Finance week – BAE Systems takes cautious approach

Cautious and careful would be an appropriate slogan for BAE Systems’ transition to IFRS, after the company provided a detailed analysis of how new standards would affect its accounts, without actually going so far as to restate its 2004 figures.

Referring to its IFRS analysis, the defence and aerospace giant said that its directors were ‘using their best knowledge’ of the standards and interpretations ‘expected to be effective’ on 31 December 2005.

‘As these interpretations develop, there is a possibility that the analysis may evolve further before constituting the final IFRS balance sheet as at 31 December 2005,’ the company added, providing a further hint that it will be extremely vigilant when implementing the new standards.

Looking over how BAE Systems expects to be influenced by IFRS, it becomes clear why the group will have to be careful.

On transition to IFRS, BAE Systems will have to include special purpose entities (SPEs) – complex financial instruments – in its consolidated group accounts for the first time.

BAE Systems uses SPEs to arrange guarantees for residual values, head leases and finance payments on some of the commercial aircraft it sells.

At the end of 2004, the business had £2.3bn worth of future payments because of these guarantees. The group has an insurance policy covering £1,826m of this exposure.

Under IAS27, the group will have to include all the gross assets and obligations of SPEs that have structured these arrangements in its consolidated balance sheet.

As if the added disclosure were not tricky enough, BAE Systems will also have to reclassify some of the lease arrangements from operating leases to finance leases under IAS17, which sets out criteria for leases that cause changes in assets and debt. It explains why the company is moving cautiously.

The nature of BAE Systems’ business means it will be particularly affected by changes to accounting for long-term contracts and derivative financial instruments.

Under IAS11 and IAS18, the timing and amount of revenue recognition on a long-term contract will change, and the amount of revenue recognised in the early stages of a long-term contract will be reduced. With an order book at the end of 2004 sitting at £50.1bn, the implications for BAE Systems are obvious.

The company’s profit and loss account is also set for some volatility. Because it is a global player exposed to shifts in exchange rates, BAE Systems uses hedges and derivative instruments to manage this risk. Under IFRS, the company will have to reflect these instruments at fair value in the profit and loss account. The gains and losses of the instruments are bound to have an effect on earnings.

With so many balls to juggle, the company’s guarded approach to the new standards is understandable.

IFRS causes £5m charge to Capita, and Hanson makes provision for asbestos claims.

Support services company Capita Group will provide its first restated IFRS accounts – for 2004 – with its 2005 interim results. Capita estimated it would take a £5m charge to its 2005 loss account, because of changes in accounting for share-based payments. It estimated this charge would be around £4m for the restated 2004 accounts.

Hanson plc has had to make provisions in its accounts, as a result of lawsuits against the company’s US subsidiaries from people alleging they were injured by asbestos in its products. Hanson, which reported operating profits of £399.5m and turnover of £3.8bn, made a full-year increase in provisions of $222m (£115m) bringing gross provision to $480m, though discounting brings the provision down by $79m. Settlements, however, are allowable for tax purposes in the US at a rate of 39%, making a gross cost of $60m, equivalent to $36m, post tax.

Alliance & Leicester is expecting IFRS to have little impact on its 2004 pro-forma profit and loss account and the 2005 opening reserves. The banking group said it estimated pre-tax profits to drop by between £10m and £30m – less than 5% of its total pre-tax profit. Opening reserves for 2005 are estimated to drop by around £25m.

Old Mutual plc said its transition to IFRS is on track and that it will be ready to release restated 2004 accounts in May. Old Mutual also saw a £31m one-off increase to its profit and loss account for 2003, after including accounting standards adopted by its South African subsidiary Nedcor. Local reporting requirements saw Nedcor discount future cashflows on advances. The change was acceptable under UK GAAP and Old Mutual decided to include the requirement in its financial statements.

Property investment and management company Hammerson has said it is in discussion with other property companies on the most consistent way to implement IFRS. The company, which reported operating profits up to £127.2m from £67.1m, said the main impact of IFRS would be to move property-revaluation surplus deficits from the statement of recognised gains and losses to the income statement.

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