Consolidated financial statements
Significant accounting policies

Reporting entity

Morgan Sindall plc (‘the Company’), is a company domiciled and incorporated in the UK. The nature of the Group’s operations and its principal activities are set out in note 1 and in the business review on pages 17 to 60. The report and accounts includes the consolidated financial statements of the Company and its subsidiaries (collectively referred to as the ‘Group’) and the Group’s interest in joint ventures and separate financial statements for the Company.

Basis of preparation

(a) Statement of compliance
The consolidated financial statements have been prepared on a going concern basis as discussed in the business review and in accordance with International Financial Reporting Standards (‘IFRS’) adopted by the European Union and therefore comply with Article 4 of the EU IAS Regulation. The consolidated financial statements are prepared in accordance with those parts of the Companies Act 2006 applicable to companies reporting under IFRS.

(b) Basis of measurement
The consolidated financial statements have been prepared on the historical cost basis, except where otherwise indicated.

(c) Functional and presentation currency
These consolidated financial statements are presented in pounds sterling, which is the Group’s functional currency. All financial information, unless otherwise stated, has been rounded to the nearest £0.1m.

(d) Changes in accounting policy and disclosures
(i) New and revised accounting standards adopted by the Group
The Group has adopted the following new, amended and revised standards and interpretations from 1 January 2009:

• IFRS 2 (amendment) ‘Share-based Payment’: clarifies that vesting conditions of a share-based payment are service and performance conditions only. Other features are non-vesting conditions, which must be taken into account when determining the fair value at the grant date and a failure to meet such conditions is treated as a cancellation. Adoption of this amendment has not had a material impact on the Group’s consolidated financial statements.
• IFRS 7 (amendment) ‘Financial Instruments Disclosures’: expands disclosures required in respect of fair value measurement and liquidity risk. The amendment specifically requires fair value disclosures to be made by each class of financial instrument with an increasing level of fair value measurement disclosure depending on the instrument’s position in the prescribed fair value hierarchy.
• IFRS 8 ‘Operating Segments’: requires disclosure of operating segment information on the same basis as that used to present information internally to the Chief Operating Decision Maker. Adoption of this standard has only impacted disclosure and presentation with the Investments segment being disclosed for the first time separately.
• IAS 1 (revised) ‘Presentation of Financial Statements’: requires certain classification and presentational changes to the Group’s primary consolidated financial statements. There has been no impact on the Group’s consolidated financial statements.
• IAS 23 (revised) ‘Borrowing Costs’: requires the capitalisation of borrowing costs attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. The previously available option to immediately expense these borrowing costs has been removed. Adoption of this revision is prospective (from 1 January 2009) and there has been no material impact on the Group’s consolidated financial statements.
• International Financial Reporting Interpretations Committee (‘IFRIC’) 15 ‘Agreements for the Construction of Real Estate’: as the Group already accounts for the construction of real estate in accordance with this IFRIC, there has been no impact on the Group’s consolidated financial statements.
• IFRIC 14 – IAS 19 ‘The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’: provides guidance on how to assess the limit of IAS 19 ‘Employee Benefits’ on the amount of a surplus that can be recognised as an asset. As the Group’s defined benefit plan is currently in a deficit position, adoption of this interpretation has had no impact on the Group’s consolidated financial statements.
• Part 1 of the improvements to IFRS project: required a number of smaller amendments to existing IFRS that had implementation dates throughout 2009. None of these have had an impact on the Group’s consolidated financial statements.

(ii) Accounting standards, amendments and interpretations to existing standards not yet effective and not adopted early by the Group
The following have been published and, when approved by the EU, will be mandatory for periods beginning on or after 1 January 2010 and have not been adopted early by the Group:

• IFRS 2 (amendment) ‘Group cash-settled and share-based payment transactions’: expands guidance issued as part of IFRIC 11 on group share-based payment arrangements with the aim of addressing the classification of group arrangements not covered in that interpretation. This is not expected to have a material impact on the Group’s consolidated financial statements.
• IFRS 3 (revised) ‘Business Combinations’: requires the expensing of all acquisition related transaction costs (previously certain costs could be capitalised) and the recognition and measurement of contingent consideration at fair value, with subsequent changes in fair value usually taken through the income statement. The revision also provides the option of measuring non-controlling interests at fair value. The revised standard is prospective and will only affect business combinations effected from 1 January 2010.
• IAS 27 (revised) ‘Consolidated and Separate Financial Statements’: primarily relates to the accounting for non-controlling interests (partial and stepacquisitions) and the loss of control. Similar to the revised IFRS 3, this revised standard will only impact transactions in the Group’s consolidated financial statements from 1 January 2010.
• IAS 38 (amendment) ‘Intangible Assets’: the amendment is part of the annual improvements project and will apply from 1 January 2010 when IFRS 3 (revised) is adopted. The amendment clarifies guidance in relation to measuring the fair value of an intangible asset acquired in a business combination and permits the grouping of intangible assets as a single asset if the assets have similar economic lives. This is not expected to have a material impact on the Group’s consolidated financial statements.
• IFRIC 12 ‘Service Concession Arrangements’: the Group currently classifies financial assets arising from its service concession arrangements as available for sale financial assets. However, under IFRIC 12, where a concession conveys to the operator a right to charge users for the public sector asset it has constructed or upgraded, that intangible asset must be bifurcated and recognised separately from the finance debtor component. The intangible asset will then need to be amortised and assessed for impairment. Adoption of this IFRIC is not expected to have a material impact on the Group’s consolidated financial statements although additional disclosures will be required.
• IFRIC 18 ‘Transfers of Assets from Customers’: clarifies the treatment where an item of property, plant or equipment is received from a customer to connect to an ongoing supply of goods and services. This is not expected to have a material impact on the Group’s consolidated financial statements.
• International Accounting Standards Board (‘IASB’) annual improvements 2008 – 2009: requires a number of smaller amendments to existing International Financial Reporting Standards with implementation dates at various points throughout 2010. The impact of these amendments is currently being assessed.
• IFRS 9 ‘Classification and Measurement’: aims to simplify the classification and measurement of financial instruments according to a business model approach, which requires recognition and measurement according to how an entity manages its financial instruments and the contractual cash flow characteristics of the financial assets. Although approved by the IASB, this has not been endorsed by the EU and endorsement is not expected until the complete IAS 39 replacement programme is complete.
• IAS 24 (revised) ‘Related Party Transactions’: simplifies the disclosure requirements for government-related entities and clarifies the definition of a related party. This is not expected to have a material impact on the Group’s financial statement disclosures.
• Amendment to IFRIC 9 ‘Reassessment of Embedded Derivatives’ and IAS 39 ‘Financial Instruments: Recognition and Disclosure’: clarifies that where an entity has taken advantage of the reclassification amendment issued by the IASB in late 2008 (allowing certain financial instruments to be reclassified from fair value through profit or loss to amortised cost), an assessment has to be made for embedded derivatives with separate accounting if necessary in the financial statements. This amendment has no impact on the Group consolidated financial statements as the 2008 amendment was not applied.

(e) Restatement of comparative balances
Certain comparatives have been reclassified to conform to the current year’s presentation.

(f) Critical accounting judgments and key sources of estimation uncertainty
The preparation of financial statements under International Financial Reporting Standards requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expense. Actual results may differ from these estimates.

Estimates and assumptions are reviewed on an ongoing basis and any revision to estimates or assumptions are recognised in the period in which they are revised.

(i) Critical accounting judgments
The following are critical judgments, apart from those involving estimations (which are dealt with separately below), that the directors have made in the process of applying the Group’s accounting policies and that have the most significant effect on the amounts recognised in the consolidated financial statements.

• Accounting for tax in relation to the Amec acquisition fair value adjustments
  The Group is in discussion with HMRC concerning the corporation tax treatment of the fair value adjustments which arose following the 2007 acquisition from Amec. As a result of these discussions, the Group received £9.5m in provisional corporation tax repayments from HMRC during 2009, and reduced payments which it would otherwise have made to HMRC during the year by £9.2m. No benefit has been recognised in the tax charge in the income statement in respect of this matter, as discussions are at an early stage and the eventual outcome is unclear. In total the Group received a net corporation tax repayment of £7.7m during 2009 (2008: net payment of £18.9m).

(ii) Key sources of estimation uncertainty
The key assumptions concerning the future, and other key sources of estimation at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying value of assets and liabilities within the next financial year are discussed below.

• Accounting for construction and service contracts
  Recognition of revenue and margin is based on judgments made in respect of the ultimate profitability of a contract. Such judgments are arrived at through the use of estimates in relation to the costs and value of work performed to date and to be performed in bringing contracts to completion, including satisfaction of maintenance responsibilities. These estimates are made by reference to recovery of pre-contract costs, surveys of progress against the construction programme, changes in work scope, the contractual terms under which the work is being performed, costs incurred, and external certification of the work performed. The Group has appropriate control procedures to ensure all estimates are determined on a consistent basis and subject to appropriate review and authorisation.
• Recognition and measurement of intangible assets
  The Group recognises certain intangible assets in respect of secured customer contracts, other contracts and related relationships, software, a non-compete agreement and goodwill. The recognition and subsequent measurement of these intangible assets requires management to make certain assumptions and estimates, particularly in respect of the future potential benefits to be derived and the estimated useful lives over which the future economic benefits are expected to flow to the Group. To assist in making these judgments, the directors engaged an independent expert to assist in the determination of the fair values and the estimated useful lives of these assets.
• Impairment of goodwill and other intangible assets
  Goodwill and other intangible assets are subject to an impairment test on an annual basis or earlier where any event or change in circumstance is identified that indicates that the carrying value may not be recoverable. Testing for impairment requires a comparison of the carrying amount of goodwill and other intangible assets against the recoverable amount, which is the value-in-use of the cash-generating unit to which the goodwill and other intangible assets are allocated.
  
  Value-in-use requires estimation of the future cash flows expected from the cash-generating unit as well as an appropriate growth factor and discount rate to calculate the present value of the cash flows.
• Impairment of work in progress
  In assessing whether work in progress is impaired, estimates are made of future sales revenue, timing and build costs. The Group has controls in place to ensure that estimates of sales revenue are consistent, and external valuations are used where appropriate.
• Accounting for the Group’s defined benefit plan
  The directors engage an independent and qualified actuary to calculate the Group’s liability in respect of the defined benefit plan. In order to arrive at this valuation, certain assumptions in respect of discount rates, salary escalations, expected return on the plan’s assets and future pension increases have been made. Estimates and judgments regarding future mortality are derived using published statistics and mortality tables. As the actual rates of increase and mortality may differ from those assumed, the actual pension liability may differ from that recognised in these consolidated financial statements.
• Insurance provisions
  In valuing the provision for the Group’s retained insurance risks, estimates are made of the rate of occurrence and severity of events for which the Group will bear liability and external valuations are used where appropriate.
• Private Finance Initiative (‘PFI’)/Private Public Partnership (‘PPP’) derivative financial instruments
  Certain Group joint ventures use swaps to hedge interest rate and Retail Price Index (inflation) risk to which PFI/PPP concessions are exposed. These are initially recognised, and subsequently re-measured at each year end, at fair value derived from current market rates.
• Financial receivables
  In assessing the fair value of certain financial receivables, including trade receivables and those held by joint ventures, estimates are made of future cash flows and the appropriate discount rate to be used.
• Tax
  Judgments are required in establishing the Group’s liability to pay taxes where tax positions are uncertain.
• Share-based payments
  Recognition and measurement of share-based payments requires estimation of the fair value of awards at the date of grant and, for cash-settled awards, re-measurement at each reporting date. Judgment is exercised when estimating the number of awards that will ultimately vest and these estimates have a significant impact on the amounts recognised in the income statement and the balance sheet. To assist in determining each award’s fair value, the directors engage a qualified and independent valuation expert. Assumptions in relation to the number of awards that will ultimately vest is based on estimates at the reporting date of the extent to which performance conditions are anticipated to be satisfied, anticipated future lapses by leavers and the current intrinsic value of those awards.
• Recognition and measurement of embedded derivatives contained in shared equity loans
  The Group’s balance sheet includes loans that arise on the sale of properties under shared equity home ownership schemes which are recognised and measured at fair value through profit or loss (as discussed in the Group’s accounting policies). Because it is impracticable to obtain regular market valuations on a property-by-property basis, except as required at repayment, the Group makes judgments on the fair value of the loans on a portfolio basis. This approach requires judgment on inputs used to determine fair value and which include property price indices, the discount rate, the anticipated loan duration and the expected rate of debtor default. Assumptions made in relation to these inputs have a material impact on the carrying value of the loan portfolio recognised on the balance sheet and the fair value movement recognised in the income statement.
  
  The accounting policies as set out below have been applied consistently to all periods presented in these consolidated financial statements.

Basis of consolidation

The consolidated financial statements incorporate the financial statements of the Company and the entities controlled by the Company (its subsidiaries), together with the Group’s share of the results of joint ventures made up to 31 December each year. The acquisition of subsidiaries is accounted for using the purchase method. The cost of the acquisition is measured at the fair value, at the date of acquisition, of assets given, liabilities incurred or assumed, and equity instruments issued by the Group in exchange for control of the acquiree, plus any costs directly attributable to the business combination. The acquiree’s identifiable assets (including previously unrecognised intangible assets), liabilities and contingent liabilities that meet the conditions for recognition are recognised at their fair value at the acquisition date. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets is recorded as goodwill. If the cost of the acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is immediately recognised in the income statement. Minority interests in the net assets of consolidated subsidiaries are identified separately from the Group’s equity therein. Minority interests consist of the amount of those interests at the date of the original business combination (see below) and the minority’s share of the changes in equity since the date of the combination.

(a) Subsidiaries
Subsidiaries are entities that are controlled by the Group. Control is exerted where the Group has the power to govern, directly or indirectly, the financial and operating policies of the entity so as to obtain economic benefits from its activities. Typically a shareholding of more than 50% of the voting rights is indicative of control. However, the impact of potential voting rights currently exercisable is taken into consideration.

The financial statements of subsidiaries are included in the consolidated financial statements of the Group from the date that control commences to the date that control ceases. The accounting policies of new subsidiaries have been changed where necessary to align them with those of the Group.

The interest of minority shareholders in the acquiree is initially measured at the minorities’ proportion of the net fair value of the assets and liabilities recognised.

(b) Joint ventures
A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control, which requires unanimous consent for strategic financial and operating decisions.

(i) Jointly controlled entities
A jointly controlled entity is a joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The results, assets and liabilities of jointly controlled entities are incorporated in the financial statements using the equity method of accounting.

Goodwill relating to a joint venture which is acquired directly is included in the carrying amount of the investment and is not amortised. After application of the equity method, the Group’s investments in joint ventures are reviewed to determine whether any additional impairment loss in relation to the net investment in the joint venture is required. When there is a change recognised directly in the equity of the joint venture, the Group recognises its share of any change and discloses this, where applicable, in the statement of recognised income and expense.

Where the Group’s share of losses exceeds its equity accounted investment in a joint venture, the carrying amount of the equity is reduced to nil and the recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations. Appropriate adjustment is made to the results of joint ventures where material differences exist between the joint ventures’ accounting policies and those of the Group.

Dividend income from investments is recognised when the shareholders’ rights to receive payment have been established.

(ii) Jointly controlled operations
Construction contracts carried out in joint venture without the establishment of a legal entity are jointly controlled operations. The Group’s share of the results and net assets of these jointly controlled operations are included under each relevant heading in the income statement and balance sheet.

(c) Transactions eliminated on consolidation
Intra-group balances and transactions, and any unrealised income and expense arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains arising from transactions with equity accounted investments are eliminated to the extent of the Group’s interest in that investment. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment.

Revenue and margin recognition

Revenue and margin are recognised as follows:

(a) Construction contracts
Revenue comprises the fair value of construction carried out in the year based on an internal assessment of work carried out. This assessment is carried out by reference to the construction programme, the construction contract, costs incurred, and external certification of the work performed. Once the outcome of a construction contract can be estimated reliably, margin is recognised in the income statement on a stage of contract completion basis by reference to costs incurred to date and total forecast costs on the contract as a whole. Losses expected in bringing a contract to completion are recognised immediately in the income statement as soon as they are forecast.

Where houses for open market sale are included in a construction contract as part of a mixed tenure development, revenue on open market sales is recognised on sale completion and margin is recognised using the same principle as for the construction contract element of the development.

(b) Service contracts
Revenue comprises the fair value of work performed in the year based on an internal assessment of work carried out. This assessment is carried out by reference to the service contract, costs incurred, surveys of work performed and external certification of work performed.

(c) Sale of development properties
Revenue from the sale of development properties is measured at the fair value of the consideration received or receivable. Revenue is recognised when the significant risks and rewards of ownership have been transferred to the buyer, there is no continuing management involvement with the properties and the amount of revenue can be estimated reliably.

The transfer of risks and rewards vary depending on the individual terms of the contract of sale. For properties, transfer usually occurs when the ownership has been legally transferred to the purchaser. Revenue from the sale of properties taken in part exchange is not included in revenue.

(d) Pre-contract costs
Pre-contract costs incurred prior to the appointment as preferred bidder for a contract are expensed.

(e) Government grants
Funding received in respect of developer grants, where funding is awarded to encourage the building and renovation of affordable housing, is recognised as revenue on a stage of completion basis over the life of the project to which the funding relates.

Funding received to support the construction of housing where current market prices would otherwise make a scheme financially unviable is recognised as revenue on a legal completion basis when the properties to which it relates are sold.

Finance income and expense

Finance income comprises interest income on funds invested and other interest. Interest income is recognised as it accrues in the income statement using the effective interest rate method.

Finance expense comprises interest on bank overdrafts, unwinding of the discounts on provisions, impairment losses recognised on financial assets and losses on hedging instruments recognised through the income statement. The finance charge component of minimum lease payments made under finance leases is also recognised as a finance expense using the effective interest rate method.

Borrowing costs are recognised in the income statement on an effective interest rate method in the period in which they are incurred except where such costs relate to qualifying assets for which the commencement date for capitalisation was on or after 1 January 2009. Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are included as part of the cost of that asset.

Income tax

The income tax expense represents the current and deferred tax charges. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in equity.

Current tax is the Group’s expected tax liability on taxable profit for the year using tax rates enacted, or substantively enacted at the reporting date and any adjustments to tax payable in respect of previous years.

Taxable profit differs from that reported in the income statement because it is adjusted for items of income or expense that are assessable or deductible in other years and is adjusted for items that are never assessable or deductible.

Deferred tax is recognised using the balance sheet method, providing for temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the corresponding tax bases used in tax computations. Deferred tax is not recognised for the initial recognition of assets or liabilities in a transaction that is not a business combination and affects neither accounting nor taxable profit, or differences relating to investments in subsidiaries and joint ventures to the extent that it is probable that they will not reverse in the foreseeable future. Deferred tax is not recognised for taxable temporary differences arising on the initial recognition of goodwill.

Deferred tax is recognised on temporary differences which result in an obligation at the balance sheet date to pay more tax, or a right to pay less tax, at a future date, at the tax rates expected to apply when they reverse based on the laws that have been enacted or substantively enacted at the reporting date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered. Deferred tax assets and liabilities are not discounted and are only offset where there is a legally enforceable right to offset current tax assets and liabilities.

Intangible assets

(a) Goodwill
(i) Initial recognition
Goodwill arises on the acquisition of subsidiaries, associates, joint ventures and other business assets and liabilities. Goodwill represents the excess of the cost of acquisition over the Group’s interest in the net fair value of identifiable assets, liabilities and contingent liabilities of the acquiree. Where that excess is negative (i.e. negative goodwill), it is immediately recognised in the income statement.

Goodwill arising on acquisitions before the date of transition to IFRS has been retained at the previous UK GAAP amounts subject to being tested for impairment at that date. Goodwill written off to reserves under UK GAAP prior to 1998 has not been reinstated and is not included in determining any subsequent profit or loss on disposal.

(ii) Subsequent measurement
Goodwill is measured at cost less accumulated impairment losses. In respect of equity accounted investments, goodwill is included in the carrying amount of the investment.

(iii) Impairment
Goodwill is subject to an impairment review on an annual basis or earlier where a factor or change in circumstance has been identified which may indicate impairment. For the purpose of impairment testing, goodwill is allocated to each of the cash-generating units of the Group at acquisition. The units to which the goodwill has been allocated is the lowest level within the Group at which the goodwill is monitored for internal management purposes.

If the recoverable amount of the cash-generating unit is lower than the carrying amount of the unit, then the impairment loss is first applied to the goodwill allocated to the cash-generating unit and then to the other assets of the unit on a pro-rata basis based on the carrying amount of each asset in the unit. Any such impairment loss is recognised immediately in the income statement and is not subsequently reversed.

b) Other intangible assets
Other intangible assets, such as those identified on acquisition by the Group that have finite useful lives, are recognised at fair value and measured at cost less accumulated amortisation and impairment losses.

The Group has the following significant classes of finite life intangible assets:

(i) Secured customer contracts
On acquisition, value is attributable to customer contracts to the extent that future economic benefits are expected to flow from the contracts. The fair value of customer contracts recognised in the Group financial statements has been determined with the assistance of an independent expert. Secured customer contracts are amortised over their expected useful lives at a rate to match the expected future economic benefits.

(ii) Other contracts and related relationship
On acquisition, value is attributed to non-contractual relationships and other contracts with long-standing or valued clients to the extent that future economic benefits are expected to flow from the relationships. The fair value of other contracts and related relationships recognised in the Group financial statements has been determined with the assistance of an independent expert. Other contracts and related relationships are amortised over their expected useful lives at a rate to match the expected future economic benefits.

(iii) Software
Software acquired on acquisition is valued on a replacement cost basis and is amortised over its expected useful life on a straight-line basis.

(iv) Non-compete agreements
Value is attributable to contractual non-compete agreements acquired through acquisition to the extent that they ensure that the value paid for a business is not diminished by the previous owner or its employees taking away revenue through competition. Non-compete agreements are amortised over their useful lives on a straight-line basis.

The estimated useful lives for the Group’s finite life intangible assets are:

• secured customer contracts 1–3 years
• other contracts and related relationships 1–16 years
• software 1–3 years
• non-compete agreements 3 years.

Property, plant and equipment

Freehold and leasehold properties, plant, machinery and equipment are stated at cost less accumulated depreciation and any recognised impairment loss. Depreciation is charged so as to write off the cost or valuation of assets, other than land, over their estimated useful lives using the straight-line method on the following bases:

• plant, machinery and equipment between 8.3% and 33% per annum
• freehold property 2% per annum
• leasehold property over the period of the lease.

Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. Residual values of property, plant and equipment are reviewed and updated annually. Assets under construction are not depreciated until they become available for productive use.

Gains and losses on disposal are determined by comparing the proceeds from disposal against the carrying amount and are recognised in the income statement.

The cost of replacing part of an item of property, plant and equipment is recognised in the carrying amount only where it is probable that the future economic benefits embodied within the part will flow to the Group and its cost can be measured reliably. The carrying amount of the replaced part is derecognised.

Investment property

Investment property, which is property held to earn rentals and/or capital appreciation is stated at its fair value at the balance sheet date. Gains or losses arising from changes in the fair value of investment property are included in the income statement for the period in which they arise.

Shared equity scheme receivables

The Group offers shared equity home ownership schemes under which qualifying home buyers can defer payment of part of the agreed sales price up to a maximum of 25% until the earlier of 10 years, remortgage or resale of the property. On occurrence of one of these events, the Group will receive a repayment based on its contributed equity percentage and the applicable market value of the property as determined by a member of the Royal Institute of Chartered Surveyors. Early or part repayment is allowable under the scheme and amounts are secured by way of a second charge over the property.

The shared equity loans receivable are a hybrid financial instrument consisting of an initial principal component and an embedded derivative whose fair value varies in accordance with movements in the specific property prices to which the loan relates. The loans are non-interest bearing

The Group has elected to designate the financial assets resulting from the shared equity schemes as fair value through profit or loss. This election can only be made at initial recognition and is irrevocable. As it is not practicable to obtain current market valuations on a property-by-property basis at each reporting date, the fair value of the loans is calculated on a portfolio basis using region specific property price indices, a discount rate which reflects the prevailing interest rate and a suitable risk premium for the borrowers, an anticipated loan duration and the expected rate of debtor default. Fair value movements are recognised in operating profit and the resulting financial asset is presented as a non-current receivable.

At each reporting date the accuracy of each of these assumptions is reviewed and, where appropriate, adjusted to reflect changes in market conditions and the Group’s experience with the debtors.

Revenue resulting from the sale of properties under the shared equity scheme is recognised at the fair value of the consideration received or receivable.

Inventories

Inventories are stated at the lower of cost and net realisable value. The cost of work in progress comprises raw materials, direct labour, other direct costs and related overheads. Net realisable value is the estimated selling price less applicable costs.

Trade receivables

Trade receivables are initially recognised at fair value and are subsequently measured at amortised cost using the effective interest rate method with an appropriate allowance for estimated irrecoverable amounts recognised in the income statement when there is objective evidence that the asset is impaired.

Cash and cash equivalents

Cash and cash equivalents comprise cash in hand, demand deposits and other short-term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of change in value.

Trade payables

Trade payables are recognised initially at fair value and are subsequently measured at amortised cost using the effective interest rate method.

Leased assets

(a) Finance leases
Leases in which the Group assumes substantially all the risks and rewards incidental to ownership are classified as finance leases. Finance lease assets are recognised as assets of the Group at an amount equal to the lower of their fair value and the present value of the minimum lease payments, each determined at the inception of the lease. Subsequent to recognition, finance lease assets are measured at cost less accumulated depreciation and impairment losses.

The lease liability is included in the balance sheet as a finance lease liability. Lease payments are apportioned between finance charges and the reduction of lease liabilities so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income.

(b) Operating leases
Rentals payable under operating leases are charged to income on a straight-line basis over the term of the relevant lease.

Retirement benefit schemes

(a) Defined contribution plan
A defined contribution plan is a post-retirement benefit plan under which the Group pays fixed contributions to a separate entity and has no legal or constructive obligation to pay further amounts. The Group recognises payments to defined contribution pension plans as staff costs in the income statement as and when they fall due. Prepaid contributions are recognised as an asset to the extent that a cash refund or reduction on future payments is available.

(b) Defined benefit plan
A defined benefit plan is a post-retirement plan other than a defined contribution plan. The Group’s net liability is recognised in the balance sheet and is calculated by estimating the amount of future benefit that employees have earned in return for their service in the current and prior periods and discounting this to its present value. Any unrecognised past service costs and the fair value of the plan’s assets are deducted.

The calculation of the net liability is performed by a qualified actuary on an annual basis using the projected unit credit method. The cost of the plan is charged to the income statement based on actuarial assumptions at the beginning of the financial year. Where the calculation results in a benefit to the Group, the asset recognised is limited to the net of the total unrecognised past service costs and the present value of any future refunds from the plan or reductions in future contributions to the plan.

When the benefits of the plan are improved, the portion of increased benefit relating to past service by employees is recognised in the income statement on a straight-line basis over the average period until the benefits become vested. Where the benefits vest immediately, the expense is recognised in the income statement immediately.

Actuarial gains and losses are recognised in full in the statement of recognised income and expense in the period in which they occur. Net pension obligations are included in the balance sheet at the present value of the plan liabilities, less the fair value of the plan assets.

Provisions

Provisions are recognised when the Group has a present legal or constructive obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation and the amount of the obligation can be estimated reliably.

Impairment of financial assets

Financial assets are assessed for indicators of impairment at each balance sheet date. Financial assets are impaired where there is objective evidence that as a result of one or more events that occurred after the initial recognition of the financial asset the estimated future cash flows of the investment have been reduced. For loans and receivables the amount of the impairment is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate.

The carrying amount of financial assets are reduced by the impairment loss directly for all financial assets with the exception of trade receivables where the carrying amount is reduced through the use of a provision for impairment losses. When a trade receivable is uncollectible, it is written off against the provision. Subsequent recoveries of amounts previously written off are credited against the provision. Changes in the carrying amount of the allowance are recognised in the income statement.

With the exception of available for sale financial assets, if, in a subsequent period, the amount of the impairment loss previously recognised decreases and this decrease can be objectively related to an event that occurred after the impairment was recognised, the previously recognised impairment loss is reversed through the income statement.

Government grants

Government grants are initially recognised as deferred income at fair value when there is reasonable assurance that the Group will comply with the conditions attached and the grants will be received.

Revenue arising from Government grants is recognised on either a stage of completion or legal completion basis.

Share-based payments

The Group issues equity-settled and cash-settled share-based payments to certain employees. Equity-settled share-based payments are measured at fair value at the date of grant and are recognised as an employee expense, with a corresponding increase in equity, over the period from the date of grant to the date on which the employees become unconditionally entitled to the options.

Cash-settled share-based payments are measured at fair value at each balance sheet date and recognised as an expense, with a corresponding increase in liabilities, over the period from the date of grant to the date on which the employees become unconditionally entitled to the payment. Any changes in the fair value of the liability are recognised as an employee expense in the income statement. Fair value is measured by use of a modified Black-Scholes model. None of these awards when granted was subject to a share price related performance condition.

The Group has applied the requirements of IFRS 2 ‘Share-based Payments’ (‘IFRS 2’). In accordance with the transitional provisions, IFRS 2 has been applied to all grants of equity instruments after 7 November 2002 that were unvested as of 1 January 2005.

Financial receivables

Certain joint ventures’ financial receivables are measured at fair value at the balance sheet date. The fair value is determined by discounting the future cash flows directly associated with the financial receivables at a risk-adjusted discount rate. The change in fair value is recognised in equity to the extent of the Group’s equity accounted investment.

Derivative financial instruments and hedge accounting

Derivative financial instruments are used in joint ventures to hedge long-term floating interest rate and Retail Prices Index (‘RPI’) exposures.

Under IAS 39 ‘Financial Instruments: Recognition and Measurement’ (‘IAS 39’), interest rate and RPI swaps are stated in the balance sheet at fair value. At the inception of the hedge relationship the entity documents the relationship between the hedging instrument and the hedged item, along with its risk management objectives and its strategy for undertaking various hedge transactions. Furthermore, at the inception of the hedge and on an ongoing basis, the Group documents whether the hedging instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

Where financial instruments are designated as cash flow hedges and are deemed to be effective, gains and losses on re-measurement relating to the effective portion are recognised in equity and gains and losses on the ineffective portion are recognised in the income statement, both to the extent of the Group’s equity accounted investment.

Embedded derivatives are separated from the underlying host contract where the economic characteristics and risks of the host contract and the embedded derivative are not closely related except, as is the case with the Group’s shared equity loan receivables, an election has been made to designate the financial asset which contains an embedded derivative as fair value through profit or loss as permitted by IAS 39. This designation can only be made at initial recognition and is irrevocable but can be made on a transaction-by-transaction basis.