1 Basis of preparation.

Significant accounting policies

The Group financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB) as adopted by the European Union, and with those parts of the UK Companies Act 2006 applicable to companies reporting under IFRS. The Group’s financial statements also comply with IFRS and interpretations by the IFRS Interpretations Committee as issued by the IASB. The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of land and buildings, available-for-sale financial assets, and financial assets and financial liabilities (including derivative instruments) at fair value through profit and loss.

The Group has selected accounting policies which state fairly its financial position, financial performance and cash flows for a reporting period. The accounting policies have been consistently applied to all years presented, unless otherwise stated. Accounting policies that relate specifically to a balance or transaction are presented above the relevant numerical disclosure.

The Group presents its balance sheet in order of liquidity. This is considered to be more relevant than a before and after 12 months presentation, given the long term nature of the Group’s core business. However, for each asset and liability line item which combines amounts expected to be recovered or settled before and after 12 months from the balance sheet date, disclosure of the split is made by way of a note. The presentation of the order of the notes to the financial statements has been amended to enable greater understanding of the Group’s financial position and performance, details of which are outlined in the contents page to this report.

Financial assets and financial liabilities are disclosed gross in the balance sheet unless a legally enforceable right of offset exists and there is an intention to settle recognised amounts on a net basis. Income and expenses are not offset in the income statement unless required or permitted by any accounting standard or IFRIC interpretation, as detailed in the applicable accounting policies of the Group.

Foreign currency transactions are translated into the functional currency using the exchange rate prevailing at the date of the transactions. The functional currency of the Group’s foreign operations is the currency of the primary economic environment in which the entity operates. The assets and liabilities of all of the Group’s foreign operations are translated into sterling, the Group’s presentational currency, at the closing rate at the date of the balance sheet. The income and expenses for each income statement are translated at average exchange rates. On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to a separate component of shareholders’ equity.

Standards, interpretations and amendments to published standards that are not yet effective

Certain standards, amendments and interpretations to existing standards have been published which are mandatory for the Group’s accounting periods beginning on or after 1 January 2012 or later periods but which the Group has not adopted early. Details of these are contained within Note 10 (Financial investments), Note 52 (Subsidiaries) and Note 23 (Provisions).

Use of estimates

The preparation of the financial statements includes the use of estimates and assumptions which affect items reported in the consolidated balance sheet and income statement and the disclosure of contingent assets and liabilities at the date of the financial statements. Although these estimates are based on management’s best knowledge of current circumstances and future events and actions, actual results may differ from those estimates, possibly significantly. This is particularly relevant for the determination of fair values of investment property (Note 9) and unquoted and illiquid financial investments (Note 10); the estimation of deferred acquisition costs (Note 40); tax balances (Notes 35, 41 and 42); and the estimation of insurance and investment contract liabilities (Notes 18 and 19). The basis of accounting for these areas, and the significant judgements used in determining them, are outlined in the respective notes to the financial statements.

Reportable segments

During the year, the Group has changed the management lines of the international subsidiaries to reflect the development of our international strategy. This has had the consequence of changing the reportable segments of the Group. Details of the Group’s reportable segments are included in Note 27. In accordance with the requirements of IFRS 8, ‘Operating segments’, the prior period segmental information has been restated to reflect these changes.

Consolidation principles

Subsidiary undertakings

The consolidated financial statements incorporate the assets, liabilities, equity, revenues, expenses and cash flows of the Company and of its subsidiary undertakings drawn up to 31 December each year. All intra-group balances, transactions, income and expenses are eliminated in full. Subsidiaries are those entities (including special purpose entities, mutual funds and unit trusts) over which the Group directly or indirectly has the power to govern the operating and financial policies in order to gain economic benefits (Note 52). Profits or losses of subsidiary undertakings sold or acquired during the period are included in the consolidated results up to the date of disposal or from the date of gaining control. The interests of parties, other than the Group, in investment vehicles, such as unit trusts, are classified as liabilities and appear as ‘Net asset value attributable to unit holders’ (Note 48) in the consolidated balance sheet. The assets and liabilities of all of the Group’s foreign operations are translated into sterling, the Group’s presentational currency, at the closing exchange rate at the date of the balance sheet. The income and expenses for each income statement are translated at average exchange rates. On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and the borrowings and other currency instruments designated as hedges of such investments, are taken to a separate component of shareholders’ equity.

Associates and joint ventures

The Group has interests in associates and joint ventures (Note 53) which form part of an investment portfolio held through private equity partnerships, mutual funds, unit trusts and similar entities. In accordance with the choices permitted by IAS 28, ‘Investments in associates’, and IAS 31, ‘Interests in joint ventures’, these interests have been classified as fair value through profit or loss and measured at fair value within financial investments, with changes in fair value recognised in the income statement.

Associates which do not form part of an investment portfolio are initially recognised in the balance sheet at cost. The carrying amount of the associate is increased or decreased to reflect the Group’s share of the profit or loss after the date of the acquisition.

Product classification

The Group’s products are classified for accounting purposes as either insurance contracts (participating and non-participating) or investment contracts (participating and non-participating). The basis of accounting for these products is outlined in Notes 18 and 19 respectively.

Fiduciary activities

Assets associated with fiduciary activities and the income arising from those assets, together with associated commitments to return such assets to customers, are not included in these financial statements. Where the Group acts in a fiduciary capacity, for instance as a trustee or agent, it has no contractual rights over the assets concerned.

Change to accounting policy – US deferred acquisition costs

During 2012, the Group has changed its accounting policy for deferred acquisition costs in the US. This follows the FASB’s pronouncement on deferral methodology, applying to reporting periods starting after 15 December 2011. This has been applied to IFRS as an improvement in accounting policy, as allowed under IFRS 4, ‘Insurance contracts’.

In October 2010, the Emerging Issues Task Force of the US Financial Accounting Standards Board issued Update 2010-26 on ‘Accounting for costs associated with acquiring or renewing insurance contracts’. Under US GAAP, costs that can be deferred and amortised are those that ‘vary with and are primarily related to the acquisition of insurance contracts’. The Update requires insurers to capitalise only those incremental costs directly related to acquiring a contract, charging all other indirect acquisition expenses to the income statement as incurred. The main impact of the update is therefore to disallow insurers from deferring indirect acquisition costs and those costs relating to unsuccessful sales.

We currently apply US GAAP to value the insurance assets and liabilities of our US operations, as allowed under IFRS 4 ‘Insurance contracts’. As a result of the FASB’s pronouncement we are applying the change in deferral methodology for our US business for deferred acquisition costs retrospectively, restating the comparatives as required under IAS 8, ‘Accounting policies, changes in accounting estimates and errors’.

The impact of the restatement on 2012 was to reduce operating profit and profit before tax by £8m and profit after tax by £5m.

The impact of this change upon the 2011 Group consolidated income statement and Group consolidated statement of comprehensive income, together with the Group consolidated balance sheet at 31 December 2011 and 31 December 2010 is shown below.

The 2010 consolidated balance sheet has not been re-presented as it is not considered material to the understanding of the Group consolidated financial statements.


(XLS:) Changes in Consolidated Income Statement and Statement of Comprehensive Income 2011

 

As reported 2011
£m

Change in US DAC treatment 2011
£m

Restated
2011
£m

Consolidated Income Statement

 

 

 

Acquisition costs

780

3

783

Profit before tax

778

(3)

775

Tax expense

(55)

1

(54)

Profit for the period

723

(2)

721

 

 

 

 

Consolidated Statement of Comprehensive Income

 

 

 

Exchange differences on translation of overseas operations

1

(1)

Net change in financial investments designated as available-for-sale

10

5

15

Total comprehensive income for the period

661

2

663

The restatement of US DAC reduces operating profit by £3m for the 12 months ended 31 December 2011.

(XLS:) Changes in earnings per share and diluted earnings per share 2011

 

As reported 2011
p

Change in US DAC treatment 2011
p

Restated
2011
p

Earnings per share

 

 

 

Based on profit attributable to equity holders of the Company

12.46

(0.04)

12.42

 

 

 

 

Diluted earnings per share

 

 

 

Based on profit attributable to equity holders of the Company

12.25

(0.03)

12.22

(XLS:) Changes in Consolidated Balance Sheet 2010 and 2011

Consolidated Balance Sheet

As reported 2011
£m

Changes in US DAC treatment 2011
£m

Restated 2011
£m

As reported 2010
£m

Changes in US DAC treatment 2010
£m

Restated
2010
£m

Assets

 

 

 

 

 

 

Deferred acquisition costs

2,053

(220)

1,833

2,000

(225)

1,775

Equity

 

 

 

 

 

 

Capital redemption and other reserves

101

16

117

79

12

91

Retained earnings

4,059

(160)

3,899

3,704

(158)

3,546

Liabilities

 

 

 

 

 

 

Deferred tax liabilities

403

(76)

327

356

(79)

277