Tesco 2015 Annual Report Download - page 95

Note 1 Accounting policies continued
• IAS 19 ‘Employee Benefits’ – non-cash Group Income Statement charge
for pensions. Under IAS 19, the cost of providing pension benefits in the
future is discounted to a present value at the corporate bond yield rates
applicable on the last day of the previous financial year. Corporate bond
yield rates vary over time which in turn creates volatility in the Group
Income Statement and Group Balance Sheet. IAS 19 also increases the
charge for young pension schemes, such as the Group’s, by requiring the
use of rates which do not take into account the future expected returns on
the assets held in the pension scheme which will fund pension liabilities as
they fall due. The sum of these two effects can make the IAS 19 charge
disproportionately higher and more volatile than the cash contributions
the Group is required to make in order to fund all future liabilities.
Therefore, within underlying profit the Group has included the ‘normal’
cash contributions for pensions but excluded the volatile element of IAS 19 to
represent what the Group believes to be a fairer measure of the cost of
providing post-employment benefits;
• IAS 17 ‘Leases’ – impact of annual uplifts in rent and rent-free periods.
Some operating leases have been structured in a way to increase annual
lease costs as the businesses expand. IAS 17 requires the total expected cost
of a lease to be recognised on a straight-line basis over the term of the
lease, irrespective of the actual timing of the cost. This adjustment also
impacts the Group’s operating profit and rental income within the share
of post-tax profits ofjoint ventures and associates;
• IFRS 3 (Revised) ‘Business Combinations’ – intangible asset amortisation
charges and costs arising from acquisitions. Under IFRS 3 intangible assets
are separately identified and fair valued. The intangible assets are required
to be amortised on a straight-line basis over their useful lives and as such is
a non-cash charge that does not reflect the underlying performance of the
business acquired. Similarly, the standard requires all acquisition costs to be
expensed in the Group Income Statement. Due to their nature, these costs
have been excluded from underlying profit as they do not reflect the
underlying performance of the Group;
• IFRIC 13 ‘Customer Loyalty Programmes’ – fair value of awards.
The interpretation requires the fair value of customer loyalty awards
to be measured as a separate component of a sales transaction.
The underlying profit measure removes this fair value allocation
to present underlying business performance, and to reflect the
performance of the operating segments as measured by management;
• restructuring and other one-off items. These relate to certain costs
associated with the Group’s restructuring activities and certain one-off
costs including costs relating to fair valuing the assets of a disposal group.
These have been excluded from underlying profit as they do not reflect
the underlying performance of the Group; and
• profits/losses from property-related items. These relate to the Group’s
property activities including gains and losses on disposal of property assets,
development property built for resale and property joint ventures; costs
resulting from changes in the Group’s store portfolio and distribution
network, including pre-opening and post closure costs; and income/
(charges) associated with impairment of non-trading property and related
onerous contracts. These have been excluded from underlying profit
as they do not reflect the underlying performance of the Group.
Standards issued but not yet effective
As of the date of authorisation of these financial statements, the following
standards were in issue but not yet effective. The Group has not applied
these standards in the preparation of the financial statements, and has
not adopted any new or amended standards early:
• IFRS 9 ‘Financial instruments’ is effective for periods commencing
on or after 1 January 2018 subject to endorsement by the EU. IFRS 9 is
a replacement for IAS 39 ‘Financial Instruments’ and covers three distinct
areas. Phase 1 contains new requirements for the classification and
measurement of financial assets and liabilities. Phase 2 relates to the
impairment of financial assets and requires the calculation of impairment
on an expected loss basis rather than the current incurred loss basis. Phase
3 relates to less stringent requirements for general hedge accounting; and
• IFRS 15, ‘Revenues from Contracts with Customers’, replaces IAS 18,
‘Revenues’, and introduces a five step approach to revenue recognition
based on performance obligations in customer contracts. The International
Accounting Standards Board (‘IASB’) has proposed to issue some clarifications
and to defer the standard’s effective date of 1 January 2017 to 1 January
2018. The effective date for the Group is also subject to EU endorsement.
The impact on the Group’s financial statements of the future adoption
of these standards is still under review.
Use of non-GAAP measures
Free cash flow
Free cash flow is net cash generated from/(used in) operating activities
less capital expenditure on property, plant and equipment, investment
property and intangible assets.
Net debt
Net debt excludes the net debt of Tesco Bank but includes that of the
discontinued operations. Net debt comprises bank and other borrowings,
finance lease payables, net derivative financial instruments, joint venture
loans and other receivables and net interest receivables/payables, offset
by cash and cash equivalents and short-term investments.
Trading profit
Trading profit is an adjusted measure of operating profit and measures
the performance of each segment before profits/(losses) arising on
property-related items, the impact on leases of annual uplifts in rent and
rent-free periods, intangible asset amortisation charges and costs arising
from acquisitions, and goodwill impairment and restructuring and other
one-off items. The IAS 19 pension charge is replaced with the ‘normal’
cash contributions for pensions. An adjustment is also made for the fair
value of customer loyalty awards.
Underlying net interest
Underlying net interest, as included in underlying profit, excludes
net pension finance costs and IAS 39 ‘Financial Instruments’ – fair
value measurements.
Underlying profit before tax
The Directors believe that underlying profit before tax and underlying diluted
earnings per share measures provide additional useful information for
shareholders on underlying trends and performance. These measures are
used for performance analysis. Underlying profit is not defined by IFRS and
therefore may not be directly comparable with other companies’ adjusted
profit measures. It is not intended to be a substitute for, or superior to,
IFRS measurements of profit. Tax impact on non-GAAP measures is included
within Note 9. The adjustments made to reported profit before tax are:
• IAS 32 and IAS 39 ‘Financial Instruments’ – fair value remeasurements.
Under IAS 32 and IAS 39, the Group applies hedge accounting to its various
hedge relationships when allowed under IAS 39 and when practical to
do so. Sometimes the Group is unable to apply hedge accounting to the
arrangements but continues to enter into these arrangements as they
provide certainty or active management of the exchange rates and interest
rates applicable to the Group. The Group believes these arrangements
remain effective and economically and commercially viable hedges despite
the inability to apply hedge accounting. Where hedge accounting is not
applied to certain hedging arrangements, the reported results reflect the
movement in fair value of related derivatives due to changes in foreign
exchange and interest rates. In addition, at each year end, any gain or loss
accruing on open contracts is recognised in the Group Income Statement
for the financial year, regardless of the expected outcome of the hedging
contract on termination. This may mean that the Group Income Statement
charge is highly volatile, whilst the resulting cash flows may not be as
volatile. The underlying profit measure removes this volatility to help
better identify the underlying performance of the Group;
93Tesco PLC Annual Report and Financial Statements 2015
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