Total fair value to Group recognized on acquisition £102.3 million (2015: £417.2 million)

Refer to page 83 (Audit and Risk Committee Report), page 115 (accounting policy note 2(j)) and pages 138–140 (financial disclosures in note 17).

During the year the Group acquired businesses for a total consideration of £102.3 million (2015: £417.2 million).

The Directors have calculated the fair value of the assets and liabilities acquired. We consider that these calculations require judgement and contain significant estimation uncertainty, and therefore we consider this area to be a significant audit risk. However, given the reduction in the overall level of acquisitions compared with the prior year we consider that the overall risk has reduced.

Our audit procedures included selecting a sample of acquisitions made during the year, for further investigation, based on quantitative and qualitative factors. The acquisitions selected included those acquisitions with the greatest impact on the Group’s financial results, and those containing the greatest degree of judgement. For each of these acquisitions:

› We challenged, with the support of our own valuation specialists, the key assumptions used by the Group to determine fair values of assets and liabilities acquired;

› We discussed these assumptions with the Directors and corroborated the explanations provided by comparing them to market data, our past experience of similar transactions, and the Group’s business plan supporting the acquisition;

› Where available, we compared the amounts recognized to supporting external documentation;

› We assessed the appropriateness of the accounting for significant fair value adjustments, including those in the measurement period, with reference to the acquisition accounting standard, and considered the presentation and disclosure of material adjustments in the financial statements; and

› We evaluated the adequacy of the disclosure of acquisitions in the annual report and financial statements.

Refer to page 83 (Audit and Risk Committee Report), page 117 (accounting policy note 2(s)) and pages 158–162 (financial disclosures in note 32).

Significant estimates are made in valuing the Group’s defined benefit pension schemes and small changes in assumptions and estimates used to value the Group’s pension obligation (before deducting scheme assets) would have a significant effect on the Group’s net pension deficit.

Our audit procedures included the following:

› We challenged the key assumptions applied in determining the Group’s defined benefit obligation, being the discount rate, inflation rate and mortality/life expectancy, with the support of our own actuarial specialists. This included a comparison of these key assumptions against externally derived data; and

› We evaluated the adequacy of the Group’s disclosures in respect of the sensitivity of the deficit to these assumptions.

Refer to page 83 (Audit and Risk Committee Report), page 116 (accounting policy note 2(q)) and pages 144 and 157 (financial disclosures in notes 25 and 31).

Significant judgment is required to assess whether actual or potential claims, litigation and fines arising from regulatory oversight should be recognized as provisions within the financial statements or warrant disclosing as contingent liabilities.

The determination and valuation of these provisions is judgmental by their nature and there is a risk that the estimate is incorrect and the provision is materially misstated.

At 31 December 2016, the Group has recognized a provision for £49.4 million of restructuring and reorganization charges relating to the major restructuring programme announced in November 2016.

We have assessed that the risk has increased in the current year as a result of the complexity in applying the recognition criteria to the restructuring activities in order to determine the provisions recorded at the year-end.

Where the impact of possible and present obligations is not probable or not reliably measurable, and thus no provision is recorded, failure to adequately disclose the nature of these circumstances within the financial statements may distort the reader’s view as to the potential risks faced by the Group.

Our audit procedures included the following:

› We enquired of the Directors and inspected board minutes for actual and potential claims arising in the year, and challenged whether provisions are required for these claims;

› We obtained an understanding of existing claims and litigations and the Directors’ assessment regarding the likelihood of the existence of obligations, and the basis used to measure the provisions;

› We compared the Directors’ estimate of the risk and impact of these claims and litigations to third party evidence, where available;

› In respect of open matters of claims and litigations, where appropriate, we had discussions with the Group’s external legal advisors in respect of the reasonableness of the estimated liability;

› We assessed whether the restructuring provisions recognized at 31 December 2016 met the recognition requirements, in particular that sufficient announcements had been made to the employees affected to set a valid expectation; and

› We evaluated the adequacy of the Group’s provisions and contingent liability disclosures in the accounts in accordance with accounting standards, in particular the disclosure of the estimation uncertainty and the quantification of that uncertainty where appropriate.

Refer to page 81 (Audit and Risk Committee Report), and page 112 (accounting policy notes 2(e) and 2(f)).

Group revenue is split between those contracts that are transactional in nature, that require limited judgement, and those that relate to a contracting environment, typically over multiple years (‘long-term contracts’).

For the long-term contracts, the contractual arrangements that underpin the measurement of revenue in the period can be complex, with significant judgements involved in the assessment of current and future financial performance which are relevant to the application of long-term contract accounting principles.

We have assessed that this risk has increased during the year because of the deteriorating performance of certain contracts, increasing the pressure on the
Group’s performance.

Judgements impacting the recognition of revenue and resulting profits include, amongst others, those over:

› The interpretation of contract terms and conditions;

› The assessment of the stage of completion, and costs to complete, on long-term contract arrangements;

› The allocation of revenue to separately identifiable components within a contractual arrangement; and

› The consideration of onerous contract conditions and associated loss provisions.

In respect of specific long-term contracting activities, and more broadly over IT enabled technologies supporting the Group’s various market offerings, amounts are capitalized in the balance sheet in either PPE or intangibles. As with other contract related assets, such as accrued income and accounts receivable, these need to be considered in the overall contract profitability assessments including onerous contract provisions.

However, we also consider the risk that the amounts recognized are not directly attributable to the relevant asset, do not meet the criteria for capitalization or are not expected to be recovered. As such there is a risk that costs that have been capitalized should have been expensed in the period. Certain contracts may show marginal lifetime recovery assessments and judgement is therefore required to ascertain whether economic benefits that flow from the contracts are sufficient to recover the assets.

In 2016 there is a key judgement in respect of the treatment and disclosure of the profits arising on a significant sale and leaseback transaction. The risk is that the accounting judgement is inappropriate and a finance lease should be recognized and/or the profit recognized on the sale is overstated. See notes 2 and 7 of the financial statements for further details of the transaction and accounting judgements involved.

Our audit procedures included testing the controls over the monitoring of contract performance and costs. These controls include the review of contract performance at monthly operating board review meetings, where divisional management present details of performance and business developments to Executive members of the Group Board.

We selected contracts for testing based on quantitative factors (for example, those with the greatest impact on the Group’s financial results) and qualitative factors (for example, new long-term contracts entered into during the year, where specific delivery issues have arisen, or where the payment profile may not reflect the timing of revenue recognition). Our audit procedures included the following:

› We obtained and inspected the contractual agreements to understand the contract terms and conditions that underpin the revenue and the profit
recognition assumptions;

› We assessed, through discussion with the Directors and inspection of correspondence with customers, the range of judgements regarding the appropriate timing of the revenue recognition, including the allocation of revenue to separately identifiable components within a contractual arrangement;

› We discussed the contract forecasts with divisional and Group management to understand their basis for recognition and, where appropriate, we compared the assumptions underpinning the forecasts to contract terms and/or correspondence with customers, particularly on those where there are long-term contract arrangements. Where the contract negotiations are ongoing we discussed the current status with those involved in the negotiations;

› We compared the contract forecasts to actual results to assess the performance of the contract and the historical accuracy of the forecasting;

› We challenged the assumptions within the business plans and lifetime assessments produced by management, ensuring that onerous contracts have
been recognized appropriately, particularly on contracts that have had a poor performance in the current year;

› In determining whether onerous contract provisions should be recorded, we assessed contract profitability forecasts by analyzing historic performance relative to contractual commitments over its full term. This included challenging the Directors’ assumptions on the future costs including projected savings and the actions required to achieve these; and

› For contracts where significant adjustments to asset carrying values or onerous contract provisions have been recognized, or released during the year, we have assessed whether the resultant charges or income were a change of estimate arising from new circumstances in the year or whether they represented the correction of a prior period error.

We obtained a breakdown of assets capitalized at 31 December 2016. We selected a sample of these assets, including those associated with the contract selection noted above.

For each of the assets sampled we obtained third party support, or for internally generated time, the relevant timesheet records, to support the basis of capitalization and to ensure these are directly attributable to the asset. We assess the recoverability of the assets against future contract profitability.

We challenged management’s assessment to treat as a sale and operating leaseback, rather than a finance lease. We challenged the fair values of assets acquired and received through a review of the contracts with the support of our own property specialists. We ensured that adequate and appropriate disclosures have been included in the financial statements, including the resulting profit, as set out in note 7.

We have assessed that this risk has increased in the current year as a result of the reduced level of reported profits combined with the net debt of the Group at the year-end. This places increased pressure on financial covenant compliance at the year-end and in the going concern forecast period.

The Group has £1.8 billion of net debt as at 31 December 2016 including committed bank facilities and private placements which are subject to financial covenants. These covenants include a restriction on the ratio of adjusted net debt to adjusted EBITDA. See page 111 for further details of the requirements.

Any breach of these financial covenants will require a waiver from the lenders, which brings into question the future availability of existing and future funding, and related charges, and could impact the going concern basis upon which these financial statements have been prepared. Forecast covenant compliance is a judgmental area as it is based upon forecast cash collection rates and performance against the 2017 Business Plan.

In addition there is judgement over what adjustments should be made to calculate the adjusted EBITDA figure used in the covenant calculation.

As set out in note 26 to the financial statements the Group also manages its cash flow and working capital through the use of certain non-recourse finance arrangements that improve the net debt position on a short-term basis.

Our audit procedures included the following:

› We re-performed calculations, for 31 December 2016, 30 June 2017 and 31 December 2017, made for the Group’s covenant statements to confirm mathematical accuracy;

› We challenged any adjustments made to EBITDA in the covenant calculations, considering the appropriateness compared to the loan agreements and accepted and historical practice with the current lenders;

› We tested the integrity of the cash flow projections and challenged the appropriateness of key assumptions used in preparing those projections (including the forecast cash collection rates and the 2017 Business Plan).

We evaluated these projections and assumptions by reference to our knowledge of the business and
general market conditions and assessed the potential risk of management bias;

› We assessed the historical accuracy of forecasts prepared by management and the review and challenge by management of the current forecasts;

› The Group applied sensitivities to its cash flow forecasts, and considered the impact of these sensitivities on covenant compliance and available headroom.

We challenged the level of sensitivities applied for reasonableness and we evaluated whether the Directors’ plans to alleviate the downside risk evident from these scenarios were feasible in the circumstances;

› We evaluated the Group’s analysis of non-recourse finance arrangements at the year-end, considering the impact of these arrangements on the available cash position at the year-end; and

› We considered whether the Group’s disclosures in relation to its liquidity and capital resources were complete, represented the position of the Group at the date of approval of the financial statements, and included the Directors’ key considerations in deciding to prepare the financial statements on a going concern basis. We also considered the adequacy of the extent of disclosure around the uncertainty affecting the going concern assumption.

Refer to page 82 (Audit and Risk Committee Report), pages 115–116 (accounting  policy notes 2(j) and 2(k)) and pages 134–135 (financial disclosures in notes 14 and 15).

We consider the carrying value of intangible assets and goodwill and the risk over potential impairment to be a significant audit risk because of the inherent uncertainty involved in forecasting and discounting future cash flows, which are the basis of the assessment of recoverability. We consider the key inputs into the impairment model to be the approved business plans and assumptions for the growth and discount rates.

The risk in the year has increased given the underperformance of certain divisions against prior year business plans and the deterioration in the Group’s market capitalization.

Our audit procedures included detailed testing of the Group’s impairment assessment over the carrying value of intangible assets, including goodwill, and performing the following procedures:

› We compared the total amount of discounted cash flows as per the Group’s calculations to the Group’s market capitalization. We assessed the rationale for the difference at the year-end with the support of our own valuation specialists;

› We tested the principles and integrity of the Group’s discounted cash flow model;

› We assessed the appropriateness of any changes in the composition of cash generating units with reference to our understanding of the business;

› We compared the cash flows used in the impairment model to the output of the Group’s budgeting process and against the understanding we obtained about the business areas through our audit, and assessed if these cash flows were reasonable;

› We assessed the historical accuracy of the forecasts used in the Group’s impairment model by considering actual performance against prior year budgets;

› In light of the underperformance in the year we used external data and our own internal valuation specialists to evaluate the key inputs and assumptions for growth and discount rates;

› We performed sensitivity and break-even analyses for the key inputs and assumptions, and identified those cash-generating units we consider most sensitive to impairment; and

› We evaluated the adequacy of the Group’s disclosures related to the estimation uncertainty, judgements made and assumptions over the recoverability of intangible assets and goodwill, in particular ensuring that the sensitivity disclosures in note 15 of the financial statements reflected the current position.

Refer to page 82 (Audit and Risk Committee Report), page 110 (accounting policy note 2) and pages 120–124 and 128 (financial disclosures in notes 4, 5 and 7).

The Group separately presents certain income and expenditure as ‘non-underlying’ on the face of the income statement. Its financial highlights and commentary refers to ‘underlying’ measures as well as those derived on an adopted IFRS basis. The reasoning behind this presentation is set out in notes 2, 5 and 7 to the financial statements.

‘Non-underlying’ items are not defined by IFRSs and therefore judgement is required by the Directors to identify such items as ‘non-underlying’ and to maintain the comparability of results with previous years and in accordance with the Group’s accounting policy. As such there is a risk of management bias. Failure to disclose clearly the nature and impact of material non underlying earnings may distort the reader’s view of the financial result in the year.

Our audit procedures included the following:

› We inspected and challenged the nature and amounts of the items included within ‘non-underlying’ and agreed to supporting documentation and to third party correspondence where appropriate;

› We considered whether there were any items included in the underlying results that would be more appropriately classified as ‘non-underlying’ and vice versa;

› As part of this consideration we assessed the consistency of application of the Group’s accounting policy for the classification of ‘non-underlying’ items year-on-year and that the policy and rationale for respective disclosure is adequately disclosed;

› We assessed whether the basis of the ‘underlying’ financial information is clearly and accurately described and consistently applied and that reconciliations to the Adopted IFRS position are shown with sufficient prominence in the annual report;

› Given the importance of the covenant calculation in respect of going concern, we assessed the consistency of the definition of underlying earnings that is used in the calculation of the covenants and that the disclosures are adequate in this regard;

› We communicated our consideration on the classification of underlying and non-underlying to the Audit and Risk Committee to ensure an informed debate on the Board’s assessment of the selection and presentation of non-underlying items; and

› We examined the use of underlying measures in the front half of the annual report and considered this against applicable guidelines.