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Royal Mail Holdings pic
Report to the Audit and Risk Committee
2010-11 Audit Planning Report
19 October 2010
Royal Mail reference: ARC (10) 36
El] ERNST & YOUNG
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2i/ ERNST & YOUNG
iu
Private and confidential
Audit and Risk Committee 14 October 2010
Royal Mail Holdings pic
100 Victoria Embankment
London EC4Y 0HQ
Members of the Audit and Risk Committee
2010-11 Audit Planning Report
We are pleased to attach our Audit Planning Report for the forthcoming meeting of the Audit and Risk
Committee. The purpose of this report is to provide the Audit and Risk Committee with a basis to review
and validate our proposed audit approach and scope for the 2010-11 audit, but also to align our audit
with the Committee's service expectations. We also include the results from our P6 accelerated audit
procedures.
Whilst the new organisational structure of the Group is being implemented, the planning and execution
of our audit approach will be flexible in order to respond to changes that may arise in terms of risks,
controls, audit process and timetable. This report summarises our assessment of the expected business
and financial statement risks which drive the development of an effective audit for Royal Mail Holdings
pic. We have aligned our audit approach and scope with these issues.
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 19 October 2010.
Yours sincerely
Alison Duncan
For and on behalf of Ernst & Young LLP.
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Contents
Introduction.
Summary audit plan..
Our service commitments......
Developing our audit strategy......
Your audit team.....
Areas of audit emphasis...
Regulatory and accounting developments ..
Appendix A RESULTS OF ACCELERATED P6 AUDIT PROCEDURES.
Appendix B AUDIT SCOPING.....
AppendixC NON-AUDIT SERVICEG...... oor tA
Appendix D UK REQUIRED COMMUNICATIONS WITH THE AUDIT COMMITTEE.....29
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The contents of this report are subject to the terms and conditions of our appointment as set out in our
engagement letter of 25 February 2010.
This report is made solely to the Audit and Risk Committee in accordance with our engagement letter. Our
work has been undertaken so that we might state to the Audit and Risk Committee those matters we are
required to state to them in this report and for no other purpose. To the fullest extent permitted by law we do
not accept or assume responsibility to anyone other than the Audit and Risk Committee of Royal Mail
Holdings plc for this report or for the opinions we have formed. It should not be provided to any third-party
without our prior written consent.
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Introduction
Royal Mail is currently undergoing a period of significant change. Following a request from the Coalition
Government, Richard Hooper updated his 2008 report on the future of the UK Postal Services, which was
released in September 2010. His key findings reconfirmed:
» Private capital is required in order to complete the modernisation of the business
» The historical pension deficit should be taken over by the Government
>» Anewregulatory framework is required
Project New Future is underway, which we expect to have a significant impact on the structure of the business
over the coming months. The transformation plan to modernise and automate the Letters business continues
against a backdrop of a declining market and a reduced market share.
Whilst a new Group organisational structure is being implemented, the planning and execution of our audit
approach will be flexible in order to respond to changes that may arise in terms of risks, controls, audit process
and timetable. At the time of writing this report, there are still many unknowns in relation to the impact of the
finance team restructure on the year end close and audit processes. Consequently, the approach that we have
outlined in this report is based on the current structure of the business, as well as the changes that we have
discussed with management to date. Any changes to the details set out in this report will be reported to the
Audit and Risk Committee at its next meeting.
The areas that we expect to be of most significant audit focus in 2010-11 will be the ongoing transformation,
including the current restructuring process:
>» As the restructuring and transformation plans are executed, the funding arrangements of Royal Mail
Group and Post Office Limited (‘POL’) will require continuous monitoring and the flexibility of operational,
financing and strategic actions to be continuously reassessed.
» The restructuring and transformation processes also have accounting consequences, for example the
accounting for the proposed headcount reductions, potential curtailment of ColleagueShares and the
treatment of sale and leaseback transactions for mail centres.
During our audit, we will review the progress that has been made in the areas that required additional audit
effort in 2009-10, such as the POL payroll control environment and the elements of the SAP IT general control
environment that are outsourced to Fujitsu. We will support management as they reorganise the finance
function and use our experience and knowledge of the business to highlight areas of potential risk as they
arise.
Over the following pages, we have provided a Summary audit plan, as well as more detailed information on our
audit strategy.
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Summary audit plan
This Summary audit plan outlines the key areas of audit emphasis for our 2010-11 audit. Project New Future
has a number of financial statement impacts and we have outlined how our audit approach will reflect this. We
also highlight other key areas of audit emphasis.
Project New Future
Emst & Young [2
SUMMARY AUDIT PLAN
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As management implements Project New Future, there are a number of factors that will need to be considered
looking forward to potential privatisation. We have highlighted these below, as well as the insight that we will
provide throughout the 2010-11 process:
Insight from
the audit
> Tax structure reviewed
as part of tax loss
» Review of significant
contracts required by
ISAs model
» Pension consideration » Dividend block
as part of RMG/POL considered in pic
statutory accounts: investment testing
» Audit of ColleagueShare
model and assumptions
» insight on structure of
share plans
» Controls-based audit approach
covers main FRP requirements
» Going concern review considers
funding position, management
forecasts and working capital to
audit tolerance
Other areas of audit emphasis
In addition to Project New Future, we outline below the other key areas of audit emphasis from the underlying
business. The areas of audit emphasis that are ‘significant risks’ in accordance with International Standards on
Auditing have been highlighted in the ‘Areas of audit emphasis’ section:
Emst & Young /3
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Our service commitments
Building on your assessment of our 2009-10 service quality
In order to assess our performance during the 2009-10 audit cycle, we have undertaken an assessment of our
service quality to ensure that we provide Royal Mail with the highest level of assurance, and to ensure that we
meet your particular service needs.
We interviewed nine individuals, including the Chairman of the Audit and Risk Committee and seven senior
management team members involved in Finance and Risk. The interviews were conducted in June 2010 by
Richard Wilson and a senior member of our Service Quality team.
We asked each of the interviewees for an assessment of their overall satisfaction on a scale of 1-5, with 1
being extremely dissatisfied and 5 being extremely satisfied. The average score across all participants was
4.1.
The review identified key strengths in our relationships that we will maintain, together with areas for
improvement. The following summarises the action plans we have developed:
2810-14 commitments.
Continuous > In addition to the audit findings that we currently report, provide greater visibility and feedback on our
communication point of view on how the GLS business is run to the Audit and Risk Committee.
> Our audit process and approach is well understood by the UK finance teams following the introduction
of the joint planning day in 2008 and will continue.
Fair and > We will continue to provide management with a detailed breakdown of the proposed cost of our audit
transparent fees and where we spend the time. This is agreed each year with the respective finance teams and
aggregated at the centre. No additional work is undertaken prior to agreement with Group Finance.
Continue to strive for audit efficiency and challenge how we can get the most from working with
others, such as internal audit, to minimise the cost base.
v
Relevant insight » Continue to support management's desire to adopt a ‘plc’ culture. During our audit we will provide
observations on the financial reporting process compared to FTSE peers.
> Provide benchmarking observations around the narrative reporting section of the Annual Report to
compare Royal Mail reporting to FTSE100 companies.
Right team » Feedback on the current structure of Alison Duncan as audit signatory, with Richard Wilson as Senior
Advisory Partner is that it works well and will continue.
> Continuity in the audit teams is strong, particularly at senior levels, where there was strong feedback
‘on the quality of individuals. Management commented on the knowledge and understanding of the
business, technical abilities, as well as pragmatism.
» Following increased oversight of the GLS tax function from the centre, the audit of the GLS tax
balances will be coordinated by the Group tax team in London, rather than the GLS audit team.
Technical Ernst & Young has previously provided a tailored technical update training session as part of the joint
interaction planning day with the Group finance team. Management has requested that in 2010 we provide an all
day technical update for key Royal Mail finance staff.
v
Industry focus > We will provide industry insight and benchmarking against our other postal clients globally to share
best practices on those items that matter most to you. We are currently working with management to
benchmark the process for deferring SITHOP revenue balances against peer postal operators.
In light of the proposed finance reorganisation, we will tailor our audit service as required so that it responds to
the finance team’s most urgent needs. Through the process, we will provide management with flexibility in our
approach and continuity in our audit teams. We will continue to offer our point of view on the areas of risk,
controls and process as change is implemented.
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Developing our audit strategy
Objective and scope of our audit
Our audit service includes the provision of statutory audit opinions, together with audit-related services.
Our statutory audits include:
» The provision of statutory audit opinions under International Standards on Auditing (UK and Ireland) on
the consolidated IFRS financial statements of Royal Mail Holdings pic (‘Royal Mail’) and on the UK GAAP
parent company accounts for the year ending 27 March 2011.
» The provision of separate statutory audit opinions on Royal Mail's subsidiaries as required by local
regulations (for details of UK statutory opinions see appendix B).
We leverage our knowledge and work performed on the statutory audit in delivering audit-related and
assurance work required by the postal regulations and other related services.
Materiality
For the purposes of determining whether the accounts are free from material error, we define materiality as the
magnitude of an omission or misstatement that, individually or in the aggregate, in light of the surrounding
circumstances, could reasonably be expected to influence the economic decisions of the users of the financial
statements. 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.
The amount we consider material at the end of the audit may differ from our initial determination. At this stage,
however, it is not feasible to anticipate all of the circumstances that may ultimately influence our judgement
about materiality. At the end of the audit we will form our final opinion by reference to all matters that could be
significant to users of the accounts, including the total effect of the audit misstatements we identify, and our
evaluation of materiality at that date.
Reporting unit scoping
We 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 group accounts as a whole.
The majority of the audit work is carried out by the Ernst & Young teams from London, except for:
» GLS: The audit of Royal Mail's European parcels business, GLS, is coordinated by our Ernst & Young
Frankfurt team. In order for the GLS audit team to provide us with an opinion on the GLS group as a
whole, the team set a separate scope for each of the GLS businesses, based on the same size and risk
factors that we use to scope our audit. The GLS audit scope is approved by the GLS Audit and Risk
Committee. The local EY team mirrors the GLS approach and performs a hard close audit on the P11
numbers, and review the roll forward to P12.
In 2010-11, Ernst & Young teams will perform procedures in 15 of the 20 GLS countries, covering 95% of
the business by revenue.
» RES: Given the relative contribution of FRES to Group operating profit (30m in 2009-10), we instruct
PricewaterhouseCoopers (the statutory auditor of FRES) to report the results of their audit to us, in line
with the Group reporting timetable.
Full details of the scope and locations of our procedures are detailed in Appendix B.
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Audit process overview
Our audit process has been designed in conjunction with management over a number of years to provide an
efficient audit that meets the Group reporting timetable and addresses our assessment of audit risk.
A controls-based audit approach
Our audit approach is controls-based, which is the most efficient process for a business with a high volume of
transactions. We will test controls around selected Revenue streams and Payroll processes to gain assurance
that revenues, staff costs, trade debtors and payroll-related balance sheet and income statement balances are
materially correctly stated.
In POL, payroll control improvements we had previously suggested have now been implemented, and we
therefore expect to also be able to take a controls-based audit approach for payroll in POL.
IT controls
IT underpins a significant proportion of Royal Mail's transactions. Our audit plan is designed around reliance
on certain IT applications and the use of electronic audit evidence. We will therefore evaluate the IT general
control environment, test IT controls covering user access, programme changes and IT security.
Where it is more efficient, we plan to obtain a certificate of reliance (a “SAS70” report) from the Group's IT
suppliers. This is the case for CSC. However, based on past experience, we do not expect to receive a SAS
70 from Fujitsu. The following IT applications are in scope across the Group:
Application in audit scope Group Letters POL Regulatory
SAP — Consolidation BCP v v
SAP Revenue Management BSP v ia ¢
SAP Revenue Management BW ¢ ¢ ¢
SAP - ESFS v v v
SAP -ADS v v ¥
SAP-SDS ‘ ‘
SAP - OBA v v v
SAP -HR v v v
SAP - POL FS v
Credence v
Horizon Next Generation ¥
TDA v
Infinium Payroll Preliminary conclusion — control environment ineffective, no testing procedures
E-pro Preliminary conclusion — control environment ineffective, no testing procedures
MDR/FRS Preliminary conclusion ~ control environment ineffective, no testing procedures
The last 3 applications listed are legacy systems that do not have a strong control environment in place. We
have agreed with management to undertake alternative procedures over data from these systems.
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Leveraging technology
The benefit of a controls-based approach is that we can leverage technology and use EY’s powerful IT
analytical tools. This increases the efficiency of the process and is also valuable as it enables us to test entire
populations of data, rather than using sampling techniques.
We will use these analytical tools in our audit of journal entry postings, payroll, debtors and creditors. The
tools identify anomalies in the data such as employee payments before joining date or invoices that are paid
without a purchase order, which we investigate further.
In the current year, we will extend our use of analytics in two areas to address specific risks:
» Review the application of VAT rates for a population of transactions to vouch that the appropriate rate
change has been implemented following the TNT VAT ruling.
» EY has a proprietary IT solution called SAP Explorer, which is non-invasive and allows us to test the
control configuration of the SAP environment and identify control exceptions and anomalies with user
access rights. Whilst Royal Mail’s IT control environment is undergoing a period of change it is not
efficient to use SAP Explorer across the Group. However, to highlight the value that it can bring, we are in
discussion with management to run a pilot using one of the Group’s SAP processes.
Direct assistance from Internal Audit
Internal audit staff provide assistance in testing the controls over revenue and payroll, using their experience
and knowledge of the business. They essentially work under the direction of Ernst & Young, while key
decisions, such as sample selections and the application of judgement remain within the Ernst & Young team.
This practice is now increasingly being used on our other large and FTSE audits to keep costs down. Internal
audit personnel gain a different experience from working with Ernst & Young and there is two-way feedback as
part of our team and internal audit’s annual performance appraisal.
The following chart highlights how our ability to rely on internal audit impacts our audit:
High
Use of IA staff for
Impact on controls testing and
External Audit year end procedures
Use of IA staff
for controls
testing y
Review of
A's work a
Low
None Reliance on Substitution
Internal Audit
We are currently working with management to confirm the extent of our use of internal audit resource for the
current year.
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Period 11 hard close
Royal Mail has historically adhered to a strict reporting timetable as part of its commitment to best practice. In
the prior year, Royal Mail issued a preliminary announcement 53 days after the year end, with signed accounts
published 61 days after the year end. The graphs below show how this reporting compares to companies in
the FTSES0-100:
Days to file preliminary announcement: Days to publish Annual Report:
80
1%
so 6
a E
Ey
Fd
20
9 se 9
These charts show that Royal Mail reports on a very timely basis and would be in second quartile of this FTSE
group in respect of the preliminary announcement and the first quartile for the annual report.
The ability to report in such a timely manner has been supported by the controls-based approach, as well as.
our P11 hard close. We will perform our substantive audit procedures on P11 ‘hard close’ balances, with the
exception of balances which are only recorded at P12 such as pensions and tax. At P12 we will audit these
remaining balances and update our P11 procedures.
The benchmarking above shows that there is flexibility in the reporting timetable and the year end timeline will
be finalised once the structure of the finance function is known. Whatever timeline is agreed, the hard close
approach will reduce the peak of work that is required post year end and will assist in identifying and resolving
issues prior to our final audit visit.
Quality Assurance
We have the following processes in place to support our team in delivering an audit opinion that is both robust
and technically compliant:
» Independent review: A partner, independent of the audit team, to provide guidance and challenge on the
key judgemental areas of the audit. This partner reviews the Report and Accounts, as well as key audit
deliverables, including all reports to the Audit and Risk Committee.
» Technical review of Report and Accounts: Richard Crisp from our Financial Reporting Group will review
the Report and Accounts to check that the disclosures are appropriate and that any new reporting
requirements are met. Richard has provided support to the Royal Mail team for a number of years. We will
continue to adopt the approach that has worked in previous years with Richard reviewing a ‘skeleton’ set
of accounts in advance of the year end, as well as in the close process, to maximise efficiency and avoid
surprises.
» Every Partner is subject to an internal ‘Audit Quality Review’ every three years by a team independent of
the Audit team and the Partner’s location. This is to ensure that the Partner's audits have been conducted
in accordance with Ernst & Young's audit methodology.
We are confident that these procedures, which are consistent with those that we would perform on a listed
audit client, will provide you with the highest quality technical input.
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YOUR AUDIT 7
Your audit team
Your audit team is lead by Alison Duncan, supported by Richard Wilson, the Senior Advisory Partner.
» We have maintained significant continuity in our teams at senior levels. This was reflected in the strong
positive feedback that we received as part of our Assessment of Service Quality for our 2009-10 audit.
» The main change in the team is in IT, where we have introduced Denise Fabb and Victor Puno to leverage
their SAP experience for the audit of the core IT applications, as well as their views on the current SAP-
HR project.
» Weare currently working with the Board in relation to Audit Partner rotation. Alison Duncan is due to
rotate off the Royal Mail audit after March 2011 as she will have served the maximum 7 years. However,
in light of the significant change in management and across the business, there is the potential to invoke
an exception in the Ethical Standards that allows an Audit Engagement Partner to remain on the audit
longer.
Alison Duncan
Lead Audit Partner
Group Senior
Manager
Ben Marlies
Donald Li Group
_I Fook Manager
PostOffice tetiers GIS Group Regulalory Audit
Umited
Angus Grant Alison Duncan Martine Jeanneaux Alison Duncan
Audi Paiteer Audit Partner Audi Partner Audit Petner
Stephen Harrow Donald Li Fook Susanne Jaeger _ David Yeates
*. Sener Audit Manager Audi Senior Manager Audit Senior Manager
fanager
Our audit team also includes a number of other specialists to assist us with our procedures, including
specialists in pensions, real estate, VAT, modelling and corporate restructuring. In addition, we are able to
draw from knowledge and experience of all our EMEIA practice which operates as one firm.
Emmet & Your,
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Areas of audit emphasis
Our audit plan is developed, with input from management, to provide assurance over the Group's reported
financial results as well as providing insights and recommendations in relation to the Group's financial
processes, accounting compliance and financial statement disclosures. This allows the potential impact of
issues on the Group's financial reputation to be assessed by the Board and management. We outline below
the key areas of audit focus based on our assessment of the key business risks, key financial statement risks
and significant accounts and disclosure requirements.
We summarised the areas of audit emphasis, including those resulting from Project New Future in our
Summary audit plan on pages 2 and 3 and these are described in more detail below. We also include
commentary on additional areas of audit emphasis, such as tax and VAT. Our audit will also include the
mandatory procedures that we are required to perform in accordance with applicable laws, regulations and
auditing standards.
These key areas of focus are from a Group perspective. Our GLS team separately provides the GLS ARC with
detail of the significant financial statement risks for the GLS group. These traditionally include the collectability
of accounts receivable, deferred tax balances and LTIP.
fo
Restructuring
Description of risk and financial statement impact Our audit approach
Management is current implementing Project New Future. The = » Review management's process to assess that it continues to
restructuring will lead to a reduction in head count, with a operate effectively.
significant increase in severance provisions and spend. There > _ Review provisions that have been established to meet the
will also be an impact on the ColleagueShares provision, as IAS 37 criteria and vouch amounts provided to salary
“good leavers” are entitled to sell their shares on departure. information.
Compare exceptional costs to Royal Mail accounting policies.
»
Royal Mail has a structured process in place for managing its, ~ColleagueShares impact discussed in more detail later in this
severance provisions. Business cases are approved by section.
appropriate management, with predefined approval limits. The
provision is calculated based on known salaries or, when the
individuals are not known, on an average salary for the role
= geographical location.
The most significant long-lived assets that are held at cost less
accumulated depreciation/impairment are Royal Mail Holdings» Discuss mail centre strategy with management and
pic's investments in subsidiaries of £3.8bn and Royal Mail’s understand any assets that are at risk of impairment or
property assets and the plant and equipment of the Letters
business. » For sale and leaseback transactions, review these with
As part of the transformation plan, management continues to
review the mail centre strategy, which has led to a number of
sale and leaseback transactions and is also currently reviewing
‘ongoing capital projects, given the current funding position.
At March 2010, following a decline in property values, an
impairment exercise was performed to support the carrying
value of the properties assets. At year end, management will
Carrying value of assets »
Description of risk and financial statement impact Our audit approach
JAS 36 Impairment of Assets requires that indefinite-lived » Review of GLS goodwill impairment exercise to support the
assets are tested for impairment and that other assets are carrying value of the goodwill and challenge the significant
reviewed at each reporting date for indicators of impairment. assumptions made.
The most significant indefinite-lived asset relates to the » At year end, discuss with management their assessment of
goodwill recognised on acquisition of GLS. Royal Mail the presence of any impairment indicators. Where an
performs an annual impairment exercise to support the impairment exercise is required, we will review
carrying value of the goodwill in relation to GLS. management's calculations to assess amounts recognised in
the balance sheet are appropriate.
leases that become onerous.
management during the year to assess the appropriate
accounting treatment and determine that the lease liability
has been recognised.
» Review capital projects to assess the carrying value of
capitalised spend.
impairment.
Ni whether there are any further indicators of i
Emst & Youn
o
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Restructured finance organisation
>
Description of risk and financial statement impact
Our audit approach
The current restructuring will lead to a finance function that is
different in terms of size and structure. This could potentially
impact:
» The existing control framework
» The financial reporting timetable.
» Continue our collaborative approach with management and
work with the new team to determine an audit process and
timetable that is appropriate during this period of change and
provide detailed information requirements to meet the
timeline established.
» Provide feedback on the finance structure, key areas of risk
Systems implementation
A
escription of risk and financial statement impact
and the control environment adopted. y
Our audit approach Dy
HR PSP
The new HR PSP system due to be implemented from April
2011 is a business critical system for Letters. If correctly
designed and implemented, the system has the potential to.
streamline the payroll processes and provide greater clarity of
costs along the reporting lines within Letters.
However, the implementation of the new system also gives rise
to a number of risks. These include the transfer of sensitive
data, establishing appropriate controls within, and around, the
new system and training system users.
VAT
Following a European Court decision, HMRC will require VAT
to be accounted for on non-price controlled products from 31
January 2011.
Royal Mail has established a project team, which includes
members from Group Tax, the Letters, POL and Parcelforce
business units, Group IT and the outsourced IT providers and
is in the process of identifying the appropriate VAT treatment
for each product and how this will be tracked by the IT
i)
» Prior to implementation, we will review design of IT controls
around user access, segregation of duties.
» Perform control review procedures around the data migration
from the legacy system to the new SAP system.
» Aim of our procedures is to assess reliance on the payroll
system from implementation date and early identification of
issues.
» Understand and test process that the project team has
established in respect of the rate changes.
» Seek input from our VAT and IT experts where appropriate
and provide management with feedback prior to the
introduction date.
» Review the partial exemption calculation and the test the VA”
balances that are recorded at balance sheet date.
ColleagueShares
Description of risk and financial statement impact
Our audit approach
ColleagueShares
At March 2010 a provision of £108.6m was recorded in relation
to the ColleagueShare phantom share incentive scheme that
was introduced during 2008. This provision reflected
management's best estimate of the current value of the
obligation to buy back the ColleagueShares from employees in
2011 and 2012.
The estimation of the provision will continue to be refined as
more accurate information is obtained. The key assumptions
remain:
» The number of ColleagueShares to be paid out in 2011
and 2012 (employees’ discretion)
> The rate of leavers
» The discount rate
> The multiple of different assumptions supporting the value
of each ColleagueShare at the date of payment.
Stakeholder dividends
At each year end of the ColleagueShare scheme, Royal Mail
accrues for the stakeholder dividend payable. At March 2011,
the Group will make an accrual based on the Group's results
compared to profit targets. In previous years, the profit targets
have not been approved by the Government and we have
obtained specific representation from management on their
intention to pay out the full £400 (2009 and 2010) or £800
(2008) per employee.
» Review updated ColleagueShare model and challenge any
changes in assumptions made.
» Assess whether assumptions remain valid in light of changes
in the business during the year.
» Test payments made to “good leavers” as part of the current
restructuring process.
» Understand management's intention regarding employee
ownership as part of the privatisation process and the impact
that this may have on the ColleagueShares liability.
» Test management's calculations for the level of Stakeholder
dividends accrued. If necessary, we will continue to seek
specific representation from management on the amount
accrued.
» Review changes to the ColleagueShare scheme agreed as
part of the latest pay deal
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Going concern - Funding and covenants*
Description of risk and financial statement impact
Our audit approach
Royal Mail Group and Post Office funding
RMG
Key factors in our 2009-10 going concern conclusion were:
> Business plan forecasts and sensitivities
» Credibility of management's operational and financial
actions
> The funding plan for pension deficit repair
» Flexibility on transformation
The 2010-11 funding analysis will need to reflect the impacts of
Project New Future, including any proposed changes to capital
expenditure, planned restructuring spend and revised business
plans.
POL
Post Office's current funding agreements expire in 2016,
subject to State Aid approval, with a Social Network Payment
agreed to 2012
Covenant compliance
Management will also prepare covenant calculations for the
year ended 27 March 2011 for the Senior debt facility and the
GLS facility, as well as projected covenant calculations using
the latest strategic plan to ensure covenant compliance for the
foreseeable future.
The 2009-10 covenant projections highlighted a potential Loan
to Value (‘LTV’) covenant breach in March 2012 if property
values do not recover significantly. This was disclosed in the
2009-10 Report and Accounts, together with management's
intention to seek a waiver from Government if property values
do not recover.
» Review of updated management actions each month to
establish the impact that changes in the business have on
the flexibility of management actions.
» Review the funding analysis prepared by management and
ensure that it supports the going concern basis. We will
challenge significant assumptions, accuracy of forecasts,
areas of judgement and flexibility of cash flows as well as
performing sensitivity analysis on key drivers.
We will discuss the progress of the POL application for State Aic
approval and review the disclosures in the Annual Report to
ensure that they are appropriate.
» Review and reperform management's covenant compliance
calculations to ensure compliance with facility terms.
» We will track this matter prior to year end and participate in
the assessment of options including agreement of a waiver,
to ensure we are satisfied that any solutions are appropriate
for audit sign off.
A Pensions* »
Description of risk and financial statement impact
Our audit approach
At March 2010, Royal Mail recognised a net pension liability of
£8.0bn. During the year, the Royal mail pension trustees have
finalised their triennial pension funding valuation, and agreed a
new pension deficit funding payment profile with the Group,
although we note that The Pension Regulator is currently
reviewing the agreement.
The deficit, together with its public profile following the revised
Hooper report mean that the liability recognised on the balance
sheet, and the disclosures included in the annual report, attract
significant focus.
The size of the scheme's assets and liabilities means that the
valuation process adopted by the Group's actuaries is
‘extremely sensitive to small changes in actuarial assumptions,
VE as the discount rate and mortality assumptions.
» Review key financial assumptions supporting the valuation,
with input from Ernst & Young pension specialists, where
appropriate and ensure that the methodology is consistent
with 2009-10.
» Benchmarking Royal Mail assumptions against peers we will
assess and provide insight into the relevant position of the
treatment adopted.
» Review the results of the triennial funding valuation and
discuss it with the Group’s actuaries. We will ensure that any
updates to the scheme information, such as mortality
assumptions, are reflected in the IAS 19 valuation of the
March 2011 obligation.
v
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Regulation
Description of risk and financial statement impact
Our audit approach
The updated Hooper report has recommended that a new
regulatory framework is required and Postcomm has
conducted a consultation over the summer of 2010.
Acchange in the regulatory framework is likely to have a
significant impact on the future of the business, with impacts
on:
» Price control
» Pricing flexibility
» Competition
This will impact on future cash flow forecasts and feed into the
oe business plan.
» Consider the potential impact on the future cashflows as part
of our funding review, ensuring that appropriate sensitivities
are included to reflect potential changes.
4
7
Taxation*
S\
Description of risk and financial statement impact
Our audit approach
Income tax
At March 2010, a deferred tax asset of £94m was recorded in
the Group financial statements. This principally related to the
tax benefit of pension funding that is expected to be realised
‘over the next five years. A complex recognition model is used
to establish the amount of tax benefit expected.
Royal Mail's basis of UK deferred tax asset recognition is
testricted to the amount of tax benefit which is expected to be
realised in the next five years, with unrecognised potential
deferred tax assets of £2,847m at March 2009.
Management is currently reviewing the methodology in relation
to the deferred tax asset recognised to ensure that it remains
Vea with the approach taken by other corporates.
» Discuss deferred tax methodology with management and will
review the deferred tax calculations, together with the
updated forecast for accuracy and consistency with previous
periods.
» Assess the appropriateness of the deferred tax asset
recognised in light of the Group's forecast profitability,
together with the unrecognised potential deferred tax assets.
4
y
VAT*
Description of risk and financial statement impact
Our audit approach
Royal Mail has agreed a new partial exemption methodology
with HMRC that applies from the beginning of the 2009-10
financial year. Management is currently finalising the
calculations and the impact that the revised methodology will
have on the financial statements.
x
» Discuss new methodology with management and review and
reperform the calculations that they have made and provide
insights on how the methodology has been implemented.
y
fi
Revenue recognition*
S\
Description of risk and financial statement impact
Our audit approach
The majority of Royal Mail’s revenue transactions are routine in
nature, with minimal judgement required. An area that is more
complex is the deferred SITHOP/MITHOP revenue balances,
which require judgement and estimation.
An adjustment is made to the system-generated revenue figure
at the end of the year for stamps and meters that have been
sold to customers but not yet used. The deferred revenue is
estimated based on surveys of retailers, businesses and of the
Lae public.
» Review management's approach and the survey results and
calculations used to estimate the deferred revenue, focussing
‘on consistency of assumptions and methodology.
» For new products or revenue streams, we will review the
accounting treatment in line with the revenue recognition
accounting standard,
* Significant risks as defined by International Standards on Auditing
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Other required procedures
In addition to the audit impact of financial statement risks outlined earlier in this section, we have to perform
other procedures as required by auditing, ethical and independence standards, company law and other
regulations. We outline the procedures we will undertake during the course of our audit.
Mandatory procedures required by auditing standards on:
» Addressing the risk of fraud and error
» Auditing the significant disclosures included in the financial statements.
» Reviewing entity-wide controls
» Reading other information contained in the financial statements and reporting whether it is inconsistent
with our understanding and the financial statements
» Confirming auditor independence.
Procedures required by company law:
» Opining on whether the information contained in the directors’ report is consistent with the financial
statements.
» Auditing the disclosures contained in the auditable part of the directors’ remuneration report to ensure it is
in agreement with accounting records and returns.
Procedures we perform as required by the listing rules
Given the Group's stated aim to adopt a ‘pic’ culture and its historical approach to financial reporting, we also
perform the following procedures that are required by listing rules:
» Review of the company’s disclosures relating to corporate governance, going concern and directors’
remuneration.
>» Review of the preliminary announcement to ensure that financial information is correctly extracted from
the financial statements and that commentary is consistent with the information we have audited.
We have included in Appendix B a list of matters that we are required to communicate to you under
professional standards.
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Regulatory audit and other assurance related requirements
In addition to the statutory audit requirements, we are required, as auditors of the Group to perform procedures
on a number of reports required by postal regulation and related matters, including:
>» The audit of the regulatory accounts as required by Royal Mail's licence and the EC Directive. This is the
most significant element and is discussed in more detail below.
» Procedures in connection with the Directors’ Statement of Covenant Compliance for the Royal Mail and
Post Office Limited credit facilities from BERR.
» Procedures in relation to Licence Condition 16 on the adequacy of resources and Licence Condition 21 in
relation to the application of the price setting process.
» Procedures in relation to DVLA motor vehicle licence transactions and the Bank of England note
circularisation scheme.
» Procedures on fuel rebates submissions to the Department of Transport.
Where appropriate, we design the above procedures together with our statutory audit procedures to maximise
the efficiency and leverage the work already performed.
Regulatory accounts
As is the case in other regulated industries, Royal Mail is required by paragraph 4(a) of Condition 15 of the
Licence to prepare regulatory financial statements. We are required to issue an opinion that the financial
statements have been properly prepared, in all material respects, in accordance with the regulatory accounting
principles and basis of preparation and with the requirements of the licence.
We review regulatory financial information on a quarterly basis, to confirm our understanding of the costing
model and the systems environment. This involves an analysis of the integrity of the system, ensuring system
or costing allocations are reasonable and have been correctly implemented and applied consistently.
Changes in Regulatory accounts
The principles underlying the regulatory accounts of Royal Mail in previous years have been developed over
time in conjunction with PostComm. However, PostComm is expected to issue new Regulatory Accounting
Guidelines (“RAGs”) in December 2010. Royal Mail management has been consulted on these changes, and
based on discussion with management we expect that the RAGs will have a number of potential implications:
» The change in methodology is likely to lead to different profitability of USO products. This may have an
impact on the price setting of USO products and the perception of the business by potential investors.
» Reporting burden on Royal Mail is likely to increase in terms of complexity and reporting requirements.
We will review the new RAGs to be issued in December and work in conjunction with the Regulatory Reporting
team to assess the impact. While we do not expect that the 2010-11 Regulatory accounts will be impacted by
the new RAGs, the changes in reported costs and profits may have real implications on pricing and future cash
flows and therefore impact on the going concern assessment at the year end.
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Regulatory and accounting developments
Following the issuance of new auditing standards in October 2009 by the International Auditing and Assurance
Board (IAASB), the Auditing Practices Board (APB) has issued in the UK and Ireland a revised suite of auditing
standards which will be applicable for the current year’s audit.
This has resulted in the revision of twelve auditing standards, and the introduction of two new standards,
addressing communication of deficiencies in internal control, and the evaluation of misstatements. Our audit
approach has been amended as necessary in order to ensure compliance with the new standards. The primary
areas of change will be with respect to:
Area of change Detail o'
Related party
relationships
and
transactions
(RPTs)
Estimates
(including fair
value
estimates)
Other changes
ange and impact on the audit
Clarified ISA 550 (UK and Ireland) requires the
auditor to apply increased rigour and scepticism to
the audit of RPTs. There is an increased focus on
the identification and assessment of risks of material
misstatements associated with RPTs coupled with a
requirement to perform additional procedures to
respond to such risks. Such procedures include:
» Obtaining an understanding of the controls that
management has established to a) identify,
account for and disclose RPTs and b) authorise
and approve significant RPTs and arrangements
outside the normal course of business.
» Obtaining sufficient evidence where management
assert that a RPT was conducted on terms
equivalent to an arm's length transaction.
» Performing specified procedures on significant
RPTs outside the normal course of business.
Similar to the changes in the audit of RPTs, ISA 540
requires the auditor to exercise increased rigour and
scepticism in the audit of estimates, including a
consideration of indicators of management bias. New
requirements of the ISA include:
» More in depth understanding of how management
identifies those transactions, events that give rise
to the need for accounting estimates, and how
management makes accounting estimates
» Reviewing the outcome of accounting estimates
included in prior period financial statements or,
where applicable, their subsequent re-estimation
for the purpose of the current period
» Requiring substantive procedures to respond to
significant risks
» Reviewing management's judgments and
decisions to identify whether there are indicators
of possible management bias.
There are a number of other changes in auditing
standard requiring analytical reviews of out of scope
locations in audits of group financial statements and
communication of control deficiencies in writing to
those charged with governance.
impact on Royal Mail
We have discussed the impact with
management who have agreed to
» Document the names of RPTs, the
terms of the relationships and
arrangements, and their business.
rationale.
» Document any controls that
management have to a) identify,
account for and disclose RPTs and
b) authorise and approve
significant RPTs and arrangements
outside the normal course of
business.
This requirement will encourage
management to strengthen the
controls around the identification and
reporting of related party transactions.
Similar to the changes in the audit of
RPT, we have discussed with
management who have agreed to
prepared a summary of:
» The key accounting estimates
including pension valuation,
restructuring and non-restructuring
provisions, and QoS provisions.
» The process used in arriving at
these.
» The outcome of accounting
estimates included in prior period
financial statement.
This will allow both auditors and
management to more easily assess
accounting estimates at the year end,
and judge retrospectively the
accuracy of previous estimates.
EY audit methodology, which is based
‘on the highest common denominator
of requirements and best practice
across a number of countries, already
complied with these requirements. As
such, there will be no additional
impact on the Group.
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As part of the convergence project, the IASB and the FASB are working on a number of high profile projects
that may have significant impacts on users of IFRS and US GAAP. We highlight below those exposure drafts
issued during the year which might impact the Group in the future.
Area of change Detail of change and impact on the audit impact on Royal Mail
Leases » The IASB issued an exposure draft (ED) on >» Royal Mail will need to review all
Exposure Draft accounting for leases in August 2010. The ED is leases, including those for
part of the convergence project with the US FASB. property and office machinery and
make judgements around lease
» The ED requires lessees to recognise a liability for options, contingent rentals, as
the obligation to pay rentals, with a corresponding well as the discount rate that
right of use asset. This will see operating leases, would be appropriate for the
as well as the current finance lease commitments, Group.
come onto the balance sheet.
» Itis not possible at this stage to
» This could have potential commercial implications estimate impact of the changes
with credit ratings and certain banking covenant on the fixed charge cover,
measures. leverage multiple or loan to value
calculations. However, given the
» The lessee will recognise the obligation to pay small headroom available, we will
rentals for the longest possible lease term that is work with management to assess
more likely than not to occur and measure it at the the likely impact.
present value of lease payments discounted using
the incremental borrowing rate.
>» Aworked example:
Assumptions Balance sheet analysis
Annual Lease Payment A ‘right-of-use asset! of CU15,000 and a
(assumes no contingent rentals, residual corresponding ‘lease liability’ would be
value guarantee or term option penalties): CU6,0000 recognised on lease commencement.
Term of lease: 3 years
PV of lease payments based on incremental
borrowing rate: CU15,000
f
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
Expense analysis
Amortisation of right-of-use asset (PV/3) 5,000 5,000 5,000 15,000 /
I i
I Interest expense 1,500 900 600 3,000 /
Proposed expense 6,500 5,900 5,600 18,000 /
Current IFRS expense 6,000 6,000 6,000 18,000
a seen — sewed
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Area of change Detail of change and impact on the audit Impact on Royal Mail
Employee » The Employee benefits ED was issued in April » Royal Mail doesn’t adopt the
Benefits 2010, with the aim of simplifying accounting for ‘corridor mechanism’ so will not
Exposure Draft defined benefits plans by reducing the level of be impacted by this proposed
judgement available. The key elements are: amendment.
» Removal of the ‘corridor mechanism’ where » The proposed move to the ‘net
actuarial gains and losses could remain interest’ approach will impact the
unrecognised if they are within a range Group. Based on March 2010
(‘corridor’) of the recognised value. data, the 6.7% expected return on
assets assumption would be
» Adopts a ‘net interest’ approach, which replaced by the 5.6% discount
replaces the current expected return on assets rate. We estimate this would have
assumption with the AA corporate bond rate. increased the income statement
charge by approximately £280m
» Proposes improved disclosures, including
sensitivity analysis of changes in » The Group will have to adopt any
demographics changes to disclosure
requirements.
Revenue No implementation date has been set but we donot» No significant impact expected on
Recognition believe that any new standard would be effective covenants.
Exposure Draft before 2014. The key elements of the proposed » The main revenue streams of the
model are: Letters division and over the
» Transaction price is allocated to separate counter products of POL are
performance obligations based on their relative routine in nature. Presentational
selling prices, and revenue is recognised when changes would lead to customer
those obligations are satisfied. refunds being accounted for as a
» Performance obligations are satisfied when the reduction of revenue rather an
customer has the ability to direct the use of and expense.
receive the benefit from the good or service » However, as both POL and
(control). Letters continue to issue new
» Anet contract asset or liability is recognised products to offset the decline in
pending completion of performance obligations by their traditional revenue it is
both parties. important to assess the terms of
» Revenue is deferred for the value of a warranty these products in light of the
included in a contract, and recognised as the proposed standard to avoid any
warranty services are performed. surprises.
>» Revenue is adjusted for certain estimable items, > Potential impact on revenues of
eg. Refunds and collectability. subsidiaries and joint ventures
» Increased disclosure around the component parts within the Group, eg. In Romec
of revenue and any contract asset or liability. service contracts or in accounting
for building and sale of mail
centres in the books of Royal Mail
Estates Ltd.
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The IASB issued the IFRS for SMEs accounting standard in July 2009. In August 2009, the UK ASB issued a
consultation on “the future of UKGAAP”, proposing that IFRS for SMEs replaced UK GAAP. When the
consultation period ended in February 2010, the ASB had received over 150 replies and is currently
considering the responses.
Area of change
‘IFRS for SMES >
Combined Code >
Detail of change and impact on th
“The Fi
The IFRS for SMEs is a standalone standard that >
contains 35 chapters addressing all of the recognition,
presentation and disclosure requirements for SMEs.
The requirements of IFRS have been simplified and
significantly reduced, with a reduction in text of at
least 85%. This will give differences between IFRS
and IFRS for SMEs, where full IFRS gives a range of
options and IFRS for SMEs mandates one of these
options, to eliminate the level of choice. >
The ASB is also considering the option for listed
groups, where subsidiaries who currently adopt
UKGAAP could adopt full IFRS, with reduced
disclosures requirements, although there is not yet
any guidance on these reduced disclosures.
Despite the name of the standard, there is no size
restriction for its adoption. Instead, it is available for
entities that publish general purpose financial >
statements and do not have public accountability
(defined as having listed instruments in a public
market or holds assets in a fiduciary capacity for a
broad group of outsiders as one of its primary
businesses).
issued the UK Corporate Governance Code »
in June 2010 and it applies to Royal Mail from the
year ended March 2012.
The focus is on the spirit of the code rather than
compliance with the individual provisions of the code.
All directors of FTSE 350 companies should be
subject to annual election by shareholders, rather
than every three years.
Chairmen are encouraged to report personally in their
annual statements how the principles relating tothe >
role and effectiveness of the Board have been
applied.
The comply or explain provision remains
The board and its committees should have the
appropriate balance of skills, experience,
independence and knowledge of the company to
enable them to discharge their respective duties and
responsibilities effectively.
Evaluation of the board of FTSE 350 companies
should be externally facilitated at least every three
years.
The board is responsible for determining the nature
and extent of the significant risks it is willing to take in
achieving its strategic objectives.
The board should maintain sound risk management
and internal control systems.
In the absence of any listing of
debt or equity as part of
Project New Future by March
2013, the Group and its
subsidiaries will have the
option to adopt either full IFRS
with reduced disclosures or
IFRS for SMEs.
Any decision on the standard
to adopt should consider the
need to maintain the Group's
compliance with ‘Listed PLC’
best practice and user and tax
requirements. Listed
companies will continue to
adopt full IFRS.
An opening balance sheet
under IFRS for SMEs will be
required in the subsidiaries at
March 2011.
Whilst Royal Mi jot
required to adopt the UK
Corporate Governance code, it
has previously adopted the
Combined Code insofar as
they apply to a public company
with a single shareholder and
included disclosures in the
Annual Report.
Royal Mail will need to
consider which of the
amendments are appropriate
and how to apply them.
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Appendix A RESULTS OF ACCELERATED P6 AUDIT
PROCEDURES
Introduction
Royal Mail intends to issue a half year trading statement for the period ended 26 September 2010. Whilst
there is no formal requirement for Royal Mail to issue financial information for the first half of the year, the
Group has a track record of publishing a trading statement with selected disclosure information.
The Group do not issue full IAS34 Interim financial statements and the trading statement is not in compliance
with IAS 34. We are therefore not required to perform a review under ISRE 2410, the standard that covers
interim reporting procedures.
However, at the request of management, we have accelerated certain elements of our 2010-11 year end audit
work. This is designed to provide some level of comfort to Royal Mail management and the Audit and Risk
Committee on the statement and are broadly similar to those procedures we would have performed on specific
balances for a half year review. Procedures are performed only on those balances identified by management,
who acknowledge that these procedures represent neither a half year review nor a full audit.
We include below the procedures that we have performed and the findings:
Procedure Findings
Review of primary statements numbers and support
7 At the time of writing this report, the Trading
y tables (Group and by statement has not been finalised. We will provide an
sh flow summary e from the update at the Audit and Risk Committee on 19
extracts from the ledgers. October 2010.
Business Ur
BCS tral bailar
support for all other numbers (financial and non-
)} in the trading state
fir
wi
bus
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Findings
Current material litigation and regulatory fines, compensation and accruals
he current
compensation
ipdate on (
and accruais.
Re
year end,
nt half
4
ule of amounts provided
cluding movements
iS §
the cur
Obtain explanations for any
£10m and ensure thes
Hold a meeting 3 Doug Evans to enquire of
>» Any chi s in the position since the date of the
ure gr than
£10 ded in the above papers:
» Update on Project Q resolutions; and
> Update on the Quality of Service accrual
that
that
We have reviewed the Fines, Compensation and
Material Litigation Report to be presented to the
October 2010 Audit and Risk Committee, and have
met with Doug Evans. We note that the total
provision has decreased from £12m to £nil.
main movements relate to:
The
» The release of an accrual of £2m in relation to
Project Q, following Postcomms's investigation
» The release of an accrual of £10m in relation to
the impact of industrial action on Quality of
Service targets following Postcomm’s
investigation.
We agree that these amounts are no longer required
and should be released.
Non-exceptional provisions (including non-exceptional vacant leasehold provision)
Review the
prior year. For moveme!
explanations from rr
J ensure that the
f with the
s08e at
Hold a meeting with m emen
assumptions used are appropriate
prior year end. Where assumption
the prior year end, understand man
changing.
We have met with management and have reviewed
the breakdown of non-exceptional provisions at
September 2010. No movements greater than £10m
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.
At the time of writing this report, we are finalising our
procedures in relation to leases and we will provide
an update at the Audit and Risk Committee on 19
October 2010.
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Procedure Findings
Consolidation Journals
We have obtained appropriate support for all of the
mals,
material journals identified.
Select and audit a sample of group consolidation j
General Logistics Systems accounts receivable
There are no movements in trade accounts
receivable greater than £10m.
The decrease in trade debtors from €225m to
€217m is in line with the seasonal fluctuations, with
March reflecting higher level of activity over the
Easter period.
The slight worsening of the ageing of debtors
reflects the difficult economic climate, and the
provision for bad debts has been increased by €1m
to reflect this.
We note that a provision of €2m held centrally
remains to be allocated to specific debtors that are
deemed to be at risk. This type of general provision
is not permitted by IFRS and management will
allocate it to specific debts as part of their statutory
audit.
}
from m: on the related impact on the bad
doubtf provision,
Letters accounts receivable
nwing the The decrease in accounts receivable from £419m at
I (together with any the year end to £317m at the half year reflects
year end, including seasonality of sales, settlement of international mail
balances in July, and timing of capital expenditure in
Letters SITHOP and MITHOP accrual
@ Of SITHOP and MITHOP accruals as SITHOP/MITHOP deferred revenue has decreased
luding movemen from £197m to £176m despite the impact of price
ler than £10m: obtain increases, reflecting the higher level of sales
management. volumes and advance stamp purchases in March
ITHOP cal compared with September. This is consistent with
“ our expectations and previous years.
Review the SITHOP ai
support the above
The calculations, methodology and assumptions
used at the half year remain consistent with the prior
year end. In the case of the SITHOP balance,
management has again used the lower end of the
survey results, and is still in the process of reviewing
the scope and quality of the surveys.
We will work with management on this process and
will obtain insights from other EY audit teams on
how other postal operators address this issue.
accounting tr
s those at th
management's reason:
$ for
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Findings
Letters terminal dues balances and REIMS exit accrual
Review the schedule for each balance as at the current
haif year end, in nts since the prior year
Om obtain
Terminal dues
The net terminal dues creditor has decreased from
£117m at the year end to £103m at the half year,
reflecting both seasonality and the timing of
settlements during the year.
REIMS exit accrual
The REIMS accrual has decreased from £28m to
£14.9m reflecting settlement in Denmark,
Switzerland, Ireland, Norway and Austria, offset by
an increase in provision for Greece given the difficult
negotiations and economic conditions. There are no
other significant changes in assumptions from year
end.
Letters and POL GRNI accruals
Review the GRNI
on Issues reporte
he year end
'$ analysis and provide an update Letters
The GRNI account includes balances over 6 months
old of £16m, compared with £18m at the year end.
We have enquired about key items included in the
over 6 months balance and obtained satisfactory
explanations. We confirmed with management that
all aged items were reviewed at September 2010.
POL
There is no significant movement from the prior year
end. The slightly increase in the total GRNI balance
is due to an increase in the level of activity, and we
note that the regular review controls implemented by
management are operating well.
Letters Transformation
Obtain from mi
existing and futu ucturing
focusing on progress compared to t
benef
ormation
@ fimetable and
From discussion with management, we understand
that transformation investment is progressing with
most machines now in place, and the closure of 5
mail centres in the half year.
However, the expected changes in work practices
and the exit rates are behind schedule due to the
agreement with trade unions being agreed slightly
later than planned, and the consultation meetings
with front line staff taking longer. However, now that
these meetings have taken place, management is
confident that rate of progress should increase.
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Procedure Findings
POL Alliance and Leicester reconciliation
Review th
throug!
robustn:
reconcilia
an upda’
on Management has continued to focus on the Alliance
n the and Leicester reconciliation. The unsupported
balance at the end of P6, is less than £0.1m and is
now deemed to be immaterial.
POL Project Gamma, POCA and WH Smith update
Obtain upda
Gamma, POCA and WH Smith. From discussion with management we understand
that these contracts are progressing in all material
respects as had been expected, with no change in
accounting treatment from the year end.
VAT Review application of VAT treatment agreed with the tax authorities
Review thi
and procedures put
agreer tin princip!
computation of VAT
Ath Royal Mi
y Royal
with the tax auth
Partial exemption
The partial exemption methodology applied to the
previous tax year has been agreed with HMRC and
the cash received and benefit recognised.
We have held initial discussions with management
with regards the implementation of the partial
exemption methodology in the current year. We
understand that whilst HMRC have accepted the
use of the PESM for the period 2010-11, they have
indicated that in respect to future periods they
would expect the method to be amended to take
into consideration supplies that RM buys in and
sells on without material alteration/value add as
these are seen to be distortive to the PESM
calculation.
TNT ruling
Management has performed a bottom up review of
the various USO and non-USO items of revenue,
and are in the process of making the relevant
changes to the systems to correctly invoice VAT
and capture the transactions from February 2011.
We have agreed with management that we will
audit the changes that have been made late in
2010.
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Procedure Findings
Letters Other matters
Discussion of new trans:
treatment during the peri
tions or oh:
nges in accounting —_ Re-life of transformation assets and software
Management has revised the useful economic lives
of some new assets, such as walk sequence
machines, based on new expectations of how long
these will be in operation. They have also reflected
the latest plans to replace existing software. This
has lead to a £3m reduction in depreciation charge
in the period, with a £6m reduction expected for the
full year. We understand that there are no further
revisions of useful economic lives expected.
Core Transformation Programme
The Core Transformation Programme, due to
replace the current IT revenue system has been
placed on hold due to cash constraints. The cost
incurred to date of £6m is held on the balance sheet
pending a decision of whether to proceed with the
investment. We understand that a decision will be
reached by the year end.
Note: References to Letters in the above refer to Letters excluding Wholesale and ParcelForce
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ENDIX B DIT SCOPING
Appendix B AUDIT SCOPING
We set audit scopes for each reporting unit which, when taken together, enable us to form an opinion on the
group accounts.
The scope definitions are as follows:
» Faull scope: locations deemed significant based on size and those with significant risk factors are subject
to a full scope audit, covering all significant accounts and processes using materiality levels assigned by
the EY London audit team for purposes of the consolidated audit.
» Specific scope: locations where specific procedures are performed by the local audit team for Group
reporting purposes, based upon procedures and accounts identified by the EY London audit team.
» Limited scope: limited scope procedures primarily consist of enquiries of management and analytical
review. On-site or desk top reviews may be performed, according to our assessment of risk.
The preliminary audit scopes we have adopted to enable us to report on the Group financial statements are set
out below:
Audit Scope Audit Scope EY Office
Business unit 2010-41 2008-18 Responsible
Royal Mail Letters (including logistics and UK Full Full London ~ Letters team
ikWholesale =—=—S*=*=<C—*~=*‘“‘“‘“‘*~*”*«SSpOic”«~S*«SSipecific.:«S~S~S« London Group tearm
London —
“GlS(consolidated) =S=S*~*é<“‘“‘S*SS~*~«~S™S!™!™*C™™~™~™~™~*C anf
Full Full London**
“RMHoldingspic =~=~=~=SC*~C*<“‘“S;SCSS!~CUYSS™™!™~™ OU ~London—Groupteam
Treasury ~ Specific Specific ‘London — Group team _
ip
“Romec Ltd “ Limited*** Limited Ss London — Group team
Group Services (included within Letters) Limited Limited London ~ Group team
Property Holdings Specific Specific London — Group team
Royal Mail Estates Ltd Specific"™* Specific London — Group team
Parcelforce Worldwide ~~ “Limited Limited London— Group team
“Post Cap Guernsey *** Limited Guernsey
“RM Pension Trustees Ltd Limited Limited London — Group team _
“Royal Mail Courier Services Ltd =—=—=S*~C*~C*~*S*«~mited** =—SSSSCLimited ~~ London Group team
“iRed Redefining Document Management Ltd Limited" Limited“ London Group team
* The GLS consolidated audit will be performed by EY Frankfurt. In order to complete their audit, EY Frankfurt will instruct
other EY countries to perform full, specific and limited scope audits, depending on the size and risk of the locations. Audit
scopes by individual location are discussed and approved at the GLS ARC. We also provide a statutory audit opinion for a
number of local GLS entities throughout Europe.
** FRES is audited by PWC, who report to us as a full scope operation
“* These entities file audited financial statements. Whilst they receive specific or limited scope work for Group audit
purposes, they receive a full statutory audit to entity materiality.
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DIX C - NON-AUL
Appendix C NON-AUDIT SERVICES
Royal Mail and Ernst & Young have agreed a process for the pre-approval of non-audit services, levels of
approval required dependent on the value of the work. At each meeting of the Audit & Risk Committee, we
provide an update on the amounts that have been billed and pre-approved in relation to non-audit services.
2010-11 non-audit fees billed
Set out below is a summary of the non-audit services provided and billed by Ernst & Young for the period 29
March 2010 to 26 September 2010:
Apri0- Total YTD
Sep 16 2040-11
£090 £°000
United Kingdom
Other services supplied pursuant to legislation Note 1 54 54 28
Taxation services - - 24
Litigation services - - -
Corporate finance services - - -
Other - - 46
“Total United Kingdom — oe 54 54 98
Overseas
Taxation services - - 97
Corporate finance services - - -
4
Total 54 54 195
Note 1: This relates to work on covenant calculations, Licence Condition 21 and Whole of Government Accounts
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2010-11 non-audit fees pre-approved
Set out below is a summary of the non-audit services pre-approved by Royal Mail for the period 29 March
2010 to 26 September 2010:
Audit related Other
GLS Other GLS Other EY RM ARG
Accounting Third party Accounting Third party
dh __feporting advice _reporting _
€30
Pre approvals
since 29 March (k)
China tax - - - - - 6 - v ¥ Note 1
DVLA assurance - - - 17 - - - v v Note 1
POL Covenants - - - 13 - - - v ¥ Note 1
GLS Germany tax - - - : 48 : - v - Note 1
GLS Netherlands - - a - 69 - - v cs Note 1
Royal Mail Group : : : 3 : : : y ¥ Note 1
Covenants
GLS Belgium - - - - 6 - - v v Note 1
Royal Mail Group = : : 10 = : 3 v ¥ Note 1
Fuel Rebate
Whole of - - - 26 - - - v of Note 1
Government
accounts
Total pre- : : : 69 1236 :
approvals to 26
September (k)
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 Audit and Risk Committee 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.
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Appendix D UK REQUIRED COMMUNICATIONS WITH THE
AUDIT COMMITTEE
There are certain communications that we are required by International Standards on Auditing (‘ISA’s) to
provide to the audit committee of UK clients. These are detailed below:
Required communic Proposed EY reporting
Terms of engagement
Confirmation by the audit committee of acceptance of terms of engagement ISA 260 Engagement Letters will be
Emst & Young to provide a copy of the engagement letter ISA 210 presented to the October 2010
ARC.
Planning and audit approach
Communication of the nature and scope of the audit including any limitations. This ISA 260 Included within this report
should include: ISA 300
> Principal ways in which risks of material misstatement are to be addressed, with
particular reference to areas of higher risk
> Audit team structure and succession planning
Audit findings
Our view about the qualitative aspects of accounting practices and financial reporting. ISA 260 This will be included within our
Final draft of the representation letter that will be signed by management and the audit report to be presented to the
committee. May 2011 ARC.
Uncorrected misstatements.
Expected modifications to the audit report.
Material weakness in internal controls identified during the audit.
Fraud
Any fraud that we have identified or information we have obtained that indicates thata ISA 260 If applicable, this will be
fraud may exist. ISA 240 included within our reports to
Material weaknesses in the design or operation of internal control to prevent or detect the October 2010 ARC, March
fraud identified during the audit. 2011 ARC and May 2011 ARC.
A discussion of any other matters related to fraud.
Consideration of laws and regulations
Audit findings regarding non-compliance where the non-compliance is material and ISA 260 If applicable, this will be
believed to be intentional. This communication is subject to compliance with legislation ISA 250 included within our reports to
on tipping of. the October 2010 ARC, March
Enquiry by Ernst & Young into possible instances of non-compliance with laws and 2011 ARC and May 2011 ARC.
regulations that the audit committee may be aware of.
Independence ISA 260
Communication of all significant facts and matters that bear on Ernst & Young's APB Ethical This will be included within our
objectivity and independence. Standard 1 reports to the March 2011 ARC.
Communication of key elements of the audit engagement partner's consideration of,
independence and objectivity such as:
> the principal threats
> safeguards adopted and their effectiveness
> an overall assessment of threats and safeguards
» information about the general policies and process within the firm to maintain
objectivity and independence
For listed companies, communication of minimum requirements as detailed in the
ethical standards:
> Relationships between Emst & Young, the company and senior management
» Services provided by Ernst & Young that may reasonably bear on the auditors’
objectivity and independence
> Related safeguards
> Fees charged by Ernst & Young analysed into appropriate categories such as
statutory audit fees, tax advisory fees, other non-audit service fees
> _Astatement of compliance with the ethical standards.
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