis is more appropriate. For example, where part of the rental cost of an asset is contingent (e.g. based on the actual usage of that asset), or are revised periodically to reflect the efficiency of the asset or current market rates, the rentals actually payable may be an appropriate measure. Example: Spreading the cost of an operating lease Equipment is leased for 4 years. The rental schedule of payments is: Months 1-6 Months 7-12 Months Months No payment 20 per month 40 per month 50 per month Regardless of the timing of the cash payments, a charge should be accrued in the income statement of 37.5 each month (total rent payable over four years is 1800, divided by 48 months). Lease incentives are sometimes offered by the lessor in the form of payment holidays or up front cash payments (e.g. lump sum purchasing income). These should be included in the calculation of the overall cost of the lease, and therefore the benefit spread over the term of the lease as part of the straight-line accounting charge. For these purposes the term of the lease is the legal contracted term, and any earlier break clauses are ignored.

173 Leases, page 7 of Property leases In determining whether the buildings element of a property lease is a finance lease or not, careful attention should be paid to all the criteria outlined in the Standard (see section 20.4). In undertaking this analysis, one should not lose sight of the basic definition of a finance lease which requires the transfer of substantially all of the risks and rewards of ownership to the lessee. Taking the example of an office building, it may be that the lessee bears substantially all of the risks of ownership (as the net present value of the minimum lease payments exceeds the fair value of the building), but does not enjoy all the rewards of ownership (as the building is expected to have a substantial residual value at the end of the lease term which will be enjoyed by the lessor). The lease of a building is likely to qualify as an operating lease under such circumstances. There are three situations where the basis of property rental payments may differ from the basis of charging the income statement: 1. Treatment of leasehold land: Leasehold land should always be treated as an operating lease, unless title to the land passes to the lessee at the end of the lease. This may give rise to the situation where the buildings element of the lease is a finance lease, while land is treated as an operating lease. Under this situation the lease and the rental payments should be split with a fair value determined for the buildings element to be capitalised and accounted for as a finance lease. The land portion of the rental payments will be treated as an operating lease. 2. Rental holidays: A lessor may grant a rent-free period as an inducement at the start of a new lease. Similar incentives include an up front cash payment (a reverse lease premium) or a contribution to certain lessee costs such as fitting out or relocation. IAS 17 confirms that, whatever form they may take, any benefits received and receivable by a lessee as an incentive to sign a lease should be treated as a reduction of rental expense. The benefit should be spread on a straight-line basis over the lease term. 3. Vacancy following removal to new premises: The need to provide for rentals on a lease where the property has been vacated is covered in the Group policy on Provisions.

174 Leases, page 8 of Example: Leasehold land and buildings A property is leased for 50 years, with annual rentals of 500,000 payable. Because of the length of the lease term and the other elements of the lease agreement the building element of the lease is a finance lease. The two elements of the lease are split as such; Rental Value per annum Fair value of asset Land 100,000 n/a Building 400,000 8,000, ,000 per annum is charged to operating lease costs for the land. The building is capitalised at 8,000,000 with a corresponding finance lease obligation. The rental payment of 400,000 is split between capital and interest over the term of the lease. Example: Lease incentive A property is leased for ten years, with annual rentals of 500,000 payable. The first rent review date is at the end of year 5. On signing the lease, a cash contribution of 250,000 towards fit-out costs is received from the landlord. The 250,000 benefit should be recorded in deferred income and spread over the ten year term of the lease. The income statement charge will therefore be 475,000 a year. A long lease of a property at a fixed annual rental may be a finance lease, since the present value of the reversionary interest in the property is likely to be very small. An additional consideration is whether the rewards associated with owning the building are attributable to the lessee. Although the present value of the minimum lease payments may substantially equal the fair value of the building, if the rewards of ownership (i.e. appreciation of the value of the building) do not accrue to the lessee and the lease terms is clearly not for the majority of the economic life of the building, the lease should be treated as an operating lease. On the other hand, a short lease, or one which incorporates provision for regular rent reviews, would usually be an operating lease Third party agreements There are situations where the Group will take out a lease for equipment installed in client premises, the costs of which are recoverable from the client. In deciding whether this should be accounted for as a finance lease, the principal test is whether the risks and rewards of ownership belong to the Group. This is most easily assessed by considering whether, following default by the client, the Group is still liable under the lease. If the Group is liable, then the lease should be accounted for as a finance lease. The income from the client will be accounted for depending on the nature of the agreement with the client. There are two possibilities: Included with catering contract; and Back to back leases. Included with catering contract If the recovery of the lease costs is included as part of the catering contract, then the income earned will be included as revenue when billed to the client.

175 Leases, page 9 of In this case, the fair value of the asset being leased will be shown as a fixed asset. Example: Lease costs recoverable under catering contract A Group company leases equipment from a lessor, installed in a client s premises, for use in a contract. The contract with the client allows the company to recover the lease costs from the client. To achieve this, there is either: an adjustment mechanism in the contract whereby at the end of a given period (quarterly, annually etc.) the lease costs are apportioned based on the actual number of meals sold; or for certain clients, in general in the public sector, the company directly invoices the client the full amount of the bill received from the lessor without any reference to meals served. Over the term of the lease, the payments made to the lessor amount to substantially all of the fair value of the leased asset. Despite the fact that the costs are passed on to the client, the Group company is responsible to the lessor for the payments under the lease and bears the credit risk on its client for the reimbursements. The fact that the payments made to the lessor amount to substantially all of the fair value of the asset, is sufficient to make this a finance lease. IFRS does not permit netting the two contracts. It is not possible to "look through" these arrangements the Group has a finance lease obligation balanced by a fixed asset. The Group bears the risks and rewards of the asset because this is used to service a client contract. It is the Group that would bear the risk should the asset need to be replaced. The double entry is thus: Set up contract: Dr Property, plant and equipment (leased asset) Cr Lease obligation (HFM; BS31200 (< 1 year) and BS41200 (> 1 year)) As lease payments made Dr Lease obligation (HFM; BS31200 (< 1 year) and BS41200 (> 1 year)) Dr Income Statement - interest charge (HFM; IS71123) Cr Cash As contract revenue is received from client Dr Cash Cr Income Statement - Revenue

176 Leases, page 10 of Back to back leases If there is an equal and opposite lease with the client to that with the bank or finance house, then they will need to be treated as back-to-back leases. The fair value of the asset being leased will not be shown as a fixed asset but as a financial receivable due from the client. Repayments from the client will be treated partly as interest income and partly as repayment of principal. The interest income will be calculated in a similar manner to the interest payable on the lease from the bank or finance house. Example: Back to back leases A Group company leases equipment from a lessor, installed in a client s premises, for use in a contract. The contract with the client sets up another leasing agreement between the Group company and the client on the same terms as the agreement between the lessor and the Group company. Over the term of the lease, the payments made to the lessor amount to substantially all of the fair value of the leased asset. Despite the fact that the costs are passed on to the client, the Group company is responsible to the lessor for the payments under the lease and bears the credit risk on its client for the reimbursements. The fact that the payments made to the lessor amount to substantially all of the fair value of the asset is considered in this case to be sufficient to make this a finance lease. IFRS does not permit netting the two contracts. It is not possible to "look through" these arrangements the Group has a finance lease obligation balanced by an asset. The asset is not a fixed asset (the Group company has passed the risks and rewards of ownership of the asset onto the client) but a receivable from the client. The double entry is thus: Set up contract: Dr Finance lease receivable (HFM; BS15214 (> 1 year) and BS22214 (< 1 year)) Cr Lease obligation (HFM; BS31200 (< 1 year) and BS41200 (> 1 year)) As lease payments made Dr Lease obligation (HFM; BS31200 (< 1 year) and BS41200 (> 1 year)) Dr Income Statement - interest charge (HFM; IS71123) Cr Cash As income under the lease with client is received Dr Cash Cr Finance lease receivable (HFM; BS15214 (> 1 year) and BS22214 (< 1 year)) Cr Income Statement - interest income (HFM; IS71112) Hire purchase contracts Hire purchase contracts by their nature will normally be accounted for as finance lease contracts. However, if there are situations where it is unlikely that the purchase of the asset will be completed, they may be treated as operating leases. This situation is expected to arise very infrequently; for guidance, please contact Group Finance, Chertsey Sale and leaseback agreements Sale and leaseback agreements are arrangements under which assets are sold by the Group to another party on terms which allow the Group to either re-purchase the asset or to continue to utilise it. In such cases where the Group retains all significant rights to benefits relating to the original asset and all significant risks inherent in those benefits, the substance of the agreement is a secured loan. Accordingly, the Group will continue to show the asset on its balance sheet, together with liability for the amounts received from the buyer.

177 Leases, page 11 of Only where the sale and re-purchase agreement is not in substance a financing transaction should the asset be de-recognised. This would need the significant risks and rewards of ownership to have been transferred to, and remain with, the purchaser, including the effect of any call options retained by the seller. For example, if the seller has a call option enabling him to buy back leased property at a price derived from a formula, rather than at market value, he can potentially profit from market price movements, calling into question the assertion that the significant risks and rewards have passed to the purchaser. Proposed sales and leasebacks should always be referred to Group Finance, Chertsey, before the transaction is entered into, so that the accounting treatment can be confirmed in advance. This would include the recognition of profit on disposal of the asset on any operating sale and leaseback.

178 21. Payables Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Payables and accruals should be determined reliably and prudently. The liability recorded should be the best estimate of the cost required to settle the obligation and must not be excessive. An accrual is made for a liability that is reasonably certain to occur, but where some doubt exists as to the timing or actual amount of the settlement. Only accruals which are justified as a genuine liability at the balance sheet date should be recognised. Dividends should only be accrued for in the period in which they are declared. Holiday pay accruals should be made where there is a cost involved in meeting the accrued benefit to the employee. Liabilities for unpaid balances (for example, unclaimed dividends or client overpayments) may only be released when the statutory time in which payment can be claimed has expired Disclosed accounting policy Holiday pay Paid holidays and similar entitlements are regarded as an employee benefit and are charged to the income statement as the benefits are earned. An accrual is made at the balance sheet date to reflect the fair value of holidays earned but not taken Default policy and process for exceptions Default policy Liabilities should be recorded at the best estimate of the amount required to settle the Group s obligation at the balance sheet date. Accruals should be made for any liability that the Group is committed to paying where the exact cost or the exact timing of the settlement is not known Consultation and authorisation process for exceptions Refer any questions about the treatment and recognition of creditors and accruals to Group Finance, Chertsey. Any proposed trade payables out-sourcing scheme must be referred to the Group Financial Controller for authorisation and guidance on the accounting IFRS references IAS 1 Presentation of financial statements Framework for the preparation and presentation of financial statements IAS 19 Employee benefits

179 Payables, page 2 of Summary of IFRS requirements Liabilities are obligations of an entity to transfer economic benefits as a result of past transactions or events. Liabilities include payables, accruals, Provisions and Financial instruments. IFRS requires that liabilities should be determined reliably and, where there is uncertainty, prudently (i.e. a degree of caution has been applied in exercising judgement and making the necessary estimates). This is not, however, a basis on which to record excessive liabilities. The amount recorded, should be the best estimate of the cost required to settle the obligation at the balance sheet date. Only accruals which are justified as a genuine liability at the balance sheet date should be recognised. Liabilities for unpaid balances (for example, unclaimed dividends or client overpayments) may only be released when the statutory time in which payment can be claimed has expired.

180 Payables, page 3 of Classification of payables The various categories of payables under IFRS include: Category Bank loans, overdrafts and other borrowings Finance leases Trade payables Corporation and overseas taxation Other tax and social security Deferred consideration Other payables Accruals Deferred income Dividends Includes See section on Cash. See section on Leases. Amounts invoiced by suppliers. Net debit balances owed by suppliers should be reclassified as trade receivables for the purposes of Group reporting if the total amount is significant in the context of the local entity s receivables or payables. See section on Tax on profits. This includes all amounts due to national governments by the entity, other than tax on profits (corporation tax or equivalent). It thus includes payroll taxes, social security contributions, sales taxes and other amounts owed to government (e.g. banking tax). Property taxes and other local and municipal taxes should be disclosed as other payables. See policy on Acquisition accounting and fair value adjustments. Other amounts owed which are not included in any other category of payable. An accrual is an estimate of an actual liability which is not supported by an invoice or other request for payment. Examples include unpaid salaries, rents, interest and goods for which no invoice has been received. Corporation tax should be classified as such, rather than as an accrual. Other taxes due should be included as taxation and social security. Accruals are similar to provisions because they are liabilities of uncertain timing or amount. However, IFRS distinguishes them from provisions, noting that although it is sometimes necessary to estimate their timing or amount, the uncertainty is generally much less than for provisions. Whilst the distinction is usually clear, judgement will be required in some cases to decide whether the uncertainties are such as to require accruals to be reclassified as provisions and Group Finance Chertsey should be consulted in such cases. Income received in advance, for example payments on customer smart cards or vouchers, should be deferred and released to the income statement in the period when the service is performed (e.g. the voucher is redeemed). See the policy on Revenue recognition for further details of the application of this principle. Under IFRS dividends should be recognised in the period in which they are declared. Therefore dividends declared after the year end relating to profits made in the year just finished should be recorded in the current financial year, and not shown as an accrual for dividends payable in the prior year.

181 Payables, page 4 of Application guidance Accruals Accruals should be made for any liability that the Group is committed to paying where the exact cost or the exact timing of the settlement is not known. Some situations where accruals should be recognised are: for purchase invoices that have not been received from a supplier at a period-end, but where the goods have been received; for the use of goods or services that are invoiced periodically (e.g. electricity bills); for staff costs such as unpaid salaries and overtime including taxes, that have accrued by the period-end (and are outstanding because the payroll date differs from the period-end date); for bonus and long term incentive plan payments which have been earned by the end of the period; for holiday pay where employees are reimbursed for holiday not taken by the end of the holiday year, or when traditionally the entire work force take their holiday at a certain time of the year, or where an additional cost is incurred in covering the absence of employees on holiday; where professional fees have been incurred, such as audit and legal fees during a period, but for which no invoice has yet been received; for interest on debt where this has accrued but not been paid at the period-end; for fixed assets additions that have been brought into use but where the invoice has not been received or the finance lease has not started at the period-end; and for vouchers redeemable at third party outlets that have not yet been used (see policy on Revenue recognition). Accruals are different from provisions because the degree of uncertainty is far less. With an accrual the existence of the liability is virtually certain, but there may exist uncertainty as to the amount, or the date it will become due. With a Provision the existence of the liability is only probable therefore the degree of uncertainty is greater. Staff benefits such as holiday and sick pay need to be assessed as to whether these require an accrual. An accrual for a staff benefit should be made where the benefit accumulates over time and there is a cost involved in fulfilling the benefit. Sick pay is not usually an accumulating benefit even though there may well be a cost incurred in covering for sick employees. Where sick pay is non-accumulating an accrual for the future cost of it at the balance sheet date is not justified as its incurrence is a future contingent event. Occasionally employees are entitled to a certain amount of accumulating sick pay over their length of service and this is carried forward to future periods if unused. Where this is the case and there is a cost in meeting this benefit (i.e. a replacement cost for the employees absence) then an accrual should be made based upon an estimate of the amount of unused accumulated sick pay that will be taken in future and the cost incurred in covering that. Accruals and provisions should be reviewed regularly to assess whether the classification of the liability is correct.

182 Payables, page 5 of 5 21 Example: Accrual or provision? The Group is involved in a legal claim and has been advised that the probable outcome is that it will have to pay out a settlement of 15m. In the previous financial year the Group recognised a provision for this amount. The case has now been heard, and the Group has lost. The court has decided that the Group must pay damages of 12m and that this must be paid in the next six months. The liability should be reclassified from a provision to an accrual. The accounting entries are: Dr Provisions credited to income statement 3m Dr Provisions reclassified 12m Cr Accruals 12m Cr Income statement material operating item 3m The Group should also ensure that it has an accrual sufficient to cover the legal fees incurred. Example: Bonus Accruals Management is paid a bonus after the financial year-end based upon the performance of the business during the year. The bonus is discretionary and the level varies according to the results of the business. Historically the bonus has been paid out for the past ten years at rates of 10% to 30% of annual salary for management staff. A prudent accrual for the bonuses should be built up every month during the financial year the bonus award relates to. Example: Holiday Pay Accruals Unit level staff are entitled to twenty days annual holiday per year. When this holiday is taken additional costs are incurred as other staff cover the workload and are paid an hourly rate for doing so. An accrual for untaken holiday accrued at the period end should be made to cover the costs incurred when staff take their holidays. As holiday is taken or if the employee leaves the accrual is released to cover the additional payroll costs Trade payable schemes Schemes for outsourcing supplier settlement through intermediary parties are becoming more common. Such schemes are often run by a bank that will in addition offer a factoring service to the suppliers, i.e. an option to receive payment earlier in return for a discount off settlement value. Where these schemes are a simple outsourcing of the settlement function which takes advantage of lower transaction costs (for example settlement by the Group is made into a single disbursement account held with the intermediary) then such schemes have no impact on the accounting for trade payables regardless of whether the intermediary and supplier choose to factor the debt. However some schemes involve the Group effectively borrowing money through the intermediary to fund early settlement (factoring) and in this case the trade payable would be reclassified as debt. These schemes raise some complex accounting issues and any such scheme must be referred to the Group Financial Controller for approval and guidance on the accounting.

183 22. Provisions and contingent liabilities Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Where a liability arises in the period, provisions must be set up and charged to the income statement. On acquisition of a business, provisions may only be set up if a number of specific conditions are satisfied. Costs may only be charged against provisions if a number of specific conditions are satisfied. Unused amounts of provisions must be reversed through the income statement and cannot be used to absorb costs other than those for which the provision was originally set up. General provisions should not be recognised Disclosed accounting policy Provisions are recognised when the Group has a present obligation as a result of a past event and it is probable that the Group will be required to settle that obligation. Provisions are measured at the directors best estimate of the cost of settling these liabilities and are discounted to present value where the effect is material Default policy and process for exceptions Default policy A provision should be recognised when and only when there is an obligation to transfer economic benefits as a result of past events. Costs incurred in the period which relate to the original purpose of the provision are to be charged against the provision and categorised as expenditure in the period. Provisions can be used only for the liability for which they were originally set up and cannot be transferred or used for other purposes. Releases of provisions to the income statement are to be classified as credited to the income statement Consultation and authorisation process for exceptions The set up, usage and release of provisions should be approved by the Country Finance Director and, where material, agreed with the Group Financial Controller. Exceptions to the default policy below must be authorised by the Group Financial Controller. For more application detail contact Group Finance, Chertsey IFRS references IAS 37 Provisions, contingent liabilities and contingent assets Exposure drafts for changes are currently under discussion. Any amendment arising will be incorporated in an updated version of this policy.

184 Provisions and contingent liabilities, page 2 of Summary of IFRS requirements Provisions A provision is a liability of uncertain timing or amount. The recognition criteria for a provision are as follows: (a) (b) (c) a present obligation resulting from a past event; an outflow of economic benefits which is probable; and ability to measure the outflow. A provision should be recognised only where, at the balance sheet date, a liability exists and conditions for recognition are met. Liability Present obligation from past event Outflow is probable Provision = + + Able to measure Use of the term provision is restricted to items that are disclosed in a balance sheet under headings for liabilities. It does not cover adjustments to assets, such as depreciation, impairment and bad debts, which are sometimes referred to as provisions Contingent liabilities A contingent liability arises in three scenarios where the definition of a provision is not met: (a) (b) where the obligation is only possible rather than certain; or a present obligation exists but: (i) (ii) an outflow of economic benefits is not probable; or the probable outflow cannot be reliably measured. Present Provision = obligation from past Outflow is probable + event Able to measure Contingent = Possible obligation and/ Outflow is not and/ Liability from past event or probable or Unable to measure See policy on Other Disclosures for more detail on the contingent liabilities that should be reported to Group and for Group Treasury guidance on the issue of bonds, guarantees and letters of comfort.

185 Provisions and contingent liabilities, page 3 of Does a provision exist? The following decision tree should allow the correct classification of a liability to be arrived at: Start Present obligation as a result of an obligating event? No Possible obligation? No Yes Yes Probable outflow? No Remote? Yes Yes No Reliable estimate? No (Rare) Yes Provide Disclose contingent liability Do nothing Present obligation Obligations arise from one of two reasons: Legal enforceable by law. Constructive the event creates a valid expectation in another party such that the entity has no realistic alternative to settling that obligation. An event which happens may not immediately give rise to an obligation, but if a subsequent obligation arises, which can be traced back to the event, then the event becomes an obligating event. For example, an unexpected legal claim is received after the balance sheet date in respect of damage alleged to have occurred before the balance sheet date. The date of the obligating event must be on or before the balance sheet date in order to recognise a provision. Obligations that may arise because of future operating activity do not give rise to potential provisions at the balance sheet date. If, at the balance sheet date, the obligation is independent of future operating activities or decisions then it exists at the balance sheet date. Probable outflow of economic benefits A probable event is defined as being likely to happen (i.e. there is a greater chance of it happening than not). Reliable estimate An entity will normally be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is sufficiently reliable to use in recognising a provision. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is therefore disclosed as a contingent liability.

186 Provisions and contingent liabilities, page 4 of Provisions compared with other liabilities There is sometimes confusion over the difference between a provision and other types of liability, notably an accrual. Provisions are distinct from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. It also may not be clear-cut to judge whether there is a present obligation. By contrast: (a) (b) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or payment formally agreed with the supplier; and accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or payment formally agreed with the supplier, including amounts due to employees (for example amounts relating to accrued holiday pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions. In each case, however, the definition of a liability will be met through the existence of a present obligation arising from a past event. Example Goods or services received and invoiced Goods or services received, but not invoiced Legal claim from supplier for breach of exclusive supply agreement Classification Trade payable Accrual Provision (if conditions met) Degree of uncertainty None Some Significant Applicability The requirements of IAS 37 apply to all provisions, contingent liabilities and contingent assets, except: (a) those resulting from executory contracts, except where the contract is onerous; and Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent. This exemption covers contracts such as: (i) (ii) (iii) (iv) employee contracts in respect of continuing employment; contracts for future delivery of services such as gas and electricity; obligations to pay property tax and similar levies; and most purchase orders. An onerous contract is defined as one where it becomes more costly to fulfil or avoid than the revenues it could earn. (b) those covered by another standard. Examples include financial instruments, pension costs, taxation and leases.

187 Provisions and contingent liabilities, page 5 of Application guidance Establishment of provisions A provision should be recognised when and only when there is an obligation to transfer economic benefits as a result of past events. The amount recognised should be the best estimate of the cost needed to settle the obligation that existed at the balance sheet date. Post-balance sheet evidence can be used to determine this best estimate. HFM account: BS44000 Cust1; PLCY Where there is likely to be a considerable time delay in settlement the provision should be discounted to its net present value. Guidance on this is given in the appendix to this chapter. Provisions are all measured before tax. Deferred tax for provisions should be recognised as appropriate, in consultation with the Group Tax department where necessary Movements in provisions Costs incurred in the period which relate to the original purpose of the provision are to be charged against the provision and categorised as expenditure in the period. Provisions can be used only for the liability for which they were originally established and cannot be transferred or used for other purposes. HFM account: BS44000 Cust1; EXPEND The different movements in provisions may be summarised as follows: Brought forward X Provision brought forward at beginning of period Expenditure in period (X) Utilisation of provision in period Reclassification X Between categories, or to accruals if liability now more certain (see section on Creditors) Exchange X Exchange on provisions denominated in a foreign currency Business acquired/disposed X Addition or removal of provisions upon acquisition or disposal of a subsidiary Charged to income statement X Increase in provision in period Credited to income statement (X) Unutilised part of provision released Carried forward X Provision carried forward at end of period Other releases of provisions to the income statement are classified as credited to the income statement and form part of the operating profit for management reporting (see policy on Material profit or loss items for more detail). For actuarial or statistically determined provisions (e.g. self insurance), a release is part of normal operating profit if it is the revision of a previous estimate in light of actual events. Provisions held at the balance sheet date for continuing need should be reviewed for adequacy. Any increases or decreases should be dealt with as above.

188 Provisions and contingent liabilities, page 6 of Example: Provision no longer required A provision was established some years ago in respect of an onerous contract and the amount of the provision at the beginning of the year is 3m. During the year, the contract was renegotiated and is now no longer onerous and therefore the provision is no longer required. At the year-end, a separate contract has unexpectedly become onerous. This contract will lose 1m each year and has a further two years to run at the balance sheet date. The original provision of 3m must be reversed to the income statement. In respect of the newly onerous contract, assuming the criteria for recognising an onerous contract provision are met, 2m should be provided for the next two years unavoidable losses. It would be inappropriate simply to charge the 2m costs of the newly onerous contract against the existing provision, as it was not set up for this purpose. Extract from provisions note Correct treatment Incorrect treatment Brought forward 3 3 Credited to profit and loss (3) - Charged to profit and loss 2 - Expenditure in year - (1) Carried forward Types of provisions The Group has defined the following categories of provisions, on which further guidance is given below Pensions and other post employment benefits Insurance Onerous contracts Legal and other claims Reorganisation/closure Environmental HFM accounts: BS44000 Cust2; INSURE Cust2; ONER Cust2; CLAIMS Cust2; REORG Cust2; ENVIRON Other items covered below are: Onerous leases Major refit and repair costs Executory contracts Contract termination; employee costs General provisions are not allowed. Each provision has to be specifically identified. Future commitments to spend money do not give rise to provisions at the balance sheet date if they relate to ongoing operating activities. As a guide, if the obligation to make payment arises as a result of the Group s own intended actions, and if those intentions are reversible, then a provision for the obligation should not be recognised.

189 Provisions and contingent liabilities, page 7 of The amount of the provision must be management s estimate of the liability at the balance sheet date. Future or expected costs and losses are not allowed Pensions and other post employment benefits Areas where provisions might be required within this category are: Deficits on defined benefit pension schemes Unfunded pension obligations to current or retired staff; Medical costs for retired staff; Long service awards; Payments made on retirement ( retirement indemnities ); and Other post employment benefit costs. It is likely that an actuarial valuation at the balance sheet date is required in order for the size of the provision to be estimated reliably. This estimate should be discounted where discounting has a material effect on the provision, at a rate advised by the actuary. Pension schemes within the Group should be accounted for under the Pensions and long-term employee benefits accounting policy Insurance Insurance provisions relate to self-insurance schemes set up at Group or country level. The guidance does not apply to individual business units. The Group currently operates several self-insurance schemes. In these circumstances it is necessary to provide for an insurance reserve. Such self-insurance schemes will typically be administered by an insurance or actuarial company who calculate the insurance reserve required at the balance sheet date from claims outstanding up to that date. In some cases, a captive insurance company will be used; in other cases, a provision will be held by the company. In both situations, actuarial input will be required. IAS 37 forbids provision in respect of contributions to a self-insurance fund, as no external obligation exists at that point. The Group should, however, make provision for the costs of events which have occurred prior to the balance sheet date. This provision should cover not only those claims which have been made prior to the balance sheet date but also claims incurred but not reported (IBNR) at that date. Clearly, where an incident has happened the company might not know of its occurrence, but this in itself does not preclude it from making a provision. If a reliable estimate can be made of claims, presumably based on past experience, a provision can be made.

190 Provisions and contingent liabilities, page 8 of Example: Self insurance using a captive insurance company A Group company pays 2m cash into a self-insurance captive company (consolidated as part of the Group). At the end of the year, actuaries to the captive report: Claims received of 1.2m; and Actuarially-determined expected claims incurred but not reported (IBNR) of 0.4m. Whilst the captive itself has a liability of 2m (either to settle claims or return the funds to the Group), in the Group accounts, the appropriate provision is 1.6m, being the actuariallydetermined external obligation. 2m 0.4m 1.2m Permitted provision 1.6m C a sh p a id K n o w n IB N R Claim s Onerous contracts Where a loss-making contract exists at the balance sheet date an onerous contract provision should be made for the future loss. An onerous contract is defined as one where it becomes more costly to fulfil or avoid than the revenues it could earn. Any assets dedicated solely to the performance of the contract should be impaired (see section on Impairment) first before a separate provision is made. A lease on an unoccupied property is also an onerous contract (see ). The loss should also include all purchasing income or rebates attributable to the contract. A provision cannot be made if the contract is simply less profitable than originally envisaged. If action can be taken to reduce a loss or exit the contract in a shorter time scale then a reduced provision will be appropriate (perhaps equivalent to the termination payment the other party to the contract would accept). Similarly, it is not acceptable to allocate central overheads to a contract to demonstrate that it is not profitable. The determination of profitability should be based on the contract itself before central overheads. Most operational losses do not fulfil the criteria for onerous contracts as there are usually ways to reduce the loss or leave the contract - these may not be implemented because of other operational or commercial considerations. Onerous contracts are more likely to occur when there is some fixed element of cost which, because of changing circumstances, becomes uneconomic.

191 Provisions and contingent liabilities, page 9 of Examples: Onerous contracts 1 A contract has two years to run before it is available for renegotiation or termination. The contract currently gives rise to an operating loss of 500,000 per annum, chiefly because of the high fixed rent levels associated with it which have not been matched by expected increase in customer numbers, and there are no operational means to reduce this loss. Provide 1m for the onerous contract at the balance sheet date. 2 A contract has two years to run before it is available for renegotiation or termination. The contract currently gives rise to an operating loss of 500,000 per annum but this can be reduced to 350,000 by reducing opening times without renegotiating the contract. Provide 700,000 for the onerous contract at the balance sheet date. 3 A contract has two years to run before it is available for renegotiation or termination. The contract currently gives rise to an operating loss of 500,000 per annum, and there are no operational means to mitigate this loss. The client has indicated, however, that they would be prepared to renegotiate the contract for a one-off payment of 400,000. The renegotiation is expected to result in a contract which is profitable. Provide 400,000 for the renegotiation cost, being the minimum unavoidable cost Onerous leases A lease for property which has been vacated is onerous, and a provision recognised, to the extent that rentals continue which are not recoverable from sub-leasing the property. The provision should represent the best estimate of the expenditure required to settle the obligation at the balance sheet date, which in this case might be the amount the landlord would accept to terminate the lease. Example: Onerous leases A leased building has ten years left to run on the lease, but has been vacated and is now unoccupied. Annual lease rental is 200,000, and the building can be re-let for 50,000 per annum. Provide 1.5m for the onerous element of the lease at the balance sheet date and consider discounting if material Legal and other claims In the case of legal claims expert advice must be sought in order to assess the probability of the claim being successful and the estimated size and timing of the settlement. Legal claims must be monitored and reviewed regularly so that the change in status of a claim from remote to possible or probable, and vice versa, can be picked up and accounted for correctly. In some parts of the group, a number of cases are regularly received for similar items, for example employee-related claims. In such cases, it is valid to use an 'expected value'. This is the amount that takes account of all possible outcomes, using probabilities to weight the outcomes. Typically, this value might be determined with the assistance of external actuaries.

192 Provisions and contingent liabilities, page 10 of Example: Expected value A Group company faces 100 legal claims, each with a 10 per cent likelihood of success with no cost, a 30 per cent likelihood of failure with a cost of each claim of 25,000 and a 60 per cent likelihood of failure with a cost of each claim of 100,000. Using expected value, the statistical likelihood is that 10 per cent of claims will result in nil cost, 30 per cent of claims will result in a cost of 25,000 and 60 per cent of claims will result in a cost of 100,000. Therefore the provision is calculated as: (10% x 100 x nil) + (30% x 100 x 25,000) + (60% x ,000) = 6,750,000. Examples: Individual legal cases In the case of individual legal cases the provision relates to a single event, or a small number of events, so expected value is not a valid technique. 1 A Group company has received notice of a legal action claiming 4m in damages. Lawyers have advised as at the balance sheet date that a probable settlement figure will be 2m. Provide 2m plus claimant party costs. Accrue for legal fees incurred to date in defending the action. 2 A Group company faces a single legal claim, with a 30 per cent likelihood of success with no cost and a 70 per cent likelihood of failure with a cost of 1.5m. Expected value is not valid in this case, since the outcome will never be a cost of 1.05m (70 per cent of 1.5m). It will either be nil or 1.5m. The provision should represent whichever is the most likely of these two outcomes. In this example, it is more likely that a cost of 1.5m will result and therefore full provision would be made Restructuring Restructurings include: sale or termination of a line of business; the closure of business locations in a country or region or the relocation of business activities from one country or region to another; changes in management structure, e.g., eliminating a layer of management; and fundamental reorganisations that have a material effect on the nature and focus of the entity's operations. Although these often include both closure of an operation and the opening of a new one, only the closure part can be provided for.

193 Provisions and contingent liabilities, page 11 of The two principal requirements for recognition of a provision in respect of a restructuring are: Detailed plan Valid expectation that the plan will be implemented. The detailed plan must specify: the business or part of a business concerned; the principal locations affected; the location, function, and approximate number of employees who will be compensated for terminating their services; the expenditures that will be undertaken; and when the plan will be implemented. Achieved by: actually starting to implement that plan; or announcing its main features to those affected by it at the balance sheet date, in such a way and in sufficient detail that it gives rise to valid expectations that the entity will carry out the restructuring. A management or board decision to go ahead with its plan is not, of itself, a constructive obligation. Similarly, events involving third parties which occur before a board decision is taken or approval given to a detailed plan, e.g., negotiations with employee representatives for termination payments or with purchasers for the sale of an operation, do not amount to a constructive obligation unless there is also a valid expectation in those affected. In a restructuring, the assets of the operation should be reviewed for impairment and consideration should be given as to whether any of the entity s contracts are now onerous. Amounts included in a restructuring provision IAS 37 restricts a restructuring provision to the direct costs of the restructuring, which are those that are both: necessarily entailed by the restructuring; and not associated with the ongoing activities of the entity. Specific items which are excluded by the standard on the basis that they relate to the ongoing activities of the business are: retraining or relocating continuing staff; marketing; and investment in new systems and distribution networks.

194 Provisions and contingent liabilities, page 12 of Restructuring provision flowchart The flowchart below sets out the steps to consider in deciding whether or not a restructuring provision should be made. Start Is there a detailed plan (see section above)? No Yes Yes Yes Yes Yes A constructive obligation to restructure has arisen. A provision is required. Will the plan start as soon as possible and be completed in a timeframe which makes significant changes to the plan unlikely? Yes Has the entity started dismantling plant prior to the year end? No Has the entity started selling assets prior to the year end? No Has there been a public announcement of the main features of the plan prior to the year end, in sufficient detail and in such a way to give rise to expectations in other parties such as customers, suppliers and employees (or their representatives) that the entity will carry out the plan? No Is there any other evidence to suggest that the entity has started to implement the plan prior to the year -end? Yes No Has the entity announced the main features of the plan to those affected by it before the year end? No No No constructive obligation to restructure has arisen. No provision can be made.

195 Provisions and contingent liabilities, page 13 of Examples: Reorganisations 1 A contract is not expected to be renewed in six months time. Staff will be made redundant as there is no possibility of transferring them with the contract. No provision should be made, because the obligating event has not occurred, i.e. the client has not given formal notice that the contract will end. 2 Management plan the reorganisation of a business which will involve redundancies. No announcement has been made, although board minutes contain details of the plan. No provision should be made because there was no constructive or legal obligation at the balance sheet date. 3 As above, but detailed plans are in place and have been communicated to the employees. The timeframe for the plan has been adhered to and/or implementation of the reorganisation has begun. Provide for reorganisation costs because a constructive obligation has been created with the employees concerned, and the commitment of the business to implementing the reorganisation has been demonstrated Environmental provisions Where a legal or constructive obligation exists at the balance sheet for an environmental liability, a provision should be made. Commonly such obligations exist to restore a site after operations have ceased at the site. Where the obligation under an environmental provision occurs during the use of the site over time, the provision should be built up over the life of the site and charged to the profit and loss account as incurred. Where an obligation for an environmental provision exists at the outset of the use of the site the provision should be capitalised and depreciated over the expected useful life of the site. Such a situation would be very uncommon and should be referred to Group Finance, Chertsey for further guidance. Example: Environmental provision An entity causes contamination and operates in a country where there is no environmental legislation. However, it has a widely published environmental policy in which it undertakes to clean up all contamination that it causes and a record of honouring this published policy. The obligating event is the contamination of the land, which gives rise to a constructive obligation because the conduct of the entity has created a valid expectation on the part of those affected by it that the entity will clean up contamination. The transfer of economic benefits in settlement is probable. A provision is recognised for the best estimate of the costs of clean-up incurred to date (and not the final cost anticipated at the end of the site s life).

196 Provisions and contingent liabilities, page 14 of Major refit and repair costs There is generally no obligation to refit operating sites at some future date, and therefore no provision can be made for these future costs. Although a major refit might be an expected future cost, it does not fall into the scope of IAS 37 as a cost that should be provided for. When it occurs, the cost is usually capitalised and the economic benefit of the costs depreciated over the life of the refitted asset. At the same time, consideration of any assets that have been replaced should be given and they should be written off in the accounting records as appropriate. Example: Dilapidations Leases often have a dilapidations clause which requires that the building is put back to its original state before the end of the lease. This is a legal obligation, arising from a past event (signing the lease) and therefore a dilapidations provision should be made as long as the amount can be measured reliably. The provision at the balance sheet date should reflect the amount of dilapidations which have occurred at that point. For example, in a 15 year lease with expected total dilapidations of 1.5m (based on the current state of the building), it would be appropriate to have provided for 1m by the end of year 10. Because many building leases are over a substantial period of time it may often be appropriate to discount the dilapidations provision. The provision for dilapidations should be capitalised at the outset of the lease and depreciated over the life of the lease. The unwinding of the discount should be shown as a separate heading under interest costs and a consequent increase in the value of the provision Executory contracts Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent. Provision should not be made for executory contracts. This covers contracts such as: employee contracts in respect of continuing employment; contracts for future delivery of services such as gas and electricity; obligations to pay property tax and similar levies; and most purchase orders. Examples: Executory contracts 1 The terms of an acquisition agreement require an audit of the acquired company for the five years following the acquisition. The acquired company would not otherwise require an audit, which is expected to cost 100,000 per annum. The contract is an executory contract. At the acquisition date, the audit has not been performed and no liability to the auditors therefore exists. No provision should therefore be made. 2 A Group company has placed a purchase order for capital equipment, to be used in a profitable contract. Cancelling the order will incur a penalty of 50,000. No provision should be made as the future benefits from use of the asset exceed its cost (i.e. the contract is profitable), so the purchase order is not expected to lead to a transfer of economic benefits Contract termination; employee costs Commonly the Group incurs employee compensation costs at the end of a contract. These redundancy or compensation costs may arise due to local law or the nature of the employee contract. In most circumstances a provision (or accrual) for such costs should not be recognised either at the

197 Provisions and contingent liabilities, page 15 of start of a contract or over its life. Similarly a general provision at country level is also inappropriate. Exceptions to this principle may arise; If the contract is fixed term in nature and there is an expectation from the outset that employees will receive redundancy/termination compensation payments at the end of the contract. It becomes virtually certain that a contract will be terminated (early termination or non-renewal) and an expectation has arisen in employee s minds that they will be made redundant and that compensation will become due and the costs cannot be avoided, e.g. employees cannot be found work elsewhere. Examples: Contract termination; employee costs 1 The Group enters into a 5 year fixed term contract to provide food service at a construction site. The construction project is expected to last 5 years and there is no possibility of the contract being extended beyond this time. Local law does not permit a fixed term employment contract that avoids making a compensation/redundancy payment on termination of the contract. A provision for the termination payment costs should be built up over the life of the contract. This provision is specific to this contract only and arises because there is a legal and constructive obligation to the employees that cannot be avoided. 2 The Group operates a 3 year food service contract. Mid way through the contract is it clear that the client relationship has deteriorated and management expect not to be able to renew the contract. No provision should be made because; No expectation has arisen in the minds of the employees that a compensation/redundancy payment will become due at the end of the contract. The contract may still be renewed. The Group may be able to find alternative employment at the end of the contract. 3 At country level the Group has a 95% contract retention rate. Employee compensation costs are usually paid in the 5% of contracts that the Group loses each year in that country. A general country level provision for employee compensation costs should not be made because there is no expectation of redundancy and compensation present across the country s staff. The provision is not specific to individual contracts and there can be no reliable estimate of the cost or assessment of whether costs can be avoided through staff being found work elsewhere.

198 Provisions and contingent liabilities, page 16 of Appendix: discounting of provisions Provisions should be discounted to present value when the time value of money is material. The discount rate (or rates) should: (a) (b) (c) be pre-tax; reflect current market assessments of the time value of money; and reflect risks specific to the liability. Adjustment for risk There was some discussion on discounting in an appendix to FRS 12 but this is not replicated in IAS 37. However, IAS 37 itself does not contain anything which contradicts the comments in FRS 12. According to these, it is acceptable to reflect risk either in estimation of cash flows or by adjusting the discount rate. The use of an adjusted discount rate will normally be the easiest method. If this approach is not adopted, it follows that where risk is reflected in estimates of cash flows, the appropriate discount rate will be a pre-tax risk-free rate such as a current government bond rate. The following is a general guide: (a) (b) a risk-free rate, based on government bond rates, reflects the discount that a creditor will accept to receive a risk-free cash flow now rather than at the due date; a risk-adjusted rate, based on a general corporate bond rate, will reflect general corporate credit risk and will be appropriate for 'blue-chip' entities; (c) a risk-adjusted rate, based on an entity-specific corporate bond rate or weighted average cost of capital (adjusted to a pre-tax basis), will reflect risk factors specific to an entity and will be appropriate for most entities where risk is not specifically considered in the estimation of cash flows. Guidance should be sought from the Group Finance, Chertsey on whether to discount and the appropriate rate to use. Impact of inflation Where estimated cash flows are expressed in current prices, a real discount rate will be used. Where, alternatively, cash flows are expressed in expected future prices (normally higher than current prices), a nominal discount rate will be used. Unwinding of a discount In balance sheets for the years following the initial measurement of a provision at a present value, the present value will be restated to reflect estimated cash flows being closer to the measurement date. The unwinding of the discount should be included as other finance costs within the income statement.

199 23. Pensions and long term employee benefits Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Defined benefit and unfunded pension costs should be charged to the income statement in accordance with the rates advised by an actuary. IAS19 distinguishes various components of the pension charge, namely: current service costs, past service costs, curtailment and settlement charges which are charged to operating profit, interest costs and expected return on scheme assets which are charged to interest, actuarial gains or losses which are reported in the new IAS 1 Consolidated Statement of Comprehensive Income (previously the Statement of Recognised Income and Expenditure (SORIE)) The net present value of the obligation should be recognised immediately on the Group balance sheet, with movements other than the current service cost and finance charge recognised in the Consolidated Statement of Comprehensive Income. There are restrictions over the circumstances in which a pension plan surplus (which arises if there is an excess of the fair value of plan assets over the present value of the defined benefit obligation) can be recognised as an asset. Defined contribution pension costs are expensed as incurred Disclosed accounting policy Pension obligations Payments made to defined contribution pension schemes are charged as an expense when they fall due. Payments made to state-managed schemes are dealt with as payments to defined contribution schemes where the Group s obligations under the schemes are equivalent to those arising in a defined contribution benefit scheme. For defined benefit pension schemes, the cost of providing benefits is determined using the Projected Unit Credit Method, with actuarial valuations being carried out at each balance sheet date. Actuarial gains and losses are recognised immediately in the Consolidated Statement of Comprehensive Income. Past service cost is recognised immediately to the extent that the benefits are already vested, and otherwise is amortised on a straight-line basis over the average period until the benefits become vested. The pension obligation recognised in the balance sheet represents the present value of the defined benefit obligation as adjusted for unrecognised past service cost, and as reduced by the fair value of scheme assets. Any asset resulting from this calculation is limited to past service cost, plus the present value of available refunds and reductions in future contributions to the plan. Other post-employment obligations Some Group companies provide other post-employment benefits. The expected costs of these benefits are accrued over the period of employment using a similar basis to that used for defined benefit pension schemes.

200 Pensions and long term employee benefits, page 2 of 9 23 Actuarial gains and losses are recognised immediately in the Consolidated Statement of Comprehensive Income Default policy and process for exceptions Default policy For defined contribution schemes (where the Group has no further liability once the required contributions or premiums have been made), the income statement charge for the period is the value of contributions payable in respect of that period. For defined benefit schemes (where contributions are paid in accordance with advice from an actuary, but the Group remains liable to fund the scheme sufficiently to fulfil its obligations), the income statement charge for the period is composed of several elements which need to be evaluated by an actuary using assumptions agreed by the employing company. The actuarial assessment must be made annually at the year-end balance sheet date. A full actuarial valuation of a scheme is required with sufficient regularity. The Group policy is for full actuarial valuations to be made every three years with roll-forward valuations at the intervening year-ends. A full valuation may be required earlier if there is a major change to the scheme or employer circumstances (for example, large changes in the numbers of employees). For other pension promises not covered by a separate funded scheme, the appropriate provision must be made in accordance with actuarial advice and included in Provisions. These policies apply to pensions and other post-retirement or postemployment benefits such as healthcare, life assurance and lump sums payable on retirement or departure. HFM account: BS Consultation and authorisation process for exceptions For guidance on accounting for other types of benefits, contact Group Finance, Chertsey. Any proposed exceptions must be authorised by the Group Financial Controller IFRS references IAS 19 Employee Benefits IFRIC 14 IAS19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction 23.4 Summary of IFRS requirements Pension and long-term benefit arrangements can take different forms. The employer may have a commitment arising from the contract of employment, the provision of pensions may have arisen from custom and practice or exgratia arrangements may be made on a case by case basis. Pension schemes are basically divided into defined contribution schemes and defined benefit schemes Defined contribution schemes In a defined contribution scheme, the employer will normally make agreed contributions to a pension scheme and the benefits paid will depend upon

201 Pensions and long term employee benefits, page 3 of 9 23 the funds available from these contributions and related investment earnings. The cost to the employer can, therefore, be measured with reasonable certainty. Any risk of a shortfall in expected benefits falls on the employee, not on the employer. The charge against profits should be the amount of contributions payable to the pension scheme in respect of the accounting period Defined benefit schemes In a defined benefit scheme, the benefits to be paid will usually depend upon either the average or final pay of the employee during his or her career. Therefore it is impossible to be certain in advance that the contributions to the pension scheme, together with the investment return on those contributions, will equal the benefits to be paid. The employer may have a legal obligation to provide any unforeseen shortfall in funds or, if not, may find it necessary to meet the shortfall in the interests of maintaining good employee relations. Conversely, if a surplus arises the employer may be entitled to a refund of, or reduction in, contributions paid into the pension scheme. Thus, in this type of scheme the employer's commitment is affected by many more variables than with defined contribution schemes and the final cost is subject to considerable uncertainty. The accounting for defined benefit schemes is complex because actuarial assumptions are needed to measure the obligation and the correct discounting for when the obligations will fall due. For defined benefit schemes the pension cost should be calculated by actuaries and will be the actuary's best estimate of the cost. There may be cases where benefits are guaranteed to the employee but it is not possible to account for the scheme as a defined benefit scheme. Examples of this are state or industry schemes where the employer only has a liability for current payments, not future shortfall or surplus, and multi-employer schemes where the assets and obligations relating to one employer cannot be separated from the others. In such cases, the scheme is accounted for as a defined contribution scheme but extra disclosures may be required. Each material plan must be reviewed by actuaries who will calculate the obligations and expense according to the methods described in IAS 19 and using appropriate assumptions which should be agreed with the employer. A full actuarial valuation should take place with sufficient regularity. Group policy is for full valuations every three years, with the assumptions being rolled forward and updated for the intervening year-end balance sheet dates. A full valuation may be required earlier if there are substantial changes to the circumstances of the scheme or the employer. The stages involved are: Using actuarial techniques to make a reliable estimate of the amount of benefit earned by employees in current and prior periods, based on assumptions including employee turnover, mortality rates and future salary increases. Discounting that benefit using the Projected Unit Credit Method to calculate the present value of the benefit and current service cost. Determining the fair value of the plan s assets.

202 Pensions and long term employee benefits, page 4 of 9 23 Determining actuarial gains and losses (arising from changes in actuarial assumptions or experience adjustments which are the differences between previous actuarial assumption and actual experience). Determining changes in obligations and past service costs arising from changes in the plan s rules. Calculating the gain or loss where a plan has been restricted or closed (curtailment) or settled. The actuary will have to be provided with the necessary updated information on payroll costs and scheme membership. Assumptions including local inflation rates, appropriate discount rates and future salary increases will have to be discussed and agreed with the actuary. These assumptions can have a substantial impact on the amount of liability recognised. These assumptions are to be unbiased (that is, neither excessively conservative nor imprudent) and mutually compatible. The net of the present value of the defined benefit obligation and the fair value of the plan assets at the balance sheet date, adjusted by the actuarial gains or losses and past service costs not yet recognised, will be recognised on the balance sheet (under provisions if this is a liability). HFM account: BS43000 The Group has chosen to adopt the optional accounting treatment available under IAS 19 and recognises actuarial gains or losses in the period in which they are identified through reserves. They are reported through the Consolidated Statement of Comprehensive Income (previously the Statement of Recognised Income and Expenditure (SORIE)) and not through the income statement. Recognition of defined benefit scheme surplus as an asset IAS 19 restricts the circumstances in which an asset can be recognised if there is an excess of the fair value of plan assets over the present value of the defined benefit obligation. IFRIC 14 addresses further how to assess the limit on the amount of the surplus that may be recognised when a minimum funding requirement exists. Any asset resulting from this calculation under IAS 19 is limited to past service cost, plus the present value of available refunds and reductions in future contributions to the plan. IFRIC 14 makes it clear that: A refund is available only if there is an unconditional right to the refund. This is measured as the amount of the surplus less associated costs. Where there is a refund available and no minimum funding requirement exists, the benefit available will be the lower of the surplus in the plan and the present value of the future service cost to the entity. When a minimum funding requirement exists, the benefit available is the present value of the estimated future service costs less the estimated minimum funding contribution required in respect of the future accrual of benefits in that year. If an entity has a minimum funding requirement to pay additional contributions, the entity must determine whether the contributions will be available as a refund or reduction in future contributions

203 Pensions and long term employee benefits, page 5 of 9 23 after they are paid into the plan. If not, a liability is recognised when the obligation arises. In practice this means that it can be difficult to recognise a pension scheme surplus and an asset particularly if a schedule of future contributions has been agreed with the plan Trustees.

204 Pensions and long term employee benefits, page 6 of 9 23 Reconciliation of the defined benefit obligation The net present value of the defined benefit obligation is reconciled as follows: Opening net present value +income statement impact (detailed below) +equity impact - Actuarial gain or loss - Exchange rate differences +cash paid - Contributions paid in +acquisition or disposal = Closing net present value The income statement will include the net of: Operating profit Interest Current service cost Past service cost Effect of curtailments or settlements Interest cost Expected return on assets Increase in the pension obligation arising from employee service in the current period Increase in the present value of the obligation for employee service in previous years, resulting from the introduction or changes to the post employment benefits granted Curtailment occurs when an entity makes a material reduction in the number of employees or amends the terms of a plan to reduce benefits A settlement is a one off transaction that will eliminate all further obligation (for example, making a payment to transfer the existing obligation to a third party or a government scheme) Increase during the period in the present value of a defined benefit obligation that arises because the benefits are one period closer Expected interest, dividends and other revenue derived from the scheme s assets, together with realised and unrealised gains and losses on the plan assets, less any plan administration costs including taxation

205 Pensions and long term employee benefits, page 7 of 9 23 Where a change has been made to a scheme which changes past service costs, the liability for rights that vest immediately will be recognised in the period in which they arise. For rights which vest over a period of time, the liability for the past service element will be recognised on a straight-line basis over the expected remaining working lives of the employees affected. Contributions paid to the scheme are recognised through the increase in fair value of the plan assets and therefore decrease the present value of the defined benefit obligation. The measurement of the plan assets excludes unpaid contributions due from the Group to the fund. Therefore, if the Group has accruals which represent outstanding contributions at the year end which are not included in the fund valuation, they may reduce the net present value of the defined benefit obligation. Any deficit shown on the balance sheet is presented gross before any adjustment for deferred tax Other long-term employee benefits Other long-term employee benefits include long service benefits, long-term disability benefits and long-term compensated absences. These will also have to be actuarially assessed to determine the liability. Any past service cost which arises is recognised immediately and not spread over the expected time to the realisation of the liability Application detail HFM account: BS44000 Custom 2: [OPROV] Treatment as a defined contribution scheme Example: Company X contributes to an industry-wide pension scheme which is managed by an insurance company. Company X s only obligation is to pay the amount based on a percentage of each employee s salary to the insurance company : The charge to the income statement in respect of pensions is the same as the contributions due for the period. Example: Company S contributes to a multi-employer pension scheme. The assets are pooled and managed collectively and the liability relating to each employee is not separable by the administrators. : The charge to the income statement in respect of pensions is the same as the contributions due for the period. Additional disclosures relating to why the scheme has been treated as a defined contribution scheme and the impact on the employer may be required.

206 Pensions and long term employee benefits, page 8 of Defined benefit scheme Example: Company Y has its own final salary pension scheme. The scheme s assets are separated from company Y, the scheme has its own trustees and employs the services of an external, professionally qualified actuary. Company Y has been making contributions into its scheme for some years at a rate of 2% of employee pay. The actuary has completed a full valuation of the scheme and the following has happened: There is a scheme deficit of 6m at the start of the year. Contributions will have to increase to 2.3% of employee pay. This is made up of 2.1% of regular cost and 0.2% towards the deficit. The trustees of the scheme have asked Company Y to make an immediate cash payment of 1m as a contribution to the scheme deficit. Some of the scheme benefits for family members have been reduced (curtailment) Some scheme benefits for current employees have been expanded based on length of service. The actuary estimates that the additional liability on past service will be 3m and the average expected remaining working life of employees in the scheme is fifteen years. The movement in the scheme deficit is as follows: m Opening deficit (6.0) Acquisitions (0.4) Current service costs (calculated at 2.1%) (1.5) Curtailment credit 0.7 Contributions paid (calculated at 2.3%) 1.6 Additional contribution paid 1.0 Past service costs ( 3m spread over 15 years) (0.2) Expected return on scheme assets 0.9 Interest cost on scheme liabilities (0.6) Actuarial gains and (losses): Difference on return on scheme assets 0.2 Experience losses on scheme liabilities (0.1) Changes in assumptions (0.3) Closing deficit (4.7) : The charge in the income statement will be made up of: Current service cost 1.5 Past service cost 0.2 Curtailment credit (0.7) Total charged to profit from operations 1.0 Expected return on scheme assets (0.9) Interest cost on scheme liabilities 0.6 Net (income) included in finance costs (0.3) The following amounts will be taken to equity and reported in the Consolidated Statement of Comprehensive Income: Difference on return on scheme assets 0.2 Experience losses on scheme liabilities (0.1) Changes in assumptions (0.3) Total charged to equity (Statement of Comprehensive Income) (0.2) The deficit of 4.7m will be recorded as a non-current liability in the balance sheet.

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208 24. Government grants Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Key points A grant should not be recognised until the conditions for its receipt have been complied with and there is reasonable assurance that it will be received. Grants related to assets may either be deducted from the value of the related asset or carried as deferred income and released through the income statement over the life of the asset. Group policy is to use the deferred income method. Government grants should be recognised in the income statement so as to match them with the expenditure towards which they are intended to contribute Disclosed accounting policy The Group currently has no disclosed policy for government grants Default policy and process for exceptions Default policy A grant should not be recognised until the conditions for its receipt have been complied with and it is probable that it will be received. Grants should be recognised in the income statement so as to match them with the expenditure towards which they are intended to contribute Consultation and authorisation process for exceptions Situations not covered here should be referred to Group Finance, Chertsey IFRS references IAS 20 Accounting for government grants and disclosure of government assistance SIC-10 Government assistance - no specific relation to operating activities IAS 8 Accounting policies, changes in accounting estimates and errors 24.4 Summary of IFRS requirements Government grants basic principle Government grants are assistance by government (international, national, regional, local or municipal) in the form of cash, transfers of assets, or tax relief in return for past or future compliance with certain conditions. The requirements apply equally to similar amounts received from nongovernmental public-sector bodies.

209 Government grants, page 2 of General recognition criteria The recognition rules for government grants are summarised below: Purpose of grant Immediate financial support Reimburse previous costs Finance general activities Compensate for lost income Recognition rules Recognise in period when receivable Recognise in period when receivable Recognise in period when paid Recognise in period when paid For fixed asset expenditure Either :- recognise as deferred income and amortise over the expected useful economic life of the asset. or offset the grant against the cost of the asset resulting in a lower depreciation charge over the asset life Under the deferred income approach, if the grant is to buy freehold land which is not depreciated, the grant credit remains in deferred income until the land is sold and is then an adjustment to the net profit or loss on disposal. Non-cash grants (e.g. long leasehold interests at peppercorn rent) Include in balance sheet at fair value, with a corresponding credit shown as deferred income Government grants should be recognised in the income statement so as to match them with the expenditure towards which they are intended to contribute. A grant should not be recognised until the conditions for its receipt have been complied with and there is reasonable assurance that it will be received Repayment of grant A grant that becomes repayable is treated as a revision to an accounting estimate (as described in IAS 8). This means that the grant reversal is accounted for in the period and not treated as a prior year adjustment or directly posted to equity. A liability for potential repayment of a grant should be recognised, if it is probable that repayment will be made Application guidance Example: Fixed asset grant A grant of 400,000 is received towards the setting up of a central kitchen. The equipment is expected to last for six years. All the conditions for the grant have been complied with. The grant is taxable on receipt. The tax treatment of the grant is irrelevant for accounting purposes. The gross receipt must be credited to deferred income and released to the income statement over six years, the expected useful life of the equipment concerned.

210 Government grants, page 3 of 3 24 Examples: Other grants 1 Relocation expenses A grant is received towards relocation expenses. All the conditions for the grant have been complied with. The grant should be credited to the income statement in the same period as the relocation expenses. 2 Property tax rebate A rebate of 90% of local property taxes is made for nine months on the move to new premises. All the conditions for the rebate have been complied with. The benefit of the reduced property taxes should be recognised in the income statement in the period to which it relates. 3a 3b Job creation grant A grant of 2m is received on condition that 200 new jobs are created in a district over two years. Forecasts predict that more than 230 new jobs will be created by that time. The grant should be matched with the cost of creating and maintaining the jobs (which is likely to be more at the start) and not simply evenly spread over the period. After one year, it is forecast that only 165 new jobs will be created. If this happens, the whole grant will have to be repaid. A liability should be recorded for the likely repayment of the grant.

211 25. Accounting convention and basis of consolidation Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Group reporting must be under uniform accounting policies. Subsidiaries that close their ledgers early in order to comply with the Group s reporting timetable must make appropriate adjustments to roll forward their results and balance sheets to the Group s reporting date. The Group has chosen to account for all joint ventures using the proportionate consolidation method. The share of an associate s profit after tax is shown on the face of the income statement as a separate line item, and the tax is not separately disclosed. Minority interests are presented in the consolidated balance sheet within equity separately from the parent shareholders equity. The minority share of profit or loss is disclosed as an allocation of retained profit Disclosed accounting policy Accounting convention and basis of preparation The financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) and International Financial Reporting Interpretations Committee ( IFRIC ) interpretations as adopted by the European Union that are effective for the year ended 30 September They have been prepared under the historical cost convention as modified by the revaluation of certain financial instruments. Basis of consolidation The consolidated financial statements consist of the financial statements of the Company, entities controlled by the Company (its subsidiaries) and the Group s share of interests in joint ventures and associates made up to 30 September each year Default policy and process for exceptions Default policy All subsidiaries should prepare their Group reporting under the historical cost convention - that is, all items are recorded at their historical monetary cost/income to the Group and are not revalued to reflect price changes. All Group reporting is in accordance with IFRS. In addition, the following should be adhered to: Wherever possible, the financial year of each subsidiary should be the same as Compass s year-end (30 September). Subsidiaries must notify and seek authorisation for any exceptions to a 30 September year-end from the Group Financial Controller. Subsidiaries that close their ledgers early in order to comply with the Group s reporting timetable must make appropriate adjustments to roll forward their results and balance sheets to the Group s reporting date. This applies to all reporting dates.

212 Accounting convention and basis of consolidation, page 2 of 3 25 Group reporting must be under uniform accounting policies. The carrying amount of the parent s investment in each subsidiary and the parent s portion of equity of each subsidiary are eliminated. Minority interests in the profit or loss and net assets are separately identified. In addition, minority interests in the net assets are identified separately from the parent shareholders equity. Where potential voting rights exist, minority interests are determined on the basis of present ownership interests and do not reflect the possible exercise or conversion of potential voting rights. The minority share in an entity with net liabilities is not recognised except to the extent that the minority has a binding obligation and is able to make an additional investment to cover the losses. All intra-group balances, turnover and costs must be eliminated in preparing the consolidated accounts. On consolidation, where there is a balance between a Group subsidiary and an entity that is proportionally consolidated, the share of the balance that is within the Group must be eliminated and any remaining balance shown as being with the other party to the joint venture. Balances with associates are not eliminated but are shown in the appropriate classification in the balance sheet. Deferred tax must be considered on consolidation adjustments Consultation and authorisation process for exceptions The exclusion of any subsidiary from consolidation requires the written authorisation of the Group Financial Controller IFRS references IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Presentation IAS 39 Financial Instruments: Recognition and Measurement IFRS 7 Financial Instruments: Disclosure SIC 12 Consolidation - Special Purpose Entities 25.4 Summary of IFRS requirements The purpose of consolidated financial statements is to provide financial information about the economic activities of a group. A group is defined as a parent and all its subsidiaries Minority interests Minority interests should be reported in total in the consolidated balance sheet, separately from the parent shareholders equity. The profit or loss is attributed to the parent shareholders and minority interests. When an entity becomes a subsidiary undertaking the assets and liabilities attributable to its minority interest should be included on the same basis as those attributable to the interest held by the parent and other subsidiary undertakings. The effect of this for an acquisition is that all the subsidiary

213 Accounting convention and basis of consolidation, page 3 of 3 25 undertaking's identifiable assets and liabilities are included at fair value. No goodwill should be attributed to the minority interest Intra-group transactions Intra-group transactions may result in profits or losses being included in the book value of assets to be included in the consolidation. IFRS requires the elimination in full of any such profits or losses because, for the group as a whole, no profits or losses have arisen Consistency between parent and subsidiary undertakings Uniform group accounting policies should be used in preparing the consolidated financial statements. The financial statements of all subsidiary undertakings to be used in preparing consolidated financial statements should have the same financial year-end and be for the same accounting period as those of the parent undertaking of the group. When the reporting dates of the parent and a subsidiary are different, the subsidiary prepares, for consolidation purposes, additional financial statements as of the same date as the financial statements of the parent. In any case, the difference between the reporting date of the subsidiary and that of the parent shall be no more than three months. The length of the reporting periods and any difference in the reporting dates shall be the same from period to period Changes in membership of a group Changes in membership of a group occur on the date control passes (see policy on Acquisition Accounting and fair value adjustments), whether by a transaction or other event Acquisition of a subsidiary undertaking When a subsidiary undertaking is acquired, its identifiable assets and liabilities are brought into the consolidation at their fair values at the date that undertaking becomes a subsidiary undertaking, even if the acquisition has been made in stages. See the policy on Acquisition accounting and fair value adjustments for more information.

214 26. Acquisition accounting and fair value adjustments Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Key changes made to version 2.1 (Applicable for acquisitions made on or after 1 st October 2009) ALL acquisition costs must be written-off to the income statement in the period in which they are incurred and are prohibited from being included in the goodwill calculation. Changes in fair value of equity stakes in the acquired business, up to the date that control passes and the business becomes a subsidiary, are taken to the income statement (previously taken to the revaluation reserve). Minority interests in the acquired business may be valued at either fair value (i.e. full market price), or as the minority interest s share of the fair value of the recognised and identifiable assets and liabilities of the business. The former option would usually lead to a higher goodwill figure being recognised and therefore a potentially higher impairment charge. Consideration is measured at fair value at the date of acquisition. Changes in the value of consideration from events after the date of acquisition are recognised in the income statement. Changes in the value of consideration arising from additional information about facts at the acquisition date are recognised against goodwill, but only within a twelve month period after the acquisition. Changes to minority interest where the business remains a subsidiary are now considered as being transactions between shareholders. Differences arising, which would previously have given rise to goodwill or a profit or loss on disposal, are now taken directly to equity. However transactions that involve a gain or loss of control (e.g. subsidiary becomes an associate or investment) will still give rise to a profit or loss on disposal in the income statement. The reliably measurable criteria have been removed when identifying fair value intangibles potentially increasing the assets that should be recognised during this exercise. Intangible assets must still be identifiable i.e. either separable or arising from a contractual or legal right. Contingent liabilities are only recognised where there is a present obligation at the time of acquisition and the fair value of that obligation can be reliably measured. Possible obligations (i.e. liabilities that may arise because of the occurrence or non-occurrence of a future event) at the time of acquisition cannot be included. Key points Fair value adjustments arising on acquisitions must be appropriate and justifiable by reference to IFRS, and allocated to specific items in existence at the date of acquisition. Fair value adjustments must apply to the circumstances in existence at the date of acquisition. They must not take account of any reorganisation plans the Group has, nor may they be utilised for items they were not originally intended to cover. Intangible assets acquired through a business combination must be identified and recognised on the balance sheet. This will have implications on the post-

215 Acquisition accounting and fair value adjustments, page 2 of acquisition profits and must be evaluated before the acquisition is approved. Goodwill is subject to an annual impairment review. Negative goodwill is taken as income during the period that the acquisition takes place. A value must be attributed to the contingent liabilities of the acquired business and included in its balance sheet and in the calculation of goodwill. Fair value adjustments may only be revised during the hindsight period that extends to twelve calendar months following the date of acquisition. Every effort should be made to record adjustments to fair value during the hindsight period. Changes made within the hindsight period which straddles a year-end, are shown by restating the comparatives and brought forward balances. Therefore it is essential that the initial fair values are as accurate as possible. Fair value adjustments that come to light after the hindsight period must be taken to the income statement. Any fair value adjustments that are not utilised or considered no longer appropriate after the hindsight period has expired are adjusted through the income statement and should be separately disclosed within operating profit if material. Where an acquisition is carried out in several stages, goodwill must now be calculated at each transaction date until control passes. At this point, the change of control is recorded as the disposal of an Associate (or investment) and the acquisition of a subsidiary. Records must be kept of fair values at each stage Disclosed accounting policy The acquisition of subsidiaries is accounted for using the purchase method. The cost of acquisition is measured at the aggregate of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed are recognised at the fair values at the acquisition date, except for noncurrent assets (or disposal groups) that are classified as held for sale which are recognised and measured at fair value less costs to sell. The cost of the acquisition over the Group s interest in the net fair value of the identifiable net assets acquired is recorded as goodwill. If the cost of the acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement Default policy and process for exceptions Default policy When a new subsidiary undertaking is purchased, the date of acquisition is the date on which control of the acquired company passes to the Group. Any profits earned by the subsidiary prior to the date of acquisition are included in the value of the net assets acquired and only income and expenditure arising after the date of acquisition is included in the consolidated income statement. At the date of acquisition, the Group should assess the fair value of assets and liabilities acquired, including intangible assets and contingent liabilities, at that date and compare the net asset value acquired to the fair value of consideration paid. The difference should be recorded as goodwill (see policy on Goodwill).

216 Acquisition accounting and fair value adjustments, page 3 of The Group Approvals Manual must be followed for all acquisitions and the appropriate authorisations gained before the acquisition proceeds Consultation and authorisation process for exceptions Exceptions to the rules on acquisition and fair value accounting would be extremely unlikely. In cases where further clarification is required, or the acquisition is complex in nature, Group Finance, Chertsey should be consulted IFRS references IFRS 3 Business combinations [2008 revision] IAS 27 Consolidated and separate financial statements IAS 38 Intangible assets 26.4 Summary of IFRS requirements Accounting for acquisitions The identifiable assets and liabilities of companies acquired should be included at their fair value at the date of acquisition. These include intangible assets not previously recognised on the balance sheet of the acquired entity and a valuation of contingent liabilities. The results and cash flows of the acquired companies should be brought into the group accounts from the date of acquisition only. The difference between the fair value of the net identifiable assets acquired and the fair value of the purchase consideration is classified as goodwill (see separate policy on Goodwill) Fair value of identifiable assets and liabilities Fair value adjustments are applied to the book value of the assets and liabilities acquired in order to arrive at their fair value to the Group. Fair value adjustments arise from either accounting policy realignments to bring those of the acquired entity into line with Group policy, or revaluations of the acquired assets or liabilities at the date of acquisition. Fair value adjustments must follow these rules: Only conditions that exist at the acquisition date can be taken into account. Fair value adjustments must not reflect the Group s intentions to reorganise the acquired entity and the costs involved in that reorganisation. Fair value adjustments cannot reflect impairments that may arise from the Group s intention to reorganise the acquired entity. See policy on Impairment (27.5.2) for special rules regarding newly acquired entities and impairment testing. Fair value adjustments cannot be made for future operating losses. Fair values should be based on the value at which an asset or liability could be exchanged in an arm's length transaction. The identification and valuation of assets and liabilities acquired should be completed, if possible, by the date on which the directors approve the first

217 Acquisition accounting and fair value adjustments, page 4 of post-acquisition financial statements of the acquirer. Any provisional valuation of assets and liabilities must be finalised within twelve months of the acquisition. Thereafter, the values assigned to the assets and liabilities acquired cannot be amended as a result of a change in accounting estimate. Any differences between the fair value of the assets and liabilities recognised during the hindsight period and the final values that come to light at a later date must be accounted for under the normal IFRS rules as set out elsewhere in this manual. Any change to the provisional values used in the first post-acquisition financial statements within the twelve-month hindsight period must be accounted for as though it was present at the time of the acquisition. Therefore comparatives must be restated including amortisation and depreciation charges recognised in the previous period(s). Appropriate bases for fair values are as summarised below. Application guidance is provided in section Asset/liability Intangible assets Tangible fixed assets Inventories Other inventories Quoted investments Monetary assets and liabilities Other financial instruments including derivatives Contingent liabilities Business sold or held exclusively with a view to subsequent resale Appropriate fair value basis Fair value is based upon market value if an active market exists or a valuation, taking into account the probability of the cash flows arising, of what a willing third party would pay for the asset in an arms length transaction. The intangible will form part of goodwill if it is not identifiable (i.e. fails the separable or contract-legal tests). The reliably measurable test is no longer required as it is assumed any identifiable intangible can also be measured. Current market values of similar assets if available and for assets such as plant and machinery, fair value is the gross replacement cost less depreciation to date. Where the acquired entity trades on a market as both a buyer and a seller, they should be valued at current market prices. Valued at the lower of replacement cost by the acquired entity and net realisable value. Valued at market price, adjusted if necessary for unusual price fluctuations or for the size of the holding. Fair value should take into account amounts expected to be received or paid and their timing and should be determined by reference to market prices, where available. Fair value with reference to market prices or the indices the derivative is linked to. Financial instruments may subsequently be measured at amortised cost or fair value depending upon their categorisation (see Financial instruments). Should be measured at fair values where these can be determined, for which reasonable estimates of the expected outcome may be used. The obligation must exist at the time of the acquisition (i.e. be a present obligation), and not be contingent upon the occurrence or non-occurrence of a future event. Where the interest in a clearly distinguishable part or the whole of the acquired entity is sold as a single unit within approximately one year of the date of acquisition, the investment in that business should be treated as a single asset for the purposes of determining fair values. If the business is not sold within a year of acquisition, it should be consolidated normally with individual fair values for assets and liabilities attributed. (See Non-current assets held for sale and discontinued operations).

218 Acquisition accounting and fair value adjustments, page 5 of Pensions and other postretirement benefits Deferred taxation Fair value of a deficit of a funded pension or other postretirement benefits scheme, or accrued obligations in an unfunded scheme, should be recognised as a liability of the acquiring group and any changes following the acquisition should be dealt with as post acquisition. An asset can only be recognised to the extent of any refund available, or any reduction in future contributions (See Pensions and longterm employee benefits) Adjustments to record assets and liabilities of the acquired entity at their fair values are treated in the same way as they would be if they were timing differences arising in the entity s own accounts. Deferred tax Where a deferred tax asset is recognised in a subsequent period that did not meet the recognition criteria either initially or during the hindsight period as being present at the time of acquisition, the income is taken through the tax charge in the income statement. Intangible assets All intangibles acquired with a business must be recognised as part of the assets acquired if they are identifiable. An intangible asset meets the identification criteria of IAS 38 only if it is separable (i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged either individually or together with a related contract, asset or liability) or arises from contractual or other legal rights. The fair value must be calculated with reference to market expectations of the economic benefit that will flow from the asset taking into account different probabilities of these flows. IFRS 3 (2008) removes the requirement for the intangible to be reliably measured as it assumes that any identifiable intangible must be capable of reliable measurement. There is an expectation in IFRS that many intangible assets will be capable of recognition and measurement in a business combination. A group of intangibles may be pooled together as a single intangible asset where they are not separable. Goodwill is the residual asset remaining after all other intangibles have been identified. See the Group policies on Goodwill and Intangible Assets for more details on the treatment of these assets Fair value of cost of acquisition The cost of acquisition is the amount of cash or cash equivalents paid for which fair value is readily ascertainable. It may also include non-monetary items for which the fair value would be market prices or independent valuations. Any deferred cash consideration should be discounted to its present value where the difference is material. Where capital instruments (such as shares) comprise part of the consideration, the market price on the date of acquisition is the most reliable measure for fair value. If there is contingent consideration which is dependent on future uncertain events and consequently a precise value cannot be determined at the date of acquisition, a reasonable estimate of fair value should be used.

219 Acquisition accounting and fair value adjustments, page 6 of In future periods when those events take place and the outcome is known, the difference must be taken to the income statement (the original consideration and therefore goodwill must not be changed for events that occur after the date of acquisition). Where after the date of acquisition, more facts become known about conditions present at the time of acquisition, the estimate of contingent consideration (and therefore goodwill) can be altered as long as this is within twelve months of the date of the acquisition (the measurement period). Acquisition costs such as advisory, legal, accounting and other professional fees that are incremental to the acquisition must be written off to the income statement in the period in which the acquisition occurs. This is one of the key changes introduced by IFRS 3 (2008) as previously these costs could be included in the consideration paid and therefore goodwill. Acquisition costs, as defined above, are recorded in the financial year in which the related services are performed, which may not necessarily be the same financial year as that in which the acquisition is recorded Changes in stake Where an undertaking is acquired in stages, the fair value of the net assets and consideration must be included in the calculation of goodwill at each transaction date. This applies up to the point when control passes and the acquired entity becomes a subsidiary. The change in the fair value of the net assets between each stage that is attributable to the Group should be taken to the income statement as either a gain or loss and the value of goodwill recognised is amended accordingly. Where the Group increases its stake in an existing subsidiary, the assets and liabilities should not be revalued to the fair value at the date of the transaction. Goodwill is NOT adjusted; instead the difference between the change in the minority interest and the consideration paid (or the proceeds received) is taken to equity. Further guidance in both these areas, if required, should be sought from Group Finance, Chertsey. This is one of the key changes introduced by IFRS 3 (2008) as previously either goodwill (in the case of a minority interest buyout above book value) or a profit or loss on disposal (in the case of a disposal where the business still remained a subsidiary) would have been created. Changes in stake where there is a change in control (i.e. a subsidiary is created or removed) still result in either goodwill or a profit or loss on disposal in the income statement Minority interests (now known as Non-controlling interests ) Minority interests should be reported separately on consolidation showing the extent to which the assets/liabilities and profit/loss of the subsidiary are attributable to shareholders other than those of the parent entity. Under IFRS minority interests are now treated as part of equity and the retained profit or loss for the subsidiary attributable to the minority interest is treated as an allocation of retained earnings. IFRS 3 (2008) now allows two methods of determining the original minority interest upon acquisition; % of identifiable net assets: the existing method whereby the minority interest liability recognised is the equivalent to the minority s percentage ownership of the net assets of the subsidiary.

220 Acquisition accounting and fair value adjustments, page 7 of Full fair value method: the minority interest is calculated as the minority s percentage ownership applied to the full fair (market) value of the subsidiary. This will generally lead to a higher value for the minority, and therefore greater goodwill. There is no requirement for the Group to consistently use the same method to calculate goodwill for all acquisitions, therefore approval should be sought from Group Finance, Chertsey as to which method to use. Once the minority interest is initially established any changes in stake do not lead to an adjustment to goodwill or recognition of a profit or loss on disposal, as long as the business remains as a subsidiary after the transaction. All adjustments due to changes in stake are taken through equity as transactions between shareholders. If a subsidiary with a minority interest is loss making, the losses should be attributed to the minority interest up to the point at which this would create a debit balance for the minority interest in equity. Losses in the subsidiary above this level must be born entirely by the parent because IFRS does not allow a debit balance for minority interests. The only exception to this rule is where there exists a binding obligation on the minority partners to cover the losses, and an ability to do so Change of control The date on which a company joins or ceases to be part of the group is the date on which control passes. It cannot be backdated or anticipated. Examples of dates when control passes are set out below: Situation where control changes Public offering / private treaty Issue or cancellation of shares Changes in rights or changes in a stake held by a third party Date of control Date when unconditional offer is accepted Date of issue or cancellation of shares Date from which new rights are applicable or new shares issued The date consideration passes is not conclusive evidence of the date of change of control. A parent company may lose control of a subsidiary due to changes in the rights it holds or those held by another party. Any gain or loss arising as a result of a deemed disposal, should be recognised within profit or loss. The undertaking should cease to be consolidated but should be shown as an associated undertaking or investment in the future Internal acquisitions and reorganisations The principle of group accounting is that the Group is treated as a single entity, and therefore there is no need to carry out a fair value exercise for Group reporting purposes in circumstances where one Group entity acquires another within the Group. Internally generated goodwill may arise in the course of these transactions but this will always be eliminated as part of the consolidation process. Guidance should be sought from Group Finance, Chertsey, in the event of a complex internal reorganisation.

221 Acquisition accounting and fair value adjustments, page 8 of Application guidance Purchase consideration The following table sets out the basis by which the fair value of purchase consideration should be evaluated: Consideration given Cash and other monetary consideration Capital instruments - quoted on a ready market Capital instruments - unquoted Fair value basis The amount paid or payable in respect of the item. When settlement of cash consideration is deferred, fair values are obtained by discounting the expected cash flows to their present values (using the rate at which the acquirer could obtain a similar borrowing). The market price of the security on the date of acquisition. Estimated by reference to items such as the value of similar securities that are quoted, the present value of the future cash flows of the instrument issued, any cash alternative to the issue of securities and the value of any underlying security into which there is an option to convert. Where shares or debt are issued as part of the consideration these should be adjusted to fair value at the date of acquisition (usually by reference to market value). Non-monetary consideration Estimated by reference to market prices, estimated realisable values, independent valuations or other available evidence. Acquisition agreements may require payments to be made in various forms, e.g. as non-competition payments or as bonuses to the vendors who continue to work for the acquired company. In such circumstances, it is necessary to determine whether the substance of the agreement is payment for the business acquired or an expense such as compensation for services or profit sharing. If the former, the payments would be accounted for as purchase consideration; if the latter, the payments would be treated as expenses of the period to which they relate (see the examples in section below) Deferred and contingent consideration The acquisition agreement may provide for part of the purchase consideration to be deferred to a future date (deferred consideration) or to be contingent upon the occurrence of some future event (contingent consideration). Purchase consideration should include the fair value of deferred consideration, arrived at after discounting (if this has a material effect) the estimated cash flows to their present values using the rate at which the acquirer could obtain a similar borrowing. The fair value of consideration used to calculate goodwill, should include an estimate of any contingent consideration payable which is not revised as the exact amounts become known. Any differences arising between this estimate of contingent consideration and the actual payments made must be taken to the income statement. The only exception to this rule is if the difference arises because further facts become known about circumstances existing at the time of the acquisition. Even in this case an adjustment to

222 Acquisition accounting and fair value adjustments, page 9 of the consideration figure can only be made within twelve months of the acquisition date. Example; contingent consideration Under the terms of a business combination a contingent consideration is agreed, payable in 3 years from the date of acquisition dependant upon the level of profits made by the acquired business. At the date of acquisition the profits and expected consideration payments are; Cumulative profit < 300m > 700m Probability 25% 60% 10% 5% Cash payment Nil 30m 60m 100m The fair value of the contingent consideration is 29m (being the weighted average of the above). (Under the previous IFRS 3 rules the contingent consideration would have been recognised if the result was probable and could be measured reliably. This would have resulted in a contingent consideration of 30m.) One year later the profits are assessed as being; Cumulative profit < 300m > 700m Probability 15% 15% 60% 10% Cash payment Nil 30m 60m 100m The fair value of the contingent consideration is now 50.5m (being the weighted average of the above) and the change of 21.5m is recognised in the income statement because the change in value is due to a change of circumstances arising after the acquisition date. (Under the previous IFRS 3 rules the contingent consideration would now be revised to 60m and the difference of 30m would be taken to goodwill.) Examples: contingent consideration or post acquisition expense 1 A business is acquired, and as part of the transaction it is contracted that the Group will pay the former owners a certain percentage of operating profits over the next three years. An estimate at the time of acquisition based on the acquired business s forecasts for the next three years should be made of the operating profits and therefore the level of contingent consideration to be paid. This should be discounted if material and this amount included within the consideration figure used to calculate goodwill. A liability for the contingent consideration should be shown in creditors (as deferred consideration). Over the next three years any difference between the amount provided and actually paid must be shown in the income statement. 2 As above, though the former owners form part of the management of the acquired business. The terms of the sale agreement make it clear that the payments to the former owners are regardless of whether they remain employees of the business. Treat the payments as contingent consideration and account for as above. 3 As above, although the terms of the sale agreement state that if one of the former owners leaves the employment of the business within three years the contingent consideration payments to that person cease. The payments are in substance a profit sharing arrangement and should be charged to the post-acquisition income statement as operating costs, not taken to goodwill on acquisition. (In practice there are likely to be other factors that also must be considered before a conclusion can be reached on the correct accounting treatment.)

223 Acquisition accounting and fair value adjustments, page 10 of Date of control The date on which a company joins or ceases to be part of the group is the date on which control passes and cannot be backdated or anticipated. Example: Date of control A Group entity is in discussions with a private company with a view to acquiring it. Negotiations are progressing well, and heads of terms have been signed. An acquisition agreement is signed on 15 September, which states that, subject to due diligence procedures being updated satisfactorily, an agreed timetable will be followed until completion on 30 November. The Group will acquire the shares of the private company on 30 November and the agreement does not give it any rights of control before the acquisition is completed. At the Group's year-end of 30 September, relations with the target company are very good. A Group representative is invited to attend its board meetings and the Group receives its monthly management accounts. The Group should not consolidate the target at 30 September, as control has not passed. The Group does not legally own any shares in the entity or have any formal, enforceable powers over it. The fact that the acquisition is proceeding on an agreed timetable and that relations are good do not constitute control. Where the date of control differs from the date that economic benefit from the acquired business is obtained, the date that control passes is the date of acquisition. The acquisition balance sheet should be drawn up to this date and the economic benefit derived from an earlier date should be treated as an adjustment to the purchase price Acquisition costs Acquisition costs must be expensed in the period of the acquisition and cannot be included within the calculation of goodwill. Examples: Acquisition costs 1 30,000 of third party due diligence costs is incurred with an accountancy firm and 20,000 of legal costs is incurred with lawyers during an acquisition process. 50,000 of acquisition costs must be written off to the income statement in the period the acquisition occurs in. 2 Management working on an overseas acquisition incur 10,000 of expenses travelling to the target s head office for due diligence work and negotiations. Management working on the acquisition at their normal office location incurred 5,000 of expenses and overheads. 10,000 of expenses must be written off to the income statement in the period in which the acquisition occurs. The 5,000 of expenses and overheads should be expensed to the income statement in the period they are incurred, as these costs would have been incurred irrespective of the acquisition. 3 As part of the acquisition business case, management decide to reorganise the acquired company and incur post-acquisition reorganisation costs of 100,000. These costs do not form part of the acquisition cost and should be expensed to the income statement as incurred. A provision cannot be set-up as part of the fair value exercise when determining the business s acquired net assets for this reorganisation Fair value adjustments When considering fair value adjustments special rules exist that may allow adjustments to be made that do not conform to the policies set out elsewhere in this manual. This is because the rationale behind acquisition accounting is based on identifying the fair value of all identifiable assets and liabilities present at the date of acquisition. This can lead to differences

224 Acquisition accounting and fair value adjustments, page 11 of with normal accounting policies. Fair values are determined usually by reference to market values so that the post acquisition performance of the entity acquired is more accurately reported in the Group accounts. Areas where this rationale gives rise to differences with the policies set out elsewhere in this manual are: Contingent liabilities: these should be recognised based upon a reasonable estimate of the expected outcome. Please note this differs from the Group policies set out in policy Provisions and Contingent Liabilities, where contingent liabilities are not recognised and only disclosed. Only contingent liabilities with a present obligation at the time of the acquisition should be recognised those where the obligation will only arise because of the occurrence or non-occurrence of a future event should not be recognised. Onerous and uncompetitive contracts (for example rent, client or supplier contracts): where these existed prior to the acquisition and the contractual terms were onerous (i.e. loss making) or uncompetitive when compared to market prices at the date of acquisition, an onerous contract provision should be made. This differs from the definition of onerous contracts applied in the policy Provisions and Contingent Liabilities where only onerous lossmaking contracts can be provided for. Intangible assets: the reliably measurable test does not apply to intangible assets recognised as part of the fair value process. Therefore intangible assets need only be identifiable (either because they are separable or because they arise through a legal or contractual commitment). IFRS 3 (2008) assumes all identifiable intangible assets can be assigned a fair value. Examples: Onerous contracts on acquisition 1 The acquired company has a contract for the supply of materials at significantly uncompetitive rates which existed at the time of acquisition and which cannot be renegotiated or terminated. Provide for the obligation as part of the fair value adjustments. 2 The acquired company has a contract for the supply of materials at significantly uncompetitive rates, which is negotiated during the acquisition and signed after the date that control passes. No liability should be recorded as part of the fair value adjustments as no commitment exists at the date of acquisition. 3 Upon acquisition of a catering company, one of the contracts has a current operating loss of 200,000 per annum. There is one year to run before it is available for renegotiation or termination, and there are no operational means to reduce this loss. Provide 200,000 for the onerous contract as a fair value adjustment upon acquisition.

225 Acquisition accounting and fair value adjustments, page 12 of Examples: Onerous contracts on acquisition 4 A company is acquired that has an existing contract to provide catering services to 50 outlets. The structure of the agreement is such that there is one contract with the customer covering all 50 outlets. A number of the sites are loss making at the date of acquisition, although the contract overall is profitable. There is no significant difference between profitability of the contract and market rate of the contract at the date of acquisition An onerous contract provision should not be recorded as part of the fair value adjustments as the overall contract is profitable. 5 A company is acquired that has an existing relationship to provide catering on railway stations throughout the country. As part of the agreement, catering is provided both at profitable city centre stations and at more remote locations, some of which are not be profitable due to the volume of passenger traffic. A number of contracts exist between the acquired company and their railway customer to cover each region of the country. Two of the contracts are not profitable due to the stations included within those agreements. An onerous contract provision should not be recorded as part of the fair value adjustments under these circumstances as overall the contracts with the client are profitable. As part of winning the portfolio of contracts with the railway network and operating the more lucrative city centre stations, the company was required to serve the less profitable stations and hence the client relationship should be considered overall when assessing whether an onerous contract provision is required upon acquisition. This is an example of the commercial substance of the client relationship overriding the legal form of the contracts. 6 A business is acquired with a workforce that is overstaffed at the time of acquisition. The Group intends to reduce the number of staff. In this case an onerous contract fair value adjustment cannot be created because the decision to reduce staff costs is a result of the acquirer s intentions to re-organise the business. Pensions: where a funded defined benefit scheme is acquired the value of any deficit as determined by an actuary of the scheme should be recognised. The accrued liability of any unfunded scheme should be recognised as a fair value adjustment to the net assets acquired to the extent it is not already recognised in the entity s books. An asset can only be recognised to the extent that a refund will be received from the scheme, or future contributions will be reduced. (see Pensions and long term employee benefits). Property, plant and equipment: these assets should be adjusted to the lower of depreciated replacement cost (reflecting the acquired business s normal purchasing position for an asset in similar condition) or its recoverable amount. Recoverable amount is effectively market value. Therefore the fair value of acquired property, plant and equipment is likely to be the lower of either market value or the price which the acquired business could purchase a similar asset for. Monetary assets and liabilities: fair value adjustments should be based on the actual cash flows expected to arise. This is often equivalent to the market price at which the asset or liability could be separately acquired. For instance fixed rate debt may be adjusted for the current market price of equivalent debt to reflect any change in interest rates.

226 Acquisition accounting and fair value adjustments, page 13 of Other financial instruments (including derivatives): fair value based upon market value or where no market value exists, with reference to present values or indices linked to the instrument. Inventories: these should be valued at the lower of replacement cost or net realisable value to the acquired company. The acquired entity s obsolescence policy should be compared to the Group s and an accounting policy fair value adjustment recorded if different. Part of the acquired business is held for resale: the value assigned to this should be the net proceeds from the resale (estimated if the resale proceeds are not known). Therefore the net assets of the business held for resale are shown at net realisable value in current asset investments. Effectively any gain or loss on the sale of the business held for resale is recognised as an adjustment to goodwill acquired as opposed to the income statement. The results of a business held for resale do not form part of the Group s results and do not form part of the consolidation. An operation should not be treated as held for resale and valued at estimated sales proceeds unless: A purchaser has been identified or is being sought; and The disposal is reasonably expected to occur within approximately one year of the date of the acquisition. Deferred Tax: where unrecognised tax losses exist in the acquired entity, and the act of the acquisition makes it likely that future taxable profits will now arise in the entity against which these losses can be utilised, the deferred tax asset should be recognised as a fair value adjustment. If an acquisition results in the acquiring entity being able to use tax losses which previously it was not able to, this benefit is recognised in the income statement rather than goodwill. Restructuring and closure of operations: If the acquired entity was demonstrably committed (see Provisions and Contingent Liabilities) to restructuring or closure of an operation at the date of acquisition, then any provisions arising as a result of the reconstruction or closure should be regarded as pre-acquisition and treated as identifiable liabilities. All other reorganisation costs should be charged in the post-acquisition income statement of the combined entity. Contingent assets are not recognised on acquisition Where the seller provides warranties against potential liabilities of the acquired entity, these liabilities should not be provided for through a fair value adjustment as well. If during the hindsight period it becomes probable that the potential liability will arise and that there is a shortfall between the liability and the amount covered by the warranty, then a fair value adjustment should be made to cover the shortfall. If the liability arises after the hindsight period then any shortfall must be charged to the income statement.

227 Acquisition accounting and fair value adjustments, page 14 of Intangible assets IFRS requires that intangible assets are identified and recognised on the balance sheet of the acquired business as part of the acquired net assets. There is an expectation that a fair value can be arrived at for virtually all intangibles either by reference to market value where an active market exists for the intangible, or by valuation techniques that take into account the probability of the economic benefits accruing from the intangible. The Group policy on Intangible assets contains more information on recognition and treatment of intangibles. Goodwill is therefore the residual value inherent in the business made up of elements such as: reputation, synergies, business culture, human capital and other intangibles that cannot be assigned a fair value. Some examples of intangible assets are listed below: Intangible asset Trademarks (brands) Non-competition agreements Client contracts Customer databases Licensing and royalty agreements Purchasing agreements Lease agreements Basis of valuation Trademarks and trade names with a value due to their reputation and following. Trademarks and trade names are an element of a brand with other components of the brand (such as recipes/technologies, etc) valued separately if possible. These components may be grouped under the asset heading brands if they cannot be fair valued separately. A brand will only have significant value where a price premium can be demonstrated. The fair value of the extra profits that accrue from the agreements compared to current market prices. The value assigned to existing contracts acquired is the discounted cash flow derived from the contract over the contract term after incorporating; all operating costs such as unit labour and overheads. a reasonable charge made for support services such as management, HR and IT whether or not these costs are incremental to the Group cost of goods sold should be priced at the market cost for such goods that the contract as a stand alone activity could negotiate (i.e. additional purchasing income or discounts generated by the Group s size should be ignored). Deducting the cost of contributory assets such as kitchens. The costs recognised against the contract income should be adjusted to reflect what the contract as a stand alone business would be expected to incur. For instance distribution costs may be substantially higher for the standalone contract, than those the Group will incur in operating the contract. The value that such a database contains from the marketing information available. The value of the discounted cash inflows from granting these agreements. The value of any discounts negotiated within the purchasing contracts. The value attributable to the leasing costs (or incomes) when compared to market values for similar assets. Lease prepayment or deferred income in the acquired entities balance sheet is not recognised and instead an intangible asset or separate liability is recognised where appropriate.

228 Acquisition accounting and fair value adjustments, page 15 of Franchise agreements Employment contract Technology/IT systems Trade secrets The fair value of any franchise agreements the acquired business is party to, compared to profits from operating similar non-franchised sites. Any value within existing employment contracts where the market rate for such agreements is higher. The value of bespoke technologies or IT systems developed or owned by the acquired business. This may include ordering systems, supplier or price databases, internal control systems or access to information that creates a commercial advantage. The fair value of any trade secrets such as recipes. Intangible assets will in certain cases require specialist valuation services in order to arrive at an acceptable fair value. Therefore the costs associated with an acquisition will increase. Where they have a finite life span they will also be written off over their expected useful economic lives, which will impact post-acquisition profits. Therefore any proposed acquisitions will now require careful analysis of the types of intangibles within the acquired business, the requirement for valuing them, and the affect of amortising them on post acquisition profits. This evaluation must form part of the pre-acquisition work done before the acquisition is approved Hindsight period Fair value adjustments should be made at the time of acquisition, but can be provisional subject to adjustment at any time up to twelve months from the date of the acquisition (the hindsight period ). Changes to fair values adjusted during the hindsight period should be taken to goodwill. Amortisation or depreciation charges should be adjusted as though the revised fair value was recognised at the time of the acquisition. If the adjustment comes to light in the next financial year (but within twelve months of the acquisition) then the comparatives of the previous year, and the brought forward balances in the current year must also be adjusted. Thereafter any adjustments required to the net assets of the acquired entity must be accounted for under the normal rules set out elsewhere in this manual. Example: Hindsight period 1 At acquisition, certain property, plant and equipment relating to one particular contract acquired is identified as being obsolete. An estimate of the recoverable amount of those assets is made and a provisional fair value adjustment is recorded to write them down by 2 million to 3 million. During the next financial year, but within the twelve months following the acquisition, those assets are sold for 3.5 million. As a result of the sale within the hindsight period, it is possible to establish that the fair value of those assets was in fact higher than originally estimated. The value of assets acquired was in fact higher than initially recorded and hence the goodwill was lower. When the assets are sold the following entries should be recorded: Dr Cash Cr property, plant and equipment Cr Goodwill 3.5m 3.0m 0.5m In the comparative figures and brought forwards for the current financial year the goodwill, NBV of property, plant and equipment and depreciation charge must be adjusted to reflect the fair value change.

229 Acquisition accounting and fair value adjustments, page 16 of Fair value adjustments may only be utilised against the specific items they were originally created for. If they are subsequently found to be unnecessary they should be released either against goodwill if within the hindsight period, or to the income statement and separately disclosed, if material, thereafter. Changes to fair value adjustments must only arise because further facts and evidence becomes known about circumstances existing at the date of acquisition. Events or changes in circumstances that occur after the acquisition date do not give rise to changes to fair value adjustments. Changes to fair value adjustments that occur after the twelve month hindsight period, including those to deferred tax, must be taken to the income statement. Example: Subsequent recognition of a deferred tax asset after the hindsight period A business is acquired, with historical tax losses of 10m. However, because there is uncertainty as to when the business will start making a profit and utilise the tax losses a deferred tax asset is not recognised at the time of acquisition. Two years after the acquisition it becomes clear that the business will make a substantial profit allowing the utilisation of the entire tax loss brought forward. The deferred tax asset is recognised with a value of 3m (the tax rate is 30%). Dr Deferred tax asset (balance sheet) 3m Cr Deferred tax (income statement) 3m Changes in stake: investment becoming a subsidiary Stage 1 The Group buys 10% of an unquoted business, and accounts for it as an investment, categorised as held for sale. The book value of the net assets of the business are 5m and the fair value of the net assets is 10m. The Group pays 5m in consideration. The investment is held in the Group balance sheet at 5m. Stage 2 Over the next year the business makes a profit of 10m, increasing the book value of its net assets to 15m. However the fair value of the business s net assets at the end of the year increases by 15m ( 10m from the profit for the year and 5m from other fair value increases) to a total of 25m. The investment in the Group balance sheet still held at 5m because it is unquoted and a fair value cannot be obtained for it. Stage 3 The Group buys a further 50% stake in the business immediately after the year-end for 20m, and now accounts for the business as a subsidiary. The goodwill acquired is made up of; Stage 1; 5m (10% * 10m) = 4m Stage 3; 20m (50% * 25m ) = 7.5m Therefore total goodwill is 11.5m from the acquisition. The Group also recognises a 1.5m in the income statement (10% * 15m increase in the fair value of the net assets of the business). This adjustment represents the increase in the fair value of the acquired business in the intervening time between making the initial acquisition and acquiring control. minority interest of 10m (40% * 25m)

230 Acquisition accounting and fair value adjustments, page 17 of Changes in stake: associate becoming a subsidiary Stage 1 The Group buys 30% of an unquoted business for 5m, and treats it as an associate. The net assets of the business are 5m and the fair value of the net assets was 10m. The associate is held in the Group balance sheet at 5m, made up of; Stage 2 Share of fair value of net assets (30% * 10m) = 3m Goodwill included in associate balance ( 5m - 3m) = 2m Over the next year the business makes a profit of 10m, increasing its net assets to 15m. However the fair value of the associate s net assets at the end of the year increases by 15m ( 10m from the profit for the year and 5m from other fair value increases) to a total of 25m. The associate is shown in the Group balance sheet at 8m (being the 5m initially recognised plus the share of profit for the year of 3m). Stage 3 The Group buys a further 50% stake in the business immediately after the year-end for 20m, and now accounts for the business as a subsidiary. The Group now exercises control over the business which therefore moves from being an associate to a subsidiary. The goodwill acquired is made up of; Stage 1; 5m (30% * 10m) = 2m Stage 3; 20m (50% * 25m ) = 7.5m Therefore total goodwill is 9.5m from the acquisition. In addition A minority interest of 5m is recognised (20% * 25m) A gain is recognised in the income statement of 1.5m ( 5m * 30%) being the uplift in the fair value of the business s net asset attributable to the Group between the time it became an associate to when it became a subsidiary Acquisition of a minority interest The Group purchases the remaining 10% of a minority interest for 3 million. The book value of the net assets of the subsidiary is 5 million, and the fair value is the same. The book entries for the acquisition are: Dr Equity 2.5m Dr Minority interest (balance sheet) 0.5m Cr Consideration 3m Example; changes in stake in an existing subsidiary A Group subsidiary has a 25% minority interest and this liability has a value of 5m. The Group buys out a further 15% of the subsidiary for a cost of 4m. The transaction is recorded as; Cr Cash Dr Minority interest Dr Equity 3m 1m 4m

231 Acquisition accounting and fair value adjustments, page 18 of Reflecting acquisitions in Group reporting Where an acquisition has been made during the year, it will be necessary to produce an acquisition balance sheet for each acquired entity. This information is reported on HFM through the correct completion of the Custom 1 member, which is attached to each balance sheet account. The relevant Custom 1 members are: BSACQ Balance sheet acquired POL Accounting Policy Alignments FVADJ Fair Value adjustments It will often be the case that fair values cannot be reflected in the legal books of the acquired entity because of local statutory demands. Where this is the case the fair value adjustments should be shown in the restatement Custom 3 dimension of the entity (IFRSADJ). Any IFRS adjustments should also be shown within this Custom 3 dimension. The combined legal plus restatement levels should give the IFRS position and results of the entity as required in Group reporting. Ongoing entries in the restatement books will reflect the unwinding of the fair value adjustments in subsequent periods. Where possible, the fair value adjustments should be subsequently recorded into the underlying books of the acquired entity to maintain consistency between local accounting records and the Group position Rules for acquisitions completed before 30 September 2009 IFRS 3 [2004] continues to apply after 1 October 2009 to acquisitions completed on or before 30 September The main differences in the accounting for acquisitions compared to the guidance given above are: Acquisition costs are included within goodwill Minority interests are calculated as a proportion of the fair value of the net assets and liabilities of the acquired business. Revisions to the estimate of any contingent consideration should be taken to goodwill regardless of the length of time after the acquisition that this occurs. Any change in the deferred tax asset or liability recognised as part of the acquisition will be adjusted against the value of goodwill regardless of the length of time after the acquisition that this occurs.

232 27. Impairment of assets Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Assets should be recorded at no more than their recoverable amount. Impairment is measured by comparing the carrying value of an asset or cashgenerating unit with the recoverable amount. The recoverable amount represents the higher of fair value less selling costs and value in use. Impairment losses should be shown in operating profit. Impairment losses are allocated to goodwill first, and then to all other assets pro-rata. Impairment tests must be performed annually for goodwill and intangibles with an indefinite useful economic life, or when an indicator of impairment exists. Where indicators of impairment exist, or an asset is impaired this may also indicate that the useful economic life and residual value of an asset should be reviewed Disclosed accounting policy Goodwill is tested annually for impairment and is carried at cost less any accumulated impairment losses. Goodwill is allocated to cash-generating units for the purpose of impairment testing. A CGU is identified at the lowest aggregation of assets that generate largely independent cash flows, and that which is looked at by management for monitoring and managing the business. This is generally the total business for a country. However, in some instances, where there are distinct separately managed business activities within a country, particularly if they fall within different secondary business segments, the CGU is identified at this lower level. If the recoverable amount of the cash-generating unit is less than the carrying amount, an impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the unit and then to the other assets of the unit pro-rata on the basis of the carrying amount of each asset in the unit. Any impairment is immediately recognised in the income statement and an impairment loss recognised for goodwill is not subsequently reversed Default policy and process for exceptions Default policy Where an asset s carrying value exceeds its recoverable amount (the higher of fair value less selling costs and value in use) the asset is impaired. The value of the impairment should be taken to the income statement, unless the asset impaired has previously been revalued. The write-down of the assets associated with the business should be in the following order: 1. To the goodwill associated with the cash-generating unit. 2. To the other assets of the business on a pro-rata basis (although an individual asset cannot be written-down below its own recoverable amount).

233 Impairment of assets, page 2 of The impairment should be shown within the provision against the asset (i.e. the cumulative amortisation or depreciation provision) and not against the cost of the asset. The income statement charge should be shown in operating profit as either part of the amortisation charge for goodwill and other intangible assets or the depreciation charge on property, plant and equipment as appropriate. Impairment tests on goodwill and intangible assets with unlimited lives must be performed annually by the relevant local finance team. Goodwill impairment tests must be carried out using the Group s standard model and based on Forecast B and budget data Consultation and authorisation process for exceptions Any impairment identified must be notified to the Group Financial Controller. Any proposed exceptions to Group policy should be authorised by the Group Financial Controller IFRS references IAS 36 Impairment of assets IFRIC 10 Interim Financial Reporting and Impairment 27.4 Summary of IFRS requirements Summary Assets should be recorded at no more than their recoverable amount. Impairment is measured by comparing the carrying value of an asset or cash-generating unit with the recoverable amount. The recoverable amount represents the higher of fair value less costs to sell and value in use.

234 Impairment of assets, page 3 of New carrying value lower of : Old carrying value Recoverable amount higher of : Fair value less costs to sell (value if sold) Value in use (present value) Carrying Value Recoverable amount Fair value less costs to sell Value in use Cash-Generating Unit (CGU) The value of the asset (after any amortisation or depreciation) as recorded in the accounts. In the case of a cash-generating unit, the net book value of the net assets and any centrally held goodwill associated with the unit. The higher of fair value less costs to sell and value in use. The value of an asset if sold on an active open market less any direct selling costs. The present value of the future cash flows derived from an asset s continued use, including those resulting from its ultimate disposal. Where it is impractical to test individual assets, cash-generating units are identified and used. The smallest practical grouping of assets, liabilities and income streams that is independent from other cash-generating units in the Group, and of a size where the impairment could be material to the Group Scope Certain types of assets fall outside the scope of impairment testing because they are covered by more explicit rules in other standards. These assets include; Inventories (including balances under long-term project accounting rules). Deferred tax Assets arising from employee benefits (e.g. surpluses on pension schemes) Financial assets Assets held for resale Investments in subsidiaries fall within the scope of impairment testing in the context of an individual entity s statutory accounts but not in relation to Group reporting.

235 Impairment of assets, page 4 of When to test for impairment Goodwill and intangibles with an indefinite useful economic life Perform impairment review: annually; and again, if events or changes in circumstances indicate that the carrying value may not be recoverable in full. Other assets Review for indicators of impairment (see below) annually, and test if any indicators exist Example indicators of impairment The following events and changes in circumstances may indicate impairment of an asset or CGU. Operating losses or net operating cash outflows in the business in which the asset is involved, or an expectation of future operating losses or net operating cash outflows. The total carrying value of the net assets of a listed entity or group exceeds the market capitalisation. A significant decline in the market value of the asset. A significant adverse change in the market or business in which the asset is involved, e.g. entrance of a major new competitor, or an adverse change in the regulatory, technological or statutory environment. Evidence of obsolescence or physical damage to the fixed asset. Management commitment to a major reorganisation affecting the business in which the asset is involved. The loss of key employees affecting the business Calculating impairment IAS 36 recommends the use of estimates of fair value or acceptable shortcuts in order to determine the fair value of an asset. This means that where an active market does not exist for an asset its fair value less selling costs could still be estimated from recent transactions for similar assets. The following circumstances will mean that a value in use calculation would be appropriate: Where the fair value less selling costs of the asset is below the carrying value. Where the fair value cannot be determined reliably for an asset. Where cash flows are not attributable to an individual asset, a cashgenerating unit should be tested using the value in use calculation.

236 Impairment of assets, page 5 of There are three steps to the value in use calculation; 1 Identify Cash- Generating Units 2 Estimated expected future cash flows 3 Determine the appropriate discount rate and discount cash flows Where it is not practicable to identify cash flows for an individual asset, it is necessary to look at groups of assets that make up cash-generating units ( CGUs ). CGUs are identified by dividing the total income of a business into as many independent income streams as possible, such as different branches, groups of assets managed together, or individual subsidiary companies. Central assets and goodwill should be apportioned to individual CGUs on a systematic basis, where possible. If such assets are not apportioned, they must be tested for impairment separately. The expected future cash flows of the CGU, including any allocation of central overheads, but excluding cash flows relating to tax and financing, should be based on reasonable and supportable assumptions. Specifically, cash flows should: Be consistent with up to date budgets and plans that have been formally approved by management; Assume a steady or declining growth rate after 5 years, not exceeding the long-term average growth rate for the country in which the business operates. The discount rate used should be an estimate of the rate that the market would expect on an equally risky investment, calculated on a pre-tax basis. Usually, this is the weighted average cost of capital ( WACC ) of an entity, adjusted for the risk profile of the CGU where appropriate Recognising impairment Impairment losses should be recognised in the income statement, within operating profit. They should be shown within any provisions against the asset (e.g. for amortisation or depreciation), rather than as a deduction from the cost of the asset. In the absence of an obvious impairment of specific assets in a CGU, the impairment should be allocated: First, to any goodwill allocated to the CGU (see application guidance below for the treatment where a minority interest is included in the CGU); Then to the other assets of the CGU on a pro-rata basis. Individual assets cannot be written-down below their recoverable amount (market value or value in use). This could in theory lead to a situation where the entire impairment loss cannot be recognised because the fair value of individual assets in a CGU is greater than the value in use amount. In this situation the carrying value of the assets is held at their fair value and the remainder of the impairment loss is ignored (effectively this substitutes the value in use with the sum of fair values less selling costs) Reversal of a past impairment loss A reversal of previous recognised impairment losses is permitted only in limited circumstances: Impairment losses recorded against goodwill cannot be reversed under any circumstances. Impairment losses recorded against other assets (including intangibles with an indefinite economic life) may be reversed if the recoverable amount (fair

237 Impairment of assets, page 6 of value or value in use) supports the reversal. The method of reversal is set out below; Impaired assets are reviewed annually for indicators of impairment reversal (the opposite of the indicators of impairment, see above). The recoverable amount is then determined and the carrying value written-up to this amount with the credit taken to the income statement. An impairment loss can only be reversed to the extent that the unimpaired asset would now be carried in the accounts, i.e. amortised or depreciated cost. An impairment loss cannot be reversed simply because the passage of time has unwound the discounting effect on future cash flows and this has caused the value in use to increase. The standard states that only an increase in the cash flows, a reduction in discount rate or an increase in the fair value of an asset can lead to a reversal. A goodwill impairment recognised in an interim set of financial statements cannot be reversed if subsequent testing at the full year shows that the asset is no longer impaired. The normal reversal rules outlined above must be followed in this circumstance Application guidance: how to carry out an impairment test The application guidance below follows the steps required for a value in use calculation on a CGU. For Group Reporting purposes impairment testing is carried out at Country level. At the end of this section brief guidance is given where impairment testing is a local requirement. The Group Reporting requirement for impairment testing should not be confused with the following situations; Write-down in NBV of an asset that is obsolete, damaged, broken or no longer required. Such a write-down is part of the depreciation charge (see policy, Property, Plant and Equipment). The identification and provision for onerous contracts (see policy, Provisions and Contingent Liabilities). Impairment testing of CGU s below country level where required by local GAAP. Impairment testing of investments in subsidiaries in an entity s balance sheet ~ this is a local GAAP requirement and does not form part of Group Reporting. The Group s policy is for impairment testing to be carried out by Country finance teams immediately after their budget submission. Impairment testing is an important part of the year end process and any instances of impairment MUST be notified to the Group Financial Controller well before the year-end. Impairment testing will be carried out using the Group s standard model. This spreadsheet model extrapolates budget and plan cash flows to calculate cash flows for years four and five, and then calculates the terminal value of the Country for years six to perpetuity. The model tests impairment on a post-tax basis as this is the simplest approach to take. Although the standard requires testing on a pre-tax basis the correct

238 Impairment of assets, page 7 of answer is not affected whether pre or post tax cash flows are used provided the appropriate pre or post tax discount rate is applied. Questions regarding these impairment tests should be addressed to Group Finance, Chertsey Identify the assets to be tested The impairment test is carried out immediately after the next year s Budget submissions are received by Group in August annually. The test will be based upon the carrying value of net assets in the Forecast B for the current year, and will use cash flows shown in next year s approved budget and plans for the Country being tested. Adjustments to the forecast Country balance sheet The following adjustments to net assets should be made: The NBV of fixed asset investments (apart from the investment value of associates) should be excluded. Investments in Group companies are eliminated on consolidation and therefore should not be taken into account for Group impairment testing purposes. Trade investments should be included in the impairment test. Central goodwill should be allocated in place of fixed asset investments. This may not be the same amount as the central goodwill allocated for ROCE purposes as only central goodwill that is retained on the Group balance sheet should be tested (goodwill written off to reserves prior to the transition to IFRS should be ignored). Working capital balances should be included. Exclude tax balances (current and deferred) from the net assets. All cash, bank overdrafts, loans and other debt including lease finance should be excluded from net assets. Outstanding dividends should be excluded from net assets. The result of these adjustments will be the carrying value of the Country s net assets against which the value in use will be compared. Minority Interests A Country with minority interests should be tested on a gross basis. This means that 100% of the cash flows must be included in the value in use calculation, and that goodwill should be grossed up to reflect the minority interests goodwill for the carrying value of the assets.

239 Impairment of assets, page 8 of Example: CGU with a minority interest A Country contains a 20% minority interest and its net assets are made up as follows; m Centrally allocated goodwill 40 Local goodwill 5 Investments 10 Intangible assets 6 Tangible fixed assets 12 Working capital 5 Borrowings and debt (15) Tax balance (3) Net Assets 60 The carrying value of the Country for the purposes of the value in use calculation is made up of; m Centrally allocated goodwill 40 Central goodwill gross up adjustment; ( 40m / 80%) * 20% 10 Local goodwill 5 Intangible assets 6 Tangible fixed assets 12 Working capital 5 Net Assets 78 The value in use of the Country is found to be 53m after grossing up for the value in use attributable to the minority interest; therefore an impairment of 25m is recognised against the Country net assets as a whole. The impairment is applied first to goodwill, and the following entry is put through to reflect it; Dr Income statement: amortisation of goodwill 20m Cr Goodwill 20m Only 80% of the impairment applicable to goodwill is written off in the accounts because 20% of the impairment relates to the unrecognised goodwill of the minority interest Expected future cash flows The next step in the impairment test is to estimate future cash flows. The Group model is to use the most up to date budget and plan submitted to Group. The cash flows should be estimated for years one to three, extrapolated for years four and five and then a terminal value based on year six cash flows is calculated. The following adjustments may need to be made to these cash flows; Cash flows have to be estimated for conditions and assets that are present at the balance sheet date. This means that cash flows from a major new investment in the future cannot be included for impairment testing purposes, even though this may be included in forecasts, budgets and plans reported to Group. Cash flows from planned reorganisations cannot be included unless the provision for the reorganisation is allowed under the Group policy on Provisions and Contingent Liabilities, at the date of the impairment test.

240 Impairment of assets, page 9 of The only exception to the reorganisation rule above is in Countries that have made an acquisition and synergies from a reorganisation of the new business are anticipated. These cash flows can be included because the purchase price paid for the acquisition and consequently the goodwill value allocated to the CGU takes into account these expected synergies (therefore the cash flows and the carrying value are compared on a consistent basis). Tax cash flows should be included while financing and dividend cash flows should be excluded from the cash flow estimates The growth rate used The Group impairment testing model includes a growth in turnover for the Country and applies this to the year five cash flow in calculating the terminal value. The growth rate used must be a reasonable assumption for the prospects of the Country. Only in very rare cases can a growth rate be used in excess of the country s long-term trend of GDP or inflation growth. Where a growth rate in excess of GDP growth inflation is used it requires separate disclosure and justification in the Group s accounts. The Group s Capital Investment manual contains inflation data on a country specific basis and it is recommended this is taken as the growth rate The discount rate to use The Group s policy is to use the internal WACC rates which are published from time to time on the Mercury website, the link to which is included in the Group Approvals Manual. These internal WACC rates already include adjustments for; Political risk: country specific risk adjustors. The local inflation differential: the effect of the inflation differential by country. Example: Discount rate During 2005 a CGU in South Africa is being tested for impairment. The discount rate to use in the value in use calculation is: The Group s published WACC rate on the Mercury website is 10.8% Although the standard specifies using a pre-tax discount rate, the Group model, with agreement from the Group auditors uses the post tax WACC rate as published on the Mercury website to discount cash flows including taxation. Enquiries about the WACC rate used should be directed to Group Finance, Chertsey Calculating the value in use The cash flows for years one to five are discounted back using the pre-tax discount rate. Added to this is the terminal value, which is calculated from the year six cash flows, as follows:

241 Impairment of assets, page 10 of Terminal value calculation The formula is as follows; TV = (Year 6 cash flow) * (1 / (discount rate growth rate)) Example A Country has a year five cash in flow of 10m. The inflation rate for the Country is 1.8%, and the discount rate is 8% per the capital investment manual. The terminal value of the CGU is; 10m * 1.8% = year six cash flow = 10.2m * 1 / (8 1.8) % = 164.2m The terminal value is added to the discounted cash flows in years one to five to arrive at the value in use. The value in use is then compared to the carrying value of the CGU s net assets to determine whether an impairment write-down should be made or not. If the results of this test indicate that an impairment is required, then the Country Finance Director must contact the Group Financial Controller immediately and before any write-down is booked Impairment tests required under local GAAP Impairment testing may be a requirement under local GAAP. Where this is the case any impairment found to be required must be reversed when reporting to Group. Only impairment at a Country level should be reflected in HFM reporting. A local impairment on a CGU within a Country may indicate; That an onerous contract provision may be required (see policy Provisions and Contingent Liabilities, or A tangible asset write down may be required, but only if the assets are dedicated to an onerous contract (see above). Dedicated contract assets should be impaired before any provision is made. CGU s beneath Country level should be separately identifiable businesses so that assets, liabilities and cash flows can be allocated to them. Usually this will correlate with internal management reporting structures. Example: Identifying CGU s A Country has separate and distinct businesses operating in the B&I, education, leisure and medical sectors. These businesses are managed separately although share common support functions such as purchasing and administration. Within B&I, which is the biggest business, the operation is managed through 3 distinct geographical regions. It would be appropriate if performing an impairment test required by local GAAP to follow the operating structure within the Country and treat each business as a CGU. Within B&I, if the geographical regions are exposed to different operating and economic conditions it would be appropriate to treat these as separate CGU s within the Country.

242 Impairment of assets, page 11 of The principle behind allocating net assets to cash-generating units is that the sum of all the CGUs in the Country will add up to the Country s balance sheet. Therefore centrally held assets, such as goodwill and head office assets, need to be allocated in an appropriate manner to CGUs. Where this is not possible in a sensible fashion the CGUs are simply combined together until the size of the CGU being tested is such that the central assets directly relate to it. Practical methods of allocating central assets to CGUs include: In proportion to the directly attributable net assets of the CGUs serviced by the central asset. In proportion to management fees charged by the head office function. In proportion to the number of employees in each CGU. Example: Allocation of central assets A Country has three independent income streams, A, B and C, with net assets directly involved in the income streams with carrying amounts of 100m, 150m and 200m respectively. In addition there are head office net assets with a carrying amount totalling 18m. The relative proportion of the head office resources used by the income streams is 2:3:4. The cash-generating units are defined as follows: Cash-generating unit A B C Total Net assets directly attributable to incomegenerating unit ( m) Head office net assets ( m) Total If there were an indication that cash-generating unit B was impaired, the recoverable amount of B would be compared with 156m, not 150m. Similarly, the cash flows upon which the value in use of B is based would include the relevant portion of any cash outflows arising from central overheads. The discount rate to use when calculating the net present value of the estimated cash flows of CGU is the rate of return an independent third party investor would require from an investment of equal risk. Any risks that have been adjusted for in the actual cash flows used should be excluded from the discount rate. Sources of evidence for an appropriate discount rate include: The rate implicit in acquisitions of similar CGUs in the market. The WACC of a listed company of similar size and risk profile to the CGU. The Country s WACC rate as published on the Group s Mercury website. Local impairment tests should follow the same guidelines for adjustments to net assets and cash flows as outlined in the sections on Group impairment testing. Countries should inform Group Finance Chertsey if they have a local impairment, even though this is reversed in their HFM reporting.

243 28. Foreign exchange Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Exchange differences arising on settled transactions within individual companies should be recognised as part of the profit or loss for the year. Exchange differences on investments in foreign operations and long-term intragroup loans that are part of the Group s net investment in the foreign operation (structural loans) should be taken directly to reserves in Group reporting and are shown in a separate translation reserve. Exchange differences arising on external third party foreign currency borrowings may be taken directly to equity (translation reserve) only if formal hedge accounting treatment has been adopted using the rules set out in IAS 39 and the hedging relationship has been proved to be effective. Exchange differences deferred within the translation reserve are recycled to the income statement when the foreign operation is disposed of. The budget rates issued must be used in Group reporting, except at half year and full year when actual rates must be used. All rates will be notified by Group Finance, Chertsey. There are special rules regarding the hedging of investments in foreign entities via long-term foreign currency loans Disclosed accounting policy The consolidated financial statements are prepared in pounds Sterling, which is the functional currency of the parent company. In preparing the financial statements of individual companies within the Group, transactions in currencies other than pounds Sterling are recorded at the rates of exchange on the dates of the transaction. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rates on the balance sheet date. Gains and losses arising on retranslation are included in the income statement for the period, except for where they arise on items taken directly to equity, in which case they are also recognised in equity. In order to hedge its exposure to certain foreign exchange risks the Group enters into forward contracts (see Financial Instruments for the Group s accounting policies in respect of derivative financial instruments). On consolidation, the assets and liabilities of the Group s overseas operations (expressed in their functional currencies, being the currency of the primary economic environment in which each entity operates) are translated at the exchange rates on the balance sheet date. Income and expense items are translated at the average exchange rates for the period. Exchange differences arising, if any, are classified as equity and transferred to the Group s translation reserve. Such translation differences are recognised as income or expense in the period in which the operation is disposed of. Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate.

244 Foreign exchange, page 2 of Default policy and process for exceptions Default policy A transaction should be translated into the company s functional accounting currency using the exchange rate on the date on which the transaction occurred. At the balance sheet date in P6 and P12, monetary items such as cash and bank balances, loans, intra-group balances and external amounts receivable and payable denominated in a foreign currency should be translated using the period-end closing exchange rate. For other month ends, budget rates should be used. Foreign exchange gains and losses, except for those listed below, should be recognised in the income statement in the account called Exchange Differences. Exchange differences on long-term structural intra-group loans and third party borrowings (which have been formally designated as hedging instruments in a net investment hedge) in place as part of the Group s treasury and tax strategy should be taken directly to reserves in Group reporting. Where a company enters into contracts in a foreign currency it should seek to match currency revenues with currency costs wherever possible to reduce its risk. Significant foreign exchange exposures must be notified to Group Treasury Consultation and authorisation process for exceptions Any Group entity that believes that for tax or other reasons any treatment of exchange differences other than that documented above should be permitted in their Group reporting will need the written consent of the Group Tax Manager and the Group Financial Controller before proceeding IFRS references IAS 21 The effects of changes in foreign exchange rates IAS 29 Financial reporting in hyperinflationary economies IAS 39 Financial instruments: recognition and measurement

245 Foreign exchange, page 3 of Summary of IFRS requirements Definitions Functional currency Functional currency is the currency that the entity does the majority of its business in. This is not necessarily the currency that the majority of transactions are conducted in; another currency may dictate prices and costs to a greater extent and have more influence over the entity s results. Therefore the functional currency is not a matter of choice but fact because it is determined by the economic environment that the entity operates in. Presentation currency This is the currency that the entity presents its results in, and there is no restriction as to which currency this is. Where the entity chooses a presentational currency that is different from its functional currency, the method of translation into the presentation currency is the same as that for preparing consolidated accounts (see below) Foreign exchange differences A company may engage in foreign currency operations in two ways: via direct business transactions in foreign currencies; or via foreign entities that maintain accounting records in a foreign currency Individual companies Income Statement Transactions entered into by an individual company in a foreign currency, should be translated into the company's functional currency using the exchange rate in operation on the date on which the transaction occurred, or, if the rates do not fluctuate significantly, the average rate for a period. The use of forward foreign exchange contracts for the purpose of hedging future commitments must be approved by Group Treasurer and the Country Finance Director. The forward contract should be shown on the balance sheet at its fair value. The exchange gains or losses incurred should be shown in operating profit. The policy on Financial instruments contains more details about accounting for forward exchange contracts. HFM account: IS45331 Balance sheet At the balance sheet date, non-monetary assets (e.g. plant, machinery and inventory) should remain at the historical rate and are not subsequently retranslated. The treatment of investments is discussed further below, and is now governed by the accounting rules set out in the policy on Financial instruments. Monetary assets and liabilities (e.g. cash and bank balances, loans and trade receivables or payables) should be translated at the rate of exchange ruling at that date. Recognition of gains and losses Exchange gains or losses arising on settled transactions should be recognised as part of the profit or loss for the year. Gains or losses on exchange arising from transactions between a parent company and its subsidiaries, or from transactions between fellow subsidiaries, should be reported in the individual company's financial

246 Foreign exchange, page 4 of 8 28 statements as part of the profit or loss for the year in the same way as gains or losses arising from transactions with third parties Consolidated accounts Amounts in the income statement of a foreign enterprise should be translated at the average rate for the accounting period. Where the average rate used differs from the closing rate, a difference will arise which should be dealt with in equity (translation reserve). Amounts in the balance sheet of a foreign entity should be translated into the reporting currency of the investing company using the rate of exchange ruling at the balance sheet date. Where the closing rate used differs from the opening rate, the difference that arises should be dealt within equity (translation reserve). Where financing of a foreign entity by the investing company uses intragroup balances intended to be as permanent as equity, such intra-group balances should be treated as part of the investing company's net investment in the foreign enterprise and any exchange differences arising should be taken to the translation reserve Equity investments financed by foreign borrowings Individual companies Investments in other entities are classified as equity instruments and fall within the definition of a financial instrument. IAS 39 requires that such investments are categorised as either fair value through profit or loss or as available for sale. However investments in equity instruments where there is not a readily available market must be held at cost in the available for sale category. The policy on Financial instruments has more detail on the IFRS categories of financial assets. Investments in Group entities should be shown at cost less any impairment recorded in the books of the Group holding company. Investments held at cost are not retranslated at the balance sheet date, i.e. they are held at historical cost in the functional currency Foreign currency denominated borrowings used to finance investments are re-translated at each period-end using the closing rate. Exchange gains or losses are taken to the income statement.

247 Foreign exchange, page 5 of 8 28 Consolidated accounts This is only relevant to entities that prepare multi-currency sub-consolidations. Within a group, foreign currency borrowings may have been used to finance group investments in foreign entities or to provide a hedge against the exchange risk associated with holding similar existing investments. In the consolidated financial statements, the exchange gains or losses on such foreign currency borrowings, which would otherwise have been taken to the group income statement, may be offset as translation reserve movements against exchange differences on the retranslation of the net investments (provided that formal hedge accounting treatment has been adopted under IAS 39 rules). The conditions that must be applied are as follows: the Group must designate the foreign borrowings and net assets in a formal net investment hedge, which requires documentation and effectiveness testing. See policy on Financial instruments for more details. the accounting treatment adopted should be applied consistently from period to period. There are intra-group long-term loans which are treated as part of the net investment in foreign entities. Exchange gains or losses on these loans will arise in either the foreign entity, or the holding company, and these should be taken to equity through the translation reserve. All exchange movements taken to the translation reserve arising from the translation of the foreign net assets, the successful hedging of third party borrowing, or long term intra group loans, must be recycled to the income statement when the foreign entity is disposed of. This means that detailed records and analysis of movements in the translation reserve must be kept so that this information is available when an entity is disposed of.

248 Foreign exchange, page 6 of Application guidance Summary Example of foreign exchange difference Movement in exchange rate between the date of invoicing a client in another currency and receiving payment in that currency. Revaluation at the balance sheet date of a bank account held in another currency. Revaluation at the balance sheet date of an intra-group trading account denominated in another currency. Revaluation at the balance sheet date of a long term structural loan denominated in another currency with Compass Group International CV. Movement in exchange rate between accounting for interest charge on foreign currency loan from CGICV and paying interest in currency. Revaluation at the balance sheet date of subsidiary or associate in consolidated accounts. Treatment in Group reporting Income statement Foreign exchange g/l HFM account IS45331 Income statement Foreign exchange g/l HFM account IS45331 Income statement Foreign exchange g/l HFM account IS45331 Retained earnings EXRESIGLOAN HFM account BS76000 Income statement Foreign exchange g/l HFM account IS45331 Translation reserve Custom 1 EXTFR. HFM account BS75400 HFM will automatically calculate this movement Individual company reporting The Group circulates a list of period-end closing and average rates for use in Group reporting and translation of foreign exchange transactions. Reporting of exchange gains and losses Foreign exchange gains and losses on transactions and the revaluations of trading items at the balance sheet date form part of the profit on ordinary activities of the company. Companies should report all such exchange gains and losses in the income statement in the account called Foreign exchange g/l. Note that gains or losses arising on trading transactions with Group companies should be treated in the same way as those arising on transactions with third parties. HFM account: IS45331 In an individual entity s books exchange differences on intra-group balances and third party borrowings should be taken to the income statement. Investments in other Group entities will be shown at historical cost and not retranslated. Certain other investments may require translation and the policy Classification of investments contains more details on these investments. Exchange gains or losses on these other investments should be taken to equity if they are classified as available for sale or profit and loss if they are classified as fair value through the profit and loss account. In cases of doubt as to whether an intra-group balance is a longterm structural item or not, guidance should be sought from Group Finance, Chertsey. No exchange difference should form part of the income statement interest charge.

249 Foreign exchange, page 7 of Consolidated reporting The income statement of a subsidiary should be consolidated using the average rate of exchange for the period. For Group companies, a list of average rates and month-end closing rates is prepared and circulated each month. The assets and liabilities of the subsidiary should be translated using the period end rate at P6 and P12. (note: Compass budget exchange rates are to be used at other month ends) The following exchange differences can be taken directly to reserves: Differences between translating the retained profit at average rate and at closing rate; and Differences between translating opening balances at the previous year s closing rate and translating at this period s closing rate. Group companies should show these exchange differences in the translation reserve in the balance sheet using the HFM Custom 1 dimension EXTFR. These exchange differences do not have to be reported as part of the trading result in Group reporting. Exchange differences on third party borrowings that have been formally designated and documented as hedging instruments within net investment hedges, in place as part of the Group s treasury and tax strategy, should be taken directly to translation reserve in the same way. All other exchange differences must be shown in the income statement within the account called Foreign exchange g/l. HFM account: BS76000 HFM account: IS Intra-group accounts - treatment of exchange differences IAS 21 rules only allow exchange differences on structural loans to be passed through reserves on consolidation. Exchange differences arising on trading accounts and other intra-group balances which are not formally designated as structural loans must be reflected through the income statement. Entities are required to review intra-group balances on a regular basis and formally designate and document balances that are neither planned nor expected to be settled as structural loans. If you intend to redesignate intra-group balances in this way please consult with Chertsey Group Technical Accounting department. Example A divisional office pays certain expenses on behalf of a subsidiary operating in a country with economic instability. There is no intention to settle the balance. At the end of the financial year, the additional balance that has been built up is designated as a structural loan and an agreement is signed by the operating company and the divisional office. Exchange differences on this structural loan can from now be taken through reserves in the consolidated Group accounts Hyper-inflationary areas Where a foreign enterprise operates in a country in which a very high rate of inflation exists, local currency financial statements may have to be adjusted to reflect current price levels. Such instances should be referred to Group Finance, Chertsey, before proceeding. Exchange differences arising as a result of such adjustments should be shown in the income statement in the account called Foreign exchange g/l. HFM account: IS45331

250 Foreign exchange, page 8 of 8 28 Should adjustment for hyperinflation be necessary, guidance on the appropriate accounting will be provided from the centre Special cases The treatment of exchange differences in Compass Group International BV and its related holding companies, Compass Group PLC, Compass Group Holdings PLC, Hospitality Holdings Ltd and Compass Overseas Holdings No.2 Ltd have been separately addressed, and guidance should be sought from Group Finance, Chertsey.

251 29. Private Finance Initiative ("PFI") contracts Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Under a PFI contract, the private sector is contracted to supply services traditionally provided by the public sector. Usually, the private sector entity designs, builds and finances a property, e.g. a hospital, prison or office, in order to provide the contracted service. The accounting treatment depends on whether the PFI contract is similar to a lease, involving payments for a property, or whether the contract also includes non-separable service elements. Where the contract includes non-separable service elements, the accounting treatment depends on whether the purchaser or operator includes the property as an asset due to its rights to the risks and rewards of ownership of the property. Any contract that may be of this type should be referred to Group Finance, Chertsey Disclosed accounting policy There is no externally disclosed accounting policy for PFI contracts Default policy and process for exceptions Default policy The few PFI contracts operated by the Group are generally accounted for as for any fixed-price, fixed price plus, or concession contract, using the revenue recognition criteria set out in the Revenue recognition policy. Where contracts span several years, revenue should be recognised appropriately over the period over which it is earned, not just in the period in which cash is received. Appropriate consideration should be given to the accounting treatment for purchasing income receivable and signing bonuses or key money payable during a PFI contract (see policies on Purchasing Income and Intangible Assets). Pre-contract and other start-up costs should only be capitalised during preferred or sole-bidder status, following the policy on Contract costs: bidding and mobilisation Consultation and authorisation process for exceptions Permission to classify contracts as PFI contracts must be received in writing from the Group Financial Controller, who must also authorise exceptions to the default policy or more specific application detail below.

252 Private Finance Initiative ("PFI") contracts, page 2 of IFRS references Framework for the preparation and presentation of financial statements IAS 8 Accounting policies, changes in accounting estimates and errors IFRIC 12 Service concession arrangements 29.4 Summary of IFRS requirements Basic principles Under a PFI contract, the private sector is contracted to supply services that traditionally have been provided by the public sector. Under most PFI contracts, the operator, or a partnership of operators, designs, builds, finances and operates a property such as a hospital, prison or office, in order to provide the contracted service. Alternatively (in the case of the Group), the operator may only provide services under such a contract. Where the contract is a simple, management, fixed price/fixed price plus service contract, it is generally accounted for by the operator using the normal Revenue recognition rules. Where a property or asset has been built by one or more of the parties, specifically for the provision of the contract, the principles that govern the appropriate accounting treatment are: (a) (b) whether the purchaser (the client) recognises the property as an asset on its balance sheet together with a corresponding liability to pay the operator for it or, alternatively, has a contract only for services; and whether the operator (the service-provider) recognises the property as an asset on its balance sheet or, alternatively, a financial asset being a debt due from the purchaser. A party will recognise the property as an asset on its balance sheet where that party has access to the benefits of the property and exposure to the risks inherent in those benefits. Where service elements of a contract are operated independently, as in the case of Compass, and may be separated from the other elements of the contract, e.g. cleaning, laundry, catering, any such service elements should be ignored when determining whether the property is the asset of the purchaser or the operator. Instead, the contract is accounted for by both the purchaser and the operator, using the normal cost and revenue recognition rules respectively.

253 Private Finance Initiative ("PFI") contracts, page 3 of Purchaser recognises the property as an asset on its balance sheet in operator s books The operator recognises a financial asset, being the debt due from the purchaser for the fair value of the property (finance lessor accounting). This asset is recorded at the fair value of the property and reduced in subsequent years as payments are received from the purchaser. The asset should be analysed between receivables due within one year, and receivables due after one year. Finance income on this financial asset is calculated (using a property-specific rate) and recorded within interest receivable. The remainder of the PFI payments, being the full payments, less the capital repayment and the imputed financing income should be recorded within operating profit Operator recognises the property as an asset on its balance sheet Operator s accounting treatment A fixed asset is recognised, initially recorded at cost and depreciated to its expected residual value over its useful economic life. If the contract specifies a sum for which the residual value will be transferred to the purchaser at the end of the contract, the difference between this contracted residual value and the estimated residual value should be accounted for so as to ensure that at the end of the contract, the accumulated balance (whether positive or negative), together with any final payment, should exactly match the originally estimated fair value of the residual. If the operator is obliged to meet any other liabilities as a result of the contract (e.g. environmental clean-up costs), these should be recorded separately, within liabilities, under the appropriate accounting policy.

254 Private Finance Initiative ("PFI") contracts, page 4 of Application guidance Examples: Treatment of capital investment in new contracts 1 The Group enters into a new three year catering and cleaning contract which requires the refurbishment of the kitchen and restaurant facilities at a total initial cost of 500,000. This is a normal catering contract, not a PFI contract. To the extent that costs incurred in respect of the refurbishment meet the criteria for capitalisation (see policy on Property, plant and equipment), they should be capitalised and amortised over the life of the contract in this case three years. 2 The Group enters into a 15 year PFI arrangement with a hospital trust to provide catering, cleaning, portering and receptionist services. The arrangement requires Compass to procure the refurbishment of parts of the building associated with providing the catering, retail services, reception and day-care centre although the design and requirements of the building are dictated by the trust. The Group will fund the initial capital works and anticipate that 4 million of costs will be incurred. These costs will be recovered via the Monthly Service Payment (MSP) received from the trust over the 15 year period of the contract. The MSP comprises both an element covering that month s operational charges and part of the capital repayment. The MSP can be adjusted based upon certain performance criteria, subject to a maximum deduction that can be made. Provided operational performance is acceptable, the Group will recover the initial capital cost over the life of the contract through the MSPs. Therefore, as cash is spent on the capital works a receivable due from the trust should be recognised. The element of each MSP that relates to the capital repayment should be credited against the receivable each month. The risk and reward of this receivable remains with Compass and hence at any time, if collection is considered uncertain due to poor operational performance, a provision may need to be recorded.

255 30. Other disclosures Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Certain additional information is required by the Group for statutory disclosure in the Group accounts or for internal management purposes. This information may be outside the reporting entity s ledger system; nevertheless, it is still important and requires the same care in preparation and accountability as income statement, balance sheet or cash flow information. Particular attention must be paid to operating lease disclosure (income statement and commitments) as this influences the Group s cost of borrowing. The total minimum commitment payable under non-cancellable operating leases for one year, two to five years and over five years must be disclosed. The level of bad debt provision against estimated irrecoverable amounts has to be disclosed - see policy on Receivables. The value of inventory write-down (or any reversal of such a write-down) charged to the income statement in the period has to be disclosed - see policy on Inventories Disclosed accounting policy Not applicable Default policy and process for exceptions Default policy Certain additional information is required by the Group for statutory disclosure in the Group accounts or for internal purposes. This information may be outside the reporting entity s ledger system; nevertheless, it is still important and requires the same care in preparation and accountability as income statement, balance sheet or cash flow information Consultation and authorisation process for exceptions Any queries regarding specific disclosure requirements for Group reporting purposes should be referred to Group Finance, Chertsey IFRS references The significant disclosure requirements which are not covered elsewhere in this manual are highlighted below Summary of IFRS requirements There are various disclosure requirements for listed groups set out in international accounting standards, legal and other regulations, such as the Companies Act 1985 and Listing Rules. Items specific to Compass are set out in the Application guidance below Application guidance Contingent liabilities Accounting for Contingent liabilities is dealt with in a separate policy. Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report.

256 Other disclosures, page 2 of 7 30 Disclosure requirements The following categories are reported in HFM for both intra-group and external liabilities: Performance guarantees / bonds. These are guarantees or indemnities given by a Group company to a surety company or bank in support of contract bonds and guarantees (typically advance payment, tender, performance or retention bonds) where the surety company or bank has issued the bond or guarantee for that company or another within the Group. Guarantees of indemnities (usually where a business has been sold but guarantees for items such as tax have been given to the purchaser). Loans and overdrafts (for example, where one Group company cross-guarantees the obligations of other Group companies as part of a cash pooling arrangement or where a Group company provides a guarantee directly to a bank in respect of a loan made to another Group company). Customer guarantees (for example, a guarantee given to a client by one Group company in respect of the performance of a contract by another Group company). Rent guarantees. Other (including legal claims). It is important that the liabilities are correctly classified as external or intragroup. For Group Treasury guidance on the conditions under which contract bonds, guarantees, indemnities and letters of comfort should be issued, see Appendix to this policy Capital commitments Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report. Disclosure requirements The total capital expenditure contracted for (ordered) but not invoiced or accrued and therefore not included in property, plant and equipment at the reporting date Operating lease commitments Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report. Disclosure requirements The requirement is to show the total minimum payments the Group is contractually committed to over the term of non-cancellable leases. This amount is split between operating leases of land and buildings (i.e. nontrading property including offices and central kitchens), other occupancy rentals (i.e. trading sites) and operating leases of other assets (plant and equipment). In addition this amount must be split into time bands of less than one year, two to five years and over five years depending on when the payments fall due.

257 Other disclosures, page 3 of 7 30 Non-cancellable leases; at inception of the lease consideration should be given to whether it is a non-cancellable lease (requiring commitment disclosure) or cancellable (no commitment disclosure required). Non-cancellable leases are those where there is no termination option available to the lessee or where there is a penalty clause for early termination of sufficient size to make it reasonably certain that at inception the lessee is committed to the lease for its entire term. Lease term; usually the specified term of the lease arrangement, however where a secondary period exists in the lease and at inception it is reasonably certain that the lessee will exercise this secondary period, the commitment disclosure is the total of all payments over the initial and secondary terms of the lease time apportioned to when they fall due. This statutory disclosure is used by rating agencies which treat a multiple of the disclosed amounts as implied debt impacting the Group s cost of borrowing. Examples: Operating lease commitment disclosure 1 An operating lease on an office building which has eight and a half years to run at 100,000 per year but can be terminated on six month s notice. No commitment disclosure is required; the lease at inception does not meet the definition of a non-cancellable lease because the commitment payable should the lease be terminated ( 50,000) is not enough to deter the lessee from exercising the termination option. The lease is cancellable. 2 An operating lease on an office building which has eight and a half years to run at 100,000 per year. There is no early termination option. Commitment type: operating lease of land and buildings Commitment amount: 850,000 in total, split 100,000 less than one year, 400,000 in two to five years, and 350,000 in over five years. 3 An operating lease on an office building which has eight and a half years to run at 100,000 per year but can be terminated on six month s notice and an additional payment of 100,000. At inception of the lease the commitment should the lease be terminated ( 150,000) is considered sufficient to make reasonably certain that the lessee is committed to the full term. The lease is therefore considered non-cancellable at inception. Commitment type: operating lease of land and buildings Commitment amount: 150,000 in total all within one year. 4 A rental agreement exists for the catering operation at a sports stadium for two years. There is a minimum guaranteed rental payable of 500,000. The expected rent payable in the next year based on budget turnover is 900,000. Commitment type: other occupancy rentals Commitment amount: 1,000,000 (the minimum guaranteed rent), split 500,000 less than one year, and 500,000 in two to five years. 5 There is an agreement to pay sales commissions on vending receipts at a client s premises. The expected sales commission in the next year is $25,000. Commitment type: None - this is not a rental agreement and there is no commitment to a minimum payment. Any payments made are not linked to the passage of time but the usage of the assets. If no sales were made, no payment would be made Analysis of operating leases in the income statement Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report.

258 Other disclosures, page 4 of 7 30 Disclosure requirements As for commitments, the rents payable for the year are split between property lease rentals, other occupancy rentals and other asset rentals. Other occupancy rentals are further split between minimum guaranteed amounts and amounts above the guaranteed minimum in those lease arrangements where a minimum is specified. Arrangements that are entirely contingent are not leases as there is no relationship between the term of the arrangement and the payments falling due under it (see Group policy on Leases for more details) This statutory disclosure is used by rating agencies which treat a multiple of the disclosed amounts as implied debt impacting the Group s cost of borrowing. Note that vending sales commissions are not rental payments and should not be included here, but should be shown as cost of sales Disclosure of gross payments under finance leases Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report. Disclosure requirements IFRS requires that the total future minimum payments (i.e. capital and interest) due under finance leases is disclosed in yearly time bands up to five years and then over five years. The interest element is then disclosed as a deduction from this total to reconcile to the liability shown in the balance sheet (capital element only) Staff numbers and staff costs Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report. Disclosure requirements The total average number of employees in the financial year should be disclosed (not full-time equivalents). Numbers reported must be the average for the year, in units (not thousands). For Group reporting, only a total for each reporting entity is required. Staff costs for the year should be reported and analysed as follows: (a) (b) (c) wages and salaries paid and payable; social security costs incurred by the company; and other pension costs Post balance sheet events Frequency of disclosure Disclosure required in the Group year-end reporting for the Group annual report.

259 Other disclosures, page 5 of 7 30 Disclosure requirements Non-adjusting events which are material to the Group have to be disclosed as a note in the Group accounts. Examples would include a material acquisition or disposal of all or part of a business. Entities which believe they have such an event should ensure that the Group Financial Controller is aware of the situation.

260 Other disclosures, page 6 of 7 30 Appendix: Treasury Guidance on contract bonds, guarantees and indemnities Contract Bonds Group companies will most commonly be required to issue tender, advance payment and performance bonds. Bonds may also be required in respect of rental obligations, etc. Where such bonds are issued by a bank they are likely to give the beneficiary the right to call for payment on his first demand. The following requirements are mandatory for all standby letters of credit and bonds issued on behalf of the Group. All bonds must state: the commencement date and a fixed or identifiable expiry date which may not extend the validity beyond the completion by Compass of its underlying contractual obligations; the maximum value of the liability; the cancellation procedure, including documents to be lodged; the reduction mechanism where applicable; the applicable law and jurisdiction; that (where a tender bond has been provided) the performance bond becomes valid only upon cancellation of such tender bid; and that it is for the benefit of the client only and is not assignable (unless this is inconsistent with the ability of the client to assign the underlying contract). and must not permit the client to demand reinstatement of the bond to its original value following a call. All bonds must specify that any call must: be in writing; state the nature of the default which has resulted in the call; and be accompanied by confirmation from the client s bankers as to the authenticity of the signatories to the demand and (preferably) state the titles of those authorised to sign such a call. Bonds that do not comply with the mandatory requirements may only be issued with the prior approval of the Group Treasurer. Guarantees and indemnities It is the nature of the Group s business that operating company balance sheets are likely to be insufficient to support a significant amount of debt. Where local credit facilities have been approved in accordance with the policy on Cash, and support is required is required, such support must be; specific and quantified,

261 Other disclosures, page 7 of 7 30 provided by the most immediate parent company in the chain of ownership. If such an entity does not have the substance to provide the level of support needed it would be offered from the next company above it in the chain of ownership. Compass Group PLC support is unlikely to be available unless the underlying obligation is substantial, or where there is no suitable intermediate guarantor available. PLC support may not be offered without the specific approval of the Group Treasurer and Group Finance Director. It should be noted that the structure of the Group s funding would preclude substantial facilities at a level below PLC. Support would normally be in the form of a letter of comfort, and we view this in the terms that it is provided. If a guarantee is provided, we would expect the pricing on the underlying obligation to reflect the creditworthiness of the Guarantor (i.e. PLC pricing for a PLC guaranteed obligation).

262 31. Intra-group items Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Key points As a basic consolidation requirement, all intra-group balances and transactions must be matched and cancelled in Group accounts. This can only be done if all entities: separate intra-group items, account for them in the correct period, report using the correct exchange rates, regularly ensure that intra-group balances are agreed with the other party, and do not deviate from these agreed balances when reporting to Group. It is the responsibility of the entities concerned to agree their mutual balance and transaction reporting to the Group. Group Finance, Chertsey cannot get involved in disputes at any point in the reporting cycle. Many intra-group relationships have been reviewed and assessed to comply with tax regulations and to reduce tax risk. These must not be amended without the express authorisation of the Group Tax Manager or the Group Finance Director. Instructions regarding documentation, payment schedules or other matters must be adhered to in order to protect the Group s tax position. Under IFRS, a number of entities (which were previously treated as subsidiaries) are classified as joint ventures and are therefore proportionately consolidated. Balances and transactions with joint ventures are still treated as intra-group and must be matched to the extent of the Group s shareholding and cancelled in Group reporting Disclosed accounting policy All intra-group transactions, balances, income and expenses are eliminated on consolidation. Where a Group subsidiary transacts with a joint venture of the Group, profits or losses are eliminated to the extent of the Group s interest in the relevant joint venture Default policy and process for exceptions Default policy Transactions and balances with Group entities must be separated in the accounting records. Charges to Group companies must be notified in writing (by invoice, where appropriate) with full details of how the charge has arisen and, in the case of recharges, the name of the person incurring the expense. Only balances and transactions with fellow Compass Group subsidiaries should be shown as intra-group in Group reporting Balances with Group joint ventures should be included, matched and cancelled on a 100% basis. As part of the consolidation process, the joint venture partner s share of balances will be collected and disclosed separately. Balances with associates or joint venture partners are not included in the intra-group matching process.

263 Intragroup items, page 2 of 4 31 As a matter of good accounting practice and control, significant intra-group balances should be fully reconciled on a monthly or quarterly basis. Balances which have not been agreed with the other Group entity must not be reported as intra-group. The balances reported by both parties must be those agreed with the other party, not adjusted for any later changes or corrections unless these have also been agreed in writing. The basis of charging trademark, franchise and management fees, cost sharing charges and intra-group interest should be agreed between the parties (accrual or invoice basis). Payments should be made promptly in accordance with the relevant agreement or budget instruction. Any deviation from the relevant agreement should be approved by Group Tax. Dividends to Group companies should be cleared (at least four weeks in advance) with the Group Tax department before declaration or payment. Dividends declared should be notified to the holding company at the time of declaration. In general, dividends should be budgeted and paid in accordance with the Group s budget instructions, except where this conflicts with local restrictions or advice from the Group Tax department. Balances with Group companies may only be offset with the consent in advance of the other parties involved. Where a company has a balance with another Group company which is denominated in a different currency to its own reporting currency, the balance should be revalued using the actual closing exchange rates at the year-end and half year-end. At the intervening monthends the balance should be valued using the budget rate for the year Consultation and authorisation process for exceptions It is the responsibility of the entities concerned to agree their mutual balances and transactions before reporting them to the Group. If transactions or balances of a special nature arise with a Group company but for which normal intra-group reporting is not considered appropriate, Group Finance Chertsey must be consulted. Any other exceptions will require authorisation in writing from the Group Financial Controller IFRS references IAS 24 Related party disclosures IAS 27 Consolidated and separate financial statements" 31.4 Summary of IFRS requirements IAS 27 requires that intra-group balances, transactions, income and expenses shall be eliminated in full in preparing group accounts.

264 Intragroup items, page 3 of Application guidance Common intra-group partners Formal procedures to be followed for the agreement and reporting of intragroup balances on HFM are included within D Period End Procedures D6. Transaction Entity name HFM entity Funding loan & interest Compass Group International Finance CV NLD_CGIFCV Dividends Compass Group International BV NLD_CGIBV Eurest trademark Compass Group Nederland BV NLD_TRADEMK Medirest, Scolarest and Chartwells franchise fees Cost sharing Compass Group Holdings PLC Compass Group Holdings PLC Paris branch GBR_HOLD FRA_PARIS Management charges Compass Group Holdings PLC GBR_HOLD Purchasing services Compass International Purchasing GBR_CIPL Agreeing and reporting intra-group balances Examples: Intra-group (1) Company J and Company K are both 100% subsidiaries of the Group. Both companies report in Euros. Each company has the following balances in its accounting records at X: Company J Loan 500,000 Cr Interest on loan 32,000 Cr Sales ledger 10,000 Dr Intra-group current account 5,432 Cr Company K Loan 520,000 Dr Interest on loan 12,634 Dr Purchase ledger 8,000 Cr Intra-group current account 6,063 Dr The investigation by the accountants in both companies produces this information: i The finance director of Company J agreed with the finance director of Company K that 20,000 would be transferred from interest to capital on the loan account and interest would be charged from 1.7.0X. An amendment to the signed loan agreement was prepared. : Company J should update its accounting records and accrue interest based on the new principal amount from 1.7.0X. ii iii iv The difference on the interest account is due to the results of A above, and also that Company K has miscoded a receipt of 500 to bank interest rather than intra-group interest and not grossed up the receipt for bank charges deducted by Company K s bank : Company K should correct the misposting and correctly account for bank charges deducted from its receipts. Company K sent a cheque for 2,000 to Company J on X - Company J did not receive the cheque until X : This should be agreed between Company J and Company K. One must make an adjustment in its Group reporting so that both companies show the same intra-group balance and the bank balance is correspondingly amended. No cash has gone out of the Group so it must be reflected in the Group s consolidated net debt position. Company J as the receiving party should make the necessary adjustment. Company K raised an invoice for travel costs incurred by a Company J employee for 631 on X. Company J did not have the invoice authorised for processing by its cut off date for P12 so the invoice was processed in P1. : Again, the resolution of this difference should be agreed between Company J and Company K. Company J should have accrued for the charge which was incurred but not invoiced at the balance sheet date. It is probably simpler for Company J can make an adjustment between its intra-group balance and external accruals.

265 Intragroup items, page 4 of 4 31 Note from this example that it is important to raise invoices and arrange for cheques and cash transfers well before the period end to make sure that the recipient has time to process the items in the same period. Examples: Intragroup (2) 2 When the accountant for Company J is preparing the HFM input for Group reporting, an additional balance of 5,000 EUR owed by Company K is found. Company K has already completed its Group reporting and agreed the intra-group position. At this point, it is too late to change the agreement on the intragroup balance for P12. If the balance in Company J s books is valid, it should be, for practical convenience, included in external receivables for P12 and included the next time the balance with Company K is reconciled. If material, the Group centre should be informed. If the balance is not valid, it should be written off through the income statement. In either case, Company J should use the balance on the signed intra-group certificate with Company K for its Group reporting. 3 Company L made a loan of $10,000,000 to Company M on X. Company L reports in US dollars; Company M reports in Euros - both are 100% subsidiaries of Compass. When Company M received the loan, $1 = At X, $1 = The loan is denominated in USD. Company L reports a balance of $10,000,000. Company M will have originally recorded the loan at the exchange rate of 0.83 and so have 8,300,000 in its accounting records. This loan needs to be revalued at the period end rate so that Company M reports its balance with Company L as 8,100,000. The exchange difference of 200,000 should be taken to the reserves (translation reserve) if the loan is a long-term structural loan (see policy Foreign Exchange for guidance). 4 Company N has made a loan of 1,000,000 to Company O which is repayable on demand. Company N is a subsidiary of the Group but Company O is accounted for as an associated undertaking (see policy Classification of investments). Company N should not report the amount owed by Company O as intra-group - it should properly be categorised as receivable from associated undertakings in amounts receivable in under one year Offsetting intra-group balances Intra-group balances may only be offset with the advance written consent of all the other parties involved. Example: Offsetting intragroup balances Company P owes $400,000 to Compass Group International CV (CGICV). Company P is also owed 200,000 by Compass Group Nederland (CGN). Company P wishes to offset the amount owed by CGN against the amount it owes to CGICV. Company P s wish to offset these amounts is understandable as it reduces the number of intra-group balances to be maintained and reported, and saves the costs of transferring funds. However, Company P may not simply put through the accounting entries itself and notify the other parties - it must obtain both their agreement and that of the Group Tax department first as there may be reasons why the offset should not be done. These could include the balances involved may not be agreed by the other party; there may be withholding tax issues to consider; there may be interest charge and other tax complications ; bank transfers may be needed to show the substance of the transaction. All parties must agree the date and the exchange rates to be used for the offset. Company P needs to be certain that the other parties are in agreement and there are no objections before the offset is processed.

266 32. First-time adoption of International Financial Reporting Standards Approval Approved by: Key points Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued All Group reporting has been under IFRS since 1 October Whilst first-time adoption of IFRS has now been completed by the Group, this policy is retained for reference purposes and to provide guidance for any subsidiary that chooses to adopt IFRS for local statutory reporting purposes at a future date. IFRS 1 applies when an entity adopts IFRS for the first time by an explicit and unreserved statement of compliance with IFRS. In general an entity must comply with each IFRS effective at the reporting date for its first IFRS financial statements. In particular, within the opening (transition) balance sheet an entity must: Recognise all assets and liabilities whose recognition is required by IFRS. Not recognise items as asset or liabilities if IFRS do not permit such recognition. Reclassify items that are a different type of asset, liability or component of equity under IFRS than under previous GAAP. Apply IFRS in measuring all assets and liabilities. IFRS 1 grants limited exemptions from these requirements and prohibits the retrospective application of IFRS in some areas. IFRS 1 requires disclosures that explain how the transition from previous GAAP to IFRS affected the entity s reported financial position, financial performance and cash flows. All UK-based companies are to continue to prepare their statutory accounts in accordance with UK GAAP until informed otherwise. Companies in other countries should agree their statutory reporting framework with the country finance director Disclosed accounting policy Not reproduced here. On the first-time adoption of IFRS, the financial statements should include a section setting out in detail the impact on accounting policies arising from the adoption of IFRS, including details of any IFRS 1 exemptions that have been adopted Default policy and process for exceptions Default policy Certain additional information is required for statutory disclosure in the financial statements of an entity adopting IFRS for the first time. This information may be outside the reporting entity s ledger system; nevertheless, it is still important and requires the same care in preparation and accountability as profit and loss, balance sheet or cash flow information. Whilst first-time adoption of IFRS has now been completed by the Group, this policy is retained for reference purposes and to provide guidance for any subsidiary that chooses to adopt IFRS for local statutory reporting purposes at a future date.

267 First time adoption, page 2 of 5 32 All UK-based companies (regardless of reporting division) are to continue to prepare their statutory accounts in accordance with UK GAAP until informed otherwise. This will reduce the complexity of subsidiary company statutory reporting. Companies in other countries should agree their statutory reporting framework with the country finance director Consultation and authorisation process for exceptions Any queries regarding specific disclosure requirements for Group reporting purposes, should be referred to Group Finance, Chertsey IFRS references IFRS 1 First-time Adoption of International Financial Reporting Standards 32.4 Summary of IFRS requirements There are a number of exemptions that an entity may elect to use when adopting IFRS for the first time. The list following contains the most significant areas. A detailed process needs to be undertaken to correctly arrive at the opening balance sheet and comparative information Accounting Policies An entity shall use the same accounting policies in its opening IFRS balance sheet and throughout all periods presented in its first IFRS financial statements, subject to certain specific exemptions. In general an entity must comply with each IFRS effective at the reporting date for its first IFRS financial statements and cannot apply different versions of IFRS s that were effective in earlier periods. In particular, within the opening (transition) balance sheet an entity must: Recognise all assets and liabilities whose recognition is required by IFRS. Not recognise items as asset or liabilities if IFRS does not permit such recognition. Reclassify items that are a different type of asset, liability or component of equity under IFRS than under previous GAAP. Apply IFRS in measuring all assets and liabilities Business Combinations An entity may choose not to apply IFRS 3 Business combinations retrospectively to a business combination that occurred before the date of transition to IFRS. If so, it will retain the same business combination classification that was adopted under previous GAAP. It must exclude any asset or liability recognised under previous GAAP, that does not qualify for recognition under IFRS, and adjust goodwill. The carrying amount of goodwill under previous GAAP becomes the carrying amount under IFRS, subject to certain specific permitted adjustments. An entity must also carry out a goodwill impairment test at the date of transition and recognise any resulting impairment loss in retained earnings. If an entity restates any business combination to comply with IFRS 3 then it must restate all later business combinations and also apply IAS 36 Impairment of Assets and IAS 38 Intangible Assets from that same date.

268 First time adoption, page 3 of 5 32 Application in Compass Group consolidated accounts IFRS 3 Business combinations was not applied retrospectively to any business combination that occurred before the date of transition to IFRS (1 October 2004). The same business combination classification that was adopted under previous GAAP was retained. The carrying amount of goodwill under previous GAAP became the carrying amount under IFRS. Compass carried out goodwill impairment tests at the date of transition and recognised any resulting impairment loss in retained earnings Fair value or revaluation as deemed cost An entity may measure an item of property, plant and equipment at the date of transition at its fair value and use that fair value as deemed cost. It may also use a previous GAAP revaluation of an item of property, plant and equipment at, or before, the date of transition as deemed cost at the date of that revaluation, provided it was broadly comparable to fair value, cost or depreciated cost under IFRS at that date. Application in Compass Group consolidated accounts As Compass Group does not revalue property, plant and equipment assets, these were recognised at historical cost Employee benefits Under IAS 19 Employee benefits, an entity may elect to use a corridor approach that leaves some actuarial gains and losses unrecognised. A firsttime adopter may elect to recognise all cumulative actuarial gains and losses at the date of transition, even if it uses the corridor approach for actuarial gains and losses that arise subsequently. Application in Compass Group consolidated accounts Compass Group elected to recognise all cumulative actuarial gains and losses at the date of transition, rather than apply the corridor approach to earlier periods for all pension plans Cumulative translation differences IAS 21 The Effects of Changes in Foreign Exchange Rates requires some translation differences to be classified as a separate component of equity and, on disposal of a foreign operation, to transfer the cumulative translation difference (including gains and losses on related hedges) to the income statement as part of the gain or loss on disposal. A first-time adopter may elect to deem the cumulative translation difference as zero at the date of transition. Application in Compass Group consolidated accounts Compass elected to deem the cumulative translation differences relating to the translation of foreign operations as zero at the date of transition (1 October 2004) Assets and liabilities of subsidiaries, associates and joint ventures This will only apply to local statutory reporting under IFRS

269 First time adoption, page 4 of 5 32 If a subsidiary, associate or joint venture becomes a first-time adopter later than its parent, then it may measure its asset or liabilities at either the carrying amounts that would be included in the parent s consolidated financial statements, based on the parent s date of transition to IFRS, or the carrying amounts required by IFRS 1 based on the entity s date of transition to IFRS. If a parent becomes a first-time adopter later than its subsidiary, associate or joint venture, then it shall measure the assets and liabilities of the subsidiary, associate or joint venture at the same carrying amounts as in the financial statements of its subsidiary Designation of previously recognised financial instruments Financial instruments are normally classified as financial assets or financial liabilities at fair value through profit or loss or available for sale on initial recognition but may also be classified as at the date of transition to IFRS Share-based payment transactions A first-time adopter is encouraged to apply IFRS 2 Share-based Payment to equity instruments that were granted on or before 7 November 2002 and in relation to equity instruments granted after that date that vested before the date of transition to IFRS. However, it may only do so if it has publicly disclosed the fair value of those equity instruments, determined at the IFRS 2 measurement date. Application in Compass Group consolidated accounts Compass Group applied IFRS 2 Share-based Payment to certain equity instruments (employee share options) that were granted on or before 7 November 2002, but which had not vested by the date of transition to IFRS (1 October 2004) Leases A first time adopter may apply the IFRIC 4 transitional provisions and can therefore determine whether an arrangement existing at the date of transition contains a lease on the basis of the facts and circumstances existing at that date Financial instruments In addition IFRS 1 prohibits retrospective application of some aspects of other IFRS s relating to derecognition of financial assets and liabilities and hedge accounting Estimates An entity s estimates under IFRS at the date of transition shall be consistent with estimates made under previous GAAP (after adjustments to reflect any changes in accounting policies) unless there is objective evidence that those estimate were in error. In other words, hindsight cannot be applied in this area Assets held for sale and discontinued operations IFRS 1 allows entities moving to IFRS after 1 January 2005 to apply IFRS 5 Non-current Assets Held for Sale and Discontinued Operations retrospectively. Further rules are set out regarding the provision of comparative information.

270 First time adoption, page 5 of Exemption from requirements to restate comparatives An entity adopting IFRS before 1 January 2006 is required to present at least one year of comparative information, but this comparative information need not comply with the three financial instruments standards, IAS 32, IAS 39 and IFRS 7. There is no requirement to restate historical summaries of selected data for periods before the date of transition to IFRS. Application in Compass Group consolidated accounts Compass Group presented comparative information for the year ended 30 September 2005 that complied with the two financial instruments standards, IAS 32 and IAS 39 that were current at that time Reconciliations An entity is required to explain how the transition from previous GAAP to IFRS affected its reported financial position, financial performance and cash flows. It is therefore required to include the following reconciliations between previous GAAP and IFRS in its first IFRS financial statements: Equity at the date of transition. Equity at the latest period-end presented under previous GAAP. Profit or loss for the latest period presented under previous GAAP. These reconciliations should provide sufficient detail to enable users to understand the material adjustments to the balance sheet and income statement. If a cash flow statement has been presented under previous GAAP, material adjustments to the cash flow statement should also be explained.

271 D. Period end procedures Approval Approved by: Andrew Martin, Group Finance Director March 2010 Version control March 2010 Version 3.0 of policy issued Key points Accounting periods should close on the last calendar day of the relevant month unless separate arrangements have been agreed with Group Finance, Chertsey. Adequate cut-off procedures for revenues, costs, receivables, payables, inventories and cash should be in place to ensure those transactions up to and including the accounting period close are included within the accounts, and transactions after this date are excluded. Month end procedures contents D.1 Overview of month end procedures 1 D.2 Cut off policies 2 D.3 Period end procedures 2 D.4 Exchange rates 5 D.5 Group Reporting 5 D.6 Intra-group procedures 7 D.1 Overview of month end procedures Monthly management accounts cut-off at the end of the calendar month, unless separate arrangements have been agreed with Group Finance, Chertsey. Most Group companies will prepare their accounts to the end of the month. In some cases, however, Group companies will cut-off for accounting purposes to a different date, for practical reasons, applying this consistently from month to month. Alternatively, some companies in the Group will cut-off to a particular day of the week each month. For management accounting, this results in a weekly cycle. Accounting requirements applicable to the Group s external reporting at the year-end and half-year require that the balance sheet should reflect the position at the end of the month. Subsidiaries that close their ledgers early should therefore accrue for the effect of this stub period in the income statement and the balance sheet, adjusting all line items where the differences are material and including appropriate amounts in respect of cash sales in this period. Cut-off procedures need to be in place so that the correct cash, revenues, purchases, receivables, payables and inventories are shown in the Group s accounts at a period-end.