The Group has adopted International Financial Reporting Standards (IFRS)
for the first time in preparing these financial statements for the six
months ended 30 June 2005.
The date of transition to IFRS is 1 January 2004. During 2005, the Group
has already published the following restated UK GAAP financial information
onto an IFRS basis:
- Restated preliminary opening balance sheet as at 1 January 2004 under
International Financial Reporting Standards, published in Appendix
B to Aviva plc preliminary announcement 2004 on 9 March 2005 and also
in the Aviva plc Annual
report and accounts for 2004, including auditors’
opinion.
- Release to the market on 5 July 2005, “Impact
of international financial reporting standards on the results for
31 December 2004”, including the auditors’ opinion,
containing restated 31 December 2004 financial information as follows:
- summarised consolidated pro forma operating profit statement
and notes to the analysis of adjustments as a result of the
transition to IFRS;
- summarised consolidated statement of recognised income and
expense;
- summarised consolidated statement of changes in equity;
- summarised consolidated balance sheet and notes to the analysis
of adjustments as a result of the transition to IFRS;
- summarised consolidated income statement – EEV basis;
- summarised consolidated balance sheet – EEV; and
- the Group’s IFRS accounting policies.
In addition, a further update was given on the opening summarised consolidated
balance sheet as at 1 January 2004, to take in to account changes in IFRS
since the publication of the Aviva plc preliminary announcement 2004 on
9 March 2005.
In order to show comparative balances, a reconciliation of equity reported
under UK GAAP to equity reported under IFRS as at 30 June 2004 and a reconciliation
of profit and loss reported under UK GAAP to profit and loss reported
under IFRS for the six months ended 2004 are shown below.
Reconciliation of equity reported under UK GAAP to equity reported under
IFRS:
(a) Debt securities
Under UK GAAP, equity securities and unit trusts are carried at current
value. Debt and other fixed income securities are also carried at current
value, with the exception of many non-linked long-term business debt securities
and fixed income securities, which are carried at amortised cost.
As a result of applying IAS39, the Group now carries all investments in
debt and equity securities at fair value. The change in valuation of debt
securities from amortised cost to fair value increases the valuation of
investments by £1,367 million at 30 June 2004. This change in the
valuation of debt securities is largely offset by corresponding movements
in the unallocated divisible surplus and technical liabilities. The net
impact on shareholders’ funds at 30 June 2004 is £46 million.
(b) Commercial mortgages backing certain annuity business
Under IFRS, the Group has chosen to move certain of its commercial mortgage
portfolio to an active fair valuation basis in accordance with IAS 39,
which has increased the value of investments by £123 million. The
annuity liabilities which are backed by these assets have been correspondingly
revalued, reflecting the use of current interest rates. Consequently,
there is an increase in shareholders’ funds at 30 June 2004 of £33
million.
Revaluation reserve
Under IFRS, certain investment gains are recorded as a separate component
of shareholders’ equity, whereas under UK GAAP they would be included
in retained earnings.
Separate revaluation reserves are created for:
- Changes in the fair value of securities classified as available for
sale;
- Changes in the value of owner-occupied property;
- Exchange differences arising from the translation of the net investment
in foreign subsidiaries, associates and joint ventures and from borrowings
designated as hedges of such items; and
- Changes in the fair value of derivatives that are designated and qualify
as cash flow hedges.
The amounts included in the above reserves are, where appropriate, net
of deferred tax and impairment losses.
The above requirements have resulted in a transfer from retained earnings
of £237 million into separate revaluation reserves at 30 June 2004.
Note 2: Insurance changes
The impact on shareholders’ funds of insurance changes is as follows:
The principal changes to the Group’s insurance accounting upon transition
to IFRS are discussed further below.
(a) Product classification
International Financial Reporting Standard 4, Insurance Contracts (IFRS4)
requires all products issued to be classified for accounting purposes
into either insurance or investment contracts, depending on whether significant
insurance risk exists. In the case of a life contract, insurance risk
exists if the amount payable on death differs from the amount payable
if the policyholder survives. The Group has deemed insurance risk to be
significant if the difference exceeds 5% of the policy value, though the
classification would be similar if a 10% test had been used.
Following a detailed review, 61% of life policy reserves on an MSSB basis
at 30 June 2004 have been classified as insurance and 24% have been classified
as participating investment contracts (being those investment contracts
containing a discretionary participating feature as defined within IFRS4)
and both classes will continue to be accounted for under the Group’s
existing accounting policies. The remaining 17% have been classified as
non-participating investment contracts and therefore are required to be
accounted for under IAS39 and International Accounting Standard 18 –
Revenue (IAS18). Virtually all our general insurance products are classified
as insurance.
The product classification change results in technical provisions being
allocated between insurance and investment contracts and £58,932
million of liabilities classified as investment contracts.
(b) Equalisation provision
An equalisation provision is recorded in the balance sheet of individual
general insurance companies in the UK and in a limited number of other
countries, to eliminate, or reduce, the volatility in incurred claims
arising from exceptional levels of claims in certain classes of business.
The provision is required by law even though no actual liability exists
at the balance sheet date and is included in the UK GAAP consolidated
balance sheet. The annual change in the equalisation provision is recorded
in the UK GAAP profit and loss account. Under IFRS, no equalisation provision
is recorded, as no actual liability exists at the balance sheet date.
There is an increase of £375 million in shareholders’ funds
as a result of the removal of the equalisation provision.
(c) Reinsurance treaties
Following a full review of all our reinsurance contracts, a small number
of the Group’s reinsurance treaties have been revalued under IFRS,
leading to a reduction in the value of reinsurance assets of £42
million. The majority of these changes relate to participating contracts
and so these value changes affect principally the unallocated divisible
surplus rather than shareholders’ funds.
(d) Application of an active liability valuation basis in the Netherlands
The conversion to IFRS has been a particular issue in the Dutch industry
where traditionally both bond investments and associated insurance liabilities
have been held at amortised cost. IAS39 requires bonds to be held at fair
value and hence to prevent an equity mismatch, the Group has chosen to
move to a more active liability valuation basis for its insurance liabilities
within the Netherlands. Gross liabilities increased by £23 million
as a result of this change at 30 June 2004.
Having applied an active basis for valuing liabilities on traditional gross
and individual savings business, the amount representing undistributed
gains on investments backing these products, which were previously booked
to the fund for future appropriations under UK GAAP, of £43 million
has been released to equity.
(e) Non-participating investment contracts and other sundry items
The liability for those contracts classified as non-participating investment
contracts is valued in accordance with IAS 39. The majority of the Group’s
contracts classified as non-participating investment contracts are unit-linked
contracts and have been valued at fair value. For unit-linked contracts
the fair value liability is deemed to equal the current unit fund value,
plus positive non-unit reserves if required on a fair value basis. This
replaces the reserve held under UK GAAP which equals the unit fund value
plus any positive or negative non-unit reserves determined on the local
valuation basis, which differs from that required on a fair value basis.
In addition to the change in liability valuation, the accounting for deferred
acquisition costs has been revised in accordance with IAS18. This restricts
the types of acquisition costs that can be deferred leading to a reduction
in deferred acquisition costs as compared to UK GAAP.
The net impact on shareholders’ funds of the above changes and of
other sundry items is £51 million.
Note 3: Employee benefits
Under the Group’s UK GAAP pension policy, as set out in Statement
of Standard Accounting Practice, Accounting for Pensions Cost (SSAP24),
the cost of providing pension benefits is expensed using actuarial valuation
methods which gives a substantially even charge over the expected service
lives of employees and results in either a prepayment or an accrual to
the extent that this charge does not equate to the cash contributions
made into the schemes. Under International Accounting Standard 19, Employee
Benefits (IAS 19), the projected benefit obligation is matched against
the fair value of the underlying assets and other unrecognised actuarial
gains and losses in determining the pension expense for the year. Any
pension asset or obligation must be recorded in the balance sheet. Aviva
has not applied the “corridor approach” to valuing pension
deficits.
This change in accounting has resulted in the removal of the Group’s
SSAP 24 balances, a net debtor of £276 million, after allowing for
deferred tax, at 30 June 2004 and the recognition of a deficit of £530
million, net of deferred tax, valued in accordance with IAS 19. This gives
an overall impact on shareholders’ funds of £806 million at
30 June 2004.
The Group has assumed that substantially all of the pension deficit will
fall to be borne by the shareholders. This is particularly relevant to
the UK pension scheme deficit, which forms the majority of the deficit
recognised by the Group. Costs, including pension costs, are charged to
the UK Life companies and with-profits funds on the basis of a pre-determined
Management Services Agreement (MSA). As reported at the time of the conversion
to EEV, where similar assumptions have been made in connection with deficit
funding, under the MSA, NU Life Services Ltd can renegotiate the terms
relating to the recharging of the costs to the UK with profits funds in
2008, subject to regulatory approval. In evaluating the impact on IFRS,
Aviva has not sought to pre-empt the outcome of this renegotiation. Any
changes to the recharges in respect of the pension deficit will be credited
to equity in the period agreement is obtained.
In some countries, the pension schemes have invested in the Group’s
Life funds. IAS 19 requires the liquidity of the scheme’s assets
to be considered and if these are non-transferable, the presentation of
the total obligation to the scheme must include these amounts.
The Group has chosen to review its presentation of these investments. Non-transferable
obligations to staff pension schemes included within technical provisions
under UK GAAP are deducted from Insurance liabilities and included within
Provisions under IFRS.
Note 4: Goodwill / Other intangibles
Under IAS 36, Impairment of Assets, goodwill is no longer amortised but
is tested for impairment, at least annually. Any goodwill amortised prior
to the date of transition (1 January 2004) or, for goodwill arising before
1 January 1998, eliminated against shareholders’ funds has not been
reinstated. Amortisation charged in 2004 under UK GAAP is not charged
to profit under IFRS to the extent that it does not relate to an impairment
and hence shareholders’ funds upon conversion to IFRS increase.
In addition, negative goodwill of £37 million at 30 June 2004 previously
recognised under UK GAAP is included directly in retained earnings.
IFRS 3 Business combinations requires that intangible assets such as customers
lists, which can be separately identified and valued, must be recognised
separately in the balance sheet. The Group has applied IFRS 3 to acquisitions
since 1 January 2004, which has resulted in £8 million of goodwill
being reclassified as other intangibles upon conversion to IFRS.
Note 5: Dividend recognition
Under UK GAAP, dividends are accrued in the period to which they relate
regardless of when they are declared and approved. Under IAS 10, Events
after the Balance Sheet Date, shareholders’ dividends are accrued
only when declared and appropriately approved. This has increased shareholders’
funds by £220 million.
Note 6: Deferred taxes
Under UK GAAP, provision is made for deferred tax assets and liabilities,
using the liability method, arising from timing differences between the
recognition of gains and losses in the financial statements and their
recognition in a tax computation. No provision is made for tax that might
arise on undistributed earnings of subsidiaries unless a binding agreement
for distribution exists. Deferred tax is recognised as a liability or
asset if the transactions or events that give the entity an obligation
to pay more tax in future or a right to pay less tax in future have occurred
by the balance sheet date. The Group policy is to discount its deferred
tax balances.
Under International Accounting Standard 12, Income taxes (IAS 12), deferred
taxes are provided under the liability method for all relevant temporary
differences, being the difference between the carrying amount of an asset
or liability in the balance sheet and its value for tax purposes. IAS
12 does not require all temporary differences to be provided for, in particular
the Group does not provide for deferred tax on undistributed earnings
of subsidiaries where the Group is able to control the timing of the distribution
and the temporary difference created is not expected to reverse in the
foreseeable future. Deferred tax assets are recognised for unused tax
losses and other deductible temporary differences to the extent that it
is probable that future taxable profit will be utilised against the unused
tax losses and credits. Discounting is prohibited under IAS 12.
The changes to deferred tax arise from the removal of discounting, changes
to the valuation of the Group’s assets and liabilities under IFRS
and presentational changes to disclosure of tax assets and liabilities.
The main net increases in deferred tax at 30 June 2004 that reduce shareholders’
funds are:
Note 7: Borrowings and cash
IFRS requires a number of presentational changes to borrowings and cash.
The most significant change is that the linked presentation can no longer
be adopted for the Group’s borrowing securitised on certain of its
mortgage portfolios. This increases borrowings and investments by £3,774
million. The equity impact of £26 million relates to the use of
the fair value option to mortgages of the UK equity release business,
the loan notes which are securitised upon them and backing derivatives.
This has increased borrowings by £97 million. Additionally, £6,906
million of the Group’s investments meet the definition of cash equivalents
and so have been reclassified to “cash and cash equivalents”.
Note 8: Other items
The other changes that arise as a result of the transition to IFRS are
principally reclassifications and presentational changes. The total effect
of the other changes to shareholders’ funds is £76 million.
The other significant reclassification and presentational changes which
have no impact on shareholders’ funds are:
- Assets held to cover linked liabilities of £42,921 million
are no longer disclosed in a single line but have been reported in
the various asset classifications. Of this amount assets of £3,675
million have been netted off technical liabilities, reducing the gross
assets and investment contract liabilities of the Group. There is
no impact on profit or shareholders’ funds as a result of this
change.
- Technical provisions are disclosed as either insurance contracts
or investment contracts, reflecting the product classification included
in Note 2(a). The Group held investment contracts of £58,932
million at 30 June 2004.
- The assets and liabilities of the banking business are no longer
disclosed entirely in “other debtors” and “other
creditors” but have been reported in the appropriate balance
sheet classifications.
- Owner occupied properties have been reclassified from “investment
property” to property and equipment. We continue to hold these
properties at fair value.
- Mutual funds have been consolidated as these vehicles meet the definition
of a subsidiary. This has resulted in an increase in gross assets
of £2,053 million, representing the part of the funds owned
by third parties. This third party interest is recorded in the line
“net assets attributable to unitholders” within liabilities.
The consolidation of mutual funds has no impact on shareholders’
funds or profit after tax.
Reconciliation of profit and loss reported under UK GAAP to profit and
loss reported under IFRS:
Notes to the analysis of adjustments to the reconciliation of profit and
loss reported under UK GAAP to profit and loss reported under IFRS for
the six months ended 30 June 2004
Note 1: Investment valuation
The main investment valuation change upon conversion to IFRS is that assets,
which are not classified as being held to maturity, are required to be
held at fair value. Under UK GAAP certain of the Group’s bonds were
held at amortised cost. This change in valuation of debt securities resulted
in a £1,367 million increase in the valuation of securities at 30
June 2004. Most of this change was offset by corresponding movements in
the unallocated divisible surplus and technical liabilities. However,
there was a residual uplift which resulted in a positive increase in the
Group’s shareholders’ funds and the year on year movement
in respect of those investments classified as “at fair value through
profit or loss” is reported as increased profits in the income statement.
In addition changes to investment accounting have resulted in £1
million of investment gains being reclassified from short-term fluctuations
to the life operating profit.
Note 2: Insurance liabilities
Insurance changes consist of:
- The removal of the claims equalisation provision, improving profit
before tax by £11 million but with no impact on operating profit;
- The revaluation of liabilities and deferred acquisition costs on
those contracts classified as non-participating investment contracts
reducing operating profit by £43 million;
- The revaluation of certain life reinsurance treaties, increasing
operating profit by £6 million;
- Other sundry changes to our general insurance business reserves increasing
operating profit in 2004 by £3 million.
Note 3: Employee benefits
The overall impact of adopting IAS 19 Employee benefits and IFRS 2 Share
based compensation has been to increase costs by £18 million in
2004. The increase in costs partly reflects the fact that IAS 19 has used
a more current actuarial valuation to measure the ongoing pension service
cost. The charge under UK GAAP was based on the SSAP 24 valuation which
for the main UK scheme, as disclosed in the 2004 Report and Accounts,
was last updated for financial reporting purposes in April 2002.
Note 4: Goodwill
Goodwill is no longer amortised under IFRS but is subject to annual impairment
review. The UK GAAP amortisation charge was £49 million for the
six months ended 30 June 2004. No additional impairment arose as a result
of the transition to IFRS.
A further £2 million credit arises to profit before tax, as goodwill
previously charged directly to reserves was deducted from profit upon
disposal of subsidiaries under UK GAAP. Under IFRS no such deduction is
required. This change has no impact on operating profit or shareholders’
funds.
Consolidated cash flow statement
The principal differences between the cash flow statement under UK GAAP
and IFRS are the different definitions of cash and cash equivalents and
the inclusion of the cash generated and consumed by the long-term businesses.
