© Rolls-Royce Group plc 2004
1 Accounting policies
Basis of accountingThe financial statements have been prepared in accordance with applicable accounting standards on the historical cost basis, modified to include the revaluation of land and buildings.
Basis of consolidationThe Group financial statements include the financial statements of the Company and all of its subsidiary undertakings made up to December 31, together with the Group’s share of the results up to December 31 of:
i) Joint ventures
A joint venture is an entity in which the Group holds a long-term interest and which is jointly controlled by the Group and one or more other venturers under a contractual arrangement. The results of joint ventures are accounted for using the gross equity method of accounting.
ii) Joint arrangements that are not entities
The Group has certain contractual arrangements with other participants to engage in joint activities that do not create an entity carrying on a trade or business of its own. The Group includes its share of assets, liabilities and cash flows in such joint arrangements, measured in accordance with the terms of each arrangement, which is usually pro rata to the Group’s risk interest in the joint arrangement.
Any subsidiary undertakings, joint ventures and joint arrangements that are not entities, sold or acquired during the year are included up to, or from, the dates of change of control.
During the year
Some small adjustments have been made to comparative figures to put them on a consistent basis with the current year.
Purchased goodwillGoodwill represents the excess of the fair value of the purchase consideration for shares in subsidiary undertakings and joint ventures over the fair value to the Group of the net assets acquired.
i) To December 31, 1997: Goodwill was written off to reserves in the year of acquisition. The profit or loss on the disposal of a business acquired before December 31, 1997 takes into account the attributable value of purchased goodwill relating to that business.
ii) From January 1, 1998: Goodwill has been recognised within fixed assets in the year in which it arises and amortised on a straight line basis over its useful economic life, up to a maximum of 20 years.
TurnoverTurnover, excluding value added tax and discounts, comprises sales to outside customers, and the Group’s percentage interest in sales of joint ventures. Long-term contracts are included in turnover on the basis of the sales value of work performed during the year by reference to the total sales value and stage of completion of these contracts.
Risk and revenue sharing partnershipsFrom time to time the Group enters into arrangements with partners who, in return for a share in future programme turnover or profits, make cash or other payments in kind which are not expected to be refundable. Sums received are credited to other operating income and payments to partners are charged to cost of sales.
Research and developmentThe charge to the profit and loss account consists of research and development expenditure incurred in the year, excluding known recoverable costs on contracts, contributions to shared engineering programmes and application engineering. Application engineering expenditure, incurred in the adaptation of existing technology to new products, is capitalised and amortised over the programme life, up to a maximum of ten years, where both the technical and commercial risks are considered to be sufficiently low.
Foreign currenciesAssets and liabilities denominated in foreign currencies are translated into sterling at the rate ruling at the year end or, where applicable, at the estimated sterling equivalent, taking account of future foreign exchange and similar contracts. The trading results of overseas undertakings are translated at the average exchange rates for the year or,where applicable, at the estimated sterling equivalent, taking account of future foreign exchange and similar contracts. Exchange adjustments arising from the retranslation of the opening net investments, and from the translation of the profits or losses at average rates, are taken to reserves. Other exchange differences, including those arising from currency conversions in the usual course of trading, are taken into account in determining profit on ordinary activities before taxation.
Treasury instrumentsThe accounting treatment of the key instruments used by the Group is as follows:
i) Gains or losses arising on forward exchange contracts are taken to the profit and loss account in the same period as the underlying transaction.
ii) Net interest arising on interest rate agreements is taken to the profit and loss account.
iii) Premiums paid or received on currency options are taken to the profit and loss account when the option expires or matures.
iv) Gains or losses arising on jet fuel swaps are taken to the profit and loss account in the same period as the underlying transaction.
If the underlying transaction to a hedge ceases to exist, the hedge is terminated and the profits and losses on termination are recognised in the profit and loss account immediately. If the hedge transaction is terminated, the profits and losses on termination are held in the balance sheet and amortised over the life of the original underlying transactions.
Post-retirement benefitsContributions to Group defined benefit pension schemes are charged to the profit and loss account so as to spread the cost of pensions at a substantially level percentage of payroll costs over employees’ service lives.
The cost of providing post-retirement benefits other than pensions is charged to the profit and loss account over the service lives of the relevant employees.
Certification costsCosts incurred in respect of meeting regulatory certification requirements for new civil engine/aircraft combinations, including those paid to airframe manufacturers, are carried forward in intangible assets to the extent that they can be recovered out of future sales and are charged to the profit and loss account over the programme life, up to a maximum of ten years.
InterestInterest payable is charged to the profit and loss account as incurred, except where the borrowing finances tangible fixed assets in the course of construction relating to power development projects. Such interest is capitalised until the asset is complete and is then written off by way of depreciation of the relevant asset. Interest receivable is credited to the profit and loss account as earned.
TaxationProvision for taxation is made at the current rate and for deferred taxation at the projected rate on all timing differences which have originated, but not reversed at the balance sheet date.
Scrip dividendsThe amounts of dividends taken as shares instead of cash under the scrip dividend scheme have been added back to reserves.The nominal value of shares issued under the scheme has been funded out of the share premium account.
B SharesThe Company is proposing to issue B Shares to shareholders in place of a dividend. These can be redeemed for cash or converted into ordinary shares in the Company. This provides the Group with significant tax benefits. Conditional on approval by shareholders, B Shares with an aggregate nominal value of 5.00 pence per ordinary share will be issued instead of paying a final dividend. As this is not classed as a dividend, no accrual can be made for this in the financial statements.
Stock, contract provisions and long-term contractsStock and work in progress are valued at the lower of cost and net realisable value. Full provision is made for any estimated losses to completion of contracts having regard to the overall substance of the arrangements including, if appropriate, related commitments and undertakings given by customers. Provided that the outcome of long-term contracts can be assessed with reasonable certainty, such contracts are valued at cost plus attributable profit earned to date.
Progress payments received, when greater than recorded turnover, are deducted from the value of work in progress except to the extent that payments on account exceed the value of work in progress on any contract where the excess is included in creditors. The amount by which recorded turnover of long-term contracts is in excess of payments on account is classified as ‘amounts recoverable on contracts’ and is separately disclosed within debtors.
Accounting for leasesi) As Lessee
Assets financed by leasing agreements which give rights approximating to ownership (finance leases) have been capitalised at amounts equal to the original cost of the assets to the lessors and depreciation provided on the basis of the Group depreciation policy. The capital elements of future obligations under finance leases are included as liabilities in the balance sheet and the current year’s interest element, having been allocated to accounting periods to give a constant periodic rate of charge on the outstanding balance, is charged to the profit and loss account.
The annual payments under all other lease arrangements, known as operating leases, are charged to the profit and loss account on an accruals basis.
ii) As Lessor
Amounts receivable under finance leases are included under debtors and represent the total amount outstanding under lease agreements less unearned income. Finance lease income, having been allocated to accounting periods to give a constant periodic rate of return on the net cash investment, is included in turnover.
Rentals receivable under operating leases are included in turnover on an accruals basis.
Tangible fixed assets and depreciationTangible fixed assets are stated at cost or valuation less accumulated depreciation and any provision for impairments in value.
Depreciation is provided on the following basis:
i) Land and buildings
Depreciation is provided on the original cost of purchases since 1996 and on the valuation of properties adopted at December 31, 1996 and is calculated on a straight line basis at rates sufficient to reduce them to their estimated residual value. Estimated lives, as advised by the Group’s professional valuers, are:
a) Freehold buildings – five to 45 years (average 23 years).
b) Leasehold land and buildings – lower of valuers’ estimates or period of lease.
No depreciation is provided in respect of freehold land.
ii) Plant and equipment
Depreciation is provided on the original cost of plant and equipment and is calculated on a straight line basis at rates sufficient to reduce them to their estimated residual value. Estimated lives are in the range five to 25 years (average 16 years).
iii) Aircraft and engines
Depreciation is provided on the original cost of aircraft and engines and is calculated on a straight line basis at rates sufficient to reduce them to their estimated residual value. Estimated lives are in the range five to 20 years (average 15 years).
iv) In course of construction
No depreciation is provided on assets in the course of construction.