Royal Mail Holdings pic
Audit results report for the year ended
30 March 2008
Royal Mail reference: ARC(08) 16
7 May 2008
3] Ernst & YOUNG
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ii SUERNST&YOUNG =o,
Private and confidential
Audit and Risk Committee 2 May 2008
Royal Mail Holdings pic a
148 Old Street Direct Line:}_ GRO
London e-mail: aduncan1@:
EC1V 9HO
Members of the Audit and Risk Committee
Audit results report for the year ended 30 March 2008
We are pleased to attach our Audit Results Report for the forthcoming meeting of the Audit and Risk
Committee. The purpose of this report is to provide an update on the status of our audit prior to the
Group's preliminary announcement on 8 May 2008. Our report also provides our conclusions on the
key areas highlighted in our Audit Planning Report and on other matters that have arisen during the
audit. We have included our observations in relation to controls insofar as they impact the scope of
our audit work and we also present our preliminary release letter and confirm our independence from
Royal Mail Holdings pic.
We welcome the opportunity to discuss this report with you on 7 May 2008.
Yours sincerely,
For and on behalf of Ernst & Young LLP
Alison Duncan
Ernst & Young
United Kingdom
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Contents
Overview.
Significant audit and accounting issue:
Control themes and observations
Scope update and status of the audit....
Appendix A Auditor independence and fees...
Appendix B Preliminary announcement - auditor consent letter
AppendixC _ Draft letters of representation...
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OVERVIEW
Overview
The proposed publication of an unaudited preliminary announcement of the Group's results
on 8 May requires our audit to be at an advanced stage at that date. We have therefore
accelerated our audit procedures to ensure that the primary statements and all notes to
the accounts that tie directly to these statements will be completed by 7 May. Following the
preliminary announcement, we will focus our work on narrative disclosures and ‘front end’
statements such as the directors’ report and remuneration report, prior to finalisation and
signing of the accounts in the week commencing 19 May.
The ability to accelerate the publication of the Group's annual results is supported. by a
strong financial statement close process, including P11 hard close audit, that was well
executed by the business unit and Group finance teams. Our agreed audit approach of
highlighting and discussing issues at Period 11 has facilitated resolution by the time of our
year end audit visit.
We confirm that we have received full co-operation from the Royal Mail teams with whom
we work and to the best of our knowledge we have received all information necessary to
enable us to complete our audit.
Significant audit and accounting issues
See pages 3 to 16
The following significant items were discussed and agreed with management:
» The going concern basis for RMG and RMH has been confirmed
> Anupdate on our going concern review for POL will be given at the Audit and Risk
Committee (‘ARC’) meeting. Retention, or otherwise, of the emphasis of matter
paragraph in our POL audit report to be determined
» The key actuarial assumptions used in determining the pension deficit are within
acceptable ranges
» We concur with amounts accrued for regulatory compensation and other penalties at
March 2008
» Severance and non-severance provisions are appropriately stated
» We agree with the accounting treatment for ColleagueShares and with the disclosure
of the costs as exceptional
>» Accruals made for management bonuses, together with the UK and GLS LTIP schemes
are appropriate with reasonable judgments applied. Government approval of certain
UK targets is outstanding
>» The impairment of Project Breakthrough has been made in accordance with
accounting standards and the disclosure of the costs as exceptional is in accordance
with Group accounting policies
> Following the Project Speedy management fraud at GLS Italy, extended audit
procedures have not highlighted any manipulation of the financial statements. We
concur with amounts accrued for potential costs
» The corporate taxation charge is appropriate and a prudent methodology has been
used to calculate the deferred tax position. Significant increase in deferred tax asset
recognised reflects future pension benefits offset by a reduction in tax rate
>» The non EU revenue related VAT accrual is appropriate. Work on the VAT accrual for
miscoding exposures is ongoing and a verbal update will be given at the ARC meeting
> Other areas where we agree with management's accounting treatments are: the
REIMS accrual, the classification of vehicle leases, the treatment of Black Eagle costs
and the capitalisation of POL broadband modem costs
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OVERVIEW {
Control themes and observations
The key internal control findings arising from our audit work are:
See pages 17 to 22
» No material control exceptions noted from our work on the Royal Mail Group revenue
and payroll processes
» Changes in audit approach were required following exceptions noted in the IT general
control environment and POL payroll process
>» Improvements are required in the indirect tax process to support the VAT returns and
partial exemption calculations
» Asummary of our controls observations, update on prior year management letter
agreed actions and 2008 challenges are set out on pages 17 to 22
> Detailed control observations and recommendations of a ‘housekeeping’ nature are
being discussed with management and will be reported in our management letter
Scope update and status of the audit
We undertook our audit in accordance with the scope set out in our engagement letter, our
September 2007 Audit Planning Report and our March 2008 Audit Update Report.
See pages 23-24
We have finished our audit procedures at the business units and the Group audit is
substantially complete. Key matters outstanding include detailed narrative disclosures and
“front end’ statements and reports.
Summary of audit differences
See page 24
» There are no unadjusted audit differences above our reporting threshold of £1.0m
Our opinions and confirmations
See pages 24-32
>» We anticipate providing the directors with our consent letter, on the unaudited
preliminary announcement, on 8 May 2008 (refer to Appendix B)
» We anticipate issuing an unqualified audit opinion on the consolidated Royal Mail
Holdings plc Group accounts for the year ended 30 March 2008
» We confirm that there have been no changes in our assessment of our independence
since our report dated March 2008
» We confirm that our fees for non-audit services during 2007-08 have been reviewed to
ensure we have maintained our independence as your auditor
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES.
Significant audit and accounting issues
Set out in this section are those key audit findings discussed with local and Group
management during the P11 hard close and final audits.
In order to provide clear opinions on the issues that matter most, we have introduced our
own assessment of the subjectivity involved in determining the accounting treatment used
in preparing the financial statements to provide an indication of the level of risk involved. In
addition, we provide our assessment of where judgments and estimates determined by
management fall in a range of possible outcomes. The bases for our assessments are
outlined below:
Description of criteria
Level of subjectivity
This applies only to significant estimates and indicates the level of subjectivity in the
estimate as well as the reliability of the underlying data used to develop the estimate.
Ratings applied to each criteria
High - Estimate involves significant judgment and is made with little verifiable historical
experience, current trend information or market and industry comparative information.
Medium - Estimate still involves some judgment and is made with verifiable historical
experience, current trend information, or market industry comparative information.
Low - Estimate involves limited judgment and is made with verifiable historical experience,
current trend information, or market industry comparative information.
Assessment of management's judgments and accounting treatment
This measurement provides an
indication of where in the range of
possible acceptable outcomes the
estimate has been recorded.
The evaluation of any estimate or
treatment being in the upper (more
conservative) or lower range (less
conservative) of acceptable outcomes
does not imply the estimate/treatment
is not in accordance with GAAP, or the
preferred accounting has not been given
to the estimate/treatment or that the
estimate should move to the mid range
immediately.
The estimate/treatment is
within the lower range of
acceptable outcomes
resulting in a less
conservative treatment.
The estimate is within the
mid range of acceptable
outcomes.
The estimate/treatment is
within the upper range of
acceptable outcomes
resulting in a more
conservative treatment.
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Issues dashboard
The following ‘dashboard’ summarises the significant audit and accounting issues outlined
in this report. It seeks to provide the ARC with an overview of the subjectivity involved and
our assessment of where the accounting treatment falls within a range of acceptable
outcomes.
Audit and accounting issue Level of EY Page
subjectivity Assessment reference
Funding
> RMG&RMH N/a N/a 5
> POL N/a N/a _ 6
Pensions High tim /H 6
Regulatory compensation and other penalties
> Bulk compensation High ti M[H 7
> Other penalties Low to oM [ H I 8
Provisions —
> Severance Low Lj} MH 9
>» _Non-severance Medium L {Mi H 10
ColleagueShare High LiMI]H 10
LTIP
>» UK Low t[M[H ii
> GLS . Lowi tIMjH 11
Project Breakthrough Low uo l H 12.
Project Speedy Low Li M/IH 12
Corporate tax Medium LM! Hi 13
> Non EU revenue related accrual Low L [ M [ H 15
>» Accrual for miscoding exposures High Audit ongoing 15
Other issues
>» REIMS Low tL} M/H 16
> Vehicle leases Low Lj M {LH 16
> _ Black Eagle costs Low Li Mi) H 16
> POL broadband costs Low Lim/H 16
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES.
Going concern
RMG & RMH
We have reviewed the funding analysis prepared by management and presented in the
Briefing Book. We note that the cash flow forecasts are based on an updated Strategic Plan
that has been approved by the Board, but not yet by Government. Below is a reconciliation
to the funding analysis previously presented:
Headroom reconciliation 2008-09 2009-10 2010-11
£m £m £m
March brought forward 627 457 354
_Opening funds improvement 449 __ 406 88
Free cash flow movements -43 318 81
Risk changes 180 181 6
Management actions 7197 7176 54
March carry forward 1016 550 421
Opening funds improvement
The improvement is mainly due to delayed capital expenditure relating to the
Transformation case. As the capital is spent this improvement is reduced.
Free cash flow movement
The changes are due to:
Benefits from the pay deal
Benefits from pension reform
Modelling the impact of declining revenue
Ongoing delays in capital expenditure
vvvy
Risk changes
The improvement to ‘Risks’ is due to a significant portion of the previously noted revenue
tisk being modelled into the free cash flow numbers. Management has assumed within the
new Risk numbers that the market will decline by around 8% over 4 years.
In addition, management has identified a risk that Royal Mail will not be allowed to benefit
from the pension changes and will be required to pass these on to the pension trustees.
Management actions
The main changes relate to:
» More accurate information relating to the stakeholder dividend which has resulted in
lower amounts being recognised
» No management action recognised in the updated analysis relating to slowing down
investment. Previously this accounted for £98m in 2008-09
>» Norisk amount for fines and compensation associated with Industrial Action. In the
previous analysis there was a downside of £200m in 2008-09
We also note that the management actions are not exhaustive and further actions such as
the disposal of GLS could be taken, if necessary.
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES,
Funding covenants
Management has prepared covenant calculations for the 12 months to March 2008,
September 2008 and March 2009 for both the Senior Debt and GLS facility. The
calculations, which incorporate the forecast numbers included in the updated Strategic
Plan, indicate sufficient headroom on each financial ratio covenant. Management has
been unable to perform the covenant calculations at September 2009 as the 2009-10
forecast is only available in annualised form.
We have performed sensitivity analysis on the covenant calculations by considering the
2008-09 ‘Risks’ as included in Table 1 of the RMG Latest Funding Analysis included in the
March 2008 Briefing Book. The ‘sensitised’ calculations indicate that there would be no
breach in the covenants in 2008-09.
We have also prepared high level covenant calculations for 2009-10 incorporating the
updated Strategic Plan forecast and the downside Risks for this period. The analysis
highlights a breach in the covenants should the downside Risks materialise. However we
acknowledge that the calculation does not take into consideration the potential
management actions.
We suggest that the future covenant compliance position is regularly monitored to provide
management with sufficient time to identify and implement any actions necessary.
Going concern conclusion
We concur with the directors’ conclusion that both the RMH Group and RMG accounts
should continue to be prepared on a going concern basis.
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The key change in the assessment of going concern from prior years has been the funding
arrangements agreed with government on 16 May 2007, the subsequent receipt of funds,
and the agreement to extend the £1.15bn working capital facility from 2010 to 2011 on
18 April 2008.
At the time of writing this report, POL management are updating their headroom analysis
incorporating the fund flows from both the financing outlined above and from the 5 year
Strategic Plan. We have requested that the cash flow forecasts are overlaid with risk
sensitivities so that a range of potential scenarios can be considered.
On reviewing this data, and particularly in view of the funding package agreed with
government, we will need to consider whether it is appropriate to retain the emphasis of
matter paragraph included within our audit report on the POL statutory accounts since
2004-05. Our Professional Standards Panel, which was consulted on the initial
modification of our audit report, is due to meet on the 6 May, and we will provide
confirmation of our conclusions at the ARC meeting on 7 May.
Pensions
Level of subjectivity EY assessment
High LiEM/H
Royal Mail has recognised a liability of £2.9bn on its balance sheet at March 2008 (March
2007: £5.0bn) in respect of its net pension liability in accordance with IAS 19 ‘Employee
Benefits’. This amount comprises £23.9bn scheme assets offset by £26.8bn of defined
benefit obligation.
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During the year, following consultation with its actuaries, Royal Mail has updated its
assumptions used in the measurement of the defined benefit obligation. These updated
assumptions have led to a decrease in the obligation of £1.8bn, with the asset value
increasing by £0.3bn.
We have reviewed the key financial assumptions underpinning the valuation, with input
from EY pension specialists where appropriate. We have also discussed and reviewed the
methodology used in preparing the assumptions with the Group's actuaries. The
assumptions have been prepared on a consistent basis with previous years, with
adjustments made for current market conditions.
In our opinion, Royal Mail has used appropriate assumptions which are consistent with
those applied by UK plc in valuing the quantum of their pension obligation in accordance
with the measurement criteria set out in IAS 19. All of the assumptions fall within an
acceptable range and we have the following observations:
2007-08 2006-07 EY View
Salary increase rate 4.6% 4.1% Middle of range
Pensions in payment increase rate 3.6% 3.1% Prudent end of range
Deferred pension increase rate 3.6% 3.1% Middle of range
Discount rate 6.5% 5.3% Optimistic end of range
Price inflation 3.6% 3.1% Prudent end of range
Return on assets 6.8% 7.0% Middle of range
We note that the pension obligation is extremely sensitive to small changes in the
assumptions, with a 0.1% change in the discount rate leading to a change in obligation of
approximately £450m. We are working with management to ensure that the financial
statements contain appropriate disclosure in relation to this sensitivity.
The changes in the Plan benefits for future service that come into force from 1 April 2008
have no impact on the deficit recorded at March 2008. However, these changes will be
considered by the Group's actuaries in future fund measurements.
Regulatory compensation and other penalties
At March 2008, Royal Mail has accrued a total of £60.4m (March 2007: £44.2m) for
regulatory compensation and fines. The most significant items are £35.0m in respect of
potential bulk compensation following the impact of the industrial action on Quality of
Service during the year and £12.8m in respect of an EU challenge to government funding
in 2001.
Bulk compensation Level of subjectivity EY assessment
High L
Industrial action in Q2 and Q3 had a significant impact on the Group's ability to achieve its
Quality of Service targets.
As a result, Royal Mail has submitted an interim application to Postcomm to waive payment
of Q2 compensation to bulk mail customers. Non-binding feedback has been received from
Postcomm stating that they are minded to agree with Royal Mail's request, although there
will be no formal decision until late May 2008. A similar application for Q3, when the
nature of the industrial action had a greater impact on Quality of Service, will also be
submitted.
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Notwithstanding the tone of the current communication, management has assessed that
Postcomm will levy a compensation payment to respond to stakeholder concerns and
representations. Postcomm’'s track record of instructing compensation payments and
levying fines alongside its decision to hold a public forum, which will hear from customers,
competitors and other stakeholders are in management's view, indicators that an exposure
is probable. A £35m accrual has been recognised at March 2008, which is management's
best estimate of the compensation payout.
Given the level of subjectivity and judgment involved in determining the amount to be
accrued, we have understood and validated the potential range of liability, reviewed
correspondence with Postcomm and challenged management's assumptions. We are
satisfied that the recognition of a liability is appropriate and that £35m is management's
best estimate of the compensation exposure. We will obtain a specific representation from
management in relation to this item,
Other penalties Level of subjectivity EY assessment
Low tL MIH]
The EU has launched legal proceedings against the UK Government in relation to funding
packages agreed with Royal Mail in 2001, 2003 and 2007.
Following correspondence between the EU and the UK Government during the year, it has
become clear that the EU will find against the UK government in relation to the GLS loan in
2001. Any penalty levied will in turn be passed on to Royal Mail. Based on interpretation of
the benefit of this arrangement enjoyed by Royal Mail, management believes the penalty
will be either £5m or £12.8m, and have accrued for the larger amount, which has been
booked as interest.
The Government has sought and received professional advice that the funding for 2003
and 2007 is in compliance with the Market Economy Investor Principle (‘MEIP’), and
therefore was agreed with appropriate terms and conditions. On this basis no amount has
been accrued in relation to this challenge.
We have reviewed the correspondence and challenged management's assumptions and
agree that the amount booked is appropriate.
In relation to the remaining fines and compensation accruals, we are satisfied that they are
correctly stated.
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES.
Provisions
The table below summarises the utilisation, charges and reclassification of provisions by
major project. Overall, the Group continues to manage its provisions appropriately.
Provision I Charges/ Utilised — Provision
at Mar 07 reclass at Mar 08
£m £m £m £m
Severance Provision
Royal Mail
> HWDC 21.0 2.6 (0.9) 22.7
____>__ Other mail projects 43.7 92.5 (84.5) 51.7
POL 1.4 189.2 (47.2) 143.4
Others (incl. PFWW, Group 7.6 18.3 (11.2) 14.7
Functions and pension)
Total severance provisions 73.7 302.6 (143.8) 232.5
Non-severance provision
Property 33.1 (7.0) (5.0) 21.1
ColleagueShares bd 116.0 - 116.0
POL 3.3 62.3 (27.4) 38.2
Others 0.3 4.7 (1.2) 3.8
Total non-severance provisions 36.7 176.0 (33.6) 179.1
Total Provisions 110.4 478.6 (177.4) 411.6
Severance Level of subjectivity EY assessment
Low LIM !H
Heathrow Worldwide Distribution Centre (‘'HWDC')
The project for consolidating international mail sorting from mail centres across the
country to HWDC commenced in 2003 and is ongoing through a revised timetable of
change, with further delays experienced as a result of the industrial action during 2007-08.
The most recent updated plans indicate that significant migration is scheduled to occur
during the remainder of 2008.
Despite the ongoing delays, management remains committed to full operation of the HWDC
facility and we are satisfied that the provision at March 2008 continues to meet the
recognition criteria of IAS 37.
Other mail projects
The provisions in relation to other mail projects reflect actions being undertaken as part of
the transformation plan. Significant components of this provision are delivery best
practice (£23.7m) and the relocation of Reading and Oxford mail centre traffic to Thames
Valley (£12.5m). We are satisfied that these amounts have been appropriately
recognised and applied, and that the year end balance is correctly stated.
POL restructuring
At March 2008, POL has recorded restructuring provisions in relation to the Post Office
branch closure programme and the transfer of a number of branches to WH Smith shops.
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The branch closure programme relates to approximately 2,500 Post Offices, for which
government funding of £313m was received. Agreement has also been reached to transfer
70 existing Post Office branches to WH Smith shops located in the same area.
Formal plans were established during the first half of the year for both programmes and at
that point a provision was booked for the expected costs of the related severance and
closure costs. The majority of the provision, £129m, relates to severance and the
remaining £38m relates to non-severance costs associated with closing the branches such
as decommissioning costs.
POL has also booked severance provisions during the year in relation to other ongoing
restructuring programmes (£14m). We have reviewed the detail of the provisions and the
supporting evidence and concur that they correctly reflect liabilities at March 2008.
Other
The main component of the ‘Other’ severance provisions is £7.7m in relation to the Group
Technology review. Redundancies were announced during the current year and
assessment centres held prior to the year end to identify the individuals who would remain
in the business.
Non-severance Level of subjectivity EY assessment
Medium t[M/H
Property
At March 2008, the Group is carrying a provision of £21.1m (March 2007: £33.1m) in
relation to ongoing onerous property leases. The provision has decreased during the year
following the payment of ongoing lease amounts, combined with the sale or rental of a
number of buildings. The methodology in calculating the provision remains consistent with
previous years and we have reviewed and challenged the estimates and assumptions. We
concur that the provision remains appropriate.
Other
The most significant other non-severance provisions relate to POL and ColleagueShares.
The details of the POL provisions are included in the severance section above. The
ColleagueShares detail is included below.
ColleagueShares
Level of subjectivity EY assessment
High tlmM/uH
During the year an amount of £116m has been booked in relation to the ColleagueShare
phantom share incentive scheme.
The estimation of the provision in the current year involves a number of judgmental
assumptions, and adjustments to the provision are probable over the period of the scheme
as more accurate information is obtained and the liability is trued-up. The key assumptions
driving the provision are the number of ColleagueShares to be paid out in four and five
years’ time, the rate of leavers, the discount rate, and the value of each ColleagueShare at
the date of payment. We have reviewed the ColleagueShare model and identified some
differences in assumptions used in terms of discounting calculations and inclusion of future
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Joiners, among others. However, the net impact of these judgmental differences is not
material, and we are satisfied that the provision is correctly stated.
Stakeholder dividends
At March 2008, the Group has accrued £161m reflecting management's intention to pay
the maximum possible payment of £800 per employee, although both the targets for Group
Profit and local business unit targets have not yet been approved by the Government. The
calculation supporting the accrual is appropriate and we will obtain a specific
representation from management on their intention to pay out the full £800 per employee.
Disclosure
The disclosure of these costs as operational exceptional items was agreed and reported to
the ARC at its meeting on 6 March 2008.
Long Term Incentive Plans and Bonuses
UK LTIP and bonuses Level of subjectivity EY assessment
Low tiuiu
At March 2008, the Group has recorded a liability of £17.9m (March 2007: £42.0m) in
relation to the UK Long Term Incentive Plans (‘LTIP’). This includes £3.2m for the
amended 2005-08 Executive LTIP scheme (March 2007: £42.0m) and £14.5m for the
2007-10 LTIP scheme (March 2007: nil).
In addition to the above, the Group has recorded a liability of £81.1m (March 2007:
£74.1m) in relation to management bonuses, based on Group profit and Quality of Service
targets.
In calculating the liabilities at March 2008 the most significant assumption that has been
made is in relation to the targets for the 2007-10 LTIP scheme and the Board member
bonuses. The targets have been approved by the Group Board, but have not yet been
approved by the Shareholder Executive.
Our procedures on the calculations have not highlighted any exceptions and we concur
that, in the absence of government approval, using Board-approved targets is the most
appropriate way for management to estimate the liability at March 2008.
GLS LTIP Level of subjectivity EY assessment
Low t[mMiuH
At March 2008, GLS has recorded a liability of £12.8m (March 2007: £7.0m) in relation
to the 2006-08 GLS LTIP scheme.
This is the final year of the 2006-08 scheme and GLS management is entitled to payments
under this scheme based on the incremental increase in the value of the GLS business over
the three year period. The amount recorded includes two key judgments; an uplift of the
bonus pool for organic growth and an additional six months of earnings in relation to the
Milan acquisition.
A 20% uplift of the bonus pool has been applied for meeting the organic growth targets.
The actual organic growth over the three year period is marginally below the 7% target.
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The Milan acquisition occurred halfway through the 2007-08 year. An additional six
months of earnings has been included for the six months of the financial year that GLS did
not own Milan.
We understand that the Group Remuneration Committee will agree to these assumptions at
its May meeting. We are therefore satisfied that the obligation at the year end has been
correctly calculated based on the parameters set out in the scheme and the quantum of the
provision recorded is management's best estimate of the obligation at March 2008.
Project Breakthrough - Impairment
Level of subjectivity EY assessment
Low tiM/4H
Following the decision to terminate the project to create a single parcel management
system for PFWW, management has recognised an impairment of £8.0m. The majority of
this balance relates to a £5.1m write off of the intangible asset capitalised and for which no
future value is anticipated given the issues that arose in relation to the capability of the
software supplier and the likely change in scope in any revised track and trace solution.
The impairment also includes £2.0m for the cost of exit from the 5 year contract with the
supplier TX. Whilst the maximum contractual termination payout is £8.0m, PFWW
management believes there is a strong legal case to achieve a much lower settlement. At
the time of writing this report, we understand that lawyers for both parties are working on
a £2.0m settlement agreement.
We concur with the £8.0m impairment and note that it will be classified as an exceptional
item within the Group's operating profit. Given the materiality of this amount to the results
of PFWW and to the understanding of the underlying performance of this business
segment, we concur that this treatment is in line with the Group's accounting policy for
exceptional items.
Project Speedy
Level of subjectivity EY assessment
Low uc[mM[u
In February 2008 a fraud investigation was initiated by GLS Corporate Management in
respect of alleged improper activities by the top management of GLS Italy. Forensic
accountants have been engaged to perform a detailed investigation and their work remains
in progress. To date a number of items of circumstantial evidence have been discovered.
However, it is questionable whether adequate evidence has been gathered to support legal
action.
We have extended our audit procedures in Italy by increasing sample sizes and increasing
the level of journal entry testing. These procedures, together with those of the forensic
accountants, have not highlighted any manipulation of the financial statements.
The employment contracts of both individuals concerned were terminated on 30 April
2008. Management believes that the maximum potential exposure in relation to claims by
the individuals is £2.4m and a provision of £1.6m has been established as the best
estimate of the amount payable. An additional £0.3m has been accrued in relation to
professional fees incurred to date and we concur that these amounts are appropriate.
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Corporate tax
Level of subjectivity EY assessment
Medium tL MIH
The Group's tax charge for the period is as follows:
2007-08 2006-07
Profit before tax (£77m)__-£313.0m
Tax charge/ (credit) - income statement (£212m) £27.0m
Effective tax rate N/a 8.6%
Tax (credit) /charge - summary of Group recognised £18m = (£27.0m)
income and expenses (SORIE)
Net total tax credit recognised in year (£194m) (£0.0m)
Net effective tax rate N/a N/a
Tax credit - income statement
The principle figures affecting the recognition of a £212m tax credit are:
> AUK current tax credit of (£19m) in respect of payment for losses from joint
ventures
>» A foreign tax charge of £29m in respect of GLS
>» Adeferred tax credit (UK and overseas) of (£216m)
The deferred tax credit of £216m is made up of the following elements:
> £246m credit in respect of the reassessment of deferred tax assets for fixed assets,
losses and ongoing pension contributions
> £30m charge reflecting the change in UK and German corporation tax rates
Tax charge - SORIE
The £18m tax charge recorded in the SORIE comprises:
» Current tax charge of £3m in relation to fair value movements on gilts during the year
>» Deferred tax charge of £15m following the remeasurement of the deferred tax asset
recognised in equity on the pension scheme deficit as a result of the decrease in the
UK corporation tax rate from 30% to 28% with effect from 1 April 2008
Deferred tax assets
Recognised deferred tax assets
A deferred tax credit of £216m has been recognised in the year, bringing the total net UK
deferred tax asset to £591m at March 2008 (March 2007: £397m). This credit is
primarily in respect of deferred tax on ongoing pension liabilities (£125m), fixed assets
(£35m), and losses (£33m). The basis of UK deferred tax asset recognition remains
prudent and consistent with the approach adopted at March 2007, with the amount
recognised being restricted to the tax benefit which is expected to be realised in the next
five years based on the information in the Strategic Plan approved by the Board. The key
reason for the increase in UK deferred tax asset recognition arises from the significant
increase in forecast profits in the updated Strategic Plan over the next five years
(particularly in years 4 and 5) mainly as a result of the benefits from the pension reform.
The Group's overall deferred tax asset at March 2008 is £608m. This comprises £591m
relating to UK operations and £17m relating to GLS overseas operations.
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES
The rate of UK corporation tax has reduced from 30% to 28% from 1 April 2008. In
addition, the combined effective corporate income tax rate in Germany has reduced from
37.8% to 28.6% with effect from 1 January 2008. These rate changes have decreased the
size of the Group's balance sheet deferred tax asset by £45m
Unrecognised deferred tax assets
At March 2008, the Group has potential net deferred tax assets of £758m, principally
attributable to the actuarial deficiency of the Group pension plan, together with losses
carried forward in POL and fixed asset temporary differences in RMG and POL. In view of
the uncertainty regarding the availability of suitable future profits, and in accordance with
IAS 12 these deferred tax assets have not been recognised at the balance sheet date.
Correspondence with revenue authorities
HMRC are currently updating their risk assessment of large businesses following
publication of revised risk assessment guidelines at the end of 2007. We expect that Royal
Mail should receive a revised risk assessment/rating shortly. The risk rating awarded will
have a significant impact on the resource allocation the Group receives from the tax
authorities over the next few years.
A review of HMRC correspondence on open enquiries has been undertaken. A prior year
credit of £3.0m has been recognised as a result of the closure of earlier periods (2000-01
and 2001-02) and developments in HMRC enquiries in other years. With regard to other
open enquiries, it is anticipated that any increases in UK taxable profits arising as a result
of these enquiries will be sheltered by a combination of rollover relief, capital losses and
trading losses such that no additional provisions should be required.
Future changes
In the 2007 Budget, the Government announced their intention to phase out industrial
buildings allowances (IBAs) through legislation to be implemented in Finance Act 2008. In
the 2008 Budget, the Government published draft legislation confirming that there would
be a phased abolition of IBAs with effect from 1 April 2008, with no further allowances
being available after April 2011. These changes are still subject to Parliamentary approval,
and so their effect is not reflected in the Group's balance sheet at March 2008. However, it
is anticipated that these changes will reduce the Group's unrecognised deferred tax assets
by approximately £100m.
As this is a non-adjusting post balance sheet event, in accordance with IAS 10, the nature
and impact of such a change must be disclosed in the financial statements.
VAT
In relation to the VAT accounting issues outlined in papers to the ARC in March 2008, the
Group has accrued £38.4m in relation to estimated over recoveries of VAT. The key
elements to this liability are:
1. £31.6m in relation to over recovery of VAT as a result of the application of
unsupported non EU revenue figures applied in the calculation. £26.7m relates to the
difference in VAT claimed since 2004-05 up to March 2008. The balance of the
accrual relates to management's estimate of interest and penalties.
2. £5.5m in relation to the potential underpayment of VAT as a result of general ledger
mis-codings that have resulted in the incorrect treatment for VAT purposes.
3. Sundry items, including unreconciled VAT balance (£1.7m), and potential
overrecoveries of VAT (£2.3m) and £0.1m for other minor items.
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES
Non EU revenue related accrual
Level of subjectivity EY assessment
Low LiMiH
In the absence of formal correspondence with HMRC on the likely assessment in relation to
the over recovery of VAT as a result of the unreconciled non EU revenue figures, we
obtained permission from management to speak directly with HMRC and confirmed the
following:
» The proposed assessment for the overrecovery of residual VAT by RM will be for
£26.8m, plus interest and penalties. The assessment is expected to be issued at the
end of May
» The assessment is subject to review by the partial exemption specialist officer, but is
not expected to change significantly
>» The Client Relationship Manager for Royal Mail has indicated that penalties will be
mitigated to the fullest extent possible
> There is no current intention to issue the assessment and then review the historic
position in detail
» The partial exemption annual adjustment will be undertaken in September 2008 (for
the year ended March 2008) which, as in any other year, could lead to an additional
liability depending on the result of the adjustment calculations and/or the review
thereof
On this basis, we are satisfied that this accrual is management's best estimate of the
liability at March 2008.
Accrual for miscoding exposures
Level of subjectivity EY assessment
High Audit ongoing
The £5.5m accrual has been calculated from a high level analysis of likely error rate for
each revenue material master code in the system. At the time of writing this report, our
work in validating the appropriateness of this analysis and the adequacy, or otherwise, of
the accrual is ongoing. Our current approach is to:
» Perform sample testing on both accounts payable and accounts receivable in the year
to identify any miscoded items and to extrapolate our findings across the complete
population of transactions
» Seek to ‘cleanse’ accounts payable data provided to us, so that we can run these
details through our Discovery software which is designed to ‘flag’ potential miscoded
items and would provide a more holistic indicator for the potential scale of miscoding
within the accounts payable ledger
We will provide the ARC with a verbal update on the audit status of this item at its meeting
on 7 May 2008.
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SIGNIFICANT AUDIT AND ACCOUNTING ISSUES
Other issues
REIMS Level of subjectivity EY assessment
Low tim[u
At March 2008, Royal Mail has accrued £14.4m (March 2007: £11.3m) for potential
settlements in respect of the difference between UPU and REIMS rates. This accrual is
calculated based on the total balances known for periods up to March 2007 and includes an
estimate of traffic for the year ending 30 March 2008. We have reviewed management's
calculation and supporting assumptions and concur that the amount accrued is
appropriate.
Vehicle leases Level of subjectivity EY assessment
Low ti M]H
Royal Mail has used finance leases to fund their £90m 2007-08 fleet replacement
programme. We have reviewed the details of the leases and concur that they are finance
leases in substance and that the appropriate accounting treatment has been followed.
POL Black Eagle costs Level of subjectivity EY assessment
Low tlM/H
In previous years management had capitalised £8.2m of professional fees associated with
obtaining further Government funding (Project Black Eagle) to enable them to restructure
the Post Office network.
Following receipt of £533m of short-term and other funding, in addition to £150m rural
network funding in the current year, management has written these previously capitalised
costs off during the year. We concur with this accounting treatment.
POL broadband costs Level of subjectivity EY assessment
Low Li MH
Modems issued to POL broadband subscribers remain the property of POL throughout the
subscription. Royal Mail has capitalised the costs of these modems with an appropriate
useful life based on industry-expected subscription lives. We concur with this accounting
treatment.
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CONTROL THEMES AND OBSERVATIONS.
Control themes and observations
Our review of the Group's system of internal control is carried out to assist us in expressing
an opinion on the accounts of the Group as a whole. This work focuses on the key
processes that impact the financial statements, namely payroll, revenue and IT. We
selected key controls within these processes and performed testing to address the material
financial statement risks in specific areas. We also revisited the recommendations that we
made in 2007 and reviewed the status of management's agreed actions.
We set out below a high level summary of our observations and audit findings in these
areas.
Group Finance
Control observations
Financial statement close process
The ability of the Group to accelerate, post year end, its results announcement by two
weeks on the original timetable, is supported by the completion of P11 hard close audits
and the quality of the Group finance team and its organisation in consolidating the Group
results and preparing the Group accounts. The most challenging area of audit related to
VAT, and we set out our specific comments below.
Taxation
The issues arising in relation to VAT in the current year, compounded by the changes of
personnel within the Group tax department, meant that a high level of attention to this area
was appropriate. The audit of the VAT balances was challenging and protracted. A key
issue was continued lack of appropriate controls and processes to support the numbers in
the VAT returns and the partial exemption calculations and as discussed at the ARC
meeting on 6 March, the Group will need to contract in some specialist support and recruit
appropriately to bolster their capabilities in this area. The following items will need to be
addressed as a matter of urgency so that the Group can have certainty in its VAT
accounting in future years and obtain a more favourable risk assessment from HMRC:
> Quarterly returns, calculations and submissions
» Adetailed end to end review of the Group's VAT processes, controls and accounting
including a review of transactions posted to facilitate possible disclosures of any
additional liabilities
» Negotiations with HMRC to agree a new special method for Royal Mail Group for the
partial exemption year ending March 2009 and beyond
Journal entry testing
As in prior year audits, one of the ways we have addressed the requirements of ISA 240,
‘The auditor's responsibility to consider fraud in an audit of financial statements’, is by
performing testing of journal entries posted throughout the year.
All manual journals relating to the UK Group, GLS Germany, GLS France and GLS Italy
operations, for the 12 month period, were input into a data analysis too! to highlight
inconsistencies that may be due to fraud or errors. Any anomalies identified by the tool,
such as debits to liability accounts, credits to asset accounts, significant round numbers,
duplicate transaction references, significant journals posted close to the year-end, and
journals with unusual descriptions were investigated, and support for the selected journals
was obtained. We noted no exceptions in our procedures.
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CONTROL THEMES AND OBSERVATIONS,
2008 challenges
The Group is currently in the process of recruiting a new tax director whose role will need
to encompass compliance, reporting, forecasting, processes, risk management, planning,
transactions, litigation, lobbying and global responsibility and oversight in respect of GLS
Cin view of the increasing global reporting to HMRC). This individual should have
responsibility for all taxes, mirroring the approach adopted by HMRC with their Customer
Relationship Manager in their new risk-based approach. On this basis, addressing the VAT
actions outlined above will be an immediate priority.
We also recommend that the tax department builds stronger links with:
» Internal Audit & Risk management, especially for assurance over processes and
controls
» Business units to ensure proper understanding of the tax implications of transactions
and quality controls over tax-relevant information processes
IT
Audit process and approach
Following the challenges experienced in performing our IT audit in prior years, the audit
process was greatly improved, in particular for Royal Mail Group, as the ownership within
the Group IT function for managing third party suppliers and delivery of audit information
requests becomes clearer and individuals are more accountable.
Where possible we sought to rely on SAS 70 certificates in respect of the control
environments of the Group's IT suppliers. However, reliance was limited, as those available
only related to part of the financial year and/or did not cover configuration of operating
systems and databases as comprehensively as we required.
The opportunity for the Group to obtain greater assurance (and audit efficiency) from
SAS 70 certificates is being considered as part of the ongoing review of arrangements with
third party suppliers.
Control observations
The most significant finding related to the SAP system. Whilst we are satisfied that the
mechanism for granting access rights to Royal Mail employees is appropriate, we identified
61 third party programmers at the year end (and a further 76 during the year) who had
unlimited access to the Group's SAP systems as a result of having the all powerful
“SAP_ALL' profile for which there was no audit log or other such mechanism to monitor the
use of this access. Whilst we acknowledge that some super users may require such
extensive access, our experience indicates that it should only be granted on an exceptional
basis and typically this is to a handful of users where the activities performed whilst using
the SAP_ALL profile are monitored and reviewed.
In addition, for a sample of programme changes, evidence of authorisation, testing and
approval to transport into production was not available.
As a result, we have not been able to rely on the IT general controls over the SAP
environment and have extended our substantive work to address what we believe to be the
principle risk of cash fraud, such as programmers creating and paying a ‘ghost’ employee,
changing a supplier's bank details to their own, creating fictitious suppliers, or changing a
customer's bank details and raising credit notes. As the majority of the users are third
parties, we do not believe that there is an increased risk of the Group's results being
manipulated. Notwithstanding this, our use of analytical tools on journal entries is
designed to identify unusual items.
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CONTROL THEMES AND OBSERVATIONS
In our experience, where IT systems and processes are outsourced, it is not unusual for
third parties to have super user access to an organisations systems in order to discharge
their contractual responsibilities. However, the number of individuals with these rights are
usually relatively few and they are known to the company. Where it is necessary to provide
this level of access rights to additional outsourced contractors, authorisation is required
from the company prior to execution by the supplier. Access is then reported and
monitored, which can be restricted to those security areas of greatest concern.
Our audit work also identified the following control items:
>» E-Pro and Infinium payroll systems: Developers have access to move programme
changes into production and there is no facility within the systems for such activity to
be logged and monitored. Our extended audit procedures were designed to address
the risks arising from this situation.
>» POL-MI, MDR/FRS: A limited set of users have access to manipulate data as it is loaded
into these databases. Our extended procedures were designed to address the risks
arising from this and the ineffective change contro! issue for SAP-ADS. This extended
testing also represented our alternate approach to Horizon.
We highlight that as a result of our findings, we did not complete our work programme in alt
areas and there may be other items that have gone undetected.
These findings are consistent with the broad themes and challenges in relation to the
Group's IT environment presented to the ARC on 6 March 2008.
Royal Mail Group
Control observations
Financial statement close process
As in prior years, the finance teams across the UK were well prepared for our audit visits,
with all information requests received on time and of a good quality.
Revenue process
Our work on the ‘order to cash’ revenue process focused on the ES Revenue, Meter
Revenue and Counter Stamp income streams, representing circa 90% of total revenue.
The controls we sought to rely on were tested as operating effectively, and we have a small
number of minor contro! recommendations agreed with management to include within our
management letter.
Payroll process
As a result of our IT audit findings on the Infinium payroll system (noted above), we
concluded that we could not rely on the IT general controls in relation to access security
and programme changes. Therefore, we have extended our sample testing in relation to
application controls, have tested the source data for IT dependent manual controls and
have recast any reports obtained from Infinium.
For those manual or management level controls we have sought to rely on for audit
purposes, all were deemed to be operating effectively. Key management controls include
the 40x Report and Area Performance Analysis (APA). The 40X Report produces a list of
items that fall outside pre defined thresholds which are investigated (e.g. any payment >
£2,750 per month). The APA analyses variances and trends such as staff hour's costs,
sickness, by week and by area against budget and previous weeks.
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CONTROL THEMES AND OBSERVATIONS
Payroll analytics
In addition to our sample testing of the payroll process controls, we obtained the full year’s
payroll data from Infinium and performed procedures using computer based analytical
procedures. These tests interrogated the payroll details for 211,801 RMG employees ‘
(including casual labour) and included analyses that identified items for further
investigation.
Item for investigation Explanation
12,593 duplicate bank account numbers » Couples employed paid into joint account
» Employees with same bank account
number but different sort codes, i.e. no
duplicates
1,363 duplicate national insurance numbers» Reflects seasonal employment patterns,
with individuals being re-employed
resulting in new payroll record. Only one
record is active
5 duplicate employee records » As above, giving rise to several payroll
records with duplicate national insurance
numbers
9 individuals are aged 80 and over » Relates to 8 temporary workers at
Christmas and 1 permanent employee
contracted for 3 hours per week.
282 individuals received more than 5 » Casual workers are paid for each
payments per month, on average individual day worked.
£38.8m in gross pay paid after leaving date» The majority is redundancy pay. £3.5m
relates to overpayment, of which £3.0m
has been recovered.
£7.9m in gross pay paid before joining date » Reflects the way employee data is
managed e.g. switch from casual to
contracted service. Joining date is
recorded at date contract commences.
£439k who were receiving a ‘round number’ _» All instances salary confirmed as
as salary (e.g. £17,000 exactly per month) accurate and legitimate.
For each category of ‘anomaly’, we have selected a test sample for which appropriate
explanations were sought and obtained.
Status on 2006-07 management letter points
» Asreported to the ARC in November 2007, the Letters’ finance team have focused on
simplifying the SITHOP/MITHOP accrual. This has included a review of the numerous
surveys and assumptions inherent in the calculation. This work has resulted in greater
transparency of the components of SITHOP/MITHOP with the application of updated
and more relevant inputs. The net impact on the recorded liability of these updates is
not material.
> The key ‘Human Asset Check’ payroll control was updated and initially trialled in
January 2007 in the North region. During 2007-08 the Human Asset Check was
rolled out and completed twice across the UK business, and consequently we were able
to place reliance over its operation for the first time in a number of years.
» There were a number of control observations and recommendations agreed with
management in relation to the Revenue and Payroll processes, to the extent we
sought to rely on these controls in the current year, all deficiencies had been
addressed.
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CONTROL THEMES AND OBSERVATIONS
2008 challenges
Wholesale revenue process
As part of the ongoing drive to ensure compliance with Licence Condition 10, much of the
revenue process for the wholesale business will be extracted from the existing Letters
revenue activities at Peterborough and Bolton, with credit control and cash collection
activities being set up within the central Wholesale team in London. This move will result in
the creation of a new revenue team and the design and implementation of a controls
framework for this income stream.
New human resources/payroll system development
The next 12 months will be critical in the first phase of development of the SAP solution to
replace the existing human resources Infinium system. A key workstream of this project
will be the controls to be embedded within the system and their role within the overall
human resources/payroll controls framework. We will share with management insights
from our work with other organisations on similar projects, to ensure that the opportunities
to systemise controls are maximised and ultimately that the controls provide the necessary
assurance over the human resources operations.
Post Office Limited
Control observations
Financial statement close process
The Product and Branch accounting (‘P&BA’) team in Chesterfield has been streamlined
over the last few years. Despite this reduction in headcount, we observed a step change in
the preparation and timely review of reconciliations. We recommend that P&BA team
receive ongoing support as they continue to develop and improve the control environment
over this fundamental area of POL accounting.
Given the ongoing change in key personnel, and the complexity and demands arising from
the funding and transformation programme, we did not observe the same overall
improvement in the close process at POL centre. However, we wish to highlight that the
quality of the documentation and support for the severance provisions were of a high
standard.
Payroll process
The POL payroll process is independent of the process and systems that support RMG. It
covers approximately 20,000 employees which primarily include front line workers and
agents working at Post Offices around the country. The system supporting this process is
SAP-HR module.
Many of the controls that we have relied on in prior years, have been assessed as
ineffective in the current year. These controls included not only those at a transactional
level but also management controls such as the Employee Performance Pack review (i.e.
detailed variance analysis). In the main, the control weaknesses that we observed related
to review procedures not being undertaken, acerbated by the move of the POL payroll
function from Salford to Bolton during the year. Our management letter will include a
number of detailed recommendations. As a result of our controls findings, we have
adopted a fully substantive audit approach for POL payroll.
Management is in the process of transferring the Payroll operation from a Group shared
service back into POL in order to ensure the necessary control improvements are
implemented.
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CONTROL THEMES AND OBSERVATIONS
Status on 2006-07 management letter points
Many of the prior year controls observations have been addressed and were reflected in
the improvement in the control environment and financial statement close process at
Chesterfield. The key themes that we will include in our 2007-08 management letter are:
> policy and review procedures in relation to aged credits on the balance sheet (e.g.
GNRI and client balances)
» recommendations in relation to the control deficiencies observed in the payroll
process
2008 challenges
Senior management will be focussed on executing a challenging transformation plan whilst
growing the business in new products and services and securing ongoing funding post
2011. It is essential that they are adequately supported by their teams, and in particular
that the integrity of the internal financial control environment is maintained and strengthen
during this period of change. We will continue to provide management with our views on
the quality and adequacy of their teams during this period.
GLS
Control observations
Financial statement close process
In order to meet the Group reporting requirements at year end, GLS entities report eleven
months of actual results together with one month of forecast results. GLS have a number
of years of experience in this methodology and in 2008 the difference between the P12
forecast and P12 actual EBITA was only €0.2m. This accurate forecasting allows GLS to
meet the Group's fast timetable for consolidating results with a true-up performed once the
actual results are finalised, and allows us to complete our audit procedures in line with the
Group reporting deadlines.
Status on 2006-07 management letter points
Acontrols-based audit approach is taken at the significant GLS locations. Management is
conscious of the recommendations that we raise and appropriate attention has been given
to the points that we have made in previous years, including foreign exchange rates used
for consolidation and amendments to the intercompany confirmation process.
2008 challenges
The key focuses for senior management in 2008-09 will be executing the new business
model in France, supporting the new Italian management and considering the potential
Spanish acquisitions. It is essential that the current plan to provide an additional level of
support continues in order to maintain a strong control environment.
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SCOPE UPDATE AND STATUS OF THE AUDIT
Scope update and status of the audit
We conducted our audit, for the year ended 30 March 2008, in accordance with
International Standards on Auditing (UK and Ireland) in order to provide reasonable
assurance that your financial statements are free of material misstatement.
Our Audit Planning Report was presented to the Audit and Risk Committee in September
2007. As discussed in our March 2008 Audit Update Report, the scope of our work has
been extended to include full scope reporting from PricewaterhouseCoopers on First Rate
Exchange Services Ltd, the joint venture between Post Office Limited and Bank of Ireland.
We have also performed additional procedures following the deficiencies noted in the IT
general control environment and the POL payroll controls as discussed in the Contro!
themes and observation section of this report.
Status of audit
Our responsibilities in regard to the Group's preliminary announcement are set out in the
APB Bulletin 2008-02. As the preliminary announcement will be issued before the audit is
complete, we have conducted our work so that we are satisfied that the outstanding audit
procedures are unlikely to result in changes to the information contained in the preliminary
announcement. Accordingly, our work has focused on the primary statements and related
notes to the accounts and we anticipate that the audit thereof will be substantially
complete by the time we meet the Audit and Risk Committee on 7 May 2008, prior to
finalisation of the preliminary announcement and release the following day.
The following tasks will need to be completed following the results announcement and prior
to accounts finalisation and sign off in the week commencing 19 May.
Item
Actions to resolve
Outstanding items
Review of ‘front end’ statements including
audit of the Directors’ Remuneration
Report, Chairman's and CEO's statements
and completion of EY technical review
thereon.
Review of ‘front end’ statements and review
of the final draft pending finalisation by
management.
Input from the Audit and Risk Committee
(including representations on fraud).
To be discussed at the Audit and Risk
Committee on 7 May 2008.
Post balance sheet events.
Completion of our post balance sheet events
review up to the date of signing our
opinions.
Receipt of letters of representation, for the
Group, and Royal Mail Holdings pic company
accounts.
To be tabled at the Audit and Risk
Committee on 7 May 2008 and signed by
management in the week commencing 19
May 2008.
Audit of Royal Mail Holdings plc company
balance sheet and notes, prepared under UK
GAAP.
Royal Mail to provide draft financial
information. EY to audit once received.
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SCOPE UPDATE AND STATUS OF THE AUDIT
Audit conclusion
On the basis of our work performed to date, we have not identified anything which would
lead us to believe we will not issue an unqualified audit report in respect of the Group
financial statements and related notes. On this basis, we are satisfied to provide our
auditor's consent letter for the unaudited preliminary announcement (see appendix B).
However, as described above, there are a number of outstanding matters and until we have
completed these procedures, it is possible that further matters requiring amendment may
arise.
Summary of audit differences
Our technical review of the Annual Report is ongoing and feedback to date has been
reflected in subsequent drafts of the accounts. As required by International Auditing
Standards (UK and Ireland), we will draw to the attention of the Chairman of the Audit and
Risk Committee any material technical comments that are not reflected in subsequent
drafts as this process is finalised.
There are no unadjusted audit differences greater than our reporting threshold of £1.0m.
No audit differences identified in previous years have a turnaround impact of greater than
£1.0m in 2007-08.
There are no amounts that we have identified that are individually or in aggregate material
to the presentation and disclosures of the consolidated financial statements for the year
ended 30 March 2008.
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APPENDIX A - AUDITOR INDEPENDENCE AND FEES
Appendix A _—— Auditor independence and fees
Independence confirmation - update
We confirm that there are no changes in our assessment of independence since our
confirmation in our report to the Audit and Risk Committee, dated 6 March 2008. We have
complied with the APB Ethical Standards and in our professional judgment the firm is
independent and the objectivity of the audit engagement partner and audit staff has not
been compromised within the meaning of regulatory and professional requirements.
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.
2007-08 non audit fees
Set out below is a summary of the non-audit services provided by Ernst & Young in the last
financial year.
Notes Apr 07- Feb08- Total YTD Total
Jan 08 Mar08 2007-08 2006-07
£000 £'000 £'000 £'000
United Kingdom
Other services supplied pursuant - - - 20
to legislation
Taxation services 1 : 1 74
Litigation services 1 40 205 245 128
Corporate finance services : : : :
Other 51 : 51 133
Total United Kingdom 92 205 297 355,
Overseas
Taxation services (GLS) 274 8 282 215 I
Corporate finance services (GLS) 2 : 109 109 91 I
Total 366 322 688 66.
Note 1: Litigation services relate to Tele2
Note 2: Corporate finance services relate to potential GLS acquisitions
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APPENDIX A - AUDITOR INDEPEN!
AND FEES
2007-08 non audit fees
Audit related Tax Services Other Approval
Services
GLS Other GLS Other EY RM — ARC
Accounting Third Accounting —Third
advice party advice party
reporting reporting
Pre- €170 €30 £250 £250 €400 £200 £250
approval
limit (k).
Previous £15 £55 €334 £14 £209
total pre-
approval by
Royal Mail
Pre
approvals
during 1
Feb - 30
Mar
China Tax 13 v ¥— Note1
Gis 2 v ¥ Note1
Denmark -
Tax
GLs 55 vv Note 1
Netherlands
Tele2 145 ¥ ¥_—Note2
UK-Tax = 50 v ¥_— Notet
Total pre- €57 «£63 «E145
approvals 1
Feb- 30
Mar 08 :
Total pre- £15 £55 €391 £77 £354
approvals
to 30 Mar
08
Billings (k)
Billings £15 £36 €378 £1 £40
previously
reported:
Total €23 £314
billings
during 1
Feb- 30
Mar 08 S eS
Total £15 £36 €401 £1 £354 Note 3
billings to
30 Mar 08
Note 1: As noted in the ‘Approval of Auditors’ Remuneration’ paper submitted to the Audit and Risk Committee in
May 2007, these amounts are below the pre-approval limits and have therefore, in accordance with the process,
been approved by the Group Finance Director. They are presented here for final approval by the Audit and Risk
Committee.
Note 2: As discussed at the March Audit and Risk Committee, an additional £145k was pre-approved taking the
total pre-approval for this project during 2007-08 to £245k.
Note 3: Included in the total billings to GLS is €57k relating to services pre-approved prior to the current pre-
approval policy.
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APPENDIX B - PRELIMINARY ANNOUNCEMENT - AUDITOR CONSENT LETTER
Appendix B Preliminary announcement - auditor
consent letter
The Directors 8 May 2008
Royal Mail Holdings pic
148 Old Street
London
EC1V 9HO
Dear Sirs
Royal Mail Holdings plc: preliminary announcement of results
for year ended 30 March 2008
In accordance with the terms of our engagement letter dated [date once signed], we have
reviewed the attached proposed preliminary announcement of Royal Mail Holdings plc for
the year ended 30 March 2008. Our work was conducted having regard to Bulletin 2008-2
"The auditor's association with preliminary announcements made in accordance with the
requirements of the UK and Irish listing rules" issued by the Auditing Practices Board. As
directors you have accepted responsibility for preparing and issuing the preliminary
announcement.
Our responsibility is solely to give our agreement to the preliminary announcement having
carried out the procedures specified in the Bulletin as providing a basis for such
agreement. In this regard we agree to the preliminary announcement being published.
As you are aware we are not in a position to sign our auditor's report on the annual
financial statements as they have not yet been approved by the directors and we have not
yet completed the subsequent events review or obtained final signed written
representations from directors. Consequently there can be no absolute certainty that we
will be in a position to issue an unmodified audit report on financial statements consistent
with the results and financial position reported in the preliminary announcement. However,
at the present time, we are not aware of any matters that may give rise to a modification to
our report. In the event that such matters do come to our attention we will inform you
immediately.
Yours faithfully
Alison Duncan
Partner
For and on behalf of Ernst & Young LLP
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Appendix C Draft letters of representation
Ernst & Young LLP
1 More London Place
London, SE1 2AF
United Kingdom
X May 2008
Dear Sirs
Royal Mail Holdings plc and subsidiaries (‘the Group’)
This representation letter is provided in connection with your audit of the financial
statements of the above Group for the year ended 30 March 2008 for the purpose of
expressing an opinion as to whether the financial statements give a true and fair view of
the financial position of the Group as of 30 March 2008 and of the results of its operations
and its cash flows for the year then ended in accordance with International Financial
Reporting Standards.
The financial statements have been considered and approved at a duly convened meeting
of the Board of Directors at which the attention of the Board was drawn to their
responsibilities in connection therewith. The undersigned were authorised to sign the
balance sheet on behalf of the Board and to give you the assurances below. We
acknowledge our responsibility for the fair presentation of the financial statements in
accordance with International Financial Reporting Standards.
We confirm to the best of our knowledge and belief, the following representations:
a. Availability of information
As far as we are aware, all the accounting records have been made available to you for the
purpose of your audit and all the transactions undertaken by the Group have been properly
reflected and recorded in the accounting records. All other records and related
information have been made available to you, including the minutes of all directors' and
shareholders' meetings which are a complete and authentic record of the proceedings at
those meetings.
b. Transactions with directors (or persons connected with them)
At no time during the year has an entity within the Group had any arrangement,
transaction or agreement to provide credit facilities (including loans, quasi-loans or credit
transactions) for directors (or persons connected with them) or to guarantee or provide
security for such matters.
c. Related parties and related party transactions
We have identified and disclosed to you all related parties. During the year the Board has
identified and approved, in a manner deemed appropriate by the Board, related party
transactions and provided the information for disclosure of all transactions relevant to the
Group in note 29 of the financial statements. They are not aware of any other matters
which require to be disclosed under IAS 24 (‘Related Party Disclosures’) or other
requirements.
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d. Events after the balance sheet date
Other than those mentioned in Note 30 in the financial statements, there have been no
events since the balance sheet date which necessitate revision of the figures included in
the financial statements or the inclusion of a note thereto. Should any such material events
occur before the date of the AGM, we will advise you accordingly.
We have also reviewed events occurring in subsidiary undertakings, associates and joint
ventures since the dates of their respective balance sheets and this enables us to conclude
that nothing has occurred in those periods which necessitates a revision of the figures
included in the Group financial statements or inclusion of a note thereto.
Royal Mail Holdings pic has no plans or intentions that would materially affect the
operations of its subsidiary undertakings, associates and joint ventures or the carrying
value or classification of their assets and liabilities at 30 March 2008. We are not aware of
any information that has not been appropriately considered in preparing the financial
statements of the subsidiary undertakings, associates and joint ventures.
e. Going concern
The financial statements have been prepared on the going concern basis. In assessing the
appropriateness of the going concern basis, we have taken account of all relevant
information covering a period of at least twelve months from the date of approval of the
financial statements.
In respect of preparing the Group accounts on a going concern basis, we have fully
considered the agreed financing arrangements with BERR relating to the funding of the
Group at year end and the associated EU challenge in relation to funding.
We are satisfied that relevant disclosure has been made in the financial statements which
enables them to give a true and fair view.
f. Fair Value measurements and disclosures
The measurement methods, including the significant assumptions used, in determining fair
values under International Financial Reporting Standards are reasonable in the
circumstances, and appropriately reflect our intention and ability to carry out specific
courses of action on behalf of the Group where relevant to the fair value measurements or
disclosures made in the financial statements.
g. Compliance with law or regulations
We have disclosed to you all known actual or possible non-compliance with law or
regulations, including the actual or contingent consequences which may arise from the
non-compliance, of which the directors are aware, whose effects should be considered
when preparing the financial statements.
h. Fraud and error
We acknowledge our responsibility for the design and implementation of internal control
systems to prevent and detect fraud and error. We have disclosed to you all significant
facts relating to any frauds or suspected frauds known to management that may have
affected the Group. We have disclosed to you the results of our assessment of the risk that
the financial statements may be materially misstated as a result of fraud.
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i. Audit differences
There are no unadjusted audit differences identified pertaining to the latest period
presented.
j. Contingent liabilities
Provision has been made where a material loss is expected to result from any litigation or
claims against the Group. Other contingent liabilities at the balance sheet date, none of
which are expected to result in a material loss to the Group or commitments which it
cannot meet, have been disclosed in the financial statements, unless the possibility of
losses occurring is considered remote.
All significant matters which have been referred to solicitors have been disclosed to you.
k. Retirement benefits
On the basis of the process established by us and having made appropriate enquiries, we
are satisfied that the actuarial assumptions underlying the scheme liabilities are consistent
with our knowledge of the business. All significant retirement benefits and all settlements
and curtailments have been identified and properly accounted for.
I, Intra-Group profits
Necessary adjustments have been made to eliminate all material intra-Group unrealised
profits on transactions amongst parent, subsidiary undertakings and associated
undertakings.
m. Specific accruals
We consider that the £35m accrued in relation to the bulk compensation scheme
represents management's best estimate of the liability at 30 March 2008.
Where certain targets have not yet been agreed with the Shareholder Executive for the UK
LTIP scheme and management bonuses, we consider that the use of Board-approved
targets is the most appropriate way to estimate the liability at 30 March 2008.
We consider that the £38.4m accrued in relation to VAT represents management's best
estimate of the liability at 30 March 2008.
We confirm that we intend to pay the full stakeholder dividend of £800 per employee and
the 30 March 2008 accrual has been calculated appropriately on this basis.
We confirm that the above representations are made on the basis of enquires of
management and staff with relevant knowledge and experience (and, where appropriate,
inspection of evidence) sufficient to satisfy ourselves that we can properly make each of
the above representations to you.
Yours faithfully
For and on behalf of ROYAL MAIL HOLDINGS pic
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Ernst & Young LLP
1 More London Place
London
SE1 2AF
X May 2008
Dear Sirs
Royal Mail Holdings plc
This representation letter is provided in connection with your audit of the financial
statements of the above company for the year ended 30 March 2008 for the purpose of
expressing an opinion as to whether the financial statements give a true and fair view of
the financial position of the company as of 30 March 2008 and of the results of its
operations and its cash flows for the year then ended in accordance with United Kingdom
accounting standards.
The financial statements have been considered and approved at a duly convened meeting
of the Board of Directors at which the attention of the Board was drawn to their
responsibilities in connection therewith. The undersigned were authorised to sign the
balance sheet on behalf of the Board and to give you the assurances below. We
acknowledge our responsibility for the fair presentation of the financial statements in
accordance with United Kingdom accounting standards.
We confirm to the best of our knowledge and belief, the following representations:
a. Availability of information
As far as we are aware, all the accounting records have been made available to you for the
purpose of your audit and all the transactions undertaken by the company have been
properly reflected and recorded in the accounting records. All other records and related
information have been made available to you, including the minutes of all directors' and
shareholders' meetings which are a complete and authentic record of the proceedings at
those meetings.
b. Transactions with directors (or persons connected with them)
At no time during the year has the company had any arrangement, transaction or
agreement to provide credit facilities (including loans, quasi-loans or credit transactions)
for directors of the company (or persons connected with them) or to guarantee or provide
security for such matters.
c. Related parties and related party transactions
We have identified and disclosed to you all related parties. During the year the Board has
identified and approved, in a manner deemed appropriate by the Board, related party
transactions and provided the information for disclosure of all transactions relevant to the
company in the financial statements. They are not aware of any other matters which
require to be disclosed under FRS 8 (‘Related Party Disclosures’) or other requirements.
d. Events after the balance sheet date
There have been no events since the balance sheet date which necessitate revision of the
figures included in the financial statements or the inclusion of a note thereto. Should any
such material events occur before the date of the AGM, we will advise you accordingly.
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e. Going concern
The financial statements have been prepared on the going concern basis. In assessing the
appropriateness of the going concern basis, we have taken account of all relevant
information covering a period of at least twelve months from the date of approval of the
financial statements.
We are satisfied that relevant disclosure has been made in the financial statements which
enables them to give a true and fair view.
f. Carrying value of investment
We believe that the carrying value of the investment in Royal Mail Group pic is supportable
and does not require an impairment.
g. Fair Value measurements and disclosures
The measurement methods, including the significant assumptions used, in determining fair
values under United Kingdom accounting standards are reasonable in the circumstances,
and appropriately reflect our intention and ability to carry out specific courses of action on
behalf of the company where relevant to the fair value measurements or disclosures made
in the financial statements.
h. Compliance with law or regulations
We have disclosed to you all known actual or possible non-compliance with law or
regulations, including the actual or contingent consequences which may arise from the
non-compliance, whose effects should be considered when preparing the financial
statements.
i, Fraud and error
We acknowledge our responsibility for the design and implementation of internal control
systems to prevent and detect fraud and error. We have disclosed to you the results of our
assessment of the risk that the financial statements may be materially misstated as a result
of fraud. We have disclosed to you all significant facts relating to any frauds or suspected
frauds known to management that may have affected the entity.
j. Uncorrected misstatements
There are no unadjusted audit differences identified pertaining to the latest period
presented.
k. Contingent liabilities
No material loss is expected to result from any litigation or claims against the company.
There are no other contingent liabilities at the balance sheet date which are expected to
result in a material loss to the company or in commitments which it cannot meet.
We confirm that the above representations are made on the basis of enquiries of
management and staff with relevant knowledge and experience (and, where appropriate,
inspection of evidence) sufficient to satisfy ourselves that we can properly make each of
the above representations to you.
Yours faithfully
For and on behalf of ROYAL MAIL HOLDINGS pic
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