REG - Serco Group PLC - 2017 Full Year Results <Origin Href="QuoteRef">SRP.L</Origin> - Part 4
22/02/2018 07:05
- Part 4: For the preceding part double click ID:nRSV5870Fc
£m £m £m £m £m £m £m £m £m £m
At 1 January 2016 22.0 327.9 0.1 68.5 (101.3) 80.9 (59.8) (57.7) 280.6 1.5
Total comprehensive income for the year - - - 14.6 10.2 - - 82.3 107.1 0.4
Shares transferred to option holders on exercise of share options - - - - - (7.7) 7.7 - - -
Expense in relation to share based payments - - - - - 9.7 - - 9.7 -
Change in non controlling interest - - - - - - - - - (0.5)
At 1 January 2017 22.0 327.9 0.1 83.1 (91.1) 82.9 (52.1) 24.6 397.4 1.4
Total comprehensive income for the year - - - 0.6 (89.0) - - (14.5) (102.9) 0.1
Shares transferred to option holders on exercise of share options - - - - - (6.0) 6.0 - - -
Expense in relation to share based payments - - - - - 11.4 - - 11.4 -
Change in non controlling interest - - - - - - - - - (0.2)
At 31 December 2017 22.0 327.9 0.1 83.7 (180.1) 88.3 (46.1) 10.1 305.9 1.3
Condensed Consolidated Balance Sheet
At 31 December 2017 At 31 December 2016 £m
£m
Non current assets
Goodwill 551.3 577.9
Other intangible assets 66.7 83.6
Property, plant and equipment 65.2 69.3
Interests in joint ventures and associates 14.3 14.4
Trade and other receivables 57.3 44.4
Derivative financial instruments 3.7 14.2
Deferred tax assets 55.0 50.8
Retirement benefit assets 41.8 150.4
855.3 1,005.0
Current assets
Inventories 17.4 22.4
Trade and other receivables 506.5 543.5
Current tax assets 11.2 11.0
Cash and cash equivalents 112.1 177.8
Derivative financial instruments 10.3 4.9
657.5 759.6
Total assets 1,512.8 1,764.6
Current liabilities
Trade and other payables (462.9) (524.5)
Derivative financial instruments (1.1) (0.6)
Current tax liabilities (25.3) (25.9)
Provisions (148.5) (172.3)
Obligations under finance leases (8.5) (12.3)
Loans (31.8) (9.7)
(678.1) (745.3)
Non current liabilities
Trade and other payables (28.7) (16.8)
Deferred tax liabilities (20.4) (30.5)
Provisions (211.5) (249.4)
Obligations under finance leases (11.7) (15.9)
Loans (239.7) (290.2)
Retirement benefit obligations (15.5) (17.7)
(527.5) (620.5)
Total liabilities (1,205.6) (1,365.8)
Net assets 307.2 398.8
Equity
Share capital 22.0 22.0
Share premium account 327.9 327.9
Capital redemption reserve 0.1 0.1
Retained earnings 83.7 83.1
Retirement benefit obligations reserve (180.1) (91.1)
Share based payment reserve 88.3 82.9
Own shares reserve (46.1) (52.1)
Hedging and translation reserve 10.1 24.6
Equity attributable to owners of the Company 305.9 397.4
Non controlling interest 1.3 1.4
Total equity 307.2 398.8
Condensed Consolidated Cash Flow Statement
For the year ended 31 December
2017 2016
£m £m
Net cash inflow / (outflow) from operating activities before exceptional items 16.7 (22.4)
Exceptional items (32.5) (39.9)
Net cash outflow from operating activities (15.8) (62.3)
Investing activities
Interest received 0.5 1.4
Increase / (decrease) in security deposits 0.2 (0.4)
Dividends received from joint ventures and associates 28.2 40.0
Proceeds from disposal of property, plant and equipment 1.5 0.6
Proceeds from disposal of intangible assets 0.1 0.1
Net cash (outflow) / inflow on disposal of subsidiaries and operations (7.1) 19.4
Acquisition of subsidiaries, net of cash acquired 1.5 (0.2)
Proceeds from loans receivable 0.6 -
Purchase of other intangible assets (18.4) (15.1)
Purchase of property, plant and equipment (17.8) (17.2)
Net cash (outflow) / inflow from investing activities (10.7) 28.6
Financing activities
Interest paid (17.5) (20.1)
Exceptional finance costs paid - (0.3)
Capitalised finance costs paid - (0.3)
Repayment of loans (3.8) (135.5)
Decrease in loans to joint ventures and associates - 1.1
Capital element of finance lease repayments (12.6) (17.0)
Cash movements on hedging instruments (2.5) 47.0
Net cash outflow from financing activities (36.4) (125.1)
Net decrease in cash and cash equivalents (62.9) (158.8)
Cash and cash equivalents at beginning of year 177.8 323.6
Net exchange (loss) / gain (2.8) 7.8
Cash reclassified to assets held for sale - 5.2
Cash and cash equivalents at end of year 112.1 177.8
Notes to the Condensed Consolidated Financial Statements
1. General information, going concern and accounting policies
The basis of preparation in this preliminary announcement is set out below.
The financial information in this announcement does not constitute the
Company's statutory accounts as defined in section 434 of the Companies Act
2006 for the years ended 31 December 2017 or 2016, but is derived from these
accounts. The auditors' report on the 2016 and 2017 accounts contained no
emphasis of matter and did not contain statements under S498 (2) or (3) of the
Companies Act 2006 or equivalent preceding legislation.
The preliminary announcement has been prepared in accordance with
International Financial Reporting Standards adopted for use in the European
Union (IFRS). Whilst the financial information included in this preliminary
announcement has been computed in accordance with IFRS, this announcement does
not itself contain sufficient information to comply with IFRS. The Company
expects to publish full Group and parent company only financial statements
that comply with IFRS and FRS101 respectively, in March 2017.
The financial statements have been prepared on the historical cost basis,
except for the revaluation of financial instruments. Historical cost is
generally based on the fair value of the consideration given in exchange for
goods and services. The following principal accounting policies adopted have
been applied consistently in the current and preceding financial year except
as stated below.
Going concern
The Directors have a reasonable expectation that the Company and the Group
will be able to operate within the level of available facilities and cash for
the foreseeable future and accordingly believe that it is appropriate to
prepare the financial statements on a going concern basis.
In assessing the basis of preparation of the financial statements for the year
ended 31 December 2017, the Directors have considered the principles of the
Financial Reporting Council's 'Guidance on Risk Management, Internal Control
and Related Financial and Business Reporting, 2014'; namely assessing the
applicability of the going concern basis, the review period and disclosures.
The Directors have undertaken a rigorous assessment of going concern and
liquidity, taking into account financial forecasts, which indicate sufficient
capacity in our financing facilities and associated covenants to support the
Group. In order to satisfy themselves that they have adequate resources for
the future, the Directors have reviewed the Group's existing debt levels, the
committed funding and liquidity positions under our debt covenants, and our
ability to generate cash from trading activities and working capital
requirements. The Group's current principal debt facilities at the year end
comprised a £480m revolving credit facility, and £261m of US private
placement notes. As at 31 December 2017, the Group had £741m of committed
credit facilities and committed headroom of £588m.
In undertaking this review the Directors have considered the business plans
which provide financial projections for the foreseeable future. For the
purposes of this review, we consider that to be the period ending 30 June
2019.
Prior year restatement
The Group has undergone a programme of work on its financial data structures
to appropriately allocate and charge costs to the relevant divisions and
between cost of sales and administrative expenses. As a result of the
activities performed in this area, the Group's classification of cost items in
the income statement has changed. The prior periods' results have been
restated to reflect the cost items identified which should have been
reallocated in 2016.
Cost of sales are considered to be the direct costs of operating ongoing
contracts. This includes the unavoidable costs of servicing contracts and all
costs that a contract would incur purely on its own without a parent company,
regardless of how those services are delivered within the wider Group, such as
IT or Human Resource management services provided centrally.
The impact on the relevant line items in the Condensed Consolidated Income
Statement for the year ended 31 December 2016 is as follows:
Impact on Condensed Consolidated Income Statement Year ended 31 December 2016 as previously stated Adjustment Year ended 31 December 2016 as restated
£m £m £m
Cost of sales (2,767.6) 43.0 (2,724.6)
Gross profit 243.4 43.0 286.4
General and administrative expenses (173.2) (43.0) (216.2)
Adoption of new and revised standards
None of the changes to IFRS that became effective in the current reporting
period have had a significant impact on the Group's financial statements.
New standards and interpretations not applied: IFRS15 Revenue from Contracts
with Customers
IFRS15 Revenue from Contracts with Customers (effective 1 January 2018),
provides a single, principles-based five step model to be applied to all sales
contracts, based on the transfer of control of goods and services to
customers. It replaces existing revenue recognition guidance for goods,
services and construction contracts currently included in IAS11 Construction
Contracts and IAS18 Revenue.
Under the transition rules IFRS15 will be applied retrospectively to the prior
period in accordance with IAS8 Accounting policies, changes in accounting
estimates and errors, subject to the following expedients:
· contracts completed prior to 1 January 2018 and that begin and end
within the same annual reporting period will not be restated;
· for contracts that have variable consideration and which have
completed prior to 1 January 2018, the revenues recognised will reflect the
actual outcome, rather than being estimated and trued up; and
· the disclosures required for comparative periods in respect of amount
of revenue allocated to the remaining performance obligations and an
explanation of when that amount is expected to be recognised will not be made.
The cumulative effect of initially applying the standard will be shown as an
adjustment to brought forward retained earnings as at 1 January 2017.
Below is set out the expected revenue recognition policy under IFRS15 together
with the estimated impact of adopting the standard.
Revenue recognition: Repeat service based contracts
The majority of the Group's contracts are repeat service based contracts where
value is transferred to the customer over time as the core services are
delivered and therefore in most cases revenue will be recognised on the output
basis, with revenue linked to the deliverables provided to the customer.
Where any price step downs are required in a contract accounted for under the
output basis and output is not decreasing, revenue will require deferral from
initial years to subsequent years in order for revenue to be recognised on a
consistent basis.
There are some contracts where a separate performance obligation has been
identified for services where the pattern of delivery differs to the core
services and are capable of being distinct. In these instances, where the
transfer of control is most closely aligned to our efforts in delivering the
service, then the input method is used to measure progress, and revenue is
recognised in direct proportion to costs incurred. Where deemed appropriate,
the Group will utilise the practical expedient within IFRS15, allowing revenue
to be recognised at the amount which the Group has the right to invoice, where
that amount corresponds directly with the value to the customer of the Group's
performance completed to date.
Under IFRS15, unless upfront fees received from customers including transition
payments can be clearly attributable to a distinct service the customer is
obtaining, then such payments do not constitute a separate performance
obligation and instead are deferred and spread over the life of the core
services.
Any changes to the enforceable rights and obligations with customers and / or
an update to the transaction price will not be recognised as revenue until
there is evidence of customer agreement in line with the Group's policies.
Any variable amounts will only be recognised where it is highly probable that
a significant reversal will not occur.
Where the Group is required to assess whether it is acting as principal or as
an agent in respect of goods or services procured for customers, the Group is
acting as principal if it is in control of a good or a service prior to
transferring to the customer and an agent where it is arranging for those
goods or services to be provided to the customer without obtaining control.
Revenue recognition: Long-term project based contracts
The Group has a limited number of long-term contracts for the provision of
complex, project-based services. When control of such a deliverable is passed
onto the customer at the final stage of a contract, the recognition of revenue
is delayed until control has been passed. However, where the customer has
control over the life of the deliverable or where the Group has a legally
enforceable right to remuneration for the work completed to date, or at
milestone periods, revenue will be recognised in line with the associated
transfer of control or milestone dates.
Revenue recognition: Other
Sales of goods are recognised when goods are delivered and title has passed.
Interest income is accrued for on a time basis, by reference to the principal
outstanding and at the effective interest rate applicable, which is the rate
that exactly discounts estimated future cash receipts through the expected
life of the financial asset to that asset's net carrying amount.
Dividend income from investments is recognised when the right to receive
payment has been established.
Contract costs
Bid costs are capitalised only when they relate directly to a contract and are
incremental to securing the contract. Any costs which would have been
incurred whether or not the contract is actually won are not considered to be
capitalised bid costs.
Contract costs are charged to the income statement as incurred, including the
necessary accrual for costs which have not yet been invoiced, unless the
expense relates to a specific time frame covering future periods.
Contract costs can only be capitalised when the expenditure meets all of the
following three criteria and are not within the scope of another accounting
standard, such as inventories, intangible assets, or property, plant and
equipment:
· The costs relate directly to a contract. These include: direct
labour, being the salaries and wages of employees providing the promised
services to the customer; direct materials such as supplies used in providing
the promised services to a customer; and other costs that are incurred only
because an entity entered into the contract, such as payments to
subcontractors.
· The costs generate or enhance the resources used in satisfying
performance obligations in the future. For initial contract costs
capitalised, such costs only fall into one of the following two categories:
the mobilisation of contract staff, being the costs of moving existing
contract staff to other Group locations; or directly incremental costs
incurred in meeting contractual obligations incurred prior to contract
delivery, which are required to ensure a proper handover from the previous
contractor. Redundancy costs are never capitalised.
· The costs are expected to be recovered, i.e. the contract is expected
to be profitable after amortising the capitalised costs.
Estimated impact of the adoption of IFRS15
The impact for the Group of adopting IFRS15 is as follows:
Year ended 31 December 2017 as reported Adjustment Year ended 31 December 2017 as restated
£m £m £m
Revenue 2,953.6 (3.0) 2,950.6
Underlying Trading Profit 69.8 (0.3) 69.5
Operating profit before exceptional items 49.6 (8.7) 40.9
Profit before tax 19.1 (8.7) 10.4
Tax (19.0) 0.4 (18.6)
Profit after tax 0.1 (8.3) (8.2)
As at 1 January 2017
£m
Retained earnings at 1 January 2017 as reported 83.1
Adjustment to retained earnings before the impact of onerous contract (54.5)
provisions
Impact of onerous contract provisions 21.7
Retained earnings at 1 January 2017 as restated 50.3
The Group will continue to work to design, implement and refine procedures to
apply the new requirements of IFRS15 and to finalise accounting policy
choices, including in its subsidiaries and joint ventures. As a result of this
ongoing work, it is possible that there may be some changes to the impact
above prior to the 30 June 2018 results being issued. However, at this time
these are not expected to be significant.
The total adjustment to the opening balance of the Group's equity at 1 January
2017 is a decrease of £32.8m. The principal components of the estimated
adjustment are as follows:
· A decrease of £14.4m due to revenues being recognised at a constant
amount over the life of the contract where the level of services provided is
broadly consistent.
· A decrease of £11.4m due to a change in the basis of measuring
progress for asset maintenance and replacement services, including dry
docking. Where the resources used to fulfil the performance obligations best
depicts how control is passed to the customer, the input method of accounting
has been applied.
· A decrease of £6.8m due to upfront fees and transition payments
being deferred and spread in line with delivery of the core services.
The following table details the specific areas impacted as a result of the
adoption of IFRS15 and cross-referenced below the table are Serco's policies
in adopting the requirements of the standard:
Impact on retained earnings as at 1 January 2017 and the Condensed Retained earnings Revenue Operating profit before exceptional items
Consolidated Income Statement for the year ended 31 December 2017
£m £m £m
Under current accounting standards 83.1 2,953.6 49.6
IFRS15 adjustments:
(i) Upfront fees (2.6) 0.9 0.8
(ii) Transition, transformation and other mobilisation activities (4.2) 2.1 (3.0)
(iii) Asset maintenance and replacement, including vessel dry docking (11.4) 1.3 (0.8)
(iv) Percentage of completion accounting (0.2) 0.5 0.1
(v) Pass through revenues and procurement arrangements - (12.6) -
(vi) Consideration payable to a customer - (0.5) (0.4)
(vii) Variable pricing (14.4) 5.3 3.0
(viii) OCP charges and releases - - (8.4)
Adjusted under IFRS15 50.3 2,950.6 40.9
(i) Upfront fees. For some contracts, the Group receives
non-refundable amounts at the start of the contract to cover initial costs.
Under IFRS15, unless upfront fees are attributable to a good or a service the
customer is in control of, such fees do not constitute a separate performance
obligation and instead are allocated to the performance obligations of the
contract, therefore being spread over the life of the other services. In some
instances such upfront fees were recognised as revenue under IAS18 but are
deferred under IFRS15. Upfront payments are analysed to determine whether they
constitute a material financing arrangement under IFRS15.
(ii) Transition, transformation and other mobilisation activities.
Transition activities which are administrative in nature are not treated as
separate performance obligations. Transition and transformation activities
which are more than administrative in nature are assessed to determine whether
they form a separate performance obligation. Where it can be demonstrated that
the transition activities benefit the customer without future activities being
provided then the transition phase is accounted for as a separate performance
obligation under the contract and revenue recognised accordingly. Where it is
concluded that the transformation, transition or mobilisation activity does
not form a separate performance obligation under the contract, any payments
received from the customer are allocated to the performance obligations of the
contract and recognised over the life of the other services. In some instances
revenue recognised under IAS18 is deferred under IFRS15.
(iii) Asset maintenance and replacement, including vessel dry docking.
In many of the contracts the Group enters into, the provision of maintenance
and replacement services are capable of being distinct and therefore these
have been accounted for as separate performance obligations. The input method
of accounting is used to reflect the pattern of delivery to the customer and
the enhancement of customer owned assets. In some instances the output method
of accounting is used due to the ongoing repetitive nature and frequency of
the services. Adopting IFRS15 will result in the deferral of revenue
recognised under IAS18 on certain contracts.
(iv) Percentage of completion accounting. Changes to the Group's
current accounting policy arise when the percentage of completion model under
IAS11 is replaced by the output method of accounting. The output method is
used where the customer simultaneously receives and consumes the benefits in
direct proportion to the deliverable performed rather than the level of
expense incurred to date.
(v) Pass through revenues and procurement arrangements. A pass
through arrangement is where goods or services are provided by a third party,
but sourced by the Group on behalf of the customer. In this instance, the
Group does not recognise revenue for the amount received from the customer as
compensation of the cost of the good or service but rather only the margin
element (if any) is recorded as revenue. Recognition of such revenues under
IFRS15 is linked directly to whether the Group has control of the deliverable
prior to transfer rather than an assessment of the risks and rewards
associated with the services as was the case under IAS18. For certain
procurement arrangements the Group does not have control prior to transfer,
but does have a level of risk associated with the activity, and therefore
these arrangements are not recognised on a net basis instead of the gross
basis under IAS18.
(vi) Consideration payable to a customer. Under IFRS15 all amounts
payable to a customer (including all payments to the customer and all
reductions to amounts paid by the customer) are recorded as a reduction in
revenue. In 2017, an element of reductions have been recorded as costs.
(vii) Variable pricing. It is not uncommon in outsourcing arrangements
for the payment terms to be set to decline over the future periods (i.e. a 5%
reduction in fees is built into years five to six, 6% reduction in years seven
to eight and so on). However, where revenue recognition under IFSR15 is based
on the output method and the service remains consistent over the contract
life, the reduction in the amounts paid by the customer should not be
reflected in declining revenues, even if this was appropriate under IAS18. As
a result, revenue recognised in prior years for certain contracts will be
deferred under IFRS15.
(viii) OCP charges and releases. Where an adjustment is required by
IFRS15 and the relevant contract is loss making, the deferral of revenue from
prior years can result in a decrease in the level of OCP needed under IFRS15,
as future losses will reduce by the level of deferred revenue. During the
year one contract recorded a release against the OCP balance held under
current accounting standards. As a result of IFRS15, revenues on this
contract have been deferred, reducing the opening OCP balance, increasing
deferred revenue and therefore the release of the relevant OCP balance is
lower under IFRS15.
In addition to the areas where a financial impact has been identified as a
result of adoption of IFRS15 as identified above, there are certain accounting
policies which are new or change existing policies applied by the Group and
may have an impact on the future financial performance of the Group. The
policies in these areas to be adopted by the Group are set out below:
(ix) Contract variations. Contract modifications such as change
orders, variations, change notices and amendments could be approved in
writing, by oral agreement or implied by customary business practices. Under
IFRS15 contract modification are changes in the scope or price (or both) of a
contract that is approved by the parties to the contract. If the parties to
the contract have not approved a contract modification, revenue should be
recognised in accordance with the existing contractual terms and associated
cash payments are deferred until the contract modification is approved. The
judgements historically applied have been consistent with this policy.
(x) Variable revenues requiring estimation. IFRS15 provides clear
guidance on variable income unlike IAS18 and two areas may be impacted as a
result. First, if the consideration paid by a customer includes a variable
amount requiring judgement, it is only recognised where it is highly probable
that a significant reversal will not occur. Second, service penalties or any
claims made by us against the customer which must be recognised in revenue
unless it is highly probable that they will not result in future settlement.
However, judgements taken historically are consistent with the requirements of
IFRS15 and there is no impact of these changes on the Group.
(xi) Capitalised redundancy costs. Under certain contracts there is an
obligation to make redundancies and the Group is compensated for these costs.
Historically, the Group may have recognised revenues as and when the customer
makes payments or the Group may have capitalised the expense to match with
payments being made in the future. Under IFRS15, all redundancy costs must be
expensed in the period they are incurred and revenue is not recognised on
these redundancy transactions, with any cash payments deferred over the
contract in line with the other services being delivered. No adjustment was
required in respect of this difference.
(xii) Licence income. Where the Group receives income for software
licences and maintenance services provided through ongoing support and
operational functionality, this licence revenue is recognised over the period
when the maintenance obligation exists. There are currently no significant
licencing arrangements entered into by the Group with its customers which are
impacted by IFRS15.
(xiii) Extension periods granted or other options. Providing the option
for a customer to obtain extension periods or other services may lead to a
separate performance obligation where a material right exists. If a separate
performance obligation exists then there would be an allocation of the
transaction price from the original contract in addition to any revenues
earned through the option period. A separate performance obligation exists for
options under a contract if both of the following conditions are met. First,
if the customer is unable to obtain the right to acquire the additional goods
or services on the same or similar terms without entering into the original
contract (for example they cannot get the option without first entering into
the main contract, which would be the case for any extension period). Second,
the option does not simply give the customer the right to acquire additional
goods or services at a price that reflects the stand alone selling price for
those goods or services (for example if the pricing of the option is
consistent with what the pricing would have been in any case there is no
separate PO, as the customer gains no incremental benefit from the existence
of the option). No differences were noted under IFRS15 in this area.
(xiv) Work in progress. Revenue is only recognised when control is
passed to a customer and therefore where revenue is recognised over time no
work in progress is created unlike under current accounting standards. None of
the contracts with revenues recognised over time have work in progress
balances.
(xv) Significant financing component. Where the timing of payments
agreed with the customer provides either party with a significant benefit of
financing (either explicitly or implicitly), the associated asset/liability is
adjusted for the time value of money and an interest charge or income is
recognised and a corresponding offset in revenue. The Group's policy under
IFRS15 is to consider "significant" to be greater than 5% of the total
transaction price of the contractual arrangement and no such arrangements are
in place.
(xvi) Non cash consideration. If a customer contributes goods or
services (for example, materials, equipment or labour) to facilitate the
fulfilment of the contract, the Group assesses whether control is obtained for
those contributed goods or services. If the Group obtains control of the
contributed goods or services, then the estimated fair value of these would be
recognised as revenue. No such transactions have been noted.
Other new standards and interpretations not applied
At the date of authorisation of these financial statements, the following
changes to IFRS have not been applied but could potentially have a significant
impact:
(i) IFRS9 Financial Instruments has been endorsed by the EU and
will be effective from 1 January 2018.
This standard replaces IAS39 and introduces new requirements for classifying
and measuring financial instruments and puts in place a new hedge accounting
model that is designed to be more closely aligned with how entities undertake
risk management activities when hedging financial and non-financial risk
exposures.
The impact of IFRS9 on the regular trading activities of the Group is expected
to be immaterial. The key areas of focus for the Group under IFRS9 are:
· External loan receivables, including those from equity accounted
entities.
· Debt refinancing not accounted for as a significant modification
under IAS39.
· Expected credit losses being recognised on trade debtors and contract
assets recognised under IFRS15.
· Intercompany loan recoverability.
IFRS9 replaces the 'incurred loss' model in IAS39 with an 'expected credit
loss' model. The new model applies to financial assets that are not measured
at FVTPL (fair value through profit and loss), including loans, lease and
trade receivables, debt securities, contract assets under IFRS15 and specified
financial guarantees and loan commitments issued. It does not apply to equity
investments.
Under the expected credit loss model, the Group is required to calculate the
allowance for credit losses by considering on a discounted basis the cash
shortfalls it would incur in various default scenarios for prescribed future
periods and multiplying the shortfalls by the probability of each scenario
occurring. The allowance is the sum of these probability weighted outcomes.
Because every loan and receivable carries with it some risk of default, it is
expected that every such asset has a loss attached to it from the moment of
its origination.
The financial assets held on the balance sheet have been reviewed in order to
determine whether any loss is required to be recorded based on these expected
credit losses. However, given the fact that the Group's customers are
governments it is unlikely that there will be a default as a result of credit
risk and any provision for bad debts is more likely to be related to a
contractual dispute. In most cases, each amount receivable has specific risk
attached to recoverability which is most likely based on the services provided
under the terms of the contract and, given the majority of receivables are
backed by organisations with a sovereign credit rating, a general view on
recoverability based on the counterparty credit risk could be misleading.
(ii) IFRS16 Leases is pending EU endorsement, which is expected
prior to the effective date of 1 January 2019.
The standard replaces IAS17 Leases and has been introduced in order to improve
the comparability of financial statements through developing an approach that
is more consistent with the conceptual framework definitions of assets and
liabilities.
The key change will be in respect of leases currently classified as operating
leases. Under the new standard leases will be recognised on the balance sheet
as liabilities with corresponding assets being created, grossing up the
balance sheet but with no net effect on net assets at the start of the lease.
The income statement impact will be a new interest charge arising from the
rate implicit in the liability and as currently the full impact is a charge to
operating profit, the change will result in an improvement to operating
results.
We have not quantified the likely impact of the new standard, the transition
approach to be taken or concluded whether it will be adopted early, which is
allowed from the date IFRS15 is adopted. The quantitative impact of the
adoption of IFRS16 will be disclosed prior to the adoption of this new
standard.
2. Critical accounting judgements and key sources of estimation uncertainty
In the process of applying the Group's accounting policies, which are
described in note 1 above, management has made the following judgements that
have the most significant effect on the amounts recognised in the financial
statements. As described below, many of these areas of judgement also involve
a high level of estimation uncertainty.
Prior year restatement: Change in accounting policy
The accounting policy regarding the classification of cost items within cost
of sales and administrative expenses was changed in the year. Judgement was
applied in reaching the conclusion that it provides more relevant financial
results to exclude these amounts from the underlying transactions of trading
operations. Further details are provided in note 1.
Use of Alternative Performance Measures: Operating profit before exceptional
items
IAS1 requires material items to be disclosed separately in a way that enables
users to assess the quality of a company's profitability. In practice, these
are commonly referred to as 'exceptional' items, but this is not a concept
defined by IFRS and therefore there is a level of judgement involved in
arriving at an Alternative Performance Measure which excludes such exceptional
items. We consider items which are material and outside of the normal
operating practice of the company to be suitable for separate presentation.
Further details can be seen in note 8.
The segmental analysis of continuing operations in note 4 includes the
additional performance measure of Trading Profit on continuing operations
which is reconciled to reported operating profit in that note. The Group uses
Trading Profit as an alternative measure to reported operating profit by
making several adjustments. Firstly, Trading Profit excludes exceptional
items, being those we consider material and outside of the normal operating
practice of the company to be suitable of separate presentation and detailed
explanation. Secondly, amortisation and impairment of intangibles arising on
acquisitions are excluded, because these charges are based on judgments about
the value and economic life of assets that, in the case of items such as
customer relationships, would not be capitalised in normal operating practice.
The CODM reviews the segmental analysis for continuing operations together
with discontinued operations.
Provisions for onerous contracts
Determining the carrying value of onerous contract provisions requires
assumptions and complex judgements to be made about the future performance of
the Group's contracts. The level of uncertainty in the estimates made, either
in determining whether a provision is required, or in the calculation of a
provision booked, is linked to the complexity of the underlying contract and
the form of service delivery. Due to the level of uncertainty and combination
of variables associated with those estimates there is a significant risk that
there could be material adjustment to the carrying amounts of onerous contract
provisions within the next financial year.
Major sources of uncertainty which could result in a material adjustment
within the next financial year are:
· The ability of the company to maintain or improve operational
performance to ensure costs or performance related penalties are in line with
expected levels.
· Volume driven revenue and costs being within the expected ranges.
· The outcome of matters dependent on the behaviour of the customer,
such as a decision to extend a contract where it has the unilateral right to
do so.
· The outcome of open claims made by or against a customer regarding
contractual performance.
· The ability of suppliers to deliver their contractual obligations on
time and on budget.
In the current year material revisions have been made to historic provisions,
which have led to a charge to contract provisions of £62.0m, including £0.5m
in relation to new provisions, and releases of £43.4m. Further details are
provided in the Finance Review. All of these revisions have resulted from
triggering events in the current year, either through changes in contractual
positions or changes in circumstances which could not have been reasonably
foreseen at the previous balance sheet date. To mitigate the level of
uncertainty in making these estimates Management regularly compares actual
performance of the contracts against previous forecasts and considers whether
there have been any changes to significant judgements. A detailed bottom up
review of the provisions is performed as part of the Group's formal annual
budgeting process.
The future range of possible outcomes in respect of those assumptions and
significant judgements made to determine the carrying value of onerous
contracts could result in either a material increase or decrease in the value
of onerous contract provisions in the next financial year. The extent to
which actual results differ from estimates made at the reporting date depends
on the combined outcome and timing of a large number of variables associated
with performance across multiple contracts.
The individual provisions are discounted where the impact is assessed to be
significant. Discount rates used are calculated based on the estimated risk
free rate of interest for the region in which the provision is located and
matched against the ageing profile of the provision. Rates applied are in the
range of 0.72% and 1.95%.
Investigation by the Serious Fraud Office
In November 2013, the UK's Serious Fraud Office announced that it had opened
an investigation, which remains ongoing, into the Group's Electronic
Monitoring Contract.
We are cooperating fully with the Serious Fraud Office's investigation but it
is not possible to predict the outcome. However, disclosed in the Principal
Risks and Uncertainties in this Report is a description of the range of
possible outcomes in the event that the Serious Fraud Office decides to
prosecute the individuals and / or the Serco entities involved.
Impairment of assets
Identifying whether there are indicators of impairment for assets involves a
high level of judgement and a good understanding of the drivers of value
behind the asset. At each reporting period an assessment is performed in order
to determine whether there are any such indicators, which involves considering
the performance of our business and any significant changes to the markets in
which we operate.
We seek to mitigate the risk associated with this judgement by putting in
place processes and guidance for the finance community and internal review
procedures.
Determining whether assets with impairment indicators require an actual
impairment involves an estimation of the expected value in use of the asset
(or CGU to which the asset relates). The value in use calculation involves an
estimation of future cash flows and also the selection of appropriate discount
rates, both of which involve considerable judgement. The future cash flows are
derived from approved forecasts, with the key assumptions being revenue
growth, margins and cash conversion rates. Discount rates are calculated with
reference to the specific risks associated with the assets and are based on
advice provided by external experts. Our calculation of discount rates are
performed based on a risk free rate of interest appropriate to the geographic
location of the cash flows related to the asset being tested, which is
subsequently adjusted to factor in local market risks and risks specific to
Serco and the asset itself. Discount rates used for internal purposes are
post tax rates, however for the purpose of impairment testing in accordance
with IAS36 Impairment of assets we calculate a pre tax rate based on post tax
targets.
A key area of focus in recent years has been in the impairment testing of
goodwill as a result of the pressure on the results of the Group. However, no
impairment of goodwill was noted in the year ended 31 December 2017.
Deferred tax
Deferred tax assets are recognised for unused tax losses to the extent that it
is probable that taxable profit will be available against which the losses can
be utilised. Significant management judgement is required to determine the
amount of deferred tax assets that can be recognised, based upon the likely
timing and the level of future taxable profits. Recognition has been based on
forecast future taxable profits.
Further details on taxes are disclosed in note 12.
Current tax
Liabilities for tax contingencies require management judgement and estimates
in respect of tax audits and also tax exposures in each of the jurisdictions
in which we operate. Management is also required to make an estimate of the
current tax liability together with an assessment of the temporary differences
that arise as a consequence of different accounting and tax treatments. Key
judgement areas include the correct allocation of profits and losses between
the countries in which we operate and the pricing of intercompany services.
Where management conclude that a tax position is uncertain, a current tax
liability is held for anticipated taxes that are considered probable based on
the current information available.
These liabilities can be built up over a long period of time but the ultimate
resolution of tax exposures usually occurs at a point in time, and given the
inherent uncertainties in assessing the outcomes of these exposures, these
estimates are prone to change in future periods. It is not currently possible
to estimate the timing of potential cash outflow, but on resolution, to the
extent this differs from the liability held, this will be reflected through
the tax charge / (credit) for that period. Each potential liability and
contingency is revisited on an annual basis and adjusted to reflect any
changes in positions taken by the company, local tax audits, the expiry of the
statute of limitations following the passage of time and any change in the
broader tax environment.
On the basis of the currently available information, the Group does not
anticipate a material change to the estimated liability in the short term.
Retirement benefit obligations
Identifying whether the Group has a retirement benefit obligation as a result
of contractual arrangements entered into requires a level of judgement,
largely driven by the legal position held between the Group, the customer and
the relevant pension scheme. The Group's retirement benefit obligations are
covered in note 18.
The calculation of retirement benefit obligations is dependent on material key
assumptions including discount rates, mortality rates, inflation rates and
future contribution rates.
In accounting for the defined benefit schemes, the Group has applied the
following principles:
· The asset recognised for the Serco Pension and Life Assurance Scheme
is based on the assumption that the full surplus will ultimately be available
to the Group as a future refund of surplus.
· No foreign exchange item is shown in the disclosures as the non UK
liabilities are not material.
· No pension assets are invested in the Group's own financial
instruments or property.
· Pension annuity assets are remeasured to fair value at each reporting
date based on the share of the defined benefit obligation covered by the
insurance contract.
3. Discontinued operations
The Global Services division, representing private sector BPO operations, was
classified as a discontinued operation in 2015 and 2016. The most significant
part of this business was disposed in 2015, and the disposal of one of the two
remaining elements of the offshore business was completed in March 2016 and
the final element completed in December 2016. The residual UK onshore private
sector BPO operations were sold or exited in 2016 with the exception of one
business consisting of a single contract, where disposal was completed in July
2017. Total revenues for the remaining operations were £5.4m and the loss
before exceptional items was £0.6m up to the point of disposal, therefore the
results have been included in continuing operations in 2017 on the grounds of
materiality. The final contract was sold with no profit or loss on disposal,
with a net cash outflow of £0.5m.
The results of the discontinued operations were as follows:
For the year ended 31 December 2016
£m
Revenue 36.8
Expenses (40.1)
Operating loss before exceptional items (3.3)
Exceptional loss on disposal of subsidiaries and operations (2.8)
Other exceptional operating items (11.4)
Operating loss (17.5)
Exceptional finance costs (0.4)
Loss before tax (17.9)
Tax charge on loss before exceptional items (0.1)
Net loss attributable to discontinued operations presented in the income (18.0)
statement
Attributable to:
Equity owners of the Company (18.1)
Non controlling interests 0.1
Included above are items classified as exceptional as they are considered to
be material and outside of the normal course of business. These are summarised
as follows:
For the year ended 31 December 2016
£m
Exceptional items arising on discontinued operations
Exceptional loss on disposal (2.8)
Other exceptional operating items
Restructuring costs (1.1)
Impairment of goodwill -
Movements in indemnities provided on business disposals (13.7)
Movement in the fair value of assets transferred to held for sale 3.4
Other exceptional operating items (11.4)
Exceptional operating items arising on discontinued operations (14.2)
In 2016 a charge of £1.1m arose in discontinued operations in relation to the
restructuring programme resulting from the Strategy Review. This included
redundancy payments, provisions and other charges relating to the exit of the
UK private sector BPO business, external advisory fees and other incremental
costs.
A charge of £13.7m arose in 2016 in relation to the movement in the value of
indemnities provided on business disposals made in previous years. These
relate to changes in exchange rates where indemnities were provided in foreign
currencies and increases to provisions for interest and penalties on any
indemnities. There were no changes in the value of these indemnities in
2017.
A charge of £0.4m was incurred in 2016 as a result of early payments to the
US Private Placement (USPP) Noteholders following the disposal of the offshore
private sector BPO business. These charges were treated as exceptional finance
costs as they were directly linked to the restructuring resulting from the
Strategy Review.
The net cash flows resulting from the discontinued operations were as follows:
For the year ended 31 December 2016
£m
Net cash inflow from operating activities before exceptional items 5.5
Exceptional items -
Net cash inflow from operating activities 5.5
Net cash inflow from investing activities 12.5
Net cash outflow from financing activities (11.4)
Net increase in cash and cash equivalents attributable to discontinued 6.6
operations
4. Segmental information
The Group's operating segments reflecting the information reported to the
Board in 2017 under IFRS8 Operating Segments are as set out below.
Reportable segments Operating segments
UK & Europe Services for sectors including Citizen Services, Defence, Health, Justice
& Immigration and Transport delivered to UK Government, UK devolved
authorities and other public sector customers in the UK and Europe;
Americas Services for sectors including Defence, Transport and Citizen Services
delivered to US federal and civilian agencies, selected state and municipal
governments and the Canadian Government;
AsPac Services for sectors including Defence, Justice & Immigration, Transport,
Health and Citizen Services in the Asia Pacific region including Australia,
New Zealand and Hong Kong;
Middle East Services for sectors including Defence, Transport and Health in the Middle
East region; and
Corporate Central and head office costs.
Each operating segment is focused on a narrow group of customers in a specific
geographic region and is run by a local management team which report directly
to the CODM on a regular basis. As a result of this focus, the sectors in each
region have similar economic characteristics and are aggregated at the
operating segment level in these condensed financial statements.
During the year two existing divisions, UK Central Government and UK &
Europe Local & Regional Government, were merged to form the new UK &
Europe division (UK&E) with the management team structure and
responsibilities altered to match the segment. This note has been adjusted to
reflect the impact of this, which has been to add together the results of the
two former divisions in the comparative period.
Geographic information
Year ended 31 December Revenue 2017 Non
- More to follow, for following part double click ID:nRSV5870Fe
Change in non controlling interest - - - - - - - - - (0.5)
At 1 January 2017 22.0 327.9 0.1 83.1 (91.1) 82.9 (52.1) 24.6 397.4 1.4
Total comprehensive income for the year - - - 0.6 (89.0) - - (14.5) (102.9) 0.1
Shares transferred to option holders on exercise of share options - - - - - (6.0) 6.0 - - -
Expense in relation to share based payments - - - - - 11.4 - - 11.4 -
Change in non controlling interest - - - - - - - - - (0.2)
At 31 December 2017 22.0 327.9 0.1 83.7 (180.1) 88.3 (46.1) 10.1 305.9 1.3
Condensed Consolidated Balance Sheet
At 31 December 2017 £m At 31 December 2016
£m
Non current assets
Goodwill 551.3 577.9
Other intangible assets 66.7 83.6
Property, plant and equipment 65.2 69.3
Interests in joint ventures and associates 14.3 14.4
Trade and other receivables 57.3 44.4
Derivative financial instruments 3.7 14.2
Deferred tax assets 55.0 50.8
Retirement benefit assets 41.8 150.4
855.3 1,005.0
Current assets
Inventories 17.4 22.4
Trade and other receivables 506.5 543.5
Current tax assets 11.2 11.0
Cash and cash equivalents 112.1 177.8
Derivative financial instruments 10.3 4.9
657.5 759.6
Total assets 1,512.8 1,764.6
Current liabilities
Trade and other payables (462.9) (524.5)
Derivative financial instruments (1.1) (0.6)
Current tax liabilities (25.3) (25.9)
Provisions (148.5) (172.3)
Obligations under finance leases (8.5) (12.3)
Loans (31.8) (9.7)
(678.1) (745.3)
Non current liabilities
Trade and other payables (28.7) (16.8)
Deferred tax liabilities (20.4) (30.5)
Provisions (211.5) (249.4)
Obligations under finance leases (11.7) (15.9)
Loans (239.7) (290.2)
Retirement benefit obligations (15.5) (17.7)
(527.5) (620.5)
Total liabilities (1,205.6) (1,365.8)
Net assets 307.2 398.8
Equity
Share capital 22.0 22.0
Share premium account 327.9 327.9
Capital redemption reserve 0.1 0.1
Retained earnings 83.7 83.1
Retirement benefit obligations reserve (180.1) (91.1)
Share based payment reserve 88.3 82.9
Own shares reserve (46.1) (52.1)
Hedging and translation reserve 10.1 24.6
Equity attributable to owners of the Company 305.9 397.4
Non controlling interest 1.3 1.4
Total equity 307.2 398.8
Condensed Consolidated Cash Flow Statement
For the year ended 31 December
2017 £m 2016£m
Net cash inflow / (outflow) from operating activities before exceptional items 16.7 (22.4)
Exceptional items (32.5) (39.9)
Net cash outflow from operating activities (15.8) (62.3)
Investing activities
Interest received 0.5 1.4
Increase / (decrease) in security deposits 0.2 (0.4)
Dividends received from joint ventures and associates 28.2 40.0
Proceeds from disposal of property, plant and equipment 1.5 0.6
Proceeds from disposal of intangible assets 0.1 0.1
Net cash (outflow) / inflow on disposal of subsidiaries and operations (7.1) 19.4
Acquisition of subsidiaries, net of cash acquired 1.5 (0.2)
Proceeds from loans receivable 0.6 -
Purchase of other intangible assets (18.4) (15.1)
Purchase of property, plant and equipment (17.8) (17.2)
Net cash (outflow) / inflow from investing activities (10.7) 28.6
Financing activities
Interest paid (17.5) (20.1)
Exceptional finance costs paid - (0.3)
Capitalised finance costs paid - (0.3)
Repayment of loans (3.8) (135.5)
Decrease in loans to joint ventures and associates - 1.1
Capital element of finance lease repayments (12.6) (17.0)
Cash movements on hedging instruments (2.5) 47.0
Net cash outflow from financing activities (36.4) (125.1)
Net decrease in cash and cash equivalents (62.9) (158.8)
Cash and cash equivalents at beginning of year 177.8 323.6
Net exchange (loss) / gain (2.8) 7.8
Cash reclassified to assets held for sale - 5.2
Cash and cash equivalents at end of year 112.1 177.8
Notes to the Condensed Consolidated Financial Statements
1. General information, going concern and accounting policies
The basis of preparation in this preliminary announcement is set out below.
The financial information in this announcement does not constitute the Company's statutory accounts as defined in section
434 of the Companies Act 2006 for the years ended 31 December 2017 or 2016, but is derived from these accounts. The
auditors' report on the 2016 and 2017 accounts contained no emphasis of matter and did not contain statements under S498
(2) or (3) of the Companies Act 2006 or equivalent preceding legislation.
The preliminary announcement has been prepared in accordance with International Financial Reporting Standards adopted for
use in the European Union (IFRS). Whilst the financial information included in this preliminary announcement has been
computed in accordance with IFRS, this announcement does not itself contain sufficient information to comply with IFRS. The
Company expects to publish full Group and parent company only financial statements that comply with IFRS and FRS101
respectively, in March 2017.
The financial statements have been prepared on the historical cost basis, except for the revaluation of financial
instruments. Historical cost is generally based on the fair value of the consideration given in exchange for goods and
services. The following principal accounting policies adopted have been applied consistently in the current and preceding
financial year except as stated below.
Going concern
The Directors have a reasonable expectation that the Company and the Group will be able to operate within the level of
available facilities and cash for the foreseeable future and accordingly believe that it is appropriate to prepare the
financial statements on a going concern basis.
In assessing the basis of preparation of the financial statements for the year ended 31 December 2017, the Directors have
considered the principles of the Financial Reporting Council's 'Guidance on Risk Management, Internal Control and Related
Financial and Business Reporting, 2014'; namely assessing the applicability of the going concern basis, the review period
and disclosures. The Directors have undertaken a rigorous assessment of going concern and liquidity, taking into account
financial forecasts, which indicate sufficient capacity in our financing facilities and associated covenants to support the
Group. In order to satisfy themselves that they have adequate resources for the future, the Directors have reviewed the
Group's existing debt levels, the committed funding and liquidity positions under our debt covenants, and our ability to
generate cash from trading activities and working capital requirements. The Group's current principal debt facilities at
the year end comprised a £480m revolving credit facility, and £261m of US private placement notes. As at 31 December 2017,
the Group had £741m of committed credit facilities and committed headroom of £588m.
In undertaking this review the Directors have considered the business plans which provide financial projections for the
foreseeable future. For the purposes of this review, we consider that to be the period ending 30 June 2019.
Prior year restatement
The Group has undergone a programme of work on its financial data structures to appropriately allocate and charge costs to
the relevant divisions and between cost of sales and administrative expenses. As a result of the activities performed in
this area, the Group's classification of cost items in the income statement has changed. The prior periods' results have
been restated to reflect the cost items identified which should have been reallocated in 2016.
Cost of sales are considered to be the direct costs of operating ongoing contracts. This includes the unavoidable costs of
servicing contracts and all costs that a contract would incur purely on its own without a parent company, regardless of how
those services are delivered within the wider Group, such as IT or Human Resource management services provided centrally.
The impact on the relevant line items in the Condensed Consolidated Income Statement for the year ended 31 December 2016 is
as follows:
Impact on Condensed Consolidated Income Statement Year ended 31 December 2016 as previously stated£m Adjustment£m Year ended 31 December 2016 as restated£m
Cost of sales (2,767.6) 43.0 (2,724.6)
Gross profit 243.4 43.0 286.4
General and administrative expenses (173.2) (43.0) (216.2)
Adoption of new and revised standards
None of the changes to IFRS that became effective in the current reporting period have had a significant impact on the
Group's financial statements.
New standards and interpretations not applied: IFRS15 Revenue from Contracts with Customers
IFRS15 Revenue from Contracts with Customers (effective 1 January 2018), provides a single, principles-based five step
model to be applied to all sales contracts, based on the transfer of control of goods and services to customers. It
replaces existing revenue recognition guidance for goods, services and construction contracts currently included in IAS11
Construction Contracts and IAS18 Revenue.
Under the transition rules IFRS15 will be applied retrospectively to the prior period in accordance with IAS8 Accounting
policies, changes in accounting estimates and errors, subject to the following expedients:
· contracts completed prior to 1 January 2018 and that begin and end within the same annual reporting period will not be
restated;
· for contracts that have variable consideration and which have completed prior to 1 January 2018, the revenues
recognised will reflect the actual outcome, rather than being estimated and trued up; and
· the disclosures required for comparative periods in respect of amount of revenue allocated to the remaining
performance obligations and an explanation of when that amount is expected to be recognised will not be made.
The cumulative effect of initially applying the standard will be shown as an adjustment to brought forward retained
earnings as at 1 January 2017.
Below is set out the expected revenue recognition policy under IFRS15 together with the estimated impact of adopting the
standard.
Revenue recognition: Repeat service based contracts
The majority of the Group's contracts are repeat service based contracts where value is transferred to the customer over
time as the core services are delivered and therefore in most cases revenue will be recognised on the output basis, with
revenue linked to the deliverables provided to the customer. Where any price step downs are required in a contract
accounted for under the output basis and output is not decreasing, revenue will require deferral from initial years to
subsequent years in order for revenue to be recognised on a consistent basis.
There are some contracts where a separate performance obligation has been identified for services where the pattern of
delivery differs to the core services and are capable of being distinct. In these instances, where the transfer of control
is most closely aligned to our efforts in delivering the service, then the input method is used to measure progress, and
revenue is recognised in direct proportion to costs incurred. Where deemed appropriate, the Group will utilise the
practical expedient within IFRS15, allowing revenue to be recognised at the amount which the Group has the right to
invoice, where that amount corresponds directly with the value to the customer of the Group's performance completed to
date.
Under IFRS15, unless upfront fees received from customers including transition payments can be clearly attributable to a
distinct service the customer is obtaining, then such payments do not constitute a separate performance obligation and
instead are deferred and spread over the life of the core services.
Any changes to the enforceable rights and obligations with customers and / or an update to the transaction price will not
be recognised as revenue until there is evidence of customer agreement in line with the Group's policies.
Any variable amounts will only be recognised where it is highly probable that a significant reversal will not occur.
Where the Group is required to assess whether it is acting as principal or as an agent in respect of goods or services
procured for customers, the Group is acting as principal if it is in control of a good or a service prior to transferring
to the customer and an agent where it is arranging for those goods or services to be provided to the customer without
obtaining control.
Revenue recognition: Long-term project based contracts
The Group has a limited number of long-term contracts for the provision of complex, project-based services. When control of
such a deliverable is passed onto the customer at the final stage of a contract, the recognition of revenue is delayed
until control has been passed. However, where the customer has control over the life of the deliverable or where the Group
has a legally enforceable right to remuneration for the work completed to date, or at milestone periods, revenue will be
recognised in line with the associated transfer of control or milestone dates.
Revenue recognition: Other
Sales of goods are recognised when goods are delivered and title has passed.
Interest income is accrued for on a time basis, by reference to the principal outstanding and at the effective interest
rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the
financial asset to that asset's net carrying amount.
Dividend income from investments is recognised when the right to receive payment has been established.
Contract costs
Bid costs are capitalised only when they relate directly to a contract and are incremental to securing the contract. Any
costs which would have been incurred whether or not the contract is actually won are not considered to be capitalised bid
costs.
Contract costs are charged to the income statement as incurred, including the necessary accrual for costs which have not
yet been invoiced, unless the expense relates to a specific time frame covering future periods.
Contract costs can only be capitalised when the expenditure meets all of the following three criteria and are not within
the scope of another accounting standard, such as inventories, intangible assets, or property, plant and equipment:
· The costs relate directly to a contract. These include: direct labour, being the salaries and wages of employees
providing the promised services to the customer; direct materials such as supplies used in providing the promised services
to a customer; and other costs that are incurred only because an entity entered into the contract, such as payments to
subcontractors.
· The costs generate or enhance the resources used in satisfying performance obligations in the future. For initial
contract costs capitalised, such costs only fall into one of the following two categories: the mobilisation of contract
staff, being the costs of moving existing contract staff to other Group locations; or directly incremental costs incurred
in meeting contractual obligations incurred prior to contract delivery, which are required to ensure a proper handover from
the previous contractor. Redundancy costs are never capitalised.
· The costs are expected to be recovered, i.e. the contract is expected to be profitable after amortising the
capitalised costs.
Estimated impact of the adoption of IFRS15
The impact for the Group of adopting IFRS15 is as follows:
Year ended 31 December 2017 as reported£m Adjustment£m Year ended 31 December 2017 as restated£m
Revenue 2,953.6 (3.0) 2,950.6
Underlying Trading Profit 69.8 (0.3) 69.5
Operating profit before exceptional items 49.6 (8.7) 40.9
Profit before tax 19.1 (8.7) 10.4
Tax (19.0) 0.4 (18.6)
Profit after tax 0.1 (8.3) (8.2)
As at 1 January 2017£m
Retained earnings at 1 January 2017 as reported 83.1
Adjustment to retained earnings before the impact of onerous contract provisions (54.5)
Impact of onerous contract provisions 21.7
Retained earnings at 1 January 2017 as restated 50.3
The Group will continue to work to design, implement and refine procedures to apply the new requirements of IFRS15 and to
finalise accounting policy choices, including in its subsidiaries and joint ventures. As a result of this ongoing work, it
is possible that there may be some changes to the impact above prior to the 30 June 2018 results being issued. However, at
this time these are not expected to be significant.
The total adjustment to the opening balance of the Group's equity at 1 January 2017 is a decrease of £32.8m. The principal
components of the estimated adjustment are as follows:
· A decrease of £14.4m due to revenues being recognised at a constant amount over the life of the contract where the
level of services provided is broadly consistent.
· A decrease of £11.4m due to a change in the basis of measuring progress for asset maintenance and replacement
services, including dry docking. Where the resources used to fulfil the performance obligations best depicts how control is
passed to the customer, the input method of accounting has been applied.
· A decrease of £6.8m due to upfront fees and transition payments being deferred and spread in line with delivery of the
core services.
The following table details the specific areas impacted as a result of the adoption of IFRS15 and cross-referenced below
the table are Serco's policies in adopting the requirements of the standard:
Impact on retained earnings as at 1 January 2017 and the Condensed Consolidated Income Statement for the year ended 31 December 2017 Retained earnings£m Revenue£m Operating profit before exceptional items£m
Under current accounting standards 83.1 2,953.6 49.6
IFRS15 adjustments:
(i) Upfront fees (2.6) 0.9 0.8
(ii) Transition, transformation and other mobilisation activities (4.2) 2.1 (3.0)
(iii) Asset maintenance and replacement, including vessel dry docking (11.4) 1.3 (0.8)
(iv) Percentage of completion accounting (0.2) 0.5 0.1
(v) Pass through revenues and procurement arrangements - (12.6) -
(vi) Consideration payable to a customer - (0.5) (0.4)
(vii) Variable pricing (14.4) 5.3 3.0
(viii) OCP charges and releases - - (8.4)
Adjusted under IFRS15 50.3 2,950.6 40.9
(i) Upfront fees. For some contracts, the Group receives non-refundable amounts at the start of the contract to cover
initial costs. Under IFRS15, unless upfront fees are attributable to a good or a service the customer is in control of,
such fees do not constitute a separate performance obligation and instead are allocated to the performance obligations of
the contract, therefore being spread over the life of the other services. In some instances such upfront fees were
recognised as revenue under IAS18 but are deferred under IFRS15. Upfront payments are analysed to determine whether they
constitute a material financing arrangement under IFRS15.
(ii) Transition, transformation and other mobilisation activities. Transition activities which are administrative in
nature are not treated as separate performance obligations. Transition and transformation activities which are more than
administrative in nature are assessed to determine whether they form a separate performance obligation. Where it can be
demonstrated that the transition activities benefit the customer without future activities being provided then the
transition phase is accounted for as a separate performance obligation under the contract and revenue recognised
accordingly. Where it is concluded that the transformation, transition or mobilisation activity does not form a separate
performance obligation under the contract, any payments received from the customer are allocated to the performance
obligations of the contract and recognised over the life of the other services. In some instances revenue recognised under
IAS18 is deferred under IFRS15.
(iii) Asset maintenance and replacement, including vessel dry docking. In many of the contracts the Group enters into,
the provision of maintenance and replacement services are capable of being distinct and therefore these have been accounted
for as separate performance obligations. The input method of accounting is used to reflect the pattern of delivery to the
customer and the enhancement of customer owned assets. In some instances the output method of accounting is used due to the
ongoing repetitive nature and frequency of the services. Adopting IFRS15 will result in the deferral of revenue recognised
under IAS18 on certain contracts.
(iv) Percentage of completion accounting. Changes to the Group's current accounting policy arise when the percentage
of completion model under IAS11 is replaced by the output method of accounting. The output method is used where the
customer simultaneously receives and consumes the benefits in direct proportion to the deliverable performed rather than
the level of expense incurred to date.
(v) Pass through revenues and procurement arrangements. A pass through arrangement is where goods or services are
provided by a third party, but sourced by the Group on behalf of the customer. In this instance, the Group does not
recognise revenue for the amount received from the customer as compensation of the cost of the good or service but rather
only the margin element (if any) is recorded as revenue. Recognition of such revenues under IFRS15 is linked directly to
whether the Group has control of the deliverable prior to transfer rather than an assessment of the risks and rewards
associated with the services as was the case under IAS18. For certain procurement arrangements the Group does not have
control prior to transfer, but does have a level of risk associated with the activity, and therefore these arrangements are
not recognised on a net basis instead of the gross basis under IAS18.
(vi) Consideration payable to a customer. Under IFRS15 all amounts payable to a customer (including all payments to
the customer and all reductions to amounts paid by the customer) are recorded as a reduction in revenue. In 2017, an
element of reductions have been recorded as costs.
(vii) Variable pricing. It is not uncommon in outsourcing arrangements for the payment terms to be set to decline over
the future periods (i.e. a 5% reduction in fees is built into years five to six, 6% reduction in years seven to eight and
so on). However, where revenue recognition under IFSR15 is based on the output method and the service remains consistent
over the contract life, the reduction in the amounts paid by the customer should not be reflected in declining revenues,
even if this was appropriate under IAS18. As a result, revenue recognised in prior years for certain contracts will be
deferred under IFRS15.
(viii) OCP charges and releases. Where an adjustment is required by IFRS15 and the relevant contract is loss making, the
deferral of revenue from prior years can result in a decrease in the level of OCP needed under IFRS15, as future losses
will reduce by the level of deferred revenue. During the year one contract recorded a release against the OCP balance held
under current accounting standards. As a result of IFRS15, revenues on this contract have been deferred, reducing the
opening OCP balance, increasing deferred revenue and therefore the release of the relevant OCP balance is lower under
IFRS15.
In addition to the areas where a financial impact has been identified as a result of adoption of IFRS15 as identified
above, there are certain accounting policies which are new or change existing policies applied by the Group and may have an
impact on the future financial performance of the Group. The policies in these areas to be adopted by the Group are set out
below:
(ix) Contract variations. Contract modifications such as change orders, variations, change notices and amendments could
be approved in writing, by oral agreement or implied by customary business practices. Under IFRS15 contract modification
are changes in the scope or price (or both) of a contract that is approved by the parties to the contract. If the parties
to the contract have not approved a contract modification, revenue should be recognised in accordance with the existing
contractual terms and associated cash payments are deferred until the contract modification is approved. The judgements
historically applied have been consistent with this policy.
(x) Variable revenues requiring estimation. IFRS15 provides clear guidance on variable income unlike IAS18 and two
areas may be impacted as a result. First, if the consideration paid by a customer includes a variable amount requiring
judgement, it is only recognised where it is highly probable that a significant reversal will not occur. Second, service
penalties or any claims made by us against the customer which must be recognised in revenue unless it is highly probable
that they will not result in future settlement. However, judgements taken historically are consistent with the requirements
of IFRS15 and there is no impact of these changes on the Group.
(xi) Capitalised redundancy costs. Under certain contracts there is an obligation to make redundancies and the Group is
compensated for these costs. Historically, the Group may have recognised revenues as and when the customer makes payments
or the Group may have capitalised the expense to match with payments being made in the future. Under IFRS15, all redundancy
costs must be expensed in the period they are incurred and revenue is not recognised on these redundancy transactions, with
any cash payments deferred over the contract in line with the other services being delivered. No adjustment was required in
respect of this difference.
(xii) Licence income. Where the Group receives income for software licences and maintenance services provided through
ongoing support and operational functionality, this licence revenue is recognised over the period when the maintenance
obligation exists. There are currently no significant licencing arrangements entered into by the Group with its customers
which are impacted by IFRS15.
(xiii) Extension periods granted or other options. Providing the option for a customer to obtain extension periods or
other services may lead to a separate performance obligation where a material right exists. If a separate performance
obligation exists then there would be an allocation of the transaction price from the original contract in addition to any
revenues earned through the option period. A separate performance obligation exists for options under a contract if both of
the following conditions are met. First, if the customer is unable to obtain the right to acquire the additional goods or
services on the same or similar terms without entering into the original contract (for example they cannot get the option
without first entering into the main contract, which would be the case for any extension period). Second, the option does
not simply give the customer the right to acquire additional goods or services at a price that reflects the stand alone
selling price for those goods or services (for example if the pricing of the option is consistent with what the pricing
would have been in any case there is no separate PO, as the customer gains no incremental benefit from the existence of the
option). No differences were noted under IFRS15 in this area.
(xiv) Work in progress. Revenue is only recognised when control is passed to a customer and therefore where revenue is
recognised over time no work in progress is created unlike under current accounting standards. None of the contracts with
revenues recognised over time have work in progress balances.
(xv) Significant financing component. Where the timing of payments agreed with the customer provides either party with
a significant benefit of financing (either explicitly or implicitly), the associated asset/liability is adjusted for the
time value of money and an interest charge or income is recognised and a corresponding offset in revenue. The Group's
policy under IFRS15 is to consider "significant" to be greater than 5% of the total transaction price of the contractual
arrangement and no such arrangements are in place.
(xvi) Non cash consideration. If a customer contributes goods or services (for example, materials, equipment or labour)
to facilitate the fulfilment of the contract, the Group assesses whether control is obtained for those contributed goods or
services. If the Group obtains control of the contributed goods or services, then the estimated fair value of these would
be recognised as revenue. No such transactions have been noted.
Other new standards and interpretations not applied
At the date of authorisation of these financial statements, the following changes to IFRS have not been applied but could
potentially have a significant impact:
(i) IFRS9 Financial Instruments has been endorsed by the EU and will be effective from 1 January 2018.
This standard replaces IAS39 and introduces new requirements for classifying and measuring financial instruments and puts
in place a new hedge accounting model that is designed to be more closely aligned with how entities undertake risk
management activities when hedging financial and non-financial risk exposures.
The impact of IFRS9 on the regular trading activities of the Group is expected to be immaterial. The key areas of focus for
the Group under IFRS9 are:
· External loan receivables, including those from equity accounted entities.
· Debt refinancing not accounted for as a significant modification under IAS39.
· Expected credit losses being recognised on trade debtors and contract assets recognised under IFRS15.
· Intercompany loan recoverability.
IFRS9 replaces the 'incurred loss' model in IAS39 with an 'expected credit loss' model. The new model applies to financial
assets that are not measured at FVTPL (fair value through profit and loss), including loans, lease and trade receivables,
debt securities, contract assets under IFRS15 and specified financial guarantees and loan commitments issued. It does not
apply to equity investments.
Under the expected credit loss model, the Group is required to calculate the allowance for credit losses by considering on
a discounted basis the cash shortfalls it would incur in various default scenarios for prescribed future periods and
multiplying the shortfalls by the probability of each scenario occurring. The allowance is the sum of these probability
weighted outcomes. Because every loan and receivable carries with it some risk of default, it is expected that every such
asset has a loss attached to it from the moment of its origination.
The financial assets held on the balance sheet have been reviewed in order to determine whether any loss is required to be
recorded based on these expected credit losses. However, given the fact that the Group's customers are governments it is
unlikely that there will be a default as a result of credit risk and any provision for bad debts is more likely to be
related to a contractual dispute. In most cases, each amount receivable has specific risk attached to recoverability which
is most likely based on the services provided under the terms of the contract and, given the majority of receivables are
backed by organisations with a sovereign credit rating, a general view on recoverability based on the counterparty credit
risk could be misleading.
(ii) IFRS16 Leases is pending EU endorsement, which is expected prior to the effective date of 1 January 2019.
The standard replaces IAS17 Leases and has been introduced in order to improve the comparability of financial statements
through developing an approach that is more consistent with the conceptual framework definitions of assets and
liabilities.
The key change will be in respect of leases currently classified as operating leases. Under the new standard leases will be
recognised on the balance sheet as liabilities with corresponding assets being created, grossing up the balance sheet but
with no net effect on net assets at the start of the lease. The income statement impact will be a new interest charge
arising from the rate implicit in the liability and as currently the full impact is a charge to operating profit, the
change will result in an improvement to operating results.
We have not quantified the likely impact of the new standard, the transition approach to be taken or concluded whether it
will be adopted early, which is allowed from the date IFRS15 is adopted. The quantitative impact of the adoption of IFRS16
will be disclosed prior to the adoption of this new standard.
2. Critical accounting judgements and key sources of estimation uncertainty
In the process of applying the Group's accounting policies, which are described in note 1 above, management has made the
following judgements that have the most significant effect on the amounts recognised in the financial statements. As
described below, many of these areas of judgement also involve a high level of estimation uncertainty.
Prior year restatement: Change in accounting policy
The accounting policy regarding the classification of cost items within cost of sales and administrative expenses was
changed in the year. Judgement was applied in reaching the conclusion that it provides more relevant financial results to
exclude these amounts from the underlying transactions of trading operations. Further details are provided in note 1.
Use of Alternative Performance Measures: Operating profit before exceptional items
IAS1 requires material items to be disclosed separately in a way that enables users to assess the quality of a company's
profitability. In practice, these are commonly referred to as 'exceptional' items, but this is not a concept defined by
IFRS and therefore there is a level of judgement involved in arriving at an Alternative Performance Measure which excludes
such exceptional items. We consider items which are material and outside of the normal operating practice of the company to
be suitable for separate presentation. Further details can be seen in note 8.
The segmental analysis of continuing operations in note 4 includes the additional performance measure of Trading Profit on
continuing operations which is reconciled to reported operating profit in that note. The Group uses Trading Profit as an
alternative measure to reported operating profit by making several adjustments. Firstly, Trading Profit excludes
exceptional items, being those we consider material and outside of the normal operating practice of the company to be
suitable of separate presentation and detailed explanation. Secondly, amortisation and impairment of intangibles arising on
acquisitions are excluded, because these charges are based on judgments about the value and economic life of assets that,
in the case of items such as customer relationships, would not be capitalised in normal operating practice. The CODM
reviews the segmental analysis for continuing operations together with discontinued operations.
Provisions for onerous contracts
Determining the carrying value of onerous contract provisions requires assumptions and complex judgements to be made about
the future performance of the Group's contracts. The level of uncertainty in the estimates made, either in determining
whether a provision is required, or in the calculation of a provision booked, is linked to the complexity of the underlying
contract and the form of service delivery. Due to the level of uncertainty and combination of variables associated with
those estimates there is a significant risk that there could be material adjustment to the carrying amounts of onerous
contract provisions within the next financial year.
Major sources of uncertainty which could result in a material adjustment within the next financial year are:
· The ability of the company to maintain or improve operational performance to ensure costs or performance related
penalties are in line with expected levels.
· Volume driven revenue and costs being within the expected ranges.
· The outcome of matters dependent on the behaviour of the customer, such as a decision to extend a contract where it
has the unilateral right to do so.
· The outcome of open claims made by or against a customer regarding contractual performance.
· The ability of suppliers to deliver their contractual obligations on time and on budget.
In the current year material revisions have been made to historic provisions, which have led to a charge to contract
provisions of £62.0m, including £0.5m in relation to new provisions, and releases of £43.4m. Further details are provided
in the Finance Review. All of these revisions have resulted from triggering events in the current year, either through
changes in contractual positions or changes in circumstances which could not have been reasonably foreseen at the previous
balance sheet date. To mitigate the level of uncertainty in making these estimates Management regularly compares actual
performance of the contracts against previous forecasts and considers whether there have been any changes to significant
judgements. A detailed bottom up review of the provisions is performed as part of the Group's formal annual budgeting
process.
The future range of possible outcomes in respect of those assumptions and significant judgements made to determine the
carrying value of onerous contracts could result in either a material increase or decrease in the value of onerous contract
provisions in the next financial year. The extent to which actual results differ from estimates made at the reporting date
depends on the combined outcome and timing of a large number of variables associated with performance across multiple
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