Significant accounting policies for the year ended 31 December 2008

Reporting entity

Morgan Sindall plc (the ‘Company’), is a company domiciled in the United Kingdom. The address of the registered office is given here. The nature of the Group’s operations and its principal activities are set out in note 1 and in the business review. The report and accounts includes the consolidated financial statements of the Company and its subsidiaries (collectively referred to as the ‘Group’) and the Group’s interest in joint ventures and separate financial statements for the Company.

Basis of preparation

(a) Statement of compliance

The consolidated financial statements have been prepared on a going concern basis as discussed in the business review and in accordance with International Financial Reporting Standards (‘IFRS’) adopted by the European Union and therefore comply with Article 4 of the EU IAS Regulation.

At the time of the approval of the financial statements the following pronouncements were in issue but not yet effective (and in some cases had not been adopted by the EU) and have not been applied in these financial statements:

• IFRS 3 Revised ‘Business Combinations’
• IFRS 8 ‘Operating Segments’
• International Accounting Standard (‘IAS’) 1 Revised ‘Presentation of Financial Statements’
• IAS 23 Revised ‘Borrowing Costs’
• IAS 27 Revised ‘Consolidated and Separate Financial Statements’
• IAS 39 Revised ‘Financial Instruments: Recognition and Measurement: Eligible Hedged Items’
• International Financial Reporting Interpretations Committee (‘IFRIC’) 15 ‘Agreements for the Construction of Real Estate’
• IFRIC 16 ‘Hedges of a Net Investment in a Foreign Operation’
• IFRIC 17 ‘Distribution of Non-cash Assets to Owners’
• IFRIC 18 ‘Transfers of Assets from Customers’.

These pronouncements are not anticipated to have any material impact on the Group’s consolidated income statement or balance sheet except for additional disclosures in relation to IFRS 8.

(b) Basis of measurement

The financial statements have been prepared on the historical cost basis, except where otherwise indicated.

(c) Functional and presentation currency

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

(d) Restatement of comparative balances

As was stated in note 23 on page 76 of the 2007 annual report and accounts, the fair value adjustments arising on the acquisition of Amec Developments Limited and certain assets and business carried on by Amec Investments Limited and the assets, liabilities and contracts relating to the Design and Project Services division of Amec plc were provisional and subject to finalisation in accordance with IFRS 3 ‘Business Combinations’.

The fair value exercise has been completed and the final acquisition balance sheet and related fair value adjustments are disclosed in note 24. In accordance with IFRS 3 ‘Business Combinations’ the affected financial statement balances have been restated. None of the restatements have had an impact on gross profit, profit from operations or net assets. There was no impact on recognised income or expense as previously stated.

Certain comparatives have been reclassified to conform with the current year’s presentation. In the 2007 comparative balance sheet, amounts of £19.3m previously shown as trade and other payables are now classified as provisions.

(e) Use of estimates and judgments

The preparation of financial statements under IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expense. Actual results may differ from these estimates.

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

The estimates and judgments that have a significant risk of causing a material adjustment to the carrying value of assets and liabilities within the next financial year are as follows:

(i) Accounting for construction and service contracts

Recognition of revenue and margin involves making estimates of the costs and value of work performed to date and to be performed in bringing contracts to completion, including satisfaction of maintenance responsibilities. These estimates are made by reference to recovery of pre-contract costs, surveys of progress against the construction programme, changes in work scope, the contractual terms under which the work is being performed, costs incurred, and external certification of the work performed. The Group has appropriate control procedures to ensure all estimates are determined on a consistent basis and subject to appropriate review and authorisation.

The same estimating principles were used in determining the fair value of certain construction contract related provisions relating to the July 2007 acquisition from Amec plc.

(ii) Recognition and measurement of intangible assets

The Group recognises certain intangible assets in respect of secured customer contracts, other contracts and related relationships, software, a non-compete agreement and goodwill. The recognition and subsequent measurement of these intangible assets required management to make certain assumptions and estimates, particularly in respect of the future potential benefits to be derived and the estimated useful lives over which the future economic benefits are expected to flow to the Group. To assist in making these judgments, the directors engaged an independent expert to assist in the determination of the fair values and the estimated useful lives of these assets. Full details of the intangible assets are set out in note 10.

(iii) Impairment of goodwill and other intangible assets

Goodwill and other intangible assets are subject to an impairment test on an annual basis or earlier where any event or change in circumstance is identified that indicates that the carrying value may not be recoverable. Testing for impairment requires a comparison of the carrying amount of goodwill and other intangible assets against the recoverable amount, which is the value-in-use of the cash-generating unit to which the goodwill and other intangible assets are allocated.

Value-in-use requires estimation of the future cash flows expected from the cash-generating unit as well as an appropriate growth factor and discount rate to calculate the present value of the cash flows, and the assumptions used are set out in full in note 10.

(iv) Impairment of work in progress

In assessing whether work in progress is impaired, estimates are made of future sales revenue, timing and build costs. The Group has controls in place to ensure that estimates of sales revenue are consistent, and external valuations are used where appropriate.

(v) Accounting for the Group’s defined benefit plan

The directors engage an independent and qualified actuary to calculate the Group’s liability in respect of the defined benefit plan. In order to arrive at this valuation, certain assumptions in respect of discount rates, salary escalations, expected return on the plan’s assets and future pension increases have been made. Estimates and judgments regarding future mortality are derived using published statistics and mortality tables. As the actual rates of increase and mortality may differ from those assumed, the actual pension liability may differ from that recognised in these financial statements. Assumptions used and full details of the Group’s liability are set out in note 17.

(vi) Insurance provisions

In valuing the provision for the Group’s retained insurance risks, estimates are made of the rate of occurrence and severity of events for which the Group will bear liability and external valuations are used where appropriate.

(vii) PFI/PPP derivative financial instruments

Certain Group joint ventures use swaps to hedge interest rate and RPI risk to which PFI/PPP concessions are exposed. These are initially recognised, and subsequently re-measured at each year end, at fair value derived from current market rates. Details of derivative financial instruments are set out in note 28.

(viii) Financial receivables

In assessing the fair value of certain financial receivables, including trade receivables and those held by joint ventures, estimates are made of future cash flows and the appropriate discount rate to be used.

(ix) Taxation

Judgments are required in establishing the Group’s liability to pay taxes where tax positions are uncertain. Details of deferred tax are set out in note 18.

(x) Share-based payments

Recognition and measurement of share-based payments requires estimation of the fair value of awards at the date of grant and, for cash-settled awards, re-measurement at each reporting date. Judgment is also exercised when estimating the number of awards that will ultimately vest. These judgments have a significant impact on the amounts recognised in the income statement and the balance sheet. To assist in determining each award’s fair value, the directors engage a qualified and independent valuation expert. Estimation of the number of awards that will ultimately vest is based on estimates at the reporting date of the extent to which performance conditions are anticipated to be satisfied, anticipated future lapses by leavers and the current intrinsic value of those awards. Details on share-based payments are set out in note 26.

The accounting policies as set out below have been applied consistently to all periods presented in these consolidated financial statements.

Basis of consolidation

The acquisition of subsidiaries is accounted for using the purchase method. The cost of the acquisition is measured as the fair values, at the date of acquisition, of assets given, liabilities incurred or assumed, and equity instruments issued by the Group in exchange for control of the acquiree, plus any costs directly attributable to the business combination. The acquiree’s identifiable assets (including previously unrecognised intangible assets), liabilities and contingent liabilities that meet the conditions for recognition are recognised at their fair value at the acquisition date. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets is recorded as goodwill. If the cost of the acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is immediately recognised in the income statement.

(a) Subsidiaries

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

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

(b) Joint ventures

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

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

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

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

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

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

(c) Transactions eliminated on consolidation

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

Revenue and margin recognition

Revenue and margin are recognised as follows:

(a) Construction contracts

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

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

(c) Service contracts

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

(d) Sale of development properties

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

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

(e) Pre-contract costs

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

Finance income and expense

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

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

Borrowing costs are recognised in the income statement on an effective interest rate method in the period in which they are incurred.

Income tax

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

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

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

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

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

Property, plant and equipment

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

• plant, machinery and equipment between 10% and 33% per annum
• freehold property 2% per annum
• leasehold property over the period of the lease

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

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

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

Intangible assets

(a) Goodwill

(i) Initial recognition

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

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

(ii) Subsequent measurement

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

(iii) Impairment

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

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

(b) Other intangible assets

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

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

(i) Secured customer contracts

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

(ii) Other contracts and related relationships

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

(iii) Software

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

(iv) Non-compete agreements

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

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

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

Inventories

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

Trade receivables

Trade receivables are measured on initial recognition at fair value and are subsequently measured at amortised cost using the effective interest rate method. Appropriate allowances for estimated irrecoverable amounts are recognised in the income statement when there is objective evidence that the asset is impaired. The allowance recognised is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the effective interest rate computed at initial recognition.

Cash and cash equivalents

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

Impairment of financial assets

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

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

If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss is reversed through the income statement to the extent the carrying amount of the investment at the date the impairment is reversed does not exceed what the amortised cost would have been had the impairment not been recognised.

Trade payables

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

Leased assets

(a) Finance leases

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

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

(b) Operating leases

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

Retirement benefit schemes

(a) Defined contribution plan

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

(b) Defined benefit plan

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

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

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

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

Provisions

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

Share-based payments

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

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

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

Financial receivables

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

Derivative financial instruments and hedge accounting

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

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

Note 28 contains details of the fair values of the derivative instruments used for hedged purposes. Movements on the hedging reserve in equity are also detailed in note 23.

Dividends

Dividends to the Company’s shareholders are recognised as a liability in the Group financial statements in the period in which the dividends are approved by the Company’s shareholders.