US GAAP reporting

The accounts have been prepared in accordance with UK GAAP, which differs in certain significant respects from US GAAP. The US GAAP accounting information in note 32 to the accounts gives a summary of the main differences between the amounts determined in accordance with the Group’s accounting policies (based on UK GAAP) and those determined in accordance with US GAAP. In addition, summary income statements, summary balance sheets, summary cash flows and a reconciliation of net income and equity shareholders’ funds from UK to US GAAP are provided in note 31 to the accounts.

The comparative figures for discontinued operations and continuing operations have been restated for 2001/02 for US GAAP reporting purposes. This restatement does not affect UK GAAP reported figures. This restatement arises because the results of operations relating to joint ventures and associate, from which the Group has now exited and which were treated as discontinued operations under UK GAAP, were reported as part of discontinued operations under US GAAP. This treatment is not permitted under US GAAP as these results should have been reported as part of the interest in equity accounted affiliates. The net loss or income reported under US GAAP for 2001/02 was not affected by this restatement.

The effect of this restatement is to reclassify an amount of net loss of £857 million for 2001/02 from discontinued operations to continuing operations through a restatement of the interest in equity accounted affiliates. Earnings per share for continuing and discontinued operations have similarly been restated. The discussion of results relating to 2001/02 has been amended to reflect this restatement.

As referred to earlier, UK GAAP merger accounting principles have been adopted in accounting for the business combination of National Grid and Lattice. Under US GAAP, acquisition accounting principles were applied to the business combination, which is a fundamentally different method of accounting from merger accounting. Under US GAAP, National Grid is viewed as the acquirer of Lattice, and as a result the separately identifiable net assets attributable to Lattice were fair valued at the date of acquisition on 21 October 2002.

A further consequence of acquisition accounting, in contrast to merger accounting, is that the results of the Group under US GAAP only include the results of Lattice with effect from the date of acquisition. Therefore, under US GAAP, in respect of the Group results for the three years ended 31 March 2004, Lattice results only feature in the period from 21 October 2002 to 31 March 2004. In addition, because fair values were attributed to Lattice’s separately identifiable net assets, rather than the book values as used in merger accounting, goodwill was recognised.

Final goodwill amounting to £3,824 million was recognised under US GAAP relating to the acquisition of Lattice by National Grid. No goodwill was recognised under UK GAAP. The methodology for determining goodwill involved attributing fair values to separately identifiable net assets and valuing the consideration, primarily National Grid Transco shares, at fair value. This process is described in note 32 to the accounts.

Individually, the most significant adjustment to establish the fair value of the net assets acquired were the fair values attributed to property, plant and equipment (PPE). Within this adjustment, the most significant element accounting for 94% of the total adjustment to PPE related to Transco. Management determined the appropriate adjustment to be made and no external specialists were used. Management believes that its knowledge of the UK regulatory environment within which Transco operates is superior to that of external specialists and therefore it was better qualified to estimate the relevant fair values.

Net income from continuing operations for 2003/04 under US GAAP was £998 million (2002/03: £790 million; 2001/02: £152 million (net loss)). The US GAAP results for 2003/04, 2002/03 and 2001/02 included losses relating to discontinued operations amounting to £nil; £39 million; and £1 million respectively. Consequently, net income for 2003/04 under US GAAP was £998 million (2002/03: £751 million; 2001/02: £167 million (net loss)). This compared with the net income/(loss) under UK GAAP for 2003/04, 2002/03 and 2001/02 of £1,099 million; £391 million; and £321 million (net loss) respectively.

Equity shareholders’ funds under US GAAP at 31 March 2004 were £9,821 million (31 March 2003: £9,426 million) compared with £1,213 million (31 March 2003: £1,113 million (restated)) under UK GAAP.

Because the application of merger accounting principles under UK GAAP has fundamentally affected the comparison of UK GAAP results with US GAAP results, the following is a discussion of the impact the application of US GAAP has had on the results, which should be read in conjunction with the Operating Review and the rest of this Financial Review.

The treatment of Lattice as an acquisition under US GAAP has significantly affected the UK electricity and gas transmission segment, UK gas distribution segment, and ‘Other’, as compared with the treatment under UK GAAP. The remaining segments are unaffected by differences between merger and acquisition accounting principles. Consequently, this has impacted on the results of the segments, as follows:

• the results of the UK electricity and gas transmission segment for 2001/02 under US GAAP relate solely to UK electricity activities, excluding the impact of any gas transmission activity, which is shown under UK GAAP. UK gas transmission impacted on the UK electricity and gas transmission from the date of acquisition on 21 October 2002 and contributed £94 million to operating profit for 2002/03. In 2003/04, the UK electricity and gas transmission segment contributed £686 million to operating profit;
• UK gas distribution is a segment that was created following the acquisition of Lattice. As a result, there is no effect on the operating result of UK gas distribution for 2001/02 but the segment contributed £567 million and £771 million to operating profit for 2002/03 and 2003/04 respectively; and
• similarly, the operating loss of £5 million for ‘Other’ in respect of 2001/02 relates solely to the activities of National Grid, which related primarily to the activities of Interconnectors, contracting and other costs incurred that were not attributable to business segments. In 2003/04 and 2002/03, the operating loss of ‘Other’ amounted to £8 million and £37 million respectively.

Note 31 to the accounts shows a summary income statement for 2003/04, 2002/03 and 2001/02 under US GAAP. These statements have reconciled the impact that material US GAAP adjustments have had on the UK GAAP income statement, including the impact of the elimination of all merger accounting (pooling of interests) adjustments under UK GAAP, and the inclusion of acquisition (purchase accounting) adjustments under US GAAP. The adjustments eliminating the pre-acquisition UK GAAP results affecting turnover and operating costs are much larger in 2001/02 than in 2002/03 or 2003/04, reflecting the fact that Lattice was acquired on 21 October 2002.

Some of the adjustments included within the US GAAP summary income statements and balance sheet substantially reflect reclassifications of items that are treated differently under UK GAAP and US GAAP, but that do not significantly impact on net income or net assets.

Under UK GAAP, the operating results of discontinued operations of Group undertakings are classified as part of total operating profit, whereas under US GAAP these amounts are shown net of any related interest and tax and shown as ‘net loss from discontinued operations’. In respect of the discontinued activities of joint ventures, under UK GAAP these activities are also classified as part of total operating profit, whereas under US GAAP these amounts are accounted for within ‘interest in equity accounted affiliates’. The share of equity affiliates’ operating profit/(loss), net interest, taxation, and minority interests are disclosed separately under UK GAAP, whereas under US GAAP, all these amounts are accounted for within ‘interest in equity accounted affiliates’.

Under UK GAAP, the results of Citelec, an equity accounted affiliate, is accounted for under hyperinflationary accounting rules. Under US GAAP, the results of Citelec are not accounted for under hyper-inflationary accounting rules, but this does not give rise to any significant difference to the UK GAAP accounting, as Citelec has been impaired under US GAAP and is carried at £nil under US GAAP, as it is under UK GAAP.

The principal adjustments to UK GAAP net income that have had a net impact in arriving at US GAAP net income mainly relate to adjustments arising from the treatment of the Lattice business combination as an acquisition under US GAAP; the capitalisation of replacement expenditure under US GAAP; the adoption of a fair value model for the recognition of derivative financial instruments under US GAAP; and the non-amortisation of goodwill under US GAAP. There are other adjustments, and these are explained in more detail in note 31 and note 32 to the accounts.

US GAAP applies a fair value model for the purposes of accounting for derivative financial instruments, and the Group applies a hedging strategy which meets UK GAAP requirements, but does not meet US GAAP hedge accounting requirements. This results in a much greater volatility in the US GAAP income statements.

The treatment of the business combination of Lattice as an acquisition by National Grid resulted in the recognition of provisional goodwill amounting to £3,813 million which, as a result of the finalisation of the fair value adjustments during 2003/04, was subsequently revised to £3,824 million, as referred to above. The acquisition of Lattice required an allocation of the purchase price to the acquired assets and liabilities of Lattice. Final changes to the provisional fair values attributed to the net assets of Lattice at 31 March 2003 arose from amendments to PPE fair values and tax balances (discussed further in note 32 to the accounts), which were completed within one year of the date of acquisition. It is the application of these acquisition accounting adjustments that explains the vast majority of the increase in equity shareholders’ funds at 31 March 2004 from £1,213 million under UK GAAP to £9,821 million under US GAAP.

During 2003/04, the additional minimum pension liability recognised as required by SFAS 87 fell by £743 million to £840 million. Of this total movement of £743 million, £633 million has been recorded through other comprehensive income.

Following a review of goodwill and other long-lived assets for impairment during 2003/04, evidence of impairment of goodwill and other intangible assets relating to Advantica was revealed. This resulted in an additional impairment charge relating to these assets being incurred under US GAAP amounting to £31 million. These charges are recorded in respect of ‘Other’.

During 2001/02, the Group adopted SFAS 133 ‘Accounting for Derivative Instruments and Hedging Activities’. The impact of adopting this standard is shown in the 2001/02 summary income statement prepared under US GAAP.

During 2002/03, the Group adopted SFAS 148 ‘Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No 123’. Prior to the adoption of this standard, the Group had accounted for stock compensation in accordance with APB 25. The Group adopted the retrospective method of accounting as permitted by this standard.

During 2003/04, the Group adopted the following US GAAP accounting standards to the extent necessary to comply with its reporting obligations in respect of this annual report:

• SFAS 132 ‘Employers’ Disclosures about Pensions and Other Post-Retirement Benefits – an amendment of FASB Statements No 87, 88 and 106’ (SFAS 132);
• SFAS 143 ‘Accounting for Asset Retirement Obligations’ (SFAS 143);
• SFAS 150 ‘Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity’ (SFAS 150);
• FIN 46 ‘Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin (ARB) 51’.

The impact of SFAS 132, SFAS 143 and SFAS 150 is discussed in note 32.

FIN 46 addresses the consolidation of entities for which control is achieved through means other than through voting rights (‘variable interest entities’ or ‘VIE’) by clarifying the application of ARB 51 ‘Consolidated Financial Statements’ to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 provides guidance on how to determine when and which business enterprise (the ‘primary beneficiary’) should consolidate the VIE. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures.

FIN 46 was revised in December 2003, following the issuance by the FASB of certain modifications to the original FIN 46. The disclosure provisions of FIN 46 are effective in all financial statements initially issued after 31 January 2003. FIN 46 is required to be immediately applied by all entities with a variable interest in a VIE created after 31 January 2003. A public foreign private issuer with a variable interest in a VIE created before 1 February 2003 is required to apply FIN 46 to that entity from 1 April 2004.

There have been no entities created since 31 January 2003 which fall within the scope of FIN 46 and therefore the application of FIN 46 has not had any material impact on the results or the financial condition of the Group. The impact of FIN 46 on future results is still being assessed in respect of the as yet unapplied provisions of the standard.

In January 2004, the FASB issued FASB Staff Position (FSP) 106-1 ‘Accounting and Disclosure Requirements Related to Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the ‘Act’)’. This FSP addresses the accounting implications of the newly issued Act to an entity that sponsors a post-retirement healthcare plan that provides prescription drug benefits. This Act, signed into law in December 2003 in the United States, introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of certain retiree healthcare benefit plans. The FSP includes an election to defer accounting for the implications of this new law until specific authoritative guidance to address the accounting treatment has been issued. As such, as a result of the lack of the existence of such guidance, any measure included in these accounts of the accumulated post-retirement benefit obligation (APBO) or net periodic post-retirement benefit cost in the accounts or accompanying notes do not reflect the effect of the Act on the plan. Authoritative guidance, when issued, could require a change in previously reported information.