The group has continued in its significant multi-year cost optimization programme including factory closures, organizational rationalization and the establishment of shared service centres. The group also continues to integrate its US businesses. Management has indicated they expect these programmes will require several years to complete.

In 2016 the charge in the Consolidated Income Statement relating to these programmes was £307m and there is a total restructuring provision held on the Consolidated Balance Sheet of £304m. The restructuring charge is separately identified on the face of the income statement and excluded from the non-GAAP earnings measure Adjusted Operating Profit.

The recognition of restructuring costs requires judgement to estimate the value and timing of net economic outflows and the extent to which the Group is externally committed. The presentation in the financial statements also requires consideration of whether the amounts included in the charge are fair and whether their separate presentation is helpful in understanding financial performance.

The cost optimization programme operates predominantly through a series of distinct projects incorporating centralized governance and project management supporting local execution. This process gives rise to a series of specific restructuring charges being booked either at head office level or in individual component businesses. We conducted audit testing through our group team on centrally held charges and through local testing of charges at component businesses. Because the total restructuring cost also included some costs incurred at business units not included in our full scope audits the Group team tested these on a sample basis.

Using this approach we tested the valuation, accuracy and completeness of the individual restructuring costs. These primarily consisted of redundancies and related costs, consulting and professional fees and asset impairments. We found no material exceptions in our testing.

The principal areas of judgement underlying this work related to:

–the estimation of uncertain liabilities and impairment losses,

– the extent to which costs incurred on projects were sufficiently distinct and incremental to warrant inclusion in the restructuring charge and,

–projects which did not fit readily into the major elements of the programme but were considered by management to be appropriate for inclusion within the overall restructuring charge.

We challenged management over the basis for their judgements in these areas and determined that the amounts included in the charge were reasonable.

We also considered the merits of separate disclosure of the restructuring charge and discussed this with management and the audit committee. We concurred with their conclusion that the extensive scale and cost of the programme, its duration over several years and the level of centralized group wide control and board focus, indicated that separate disclosure was acceptable.

We focused on this area because the determination of whether elements of goodwill and intangible assets are impaired involves complex and subjective judgements by the Directors about the future results of the relevant parts of the business.

At 30 September 2016 the Group had £12,098m of goodwill and £594m of intangible assets with indefinite lives and reasonable headroom in the majority of the Group’s groupings of cash generating units (CGU’s).

We focused on the valuation of the Growth Markets reporting segment (£2,269m of goodwill and intangible assets with indefinite lives). Growth Markets is made up of a number of operating segments and individual CGU’s, including the Drive Growth CGU grouping and the Other Premium Cigar CGU grouping. For both of these goodwill is analysed separately and management’s assessment indicated low headroom (£210m and £100m respectively).

For the Drive Growth CGU grouping we focused on the valuation of both the Russian and Italian businesses, which represent the most material parts of this CGU grouping. In particular we considered the robustness of short term growth included in the impairment models, together with discount rates and long term growth rates.

For the Other Premium Cigar CGU grouping the valuation is dependent on continuing steady profit growth. As such we focused on the assumptions the Directors made about the growth rates in the context of constraints which could reasonably impact their ability to meet forecast.

We challenged the Directors’ analysis around the key drivers of the cash flow forecasts including the ability to achieve sustained price increases, market size and market share. We also evaluated the appropriateness of the key assumptions including discount rates, short-term and long-term growth rates and performed sensitivities across the reporting segments.

For the Russian and Italian businesses we considered the impact of investment in marketing programmes over the medium-term forecast, together with the broader potential to grow profits in the longer term. We also considered the impact of current and expected legislative and duty changes on the business and considered the accuracy of management’s current year forecasts.

For the Other Premium Cigar CGU, we evaluated the reasonableness of the Directors’ forecast by challenging key assumptions about growth strategies including supply constraints, regulatory changes in key markets, opportunities in new markets and changes in the relationship between the USA and Cuba. We also considered the accuracy of management’s current year forecasts.

As a result of our work we determined that the judgement by management that no impairment was required in respect of Drive Growth and Other Premium Cigar was reasonable. We note however that goodwill and intangibles held by these businesses remain sensitive to changes in key assumptions. In particular, for Drive Growth, a failure to achieve the growth objectives for planned market initiatives could give rise to an impairment. Given this management has disclosed relevant sensitivities (see note 11).

There are a number of significant judgements involved in the determination of tax balances, specifically in relation to the recognition of tax losses and the assessment of deferred taxation liabilities in relation to the distribution of reserves held in overseas subsidiaries. The group also has a number of uncertain tax positions in relation to which management apply judgement in setting provisions.

Given the number of judgements involved and the complexities of dealing with tax rules and regulations in numerous jurisdictions, this was an area of focus for us.

In the calculation of deferred taxes, we assessed the adequacy of tax loss recognition and the level of provision established in relation to a number of uncertain tax positions primarily in Europe including the challenge from the French tax authorities in relation to Altadis Distribution France. We determined that the position adopted in the financial statements was reasonable based on our consideration of management’s assessment of risks combined with their use of experts in support of their provision for uncertain tax outcomes. We also considered the reasonability of the tax losses recognised.

We considered the overall clarity of disclosure in relation to tax provisioning and the discussion of contingent liabilities including Altadis Distribution France and a more general assessment of cross border transfer pricing and determined that they were fair and proportionate.

Forecast-based valuation: Goodwill is carried, principally relating to the acquisitions of Rothmans, Imperial Tobacco Canada, ETI (Italy), ST (Scandinavia) and Bentoel (Indonesia). There is significant judgement with regard to assumptions and estimates involved in forecasting future cash flows, which form the basis of the assessment of the recoverability of goodwill balances. These include budgeted volumes, operating margin, long-term growth rates and with regard to the discount rate used. This is particularly so in regions where BAT operations are new or developing, or where there are challenging economic or legislative factors. In the current year, the cash generating units with the lowest headroom, and therefore requiring particular attention were Indonesia (goodwill of ￡186 million), TDR Croatia (goodwill of ￡121 million) and Colombia (goodwill of ￡106 million).

Our procedures included:

– Control design: Assessing the Group’s budgeting review and approval procedures upon which the cash flow forecasts are based;

– Our sector experience: Evaluating assumptions used, in particular those relating to forecast revenue growth and profit margins in Indonesia, Croatia, and Colombia, as well as the discount rates, including using our own valuation specialists;

– Benchmarking assumptions: Comparing the Group’s assumptions to externally derived data in relation to key inputs such as projected economic growth, competition, and discount rates. To challenge the reasonableness of the assumptions we also assessed the historical accuracy of the Group’s forecasting;

– Sensitivity analysis: Performing scenario-specific models including changes to, and breakeven analysis on, the discount rate, long term growth rates and forecast cash flows;

– Comparing valuations: Comparing the sum of the discounted cash flows to the Group’s market capitalization to assess the reasonableness of those cash flows; and

– Assessing transparency: Assessing whether the Group’s disclosures about the sensitivity of the outcome of the impairment assessment to changes in key assumptions reflected the risks inherent in the valuation of goodwill.

Dispute Outcome: The Group is subject to a large volume of claims including class actions, which could have a significant impact on the results if the potential exposures were to materialize. The Directors apply a number of judgements when considering whether, and how much, to provide for the potential exposure of each litigation. These include assumptions relating to the likelihood and/or timing of cash outflows from the business and the interpretation of local pending or preliminary court rulings in assessing whether provision arises. We placed specific focus on the judgments in respect of the ongoing smoking and health litigation brought against the operating company in Canada which is disclosed in note 28.

Our procedures included:

– Control Design: Evaluation of the processes and controls over litigations operated by management at a Group, regional and local level through regular meetings with in-house legal counsels and review of Board and sub-committee meeting minutes;

– Enquiry and circularization of lawyers: For all significant legal disputes, assessment of correspondence with the Group’s external counsel accompanied by formal confirmations from that external counsel and discussions with in-house counsel;

– Accounting analysis: Use of KPMG legal specialists to assess relevant historical and recent judgments passed by the court authorities, as well as the formal confirmations of current stats from external counsel, in order to challenge the basis used for the accounting treatment and resulting disclosures; and

– Assessing transparency: Assessment of the Group’s contingent liabilities disclosures in note 28 to determine whether management has presented the facts and circumstances clearly and accurately.

Dispute Outcome: The Group operates in a complex multinational tax environment and has a number of uncertain tax positions. The tax matters are at various stages, from preliminary discussions with tax authorities through to tax tribunal or court proceedings where the matters can take many years to resolve. A number of significant judgements are made by the Directors in assessing whether any contingent liability or provision arises from disputes in particular in Brazil, Canada, South Africa and the Netherlands.

Our procedures included:

– Own tax expertise: Use of our own international and local tax specialists to assess the Group’s tax positions, its correspondence with the relevant tax authorities, and to analyze and challenge the assumptions used to determine tax provisions or contingent liability disclosure based on our knowledge and experience of the application of the international and local legislation by the relevant authorities and courts. In respect of the most significant disputes, we read recent rulings and correspondence with local tax authorities, as well as external advice received by the Group  where relevant, to satisfy ourselves that the tax exposures had been appropriately provided for or determined to be contingent liabilities; and

– Assessing transparency: We assessed the adequacy of the Group’s disclosures in respect of uncertain tax positions.