In accordance with European Union Regulations, the Group adopted IFRS from January 1, 2004, and restated its financial statements for the year ended December 31, 2004, which were previously reported under UK Generally Accepted Accounting Practices (GAAP). An analysis of the impact of implementing IFRS was published in a news release on April 14, 2005, available here.
The major changes required by the introduction of IFRS were:
- recognition of intangible assets, whereby certain qualifying costs, in particular related to research and development and recoverable engine costs, which were written off under UK GAAP, are required to be recognised and amortised over a future period of time;
- treatment of financial instruments, whereby the majority of financial assets and derivatives, employed by the Group to provide stability for long-term business planning, for example in respect of foreign exchange rates, will be fair-valued on the balance sheet with subsequent changes in fair values recorded in the income statement, unless cash flow hedge accounting is applied;
- financial risk and revenue sharing partnerships, whereby a balance sheet liability is required to be established to reflect the expected future value of payments to partners;
- pensions and other post-retirement costs, whereby pension scheme deficits are required to be recorded on the balance sheet;
- the cessation of amortisation of goodwill; and
- the recording of share-based payments at fair value.
The Group achieved hedge accounting under UK GAAP. However the strict methodology to achieve hedge accounting under IAS 39 limits its application for use by the Group unless there are significant changes to the way in which the Group operates its economic hedging policies. The Group has determined that its existing hedging strategy is in the best interests of the business and its shareholders. It has not, therefore, altered its hedging activities in order to achieve a particular accounting presentation under the new rules.
The Group has applied hedge accounting to its interest rate derivative hedge book, but has not applied cash flow hedge accounting to its foreign exchange and commodity derivative hedge books. Details of the adjustments made in adopting IFRS are provided below. Reconciliations for the 2004 restated opening and closing balance sheets, income statement and cash flow are also provided.
Presentation of financial statements
The Group's primary financial statements have been presented in accordance with IAS 1 Presentation of Financial Statements.
The principal impact on the income statement is the presentation of the Group's share of the results of joint ventures (which are accounted for using the equity method) as a single line. Under UK GAAP, the Group's shares of operating profit, interest and taxation were reported separately. As a consequence, the Group's share of joint venture taxation is included in profit before tax. There is no impact on reported profit after tax.
The format of the balance sheet has been amended to include the items required by IAS 1 to be presented on the face of the balance sheet.
Transitional arrangements
The rules for the first-time adoption of IFRS are set out in IFRS 1. In general, a company is required to determine its IFRS policies and apply those retrospectively to determine its opening balance sheet under IFRS. IFRS 1 allows a number of exemptions to this general requirement. Where Rolls-Royce has applied these exemptions, they are noted in the relevant section below. In particular the Group has adopted the exemption that IAS 32 and IAS 39 Financial Instruments need not be applied to the comparative period. Consequently the restated results for the year ended December 31, 2004 have been prepared using the accounting policies for financial instruments previously adopted under UK GAAP. This has led to a second transition at January 1, 2005, details of which are provided below, together with a balance sheet reconciliation.
Research and development
IAS 38 requires that all development costs meeting specified criteria be capitalised as intangible assets.
As part of its IFRS transition project, Rolls-Royce reviewed all development projects, whether the costs were previously recognised under UK GAAP or not, to determine whether the criteria in IAS 38 were met. The key eligibility criteria for capitalisation relate to:
- Identification of development costs. In general, research and development activities are closely interrelated and it is not until the technical feasibility of the project can be determined with reasonable certainty that development costs can be separately identified; and
- The generation of future economic benefit. Intangible assets are not recognised unless the project is expected to generate future economic benefit exceeding the amount capitalised.
Certain expenditures on internal product development meet all the criteria of IAS 38 and have therefore been capitalised.
