Post Office Limited
POST OFFICE LIMITED
(Company Number 2154540)
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Meeting of the AUDIT, RISK AND COMPLIANCE SUB-COMMITTEE
to be held at 14.00 on Tuesday 13 November 2012
at 148 Old Street, London, EC1V 9HQ in the Board Room
14.00 1 Governance:
e Review of updated Terms of Reference
* General outline of meeting topics, annual meetings
schedule and content of standing agenda.
14.15 2 Annual Report and Accounts and half year Trading Statement
Review and approve half year Trading Statement
Agree approach to Annual Report and Accounts
Communications strategy and key messages
Next steps
15.00 3 Risks — high risk contracts
15.15 4 External and Internal Audit
¢ Post Office Internal Audit Charter
« Internal Audit — recent results and status of 2012/13
Internal Audit plan (Royal Mail Internal Audit team)
e External audit plan and approval of fees
« Opportunity for auditor comments
16.00 5 Specific matters referred by the Board to ARC
« Governance of Eagle contract with Bank of Ireland
« Uncommitted facilities
16.30 6 Any other business
Alasdair Marnoch
Chris Day
Lesley Sewell
Malcolm Zack/
Stephen Collins!
Ernst & Young
Nick Kennett
Chris Day
PRESENT: Alasdair Marnoch (Chairman)
Tim Franklin (Non-executive director)
Susannah Storey (Non-executive director)
Neil McCausland (Non-executive director)
SECRETARY: Alwen Lyons (Company Secretary)
IN ATTENDANCE: _ Alice Perkins (Company Chairman)
Chris Day (CFO)
Sarah Hall (Head of Financial Control and Compliance)
Nick Kennett (Financial Services Director)
Lesley Sewell (Chief Information Officer)
Malcolm Staite (Interim Head of Risk Governance)
Malcolm Zack (Head of Internal Audit)
Stephen Collins (Audit Manager, Royal Mail Group Internal Audit)
Angus Grant (Ernst & Young)
Jeremy Midkiff (Ernst & Young)
APOLOGIES: Susan Crichton (HR & Corporate Services Director)
' Stephen Collins will join the meeting at this point.
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Confidential
POST OFFICE LTD AUDIT, RISK AND COMPLIANCE COMMITTEE
Terms of Reference Review November 2012
1. Purpose
The purpose of this paper is to:
41 Present updated terms of reference for the Audit, Risk and Compliance Committee for
approval by the Committee and recommendation to the Board.
2. Background
2.1 The terms of reference for the Committee were initially drafted before the Post Office
Audit, Risk and Compliance Committee which met in May 2012.
2.2 The Board plans to review all terms of reference at its meeting in November 2012.
2.3 The initial draft has been reviewed, updated and amended to closer reflect accepted
good practice insofar as it applies to Post Office. The changes have been discussed
with Alasdair Marnoch, the Company Secretary's Office and the Head of Internal Audit.
3. Activities/Current Situation
The document outlines:
« Overall purpose of the committee
« Composition and terms of office
* Governance of the Committee and the internal and external auditing services
e Responsibilities towards accounting, financial control and disclosure
e Risk Management, Operational controls and policies including ethics, code of
conduct and fraud.
« Administrative matters.
e Annual timetable
3.1 A proposed timetable is included in the appendix. At this point in time the items
indicated and their suggested timings are illustrative only.
3.2 A timetable will assist the Committee in ensuring it covers its main requirements through
the year, aid agenda planning and allow sufficient time for all items as appropriate. The
Committee Chairman will agree the agenda for each meeting, taking into account
matters arising from previous meetings, Board direction and items from management.
4. Recommendations
The Audit, Risk and Compliance Committee is asked to
¢ Review the terms of reference,
¢ Highlight amendments or items for clarification
e Recommend approval by the Board.
Malcolm Zack
6" November 2012
Terms of Reference Malcolm Zack— Head of Internal Audit Page1 of 1
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
1.
Purpose
The purpose of the Audit, Risk and Compliance Committee (“ARC” or the “Committee”)
is to assist the Board of Directors in fulfilling its fiduciary responsibilities by:
Contributing an independent view on the accounting, financial control and
financial reporting practices of the Company.
Taking all reasonable steps to ensure accurate and informative corporate
financial reporting and disclosures which meet appropriate accounting and
corporate governance standards.
Providing oversight of the company’s risk management systems, operational
controls and key systems.
The responsibilities undertaken by the ARC under delegated authority from the
Board will be subject always to the powers and duties of the Board, as set out in
the Articles of Association.
Composition, Terms of Office and Governance.
2.1 Composition and Terms of Office.
The Committee shall serve as a standing committee of the Board. Its Chairman
and members will be appointed by the Board. It shall consist of at least two
independent non-executive directors.
Only non-executive directors shall be eligible for membership of the Committee.
Members of the Committee will normally serve for a period of three years. Their
appointment may be renewed on an annual basis thereafter with the consent of
the Chairman of the Committee but no director shall serve for more than six
years.
The quorum shall be two directors, of whom one will have recent and relevant
financial experience.
The Committee shall meet as often as required but at least three times per year.'
' The Financial Reporting Council recommends a minimum of 3 meetings but suggests that more will be
usually required.
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November 2012
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
e The Company Chairman and executive directors may be invited to attend any
meeting, or any part of any meeting, by the Committee Chairman.
e The CFO, HR & Corporate Services Director or General Counsel, Head of Risk
Governance and Head of Internal Audit will be permanent invitees.
e The Company Secretary shall act as Secretary to the Committee and shall attend
all meetings to keep minutes and record actions.
e The Committee Chairman will report regularly to the Board. Minutes of each
Committee meeting will be circulated to all members of the Committee and,
once agreed, to all members of the Board
e The External Auditors may attend all or part of any Committee meeting at the
invitation of the Committee Chairman. As a minimum the External Auditors will
attend to present their external audit plan for approval and to present their
reports.
¢ The Company will provide current and new Committee members with any
training, briefings or induction required. The Company Secretary, Head of
Internal Audit and the External Audit Partner will keep members informed of
relevant published guidance as necessary.
2.2 Governance of Auditing Services
The Committee will:
e Review and recommend to the Board the nomination or discharge of the
independent external auditors, the proposed fees (in consultation with
management) and the acceptance of the scope and general extent of the
engagement.
e Formally review, challenge and approve the agreed annual external audit plans
and approach.
e Periodically review the scope, resourcing and capabilities of the Internal Audit
function.
e Review and re-approve the Internal Audit Charter on an annual basis.
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
Approve each year in advance the Internal Audit plans and review both
resources and any proposed amendments that may occur through the following
year. The review should include methods employed by the internal auditors to
assess risk and to prioritise the various audit proposals identified in the annual
plan.
Assume a primary role in the appointment, assessment and if necessary the
discharge of the Head of Internal Audit.
Ensure the independence of the external and internal auditors including an
annual review of any non-audit services provided by either.
Ensure free and effective communication between the Committee, external
auditors and internal auditors and hold separate sessions, or informal meetings
and contact as required.
o These meetings may discuss matters that any of these groups believes
should be discussed privately with or without management.
Ensure lines of communication are maintained with the Board.
2.3 Governance — Meetings
e Any member of the committee or the Company Secretary may convene a
meeting. The External and Internal auditors may request a meeting with or
without management present.
e Meetings may be held in person or by telephone or other electronic means, so
long as all participants can contribute to the meeting simultaneously.
e Notice of each meeting shall be given to all those entitled to participate at least 2
working days before the meeting.
e Meetings shall be planned in accordance with key reporting and financial
planning dates.
2.4 Governance — Other
The Committee will:
e Review and update its terms of reference annually.
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
Conduct an annual evaluation of the performance of its duties and
responsibilities and of its effectiveness, and discuss the results with the Board of
directors.
Prepare an annual report on its activities for inclusion in the Annual Report and
shall review and approve on behalf of the Board statements to be included in the
Annual Report concerning financial controls, internal control and_ risk
management.
In the absence of express authority from the Board, the Committee will not,
without the concurrence of both management and the auditors, have either the
responsibility or authority for altering the financial statements or the accounting
procedures of the Company.
Accounting, Financial Control and Financial Reporting and Disclosure
The Committee will:
Review, discuss and consider with the external auditors their approach to risk
assessment and the scope and plan of their audits
Review the annual financial statements which are to be submitted to the Board,
including Management’s explanatory notes.
The review may include:
e Reports from the external auditors as to the results of their examination to
date.
e Discussion of any problems regarding financial reporting which may need to
be reported in the annual report to the shareholders including any
disagreements that may have arisen between the auditors and management
in any area.
e Meeting(s) with the senior financial executives who shall outline any
problems as to financial policies, financial reporting or matters relating to
internal control and any matters in contention with or under consideration
by the external or internal auditors;
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
e The appropriateness of existing accounting principles being employed and
any change in accounting policies or practices which the corporate auditors
may refer to in their report to the shareholders, and the impact on the
Company’s financial statements.
e Any proposed changes in the presentation of the financial statements or
accompanying notes which the auditors may recommend.
¢ Other matters related to the conduct of the audit communicated to the
Committee under generally accepted accounting standards.
e The Management Letter
e The Committee shall review with management any half yearly trading
statements or financial reports and the contents of any press release
concerning the Company’s financial performance or situation, before release
to the public or to shareholders.
4. Risk Management, Operational Controls and Policies
41 Risk Management Framework
The Committee will:
e Review the overall risk management framework in place for the Company
including its appetite for risk.
e Oversee the Risk and Compliance Committee activities and receive summary
reports as appropriate
e Review the Company’s overall risk position and periodically invite management
to outline risk management strategy and status within their specific business
units.
e Review management’s assessment of the degree of risk the Company prudently
incurs in achieving a reasonable balance between the cost of managing risk and
control systems and the benefits derived.
e Consider and review areas of specific risk as highlighted by the Risk and
Compliance committee. This should include, but is not limited to, sufficient
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November 2012
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
coverage of strategic risk, financial risk, operational risk, technology risk,
reputation, regulatory, major change initiatives and people risks
e Review legal, regulatory and any other matters that may have a material impact
on the financial statements, related Company compliance policies, and
programmes and reports prepared to manage and monitor Company compliance
policies.
4.2 Controls and Policies
The Committee will consider and review with the external auditors and the internal
auditors:
e The adequacy of the Company’s internal controls;
e Recommendations for the improvement of the Company’s internal controls,
processes and systems.
e Significant findings (the “management letter” from external auditors) and
recommendations together with management’s responses.
e Note any reportable restrictions experienced regarding scope or access to
required information by either external or internal audit.
4.3 Fraud, Theft and ethics
The Committee will
e Review with management their fraud assessment, detection measures and their
investigation of illegal acts, as appropriate.
e Review any summary of frauds, thefts and other irregularities of any size.
e Review with the internal auditors and the external auditors the results of any
review of the compliance with the Company's codes of ethical conduct and
similar policies including whistleblowing.
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
44 Risk Management — Other
e The Committee shall have the power to conduct or authorise investigations into
any company matters within the Committee’s scope of responsibilities. The
Committee shall be empowered to obtain independentlegal advice, and engage
counsel, accountants, or others to assist it in the conduct of any investigation.
e The Committee shall perform such other functions as may be assigned or
delegated to it by the Board, and may review other items of an internal control
or risk management nature which may from time to time be brought before the
Committee.
5. Committee timetable.
A timetable shall be produced each year showing the current membership of the
Committee and the major annual activities of the Committee, in a similar format to that
set out in the appendix.
ARC Membership November 2012
Chairman Alasdair Marnoch
Members Tim Franklin
Neil McCausland
Susannah Storey
Company Secretary Alwen Lyons
External Audit Ernst & Young
Head of Internal Audit Malcolm Zack
ARC ToR Malcolm Zack Page 7 of 8
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TERMS OF REFERENCE FOR THE AUDIT, RISK AND COMPLIANCE COMMITTEE
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Appendix”
Annual Timetable April June Nov Feb
1. Governance items
Annual review of terms of reference and IA v
charter.
External Auditor v
review/appointment/reappointment
Minutes and actions of previous meeting v v v v
Evaluation (annual) v
Private meetings with auditors/management v v v v
2. Financial reporting and disclosure
Review and approve external audit plan v
Financial statements full year v
Financial statements — half year v
External audit management letter v
Approval of Committee report for inclusion in v
Annual Report
3. Risk management and control
Internal Audit update report v v v v
Risk and Compliance activity and highlights v v v v
Strategic risk update v v
Financial risk update v v
IT and systems risk update v
Selected business risk review update v v
Insurance review v
Other (Less frequent)
Fraud and Theft report v
Security update v
Ethics and Code of Conduct and Whistle- v
Blowing policy
> The timetable sets out standing agenda items. It may be modified by the audit committee in light of
specific requests or actions arising from meetings. The months indicated are provisional and subject to
change.
ARC ToR Malcolm Zack
November 2012
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Confidential
POST OFFICE LIMITED BOARD AUDIT RISK AND COMPLIANCE SUB-COMMITTEE
Review of the Trading Statement for the 6 months ended 23 September 2012
1. Purpose
The purpose of this paper is to:
1.4 Share the final draft of the Post Office Trading Statement for the 6 months
ended 23 September 2012 incorporating Board feedback for Audit Committee
review and recommendation to the Board Sub-Committee.
2. Background
2.1. The Board reviewed the Trading Statement at its meeting on 23 October and
comments have been incorporated into this latest draft for review by the Audit
Committee. The intention is to publish the statement later in November after
Royal Mail has made its announcement.
2.2 Acopy of the draft Trading Statement for comment is attached at Appendix 1.
2.3. A briefing book providing more background to the half year results is attached for
information at Appendix 2.
3. Recommendations
The Audit Committee is asked to:
3.1 Recommend that the Trading Statement is approved by the delegated Board Sub
Committee.
Chris Day
November 2012
Review of the Trading Statement Chris Day Page 1 of 1
13 November 2012
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Appendix 1
Post Office
Post Office results for the six months ended 23 September 2012
Chairman and Chief Executive's Statement
“An encouraging six months - and optimism for the rest of the year.”
On 1 April 2012 the Post Office separated from the Royal Mail Group and became an independent business. This Trading Statement
is the first that the Post Office has issued to update on progress made. The Government Funding Agreement reached in October
2010 provided investment for thousands of Post Office branches across the Post Office Network to be modernised to provide service
improvements and longer opening hours to make them more accessible for customers. As well as developing the financial services,
telephony and mails business, the Post Office is building on a long history of delivering essential Government services and becoming
established as an effective Front Office for local and national Government.
The first six months have seen the Post Office take its first steps towards the longer term goal of becoming financially sustainable in
a challenging environment. The financial results and achievements are encouraging though the scale of change ahead remains
significant. The first tranche of Government funding was received on 2 April 2012 and expenditure has commenced to implement
the transformational changes required towards the goals of Growth, Customer Excellence and Modernisation.
Financial Performance
Turnover increased from £485 million in the first 6 months of the prior year to £501 million this year with growth in the Mails,
Retail, Financial Services and Telephony businesses. There has been continued strong performance in the mails area particularly in
packets and premium mails products including Special Delivery. Government Services income has seen a small decline. In addition
the Network Subsidy Payment from Government has increased by £13 million to £103 milion consistent with the Government
funding agreement. Other operating costs have increased by £19 million to £437 million driven by investment in activity to drive
future revenue growth and build the brand as well as establishing the framework for longer term efficiencies and improving the
supporting infrastructure across the network. Operating profit before exceptional items was £61 million, against a comparable
performance of £56 million last year.
Key performance figures - six months ended 23 September 2012
Summary Group Profit and Loss Account
2012 2011
£m £m
Turnover 501 485
Network Subsidy Payment 103 90
Revenue 604 575
People costs (128) (423)
Other operating costs (437) (418)
Share of post tax profit from joint venture 22 22
Operating profit before exceptional items 61 56
* All references to operating profit/(loss) are before exceptional items
Note that the Royal Mail Holdings plc Interim Report for the half year ended 25 September 2011 reported operating profit after modernisation costs but before other
exceptional items of £55m. The prior year result has been presented to exclude modernisation costs consistent with 2012 where results are reported before alt
exceptional items.
Post Office Network
This year has seen the Post Office network at its most stable for over a quarter of a century with 11.818 branches currently open
and trading, Our network is visited by nearly 20 million customers a week as well as by over half of all the nation’s small businesses
99.7% of the UK population is within 3 miles of their nearest Post Office outlet and the Post Office network remains a key part of the
1
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UK's infrastructure. Currently, 80% of UK bank personal customers can access their current accounts at Post Office branches and in
the first six months an agreement was signed that will see this figure rise to 95% next spring,
Following the launch of the £1.34 billion branch investment and support programme in March this year to modernise and sustain the
Post Office network, 269 new local and main-style branches were open or converted at the end of the half year. The transformation
of the network represents part of a wider Post Office strategy to win new customers and revenue streams for our business to ensure
its long-term viability. Extended opening hours, modern retail environments, and the unrivalled access and trust that our
subpostmasters hold in communities mean we can better serve the needs of our existing and future customers. Independent
research consistently shows that over 90% of customers are satisfied with the new style branch formats and the new formats are
having a positive effect on the income subpostmasters generate from their retail businesses
Post Office has extensively piloted the new style local and main branch formats and in doing so has benefitted from feedback from a
variety of sources including Consumer Focus. This has helped to further develop, improve and finesse our new operating models and
we will continue to roll out these new-style branches in the coming months, using the funding the Government has made available
up to 2015 to support this important programme of investment. The Post Office modernisation programme remains a voluntary
process and is conducted in close liaison with individual subpostmasters. It forms part of the Government's commitment to no
further programme of branch closures and our continued focus on making our network accessible and convenient to ensure we
maintain it at its current size and thereby increase both our customer base and our income.
Financial Services
The Post Office and Bank of Ireland have built a very successful partnership and business since 2004 providing accessible financial
services across the Post Office network in the UK. At the beginning of August this year, we announced a three-year extension to this
relationship with Bank of Ireland until 2023. Together, we are committed to investing in the capability and capacity of our financial
services operation to deliver benefits to our customers and drive the next phase of business growth and long-term value
The Post Office already has almost 3 million financial services customers as well as a savings book of over £17 billion. We provide a
wide range of services and products including mortgages, savings accounts, foreign exchange, credit cards and insurance for both
consumers and small businesses. Since March, the Post Office has introduced mortgage specialists into branches for the first time
and the second stage of this programme will take place later this year. We continue to top best-buy tables and win accolades for the
transparency, competitiveness and ease of use of our products and services. Post Office's overriding ambition continues to be to
build on these strong foundations, and establish itself as a recognised and trusted financial services alternative to the major UK
banks,
Front Office of Government
Post Office's goal is to build strong and lasting partnerships with key stakeholders to drive sales of existing and new Post Office
services to build towards becoming a financially sustainable business. We see this as our public service responsibility and it builds on
a long history of successfully delivering essential government services. In the first six months of this financial year, Post Office won a
4-year contract with Hammersmith and Fulham Council to provide government services to customers in the local area through the
Post Office network of branches including payments for council tax, business rates, housing rents and service charges. The service
will go live in early 2013 and can also be extended in the future to include more services and as this is a framework agreement, it
can be readily taken up by other councils.
In the period under review, we also announced that the Post Office's Application Enrolment and Identification (AEI) programme had
processed the biometric information of more than one and a half million applicants. The service captures applicant information such
as fingerprints, photographs, and digital signatures within branch for efficient transmission to the relevant authority. The service is
designed to serve multiple clients and is currently being used by the Driver Vehicle Licensing Authority (DVLA) and the UK Border
Agency.
Building on this success, Post Office was delighted to be informed in (October 2012) that it had won the DVLA contract to provide a
wide range of licence services as well as the majority of tax disc services. This x year contract is a key stepping stone to Post Office
realising its vision to become a Front Office of Government and positions us as the key service provider for customer facing
government departments.
Olympics
The Olympics and Paralympics captured the hearts and minds of millions of people across the UK this summer, particularly so with
our colleagues here in the Post Office. Branches across our network were very much at the heart of these two great sporting
occasions helping the public celebrate these historic events. We sold £8 million worth of Team GB Gold Medal stamps during both
the Olympic and Paralympic Games. Over 500 branches opened on Sundays, many for the first time, to ensure customers could
purchase the stamps the day after a Team GB Gold Medal win, with a further 4,700 branches selling the stamps within days of each
win
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The Post Office Board is complete
We are delighted to welcome Virginia Holmes, Susannah Storey, Alasdair Marnoch and Tim Franklin to the Board as Non-executive
Directors in the first six months of the financial year. The Board looks forward with great anticipation to the opportunities ahead of
us to grow and modernise the business.
Overview and the future
Pes
é
The results for the first 6 months have been encouraging with strong mails revenue performance. The plans for growth,
modernisation and excellence in customer service are underway but are challenging and there is a significant task ahead. However,
the customer satisfaction results from the new style branch formats demonstrate that good progress is being made against these
ambitions. The Post Office took a step forward in its aim to establish itself as a recognised and trusted financial services alternative
to the major UK banks with the extension of its agreement with the Bank of Ireland [and the recent DVLA contract win underlines
our strength in delivering Government Services]. The Post Office is changing, stil at the heart of communities across the UK, but
growing and modernising its products and services.
Alice Perkins Paula Vennells
Chairman Chief Executive
Post Office Post Office
box] November 2012 [xx] November 2012
Basis of preparation
The information shown in this publication is unaudited and does not constitute statutory financial statements. It includes certain extracts of
relevant financial information for the period ended 23 September 2012. The Post Office forms part of the Royal Mail Holdings plc Group
which prepares its consolidated statutory financial statements on the basis of International Reporting Standards (IFRSs) as adopted by the
European Union.
The financial information presented herein has been prepared on a going concern basis and in accordance with the accounting policies used in
the Royal Mail Holdings plc consolidated statutory financial statements for 2011-12 which have been filed with the Registrar of Companies.
The preparation of this Trading Statement required management to make various judgements, estimates and assumptions. Actual results
may differ from the estimates.
Cautionary statement
Where this trading update contains forward looking statements, these are made by the Directors in good faith based on the information
available to them at the time of their approval of this report. These statements should be treated with appropriate caution due to the
inherent uncertainties underlying any such forward looking information.
Registered Office & Corporate Website
Post Office Limited, 148 Old Street, London, EC1V 9HQ. Registered No: 2154540
www. postoffice.co,uk
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Appendix 2
Post Office Limited
Audit, Risk and Compliance Board Sub-
Committee
Briefing Book
Half Year ended 23 September 2012
Section
1. Glossary
2. Introduction
3. Accounting Policies
4. Primary Statements
5. Operating profit
6. Revenue
7. Costs and people
8. Quality of earnings
9. Exceptional items and provisions
10. ‘Interest, cash, debt, funding, hedging and going concern
11. POL funding analysis
12. Property, plant and equipment and non-current assets held for sale
13. Investments
14. Litigation and claims- potential claims regarding Horizon
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13
17
18
20
22
25
26
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1 Glossary review
Below is a listing of key abbreviations used throughout this document with the full meaning
given:
Abbreviation Meaning
ATM Automated teller machine
BIS Department for Business Innovation & Skills
CWU Communications Workers Union
DVLA Driver & Vehicle Licensing Authority
DWP. Department of Work & Pensions
Eagle Deal in August 2012 to sell POFS to the Bank of Ireland,
restructure commission rates for personal financial
services and extend the contract to 2023
EC European Council
FRES First Rate Exchange Services
Gamma A contract variation made in 2007 with POFS generating
£100m cash and income over a number of years in
return for a series of commitments through to 2020.
Horizon Horizon Next Generation- Counter system
JV Joint venture
LTIP Long Term Incentive Programme
MDA Master Distribution Agreement - agreement for
distributing RM Mails products through POL outlets
MSA Master Services Agreement - agreement for services
provided between POL and RM post Separation
NBV Net Book Value
NS&l National Savings & Investments
NSP Network Subsidy Payment
NTP Network Transformation Programme
POCA Post Office Card Account
POFS Post Office Financial Services
POL Post Office Limited
POOC Project One Off Costs
RM Royal Mail
RMPP. Royal Mail Pension Plan
SGEI Services of General Economic Interest
UKBA United Kingdom Borders Agency
WCF Working Capital Facility
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2. Introduction
This Briefing Book has been prepared to explain the Post Office Limited results for the half
year ended 23 September 2012. It is a summary of the key data, trends and analyses to be
read in conjunction with the Trading Statement, which readers may find useful to further their
own understanding of the results for 2012-13. Post Office Limited has opted not to take
advantage of the Companies Act exemption from the preparation of consolidated accounts as
it is a wholly owned subsidiary within the Royal Mail Holdings plc group which prepares group
accounts. The Trading Statement therefore reports consolidated results.
Most of the analyses are based on the comparison of the half year’s actual results to prior
year.
Comparison against budget is discussed in the Monthly Performance Report presented to the
Post Office Limited Board on a monthly basis.
3. Accounting policies
There have been no changes to the accounting policies in the current year that have had a
material impact on the financial information reported in the Annual Report and Financial
Statements.
4, Primary Statements
4.1 Post Office Limited consolidated Profit & Loss account.
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Post Office Limited consolidated Profit & Loss Account for the six months to 23 September 2012 and
25 September 2011
Sept 2012 Sept 2011 2011-12
Section £m £m £m
Continuing operations
Turnover 501 485 980
Network Subsidy Payment 103 90, 180
Revenue 6 604 575 1160
People costs 72 (128) (123) (254)
Other operating costs 73 (437) (418) (875)
Share of post tax profit from joint venture and associates 22 22 34
Operating profit before operating exceptional items 5 61 56 61
Operating exceptional items 94 (21) (9) (39)
Operating profit 40 47 23
Profit/(loss) on disposal of fixed assets 94 (28) : 1
Profit before financing and taxation 12 47 24
Net interest payable a4 (a) (4) (6)
Net pensions interest 1 a 2
Profit before taxation 12 44 19
Taxation credit = = 10
Profit for the financial period from continuing operations 12 44 30
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4.2 Post Office Limited Cashflow Statement
Post Office Limited consolidated cashflow statement for the six months to 23 September 2012
Sept 2012 Sept 2011
£m £m
Cash flow from operating activities
Operating profit before exceptional items 61 56
Add back
Pension operating costs 13 12
Depreciation and amortisation 0 0
Share of post tax profit from joint ventures (22) (22)
and associates
52 46
Working capital and other non-cash movements: 128 78
(Increase)/decrease in inventories (3) (a)
(Increase)/decrease in receivables (42) (5)
Increase/(decrease) in payables 107 43
(Increase)/decrease in client receivables 3 0
Increase/(decrease) in client payables 33 45
Increase/(decrease) in non-exceptional 0 (4)
provisions
Pension operating costs paid (13) (14)
Receipt of Government Grant 200 0
Cash payments in respect of operating exceptional items (21) (21)
Operating exceptionals
Business transformation (47) (20)
Redundancy (2) (7)
Redundancy related pension costs 0 (2)
Other (2) (2)
Cash inflow from operations 346 92
Income tax received 11 12
Net cash inflow from operating activities 357 104
Cash flows from investing activities
Dividends received from associates and joint ventures 0 0
Proceeds from sale of property, plant and equipment 2 0
Proceeds from sale of associate company 3 0
Purchase of property, plant and equipment (11) (2)
Investment in Associate company (11) 0
Purchase of intangible assets (8) (6)
Net cash outflow from investing activities (25) (8)
Net cash inflow before financing activities 332 96
Cash flows from financing activities
Finance costs paid (a) (3)
Payment of capital element of obligations under finance lease contracts (3) (2)
Repayment of borrowings (250) (50)
Net cash outflow from financing activities (254) (55)
Net increase in cash & cash equivalents 78 41
Opening cash & cash equivalents 820 782
Cash & cash equivalents at the end of the period 898 823
Net cash inflow before financing activities 332 96
Finance costs paid (a) (3)
Movement in Network Cash (29) (44)
Free cash inflow 312 49
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4.3. Post Office Limited consolidated Balance Sheet
Post Office Limited consolidated balance sheet at 23 September 2012 and 25 September 2011
Sept 2012 Sept 2011. March 2012
£m £m £m
Fixed assets
Intangible assets - - -
Tangible assets 12 11 11
Investments in joint ventures and associates 90 118 90
Total fixed assets 102 129 101
Current assets
Stocks 9 6 6
Debtors - receivable within one year 226 236 227
Financial assets - investments. 119 82 62
Cash at bank and in hand 779 740 758
1,133 1,064 1,053
Current liabilities
Creditors - amounts falling due within one year (893) (655) (588)
Financial liabilities - interest bearing loans and borrowings (127) (325) (377)
Net current assets 113 84 88
Total assets less current liabilities 215 213 189
Creditors - amounts falling due after more than one year (8) (13) (8)
Provisions for liabilities and charges (18) (a9) (45)
Retirement benefit obligation 53 (315) (206)
Net assets/(liabilities) 242 (134) (40)
Capital and reserves
Called up share capital - - -
Profit and loss account 238 (179) (85)
Other reserves 4 45 45
Shareholder’s surplus/(deficit) 242 (134) (40)
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5. Operating profit
5.1 Operating profit bridge analysis
‘a >)
29 4
Ee = a
(5)
£m 23
T T T T
2011 Revenue Staff Costs Agents Costs Non People 2012
Costs
5.2. Explanations for some of the movements above are as follows:
e Revenue explanation is in section 6.1.
e The £4.6m increase in Staff costs was mainly due to:
o Pay awards, and higher Productivity & Bonus costs
o Higher temporary resource costs driven by recruitment to support various
projects and higher agency labour in Network. Year on year the headcount
figure has increased by 213.
e Agents’ cost are £3.5m lower than last year due to a one off payment of £400 made
in June 2011 to all agents to maintain stability in the network.
© Non people costs (including project one off costs) were higher by £22.6 mainly due to:
£16.6m higher project one off costs (POOC),
Last year’s costs included a £2.4m release relating to WHS TUPE transfers,
£0.5m increase in compensation which includes a reassessment of the personal
injury provision,
£1.8m increase in marketing expenditure,
£1.7m increase in property costs,
higher cost of sales by £1.8m mainly due higher UKBA volumes as a result of
rolling out more ID Services terminals and also due to higher Retail costs due
to the Olympic and Jubilee collectables, partially offset by;
o £1.9m lower Interbusiness costs as a result of Separation.
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6. Revenue
Sept 2012 Sept 2011
£m £m
Revenue
External Revenue 432 406
Internal Revenue 172 169
Total Revenue 604 575
61 Post Office Limited - External revenue analysis
Post Office Limited External Revenue Bridge £m
432
13
7
——_
(1)
2011 Government Retail& Telephony —_ Financial Other Network 2013
Services Lottery Services Subsidy
Payment
XN
The increase in year on year external revenue of £26.8m (7%) to £432.3m (2011 £405.5m)
is driven by the £13m increase in the Network Subsidy payment and an increase of £13.8m
in like for like income.
The following commentary gives further detail on the external revenue variances by category:
6.1.1 Government Services
The £0.8m (1%) decrease in Government Services revenue is principally due to:
. £2.2m lower DVLA revenues as volumes are below the minimum guaranteed income
levels and a one-off Service Level Agreement payment last year, and
. £1.0m adverse from falling numbers of POCA accounts through natural attrition and
migration of customers to bank accounts.
This was offset by
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° £1.9m higher revenues from the new UKBA contact.
6.1.2 Retail & Lottery
Retail and Lottery revenues have increased by £1.9m:
« Lottery is flat with last year, with both periods seeing high levels of rollovers,
« Retail up £1.9m benefiting from collectibles for the Olympic and Paralympic
games as well as the Jubilee.
6.1.3 Telephony
Year on year increase in Telephony of £2.1m (3.5%) has resulted from:
. 22k more customers, following last year’s Q4 marketing campaign, offset by;
. A decrease in E Top Up revenues of £0.8m is due to volume reduction.
6.1.4 — Financial Services
Financial Services income has increased by £3.3m (2.5%) year on year. This continues the
trend of increases in new products offsetting the decline of traditional products. The main
variances are:
. a £7.7m increase in POFS products particularly savings related products (Growth
Bonds, Instant Saver and Reward Saver - £2.6m, £1.8m and £1.4m favourable
respectively). This includes the benefit of the renegotiated commission rates
following the ‘Eagle’ deal, and
. a £0.2m increase in ATM revenue, driven by increased volumes as machines reach
maturity.
This was offset by
. a £1.7m decline in NS& revenues as NS&I look to provide some of their products,
particularly savings, through their own direct channel,
. a £1.5m decrease in Banking revenue from:
o a £1.6m fall from the Department of Work and Pensions (DWP) as volumes
continue to fall as the Government is migrating customers to other payment
methods, and
o a £0.4m fall in Santander business revenues due to rate reduction from
renegotiated contract, offset by
o an increase of £0.5m in personal banking.
. flat revenues from Payment Services due to:
o a £0.7m decline from bill payments, as utilities and other bill payment clients
continue to migrate customers to other payment methods such as direct debit
and online, and
o a £0.7m increase in Postal Order income (including write back of uncashed
Postal orders over 2 years old).
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6.1.5 Other
Year on Year increase of £7.3m was due to:
. a £6.5m movement due to the MDA (agreement post Separation) excluding Mailwork
income from internal revenue (see 6.2.2). This will be corrected for year end, and
. an increase in Gamma income of £1.2m due to a change in the way the payments
are structured.
This was offset by
. a £0.4m reduction from marketing services, primarily Photo Booth income where
volumes and rates have reduced.
6.2 Post Office Limited - Internal revenue analysis
-
Post Office Limited Internal Revenue Bridge £m
8
169
2014 Mails Other 2012
The following commentary gives further detail on the £2.4m internal revenue variances:
6.2.1 Mails
The £7.7m (4.7%) increase in Mails Revenue is driven by strong volumes accounting for
£6.4m of the increase and £1.3m driven by price.
° Approximately £3.4m of the £6.4m volume variance was driven by stamp sales
ahead of the price rise in April.
. The new Mails Distribution Agreement resulted in a reduction in fixed fee of £15.7m
which is more than offset by increases in variable commissions of £17.0m resulting
in a net price variance of £1.3m.
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6.2.2 Other
The £5.3m decrease in other is due to:
. a £6.5m movement due to the MDA (agreement post Separation) excluding Mailwork
income from internal revenue. This will be corrected for year-end (see 6.1.5) offset
by £1.5m increase in Swindon Stores income as a result of Olympic stamp storage.
12
7. Costs and people
This section discusses expenditure, excluding exceptionals.
71 Total costs analysis (excluding exceptionals)
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The following provides a breakdown of costs for the half year ending 23 Sept 2012 compared
to the half year ending 25 Sept 2011:
Section Sept 2012 Sept 2011 Variance Variance
£m £m £m b
Expenditure - (pre- exceptional)
Wages & Salaries 89 87 (2) (2%)
Overtime 5 4 (1) (16%)
Productivity/Bonus 7 8 1 13%
Employers NI 9 9 (1) (8%)
Pensions 13 12 (a) (10%)
Projects (temp people resource) 1 1 (0) (30%)
Temporary Resource 4 2 (2) (79%)
STAFF COSTS 7.24 128 123 (5) (4%)
Agent costs 731 235 239 3 1%
Collection, Delivery & Conveyance Charges 73.2 1 1 (0) (10%)
Compensation 733 1 (2) (3) 126%
Property Facilities 734 3 2 (1) (53%)
Property Maintenance 735 3 2 (4) (31%)
Vehicles 7.3.6 1 1 (0) (20%)
Computers & Telephones 73.7 36 36 (0) (1%)
Consultancy, Marketing & Legal Fees 73.8 12 4 (8) (170%)
Staff & Agent Related Costs & Consumables 73.9 5 6 108%
Finance 7.3.10 7 (2) (32%)
Cost of Sales 73.11 58 56 (2) (3%)
Other Operating Costs 7.3.12 10 10 1 5%
Depreciation 7.3.13 0 0 (0) (151%)
Interbusiness Expenditure 7.3.14 41 43 2 5h
Group Overheads 73.15 7 10 3 28%
Projects (excluding temp people resource) 7.3.16 21 4 (16) (371%)
TOTAL OTHER OPERATING COSTS 73 437 418 (19) (5%)
TOTAL EXPENDITURE (Pre Exceptionals) 565 541 (24) (4%)
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7.2 People costs (2012 £128m vs 2011 £123m)
7.21 — Staff costs (2012 £128m vs 2011 £123m)
Staff costs have increased in total by £5m to £128m, representing 25% (2011 25%) of the
cost base. The number of people employed increased by 213 to 7,912 at 23 Sept 2012
(2011 7,699) primarily due to the Network Transformation Programme. NTP staff costs are
included within exceptional costs.
The staff cost movement comprises:
e A total increase of £2m (2%) in Wages and Salaries an increase reflecting impact of
the agreed pay awards.
e Employers NI has increased marginally.
e Pension costs have increased by £1m (10%) as a result of a change in the FRS 17
rate for the RMPP service cost to 18.2% (2011 17.1%) driven by market conditions at
25 March 2012 and due to the increase in staff.
¢ Productivity costs have decreased by £1m (13%) driven by the reduced LTIP costs.
e Temporary resource costs have increased by £1m (67%) driven by recruitment to
support various projects and higher agency labour in Network.
7.2.2 Staff numbers
The following analysis shows the movements in the number of people employed during the
year.
The staff numbers were as follows:
Period end employees Average employees
23 Sept 2012 25 Sept 2011 2012 2011
Total employees 7,942 7.699 7,867 7,722
7.2.3 Average cost per employee
The 2012 average number of employees of 7,867 includes 192 NTP employees who have
been excluded for the purposes of this calculation. The average annual cost per employee
based on the average number of people employed at 23 September 2012 of 7,675 excluding
NTP (2011 7,722) has increased by 5% to £33,355 (2010-11 £31,856) due to the pay
awards.
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73 Other Operating costs (2012 £437m vs 2011 £418m)
7.3.1 Agents costs (2012 £235m vs 2011 £239m)
23 Sept 2012 25 Sept 2011
Total Agents number 8,061 8,207
There were 8,061 Agents at the half year-end 23 September 2012 (2011 8,207). The 146
(2%) reduction in Agents is mainly due to natural attrition in the Post Office network.
The average annual cost per Agency branch (excluding VAT and NI) is £42,283 (2011
£43,394), a 3% decrease which is mainly due to a move away from fixed pay.
Total agents costs have decreased by £4m (1%) due to the one off payment made in 2011 of
£400.
7.3.2 Collection, Delivery & Conveyance charges have generally remained flat year on year.
7.3.3 Compensation costs have increased by £3m mainly due to a one off provision release
relating to the CWU TUPE claim for the WHS transfers in 2011-12 of £2m.
7.3.4 Property Facilities costs have increased by £1m due to external venue costs relating to
Post Office Vision events and cross company electricity charges.
7.3.5 Property Maintenance costs have increased by less than £1m due to the increased
number of Post & Go machines requiring annual maintenance.
7.3.6 Vehicles costs have remained flat.
7.3.7 Computers and Telephones costs have generally remained flat year on year.
7.3.8 Consultancy, Marketing & Legal Fees have increased by £8m mainly due to the higher
number of IT Programmes in 2011/12 requiring contractor/ consultancy individuals
and spend for ‘point of sale’ and rebranding. Note that the increase is charged to
projects through the Staff and Agent Related line below.
7.3.9 Staff and Agent related Costs & Consumables have decreased by £5m due to
increased number of programmes which has resulted to higher recharges to projects.
7.3.10 Finance costs have increased by £2m due to a one off purchase order benefit last year
of £0.5m and increased Bureau and ATM losses.
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7.3.11 Cost of Sales has increased by £2m driven by higher Retail costs due to the Olympic
and Jubilee collectables combined with higher UKBA volumes as a result of rolling out
more ID Services terminals and telephony sales campaign. The main reasons are
detailed below:
Cost of Sales
Sept 2012 Sept 2011 Variance Variance
£m £m £m % Comments
Home Phone 40 39 @ (28) Increase of £1m due to more customers,
‘ollowing marketing campaign
Retail 3 2 (4) (54%) _ Increased Sales
Financial Services 4 2 4 63% Decrease in Travel Insurance
Government Increase due to higher UKBA volumes as
415 14 (1) (8%) a result of rolling out more ID Services
Services terminals and higher ATM usage
Total 58 56 (2) (3%)
7.3.12 Other operating costs have remained flat.
7.3.13 Depreciation costs have remained flat.
7.3.14 Interbusiness expenditure has decreased by £2m due to reduced property and
facilities management charges.
7.3.15 Group overhead expenditure has decreased by £3m due to general reduction in
Group charges as a result of Separation.
7.3.16 Non people related project expenditure has increased by £17m due to the
acceleration of work towards full implementation of major transformation
programmes such as Brand Marketing, IT Delivery, Finance Roadmap and Front
Office of Government as well as the costs of separation from Royal Mail.
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8 Quality of Earnings
2012-13 2011-12 Growth
Post Office Limited (consolidated) £m £m £m a
Operating profit before exceptional items 64 56 5 %
Network Subsidy Payment (103) (90) (43) (14%)
Project one off costs 22 5 47 (340%)
Operating (loss) before project one off costs, exceptional items and NSP (20) (29) 9 314%
Litigation re 2007-08 2)
Total adjustments 0 @
Total adjusted operating (loss) before project one off costs, exceptional items and NSP (20) (4) a4 35%
Each item in the table is explained further below:
8.1
8.2
8.3
Network Subsidy Payment
The Network Subsidy Payment increased from £180m in 2011-12 to £210m in
2012-13. The Network Subsidy Payment has been accounted for as a government
grant in both years.
Project one off costs
Project one off costs are non exceptional costs of project activity in the year. They
increased in 2012-13 as the pace of implementation towards the new plan has
continued. These costs do not form part of the underlying business as usual
performance of the company.
Litigation relating to 2007-08
This cost relates to a provision for litigation relating to the CWU challenge regarding
the transfer of staff to WH Smith during 2007-08. £6m was raised in 2008-09 and
£4m of it released in 2009-10 when the CWU lost their challenge. All routes of
challenge were exhausted during 2011-12 and the remaining £2m was released.
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9. Exceptional items and provisions
9.1. Exceptional items and provisions summary
The following exceptional items were recognised in the consolidated income statement
for the six months ended 23 September 2012 and 25 September 2011
2012-13 2011-12
Exceptional items Section £m £m £m £m
Operating Exceptionals
Capital grants utilised 9.2 35 -
Restructuring costs: Network Transformation (14) -
Provision for restructuring: Severance 93 (6) (1)
IT & Change transformation costs 94 (3) -
Project Eagle exceptional costs of disposal 94 (1) -
Sub-total 11 (1)
Other operating exceptional costs:
Impairments, 95 (32) (8)
Total operating exceptionals (21) (9)
Non-operating exceptionals:
Loss on disposal of fixed asset investment 9.6 (30) -
Profit on disposal of property 97 2 =
Net Exceptional costs (49) (9)
9.2. Grants received at the start of 2012/13 arising from the 2010 Government Funding
Agreement have been designated by BIS towards POL’s capital expenditure and
agents’ compensation. The remainder of the grant offsets NTP operating costs. At half
year grants utilised of £35m - accounted for as exceptional income - matches £21m of
capex and £14m NTP opex.
9.3. Restructuring: severance (2012/13 £6m vs 2011/12 £1m)
Included in the £6m charge is £5m in respect of Crown Transformation, a programme
to return the Crown network to profit by 2014/15, and this phase of redundancy will
release c. 135 Crown staff.
9.4. Other charges (2012/13 £4m vs 2011/12 £nil)
Costs attributable to IT & Change Transformation programme, a commitment to
modernisation arising from the 2010 Government strategic plan, and Project Eagle,
the disposal of POL’s interest in the POFS associate investment, have been accounted
for as operating exceptionals.
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9.5 Impairments (2012/13 £32m vs 2011/12 £8m)
Impairments charged in exceptional items comprise:
Impairment Sep-12 Sep-11
Property, plant and equipment 11 2
Intangible fixed assets 10 6
Investment in associate company: Midasgrange Ltd 11 ie}
Total fixed asset impairments 32 8
Section 12.1 identifies the impaired capital expenditure as summarised above. The
increased investment in Midasgrange was for a C share and relates to the Gamma
arrangements. It was impaired to reflect the carrying value of nil. Subsequently the
investment has been disposed of.
9.6 Loss on disposal of fixed assets (2012/13 £39m vs. 2011/12 Enil)
The associate investment with the Bank of Ireland - in Midasgrange Ltd (POFS) - was
disposed of in August 2012. The balance sheet carrying value at the time was £32.4m.
Sale proceeds were £2.7m and a loss on disposal of £29.7m has been included in the
half year results.
9.7 _ Profit on property disposals (2012/13 £2m vs 2011/12 £nil)
In September 2012 the freehold property of the former Crown office at Woking was
sold for £1.75m (NBV £24.0k). There were no equivalent disposals in the first half of
2011/12.
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10. ‘Interest, cash, debt, funding, hedging and going concern
10.1 Going concern
Post Office Ltd has net cash and cash equivalents of some £771m (March 2012 £443m) and
a borrowing facility of some £1,150m of which £127m (March 2012 £377m) was drawn
down. The improvement is driven by the receipt of £200m Government grant in addition to
the upfront receipt of the full year NSP of £210m.
The going concern position has been reviewed and the year-end assessment (below) is still
applicable.
10.2 Background
On 24 March 2010 a further funding agreement was agreed that provided up to £180m for
compensation for losses sustained in parts of the network in 2011-12 as well as providing
access to the working capital facility to 31 March 2016. These arrangements received State
Aid approval on 23 March 2011 though the working capital facility was limited until 31 March
2012.
A further funding agreement with Government was announced on 27 October 2010 which
provided for:
e Funding of £410m for 2012-13 (recieved 2 April 2012)
e Funding of £415m for 2013-14
e Funding of £330m for 2014-15
e Extension of the existing working capital facility of £1.15bn up to 31 March 2016.
State Aid approval for the funding for 2012-13 to 2014-15 was received on 28 March 2012
and it was also recognised that the working capital facility was no longer deemed State Aid.
The going concern analysis is based on the latest strategic plan refresh prepared and noted by
the Post Office Limited Board and Royal Mail Holdings plc Board in October 2010. This was
updated to reflect the 2012-13 budget process and an updated view of the later years as at
March 2012. The Post Office Board approved the 2012-13 budget on 15 March 2012 and
has undertaken an initial review of the later years.
10.3. Assessment for POL
POL has finished implementing its 2005-11 strategic plan and has completed its closure
programme. It posted an operating profit before exceptional items for the first time for a
number of years in 2008-09 and has continued to do so but still operates with a cash
outflow. The 2011-15 plan is intended to reverse the trend of an increasing Network
Subsidy Payment (NSP).
The 2011-15 strategic plan, updated for latest views, has been shown in section 11 and
shows that POL has sufficient cash headroom to continue to trade. The available facility has
been defined to include network cash, ATM cash, ATM debtor, POCA debtor and SGEI
cheques. Headroom was increased as the result of a more widely defined criterion for use of
the Working Capital Facility (WCF). In the EC’s decision of 23 March 2011 they noted that
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“_.the WCF is provided on condition that it is used for financing the cash and near-cash
requirements involved in delivering the SGEls...” and not limited it to cash for cash-withdrawal
Services of General Economic Interest (SGEl) as previously. Therefore the WCF can now be
used to finance all SGEI working capital requirements in particular those associated with
HMRC cheques in January and July. This will mean the peak funding requirement from non-
WCF sources will no longer be required for those months. This change has had a positive
effect on all months of c£E40m.
Other changes introduced in the one year funding deal for 2011-12 included the ability to
borrow up to £50m from other sources as well as the up to £50m in finance leases
previously allowed which would improve the headroom capacity if required.
10.4 Summary conclusion
Based on the analysis there is available borrowing headroom remaining until March 2015.
Royal Mail Group Limited is a key trading partner with POL and, in arriving at the conclusion
that POL is a going concern, the assumption is made that Royal Mail Group Limited is a going
concern or that an alternative mails provider would work similarly with POL providing a
similar level of income.
It is believed that POL will be able to meet its liabilities as they fall due in the foreseeable
future. It is therefore expected that the POL directors will consider it appropriate to continue
to prepare the accounts on a going concern basis.
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11 POL Funding Analysis
Table 1 MARCH 2012 DRAFT
£m (cumulative apart from free cash flow) 2011-12 2012-13 2013-14 2014-15
Opening Funds (321) (336) (421) (451)
Borrowing Facilities 1,150 1,150 1,150 1,150
Restriction due to level of network cash (326) (400) (400) (400)
Borrowing from other sources - finance leases, bank overdraft etc 21 16 11 6
October 2010 plan free cashflow before assumed equity injection (15) (285) (245) (207)
Assumed equity injection per October plan 200 215 170
Closing Funds Headroom 509 345 310 268
Adjusted Headroom pre risk 509 345 310 268
Table 2 Risks, with management actions
£m (cumulative) 2011-12 2012-13 2013-14 2014-15
Headroom pre risk (as above) 509 345 310 268
Risk
New Govt income does not materialise (6) (18) (42)
Innovation income does not materialise (2) (7) (14)
Pension contribution rates increase (9) (18) (27)
Headroom post risks pre management actions 509 328 267 185
Management actions
Headroom post risks pre management actions (A) 509 328 267 185
Headroom pre further management actions 509 328 267 185
Further management actions
Headroom post further management actions (B) 509 328 267 185
Notes:
2011-12 shows the year end outturn and last years are the latest view of the strategic
plan.
Available facilities are defined as network cash, ATM cash, ATM debtor, POCA debtor and SGEI cheques.
Table 1
This table shows the October 2010 strategic plan cashflow updated for the 2012-13 budget and latest
reviews of subsequent years. It demonstrates positive headroom throughout the plan period.
Table 2
This table sets out the impact of theoretical downside scenarios if the plan does not generate
the income streams anticipated and if the pension scheme costs increase.
Clearly mitigating management actions could be initiated but there remains sufficient
headroom even if they are not taken. There are a range of management actions including
implementing non-staff cost saving initiatives and closing non NSP offices without
compensation, and the overriding principle is that management will take whatever action is
required to mitigate any risk that materialises.
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There are further actions that could be taken but are not required. These include:
e Closure of the defined benefit fund replacing it with the existing defined contribution
scheme
Sell shareholding in First Rate
Defer settlement of bureau to First Rate
Sell BT book
Sell property
Sell bill payment business
Sell tax losses
e Compulsory redundancy on statutory minimum terms
11.1 Net finance costs (interest) (2012/13 £1m vs 2011/12 £4m)
2012-13 2011-12
Finance costs & investment income £m £m
Interest received on investments - UK 0.5 03
Total finance income 0.5 0.3
Interest charged on Government borrowings (0.4) (1.5)
Interest payable on finance leases (0.7) (1.0)
Unwinding of discounts (0.5) (0.7)
Other finance costs (0.7) (0.5)
Total finance costs (2.3) (3.7)
Net finance cost (1.8) (3.4)
Interest payable on the BIS Loan has reduced due as the amounts borrowed have been lower
due to £200m capital grants received at the commencement of the financial year.
23
12. Property, plant and equipment and intangible fixed assets
121 Net Book Values
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The net book value (NBV) of land and buildings, plant and fixtures and intangible fixed assets
was £12m (Sept 2011 £11m). The movements in the half year were as follows:
Land and Vehicles, plant Intangible fixed
buildings and fixtures assets Total
Movement in NBV £m £m £m £m
NBV at 25 March 2012 14 - - 14
Add capital expenditure 9 3 10 22
Less disposals (mainly property) - - - -
Less depreciation - - - -
Less impairment (8) (3) (10) (24)
NBV at 25 March 2012 12 : : 12
12.2 Assets held under finance leases
The value of equipment held under three finance leases is nil (Sept 2011: £nil) having been
impaired in the years in which it was acquired. One finance lease - Supply Chain cash boxes -
capitalised and impaired in 2007-8 with an asset value of £2m, expires in the second half of
2012-13.
12.3. Capital expenditure
The following table summarises the capital expenditure to 23 September 2012:
Land and Vehicles, plant
buildings and fixtures Intangibles Total
Capital expenditure analysis £m £m £m £m
Network Transformation: property-
related 5 - - 5
Supply Chain property-related 1 - - 1
Property transfers ex RM 4 - - 1
Other property 2 - - 2
Technology roadmap - - 8 8
Pinpads 2 - 2
Secure vehicles - a - 1
Other (items <£1m) - 2 2
Total 9 3 10 22
All capex was impaired except the Property transferred from Royal Mail giving an impairment
charge of £21m.
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13. Investments
13.1 Investments in joint ventures and associates
Sept 2012 Sept 11
£m £m
Investment in joint ventures and associates 90 118
Joint ventures
During 2012-13 and 2011-12 Post Office Limited's joint venture investment was a 50%
interest in First Rate Exchange Services Holdings Limited with a carrying value of £90m
(2011 £96m), whose principal activity is the provision of Bureau de Change.
Associates
During 2012-13 and 2011-12, Post Office Limited's associate investment was a 49.99%
interest in Midasgrange Limited with a carrying value of £nil (2011 £22m), whose
principal activity is the provision of personal financial products. Midasgrange Limited
trades as Post Office Financial Services and is a company registered in the United
Kingdom. During the period POL waived £11m due under Gamma in return for a C share.
The share was deemed of nil value and was immediately impaired. This investment was
disposed of in August 2012 by the sale of POL’s interest to the Bank of Ireland.
13.2 Movements in investments in JV and associate (consolidated for information)
Associate:
Midasgrange
Joint
venture:
(POFS) FRES Total
£m £m £m
At 25 March 2012 22 68 90
Increased investment in Midasgrange 11 0 11
Share of profit/ (loss) after tax 0 22 22
Sub Total 33 90 123
Sale proceeds (3) (3)
Loss on disposal of investment (30) (30)
At 23 September 2012 i} 90 90
13.3 The loss on disposal of investments of £28m includes the £30m loss above, offset by a
£2m profit made on the sale of property as covered in section 9.7.
25
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14. Litigation and Claims- Potential Claims regarding Horizon.
14.1 Post Office Ltd has received notification of five potential claims from former
subpostmasters. Each of these subpostmasters had their appointments terminated
following the discovery at audit of significant cash losses at their respective branches.
Two of the subpostmasters were subsequently prosecuted and pleaded guilty to false
accounting.
14.2 Each has claimed wrongful termination of contract on the basis that the losses are
alleged to have arisen due to the unfairness of the system devised by Post Office Ltd
and/or have been generated by a computer error in the Horizon system. More
specifically, it is alleged that (a) the accounting procedures in place are unfair in that
they do not permit subpostmasters to properly verify losses which are alleged to have
been incurred, (b) the Horizon system itself contains inherent defects and/or (c) the
training and support for subpostmasters using the system is inadequate,
14.3 Each subpostmaster is claiming circa £150,000 by way of damages.
14.4 Four of the claims remain at the pre-action stage (i.e. there are no live court
proceedings). Post Office Ltd has strongly denied liability and rebutted the allegations
made. The fifth claim was struck out by the Court and cannot be pursued further.
14.5 The last correspondence received on these matters was in December 2011. Post
Office Ltd is not aware of any further substantive steps having been taken to advance
these claims through the Courts since that date.
14.6 Post Office Ltd continues to receive challenges to the integrity of the Horizon system
and it is possible that further claims may be received. Reports in the press have
previously suggested that solicitors Shoosmiths may have consulted on between 85
and 150 potential cases in total.
14.7 Several subpostmasters have also made complaints about Horizon to Members of
Parliament. Post Office Ltd has commissioned an independent third party, Second
Sight Support Services Ltd, to investigate an initial sample of sixteen cases where
allegations have been made that the Horizon system is the source of unresolved
accounting shortages. That investigation is ongoing.
14.8 Post Office Ltd is also actively considering proposals from Justice for Subpostmasters
Alliance, an organisation “established to raise awareness of the issues within the Post
Office Horizon system”, to develop a system by which individual subpostmasters can
raise concerns with Horizon within a “no blame” framework.
14.9 On the basis of the evidence to date, no provision has been made and it is not
considered appropriate to make any disclosure on this matter. This position is being
actively monitored.
26
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Strictly Confidential
POST OFFICE LIMITED BOARD AUDIT RISK AND COMPLIANCE SUB-COMMITTEE
Format and Content of Annual Report and
Financial Statements for 2012-13
Purpose
1. The purpose of this paper is to:
e Invite the Post Office Limited Board Audit Risk and Compliance Sub-Committee to
consider the format and content for the 2012-13 Post Office Limited Annual Report
and Financial Statements and agree the approach to be taken; and
e Update the Committee on the planned timetable for year end.
Background
2. In previous years the main focus of the audit and financial statements production and
approval has been on the Royal Mail Holdings plc Group consolidated financial statements
with the other legal entities within the Group structure simply meeting the statutory obligation
to produce audited financial statements.
3. Following the structure changes for separation with effect from 1 April 2012 the emphasis
will change and it is anticipated that the focus of attention will be on the two main
subsidiaries of Royal Mail Holdings plc (RMH) — Royal Mail Group Ltd (RMG) and Post
Office Limited (POL). It should be noted that, despite the structure changes, technically
POL is not required to provide anything additional to the standalone company financial
statements and disclosures made in the past therefore the recommendations made in this
paper are merely options for consideration.
4. RMH plc will still be required to prepare a full consolidated set of financial statements but it
is understood from Royal Mail that these will not be the main document for external
communication purposes. However, it should be noted that Post Office Limited will need to
liaise with Royal Mail to ensure a smooth and consistent approach to content and timing.
5. In preparation of the recommendations below, consideration has been given to the approach
taken by RMH plc, which is likely to be mirrored by RMG where possible for 2012-13. Other
approaches have been reviewed for comparison including:
e John Lewis Partnership plc (JLP) - JLP has similarities to POL in that it is high profile
but not listed. It is also perceived to be owned by its employees, but in fact has
preference share capital with the employees’ interests determined by constitution.
e British Airways plc (BA) - BA was listed until its merger with Iberia in January 2011 at
which point a new parent was created above BA. It has therefore moved from
producing full listed plc financial statements to a reduced disclosure while
maintaining many of the elements of listed financial statements.
e BP plc — meets full listing requirements for the group in IFRS and includes UK GAAP
parent company financial statements at the back of the group financial statements.
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e General Medical Clinics plc (GMC) — meets plc requirements and produces
consolidated and parent company financial statements in UK GAAP.
Decisions
6. POL has three initial decisions to make which are explained further below and summarised
in a decision tree diagram in Appendix 1.
7. Once these decisions are confirmed POL has a further option to consider what, if any,
additional disclosures it wishes to make towards meeting the requirements of being a listed
ple.
8. Decision 1 — POL has historically taken advantage of the exemptions from being a wholly
owned subsidiary of a UK plc that produces Group financial statements but could take the
decision not to take these exemptions. The main exemptions are:
¢ Not to prepare a cash flow
¢ Reduced financial instruments notes
e Reduced related parties disclosure
The decision to produce consolidated financial statements is linked to these exemptions.
POL was not required to produce consolidated financial statements as it was not a parent
company but, having taken the decision to incorporate a subsidiary undertaking, it will be a
parent undertaking by the year end. As such, a further exemption exists not to produce
consolidated financial statements.
The decision has already been taken to produce consolidated financial statements in
addition to the required standalone company financial statements. The additional disclosure
required for the other exemptions is not considered onerous and these disclosures are
standard content for plc financial statements. In addition, the decision not to take advantage
of the exemptions would be a clear signal of steps towards full independence.
The potential disadvantages are that this will be the first time that a Post Office cash flow will
have been in the public domain, which may be a sensitive issue, and there may be some
sensitivity with Royal Mail regarding the related party disclosures.
It is recommended that the exemptions are not taken and POL acts as fully
independent in production of its Report & Financial Statements but that the potential
sensitivities are noted and re ited at the year end prior to publication.
9. Decision 2 — The consolidated and company financial statements could be prepared under
UK accounting standards (UK GAAP) or International accounting standards (IFRS). There
is also an option to prepare the company financial statements under UK GAAP and the
consolidated financial statements under IFRS.
There are not material differences between IFRS and UK GAAP with the main difference
being the terminology. Generally large UK plc’s report using IFRS for their consolidated
financial statements and RMG is expected to use IFRS as it already uses this for RMH.
JLP, BA and BP all report under IFRS. It is therefore recommended to report the
consolidated financial statements under IFRS.
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POL company financial statements are currently prepared under UK GAAP which is
consistent with the rest of the RMH group company financial statements. It is also not
uncommon for the parent company financial statements to be prepared in UK GAAP even in
large pics. This practice was more common when IFRS was first implemented due to
concerns relating to distributable reserves if IFRS was used for company financial
statements. Many companies have continued with this approach, for example, BP prepares
UK GAAP parent financial statements, although JLP and BA both prepare IFRS parent
financial statements. At this stage RMG has not indicated any plans to change its company
financial statements from UK GAAP. With effect from 2015 (POL’s March 2016 year end), it
will become mandatory to prepare company financial statements under IFRS.
It is recommended that POL continues to prepare its parent company financial
statements in UK GAAP at this stage but prepares the consolidated financial
statements under IFRS.
10. Decision 3 — The Report and Financial Statements could be prepared as one formal
document incorporating the consolidated results with the business review and other optional
disclosures at the front and the statutory parent company financial statements attached at
the back. The whole document would form POL’s formal submission to Companies House
and be retained on the record. Alternatively, as POL is not required to submit consolidated
financial statements to Companies House, the statutory parent company financial
statements could be prepared as a standalone document for submission to Companies
House and the consolidated Report and Financial Statements could be prepared separately
for external communications purposes. The consolidated Report and Financial Statements
would have no status and would not form part of the formal record at Companies House.
BP is required to prepare consolidated financial statements as well as parent company
financial statements and prepares these as one formal document. RMH has also historically
followed this approach but RMG has not yet confirmed if it will follow this approach .
However, this approach will result in more information than POL is required to prepare being
part of the formal Companies House record.
The alternative approach of two sets of financial statements results in considerable
duplication and potential confusion between the public document and the formal Report and
Financial Statements lodged at Companies House.
It is recommended that one formal document is produced forming both the formal
record at Companies House and being the document that is communicated
externally.
11. There is then a further option to report as if POL was a listed plc or to adopt some of the
requirements where they are considered appropriate. RMH has sought to do this for the last
few years and, with a few minor exceptions, has met this standard. The main features that
would be added for POL if it reported as if listed are an expanded Business Review, a
Corporate Governance section and a Directors’ Remuneration Report. At half year a full set
of interim financial statements under IAS 34 would be required to meet this level in full.
e The additional requirements for the Business Review include trends and factors
likely to affect the future development of the business as well as more information on
environmental matters, employees and social and community matters. It is
recommended that POL includes these additional requirements where appropriate.
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e The Corporate Governance section is determined by the requirements of the UK
Corporate Governance Code (the Code) and the Disclosure and Transparency Rules
(DTR). RMH aims to comply with these requirements and RMG is expected to do
likewise for 2012-13. It is a requirement to report exceptions and RMH reports that it
complies as far as is appropriate for a public company with a single shareholder.
JLP also reports against the Code but notes that it has some exceptions and BA has
reported against certain elements of the requirements that it deems appropriate. It is
recommended that POL investigates the requirements and aims to meet the Code
and the DTR to the extent that it is appropriate. A draft of this content will be brought
to the Audit Committee for review in February.
e The Directors’ Remuneration Report (DRR) Regulations set out the requirements for
listed plc’s. RMH states that it complies as far as it can for a non-listed company and
it is expected that RMG will act similarly. This would involve full disclosure for each
named director of their pay broken into component parts, as well as the incentive
scheme details (long term and short term) and pension arrangements. JLP does not
comply with these regulations but includes the directors’ pay disclosure required for
the notes to the financial statements. This includes the highest paid, some
description of the bonuses and pension arrangements and the pay in £50,000
bandings without names. However, the directors’ pay arrangements do not appear
complex and their incentives amount to the same percentage bonus as all the other
employees. BA also does not comply with these regulations and includes the pay
disclosure within the notes to the financial statements. It is recommended that POL
does not comply with the regulations at this stage but will disclose a summary of the
directors’ pay within the notes to the financial statements.
e Half year reporting under IAS 34 would involve producing an abridged version of the
full year financial statements and notes. RMH did not comply with this standard until
its 2011-12 half year and may opt not to comply for 2012-13. It is understood that
RMG is likely to use [AS34 in future but has prepared pro-forma interim statements
for 2012-13 in the IAS34 style but not fully complying as it has chosen to exclude the
POL results from the whole period although POL was a subsidiary for 1 week to 1
April 2012. JLP prepares interims under IAS 34. It has already been decided that
POL will not comply with this standard for 2012-13, but instead will produce a short
half year trading statement. This decision could then be re-visited for the 2013-14
interims.
12. As in 2011-12 a full Audit Committee briefing book will be produced in 2012-13 to support
the financial statements. This provides a more detailed analysis of the results to aid
understanding.
Timetable
13. The additional reporting set out above will have a significant workload impact on the Finance
team as well as Communications, HR and Company Secretariat. An initial draft timetable is
attached at Appendix 2 with the assumption that all recommendations within this paper are
taken.
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Recommendation
14. The Post Office Limited Board Audit Risk and Compliance Sub-Committee is asked to:
° Agree
i. That POL will not take advantage of the exemptions from being a wholly
owned subsidiary of a UK parent producing group financial statements;
ii. That POL will continue to report under UK GAAP but that the consolidated
financial statements will be under IFRS;
iii. That the POL Report and Financial Statements will be prepared as one
formal document for lodging at Companies House;
iv. That POL will include the additional Business Review disclosures applicable
to quoted companies where appropriate;
v. That POL will aim to meet the Code and DTR Corporate Governance
disclosure requirements that are appropriate; and
vi. That POL will not meet the DRR regulations;
e Note that a draft of the Corporate Governance disclosures will be brought to the
February Audit Committee meeting;
e Note that a draft template for the Report and Financial Statements will be brought to
the March Audit Committee meeting; and
e Note the draft timetable for year end.
Chris Day
November 2012
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Appendix 1 - Decision Tree
Decision 1
Continue to take advantage of exemptions from
being a wholly owned subsidiary of a UK plc
- Not to produce consolidated financial
statements
- Not to prepare a cash flow
- Reduced financial instruments notes
- Reduced related parties disclosure
Take exemptions Recommended
Financial Statements are Stop taking exemptions
unchanged from 2012-13. The decision has already been taken to
produce consolidated financial statements.
The additional disclosures are not onerous and
would demonstrate a step change of
independence from RM.
Decision 2
Use of UK GAAP or IFRS for group and
parent company (POL) financial statements
I I
Group and parent Recommended Group and parent financial
financial statements use Group financial statements use statements use IFRS.
UK GAAP - acceptable IRFS and parent financial
plc standard. statements use UK GAAP. Approach also widely used by
many UK groups including JLP
Used by smaller or Approach used by many UK groups, and BA. This approach will
lower profile UK plc including RMH and BP, since IFRS become mandatory for UK
groups including GMC. was introduced due to concerns companies from 2015 (for POL
around use of reserves if company - March 2016 year end).
financial statements were prepared
under IFRS.
I
Decision 3
One formal document or statutory entity financial statements kept separately
from a ‘glossy’ consolidated Report and Financial Statements
I l
Recommended Two documents —
One Report & Financial Statements Consolidated Report & Financial Statements
document — ‘glossy’ publication with document — ‘glossy’ publication.
consolidated statements at the front
under IFRS and POL company financial POL company financial statements under UK GAAP
statements under UK GAAP attached at prepared separately.
the back.
The whole document would be the formal Only the POL company financial statements would be
record submitted to Companies House. the formal record submitted to Companies House.
This is the approach used by BP and The consolidated Report and Financial Statements
RMH. would have no formal status.
lovember 2012
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Appendix 2 — Draft timetable
Date Activity
13 February Audit Committee meeting — review of Corporate Governance
disclosures
Mid February Provide template for year end financial statements to EY for
technical review prior to issuing to the Audit Committee
13 March Audit Committee meeting — review of template for year end
financial statements
24 February Period 11 month end hard close
4 March Pension Committee meeting — initial review of potential year end
accounting assumptions for pension
March EY perform audit procedures on Period 11 results
Late March EY period 11 closing meeting
31 March Year end
2/3 April Pension Committee — phone call or by correspondence to agree
pension assumptions for recommendation to the Board (not yet
booked)
April EY field work
Late April EY year end closing meeting
20 May For information - RMG Board meeting to approve financial
statements
21 May Board Meeting — to approve the financial statements and delegate
to the Audit Committee for detailed review and to a sub-committee
for final review and signing
Could be re-scheduled to be:
Audit Committee — to review the Report & Financial Statements
and recommend to the Board for approval
5 June Audit Committee — to review the Report & Financial Statements
and recommend to the Board sub-committee for signing
Could be re-scheduled to be:
Board meeting — to approve the financial statements and delegate
to a sub-committee for final review and signing
From early June Announce results (subject to alignment and discussion with Royal
Mail)
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Confidential
POST OFFICE LTD AUDIT, RISK and COMPLIANCE COMMITTEE
Implementation of the Internal Audit Charter
1. Purpose
The purpose of this paper is to:
1.1 Approve the Internal Audit Charter for the newly formed Post Office Internal Audit
department. (IA)
2. Background
2.1 As part of the separation of Post Office from Royal Mail Group, Post Office Limited will
continue to be subject to internal audit activities by the Royal Mail Internal Audit team up
to 31% March 2013 only.
2.2 Post Office appointed its own Head of Internal Audit on October 1°‘ 2012 with the remit
to create, lead and develop the Post Office Internal Audit team. An initial budget of the
Head of Internal Audit plus 3 high calibre Audit Managers supported by co-sourcing
where necessary has been agreed.
2.3 The IA department will operate under the International Standards set by the Global
Institute of Internal Auditors. These are widely recognised ways of working and form part
of the International Professional Practices Framework.
2.4 One of the required elements of governance for an internal audit team operating within
the framework is the establishment of an Internal Audit Charter.
2.5 The Charter sets out how Internal Audit operates within an organisation and requires
approval and annual review from the Audit, Risk and Compliance Committee.
2.6 It has been discussed with the CFO, General Counsel and the Committee chairman.
Once approved, it will be distributed to Executive Committee members for noting.
3. Current Situation
The charter outlines the following areas
The long term goals of the [A department
Independence of line management.
The role and scope of the function.
Access and Authority
Reporting and Audit Planning
Liaison with the Audit, Risk and Compliance Committee
Staffing and Resource
Advice and support
Standards of Audit Practice
4. Recommendation
The Committee is requested to approve the Internal Audit Charter.
Malcolm Zack
13" November 2012
Internal Audit Charter Malcolm Zack —Head of Internal Audit Page 1 of 1
6 November 2013
Internal Audit Charter
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Internal Audit is an independent review function set up within the Post Office
organisation as a service to the Board and all levels of management. The Head of
Internal Audit is responsible for evidencing the effectiveness of the design and
operation of all aspects of risk management and internal control frameworks
throughout the organisation’s activities.
Internal auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organisation’s operations. It helps an
organisation accomplish its objectives by bringing a systematic, disciplined approach
to evaluate and improve the effectiveness of risk management, control, and
governance processes."
2.1
Goals of Internal Audit
To provide the Board with independent and objective assurance over Post Office
organisation controls.
Provide assurance that the Post Office processes for identifying, assessing and
managing risks are effectively deployed.
To help management improve their decision making processes, controls and
operations through risk and control advice and support.
Independence
Reporting Line
The Head of Internal Audit will report to the Chairman of the Audit, Risk and
Compliance Committee, who is a Non-Executive Director of the Board, and ona
day to day basis to the Chief Financial Officer. The Head of Internal Audit has
access to the Board Chairman, Non-Executive Directors and the Chief Executive.
The Internal Audit staff report to the Head of Internal Audit.
' Definition of Internal Auditing — Global Institute of Internal Auditing Inc.
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For ARC 9 October 2012
3. Role and Scope
The role of Internal Audit is to understand the key risks of the organisation and to
examine and evaluate the adequacy and effectiveness of the frameworks of risk
management and internal control as operated by the organisation.
Internal Audit, will therefore review, appraise, evidence and report on:
3.1. The adequacy and effectiveness of the frameworks of
e Operational control across the organisation including outsourced services.
e Financial control
e Management control
3.2 The integrity of processes and systems, including those under development, to
ensure that controls offer adequate protection against error, fraud and loss.
3.3. Company policies, (risk and non risk) standards and procedures including their use
and appropriateness.
3.4 National and International legislation where applicable are effectively recognised
and acted upon by the company.
3.5. The operation of the organisation’s corporate governance and risk governance
arrangements.
3.6 Significant aspects of the organisation’s activity including major projects and
change programmes and as directed by the Audit, Risk and Compliance Committee
(the “Committee”).
3.7. Fraud
Management remain responsible for establishing and maintaining systems for the
prevention of fraud and theft.
e The internal audit department may be requested to assist in the investigation of
significant suspected fraudulent activities and notify the Committee of the
results.
e¢ Where regular audit work may reveal fraud risk or actual fraud and irregularities,
this will be reported to management and to the risk and audit committees.
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3.8
Other key stakeholders
The Internal Audit team will liaise with other providers of assurance including second
line defence functions, external audit and Risk Governance Compliance.
4 Access and Authority
The Post Office Internal Audit team have unrestricted access to all functions,
records, property and personnel at all management levels including the external
auditors and contractors insofar as it applies to authorised audits, reviews and
investigations.
All members of the Internal Audit team will abide by company and professional
standards with regards to confidentiality. Audit files and evidence will be
appropriately secured.
Where information is of particular sensitivity, management may request that
access to the information be restricted to the Head of Internal Audit only.
If required access has not been forthcoming and following due process remains
as such and this has a significant restriction on the effective completion of an
audit, the limitation should be reported. Effort to resolve the situation should be
undertaken and only after these steps should such limitations be reported to the
Committee.
4.1 Reporting on activity
The findings on engagements shall be cleared upwards through line
management and to the appropriate Executive Committee member. Reports will
be summarised for the Committee, who may request access to the full reports.
Reports will also be provided to the CEO, CFO and Head of Risk Governance
Compliance as appropriate.
Formal reports will be classified as confidential. Access to final reports by
individuals not directly associated with the audit, shall be approved by the Head
of Internal Audit and the owning Executive Committee member.
5 Audit Plan
The Head of Internal Audit will submit an rolling risk based plan for approval by
the Committee, review progress with the audit committee quarterly and where
necessary amend the plan to reflect changing risk priorities.
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¢ The plan will project a maximum of 6-12 months into the future although some
areas will require annual review.
e This plan will also be made available to the Board and the Executive Committee
and be flexible to requests from the business that arise during the year.
e Audits will generally be planned alongside management and announced but at
times visits, checks and investigations may be unannounced to the business area
concerned. This includes all aspects of the group including head office functions
e A follow up process will be implemented. The results of follow ups including the
implementation rate of recommendations will be reported to the Committee on
a periodic basis.
5.1 Management Requests
Management may make requests for audits or reviews through the year.
e Requests will be evaluated in terms of risks and effort will be made to address
these requests wherever possible.
e Other than short assignments, the Committee should be informed of proposed
changes to the plan especially where this will impact delivery or delay start of
currently planned work.
e The Chair of the Committee and the Head of Internal Audit will discuss significant
changes to the plan and agree steps with the business.
6. Audit, Risk and Compliance Committee Liaison
¢ The Head of Internal Audit should meet with the Chairman of the Committee
outside of regular audit meetings, without the presence of management at least
twice a year.
e The Head of Internal Audit may meet with any of the other members of the
Committee and with the external audit partner outside Committee meetings.
e All members of the Committee may request a meeting with the Head of Internal
Audit to discuss risk, control and audit matters.
e The Head of Internal Audit will ensure that all Committee members are confident
in fulfilling their responsibilities and provide support and guidance where
requested.
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7. Staffing and Resource
e The Head of Audit shall ensure that the department is sufficiently resourced to
carry out its duties in terms of professional competency, business knowledge
and awareness and technical proficiency. Additional technical training needed to
ensure an audit can be effectively conducted should be arranged.
e Specific audit tools to improve efficiency and effectiveness of audits (such as for
extraction and analysis of large quantities of data) should be identified and
obtained.
e In accordance with international standards, the department should not
undertake audit work where it does not feel it is sufficiently skilled to do so. In
which case, specialised services or staff from either within the organisation or
external to it should be considered and sought.
8. Advice and support
Internal Audit should not be required to:
e Perform operational duties
e Operate controls, other than those within the department
e Approve accounting transactions outside of the department.
e Implement controls that are the responsibility of management.
It is within normal accepted practice and International Internal Auditing Standards for
Internal Audit to be requested to assist in a facilitative or consulting nature. Where this
falls within the general remit of advising on risk and control this will be considered part
of the service offering, with regard to resources available and time required.
Where it is agreed as appropriate for a member of the IA team to provide significant
input to an activity or project that is beyond the normal remit which means they should
be temporarily seconded to another department or team, then the following will take
place.
e The request will be approved jointly by the Head of Internal Audit and the
Chairman of the Committee.
e The resource impact on the approved audit plan should be approved by
the Committee who will either approve the reduction in scope to the
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audit plan or request the Board to approve temporary resource to
address the shortfall.
e The work conducted by the seconded member will be the responsibility
of the receiving manager, not the Head of Internal Audit. The work will
not be defined as internal audit.
9. Standards of Audit Practice
The Head of Internal Audit will implement recognised international internal auditing
standards and techniques such as those developed by the Institute of Internal Auditors,
COBIT and COSO as appropriate to the Post Office.
Head of Internal Audit Dated:
Chief Executive Dated:
Chief Financial Officer Dated:
Chair of Audit, Risk and Compliance
Committee Dated:
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Confidential
POST OFFICE LTD AUDIT, RISK AND COMPLIANCE COMMITTEE
Internal Audit Report
1. Purpose
The purpose of this paper is to:
14 Summarise the initial activities of the newly established Post Office Internal Audit
department.
1.2 Explain the recruitment plan.
1.3. Summarise the status of the Internal audit plan currently run and managed by
the Royal Mail Internal Audit Team.
1.4 Highlight findings from recently completed reviews
1.5 Outline the proposed activity over the next quarter.
The Audit, Risk and Compliance Committee is asked to note the above, the attached RMIA
internal audit plan and summary of the Supplier Contract Management audit.
2. Background
2.1 The Royal Mail Internal Audit team comprises over 30 managers and staff. As
part of the separation, an agreed audit programme for 2012/13 for 500 man days
work commenced in April 2012. A summary of the audit plan to date and current
status is shown in appendix 1. RMIA Resource is supplemented by co-sourcing
arrangements with Deloittes.
2.2 The programme is managed by Stephen Collins, Manager RMIA, with oversight
from the Royal Mail Director of Audit and Risk. The audit process from setting
terms of reference, through fieldwork, reporting and clearance follows the RMIA
protocols and processes.
2.3 Malcolm Zack, joined Post Office as Head of Internal Audit (HIA) on October 1%
to commence the transistion of internal audit activity to Post Office. The current
RMIA programme as agreed with Post Office management will continue to run,
with some involvement and management from the HIA.
24 In the intervening time the HIA will determine the actions necessary for the
transition.
3. Initial Activities/Current Situation
Activities completed or underway
e Governance of Internal audit (Internal audit charter and Committee terms of
reference review).
« Assessment of recruitment needs (underway)
* Establishment of Post Office internal auditing methods, terms of engagement
and ways of working. (Commencing Q4)
e Visits to sites and business functions across the organisation for general
induction
Internal Audit Report Malcolm Zack — Head of Internal Audit Page 1 of 3
6" November 2012
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Confidential
e Beginning to understand the key risks of the organisation to support Audit
Planning.
e RM Internal Audit activity on
e Supplier Contract Management
e Post Office SAP environment (POLSAP) (at Executive Committee member
clearance)
e Transformation Programme - Financial controls. (underway)
4. IA Structure and Recruitment
4.1 The initial budget for the Internal Audit team is HIA, plus 3 Audit Mangers
supported by co-sourced arrangements. The team will be based at Old Street.
4.2 The calibre of the audit managers needs to be sufficient to enable effective
engagement at all levels of management including Executive Management. They
are therefore likely to be qualifieds (CIIA, ACA, CISA) with at least 5 or more years
PQE, with previous internal audit experience.
4.3 The focus will be on the higher more strategic risks facing the organisation rather
than lower operational risks, although these will not be excluded. Based upon
exposure to the business to date and the wide variety of risks facing the
organisation, the team will need to take a risk based/prioritised approach.
4.4 Following discussions with management the team is likely to be:
e IT Audit Manager - high level of IT infrastructure and systems change over the
next 3 years, complex head office and branch IT environment, extensive 3” party
support.
« Audit Manager - With particular focus on Projects and Programme Assurance.
Focus on key aspects of the change programme, transformation and key
initiatives
e Audit Manager - With particular focus on the retail branch network, supply chain
and liaison with the inhouse teams that work in these areas.
4.5 Recruitment processes are underway for the IT Audit Manager as this need was
determined early on in the process.
4.6 Whilst there may well be some activity in the Financial Services arena needed,
there is work conducted by the Internal Audit team of the Bank of Ireland.
4.7 \n order to maintain flexibility, remain up to date with new skills and requirements,
most modern internal audit departments set up co-source arrangements with
external firms. (For example, Royal Mail use Deloittes). An initial budget of 150
days external support is under consideration and a tender process will commence
once agreed.
5. Internal Audit Plan and recent results.
5.1 Please refer to the Royal Mail [A summary plan status in Appendix 1 and the Post
Office summary of the Supplier Contract Management Audit in Appendix 2.
5.2 At time of writing the Audit of the POLSAP system environment was at Executive
clearance with the ClO. A verbal summary will be provided at the Audit
Committee meeting.
Internal Audit Report Malcolm Zack — Head of Internal Audit Page2 of 3
6" November 2012
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6. Internal Audit Activity Nov 2012 — End January 2013
e Continue recruitment of IT Audit Manager
¢ Commence recruitment of rest of team.
« Commence tendering for co-sourcing support
e Risk Management Framework input
e Create proposed plan for 2013/2014 internal audit work.
¢ Agree budgets for 2013/2014 including relevant audit tools.
e Audits on: Transformation — Financial controls, Horizon, LINK, and Payroll.
7. Recommendations
The Audit, Risk and Compliance Committee is asked to:
e Note the activity.
¢ Raise any questions on recent audit results if needed.
e Highlight any areas of remaining focus for the Royal Mail IA team
e« Comment on the Post Office structure and resource proposals.
Malcolm Zack
6" November 2012
Internal Audit Report Malcolm Zack — Head of Internal Audit Page3 of 3
6" November 2012
Post Office Limited (POL) - Internal Audit & Risk Management Plan (IA&RM) 12/13
eee
fe tatomaten raga see Tranoranon rettwo I ongneiziis I aco Ix io lpeten Geecvecevnerierctn ete punpeerctaia
: 2 tan : T-n_ [anc acy wl bdr ie ning and pe wl bent
iat Oiomot Severe not yet started I ONEPIOE 22/13 * Comments _IProgramme, otherwise this resource will be used for the NT Programme,
sar peations melas {nigh level review of core tier payments. oe —— e ns, bee INT Programme. Replace with Critical Controls and E&Y support.
oye es = Q 6 » Se
Secon iemedunrasnier cee nmasmie. sovoring I tr » 2 = lennimcaninabar
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ses ik anesaton _[Ongan trance onthe marageret od sat of the Exectve Tenn key ets I scope I December ” I 2 45 [bone tote contre
Sub Total ‘odes 23600 385Da8
500 days as agreed per RMG/ POL MSA. So far two assignments (Payroll Data Analytics and Agents Remuneration) cancelled totalling 80 days, replaced by additions below.
fr Jr! atstation of compionee requirement screaerend I etary 2» 3 20, fbr startplonnedAvating confmation of start dte trom Secu,
nts \ssurance support for Critical Business Controls Seetanreed mt cember start plann:
ie eset ue or Ci ts Cn sees I econ » 2 SS
Sub Total sodas SDs sSDa
Grand Total $00bays 242002 s50days
POL00158012
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Supplier Contract Management — summary of Royal Mail IA report
Audit Highlights and Opinion
—] Overview.
e POL has a Contract Management Function that manages
suppliers. The review was agreed between POL and
Royal Mail Internal Audit as part of the 2012/2013
internal audit plan.
° The review assessed controls to assess supplier contract
risk including:
¢ Changes to existing contracts including authorisation
controls,
° Case management, legal review, management of
supplier charges and supplier performance.
° General governance of the function and supplier risk
management.
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Further improvement
needed
Overall Conclusions (from Royal Mail report)
e “The controls in place over existing supplier
management are largely derived from the Service
Delivery Framework,
° Contract Management provide varying levels of support.
e Ina stable environment with a low level of change, this
would suffice with some improvements.
e With the anticipated high level of change being
undertaken by the business, a more proactive
commercial approach to managing suppliers is
recommended. Management are aware of this and are
developing a Contract Management Framework.
* There is some concern over access to Horizon software
after exit because Fujitsu own the IPR rights.
Executive Responsible
Distribution (date)
Prepared By
Reviewed By
1) Service Delivery Framework in place
2) Individual working practices for
each supplier contract
3) Formal process for review and
agreement of changes between POL
and supplier.
4) Legal consulted on contract changes
5) Governance meetings to monitor
contracts and some issue escalation
6) Service Delivery managed through a
mix of service levels, KPIs and
improvement plans
Top Priority Agreed Actions
1) Develop formal risk management
process for all supplier contracts
2) Formalise policies and procedures
across Contract management function.
3) Formalise the Legal Review process
4) Strengthen senior management
review and documentation.
5) Clarify exit and IPR issues
1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
Need more proactive management of
supplier relationship, contract costs and
supplier risk
No formal standard policies for whole
of Contract Management function
Inconsistencies between contract
management across different contracts.
Risk Management varies from contract
to contract
No formal assessment of the risks of
the supplier base as a whole
Contract governance weak.
Documentation stored on local drives
or based in emails. (underway)
Legal review process not formalised for
sign off, amendment, or audit.
(underway)
Benchmarking not routinely included in
all key contracts
Exit plans for Ingenico - clarity of who
bears costs not clear
Clarity on IPR rights on Horizon needed.
1)
No items of serious risk noted
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Post Office Limited
Report to the Audit and Risk Committee
2012-13 Audit Planning Report
6 November 2012
£l/ ERNST & YOUNG
Quality In Everything We Do
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“er gt EexsreYounic cara
Private and confidential 6 November 2012
Audit and Risk Committee
Post Office Limited
148 Old Street
London
EC1V 9HQ
Dear Members of the Audit and Risk Committee
Planning Board Report
We are pleased to attach our audit planning board report for the forthcoming meeting of the Audit and Risk
Committee. The purpose of this report is not only to provide the Audit and Risk Committee with a basis to
review our proposed audit approach and scope for the 2012/13 audit, in accordance with the requirements of
the auditing standards and other professional requirements, but to also ensure that our audit is aligned with
your service expectations.
This report summarises our assessment of the key issues which drive the development of an effective audit for
Post Office Limited, considering the relevant emerging market forces coupled with the operational, finance,
and business risks which drive POL's financial statement risks. We have aligned our audit approach and scope
with these.
This report is intended solely for the information and use of the Audit and Risk Committee, Board of Directors
and management, and is not intended to be and should not be used by anyone other than these specified
parties.
We welcome the opportunity to discuss this report with you on 13 November 2012, as well as understand
whether there are other matters which you consider may influence our audit.
Yours faithfully
Angus Grant
Engagement Partner
For and on behalf of Ernst & Young LLP
K firm Ernst & Young LF ip registered in Englane anc
firm af Ernst & Young Global
Contents
Section 1
Executive summary
Section 2 Risk based approach
Section 3 Areas of audit emphasis
Section 4 Controls based audit
Section 5 Audit scope and execution
Section 6 Service delivery
Appendices
Appendix A Half Year review
Appendix B Audit fees
Appendix C Insights on IT risk
Appendix D Independence report
Appendix E
Required communications with the Audit and Risk Committee
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Page
14
19
23
26
29
31
32
35
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Executive Summary
Executive Summary
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Less than a year from the official separation of Post Office Limited (‘POL') from Royal Mail Group (‘RMG'), we
continue to witness the time and efforts expended to make changes vital for success in this new chapter of
POL's history. We have also continued to challenge our audit strategy for the coming 2012-13 financial year,
working with management so that our approach focuses on the risks faced by POL in response to changes
within the industry, economic environment and internal
ly.
In order to identify the key drivers of audit risk, we analyse the risks inherent in the sector, the markets in
which POL operates, the key strategic, operational and finance risks for POL you have identified through your
risk assessments and our knowledge of other factors that may impact POL's financial statements.
By considering these inputs, we focus our audit on the areas that matter to POL, so that our feedback is more
relevant to your business.
Risk assessment
¥
Key financial statement risks
» Revenue recognition across diverse range of
revenue streams*
> Counterparty risk”
» Pension valuation and accounting”
> Higher inherent risk of transitioned accounts
impacted by POL separation
> Valuation of provisions including Network.
Transformation provisions, and classification of
exceptional items.
> Risk of fraud/burglary arising from the logistics
process and the branch network
“Significant risk as defined by auditing standards and
professional judgement
Our audit approach is designed to appropriately respond to these risks. We will continue to focus on the key
areas where we believe there is higher inherent risk to the financial statements due to the nature and level of
judgement involved. We will also consider changes in financial reporting standards and regulations and their
impact on the presentation and disclosure in the financial statements.
er a2ea788 Post Office Limited
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Contents page
Executive Summary (cont'd)
Layers of
control we
rely on
Entity Level
controls
Controls based approach
> We will adopt a controls-based
approach, being the most efficient
approach to a business with a high
volume of low value transactions.
>» We will seek to place reliance on
business and IT general controls as
well as placing reliance on POL's own
risk management policies and other
entity level controls.
Your audit team
» Your audit team is led by Angus Grant, who is in
his fourth year on the engagement, supported by
Jeremy Midkiff, who has three years involvement
with POL.
> In response to POL's establishment as a
standalone company, our audit team will include
more specialists to assist us with our procedures,
covering pensions, tax and corporate
restructuring.
Post Office Limited
Insights and value
» Wewill use our knowledge of your business and
our experience of working with you to bring you
insights and ideas in areas that matter most.
» At the end of the audit, we will
issue a ‘Controls Themes &
Observations’ report (a
‘Management Letter’) to
share insights identified from
the audit.
» Wewill share insights from our
Governance, Retail and Public
Sector thought leadership, as
well as both global and local
perspectives.
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Risk based approach
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Contents page
Risk based approach
Controls based
audit
Audit scope and
s Service delivery
execution
Through our risk assessment approach, we analyse the risks inherent in a government funded entity, the
markets in which you operate, the key strategic, operational and tactical risks for the Company you have
identified through your risk assessments, and our knowledge of other factors that may impact the Company's
financial statements. We then map these risks to financial statement risks. This risk assessment process
informs where we will focus our audit work for 2012-13.
Risk assessment
Economic
> Continued uncertainty and recessionary
pressures in UK market
> UK Government austerity measures,
impacting future funding & assistance
> The UK economy
> Rate of e-substitution in mailing services
impacts customer buying behaviours & Post
Office impact
> Product offering does not meet market needs
> Changes in the financial services sector
Environmental and social
> Post Office as a ‘brand’ in its own right
> Corporate responsibility
> Ethical and reputational
Operational excellence
Achieved benefits of transformation
>
> Pace of transformation
> Industrial action
> Supply chain management
> Quality of service
Technology
> IT transformation project
> _ESFS replacement scheduled for April 2014
o Post Office Limited
People
> Build and maintain talent pipeline
> Develop entrepreneurial culture
» Relationships with the Communication
Workers Union
Growth
> Continue to develop revenue streams capable
of sustainable growth
> Monitor profit margins on key revenue lines
to ensure the ‘right! price is charged
> Go through successful Network
Transformation to develop the 21st century
Post Office.
Process
> Managing analyst/stakeholder/public
expectations
» Finance shared service centre
implementation
» First time ownership of central functions from
RMG including pensions & treasury
» Commercial finance and business intelligence
» Cash flow forecasting and cash optimisation
> Cost of transformation and restructuring
Balance sheet
» Pension solution and valuation
> Carrying value of assets
» Valuation of provisions and accruals
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Contents page
a>
Risk based approach (cont'd)
Significant risks
Of the financial statement risks identified, we consider some of them to be significant to our audit. Auditing
standards define significant risks as those with a high likelihood of occurrence and, if they were to occur,
could result in a material misstatement of the consolidated financial statements.
Once identified we are required by Auditing Standards to perform specific procedures over significant risks,
including the identification and testing of the effectiveness of key controls designed to address the risks.
The identified financial statement risks for POL are as follows:
Revenue recognition across diverse > The incentive to deliver expected revenue targets
fangeot revenue streams » The accounting for deferred revenue and specific commissions within complex or new
legal agreements across a variety of revenue lines.
Counterparty Risk Perceived heightened risk since 2008 credit crisis over the credit risk exposure to
counterparties, particularly given the concentration of risk associated with the Bank of
Ireland.
Pension valuation and accounting [NEW] The accounting for the pension solution and subsequent valuation of the reported balance
sheet surplus/(deficit) is very sensitive for POL management and key stakeholders
Higher inherent risk of transitioned Accounts which were previously handled by Royal Mail's finance team will be fully
accounts impacted by POL separation _ transitioned to the POL finance team, such as treasury and pensions.
INEW]
Valuation of provisions including Network Assessing the financial statement impact of any provisions, including those arising from the
Transformation provisions and Network Transformation programme, and the classification of related exceptional costs.
classification of exceptional costs [NEW]
Risk of fraud/burglary arising from the There is a large quantity of cash in the cash centres, branches and in transit which is
logistics network and the branch network potentially subject to misappropriation or the focus of burglary attempts.
Fraud risks and risk of management override
The risk of fraud exists in any business. However, frauds involving the manipulation of results to achieve
performance targets are particularly harmful to stakeholder value and the current economic environment has
increased their likelihood of occurrence.
Our responsibility is to plan and perform audits to obtain reasonable assurance about whether the financial
statements as a whole are free of material misstatements whether caused by error or fraud. To address the
increased potential risk arising from manipulation of results to achieve performance targets, we consider the
incentives and opportunities for individuals to override internal controls in our audit procedures.
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Areas of audit emphasis
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Contents page
Areas of audit emphasis
Summary
In determining our approach to the 2012-13 audit, we consider how the risks faced by the Company might
impact the financial statements. From our experience of working with a number of companies in the
government and financial services sector, our understanding of the key risk areas focused upon by
management and from our prior knowledge of the Company, we identified a number of key financial
statement risks, outlined below. These do not represent all risks but do include those items that in our opinion
are the most significant for POL in 2012/13.
The risks are largely consistent with the prior year with additional emphasis surrounding the changes that the
separation of Post Office from Royal Mail and the Network Transformation programme will bring to the
business.
> Revenue recognition across
diverse range of revenue v v No change from prior year
streams
> Counterparty risk v No change from prior year
Focus on the final valuation post
» Pension valuation and v ension solution and ‘go-forward’
accounting p ‘9
valuations
» Higher inherent risk of
transitioned accounts impacted
by POL separation
Valuation of provisions including
Network Transformation
provision & classification of
exceptional costs
Risk of fraud/burglary arising
from the logistics process and
the branch network
Project Eagle/Gamma
accounting
Additional risk following POL
separation
Additional risk following high level
of network transformation
exceptional costs budgeted in
current year
No change from prior year
Following sale of investment in
POFS associate
Post Office
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Contents page
Areas of audit emphasis (cont'd)
Accounts with significant risks
Significant risks are risks with both a higher likelihood of occurrence and a higher magnitude of effect that
require special audit considerations. The risks we have identified as significant risks are detailed below, along
with how we propose to address those risks.
Revenue recognition across diverse range of revenue streams
POL sells a large variety of products/services across a number of revenue
streams, from providing ATM services through the Bank of Ireland arrangements,
to providing telephony broadband services under POL's Homephone brand. Most
of these revenue streams will have their own specific rates, commissions and
calculations for allocating the amount of revenue owing to Post Office, which are
dependant on their underlying contracts.
Whilst we note that most of the revenue lines are not overly complex in their
revenue calculations, the main risk associated with the diverse range of revenue
streams is in the correct contractual terms being applied to the revenue lines.
We also note that reward and incentive schemes based on achieving profit
targets may also place undue pressure on management to achieve revenue
forecasts, which makes us identify revenue recognition as a fraud risk.
Counterparty risk
In light of the current economic environment, POL undertakes a review of all
counterparties to assess their level of exposure and relative risks. In particular,
given the concentration of risk associated with the Bank of Ireland (Bol), POL has
performed a more detailed assessment to determine if steps should be taken to
mitigate any risk exposure perceived excessive.
As part of their assessment, the appropriate detailed contingency plans have
been put in place, in particular focusing on Instant Saver and general banking
areas.
It is noted that the counterparty risks associated with the Bol mainly relate to the
daily trading balance which is owed from BO! to POL with the most significant
exposure in respect to the ATM debtor. On any given weekday the exposure is
approximately £20-30m; however on a Sunday, the exposure could be
approximately £80m, as it would include the full weekend's transactions.
Management will need to continue to regularly monitor and assess the level of
relative risk and exposure of their trading partners, in order to determine at any
point if steps should be taken to mitigate any perceived risk through collateral or
other arrangements.
We will perform detailed controls work on
revenue during interim, which will include
testing whether the revenue lines selected are
using the correct contractual rates and volumes
in their calculations.
We will perform a detailed analytical review to
analyze and evaluate the movements in the key
revenue lines across the business.
For significant new products or revenue
streams, we will review the accounting
treatment in line with the revenue recognition
accounting standard and relevant contractual
terms.
We will discuss the counterparty risk at year
end with the Head of Corporate Finance, and
understand management's assessment of the
counterparty risk the business is exposed to
and if this would have any related financial
statement impact.
We will keep abreast of the volatility in the
financial markets and any changes to POL's
key partners such as the Bank of Ireland's
credit rating.
We will consider the recoverability and
financial statement presentation of any
material counterparty receivables due to
POL, performing subsequent cash testing
where necessary.
We will perform detailed substantive tests on
all material vendor reconciliations at year
end.
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Contents page
Areas of audit emphasis (cont'd)
Accounts with significant risks
Pension valuation and accounting
On 1 April 2012 - after the granting of State Aid by the European Commission to
the Governmenton 21 March 2012 - almost all of the pension liabilities and
pension assets of the Royal Mail Group pension scheme, RMPP, built up until 31
March 2012, were transferred to HM Government (‘HMG’). On this date the RMPP
was also sectionalised, with Royal Mail Group Ltd and Post Office Limited each
responsible for their own sections in future. This arrangement left the RMPP fully
funded on an actuarial basis in respect of historic liabilities at that date.
The accounting of the transfer of the RMPP and related disclosures is sensitive
due to the number of stakeholders involved, including HMG and the
Communications Workers Union.
At 23 September 2012, the Group recognised a net pension asset of £53m on
their balance sheet.
Management will satisfy themselves that the assumptions used in calculating the
pension obligation at the year end are reasonable and the appropriate disclosures
are made by consultation with actuaries.
We will audit the accounting treatment in line
with [AS 19 and IAS 1.
For the final Post Office RMPP year end
valuation we will review the key financial
assumptions supporting the valuation, with
input from Ernst & Young pension specialists
and ensure that the methodology and
application is consistent with IAS 19 and IAS
=
Benchmark POL assumptions against peers.
We will assess and provide insight into the
relevant position of the treatment adopted.
Obtain evidence and support for the valuation
of pension assets.
Review the pension disclosures provided in
the financial statements.
Other areas of audit emphasis
The other areas of audit emphasis are set out below:
Higher inherent risk of transitioned accounts impacted by POL separation
On 1 April 2012 Post Office Limited ceased to be a subsidiary of Royal Mail Group »
Limited, and became a directly owned subsidiary of Royal Mail Holdings plc.
‘AS a consequence of POL’s separation from Royal Mail Group during the current
year, the POL finance team will be directly responsible for all its finance
functions, some of which were previously accounted for at Royal Mail Group.
Such accounts/finance functions will include but are not limited to pension
valuation accounting and treasury management. >
Valuation of provisions including Network Transformation provision &
classification of exceptional costs
Following its separation, POL has been going through a Network Transformation»
all of its existing branches in order to modernise them as part of their overall
strategy to make the Post Office competitive for the future.
The financial implications of Network Transformation for FY2012-13 are
anticipated to be approximately in the region of £127m.
£24m of exceptional costs relating to Network Transformation had been incurred
as at September 2012.
Risks include:
>» Costs are provided for before or after they have been committed and are
recognised in the incorrect period; and
> Other costs, not associated with the Network Transformation are
inappropriately included within this category and reported outside of the
trading profit.
We will be performing detailed testing on the
new processes, acting in close concert with
management and build on the knowledge that
the Royal Mail Group team had when these
accounts were prepared and audited at RMG
level.
We will use the same specialist teams that were
used by Royal Mail Group wherever possible
such as the Pensions team to ensure a smooth
transition from the audit side.
We will review management’s monitoring
process for being able to differentiate between
Network Transformation costs and normal
operating costs, and assess whether it captures
the appropriate information and detail to track
these costs.
We will review the detail of the costs provided
and establish when the committed obligation
arose to assess whether the cost has been
recorded in the appropriate period.
The costs included will be reviewed to
understand whether they are directly linked to
the Network Transformation and appropriately
included within this category and reported
outside of the trading profit.
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Contents page
Areas of audit emphasis (cont'd)
Other areas of audit emphasis
Risk of fraud/burglary arising from the logistics process and the branch network
POL holds large quantities of cash within its retail centres, cash centres and in
transit (£642m as at 23 September 2012), which is potentially subject to
misappropriation or under the threat of burglary attempts by organised crime.
Management has in the past created strong controls to prevent and detect any
risk of fraud and attempted burglary, and keep re-assessing whether they need to
increase their security measures.
Project Eagle/Gamma accounting
BOI sells a number of financial services products through the POL branch network
in the UK. Historically, the services were operated through Midasgrange Limited,
which traded as Post Office Financial Services (‘POFS’), a JV between POL and
Bol.
in April 2007 a deed of variation was signed between POL, BO! and POFS. This
deed of variation was intended to compensate POL for continuing to maintain a
network of 370 Crown offices rather than their plan of converting 50 of these
offices to franchise offices by 2015 (‘Gamma’).
We understand that subsequent to year-end, Gamma was terminated as POL sold
its investments in POFS to the BO! for proceeds of approximately £2.7m (Project
Eagle).
Going forward, we understand that the arrangement between POL and BO! will be
‘commissioned based’ whereby POL will directly receive a contractual commission
for each BO! product that it sells to customers through its branches.
We will visit both cash centre and branches to
attend cash counts by internal audit, and
observe controls around cash management.
We will also hold a meeting with head of
security at cash centres to gain insight into
their assessment of risks and events of fraud
in logistics process and branch network.
We will perform detailed substantive tests on
cash and bank reconciliations at year end.
We will perform detailed cash and bank cut
off testing at year end.
We will review the new contract between POL
and BOI to determine the accounting effects
on POL.
We will review management's accounting for
the sale of their investment in POFS and
treatment of cash proceeds and resulting
gain/(loss) on disposal.
We will review existing revenue deferral
under ‘old agreement’ for appropriateness
and any impact on current year financial
results.
We will review resulting disclosures in the
year-end consolidated financial statements.
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Controls based audit
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Contents page
Controls based audit
Gaining assurance through the control environment
Risk based
approach
Audit scope and
s rvi liver
execution setvice delivery
POL's Control Processes
A key consideration in our audit planning process is the extent to which POL assesses risk and implements
controls in order to minimise risk.
We intend to continue to utilise a controls-based approach in respect of IT, which is discussed in detail on
pages 16 and 17.
We also intend to continue to utilise a controls based approach in respect of the identified significant
processes of revenue, purchasing, cash settlements and payroll. Our controls testing approach focuses on the
controls implemented across the entire POL business, including the London head office, Bolton (payroll) and
Chesterfield (shared services), branches and cash centres.
Weare also aware that the POL finance systems and control environment will continue to change in a post-
separation environment, as POL begins to undertake new accounting processes and activities that it had
hitherto not carried out, such as the consolidation of results at a POL level for statutory purposes and the
development of governance structure and accounting for treasury and pension facilities. We will consider if
any of these new separation related activities will have an impact on the control environment, modifying our
approach and conducting walkthroughs to understand the new environment where applicable.
Although our audit is not designed to express an opinion on the effectiveness of internal control, we are
required to communicate to you any significant deficiencies in internal control. We will also provide you a
detailed letter at the end of the audit incorporating certain recommendations for process improvements.
noted by us in the performance of this year’s audit.
Underpinning our entire approach is a controls-based audit. It is We will test controls for POL’s payroll, purchasing, cash settlement
the most efficient approach for a business that has avery high _—_and revenue processes.
volume of low value transactions. > IT systems and applications: we will review the IT general
In adopting an efficient controls based approach we consider the controls built in to POL’s core IT applications, together with IT
various layers of assurance and leverage where there is potential application controls over your critical business processes
to do so. This informs our basis of working with management. > Entity level controls: we will maximise efficiency by seeking to
rely on entity level controls and processes, such as your
budgeting process.
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Controls based audit (cont'd)
Gaining assurance through the control environment
Risk based
approach
Audit scope and
: Servi liver’
execution er vice de ‘
IT Control Planning - Background
IT underpins a significant proportion of the Post Office's transactions. Our audit plan is designed around
reliance on certain IT applications and the use of electronic audit evidence. The following IT applications are in
scope for our POL audit: HNGX, POLSAP, SAPHR and SAP ESFS.
The IT audit process has historically, and continues to be, complex as a result of factors such as control
weaknesses in POL's IT environment, including the lack of oversight of service provider Fujitsu's control
environment. During the 2011-12 audit, the audit process improved as a result of remediating certain high
risk control weaknesses, the involvement of all parties (POL, Fujitsu and Ernst & Young) in planning activities
at an early stage of the financial year and the continued sponsorship of POL management and commitment
from Fujitsu.
2012-13 IT Audit Strategy - key considerations
> During this financial year, Fujitsu took steps to commission an ISAE 3402 report for 2012-13 on the
controls operated by Fujitsu over POL's business critical systems.
> In order to reduce our testing, we intend to place reliance on the report, with the extent of our reliance
being dependent on the opinion expressed in it.
> Inthe event that control exceptions are identified in the report, we will need to perform additional
procedures to address the risks.
» To support this approach, the POL, Fujitsu, Ernst & Young IT audit and Ernst & Young ISAE 3402 teams
have taken part in workshops to consider the control framework for POL based on the previous audit,
and the respective roles of the parties in providing an assessment on these controls for the 2012-13
financial year. During these workshops, key milestones and protocols have been agreed so that the
parties are kept up to date with the progress of the ISAE 3402 testing.
>» The remediation of prior year IT audit observations is also a key consideration in our planning for the IT
audit this year, as it impacts on the extent of our testing.
» From our discussions with POL, we understand that a process of formal risk acceptance has not yet
been undertaken for some of the risks relating to the findings identified by the previous audit.
» As we have previously highlighted, these areas will remain in scope for the upcoming IT audit and
therefore we will carry out additional procedures (substantive tests of the controls or tests of mitigating
controls) to gain comfort over the remaining risk relating to the financial statement audit.
» The remediation of open findings from last year's audit has been considered in the approach to the ISAE
3402 report as part of the workshops attended by POL, Fujitsu, Ernst & Young IT audit and Ernst &
Young ISAE 3402 teams.
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Controls based audit (cont'd)
Gaining assurance in the IT environment sphere
Risk based
approach
Audit scope and
: rvis liver’
execution Servicede ‘
2012-13 Audit Strategy - key considerations (cont'd)
> Other key considerations for the IT audit this year are POL's separation from Royal Mail Group and the
related IT transformation initiatives. We plan to work closely with POL to understand both the changes to
the organisation's risk landscape that these activities create, and the further development of POL's
governance and control frameworks. Of direct relevance to the 2012-13 audit are:
> The status of the transition plan and transitional services agreements with Royal Mail Group to maintain
and monitor the third party contractual obligations during the period of separation including ensuring
service levels are met
» How access to sensitive data, such as payroll information, is restricted during the transition period.
» Finally, a key consideration is the audit approach for two key systems that are operated by Royal Mail
Group and support POL's financially significant processes; to date these have been reviewed as part of the
Royal Mail Group IT audit. These systems are SAP ESFS, which supports the processing of branch returns,
fixed assets, purchasing and general ledger transactions, and SAP HR - HRP, which supports the payroll for
POL employees. The existing audit approach adopted for these two systems is based on the audit
efficiencies gained from assessing the controls managed by third party provider CSC, which are common
across Royal Mail Group's key financial systems. Whilst Royal Mail Group continues to provide these
services, we would anticipate requesting comfort over these systems from the Royal Mail Group audit
team. To the extent that POL migrates relevant data and applications to itself or implements new systems
to cover these requirements over time, they will fall within the scope of the POL IT audit.
We will continue to work together with POL to agree planning milestones and protocols at the early stage of
the financial year to continue to improve the audit process for the upcoming IT audit.
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Controls based audit (cont'd)
Gaining assurance in the IT environment sphere
Risk based
approach
Audit scope and
: rvis liver’
execution Servicede ‘
2012-13 Audit Strategy - looking forward
» Weintend to continue to place reliance on the ISAE 3402 report for future audits for the duration of POL's
current contract with Fujitsu. We anticipate that the extent of involvement of POL, Fujitsu, Ernst & Young
IT Audit and Ernst & Young ISAE3402 teams in planning for the audit will reduce over time as this process
matures.
> Our current understanding of the timescales for POL's IT separation and transformation is that whilst it will
have limited direct impact on our audit approach during 2012-13, it will potentially have a more significant
effect in 2013-14 and beyond as POL potentially implements new systems.
The following aspects of the transformation plan will become relevant to the audit at that stage, and we
plan to gain an insight into them during the 2012-13 audit so that we can highlight at an early stage any
potential concerns they raise for the organisation or risks to the audit approach:
> Plans and approaches to migrate or procure systems and software licences
» Plans for the segregation/separation of networks and email systems
» The planned supplier framework.
>» Wealso understand from management that as part of the separation plan between Royal Mail Group and
POL, there is a plan to migrate to a new core finance system for FY2014-15. With this in mind, we have
highlighted what we have learnt from our experience with IT programme risk management at Appendix C.
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Audit scope and execution
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Audit scope and execution
Risk based
approach
Controls based
audit Service delivery
2012-13 Ernst & Young services
Financial reporting
Internal control
communications
Regulatory audit and
other assurance related
services
>
Express opinions on, and report to the Audit and Risk Committee the results of our audits of:
> The consolidated financial statements of Post Office Limited (IFRS) and parent company financial
statements (UK GAAP) for the year ending 31 March 2013.
We are required by the primary audit team of Royal Mail Holdings (‘RMH') to perform a full scope audit of
POL for the period ended 31 March 2013 in accordancewith International Financial Reporting Standards
(IFRS) and Clarified ISAs (UK and Ireland) as required in the engagement instructions received by us from
them.
The following procedures are required by UK company law:
> Opining on whether the information contained in the Directors’ Report is consistent with the financial
statements
> Auditing the disclosures that unquoted companies are required to make with respect to directors’
remuneration
Express opinions on, and report to appropriate members of management (or the Audit and Risk
Committee, when required) on the results of our audits of:
> The separate statutory financial statements for any POL subsidiaries in accordance with local
requirements
Express our views on control themes and observations, including recommendations for improvements in
controls and procedures. We will issue a written communication at year end to:
> Management and the Audit and Risk Committee describing significant deficiencies and material
weaknesses identified during our audit, if any
> Management describing all deficiencies (not previously communicated to management in writing) in
internal control over financial reporting identified during our audit that are of a lesser magnitude than
significant deficiencies
In addition to the statutory audit requirements, we are required, as auditors of POL, to perform certain
procedures on a number of reports required by postal regulation and related matters, including:
> Procedures in connection with the Post Office Limited credit facilities from BIS and DVLA motor vehicle
license transactions
> Procedures in connection with the Bank of England Note Circularisation Scheme, which includes an AAF
01/06 Report delivered to POL management and the Bank of England.
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Contents page
Audit scope and execution (cont'd)
Materiality
For the purposes of determining whether the accounts are free from material error, we define materiality as
the magnitude of misstatement, which makes it probable that the judgement of a reasonable person, relying
on the accounts, would have been changed or influenced. Such misstatements can result from errors or
omissions and need to be considered in the light of the surrounding circumstances, both individually and in
aggregate. Our evaluation of it requires professional judgement and necessarily takes into account qualitative
as well as quantitative considerations implicit in the definition.
We would be happy to discuss with you your expectations regarding our detection of misstatements in the
financial statements.
Consolidation considerations — Scope of audit procedures
This year will also see POL financial statements prepared for the first time at a consolidated level. When
performing audit procedures on consolidated financial statements, we are required to set audit scopes for
each reporting unit, based on size and risk factors, which when taken together, enable us to form an opinion
on the POL group accounts as a whole.
POL’s consolidation is expected to be made up of two reporting units; the Post Office Limited parent entity
(which contains the majority of transactions) and the POL joint venture First Rate Exchange Services (‘FRES')
which will also form part of the consolidated POL financial statements.
The vast majority of the audit work is carried out by the Ernst & Young team from London, except for the POL
joint venture First Rate Exchange Services (‘FRES') which is audited by PricewaterhouseCoopers, which will
also form part of the consolidated POL consolidated financial statements.
Given the relative contribution of FRES to POL consolidated operating profit (£E31.4m in 2011-12), we will
instruct PricewaterhouseCoopers to report the results of their audit to us, in line with our reporting timetable.
This was done by the Royal Mail Group team in previous years when results were directly consolidated at
Royal Mail Group level, and will be taken over by us during the current year.
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Audit scope and execution (cont'd)
Timetable of communication, insight and deliverables
We set out below a timetable showing the key stages of the audit and the deliverables we have agreed to
provide to you through the 2012-13 audit cycle.
We will provide formal reports to the Audit and Risk Committee at the planning stage and at year end for the
consolidated POL accounts. These reports will incorporate the outputs from our planning review and our year
end audit procedures respectively. From time to time matters may arise that require immediate
communication with the Audit and Risk Committee and we will discuss them with the Audit and Risk
Committee Chairman as appropriate.
Following the conclusion of our audit we will prepare a Control Themes and Observations report for Post
Office Limited, outlining our comments on areas where we believe the Company exposes itself to risk, where
control matters exist or where we believe improvements can be made. This will be circulated to senior
management and to the Audit and Risk Committee in 2013, following the end of the audit. We will also provide
you with real-time control themes and observations as identified throughout the year as appropriate, as well
as practical business insights, updates on corporate governance and regulatory matters through our reporting
to the Audit and Risk Committee.
Agree audit scope/planning
> Agree service commitments
» Develop audit strategy “@
> Agree audit fees
Interim reviews
>» Half Year ee
Process reviews
> Review of key processes
» Controls testing
Year end substantive testing
» Hard close procedures cei
> Year end procedures EEE
» Results report to the audit fe
committee
> Control Themes and Ib
Observation Report
Deliverables
@® 2012-13 audit Planning & Half Year Report
@® 2012-13 Year-end Results report
@® 2012-13 contro! themes & Observation Report
Post Office Limited 22
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Service delivery
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Contents page
Service Delivery
Risk based Controls based Audit scope and
approach audit execution
Your POL audit team
The POL engagement team is led by Angus Grant from our London office, who as the Lead Engagement
Partner is ultimately responsible for all services provided to POL by Ernst & Young, the Post Office Limited
audit opinion and oversight of all other statutory and related work for POL.
Angus is supported by Jeremy Midkiff as Senior Manager and Darrell Martin as Manager. We have established
our engagement team with the principle of providing the right blend of industry, multinational and technical
experience to execute the audit and deliver on our commitments to you. This engagement team has been set
up to mirror your organisational structure. In addition, we recognise how important continuity of key Ernst &
Young team members is to your organisation.
Whilst our core team remains the same, the structure of our team has been carefully tailored to best mirror
your organisation in a post separation environment. Whilst until last year our audit team previously directly
reported to the Royal Mail Group team, during the current year, we will be directly accountable and the first
point of contact to the POL Audit & Risk Committee.
Specialists
As you are aware from experience in prior years, our audit strategy relies significantly on the leverage of IT
systems and controls. Denise Fabb (Executive IT Director) will continue to oversee delivery of the IT element
of the audit. In addition, we will also be looking to involve our Pension specialists at year end, as best suits the
auditing requirements at POL, this will be headed by Christopher Bown (Pensions Partner). Gillian Wild, who is
the tax audit partner for RMG, will also take responsibility for the audit of POL tax utilising her prior
experience in addressing the complexity of the POL tax structure, along with Julie Hadfield.
Taxation
Angus Grant
“Information
a
-
I Executive Director
II Partner I
I Senior Manager Christopher Denise Fabb I
i Manager Jeremy Midkiff Assistant Bown - I
I _ Director : Darrell Martin Manager \I Senior Manager I
I Julie Hadfield ‘Asim Noor Senior Manager_I/ Victor Puno
I Nancy Stockmeyer I I
al I
I
o Post Office Limited 24
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- Contents page
Appendices
Appendix A - Half Year review
Appendix B - Audit fees
Appendix C - Insights on IT risk
Appendix D - Independence report
Appendix E - Required communications with the Audit and Risk Committee
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Contents page Appendices
Appendix A
Half Year Review
A new chapter begins for the Post Office...
Introduction
Post Office Limited (‘POL’) will issue a half year trading statement in place of interim accounts for the half
year 2012/13. There is no formal requirement for Royal Mail Holdings to issue financial information for the
first half of the year, however, POL wish in their first year of separation from the Royal Mail Group to publisha
trading statement with selected disclosure information, as their pre-separation parent Royal Mail Group did in
prior years.
POL does not issue full IAS34 Interim financial statements and the trading statement is not in compliance with
IAS 34. We are therefore not required to, nor have we been engaged to perform a review under ISRE 2410,
the standard that covers interim reporting procedures.
Instead, at the request of management, we have accelerated certain elements of our 2012-13 year-end audit
work. This is intended to provide some level of comfort to Post Office Limited management and the Audit and
Risk Committee on the trading statement and the scope of work is broadly similar to those procedures we
would have performed on specific balances for a half year review. Management understands that these
procedures represent neither a half year review nor a full audit.
We also note that since management's trading statement will only disclose up to the point of the earnings
before interest, tax and exceptional costs, that our review will exclude these items.
We set out the full details of the Half Year procedures performed in the following pages.
Appendix A
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Contents page Appendices
Half Year Review (cont'd)
Half Year Review results
Review of primary statements numbers and support
» Perform analytical review for the current year
financial numbers included in the P&L (on profit
before interest, tax & exceptional items) and
Balance Sheet, which have been included in the
trading statement.
» Review financial numbers included in the trading
statement to ensure consistency with the financial
statements and our understanding of the
business.
Review of current material litigation & regulatory
fines, compensation and accruals.
> Review papers containing an update on (i) the
current material litigation and (ii) regulatory fines,
compensation and accruals.
> Hold a meeting with Susan Crichton to enquire of:
» Any changes in POL's legal position since our
last legal update, and to understand the status
of any legal/regulatory claims if applicable;
> Any issues with a potential material exposure
that have not been included in the above
papers.
> Review minutes to ensure completeness of legal
and regulatory accruals made by POL.
Review of GRNI Accrual
Review the GRNI accruals analysis and provide an
update on issues reported at the year end.
>
We performed an overall analytical review on both the Balance Sheet and
Profit & Loss account (on profit before interest, tax and exceptional items).
We noted that operating profit before exceptionals was £61.0m, up by 10% or
£5.5m on the same time last year. One of the main reasons for the increase
was better than expected performance of mails services, which benefited
from both a price increase and a volume increase in the month that preceded
the price rise.
We report one factual difference in relation to LTIPs, which was also reported
at year-end.
» This error is an overstatement of the LTIP Bonus accrual for the current
half year. The LTIP Bonus creditor was overstated by £1.9m as
management accrued for the full LTIP expense of the 2010/11 award and
2011/12 award by the end of the prior period. This is assessed by Ernst &
Young to be not in compliance with !AS19 which requires that the award
for such benefits be spread evenly over the lifetime of the bonus award
until vested/paid.
> The impact of unadjusted audit differences at 23 September 2012 would
be to increase profit before exceptionals by £1.4m.
» The unadjusted amounts are not material to the presentation and
disclosures in the trading statement for the period ended 23 September
2012.
Based on our discussions with management including financial controller, the
fluctuations and variances experienced during the period are consistent with
our understanding of the entity and of its financial position as of 23
September 2012. As a result of our procedures, we have not identified any
previously unidentified risks of material misstatement due to fraud.
The POL finance team provided us an update on all material provisions and
exceptional costs in the business incurred during the half-year. We noted that
no material provisions or exceptional costs were incurred or booked in relation
to litigation and regulatory fines.
We also made enquiries of Susan Crichton to gain an update of POL's litigation
and compliance with laws and regulations since year-end, with no issues
noted.
We also discussed the Horizon subpostmaster claim with Susan Crichton and
Sarah Hall, and noted that POL had contracted a firm of forensic accountants
to investigate the system in order to gain assurance over the integrity of the
system.
It was also noted that management had not made any reserve related to the
Horizon subpostmaster claim to date and have assessed they did not require
to make one. Based on our discussion with management, we agree that their
view appears to be reasonable. We will continue to revisit and gain updates
from management on the situation through the audit,
We also reviewed the minutes of Post Office Limited and noted there were no
other material litigation claims or regulatory claims that management should
consider providing for.
The GRNI accrual has increased by £6m (or 14%) to £49m at the end of the
half-year. This increase is mainly due to an increase in capital expenditure as a
result of the Network Transformation project increasing pace this period. We
also noted that 97% of GRNI balance is below six months old, compared to
‘99% of GRNI balance at the prior year end. We note that GRNI appears to be
fairly stated at the half year end,
Post Office
Appendix A
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Contents page _ Appendices
Half Year Review (cont'd)
Half Year review results
Review of non-exceptional provisions in business
> Review the breakdown of non-exceptional >
provisions as at the current half year end,
including movements since the prior year. For
movements greater than £5m obtain explanations
from management.
> Hold a meeting with management and ensure that
the assumptions used are appropriate and
consistent with the prior year end. Where
assumptions differ from those at the prior year
end, understand management's reasons for
changing.
Review accounting treatment of Project Eagle/Gamma
> Review the accounting treatment of Project >
Gamma and the proposed accounting for the
disposal of the associate Post Office Financial
Services.
Obtain update on significant accounting and audit
issues from year-end
> Obtain update on significant accounting and audit»
issues from year-end.
Review all board meeting minutes in the half-year
» Obtain meeting minutes for all board meetings up»
to our review date from management.
We have met with management and have reviewed the breakdown of non-
exceptional provisions at September 2012. No movements greater than £5m
were noted.
The assumptions used at the half year are consistent with those used at the
year end and we agree that they remain appropriate.
We have reviewed the accounting treatment for Project Eagle and agree with
management's accounting for the transaction. We also concur with
management's treatment of the future revenue profile for Gamma and the
Project Eagle disposal accounting.
We obtained from management an overall review on the significant
accounting and audit issues from year-end, with no further issues to note
aside from those mentioned in this half-year review summary.
We have reviewed all the meeting minutes for all board meetings up to the
latest date of the Remuneration Committee on 4'" October 2012. No further
issues to note.
Post Office
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Contents page Appendices
Appendix B
Audit fees
A fair fee reflecting a changing business
Asummary of Ernst & Young's proposed fees for the 53-week period ending 31 March 2013 are set out
below.
The fees below have been discussed with management to understand our cost base and to continue to work
proactively with management to identify additional efficiencies.
Most notably, given the change to the business and the impact of separation, we have differentiated between
those costs which are considered to be ‘one-off’ and those which will form a part of our cost base going
forward. We have also considered the impact of the first-year SOCR/ISAE 3402 reporting.
It is important to note that the fee provided represents a ‘best case’ scenario, especially as it relates to the
result of the ISAE 3402 report. Given that this work is ongoing it is not possible to predict the level of, if any,
remediation work which will be required. In this respect, the following are the key assumptions underpinning
the IT cost element of the audit:
>» The cost assumes no significant exceptions require mitigation work. Any additional time required to
mitigate exceptions will be flagged and agreed in advance prior to carrying out the mitigating procedures.
» Whilst there are indications that last year’s IT issues are not fully remediated, we have not budgeted for
any remediation work until we are able to quantify the level of effort required.
» The budget has been prepared based on minimal project management time required to obtain required
information from Fujitsu. However, if we encounter difficulties similar to previous years, the project
management time currently anticipated will not be sufficient. Similarly, if additional mitigation work is
required, this will result in an increase in project management time.
The fee has been calculated on the assumption that the level of client assistance relative to the prior year is
consistent.
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Contents page - lee _ Appendices
Appendix B
Audit fees (cont'd)
A fair fee reflecting a changing business
Total FY11/12 audit costs agreed with RMG 674,000 269,600
Overruns incurred in respect of IT element of FY12 audit 128,000 .
(‘overrun still in discussion with management) 802,000
Non-recurrence of IT overruns (128,000)
Additional scope changes resulting from separation
Recurring costs
Audit of treasury function 7,200
Audit of pensions 12,700
Technical review of stats 19,800
Consolidation considerations of FRES 14,000
Taxation (POL specific) 26,800
Half Year Review Costs 22,500
Corporate governance and reporting 27,700
130,700 52,280
One-off costs
Stats disclosures/determination of ‘first year’ accounts 11,400
Additional contracts (property, treasury, MSA) 10,700
Dissolution of POFS, Eagle transaction 7,000
Assessment of IT Transformation project 9,000
First year SOCR reliance set-up time 37,000
75,100 30,040
Market factors
Inflation 33,700 13,480
Change in scope/efficiencies
Anticipated impact of reliance on SOCR (76,000)
Efficiencies (11,000)
(87,000) (34,800)
Total 2012 audit costs 826,500 330,600
o Post Office Limited
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Contents page Appendices
Appendix C
Insights on IT risk
Facilitating success in IT through program risk management
As discussed on page 18 of this report, we understand that POL may migrate to a new core finance system for
FY2014-15.
If and when POL plan to go through this process, consideration should be given in managing the risk
associated with such a major programme. We have seen that despite an increase in investment, some
organisations continue to fail to deliver on large IT programmes. They frequently go over budget, are
completed too late and/or do not deliver the expected benefits.
The following publication ‘Building Confidence in IT programs’ document outlines the principles of Program
Risk Management from our experience, including common IT programme pitfalls and the options of strategic
IT initiatives that teams can take. This is available at your request.
signs on Trt
‘fae ore
Y”” Building confidence
in IT.programs
We also note that we have recently carried out an IT Risk Benchmarking survey with POL, which covers a
broader IT risk agenda. Once these results are available, we plan to discuss this with POL's IT management.
The result of the survey can help in forming a basis to track improvements of POL's IT risk management
initiatives.
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Contents page Appendices
Appendix D
Independence report
Introduction
In order to carry out our duties and responsibilities as auditor, we are required to consider our independence
and objectivity within the context of the regulatory and professional framework in which we operate.
UK APB Ethical Standards, International Standard on Auditing (UK and Ireland) 260, Communication of audit
matters to those charged with governance, and Rule 3526 Communication with Audit and Risk Committees
Concerning Independence of the Public Company Accounting Oversight Board (PCAOB) require us to
communicate on a timely basis and at least annually on all significant facts and matters that bear upon our
independence and objectivity since our last letter. The aim of these communications is to ensure full and fair
disclosure is made by us to you on matters in which you have an interest.
Relationships, services and related safeguards
We are not aware of any relationships between Ernst & Young and the Company that may reasonably be
thought to bear on our independence as of the date of this letter. As part of our considerations for any non-
audit engagement, we review potential threats in respect of self-interest, self-review, acting as management
and advocacy. We establish appropriate safeguards, which we communicate to the Audit and Risk Committee
in respect of any potential threat. Our next page details all the related services aside from the core audit for
POL.
Other required communications related to independence matters
The APB Ethical Standards require total fees you have paid us in the year ending 31 March 2013 to be
communicated to you. Details of all fees are provided to the Audit and Risk Committee with measurement
against pre-approved limits.
Listed on the following page are Ernst & Young's key firm-wide policies and processes to maintain
independence and objectivity which are required to be communicated to you by APB Ethical Standards.
Confirmations
We are not aware of any inconsistencies between the company’s policy for the supply of non-audit services
and APB Ethical Standards. We are not aware of any apparent breach of that policy.
We consider that our independence in this context is a matter that should be reviewed by both you and
ourselves. It is therefore important that you consider the facts of which you are aware and come to a view. We
look forward to discussing these matters with you at our upcoming meeting on 13 November 2012.
This report is intended solely for the information and use of the Audit and Risk Committee of the Board of
Directors, management, and others within the Company and should not be used for any other purpose.
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Appendix D
Independence report (cont'd)
Relationships, services and related safeguards
We highlight the following significant facts and matters that may be reasonably considered to bear upon our
objectivity and independence, including the principal threats, if any. We have adopted the safeguards noted
below to mitigate these threats along with the reasons why they are considered to be effective.
Fujitsu ISAE 3402 report - ISAE3402 report April to December 2012 » Nota prohibited service
for the Fujitsu services supporting the POL » Aseparate team from the POL IT team
account. This report will provide an . has been engaged for the review of the
assessment of the Fujitsu controls supporting ISAE3402 report, and standard ring
fencing applied between two teams.
POL business critical systems. The intention
is to place reliance on the ISAE3402 as part
of the 2012-13 financial statement audit. » Went through review exercise to ensure
in line with Ernst & Young independence
rules
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Contents page Appendices
Appendix D
Independence report (cont'd)
Firmwide policies
Ernst & Young LLP (EY) has policies and procedures that instil professional values as part of firm culture and
ensure that the highest standards of objectivity, independence and integrity are maintained. Listed below are
some of the key policies and processes in place within Ernst & Young for maintaining objectivity and
independence:
Financial interests Our Partners and client facing (technical) staff are prohibited from investing in any audit client around the
World.
All partners and staff are required to confirm their compliance each year with the firm's independence
policies. Monitoring of compliance in respect of all partners and professional managers takes place through
a worldwide investment tracking system.
New starters are required to confirm their compliance with the firm's independence policies on
commencement of their employment.
Training All partners and professional staff are required to undergo regular mandatory training on our Independence
and Ethical policies and processes.
Partner rotation The firm has detailed policies on the rotation of the audit partner, and in the case of listed clients key audit
partners, the independent partner and ‘other partners and staff in senior positions’.
Consultation The firm requires consultation outside the audit team on complex accounting, auditing and ethical matters.
Major issues of principle arising on all audits are referred to a panel of independent experienced audit
partners.
Independent partner Before listed company audit opinions are issued, an audit partner independent of the audit team reviews the
reviews nature of the relationship with the client, aspects of the accounts that are subject to significant estimates
and judgements, and the adequacy of the presentation of information in the accounts.
Quality reviews The firm operates a worldwide programme under the direction of senior partners that annually assesses the
quality of our work. Over a three year period, a proportion of the work of all audit partners is reviewed. The
results of the programme help us to evaluate the firm's quality controls and personnel performance and
identify areas for improvement.
As with other firms, Ernst & Young's audit practice is subject to annual review by the Audit Inspection Unit
(AIU) and the Quality Assurance Directorate (QAD) of the Institute of Chartered Accountants in England and
Wales (ICAEW) for compliance with Audit Regulations. As part of its visits, the AIU/QAD evaluate the system
of quality contro! operated by the firm for its audit practice.
Business relationships Ernst & Young has implemented a centralised process for the review and pre-approval, by our quality and
risk management team, of all new business relationships. A submission must be made and approved for
each new business relationship before committing the firm.
In addition, all new business relationships must be notified and approved by the lead audit or client service
partner before committing the firm.
Ethics Our Global Code of Conduct provides an ethical framework on which we base our decisions and our actions~
as individuals and as members of our global organisation. Ernst & Young has also established the Ernst &
Young/Ethics hotline which will allow any person, inside or outside of Ernst & Young, to confidentially and
anonymously report an activity that they believe may involve conduct that is unethical, illegal, in breach of
professional standards, or is otherwise inconsistent with Ernst & Young's established policies and Code of
Conduct.
Non-audit services Our audit engagement partners must approve any non-audit services offered to their clients. This allows
them to:
» Ensure the objectives of the proposed engagement are not inconsistent with the objectives of the audit
of the financial statement;
» Identify and assess any related threats to our objectivity; and
» Assess the effectiveness of available safeguards to eliminate such threats or reduce them to an
acceptable level.
Where no satisfactory safeguards exist we do not carry out the non-audit service.
Post Office Limitec 34
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Contentspage Appendices
Appendix E
Required communications with the Audit
and Risk Committee
There are certain communications that we must provide to the Audit and Risk Committees. We have detailed
these here together with a reference of where and when they were covered:
Communications required on all audits
Overview of planned scope and timing of the audit
Major issues discussed with management in connection with
initial or recurring retention
Other information in documents containing audited financial
statements
Significant audit adjustments
Unrecorded misstatements considered by management to be
immaterial
Expected modifications to the audit report
Our judgements/views about qualitative aspects of the
Company's accounting practices and financial reporting
Disagreements with management
Consultations with other accountants
Serious difficulties encountered in dealing with management
when performing the audit
The adoption of, or a change in, an accounting policy
Discussed within this report.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
We will review the other information
included in annual financial statements
and report to you in the Audit and Risk
Committee report.
This will be included, as necessary,
within our 2012-13 year end audit
report.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
if applicable, this will be included, as
necessary, within our 2012-13 year end
audit report.
This will be included within our year end
2012-13 Audit and Risk Committee
report.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
o Post Office Limited
Appendix E
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Contents page Appendices
Required communications with the Audit
and Risk Committee (cont'd)
Communications required on all audits (cont'd)
Methods of accounting for significant unusual transactions
and for controversial or emerging areas
Events or conditions that cause us to conclude that there is
substantial doubt about the entity's ability to continue as a
going concern
Sensitive accounting estimates
Consideration of laws and regulations
Fraud and illegal acts involving senior management and fraud
and illegal acts that cause a material misstatement of the
financial statements
Significant matters arising during the audit in connection with
the entity's related parties
Management's refusal for us to request external
confirmations or our inability to obtain relevant and reliable
audit evidence from other procedures
Representations that the auditor is requesting from
management
Significant deficiencies and material weaknesses in internal
control over financial reporting
Group audits
> An overview of the type of work to be performed on the
financial information of the components
» An overview of the nature of the Group audit team's
planned involvement in the work to be performed by the
component auditors on the financial information of
significant components
» Instances where the Group audit team's evaluation of the
work of a component auditor gave rise to a concern about
the quality of that auditor's work
Any limitations on the Group audit, for example, where the
Group engagement team’s access to information may have
been restricted
Fraud or suspected fraud involving Group management,
component management, employees who have significant
roles in Group-wide controls or others where the fraud
resulted in a material misstatement of the Group financial
statements.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included, as necessary,
within our 2012-13 year end audit
report.
This will be included, as necessary,
within our 2012-13 year end audit
report.
We will provide the management letters
of representation as part of our year
end report.
This will be included, as necessary,
within our Controls, Themes and
Observations Report which will be
shared with you after the conclusion of
our audit.
‘An overview of the planned approach
for the audit is included within this
report.
We will report on any further items with
our year end audit report.
This will be included, as necessary,
within our 2012-13 year end audit
reports.
o Post Office Limited
Appendix E
Contents page
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_ Appendices
Required communications with the Audit
and Risk Committee (cont'd)
Audit and Risk Committee pre-approval of services, including
specific pre-approval of internal control-related services and
non-prohibited tax services
Critical accounting policies and practices. ISA 260 (UK and
Ireland) requires the auditor to communicate the auditor's
views on the qualitative aspects of the Company's accounting
practices and financial reporting
All material alternative accounting treatments discussed with
management
Fees
Other material written communications with management
Communication of independence matters
Other findings or issues regarding the oversight of the
financial reporting process
This will be included, as necessary,
within our 2012-13 year end audit
reports.
This will be included in our 2012-13
year end audit reports,
This will be included in our 2012-13
year end audit reports
Discussed within this report and within
our 2012-13 year end audit reports
We will provide our 2012-13 year end
audit reports
This will be included in our 2012-13
year end audit reports
This will be included, as necessary,
within our 2012-13 year end audit
reports
o Post Office Limited
Ernst & Young LLP
Assurance I Tax I Transactions I Advisory
www.ey.com/uk
Ernst & Young LLP, 1 Mare London Place, London SE1 2AF
Ernst & Young LLP 2012, Published in the UK
Allrights rese
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POST OFFICE LTD AUDIT, RISK AND COMPLIANCE COMMITTEE
Governance for the Post Office - Bank of Ireland joint venture
1. Purpose
11 This paper provides an overview of the governance structures Post Office has
in place with the Bank of Ireland UK (plc) (Bol) following the conclusion of the
Eagle negotiations. It is tabled for noting.
2. Background
21 Prior to Eagle, the governance of the joint venture was managed through
Midasgrange, the jointly owned company established to build Post Office’s
financial services business.
2.2 The business model created too much complexity and did not deliver
sufficient income to Post Office; further, the Post Office became very
concerned at the financial position of Bol and the lack of termination rights.
2.3 The new joint venture agreement, which came into effect on 3° September
2012, created a bilateral relationship, supported by clear governance
structures, rights and obligations on both Parties and new termination rights to
Post Office. This paper sets out this governance framework.
3. Operational Governance
3.1 The governance of the relationship is formally managed through various
committees.
3.2 The overall relationship is managed through the Senior Executive Committee
(SEC), comprising the leading executives of each organisation’. The SEC
determines the strategic direction of the relationship and sets the wider
governance and operational requirements. It defines the strategy for the
relationship, approvers the annual business and sales plans and is
responsible for overall performance delivery. The SEC is quorate with two
representatives from each Party and voting (if required) is based on equal
votes aligned to the lower number of representatives. The Chair, which
rotates annually, does not have a deciding vote — the initial Chair is Bol.
Disputed matters within the wider relationship are escalated to the SEC; if
resolution is not achieved, the matter is escalated to the Chief Executive
Officers of both organisations.
3.3. There are five additional committees that manage day-to-day matters, viz:
a) Product & Pricing Forum (PPF);
b) Sales & Marketing Forum (SMF);
c) Service, Performance Management & IT Forum (SPMITF);
d) Joint Insurance Committee (JIC);
e) Regulatory Risk Committee (RRC).
Bol’s current representatives are the Chief Executive Officer, Chief Finance Officer and Directors of Distribution and
Product. Post Office’s representatives are the Chief Finance Officer and the Directors of Strategy, Financial Services
and Sales & Distribution.
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3.4 The PPF defines and reviews the overall product propositions, including
confirming features, channel mix and competitive pricing (versus the
benchmark). It assesses recommendations from either Party and if
appropriate approves changes. As with the SEC, both Parties have equal
voting rights; Bol is the permanent Chair of the PPF:
« Bol has the ultimate control over pricing but has to meet agreed
benchmarks and pricing to achieve the agreed plans.
3.5 The SMF agrees the sales and marketing plans (including the allocation of the
£15 million annual marketing budget funded by Bol) and monitors their
effectiveness. It reviews sales literature, internal and external PR and
communications, sales training and sales compliance, in conjunction with the
PPF. Both parties have equal voting rights and the Post Office is the
permanent Chair:
¢ Post Office has the final say on the allocation of the marketing fund, with
the Parties having agreed the general allocation by category sector.
3.6 The SPMITF oversees the systems and contact centre service levels and
change management processes and performance. It has equal representation
from each party with a rotating Chair.
3.7 The JIC provides the governance and oversight for the Insurance business,
approving the strategy, plans and budget. It also gives direction to Bol’s
Insurance Product Team, giving Post Office greater com fort that the business
is meeting its requirements. The Chair rotates annually, with Post Office
initially holding the position’.
3.8 The RRC oversees and monitors the compliance to the standards for for the
production and distribution of products, minimising the reputational and
regulatory risks for Post Office and Bol. It is permanently chaired by Bol with
Bol’s Chief Risk Officer and Post Office’s Legal & Compliance Director
attending quarterly. The minutes of this meeting are tabled at the Bol Board
and are made available to the Financial Services Authority (FSA)’.
3.9 The new governance structures set out above are operational with all
committees formally constituted.
4. Operational Processes and Responsibilities
44 While the governance structure establishes the decision making processes,
the contract also sets out the roles and responsibilities of each Party, viz:
e The Parties will jointly agree the business strategy and set the direction of
the business.
e Bol will manufacture the products to specifications agreed with the Post
Office and supply the RGM, provide on-going product servicing (e.g.,
sending statements, paying interest) and establish the regulatory
requirements for product marketing and sales.
e The Post Office will deploy an effective sales network, create and deliver
the marketing and sales strategies as agreed by the SMF and ensure that
As previously discussed at the Board from September 2014 Post Office has a two year one-way option to
buy out Bol’s share of the insurance business.
5 This is a continuation of the pre-existing arrangements.
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4.2
4.3
44
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all products and services (including all customer interactions) meet the
Post Office’s brand and the Regulatory Guidance Manual (RGM)‘.
To ensure that the customer proposition remains competitive the contract
requires that:
¢ All products will be reviewed on a two-year rolling basis to ensure that
they remain competitive;
e Product pricing meets agreed benchmarks.
While either party can propose new/changes to products and services Bol
must deliver products (itself or through a third party) that Post Office
reasonably requests and that align to the business plan.
Bol can only refuse to deliver a product requested by Post Office if:
e It is prohibited by regulation;
¢ It is uneconomical for it to do so;
e It is technically incapable of providing the product.
If both parties agree to develop a product but cannot agree on the aspects of
the product (e.g., features and commissions) a formal dispute process occurs.
If it remains unresolved an Independent Expert (IE) is appointed. The IE’s
recommendations are non-binding, but if Bol does not agree with them and
Post Office does, Bol is obliged to use reasonable endeavours to deliver the
product to the IE’s proposed recommendation. If it cannot, the Post Office can
identify a 30 party for Bol to enter into an agreement to manufacture the
product. If this is not possible exclusivity falls away.
5. Bol Financial Stability
5.1 The final component of Eagle governance relates to Post Office’s termination
rights and the information that Bol must provide to support these rights.
5.2 As previously presented to the Board, Post Office has a termination right if:
e Bol’s minimum core tier one capital ratio falls below the threshold? °;
¢ Bol fails to maintain liquid assets required by the regulator;
e Bol breaches the Net Stable Funding Ratio (NSFR) (to the extent that
these rules apply to Bol when they become operational from 2018); or
¢ Bol, or its parent, becomes insolvent.
5.3 To support these rights, Bol must inform Post Office immediately of any
threshold breach; failure to do so is in itself a breach of the contract.
5.4 To provide the Post Office with some notice of the potential that Bol may
breach a termination benchmark, Bol must provide Post Office with regular
updates of its financial position, including:
4 The RGM sets out the actions and duties that Post Office must perform for each product to meet its
regulatory obligations as a financial services intermediary.
5 Bol has certain grace period to remediate the situation as previously tabled to the Board.
° The definition of core tier one ratio is article 87(1)(a) of the draft European Regulation plus 3.5 percent
until 2016. A new formula will be agreed in 2016.
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¢ Formal update on its capital and liquidity status and immediate notice if it
becomes aware of any capital or liquidity issues that might give rise to a
termination event.
e 15 days after each public announcement of annual and half yearly results
and any interim management statement Bol must provide a certificate
stating’:
a) Its Minimum Core Tier One Ratio, the actual Core Tier One Ratio
and any Common Equity Tier 1 (CET1) Capital buffers or other
requirements applicable to Bol;
b) _Bol’s regulatory liquidity requirement and its position against the
benchmark;
c) Any NSFR requirement and Bol’s position;
d) That Bol is not in breach of the termination obligations, or of any
remediation plan agreed with the regulator.
e After each half year financial announcement a senior Bol executives must
provide a trading performance update.
e Bol must provide a presentation of its annual results, including a summary
of any Recovery and Resolution Plan (RRP)® submitted to the regulator
and summaries of any ARROW’ Letters received from the FSA as far as
they relate to the Post Office or Bol’s obligations to the Post Office.
6. Bol Compliance on Post Office
6.1 Post Office acts as the intermediary for Bol and is its “appointed
representative”. As such, Bol is accountable to its regulator’? to ensure that
Post Office is acting compliantly:
e The Compliance teams in both Parties monitor Post Office’s performance
to the RGM and the financial promotions rules set by the FSA. Bol assess
Post Office’s compliance through mystery shopping and other monitoring
(e.g., complaints reporting). It supports the product, marketing and sales
teams ensuring that both Bol and Post Office are meeting the applicable
Treating Customer Fairly standards. This is a continuation of the
established procedures.
6.2 Compliance performance and regulatory issues are reviewed by the joint
Regulatory Risk Committee.
7. Initial Issues
7 The governance processes with Bol are now operational and have already
thrown up issues that previously would have not been shared:
7.2 Savings pricing
The first presentation of these matters is due to Post Office in February 2013, following the presentation
of Bol’s 2012 full year results.
RRPs are FSA-required plans setting an institution’s plan for a stressed situation including orderly wind-
down.
Advanced Risk Response Operating Framework reviews are the existing FSA process to assess and
manage risk. With the establishment of the Financial Conduct Authority and the Prudential Regulation
Authority the approach is changing with increased focus on prevention rather than post-event resolution.
‘0 Currently the FSA.
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¢ Following recent significant drops in both wholesale and retail liability
(deposit) pricing, Post Office’s deposits have grown substantially ahead of
plan, reaching almost £18 billion against a 2012/13 plan of £16.6 billion.
This is not only a material cost to Bol but also risks regulatory intervention
if Bol is perceived to be securing a disproportionately large market share.
As a result, over three “emergency” Product & Pricing Committee
meetings Bol and Post Office are working together to agree a sustainable
pricing position, consistent with Post Office’s brand and competitive
position, the benchmarks and Bol’s balance sheet requirements.
7.3. Securitisation
¢ Securitising assets is a standard process for banks. The Agreement
requires that Bol seeks Post Office’s consent to securitise any Post
Office’s customers’ assets. This is to protect customers and ensure that
Post Office is able to enforce the termination rights.
e Bol has requested Post Office consent to a series of “test” repo
transactions, which includes some Post Office assets. This would not
have occurred under the previous arrangements. Post Office has given
consent for one year, provided that the counterparty is rated by Standard
& Poors as a minimum of A- and that each tranche does not exceed £250
million.
8. Conclusion
8.1 The new arrangements are in place and operational, giving Post Office
greater insight, certainty and control over the operations and direction of the
joint venture.
8.2 The Audit, Risk and Compliance Committee is asked to note the paper.
Nicholas Kennett
Director, Financial Services
November 2012
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POST OFFICE LTD AUDIT, RISK AND COMPLIANCE COMMITTEE
Approval of uncommitted loan facilities
1 Purpose
This paper seeks Committee endorsement to proceed to the Board with the following
recommendations:
e To approve entry into two uncommitted credit facilities of up to £50m each.
e To delegate authority to the CFO and Head of Corporate Finance to negotiate
and sign all related loan facility documentation.
e To approve a Board resolution in the form required by counterparties with
whom a loan facility may be agreed.
2 Introduction
At the October board meeting questions were raised regarding the counterparties that
provide operational financial and treasury banking services to Post Office Limited many
of which were inherited from Royal Mail. As a result, a review will be undertaken to
determine a strategic approach to the selection of financial counterparties. The outcome
of this review will be presented at the next Committee meeting in February for onward
ratification by the Board.
In the short term, to reduce external interest costs and improve operational efficiency
approval is requested to enter into two uncommitted credit facilities. The anticipated
interest saving resulting from this is approx. £200,000 pa as it reduces the funds that
need to be held on deposit as a contingency for unexpected working capital movements.
The banks were selected on their strength of their relationship with Post Office — though
currently no other banks have offered to provide any facility.
3 Funding Background
Under the funding agreement signed with BIS (Department of Business, Innovation and
Skills) Post Office Limited can borrow externally up to £50m, in addition to the £1.15bn
working capital loan facility from BIS. The drawdown of funds from the BIS facility
requires two days’ notice which could potentially generate a short term funding
requirement.
4 Rationale
Corporate Finance seeks approval to enter into two external facilities. These facilities
would enable the daily drawdown of funds from BIS to be managed more effectively. It
is anticipated that drawdown on these facilities will be infrequent but will provide the
flexibility to drawdown overnight to manage any shortfalls in daily cash flows. This
arrangement would replicate those previously in place with Royal Mail.
5 Operation of Facilities
Two facilities are recommended to ensure cost efficiency, flexibility, ease of access and
mitigate the financial risk of one facility being unavailable. Controls will be implemented
within Finance to ensure that the total drawdown on the two accounts does not exceed
£50m and that Post Office continues to operate within the terms of the BIS agreement.
Borrowing is limited to a term of 7 days.
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6 Counterparties and negotiation
The Head of Corporate Finance is currently negotiating with two financial institutions;
RBS (Royal Bank of Scotland), a current Post Office banking partner, and Citibank, to
secure external facilities of up to £50m each. These counterparties were selected as
current Royal Mail service providers. If negotiations are not successful with these
counterparties, other counterparties will be considered. Approval is requested for the
CFO and Head of Corporate Finance to enter into negotiations with these or other
counterparties and to sign all relevant loan documentation.
7 Facility & Interest Costs
There are no arrangement or commitment fees associated with these facilities. The only
cost is the interest charge on drawn funds. The interest cost is likely to be in the region
of LIBOR + 50 to 200 basis points. It is anticipated that these facilities will be drawn
infrequently when there is a large unexpected working capital movement e.g. bad
weather reducing the amount of physical receipts over the counter.
8 Recommendation
The Committee is asked to endorse the following recommendation to the Board:
The Board is asked to:
8.1 Confirm its approval for Post Office to enter into external borrowing
facilities up to a maximum value of £100m, such that external borrowing
of up to £50m may be drawn down at any one time.
8.2 Confirm its approval for the CFO (Chris Day) and Head of Corporate
Finance (Charles Colquhoun) to conduct negotiations with counterparties
and sign and deliver the loan and related documentation.
8.3 Confirm its approval of the attached form of Board resolution required by
the Royal Bank of Scotland or any similar resolution required by Citibank
or another counterparty with whom a borrowing facility may be agreed by
the CFO and Head of Corporate Finance.
Chris Day
November 2012
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Appendix
Board Resolution re Loan Facility (as requested by the Banks)
"After due and careful consideration of all the circumstances, the Board expressed the
opinion that it was satisfied that it would be most likely to promote the success of the
Company for the benefit of its members as a whole to enter into the letter in the form
now produced from The Royal Bank of Scotland plc (the “Bank”) in respect of the
uncommitted revolving credit facility of £50,000,000 made or to be made available to the
Company by the Bank.
IT WAS RESOLVED that in addition to and without amending, prejudicing or revoking
any Bank Mandate / Company Excerpt Minute or any other instruction/s provided or to
be provided by the Company to the Bank the CFO (Chris Day) and the Head of
Corporate Finance (Charles Colquhoun) be and are hereby authorised to sign and
deliver the letter on behalf of the Company."
Uncommitted loan facilities Chris Day Page 3 of 3
November 2012