Sky retails subscription packages to customers which include multiple elements and may include discounts and offers, for example TV subscription, hardware and telephony services sold for a single package price. The allocation of retail subscription revenue to each element of a bundled transaction is complex and requires judgement, as described in the Group’s critical accounting policies on page 86. There is a risk that inappropriate allocations could lead to non-compliance with accounting standards and incorrect acceleration or deferral of revenue, principally for new customers who may enter a contract of one to two years’ duration, which may include hardware or installation at discounted prices up front.

We evaluated the Group’s revenue recognition policy and management’s current year assessment in respect of accounting for bundled transactions against relevant accounting standards and guidance.

We tested the policy’s implementation in each territory by:

• performing tests of control to confirm our understanding of the process by which revenue is calculated by the relevant billing systems;
• performing an assessment of the different product bundles and offers made available to customers in the year and confirming the fair value of different elements of these packages to appropriate evidence of fair value;
• assessing whether revenue should be accelerated or deferred based on the relative fair value of elements delivered at different points during the contract, when compared to the revenue calculated by the relevant billing system; and
• where differences arose between the revenue calculated by the billing system and the revenue recognition profile calculated in accordance with the Group’s revenue recognition policy, auditing the valuation, accuracy and completeness of those adjustments recognized to align revenue recognized with the Group’s accounting policy.

Determining the timing and amount of general entertainment programming expense recognized in the period requires judgement in selecting the appropriate recognition profile and ensuring that this profile achieves the objective of recognizing programming inventory expense in line with the way that it is consumed by the Group, as set out in the Group’s critical accounting policies on page 87.

Entertainment programming expense involves more judgement than other types of programming due to the number of qualitative factors involved in the selection and application of an appropriate expense profile, which includes:

• The time period and frequency with which the programme is expected to be utilised on the Group’s linear and non-linear services;
• Expectations of the number of viewers a programme is likely to achieve for each broadcast on the Group’s linear channels;
• Potential benefits associated with utilising programming; and
• The relative values associated with linear channel and non-linear rights.

There is a risk that the recognition profile selected by management for entertainment programming does not correctly recognise the expense in line with the way that the Group consumes the inventory.

The level of expenditure on general entertainment programming varies in each territory, and our procedures focused on entertainment spend in the UK and Italy, which are significant to the Group.

We examined the method for expensing general entertainment programming inventory, taking into account the differing genres of programmes, any significant changes to viewing patterns during the year and industry benchmarks.

Our procedures included:

• benchmarking management’s recognition profile against industry practice;
• considering the consistency of recognition profiles applied year on year;
• assessing the design and implementation of controls over the recognition and expensing of general entertainment programming;
• comparing the expense profile determined by management against that which would be indicated by viewing trends (used as a proxy for value consumed); and
• assessing the impact of other qualitative factors, such as the value of certain types of programming to brand or channel value and the influence on the acquisition and retention of customers.

The Group’s spending on capital projects is material, as shown by the total value of additions in notes 13 and 14. The assessment and timing of whether assets meet the capitalization criteria set out in IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets requires judgement, as set out in the Group’s critical accounting policies on page 86. In addition, determining whether there is any indication of impairment of the carrying value of assets being developed or replaced also requires judgement in assessing performance against the investment business case. As a result, there is a risk that the Group’s expenditure on intangible and tangible non-current assets is inappropriately capitalised against relevant accounting guidance, that assets not yet in use are not recoverable at their carrying value and that the value of existing assets made obsolete by current year additions may be impaired.

Our procedures performed included:

• assessing the design, implementation and testing the operating effectiveness of controls in respect of the capitalization of assets and the identification of potential indicators of impairment;
• performing sample tests of capital expenditure projects including an examination of management’s assessment as to whether the project spend met the recognition criteria set forth in IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets, and reviewing the project status reports for the Group’s most significant projects to check for indicators of impairment; and
• For a sample of capital projects, developing an understanding of the business case, challenging key assumptions and estimates using our business and industry understanding and experience and using external information where relevant, verifying capital project authorization, and tracing a sample of project costs to appropriate evidence.

Forecast based valuation:
A history of business combinations and the capital intensive nature of the business model increases the magnitude of non-current assets.

There is a risk that the future performance may lead to the value of non-current assets not being recoverable in full.

The estimated recoverable amount is subjective due to the inherent uncertainty involved in forecasting and discounting future cash flows.

This uncertainty arises due to challenges in forecasting – expected changes in visitation at existing attractions, particularly where there have been recent changes in the overall offering, promotions or planned customer experience improvements. Other factors such as the unpredictable impact of competition, the weather, and the political and economic environment on trading performance also add to the uncertainty.

Specifically in relation to the Resort Theme Parks goodwill, events during 2015 at Alton Towers reduced valuation headroom, disrupted previous trading patterns and created greater uncertainty over forecasts.

Our procedures included:

• Extrapolating past forecasting accuracy: assessing five years’ historical accuracy of the Group’s forecasting, and subsequently building comparable variations in forecasting accuracy into our own model that re-performed and sensitized the valuation;
• Challenging forecasts: comparing expected changes in cash flows (from activities such as new promotions and customer experience improvements) and the planned cost base against the past results of similar activities carried out by the Group;
• Benchmarking assumptions: supported by valuation experts, benchmarking Group earnings multiple and discount rates against market data, including publicly available analysts’ reports and peer comparison;
• Sensitivity analysis: calculating the impact of changes in key assumptions and performing breakeven analysis of the earnings multiple, discount rates and forecast cash flows;
• Comparing valuations: comparing the sum of all the discounted cash flows across the Group to the Group’s market capitalization to assess the reasonableness of the underlying assumptions; and
• Assessing transparency: assessing whether the Group’s sensitivity disclosures regarding the impairment testing adequately reflect the risks inherent in the valuation of goodwill.

Accurate recording:

Merlin’s revenues arise from a number of different sources, locations and systems, sometimes featuring manual processes to match cash payments to redemptions or to transfer data to the finance systems.

The low value of individual transactions means individual errors would be insignificant, but difficult to detect, and the high volume of transactions mean systemic failure could lead to errors that aggregate rapidly into material balances.

Our procedures are performed by each component auditor, under guidance issued by the Group team, and included:

• System design: testing of the general IT control environment of the systems used to record revenue, followed by testing of the controls that check completeness and accuracy of revenue entries arising from these systems;
• Control design: testing of the design, implementation and operating effectiveness of manual controls supporting the systems, including reconciliations of till records to revenue journal entries in the accounting records;
• Analytical review: predictive analytical procedures (taking into account factors such as trends in seasonality, changes in pricing and visitation); and
• Tests of detail: performing reconciliations of total cash received to revenue recorded, confirming the appropriate timing of sales cut-off by checking the specific posting of revenue for days either side of the period end; and substantive testing of deferred and accrued revenue balances through agreeing back to ticketing system records and checking underlying calculations.

The majority of ITV’s advertising revenue (‘NAR’) is subject to regulation under Ofcom’s Contract Rights Renewal system (‘CRR’). CRR works by ensuring that the annual share of TV advertising that will be placed with ITV by each advertising agency can change in relation to the viewing figures for commercial television that it delivers. The CRR system, the pricing of the annual contractual arrangements with advertising agencies and the details of each advertising campaign, together with the related processes and controls, are complex and involve estimation.

In particular, the pricing mechanism means it is possible for a difference to arise between the price received by ITV for an advertising campaign and the value it delivered, mainly as a result of the actual viewing figures being different from the agreed level. Where the Group has over-delivered viewers this is referred to as a ‘deal credit’, or a ‘deal debt’ where delivery has fallen short. Rather than the price paid for that campaign being adjusted, these differences are noted for each agency and then taken account of when agreeing either future campaigns or the annual contract. A net deal debt position with an agency is recorded in ITV’s accounts, as a liability. Net deal credit positions are not recognized.

NAR is therefore considered a significant risk due to:

• The number and complexity of contractual agreements with advertising agencies;
• The complexity of the systems and processes of control used to record revenue; and,
• The level of estimation involved in determining the deal debt liability at the period end.

Our procedures included:

• Testing of controls, assisted by our own IT specialists, including those over: segregation of duties, input of annual deal terms with agencies, input of individual campaigns’ terms and pricing, comparison of those terms and pricing data against the related contracts with advertising agencies; linkage to transmission/viewer data; and the system generated calculation of deal debt for each campaign;
• Analyzing revenue based on our industry knowledge and external market data, following up variances; and
• Challenging the year-end deal debt position based on comparison with customers’ correspondence and agreed terms of business.

We also assessed the adequacy of the group’s disclosures in respect of the accounting policies on revenue recognition.

Non-NAR revenue includes revenue from: programme production, the sale of programme rights, transmission supply arrangements and the Online, Pay & Interactive division within the Broadcast segment.

Recognition of revenue is driven by the specific terms of the related contracts and is considered to be a significant risk as the terms of the contracts are varied and can be complex, with the result that accounting for the revenue generated in any given period can require individual consideration and judgement. Due to the contractual nature of these revenue streams, the focus of our work is on the risks associated with significant one-off contracts.

Our procedures included:

• We considered the Group’s revenue recognition policies against the relevant accounting standards; and
• For higher value revenue contracts entered into during the year, we considered whether revenue had been recognized in accordance with the contractual terms in the correct accounting period, given the requirements of the relevant accounting standard.

We also assessed the adequacy of the group’s disclosures in respect of the accounting policy on revenue recognition.

Significant estimates are made in determining the key assumptions used in valuing the group’s post-retirement defined benefit obligations. When making these assumptions the Group takes independent actuarial advice relating to their appropriateness.

Following an analysis of the membership data carried out for the related longevity swap, the Group updated its mortality assumptions in the year which had an impact on the obligations at the year-end.

The Group also closed the ITV Pensions Scheme for future benefit accrual with effect from 28 February 2017.

The valuation of the defined benefit obligations is considered a significant risk given the quantum of the pension deficits, the developments related to the schemes in the year, and given that a small change in assumptions can have a material financial impact on the Group.

Our procedures included:

• Challenging the key assumptions applied in determining the Group’s pension obligations, 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
• Testing the methodology applied in determining the revised mortality expectation by comparing the conclusions of the Group’s analysis with our own analysis formed using externally derived data.

We also considered the adequacy of the group’s disclosures in respect of the sensitivity of the deficits to these assumptions.