REG - Tesco PLC - Preliminary Results 2016/17 <Origin Href="QuoteRef">TSCO.L</Origin> - Part 5
12/04/2017 07:06
- Part 5: For the preceding part double click ID:nRSL2573Cd
(5,110)
Note 19 Business combinations and disposals
Business combinations
The Group has paid £25m of deferred consideration in the year, related to its obligations under the purchase agreements for
the acquisitions of Sociomantic Labs and Bzz Agent Limited from prior years.
Disposals
During the year, the Group sold its interests in Dobbies Garden Centres, Giraffe and Harris + Hoole and closed its
Nutricentre business, further enhancing the focus of the UK retail business on its core strengths. The Group received £213m
in cash, net of cash disposed, and recognised £1m in deferred consideration. Of the net cash received, £192m related to the
sale of Dobbies Garden Centres. In total, the Group disposed of net assets of £243m and incurred costs to sell of £15m, £8m
of which had been paid as at the year end.
In addition, the Group disposed of a 6.9% interest (on a fully diluted basis) in Lazada Group S.A. (Lazada) for net cash
consideration of US$115m (£81m), retaining an 8.8% shareholding.
The total loss on these transactions amounted to £7m, which is included within operating profit before exceptional items.
On 10 June 2016, the Group announced the proposed sale of its 95.5% controlling interest in its Turkish operations to
Migros. The assets and liabilities related to the Turkish operations have been classified as a disposal group held for sale
during the year and are presented within discontinued operations. Local regulatory approvals were obtained on 9 February
2017 and the sale completed on 1 March 2017. Refer to Note 7 and 22 for further information.
Note 20 Contingent liabilities
There are a number of contingent liabilities that arise in the normal course of business which if realised are not expected
to result in a material liability to the Group. The Group recognises provisions for liabilities when it is more likely than
not that a settlement will be required and the value of such a payment can be reliably estimated.
As previously reported, law firms in the UK have announced the intention of forming claimant groups to commence litigation
against the Group for matters arising out of or in connection with its overstatement of expected profits in 2014, and
purport to have secured third party funding for such litigation. In this regard, the Group has received two High Court
claims against Tesco PLC. The first was received on 31 October 2016 from a group of 112 investors and the second was
received on 5 December 2016 from an investment company and a trust company. The merit, likely outcome and potential impact
on the Group of any such litigation that either has been or might potentially be brought against the Group is subject to a
number of significant uncertainties and therefore, the Group cannot make any assessment of the likely outcome or quantum of
any such litigation as at the date of this disclosure.
Prior to the disposal of its Korean operations (Homeplus), Tesco PLC provided guarantees in respect of 13 Homeplus lease
agreements in Korea in the event of termination of the relevant lease agreement by the landlord due to Homeplus' default.
Entities controlled by MBK and CPPIB, as the purchasers of Homeplus, undertook to procure Tesco PLC's release from these
guarantees following the disposal of Homeplus, which currently remains outstanding. This liability decreases over time with
all relevant leases expiring in the period between 2026 and 2033. Tesco PLC has the benefit of an indemnity from the
purchasers of Homeplus for any claims made under such guarantees. The maximum potential liability under the lease
guarantees as at 25 February 2017 is KRW575bn (£407m).
Note 21 Lease commitments
Operating lease commitments - Group as lessee
Future minimum lease commitments under non-cancellable operating leases are as follows:
2017£m 2016£m
Within one year 1,199 1,296
Greater than one year but less than five years 3,767 3,918
After five years 7,395 7,831
Total minimum lease commitments 12,361 13,045
Future minimum lease commitments under non-cancellable operating leases after five years are analysed further as follows:
2017£m 2016£m
Greater than five years but less than ten years 3,161 3,272
Greater than ten years but less than fifteen years 2,225 2,303
After fifteen years 2,009 2,256
Total minimum lease commitments - after five years 7,395 7,831
The Group has used operating lease commitments discounted at 7% (2016: 7%) of £7,440m (2016: £7,814m) in its calculation of
total indebtedness. Total operating lease commitments in Turkey of £27m were included in 2016. The discounted operating
lease commitment included in total indebtedness is not an appropriate proxy for the expected impact of recognising a lease
liability under IFRS 16 'Leases', primarily due to differences in the discount rates used and the treatment of additional
lease rentals arising from contracts that contain extend or buy conditions, amongst other differences.
Operating lease commitments represent rentals payable by the Group for certain of its retail, distribution and office
properties and other assets such as motor vehicles. The leases have varying terms, purchase options, escalation clauses and
renewal rights. Purchase options and renewal rights, where they occur, are at market value. Escalation clauses are in line
with market practices and include inflation linked, fixed rates, resets to market rents and hybrids of these.
The Group has lease-break options on certain sale and leaseback transactions. These options are exercisable if the Group
exercises an existing option to buy back, at market value and at a specified date, either the leased asset or the equity of
the other joint venture partner. No commitment has been included in respect of the buy-back option as the option is at the
Group's discretion. The Group is not obliged to pay lease rentals after that date, therefore minimum lease commitments
exclude those falling after the buy-back date. The current market value of these properties is £2.9bn (2016: £3.2bn) and
the total undiscounted lease rentals, if they were to be incurred following the option exercise date, would be £2.6bn
(2016: £2.6bn) using current rent values, as shown below.
The additional lease rentals if incurred following the option exercise date would be as follows:
2017£m 2016£m
Within one year 23 45
Greater than one year but less than five years 170 72
Greater than five years but less than ten years 709 686
Greater than ten years but less than fifteen years 670 718
After fifteen years 1,019 1,115
Total undiscounted contingent additional lease rentals 2,591 2,636
Total discounted contingent additional lease rentals at 7% 1,107 1,111
The lease break options are exercisable between 2017 and 2023.
Operating lease commitments with joint ventures and associates
In prior years, the Group entered into several joint ventures and associates, and sold and leased back properties to and
from these joint ventures and associates. The terms of these sale and leasebacks varied. However, common factors included:
the sale of the properties to the joint venture or associate at market value; options within the lease for the Group to
repurchase the properties at market value; market rent reviews; and 20 to 30 full-year lease terms. The Group reviews the
substance as well as the form of the arrangements when determining the classification of leases as operating or finance.
All of the leases under these arrangements are operating leases.
Note 22 Events after the reporting period
On 1 March 2017, the Group announced the completion of the disposal of its 95.5% controlling stake in the Kipa business in
Turkey following the receipt of all local regulatory approvals.
On 10 April 2017, the Group announced that its subsidiary, Tesco Stores Limited, had obtained Court approval and entered
into a Deferred Prosecution Agreement (DPA) with the UK Serious Fraud Office (SFO) regarding historic accounting practices.
On 28 March 2017, the Group also announced that it had agreed with the UK Financial Conduct Authority (FCA) to a finding of
market abuse in relation to its trading statement announced on 29 August 2014. In making its finding, the FCA has expressly
stated that it is not suggesting that the Tesco PLC Board of Directors knew, or could reasonably be expected to have known,
that the information contained in that trading statement was false or misleading. The Group has agreed with the FCA (under
its statutory powers) to establish a compensation scheme which will compensate certain net purchasers of Tesco ordinary
shares and listed bonds between 29 August 2014 and 19 September 2014 inclusive. The Group has taken a total exceptional
charge of £235m in respect of the DPA of £129m, the expected costs of the compensation scheme of £85m, and related costs.
This has been recorded in the financial statements in the year to 25 February 2017 as an adjusting post balance sheet
event.
On 6 April 2017, the Group unwound its joint venture with British Land Co PLC (British Land). The Group obtained sole
control of BLT Properties Limited through the acquisition of British Land's 50% interest in the joint venture. The
acquisition increased the Group's owned property portfolio by £0.2bn, comprising seven stores. British Land obtained sole
control of one store and one retail centre, previously held in the joint venture.
Note 23 Proposed Booker Group transaction
On 27 January 2017, the Group announced that it had reached an agreement on the terms of a recommended share and cash
merger with Booker Group Plc. The transaction is subject to shareholder and regulatory approvals.
Glossary - Alternative performance measures
Introduction
In the reporting of financial information, the Directors have adopted various Alternative Performance Measures (APMs),
previously termed 'Non-GAAP measures' of historical or future financial performance, position or cash flows other than
those defined or specified under International Financial Reporting Standards (IFRS).
These measures are not defined by IFRS and therefore may not be directly comparable with other companies' APMs, including
those in the Group's industry.
APMs should be considered in addition to, and are not intended to be a substitute for, or superior to, IFRS measurements.
Purpose
The Directors believe that these APMs assist in providing additional useful information on the underlying trends,
performance and position of the Group.
APMs are also used to enhance the comparability of information between reporting periods and geographical units (such as
like-for-like sales), by adjusting for non-recurring or uncontrollable factors which affect IFRS measures, to aid the user
in understanding the Group's performance.
Consequently, APMs are used by the Directors and management for performance analysis, planning, reporting and incentive
setting purposes and have remained consistent with prior year.
The key APMs that the Group has focused on this year are as follows:
· Group sales (previously termed Revenue exc. fuel): This is the headline measure of revenue for the Group. It
excludes the impact of sales made at petrol filling stations due to the significant volatility of fuel prices. This
volatility is outside the control of management and can mask underlying changes in performance.
· Like-for-like sales: This is a widely used indicator of a retailer's current trading performance. It is a measure of
growth in Group online sales and sales from stores that have been open for at least a year (but excludes prior year sales
of stores closed during the year) at constant foreign exchange rates.
· Operating profit before exceptional items: This is the headline measure of the Group's performance, and is based on
operating profit before the impact of exceptional items. Exceptional items relate to certain costs or incomes that derive
from events or transactions that fall within the normal activities of the Group but which, individually or, if of a similar
type, in aggregate, are excluded by virtue of their size and nature in order to reflect management's view of the
performance of the Group.
· Retail operating cash flow: This is the operating cash flow of continuing operations, excluding the effects of Tesco
Bank's cash flows.
· Net debt: This excludes the net debt of Tesco Bank but includes that of the discontinued operations to reflect the
net debt obligations of the Retail business.
· Diluted earnings per share from continuing operations before exceptional items and net pension finance costs: This
relates to profit after tax before exceptional items from continuing operations, and net pension finance costs attributable
to owners of the parent divided by the weighted average number of ordinary shares in issue during the financial period
adjusted for the effects of potentially dilutive options.
Some of our IFRS measures are translated at constant exchange rates. Constant exchange rates are the average actual
periodic exchange rates for the previous financial year and are used to eliminate the effects of exchange rate fluctuations
in assessing performance. Actual exchange rates are the average actual periodic exchange rates for that financial year.
Income statementRevenue measures
Group sales Revenue • Exclude sales made at petrol filling stations Note 2 • Excludes the impact of sales made at petrol filling stations to demonstrate the Group's underlying performance in the core retail and financial services businesses by removing the volatilities associated with the movement in fuel prices. This is a key management incentive metric.
Growth in sales No direct equivalent • Consistent with accounting policy Not applicable • Growth in sales is a ratio that measures year on-year movement in Group sales for continuing operations for 52 weeks. It shows the annual rate of increase in the Group's sales and is considered a good indicator of how rapidly the Group's core business is growing.
Like-for-like No direct equivalent • Consistent with accounting policy Not applicable • Like-for-like is a measure of growth in Group online sales and sales from stores that have been open for at least a year (but excludes prior year sales of stores closed during the year) at constant foreign exchange rates. It is a widely used indicator of a retailer's current trading performance and is important when comparing growth between retailers that have different profiles of expansion,
disposals and closures.
Like-for-like
No direct equivalent
• Consistent with accounting policy
Not applicable
• Like-for-like is a measure of growth in Group online sales and sales from stores that have been open for at least a year
(but excludes prior year sales of stores closed during the year) at constant foreign exchange rates. It is a widely used
indicator of a retailer's current trading performance and is important when comparing growth between retailers that have
different profiles of expansion, disposals and closures.
APM Closest equivalent Adjustments to reconcile Note reference for reconciliation Definition and purpose
IFRS measure to IFRS measure
Profit measures
Operating profit before exceptional items Operating profit* • Exceptional items Note 2 • Operating profit before exceptional items is the headline measure of the Group's performance. It is
based on operating profit before the impact of certain costs or incomes that derive from events or
transactions that fall within the normal activities of the Group, but which are excluded by virtue of
their size and nature in order to reflect management's view of the performance of the Group. This is a
key management incentive metric.
Operating margin No direct equivalent • Consistent with accounting policy Not applicable • Operating margin is calculated as operating profit before exceptional items divided by revenue.
Progression in operating margin is an important indicator of the Group's operating efficiency.
Profit before Profit before tax • Exceptional items • Net pension finance costs Note 9 • This measure excludes exceptional items and the net finance costs of the defined benefit pension
tax before exceptional items and net pension deficit as the costs are impacted by corporate bond yields, which can fluctuate significantly and are
finance costs reset each year based on often volatile external market factors.
Profits/(losses) arising on property-related items No direct equivalent • Consistent with accounting policy Not applicable • Profits/(losses) arising on property-related items relates to the Group's property activities
including; gains and losses on disposal of property assets, development property built for resale and
property joint ventures; costs resulting from changes in the Group's store portfolio and distribution
network, including pre-opening and post-closure costs; and income/(charges) associated with impairment
of non-trading property and related onerous contracts.• These items are disclosed separately to
clearly identify the impact of these items versus the other operating expenses related to the core
retail and financial services operations of the business. They are often one-time in nature and can
have a disproportionate impact on profit between reporting periods.
Total finance Finance costs • Exceptional items• Net pension finance costs Note 5 • Total finance costs before exceptional items and net pension finance costs is the net finance costs
costs before exceptional adjusted for non-recurring one off items, and net pension finance costs, as the costs are impacted by
items and bond yields, which can fluctuate significantly and are reset each year.
net pension
finance costs
Diluted earnings Diluted earnings • Exceptional items• Discontinued operations Note 9 • This relates to profit after tax before exceptional items from continuing operations, attributable
per share per share to owners of the parent divided by the weighted average number of ordinary shares in issue during the
from continuing operations before exceptional items financial period adjusted for the effects of potentially dilutive options. • It excludes the impact of
certain costs or income that derive from events or transactions that fall within the normal activities
of the Group, but which are excluded by virtue of their size and nature in order to reflect
management's view of the performance of the Group.
Diluted earnings Diluted earnings • Exceptional items• Net pension finance costs• Discontinued operations Note 9 • This relates to profit after tax before exceptional items from continuing operations, and net
per share from continuing operations before exceptional items and net pension finance costs per share pension finance costs attributable to owners of the parent divided by the weighted average number of
ordinary shares in issue during the financial period adjusted for the effects of potentially dilutive
options. • It excludes the impact of certain costs or income that fall within the normal activities of
the Group, but which are excluded by virtue of their size and nature in order to reflect management's
view of the performance of the Group. It also excludes potentially volatile net pension finance costs.
Tax measures
Effective tax Effective tax rate • Exceptional items and their Note 6 • Effective tax rate before exceptional items is calculated as total income tax credit/(charge)
rate before tax impact excluding the tax impact of exceptional items divided by profit before tax before exceptional items.
exceptional items This provides an indication of the ongoing tax rate across the Group.
APM Closest equivalent Adjustments to reconcile Note reference for reconciliation Definition and purpose
IFRS measure to IFRS measure
Effective tax Effective tax rate • Exceptional items and their Note 6 • Effective tax rate before exceptional items and net pension finance costs is calculated as total
rate before tax impact• Net pension finance costs income tax credit/(charge) excluding the tax impact of exceptional items and net pension finance costs
exceptional items and net pension finance costs and their tax impact divided by the profit before tax before exceptional items and net pension finance costs.
Balance sheet measures
Net debt Borrowings less cash • Net debt from Tesco Bank Note 18 • Net debt excludes the net debt of Tesco Bank
and related hedges but includes that of the discontinued operations
to reflect the net debt obligations of the Retail business. Net debt comprises bank and other
borrowings, finance lease payables, net derivative financial instruments, joint venture loans and
other receivables and net interest receivables/ payables, offset by cash and cash equivalents and
short-term investments. It is a useful measure of the progress in generating cash and strengthening of
our balance sheet position and is a measure widely used by credit rating agencies.
Total indebtedness Borrowings less cash • Net debt from Tesco Bank • Present value of future minimum lease payments under non-cancellable operating leases.• IAS19 deficit in the pension schemes Page 8 of the Preliminary Results 2016/17 • Total indebtedness is the net debt plus the IAS19 deficit in the pension schemes (net of associated
and related hedges deferred tax) plus the present value of future minimum lease payments under non-cancellable operating
leases to provide an overall view of the Group's obligations. It is an important measure of the long
term obligations of the Group and is a measure widely used by credit rating agencies.
Cash flow measures
Retail operating Cash generated from operating activities • Tesco Bank operating cash flow• Discontinued operations Note 2 • Retail operating cash flow is the cash generated from operations of continuing operations, excluding
cash flow the effects of Tesco Bank cash flows. It is a measure of the cash generation and working capital
efficiency by the retail business, recognising that Tesco Bank is run and regulated independently from
the retail operations, and a key measure to demonstrate the recovery of the retail operations. This is
a key management incentive metric.
Free cash flow Cash generated from operating activities • Purchase of property, plant and equipment, investment property Note 2 • Free cash flow is net cash generated from/(used in) operating activities less capital expenditure on
and non-current assets classified property, plant and equipment, investment property and intangible assets. It is a measure of cash
as held for sale• Purchase of intangible assets generation, working capital efficiency and capital discipline of the business.
* Operating profit is not defined per IFRS, however is a generally accepted profit measure.
Glossary - Other
Capital expenditure (Capex)
The additions to property, plant and equipment, investment property and intangible assets (excluding assets acquired under
business combinations).
Capital employed
Net assets plus net debt plus dividend creditor less net assets of the disposal groups and non-current assets classified as
held for sale.
Enterprise Value
This is calculated as market capitalisation plus net debt.
FTE
FTE refers to full-time equivalents.
LPI
LPI refers to Limited Price Inflation.
Market capitalisation
The total value of all Tesco shares calculated as total number of shares multiplied by closing share price at year-end.
MTN
MTN refers to Medium Term Note.
Net Promoter Score (NPS)
This is a loyalty measure based on a single question requiring a score between 0-10. The NPS is calculated by subtracting
the percentage of detractors (scoring 0-6) from the percentage of promoters (scoring 9-10). This generates a figure between
-100 and 100 which is the NPS.
Return on capital employed (ROCE)
Return divided by the average of opening and closing capital employed.
Return
Profit before exceptional items and interest, after tax (applied at effective rate of tax).
RPI
RPI refers to Retail Price Index.
Total shareholder return
The notional annualised return from a share, measured as the percentage change in the share price, plus the dividends paid
with the gross dividends reinvested in Tesco shares. This is measured over both a one and five year period.
Independent auditor's report to the members of Tesco PLC on the Preliminary Announcement of Tesco PLC
We confirm that we have issued an unqualified opinion on the full financial statements of Tesco PLC.
Our audit report on the Group Financial Statements sets out the following risks of material misstatement which had the
greatest effect on our audit strategy; the allocation of resources in the audit; and directing the efforts of the
engagement team, together with how our audit responded to those risks:
Risk descriptionThe Group held £18,108m (2015/16: £17,900m) of property, plant and equipment at 25 February 2017. Under IFRS, the Group is required to complete an impairment review of its store portfolio where there are indicators of impairment or impairment reversal. There continues to be judgement required in identifying indicators of impairment and determining the fair value of the Group's store portfolio. Additionally, there is judgement is relation to triggering the reversals of impairments recognised
in previous periods. In light of the continued competitive environment in which the Group operates and changes in the macro environment, there is a risk that the carrying value of stores and related fixed assets may be higher than the recoverable amount. Where a review for impairment, or reversal of impairment, is conducted, the recoverable amount is determined based on the higher of 'value in use' and 'fair value less costs of disposal': · value in use is calculated from cash flow projections and
relies upon the Directors' assumptions and estimates of future trading performance, longer-term growth rates and discount rates utilised; and· fair value less costs of disposal is determined by reference to a sample of valuations completed by independent valuation specialists where applicable. As a result of the Group's impairment review completed during the year, an impairment release of £6m (2015/16: charge of £18m) was recognised. How the scope of our audit responded to the riskOur audit procedures
included assessing the design and implementation of key controls around the impairment review processes, assessing the appropriateness of the methodology applied by the Directors in calculating the impairment charges and reversals, and the judgements applied in determining the cash generating units ("CGUs") of the business, which the Group has determined as being individual stores and, in the UK, the general merchandising online business. As part of our procedures we have used data analytics to assist us in
determining the completeness of the impairment indicator assessment. In relation to the completeness of the Group's impairment review process, we have assessed the completeness of the Group's impairment charges and impairment reversals with reference to CGU performance. In relation to the Group's 'value in use' valuations, we have assessed the review completed by the Group by: · assessing the methodology applied in determining the value in use compared with the requirements of IAS 36 Impairment of
Assets and checking the integrity of the impairment model utilised by the Group;· challenging the key assumptions utilised in the cash flow forecasts with reference to historical trading performance, market expectations and our understanding of the Group's strategic initiatives;· assessing the long-term growth rates and discount rates applied to the impairment review for each country, comparing the rates utilised to third party evidence and in relation to the discount rate, our independently
estimated discount rates; and· completing sensitivity analysis in relation to key assumptions to consider the extent of change in those assumptions that either individually or collectively would be required for the assets to be impaired, in particular property fair values, long term growth rates and discount rates applied. In relation to the Group's 'fair value less costs of disposal', we have challenged the assumptions used by the Group in determining the fair market value of the assets, including
those completed by external valuers, using internal property valuation specialists and assessing whether appropriate valuation methodologies have been applied. Additionally, we assess the adequacy of the store impairment related disclosures. Key observationsWhilst we note actions are required by the Group to achieve these forecasts over the medium term, we concluded that the assumptions in the impairment models were within an acceptable range, and that the overall level of net reversal of impairment was
reasonable. We also agree that the disclosure of the net impairment as an exceptional item is in accordance with the Group's policy on exceptional items.
Risk descriptionThe Group has agreements with suppliers whereby volume-related allowances, promotional and marketing allowances and various other fees and discounts are received in connection with the purchase of goods for resale from those suppliers. As such, the Group recognises a reduction in cost of sales as a result of amounts receivable from suppliers. In accordance with IFRS, commercial income should only be recognised as income within the income statement when the performance conditions associated
with it have been met, for example where the marketing campaign has been held. The variety and number of the buying arrangements with suppliers can make it complex to determine the performance conditions associated with the income, giving rise to a requirement for management judgement and scope for error in accounting for such income. As such we have identified this as a key risk. How the scope of our audit responded to the riskWe obtained a detailed understanding and evaluated the design and implementation
of controls that the Group has established in relation to commercial income. In addition, our substantive audit procedures across the Group's retail operations included a combination of the following: · we tested whether amounts recognised were accurate and recorded in the correct period based on the contractual performance obligations by agreeing a sample of individual supplier agreements;· commercial income balances included within inventories and trade and other receivables, or netted against
trade and other payables have been tested via balance sheet reconciliation procedures;· we circularised a sample of suppliers to test whether the arrangements recorded were complete and held discussions with a sample of buyers to further understand the buying processes where required. Where responses from suppliers were not received, we completed alternative procedures such as agreement to underlying contractual arrangements;· we used data analytics to profile commercial income, identifying
deals which exhibited characteristics of audit interest upon which we completed detailed testing;· we reviewed the steps taken by the Group to address the recommendations made by the Groceries Code Adjudicator ("GCA") and reviewed the Group's ongoing compliance with the Groceries Supplier Code of Practice ("GSCOP"). Additionally, we reviewed the reporting and correspondence to the supplier hotline in order to help identify any areas where further investigation was required; and· we also
considered the adequacy of the commercial income related disclosure within the Group's financial statements. Key observationsThe results of our testing were satisfactory. We consider the disclosure given around supplier rebates to provide an appropriate understanding of the types of rebate income received and impact on the Group's balance sheet as at 25 February 2017.
Pension obligation valuation
Risk descriptionThe Group has a defined benefit pension plan in the UK. At 25 February 2017, the Group recorded a net retirement obligation before deferred tax of £6,621m (2015/16: £3,175m), comprising scheme assets of £13,196m (2015/16: £10,302m) and scheme liabilities of £19,817m (2015/16: £13,477m). The pension valuation is dependent on market conditions and assumptions made. The risk specifically relates to the following key assumptions: discount rate, inflation expectations and life expectancy
assumptions. The setting of these assumptions is complex and requires the exercise of significant management judgement with the support of third party actuaries. How the scope of our audit responded to the riskWe obtained a detailed understanding and evaluated the design and implementation of controls that the Group has established in relation to the pension obligation valuation process. In testing the pension valuation, we have utilised internal pension actuarial specialists to review the key actuarial
assumptions used, both financial and demographic, and considered the methodology utilised to derive these assumptions. Furthermore, we have benchmarked and performed a sensitivity analysis on the key assumptions determined by the Directors. Key observationsWe are satisfied that the methodology and assumptions applied in relation to determining the pension valuation are within an acceptable range.
Risk descriptionThe Group has been under investigation by the Serious Fraud Office (SFO) in the UK following the commercial income misstatements identified in 2014/15. On 10 April 2017, the Group announced that its subsidiary, Tesco Stores Limited, had reached a Deferred Prosecution Agreement (DPA) with the SFO. In addition, Tesco PLC and Tesco Stores Limited accepted a finding of market abuse from the FCA, arising from the same circumstances and as a result will implement a compensation scheme. This brings
greater certainty to the Group's exposure and a £235m liability has been recognised accordingly. Additionally, in 2016/17 UK shareholder actions were initiated against the Group linked to the commercial income misstatements identified in 2014/15 which may result in legal exposures. Separately, the Group has other ongoing legal matters relating to previous corporate transactions which require management judgement to be applied in order to determine the likely outcome. As a result, judgement is required in
assessing the nature of these exposures and their accounting and disclosure requirements. How the scope of our audit responded to the riskIn assessing the potential exposures to the Group, we have completed a range of procedures including : · assessing the design and implementation of controls in relation to the monitoring of known exposures; · reading Board and other meeting minutes to identify areas subject to Group consideration; · meeting with the Group's internal legal advisors in
understanding ongoing and potential legal matters impacting the Group; · reviewing third party correspondence and reports; and · reviewing the proposed accounting and disclosure of actual and potential legal liabilities, drawing on third party assessment of open matters. Key observationsWe concur that the liability recognised by management in respect of the DPA and the FCA compensation scheme and the disclosures in relation to the ongoing UK shareholder actions are appropriate. In relation to
other ongoing legal matters in respect of previous corporate transactions, we are satisfied no specific disclosure is required.
Risk descriptionThe Group carries inventory at the lower of cost and net realisable value. As at 25 February 2017, the Group held inventories of £2,301m (2015/16: £2,430m). The Group provides for obsolescence based on forecast inventory usage. This methodology relies upon assumptions made in determining appropriate provisioning percentages to estimates of future sales. How the scope of our audit responded to the riskWe obtained a detailed understanding and evaluated the design and implementation of controls
that the Group has established in relation to inventory valuation. We obtained assurance over the appropriateness of management's assumptions applied in calculating the value of inventory provisions by: · critically assessing the Group's inventory provisioning policy, with specific consideration given to aged inventory (especially for non-food and general merchandising products) as well as stock turn calculations, including the impact of seasonality;· verifying the value of a sample of inventory
to confirm whether it is held at the lower of cost and net realisable value, through comparison to vendor invoices and sales prices;· within the UK business, using data analytics to identify unusual inventory usage characteristics, completing assumption tolerance testing and recalculating the provision in totality based on the Group's policy; and· reviewing historical accuracy of inventory provisioning with reference to inventory write-offs during the year in relation to stock loss or other
inventory adjustments. Key observationsWe concur that the total level of provision is within an acceptable range.
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