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34 Explanation of transition to IFRS

These are the Group's first consolidated financial statements prepared in accordance with IFRS as adopted by the EU.

The accounting policies set out in note 1 have been applied in preparing the financial statements for the year ended 31 December 2005, the comparative information presented in these financial statements for the years ended 31 December 2004 and 31 December 2003 and the preparation of an opening IFRS balance sheet at 1 January 2003 (the Group's date of transition). IAS 39 'Financial Instruments: Recognition and Measurement' and IAS 32 'Financial Instruments: Disclosure and Presentation' have not been applied to the comparative periods because the Group has taken a transitional exemption and adopted those standards prospectively from 1 January 2005. The effect of the transitional adjustment on the balance sheet as at 1 January 2005 is set out in the tables below.

In preparing its opening IFRS balance sheet, the Group has made adjustments to amounts previously reported in its financial statements under UK GAAP. An explanation of how the transition from previous UK GAAP to IFRS has affected the Group's financial position and cash flows is set out in the tables and notes below. These adjustments include some reclassifications of items within the income statement and within the balance sheet in accordance with IFRS disclosure requirements.

Balance sheet as at 1 January 2003 (date of transition)

All figures in £ millions	UK GAAP	Adjs	IFRS
Assets
Non-current assets
Property, plant and equipment	503	(68)	435
Intangible assets	3,610	71	3,681
Investments in joint ventures and associates	113	(7)	106
Deferred income tax assets	-	374	374
Other financial assets	22	-	22
Other receivables	-	74	74
Total	4,248	444	4,692
Current assets
Intangible assets - pre-publication	-	380	380
Inventories	734	(380)	354
Trade and other receivables	1,059	(79)	980
Deferred income tax assets	174	(174)	-
Cash and cash equivalents	575	(10)	565
Total	2,542	(263)	2,279
Total assets	6,790	181	6,971
Liabilities
Non-current liabilities
Financial liabilities - Borrowings	(1,734)	(2)	(1,736)
Deferred income tax liabilities	-	(119)	(119)
Retirement benefit obligations	-	(351)	(351)
Provisions for other liabilities and charges	(165)	120	(45)
Other liabilities	(60)	(10)	(70)
Total	(1,959)	(362)	(2,321)
Current liabilities
Trade and other liabilities	(1,114)	178	(936)
Financial liabilities - Borrowings	(249)	(3)	(252)
Current income tax liabilities	-	(52)	(52)
Provisions for other liabilities and charges	-	(34)	(34)
Total	(1,363)	89	(1,274)
Total liabilities	(3,322)	(273)	(3,595)
Net assets	3,468	(92)	3,376
Equity
Share capital	200	-	200
Share premium	2,465	-	2,465
Other reserves	(121)	-	(121)
Retained earnings	732	(88)	644
Total equity attributable to equity holders of the Company	3,276	(88)	3,188
Minority interest	192	(4)	188
Total equity	3,468	(92)	3,376

Balance sheet as at 31 December 2003

All figures in £ millions	UK GAAP	Adjs	IFRS
Assets
Non-current assets
Property, plant and equipment	468	(66)	402
Intangible assets	3,260	290	3,550
Investments in joint ventures and associates	64	-	64
Deferred income tax assets	-	342	342
Other financial assets	21	-	21
Other receivables	-	100	100
Total	3,813	666	4,479
Current assets
Intangible assets - pre-publication	-	362	362
Inventories	683	(364)	319
Trade and other receivables	1,134	(109)	1,025
Deferred income tax assets	145	(145)	-
Cash and cash equivalents	561	(10)	551
Total	2,523	(266)	2,257
Total assets	6,336	400	6,736
Liabilities
Non-current liabilities
Financial liabilities - Borrowings	(1,347)	(2)	(1,349)
Deferred income tax liabilities	-	(140)	(140)
Retirement benefit obligations	-	(364)	(364)
Provisions for other liabilities and charges	(152)	93	(59)
Other liabilities	(45)	(25)	(70)
Total	(1,544)	(438)	(1,982)
Current liabilities
Trade and other liabilities	(1,129)	186	(943)
Financial liabilities - Borrowings	(575)	(3)	(578)
Current income tax liabilities	-	(54)	(54)
Provisions for other liabilities and charges	-	(18)	(18)
Total	(1,704)	111	(1,593)
Total liabilities	(3,248)	(327)	(3,575)
Net assets	3,088	73	3,161
Equity
Share capital	201	-	201
Share premium	2,469	-	2,469
Other reserves	(122)	(288)	(410)
Retained earnings	345	364	709
Total equity attributable to equity holders of the Company	2,893	76	2,969
Minority interest	195	(3)	192
Total equity	3,088	73	3,161

Balance sheet as at 31 December 2004

All figures in £ millions	UK GAAP	Adjs	IFRS
Assets
Non-current assets
Property, plant and equipment	473	(118)	355
Intangible assets	2,890	388	3,278
Investments in joint ventures and associates	48	(1)	47
Deferred income tax assets	-	359	359
Other financial assets	17	(2)	15
Other receivables	-	102	102
Total	3,428	728	4,156
Current assets
Intangible assets - pre-publication	-	356	356
Inventories	676	(362)	314
Trade and other receivables	1,104	(171)	933
Deferred income tax assets	165	(165)	-
Cash and cash equivalents	613	(152)	461
Total	2,558	(494)	2,064
Non-current assets classified as held for sale	-	358	358
Total	2,558	(136)	2,422
Total assets	5,986	592	6,578
Liabilities
Non-current liabilities
Financial liabilities - Borrowings	(1,712)	(2)	(1,714)
Deferred income tax liabilities	-	(139)	(139)
Retirement benefit obligations	-	(408)	(408)
Provisions for other liabilities and charges	(123)	80	(43)
Other liabilities	(60)	(39)	(99)
Total	(1,895)	(508)	(2,403)
Current liabilities
Trade and other liabilities	(1,168)	300	(868)
Financial liabilities - Borrowings	(107)	(2)	(109)
Current income tax liabilities	-	(89)	(89)
Provisions for other liabilities and charges	-	(14)	(14)
Total	(1,275)	195	(1,080)
Liabilities directly associated with non-current assets classified as held for sale	-	(81)	(81)
Total liabilities	(3,170)	(394)	(3,564)
Net assets	2,816	198	3,014
Equity
Share capital	201	-	201
Share premium	2,473	-	2,473
Other reserves	(132)	(491)	(623)
Retained earnings	61	688	749
Total equity attributable to equity holders of the Company	2,603	197	2,800
Minority interest	213	1	214
Total equity	2,816	198	3,014

Adjustments to equity

All figures in £ millions	Notes	1 Jan 2003	31 Dec 2003	31 Dec 2004
Total equity UK GAAP		3,468	3,088	2,816
Goodwill amortisation	a	66	228	394
Intangible assets acquired	b	-	40	48
Intangible assets - capitalised software costs	c	3	-	-
Intangible assets - pre-publication expenditure	d	-	-	-
Share-based payments	e	13	15	22
Employee benefits	f	(259)	(284)	(338)
Leases	g	(12)	(22)	(33)
Joint ventures	h	(3)	(5)	(6)
Associates	i	(10)	(10)	(8)
Income taxes	j	(3)	(5)	(7)
Dividends	k	115	119	125
Other		(2)	(3)	1
Discontinued operations	l	-	-	-
Total adjustments to equity		(92)	73	198
Total equity IFRS		3,376	3,161	3,014

Income statement for the year to 31 December 2003

All figures in £ millions	UK GAAP	Adjs	IFRS
Continuing operations
Sales	4,048	(198)	3,850
Cost of goods sold	(1,910)	64	(1,846)
Gross profit	2,138	(134)	2,004
Operating expenses	(1,912)	318	(1,594)
Other net gains and losses	6	(12)	(6)
Share of results of joint ventures and associates	-	2	2
Operating profit	232	174	406
Net finance costs	(80)	(13)	(93)
Profit before tax	152	161	313
Income tax	(75)	14	(61)
Profit for the year from continuing operations	77	175	252
Profit for the year from discontinued operations	-	23	23
Profit for the year	77	198	275

Income statement for the year to 31 December 2004

All figures in £ millions	UK GAAP	Adjs	IFRS
Continuing operations
Sales	3,919	(223)	3,696
Cost of goods sold	(1,866)	77	(1,789)
Gross profit	2,053	(146)	1,907
Operating expenses	(1,832)	312	(1,520)
Other net gains and losses	9	-	9
Share of results of joint ventures and associates	10	(2)	8
Operating profit	240	164	404
Net finance costs	(69)	(10)	(79)
Profit before tax	171	154	325
Income tax	(62)	(1)	(63)
Profit for the year from continuing operations	109	153	262
Profit for the year from discontinued operations	-	22	22
Profit for the year	109	175	284

Adjustments to profit

All figures in £ millions	Notes	2003	2004
Profit for the year UK GAAP		77	109
Goodwill amortisation	a	242	204
Intangible assets acquired	b	(4)	(5)
Intangible assets - capitalised software costs	c	(1)	(1)
Intangible assets - pre-publication expenditure	d	-	-
Share-based payments	e	(23)	(16)
Employee benefits	f	1	6
Leases	g	(10)	(12)
Joint ventures	h	(2)	(2)
Associates	i	(2)	(2)
Income taxes	j	(2)	(2)
Other		(1)	5
Discontinued operations	l	-	-
Total adjustments to profit for the year		198	175
Profit for the year IFRS		275	284

Cash flow for the year to 31 December 2003

All figures in £ millions	UK GAAP	Adjs	IFRS
Cash flows from operating activities	228	172	400
Cash flows from investing activities	(91)	(172)	(263)
Cash flows from financing activities	(228)	86	(142)
Effects of exchange rate changes on cash and cash equivalents	37	8	45
Net (decrease)/increase in cash and cash equivalents	(54)	94	40
Cash and cash equivalents at beginning of year	340	148	488
Cash and cash equivalents at end of year	286	242	528

Cash flow for the year to 31 December 2004

All figures in £ millions	UK GAAP	Adjs	IFRS
Cash flows from operating activities	387	175	562
Cash flows from investing activities	(102)	(179)	(281)
Cash flows from financing activities	(255)	(6)	(261)
Effects of exchange rate changes on cash and cash equivalents	(3)	(1)	(4)
Net increase/(decrease) in cash and cash equivalents	27	(11)	16
Cash and cash equivalents at beginning of year	286	242	528
Cash and cash equivalents at end of year	313	231	544

Effect of IAS 32 and IAS 39 transitional adjustment (note 1m)

All figures in £ millions	31 Dec 2004	Adj	1 Jan 2005
Non-current assets
Deferred income tax assets	359	5	364
Financial assets - Derivative financial instruments	-	145	145
Current assets
Financial assets - Derivative financial instruments	-	1	1
Non-current liabilities
Financial liabilities - Borrowings	(1,714)	(134)	(1,848)
Financial liabilities - Derivative financial instruments	-	(40)	(40)
Current liabilities
Trade and other liabilities	(868)	14	(854)
Financial liabilities - Borrowings	(109)	-	(109)
Financial liabilities - Derivative financial instruments	-	(3)	(3)
Reserves	(126)	12	(114)

First-time adoption exemptions applied

IFRS 1 'First-time Adoption of International Financial Reporting Standards' sets out the transition rules which must be applied when IFRS is adopted for the first time in reporting IFRS financial information. In general the Group is required to select accounting policies in accordance with IFRS valid at its first IFRS reporting date and apply those polices retrospectively. The standard sets out certain mandatory exceptions to retrospective application and certain optional exemptions. The most significant optional exemptions adopted by the Group are set out below:

1 Business combinations

The Group has elected not to apply IFRS 3 'Business Combinations' retrospectively to business combinations that occurred before the date of transition. Subject to the transition adjustments to IFRS required by IFRS 1, the accounting for business combinations before the date of transition is grandfathered at the date of transition from the UK GAAP financial statements.

2 Employee benefits

All cumulative actuarial gains and losses have been recognised in full in the period in which they occur in the statement of recognised income and expense in accordance with IAS 19 'Employee Benefits' (as amended on 16 December 2004).

3 Share-based payments

The Group has elected to apply IFRS 2 'Share-based Payment' retrospectively to all options granted but not fully vested at the date of transition. Consequently the share-based payment charge from 2003 represents the charge for all options granted and not fully vested at 31 December 2002.

4 Financial instruments

The Group has elected to apply IAS 39 'Financial Instruments: Recognition and Measurement' and IAS 32 'Financial Instruments: Disclosure and Presentation' from 1 January 2005. After this date, where hedge accounting cannot be applied under IAS 39, changes in the market value of financial instruments will be taken to the income statement. No adjustment to the 2003 or 2004 UK GAAP financial statements was required due to the chosen adoption date of IAS 32 and IAS 39.

5 Cumulative translation differences

The Group has deemed the cumulative translation differences for foreign operations to be zero at the date of transition. Any gains and losses on disposals of foreign operations will exclude translation differences arising prior to the transition date.

Significant adjustments

a. Goodwill amortisation - IFRS 3 'Business Combinations' requires that goodwill is not amortised but instead is subject to an impairment review annually or when there are indications that the carrying value may not be recoverable. The Group has elected not to apply IFRS 3 retrospectively to business combinations before the date of transition.

b. Intangible assets acquired - Business combinations since the date of transition have been accounted for in accordance with IFRS 3 'Business Combinations', with intangible assets recognised and amortised over their useful economic lives where they are separable or arise from a contractual or legal right. As part of the acquisition of Comstock Inc in February 2003, certain intangible assets were acquired, mainly relating to customer lists and acquired technology, which are being amortised over periods between two and 30 years. In addition, other less significant intangible assets, mainly relating to publishing rights, have been recognised for some of the smaller acquisitions made during 2004 and amortised over periods of up to 15 years.

c. Capitalised software costs - Under IAS 38 'Intangible Assets' computer software which is not integral to a related item of hardware should be classified as an intangible asset. As such, certain computer software costs have been re-classified from property, plant and equipment to intangible assets. In addition, certain costs relating to software development, previously expensed under UK GAAP, have been capitalised under IAS 38 and are being amortised over their estimated useful lives.

d. Pre-publication expenditure - Under IAS 38 'Intangible Assets', intangible assets are required to be recognised if they meet the criteria of identifiability, control over a resource and existence or probability of inflow of future economic benefits. As such pre-publication costs (the direct costs incurred in the development of educational programmes and titles prior to their publication) have been re-classified from inventory to intangible assets. They continue to be amortised upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years.

e. Share-based payments - IFRS 2 'Share-based Payment' requires that the expense incurred for equity instruments granted is recognised in the financial statements at their fair value measured at the date of grant and that the expense is recognised over the vesting period of the instrument. The Group has a number of employee option and performance share schemes. The Group has elected to apply IFRS 2 'Share-based Payment' retrospectively to all options granted but not fully vested at the transition date. Consequently the share-based payment charge from 2003 represents the charge for all options granted and not fully vested at 31 December 2002.

f. Employee benefits - IAS 19 'Employee Benefits' was amended on 16 December 2004. The Group has elected to adopt the December 2004 amendments to the standard early and differences between the actual and expected return on assets, changes in the retirement benefit obligation due to experience and changes in actuarial assumptions are included in full in equity in the statement of recognised income and expense. Therefore the amount recognised on the balance sheet in respect of liabilities for defined benefit pension and other post-retirement benefit plans represents the present value of the obligations for past service offset by the fair value of scheme assets.

The service cost of benefits accruing is accounted for as an operating cost and the unwinding of the discount rate on the scheme liabilities and the expected return on scheme assets as a financing charge or financing income. The Group has adopted the same assumptions under IAS 19 as were used for FRS 17 purposes under UK GAAP in 2003 and 2004.

The restated opening IFRS balance sheet reflects the fair value of the plan assets and the present value of the defined benefit obligation of the Group's defined benefit schemes.

g. Leases - IAS 17 'Leases' sets out additional criteria to be considered in ascertaining whether a lease is a finance or operating lease. Following a review of all lease agreements no properties have been re-classified.

In addition, IAS 17 requires that the expense is recognised on a straight line basis over the lease term, including any rent-free periods given at the inception of a lease. Contracted future lease increments must also be amortised evenly over the full period of the lease rather than the period to which the lease is estimated to revert to market rates. The profit and loss account has been adjusted to take into account the amortisation of lease incentives over longer periods than under UK GAAP and to accelerate the charge in respect of fixed contractual increments in lease payments.

h. Joint ventures - Following a review, the Group has concluded that its 50% holding in Maskew Miller Longman should be accounted for as a joint venture under IFRS rather than its classification as a subsidiary under UK GAAP.

i. Joint ventures and associates - The results of all joint ventures and associates have been adjusted to take into account IFRS adjustments within their own financial statements.

j. Income taxes - IAS 12 'Income Taxes', requires that deferred taxation also be provided on all temporary differences, not just timing differences as required under UK GAAP. Deferred tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements unless the initial recognition exemption applies. Deferred tax is not recognised for temporary differences arising on initial recognition of an asset or liability in a transaction other than a business combination if at the time of transaction neither accounting nor taxable profit is affected. Deferred taxation has been provided on the post-acquisition difference between the book and tax bases of intangible assets and goodwill if its amortisation is tax deductible. A deferred tax liability has also been recognised in respect of the undistributed earnings of subsidiaries other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future.

Deferred taxation has been recognised on the IFRS adjustments at the tax rates that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the asset is realised or the liability is settled. Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised.

k. Dividends - IAS 10 'Events after the Balance Sheet Date' requires that dividends declared after the balance sheet date should not be recognised as a liability at the balance sheet date as they do not represent a present obligation at that date as defined by IAS 37 'Provisions, Contingent Liabilities and Contingent Assets'.

The final dividends relating to the years to 31 December 2002, 2003 and 2004 have been reversed and recognised as a liability in the years 2003, 2004 and 2005 respectively.

l. Discontinued operations - Consistent with the UK GAAP treatment, Recoletos has been treated as discontinued as at 31 December 2004 and met the criteria as 'held for sale' at that date. Accordingly the results are disclosed in one line in the income statement, 'Profit for the year from discontinued operations' for both 2003 and 2004 and, at 31 December 2004, it is disclosed in the balance sheet in two lines - 'Non-current assets classified as held for sale' and 'Liabilities associated with non-current assets classified as held for sale'.

When an asset's carrying value will be recovered principally through a sale transaction rather than through continuing use and certain criteria regarding probability and proximity of the sale are satisfied, it is classified as held for sale and stated at the lower of carrying value and fair value less costs to sell. No depreciation is charged in respect of non-current assets classified as held for sale.

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