Operating and Financial Review

Financial Review

 
 

US GAAP reporting

Overview

The accounts have been prepared in accordance with UK GAAP, which differs in certain significant respects from US GAAP. A reconciliation of net income and equity shareholders’ funds from UK GAAP to US GAAP, together with a summary of adjustments, is provided in note 32 to the accounts on. In addition, condensed income statements, balance sheets and segmental information prepared in accordance with US GAAP are provided in note 33 to the accounts.

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Results and financial position under US GAAP

Net income from continuing operations for 2004/05 under US GAAP was £1,304 million (2003/04: £998 million; 2002/03: £790 million). The US GAAP results for 2004/05, 2003/04 and 2002/03 included losses relating to discontinued operations amounting to £nil; £nil; and £39 million respectively. Consequently, net income for 2004/05 under US GAAP was £1,304 million (2003/04: £998 million; 2002/03: £751 million). This compared with the profit for the year under UK GAAP for 2004/05, 2003/04 and 2002/03 of £908 million; £1,074 million; and £351 million respectively.

Equity shareholders’ funds under US GAAP at 31 March 2005 were £10,591 million (2004: £9,821 million) compared with £1,359 million (2004: £1,221 million (restated)) under UK GAAP. Because the application of merger accounting principles under UK GAAP has fundamentally affected the comparison of UK GAAP results with US GAAP results, the following is a discussion of the impact the application of US GAAP has had on the results, which should be read in conjunction with the Operating Review and the rest of this Financial Review.

Note 33 to the accounts shows condensed financial statements for 2004/05, 2003/04 and 2002/03 under US GAAP.

The principal adjustments from net income and equity shareholders’ funds under UK GAAP to their equivalents under US GAAP relate to adjustments arising from differences in accounting for the acquisition of the UK operations of Crown Castle International Corp. during 2004/05; the treatment of the business combination with Lattice Group plc as an acquisition instead of as a merger; the capitalisation of replacement expenditure; the recording of derivative financial instruments at their fair value in the balance sheet; and the non-amortisation of goodwill. The other adjustments between UK GAAP and US GAAP are explained in more detail in note 32 to the accounts.

Some of the adjustments included within the US GAAP summary income statements and balance sheet substantially reflect reclassifications of items that are presented differently under UK GAAP and US GAAP, but that do not significantly impact on net income or net assets.

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Continuing and discontinued operations

Under UK GAAP, the operating results of discontinued operations of Group undertakings are classified as part of total operating profit, whereas under US GAAP these amounts are shown net of any related interest and tax and shown as ‘net loss from discontinued operations’. In respect of the discontinued activities of joint ventures, under UK GAAP these activities are also classified as part of total operating profit, whereas under US GAAP these amounts are accounted for within ‘interest in equity accounted affiliates’. The share of equity affiliates’ operating profit/(loss), net interest, taxation, and minority interests are disclosed separately under UK GAAP, whereas, under US GAAP, all these amounts are accounted for within ‘interest in equity accounted affiliates’.

At 31 March 2005, the planned sales of four of our regional gas distribution networks did not meet the criteria to be classified as discontinued under UK GAAP, US GAAP or IFRS. Since 31 March 2005, these criteria have been met for US GAAP and IFRS purposes, and so the Group will reclassify the assets, liabilities and results of these operations as discontinued in preparing the interim results for the six months ending 30 September 2005 and the full year results for the year ending 31 March 2006.

Under UK GAAP, the planned sales are not presented as discontinued as the sales had not completed at the date the financial statements were approved. However, additional UK GAAP information has been included in note 2 to the accounts and additional US GAAP information has been included in note 32.

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Business combinations
Acquisition accounting

Under US GAAP, the Group applies purchase accounting to its business combinations, which is different from acquisition accounting under UK GAAP in certain respects. The most significant areas of difference are in the recognition of separately identifiable intangible assets and in measuring the fair value of acquired assets and liabilities assumed. This affects the amount of goodwill recognised under US GAAP as compared with UK GAAP. In the acquisition of the UK operations of Crown Castle International Corp. during 2004/05, the Group recognised £509 million of goodwill under US GAAP, compared with £622 million recognised under UK GAAP. The difference arises primarily as a result of £220 million of separately identifiable intangibles being recognised under US GAAP, partially offset by £96 million of deferred tax on that and other fair value adjustments. Furthermore, goodwill is not amortised under US GAAP as it is under UK GAAP but is measured annually for impairment.

Merger with Lattice Group plc

The application of UK GAAP to the business combination of National Grid Group plc and Lattice Group plc in 2002/03 resulted in the transaction being treated as a merger, and so the accounts present the results of the Group on a combined basis both before and after the merger, using common accounting policies.

Under US GAAP, purchase accounting was applied to this business combination, which is a fundamentally different method of accounting from the merger accounting applied under UK GAAP. Under US GAAP, National Grid Group plc (now National Grid Transco) is viewed as the acquirer of Lattice Group plc.

The results of the Group under US GAAP only include the results of Lattice Group plc from 21 October 2002, the date of the business combination, and not prior to this date.

In an acquisition under US GAAP, the assets and liabilities of the acquired business are measured at fair value as at the date of the acquisition and goodwill is recognised for the amount of the purchase price in excess of the fair value of the net assets acquired and liabilities assumed. The assets and liabilities of Lattice Group plc were measured and recorded at their fair values in the consolidated accounts of National Grid Group plc at the time of the business combination. This resulted in £3,824 million of goodwill being recognised under US GAAP.

The most significant adjustment in establishing the fair value of the net assets acquired was attributable to property, plant and equipment. The most significant element, accounting for 94% of the total adjustment to property, plant and equipment, was in relation to Transco plc. Management determined that its knowledge of the UK regulatory environment within which Transco plc operates is superior to that of external specialists and therefore it was better qualified to estimate the relevant fair values. Thus, no external specialists were used and the adjustments were determined by management.

The treatment of this business combination as an acquisition under US GAAP has significantly affected the UK electricity and gas transmission segment, UK gas distribution segment, and other activities, as compared with the treatment under UK GAAP. The remaining segments are unaffected by differences between merger and acquisition accounting principles. Consequently, this has impacted on the results of the segments as follows:

  • under US GAAP, the results of the UK electricity and gas transmission segment for 2002/03 relate solely to electricity transmission activities prior to 21 October 2002. Subsequent to that date, the segment results under US GAAP included gas transmission activities, which contributed £94 million to operating profit for 2002/03. In 2004/05 and 2003/04 respectively, the UK electricity and gas transmission segment contributed £ 711 million and £676 million to operating profit; and
  • UK gas distribution is a segment that was created following the business combination. The segment contributed £712 million, £758 million and £567 million to operating profit for 2004/05, 2003/04 and 2002/03 respectively.

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Investments

Under UK GAAP, the results of Citelec, an equity accounted affiliate, were accounted for under hyper-inflationary accounting rules. Under US GAAP, the results of Citelec are not accounted for under hyper-inflationary accounting rules, but this did not give rise to any significant accounting difference compared with UK GAAP, as Citelec had already been impaired under US GAAP and was carried at £nil.

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Derivatives

Under US GAAP, all derivatives are recorded at fair value except those that qualify for exemptions, such as normal purchase rules for commodity contracts. Changes in fair values of derivatives not designated as a hedge under US GAAP are recorded through earnings. The Group applies a hedging strategy which meets UK GAAP requirements, but does not apply US GAAP hedge accounting in most cases. This results in a much greater volatility in the US GAAP income statements.

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Pensions

The Group accounts for its pension schemes under US GAAP in accordance with FAS 87 'Employers' Accounting for Pensions'. Under FAS 87, when pension scheme assets are less than the accumulated benefit obligation of that scheme, a minimum pension liability is recognised.

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Impairments

No additional impairments to goodwill or other long-lived assets were identified during 2004/05. Following a review of goodwill and other long-lived assets for impairment during 2003/04, evidence of impairment of goodwill and other intangible assets relating to Advantica was revealed. This resulted in an additional impairment charge relating to these assets being incurred under US GAAP amounting to £31 million. These charges are recorded in respect of Other activities.

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New US accounting standards adopted during 2004/05

During 2004/05, the Group adopted the following US GAAP accounting standards.

FIN 46(R)

FIN 46(R) requires the primary beneficiary of a variable interest entity for which control is achieved through means other than through voting rights to consolidate that variable interest entity. The Group adopted FIN 46(R) for the financial year beginning 1 April 2004. The Group has completed an assessment of this standard and determined that it did not have a material impact on the Group's financial statements.

FSP 106-2

Financial Accounting Standards Board Staff Bulletin 106-2 'Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003' (FSP 106-2), was issued in May 2004, superseding FSP 106-1 of the same title issued in January 2004. This pronouncement relates to legislation which introduced a US federal subsidy to sponsors of certain retiree health care benefit plans. The Group has concluded that, if the provisions are finalised in their current form, the benefits provided under the Group's plan will be 'actuarially equivalent' to Medicare Part D as required by the legislation. The Group adopted FSP 106-2 prospectively in the quarter ended 30 September 2004, thereby reducing its accumulated benefit obligation by £43 million and realising a related £4 million tax benefit. Any decrease in the US GAAP future net periodic post-retirement benefit expense that results from this legislation will be deferred and credited to customers.

EITF 03-1

In March 2004, the US Emerging Issues Task Force reached a consensus on assessing impairment losses and issued EITF Issue 03-1 'The Meaning of Other-Than-Temporary Impairment and Its Application for Certain Investments', which provides new guidance in this area and prescribes a three step impairment model. In September 2004, FASB Staff Position EITF 03-1-1 delayed the effective dates of the measurement and recognition guidance in paragraphs 10-20 of EITF 03-1. The disclosure requirements of EITF 03-1, remain effective and have been adopted by the Group; however, they did not have a significant impact on the Group.

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Recent US pronouncements not yet adopted
SFAS 123(R)

Financial Accounting Standards Board Statement No. 123 (revised 2004) 'Share-Based Payment' (SFAS 123(R)) was issued in December 2004. This is a revision of SFAS 123 'Accounting for Stock-Based Compensation'. SFAS 123(R) supersedes APB Opinion No. 25 'Accounting for Stock Issued to Employees', and amends FASB Statement No. 95 'Statement of Cash Flows'. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognised in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. The Group expects to adopt SFAS 123(R) as of 1 April 2006.

SFAS 123(R) permits adoption of the requirements using one of two methods: a 'modified prospective' method where the requirements are applied to all share-based payments granted after the effective date of the pronouncement; or a 'modified retrospective' method which allows entities to restate prior periods based on the amounts previously recognised under SFAS 123 for the purposes of pro forma disclosures. The Group plans to adopt SFAS 123(R) using the modified prospective method.

The Group adopted the fair-value based method of accounting for sharebased payments using the 'retroactive restatement method' described in FASB Statement No. 148 'Accounting for Stock-Based Compensation - Transition and Disclosure'. Currently, the Group uses a Monte Carlo simulation model for awards with market-based vesting conditions. For options granted to employees under the Company's shareholder schemes, the Group used the Black-Scholes European option pricing model to estimate the value of stock options granted to employees and expects to continue to use this acceptable option valuation model upon the required adoption of SFAS 123(R) on 1 April 2006. The Group does not anticipate that adoption of SFAS 123(R) will have a material impact on its results of operations or its financial position. However, SFAS 123(R) also requires the benefits of tax deductions in excess of recognised compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting guidance. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date.

SFAS 153

In December 2004, as part of the FASB's short-term convergence project with the International Accounting Standards Board, the FASB issued FASB Statement No. 153 'Exchanges of Non-Monetary Assets' (SFAS 153), which is an amendment to APB Opinion No. 29 'Accounting for Non-Monetary Transactions' (APB 29). APB 29 provided an exemption to its general principle of measuring such transactions at fair value where the exchange related to similar productive assets. The exemption permitted the exchange to be valued at the recorded amount of the assets relinquished. SFAS 153 removes this exemption so that all non-monetary transactions (apart from those without commercial substance) are recorded at fair value. The Group expects to adopt SFAS 153 prospectively for all transactions taking place after 1 April 2006. The impact of the adoption of SFAS 153 cannot be predicted at this time because it will depend on whether applicable non-monetary transactions take place after the effective date.

FIN 47

FASB Interpretation No. 47 'Accounting for Conditional Asset Retirement Obligations' (FIN 47) was issued in March 2005. FIN 47 clarifies that the term 'conditional asset retirement obligation', as used in SFAS No. 143 'Accounting for Asset Retirement Obligations' (SFAS 143), refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the Group. FIN 47 is effective for financial years ending after 15 December 2005. The Group does not believe the adoption of FIN 47 will have a material impact on its accounts.

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