International Financial

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• International Financial
• Reporting Standards -
• Update

Hanif Lalani Group Finance Director John Wroe
Director Group Financial Control Treasury Glyn
Parry Head of Group Financial Control 21 March
2005
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Agenda

• Key messages
• Timetable for IFRS
• Key areas for BT
• Pro-forma impact on BT for year to 31 March 2004
• Questions

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Key Messages

• No effect on BTs strategy or business
  performance
• No effect on free cash flow, minimal effect on
  net debt
• Main areas for BT
• - Pensions
• - Share based payments
• - Leases
• - Foreign exchange
• - Intangible assets
• - Financial instruments
• Latest view is EPS reduced by approximately 1.5p
  in 2003/04 compared to UK GAAP
• Expected EPS impact is broadly neutral in
  2004/05 compared to UK GAAP
• before goodwill amortisation
  and exceptional items

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Timetable for IFRS
1 April 2003 Transition Date for all standards,
except IAS 32 and 39 1 April 2005 Transition
Date for IAS 32 and 39 Financial Instruments
21 March 2005 IFRS event latest view of 31
March 2004 pro-forma UK / IFRS reconciliation and
explanation of key issues
19 May 2005 Q4 and full year results under UK
GAAP for 31 March 2005 Overview of IFRS impact
for 2004/05
June 2005 Accounts published under UK GAAP. To
include IFRS impact at 31 March 2005
July 2005 Q1 2005/06 results, reported under IFRS
with UK GAAP reconciliation
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Key areas for BT

• Pensions (IAS 19)
• Share based payments (IFRS 2)
• Lease accounting (IAS 17)
• Foreign exchange (IAS 21)
• Intangible assets (IAS 38 and IFRS 3)
• Financial instruments (IAS 32 and IAS 39)

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Pensions - (IAS 19) New Rules

• Similar to FRS 17
• Impact of FRS 17 disclosed in 2002/03 and 2003/04
  accounts
• Balance sheet reflects scheme deficit or surplus
• Assets valued at market value and liabilities
  discounted at AA bond rate

• Basis of the funding valuation remains unchanged
• Funding valuation determined by actuary
• Cash tax benefit for pensions based on actual
  cash paid

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Pensions - (IAS 19) - New Rules

• Profit and loss charge split between operating
  charge and interest
• Operating charge is the cost of benefits accrued
  to members in the year
• Interest is a forward looking actuarial estimate
  of the return on scheme assets and unwind of the
  discount on liabilities
• Actuarial gains or losses are differences between
  expected and actual experience

• IAS 19 allows choice over the treatment of
  actuarial gain/loss, either through the profit
  and loss (in full or using the 10 corridor) or
  directly to reserves
• We have elected for reserves treatment
• Potential volatility in interest as scheme asset
  values and interest rates move

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Pensions - (IAS 19) - BT Effect

• Post tax deficit was 3.6bn at 31 March 2004
• BT elects to take actuarial gain or loss directly
  in reserves
• IAS 19 operating charge expected to be relatively
  stable
• Future finance costs will depend on value of
  scheme assets and liabilities and interest rates.
  2004/05 net finance income of approximately 200m
• Future actuarial gain/loss movements are
  unpredictable

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Pensions - (IAS 19) - BT Effect
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Share Based Payments - (IFRS 2) - New Rules

• Fair values of share and option awards at grant
  date are charged to profit and loss over the
  related vesting period
• Fair value is calculated using modelling analysis
  
• Fair value impacted by share price at grant,
  terms of issue, share price volatility, dividend
  yield

• Can elect to adopt for all awards or only those
  granted since November 2002
• Profit and loss includes IFRS 2 charge in
  operating costs
• Tax credit for share based payments based on
  intrinsic values (market price less option
  exercise price)

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Share Based Payments - (IFRS 2) BT Effect

• BT has elected to adopt IFRS 2 for awards after 7
  November 2002
• BT has executive schemes, but approximately 75
  of the charge relates to all-employee SAYE
  schemes
• Future costs expected to rise by approximately
  15m per annum for three years and level out
  thereafter
• Increase continues until all BTs schemes are
  factored into calculations

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Leases - (IAS 17) New Rules

• Combined leases of land and buildings must be
  reviewed separately for land and buildings
  elements
• Operating lease charges recognised on a straight
  line basis unless another systematic basis is
  more representative of the time pattern of users
  benefit

• IAS 17 deals with operating and finance lease
  issues
• Qualitative review of lease is required to
  establish the risks and rewards of asset
  ownership

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Leases - (IAS 17) - BT Effect

• Profile of operating profit charge for operating
  leases changes to straight line basis
• 2003/04 operating profit effect currently
  estimated to be a reduction of approximately
  85m (EBITDA 81m and depreciation 4m)
• 2003/04 interest charge increased by
  approximately 10m
• Net debt increased by approximately 100m

• BTs UK property portfolio was sold to and leased
  back from Telereal in 2001
• This was an operating lease under UK GAAP
• Payments to Telereal are treated as rental charge
• Detailed review undertaken of the specific
  elements of the Telereal contract under IFRS
  rules
• Land and buildings remain operating leases with
  the exception of a small number of buildings

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Foreign Exchange - (IAS 21)

• New Rules
• Monetary items held in a foreign currency
  converted to spot rate each period end
• Foreign currency movements on inter-company
  trading balances recognised in the profit and
  loss account
• Balance sheet re-classification to gross up
  assets and liabilities

• BT Effect
• Foreign exchange on inter-company trading
  balances will be reclassified from reserves to
  the profit and loss account resulting in a net
  credit of approximately 20m to operating profit
  in 2003/04

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Intangible Assets - (IAS 38 and IFRS 3) New
Rules

• As part of business acquisitions, intangible
  assets must be identified separately from
  goodwill
• Examples of acquired intangibles include
  trademarks, customer relationships, licenses
• Intangible assets are amortised over useful life
• Remaining goodwill (difference between all assets
  identified and cost) is not amortised but
  reviewed for impairment annually

• Goodwill impairment charge would go to profit and
  loss account
• IFRS allows option to apply to transactions from
  date of transition or earlier
• Reclassification of assets may be required from
  tangible to intangible on the balance sheet

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Intangible Assets - (IAS 38) - BT Effect

• BT has elected to adopt from date of transition
  (1 April 2003)
• Acquisitions in 2003/04 gave rise to 35m of UK
  GAAP goodwill
• Reversal of 2003/04 goodwill amortisation charge
  of 12m
• Balance sheet reclassification of tangibles to
  intangibles for certain items (e.g. computer
  software) of approximately 400m
• 2005/06 will include full year effect of Infonet,
  Albacom and Radianz acquisitions

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Financial Instruments - (IAS 32 39) New Rules

• Measurement rules relating to financial assets
  and liabilities
• Each financial asset and liability recorded at
  either fair value or amortised cost
• All derivatives recorded at fair value with
  movements going to the profit and loss account
• If hedge accounting is applied, fair value
  movements are not recognised in the profit and
  loss account until the underlying hedged risk is
  recognised

• Possible for a derivative to be an economic hedge
  but not effective under IFRS due to the
  specific documentation and testing rules
• IFRS 1 gives the option not to adopt IAS 32 39
  in comparative periods
• EU have endorsed IAS 39 with a limited
  carve-out

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Financial Instruments - (IAS 32 39) - BT Effect

• BT will apply hedge accounting under IAS 39 for
  the majority of its derivative portfolio
• Fair value movements on derivatives which do not
  qualify for hedge accounting must be taken
  through the profit and loss account and BT
  estimates that a 1 decrease in interest rates
  will give rise to approximately 25m loss before
  tax and vice-versa

• BT has elected to adopt from 1 April 2005. No
  effect in prior years
• On adoption reserves will reduce reflecting the
  fair value of derivatives not recognised under UK
  GAAP and the re-classification of certain UK GAAP
  balances to reserves. Would have been about 350m
  at 1 April 2004
• Of this, some will not unwind through the future
  profit and loss account. All other factors being
  equal, interest expense will be lower than it
  would have been under UK GAAP (expected to be
  30m to 35m in 2005/06)

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Income Statement Year to 31 March 2004
pro-forma changes due to IFRS effects
before goodwill amortisation and exceptional
items Unaudited
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Balance sheet - At 31 March 2004

• Pension liability
• We shall recognise pension scheme deficit on the
  balance sheet
• Market movements will affect balance sheet
• No direct effect on distributable reserves
• Leases
• Net debt increased by approximately 100m for
  finance leases
• Increased creditor reflects timing difference
  between lease payments and profit and loss charge
• Dividend
• Dividends only accounted for in the period in
  which they are declared
• Change shown is the 2003/04 proposed final
  dividend, now accounted for in 2004/05
• No effect on cash payments and distribution
  policy
• Financial instruments
• From 1 April 2005 financial instruments will
  affect the balance sheet. Fair value movements
  will affect gross assets and liabilities at
  period ends.
• Deferred tax
• Gross up balance sheet for deferred tax assets
  and liabilities

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Balance sheet pro-forma at 31 March 2004

Reported figures for 2004 as restated for UITF 38
ESOP Trusts and UITF 17 Employee share
scheme Unaudited
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Cautionary statement

• The unaudited pro-forma financial
  information has been prepared based on the IFRSs
  that had been published by 31 December 2004 and
  apply to accounting periods beginning on or after
  1 January 2005. The group has, in preparing this
  information, early adopted the amendment to IAS
  19 that was published in December 2004. The
  standards used are those endorsed by the EU
  together with those standards and interpretations
  that have been issued by the IASB but not yet
  endorsed by the EU by March 2005. The 2004
  information has, as permitted by the exemption in
  IFRS 1, not been prepared in accordance with IAS
  32, Financial instruments Disclosure and
  presentation and IAS 39, Financial instruments
  Recognition and measurement.
• Further standards and interpretations may
  be issued that will be applicable for financial
  years beginning on or after 1 April 2005 or that
  are applicable to later accounting periods but
  may be adopted early. The group's first IFRS
  financial statements may, therefore, be prepared
  in accordance with some different accounting
  policies from the financial information presented
  here.
• Additionally, IFRS is currently being
  applied in the United Kingdom and in a large
  number of other countries simultaneously for the
  first time. Furthermore, due to a number of new
  and revised Standards included within the body of
  Standards that comprise IFRS, there is not yet a
  significant body of established practice on which
  to draw in forming opinions regarding
  interpretation and application. Accordingly,
  practice is continuing to evolve. At this
  preliminary stage, therefore, the full financial
  effect of reporting under IFRS as it will be
  applied and reported on in the group's first IFRS
  financial statements cannot be determined with
  certainty and may be subject to change.

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• International Financial
• Reporting Standards -
• Update

QA 21 March 2005
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