Impact of adoption of IFRS
EXPLANATION OF IFRS ADJUSTMENTS
The following paragraphs explain the key adjustments which have been made to the financial results for the year ended 30 September 2005, in order to reflect IFRS.
1. Share-based Payments (IFRS 2)
The Group currently maintains share-based incentive schemes comprising a Long Term Incentive Plan (LTIP) and a closed Matching Share Bonus Scheme (MSB).
Under UK GAAP, companies were required to recognise an expense over the performance period based on the intrinsic value of the share-based award. This value was the difference between the exercise price and the fair value of the share at the date of the award (typically the market price), adjusted to reflect expected and actual levels of vesting and the actual cost of the shares acquired to satisfy the award.
Under IFRS 2, an expense is also recognised in the income statement for all share-based payments over the vesting period. Where performance conditions for the Group's LTIP and MSB are based on growth in earnings per share, which under IFRS is a "non-market based" measure, the expense is adjusted each year to reflect expected and actual levels of vesting.
However, under the Group's LTIP, part of the award is also based on the performance condition of total shareholder return ("TSR") relative to the FTSE mid-250 Index (excluding investment trusts). Under IFRS this is a "market based" measure and the expense is determined at commencement of the award and not adjusted, other than for forfeitures.
The IFRS expense in respect of this "market based" measure of the LTIP has been based on the fair value of the award at the date of grant; IFRS requires companies to use a model to simulate future share price movements for the Company and its comparator group.
The Directors have used a predicted future value model to determine the fair value of the award at the date of grant. The adoption of this model was subsequent to the Announcement on 25 January 2006 and has led to a reduction in the cost of the share awards; this has resulted in an additional credit to profit of £0.1m in the year ended 30 September 2005.
There were two potential principal differences in the accounting methods for share-based payments under UK GAAP and IFRS. These related to:
- the cost of the shares acquired by the Group to meet the awards, on the assumptions set out above, which were used under UK GAAP to determine the fair value of the awards and was being charged to profit over the performance period. Under IFRS, the cost of acquiring shares is charged directly to retained earnings and not the income statement; and
- the closed MSB which (subject to achieving a "non-market based" performance condition) gave participants matching shares after two years, if they invested their annual cash bonus in the Company's shares. Although the total charge over time was the same under UK GAAP and IFRS, the phasing was different. Under UK GAAP, all of the expense of a grant was taken in the year in which the performance was measured. Under IFRS, the expense has been spread over a three year period starting in the year when the bonus on which it is based was earned.
The operating expense arising from the adoption of IFRS 2 in the year ended 30 September 2005 was £0.4m compared to a UK GAAP expense of £0.6m. The ongoing annual operating expense under IFRS is expected to be in the region of £0.5m, although the actual charge each year will be influenced by the likelihood of performance conditions being met in respect of the non-market based measure part of the LTIP award.
2. Employee Benefits (IAS 19)
Under UK GAAP, the Group accounted for pensions in accordance with SSAP 24. This Standard adopted an income statement driven approach which spread the cost of providing benefits over the estimated average service lives of employees. This resulted in a stable, regular charge to income. The SSAP 24 discount rate was based on the long-term estimate of the scheme's investment return. Typically, under SSAP 24, pension costs were reviewed triennially.
Under UK GAAP, the Group also provided the required disclosures in accordance with FRS 17 which set out the pension fund deficits and the assets and liabilities based on the valuation methodologies of that Standard. FRS 17 was fundamentally different to SSAP 24 and adopted a balance sheet driven approach with market based measures. The discount rate under FRS 17 was based on the market yield of high quality corporate bonds at the valuation date. Valuations were updated annually.
IAS 19 Employee Benefits adopts a similar valuation approach to FRS 17. Furthermore, an amendment to IAS 19 also provided an option that allowed actuarial gains and losses to be accounted for through the consolidated statement of recognised income and expense, similar to FRS 17, from the date of transition to IFRS, namely 1 October 2004. The Group chose to adopt this option.
Set out below is a comparison of the impact of accounting for the Group's defined benefit pension schemes under SSAP 24, FRS 17 and IAS 19, in the income statement for the year ended 30 September 2005 and the balance sheet as at 30 September 2005:
|
Income Statement 2005 |
Balance sheet 30 September 2005 |
|||||||||
|
SSAP 24 |
FRS 17 |
IAS 19 |
SSAP 24 |
FRS 17 |
IAS 19 |
|||||
Principal Schemes: |
|||||||||||
PLC |
(0.1) |
- |
- |
(0.1) |
(0.9) |
(0.9) |
|||||
Anachem |
(0.3) |
- |
- |
(0.5) |
(3.5) |
(3.5) |
|||||
Pre-tax charge / net deficit |
(0.4) |
- |
- |
(0.6) |
(4.4) |
(4.4) |
|||||
Deferred tax asset |
0.2 |
1.3 |
1.3 |
||||||||
| Net liability | (0.4) |
(3.1) |
(3.1) |
||||||||
IAS 19 compared to SSAP 24
Under SSAP 24, there was a charge in the income statement amounting to £0.4m. Under IAS 19, this charge (after the curtailment gain of £0.2m) was reduced to £nil for the year ended 30 September 2005, which increased operating profit by £0.4m. The impact of IAS 19 on the UK GAAP (SSAP 24) balance sheet at 30 September 2005 was to reduce net assets by £2.7m, including the impact of deferred tax. The impact excludingdeferred tax was £3.8m, which arose as a result of including the pension scheme deficit on the balance sheet, which was not required under SSAP 24.
The net pension deficit (after deferred tax) of the Group's defined benefit pension schemes under IFRS at 30 September 2005 was £3.1m.
IAS 19 compared to FRS 17
IAS 19 has some minor differences from FRS 17, but these do not result in a significant difference in the impact of these two Standards on the income statement. In addition, IAS 19 is not specific in a number of areas and is therefore open to interpretation. In particular:
- IAS 19 is not specific with respect to the inclusion of scheme expenses when calculating scheme liabilities. The Group has included an allowance for the cost of future scheme expenses in calculating scheme liabilities. Such an allowance was not required under FRS 17; and
- IAS 19 is silent on the treatment of non-service related benefits, for example death in service lump sum payments. The Group has adopted the treatment of apportioning the cost between the past service liability and the service cost. This is slightly different to the method under FRS 17.
The impact of these two areas of interpretation at the transition date and at 30 September 2005 was to slightly increase the pension scheme liabilities, compared to that disclosed under FRS 17. However these numbers are not significant and have not impacted the reported numbers.
3. Termination of Defined Benefit Pension Scheme (IAS 19)
During 2005 the Group negotiated the termination of the defined benefit scheme of one of its subsidiary companies, namely the Anachem Pension Scheme. The negotiations resulted in the cessation of future accrual of benefits and as such, represented a curtailment under IAS 19, since the Group is demonstrably committed to control the costs of pension provision.
Under UK GAAP in SSAP 24, no gain or loss was recognised in the income statement from the decision to close the pension scheme to future accrual. However under IFRS, the curtailment gain which arose from the termination of this Scheme is the aggregate of the change in the present value of the defined obligation, the change in the fair value of the Scheme's assets and any related actuarial gains and losses. Hence in the year ended 30 September 2005, under IFRS the Group has recognised a curtailment gain of £0.2m, being the aggregate reduction in the present value of the defined benefit obligation, less the reduction in the unrecognised actuarial loss.
4. Business Combinations and Goodwill
A business combination occurs when one entity gains control of another. The acquired assets and liabilities should be stated at fair value in the books of the acquirer (if appropriate) or in the group accounts. The excess of the purchase price over the cost is classified as goodwill on the face of the balance sheet in the group accounts.
Under UK GAAP, goodwill was amortised over its estimated useful life, which the Directors determined to be between 5 and 20 years in respect of the businesses acquired where goodwill has been capitalised.
Under IFRS, goodwill is considered to have an indefinite life and therefore goodwill should not be amortised but should be reviewed, at least annually, for impairment and carried in the balance sheet at cost less any accumulated impairment losses.
Goodwill already in existence at the transition date to IFRS has not been adjusted. The impact on the income statement for the year ended 30 September 2005 was that goodwill amortisation of £1.3m that was previously charged under UK GAAP, has now been removed under IFRS. The annual impairment test required under IFRS at 30 September 2005 did not result in any reduction in the carrying value of goodwill.
5. Intangible Assets
Under UK GAAP, all capitalised computer software was included within tangible fixed assets as plant and equipment. Under IFRS, only computer software that is integral to a related item of hardware can be included as plant and equipment. All other computer software must be recorded as an intangible asset. This means that application software costs that previously had been capitalised as tangible fixed assets, are now reclassified as other intangible assets.
Accordingly, a reclassification of the net book amount of capitalised computer software of £0.6m was made in the transition balance sheet (at 1 October 2004) and also £0.6m in the balance sheet as at 30 September 2005 between property, plant and equipment and other intangible assets. There was no impact on the income statement as a result of this reclassification since, under both UK GAAP and IFRS, computer software is depreciated over its estimated useful economic life.
6. Income Taxes (IAS 12)
Under UK GAAP, deferred taxation was recognised on the basis of timing differences, being the difference between accounting profit and taxable profit. IFRS requires deferred taxation to be based on temporary differences, being the difference between the carrying value of an asset or liability and its tax base. As a result of the accounting treatment of defined benefit pension schemes under IFRS, the Group recognised an additional £1.2m of deferred tax asset in the transition balance sheet. In addition, a further £1.9m of deferred tax assets was recognised in the transition balance sheet which primarily related to overseas goodwill, in respect of which the Group receives a tax benefit on the amortisation thereof. Where required, deferred tax was also provided on the IFRS adjustments.
The impact of IFRS on the total tax charge for the year ended 30 September 2005 was to increase the tax charge by £0.6m to £5.0m, representing an effective tax rate of 29% on profit before tax on an IFRS basis. The impact of IFRS on deferred tax in the balance sheet at transition and at 30 September 2005 was as follows:
|
2005 |
2004 £m |
| Deferred tax asset at 30 September - UK GAAP | 0.6 | - |
IFRS adjustments: |
||
| Deferred tax on pension deficit | 1.1 | 1.2 |
| Deferred tax on overseas goodwill | 1.2 | 1.5 |
| Other timing differences | 0.2 | 0.4 |
| Deferred tax asset at 30 September - IFRS | 3.1 | 3.1 |
7. Provisions Reclassification (IAS 1)
IFRS requires the elements of provisions which are expected to be paid within one year of the balance sheet date to be presented on the balance sheet within current liabilities as short term provisions. This resulted in £1.0m of provisions relating principally to deferred consideration, being reclassified as other liabilities in the balance sheet at 30 September 2005.
8. Events after the Balance Sheet Date (IAS 10)
Under UK GAAP, ordinary dividends were accounted for in the period to which they related, even if the approval of that dividend took place after the balance sheet date. However under IFRS, proposed ordinary dividends do not meet the definition of a liability until such time as they have been approved. In the case of a final ordinary dividend this approval is by shareholders at the Annual General Meeting. The approval of an interim dividend takes place at a meeting of the Board of Directors. This means that each dividend must now be accounted for in the period in which it is approved, rather than in the period to which it related.
In addition, under IFRS, ordinary dividends are no longer disclosed on the face of the income statement, but shown as a movement in equity.
The final dividend for the year ended 30 September 2004 of £2.4m was reversed in the transition balance sheet and charged to equity in the half year ended 31 March 2005. The interim dividend for the six months ended 31 March 2005 of £1.6m was reversed and charged to equity in the half year ended 30 September 2005. The final dividend for the year ended 30 September 2005 of £2.9m has also been reversed and has been charged to equity in the year ended 30 September 2006, following approval at the Annual General Meeting on 11 January 2006.
9. Financial Instruments (IAS 32 and 39)
As permitted, the implementation of IAS 32 (Financial Instruments: Disclosure and Presentation), and IAS 39 (Financial Instruments: Recognition and Measurement), was first applied to the financial year ended 30 September 2006. As a result, financial instruments continued to be accounted and presented in accordance with UK GAAP for the year ended 30 September 2005. Accordingly, there has been an adjustment at 1 October 2005 to reflect the transition from UK GAAP to IFRS, as set out in note 18 to the consolidated financial statements.
The most significant financial instruments for Diploma are its forward purchases of foreign currencies to hedge the value of transactions carried out in the UK relating to purchases from overseas. As all of the Group's derivatives qualify for hedge accounting under IFRS and there are no gains or losses on these contracts from market movements, that have been charged or credited to the income statement.