Trading Stmt/IFRS Report-Pt.2

Royal Bank of Scotland Group PLC 08 June 2005 PART 2 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Year ended 31 December 2004 Prop- erty, inclu- ding Soft- invest- ware Share Emp- ment Cons- devel- based loyee Ban- pro- Other olida- opment pay- bene- cassu- Good- Group perty Leases TPF JVs tion costs ments fits rance will Other Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Net interest income (21) (18) (70) 4 (1) 16 - - (47) - - (137) Non-interest income 22 27 (138) 25 (29) - - (85) 251 - (2) 71 Insurance net premium income - - - 109 - - - - 594 - - 703 Total income 1 9 (208) 138 (30) 16 - (85) 798 - (2) 637 Operating expenses 5 49 (74) 74 2 27 36 (83) 106 (5) (2) 135 Insurance net claims - - - 78 - - - - 702 - - 780 Operating profit before provisions (4) (40) (134) (14) (32) (11) (36) (2) (10) 5 - (278) Provisions - - (27) - 1 - - - - - - (26) Profit before intangibles amortisation and integration costs (4) (40) (107) (14) (33) (11) (36) (2) (10) 5 - (252) Intangible assets amortisation - - - - - - - - - (870) - (870) Integration costs - - - - - 251 - - - - - 251 Profit before tax (4) (40) (107) (14) (33) (262) (36) (2) (10) 875 - 367 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Half year ended 30 June 2004 (unaudited) Prop- erty, inclu- ding Soft- invest- ware Share Emp- ment Cons- devel- based loyee Ban- pro- Other olida- opment pay- bene- cassu- Good- Group perty Leases TPF JVs tion costs ments fits rance will Other Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Net interest income (11) (6) (37) 2 - 6 - - (21) - - (67) Non-interest income 9 17 (59) 14 (1) - - (24) 47 - 2 5 Insurance net premium income - - - 49 - - - - 242 - (1) 290 Total income (2) 11 (96) 65 (1) 6 - (24) 268 - 1 228 Operating expenses (2) 29 (38) 28 - (4) 15 (23) 52 - 1 58 Insurance net claims - - - 37 - - - - 231 - (1) 267 Operating profit before provisions - (18) (58) - (1) 10 (15) (1) (15) - 1 (97) Provisions - - (13) - - - - - - - - (13) Profit before intangibles amortisation and integration costs - (18) (45) - (1) 10 (15) (1) (15) - 1 (84) Intangible assets amortisation - - - - - - - - - (409) - (409) Integration costs - - - - - 121 - - - - - 121 Profit before tax - (18) (45) - (1) (111) (15) (1) (15) 409 1 204 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Divisional analysis Prop- erty, inclu- Year ding Soft- ended invest- ware Share Emp- 31 ment Cons- devel- based loyee Ban- December pro- Other olida- opment pay- bene- cassu- Good- 2004 perty Leases TPF JVs tion costs ments fits rance will Other Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Corporate Banking and Financial Markets - (39) - (14) (31) (21) - - - - (1) (106) Retail Banking - - - - - 1 - - (9) - - (8) Retail Direct - - (107) - (1) (7) - - - - - (115) Manufacturing - - - - - 27 - - - - - 27 Wealth Management - (1) - - (1) (15) - - - - - (17) RBS Insurance (4) - - - - 6 - - (1) - - 1 Ulster Bank - - - - - (2) - - - - - (2) Citizens - - - - - - - - - - - - Central items - - - - - - (36) (2) - 5 1 (32) Profit before intangibles amortisation and integration costs (4) (40) (107) (14) (33) (11) (36) (2) (10) 5 - (252) Intangible assets amortisation - - - - - - - - - (870) - (870) Integration costs - - - - - 251 - - - - - 251 Profit before tax (4) (40) (107) (14) (33) (262) (36) (2) (10) 875 - 367 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Divisional analysis Prop- erty, Half inclu- Year ding Soft- ended invest- ware Share Emp- 30 ment Cons- devel- based loyee Ban- June pro- Other olida- opment pay- bene- cassu- Good- 2004 perty Leases TPF JVs tion costs ments fits rance will Other Total (unaudited) Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Corporate Banking and Financial Markets - (18) - - (1) - - - - - - (19) Retail Banking - - - - 1 - - (14) - - (13) Retail Direct - - (45) - - - - - - 1 - (44) Manufacturing - - - - - 16 - - - - - 16 Wealth Management - - - - - (6) - - - 1 - (5) RBS Insurance - - - - - - - - (1) - - (1) Ulster Bank - - - - - (1) - - - - - (1) Citizens - - - - - - - - - - - - Central items - - - - - - (15) (1) - (2) 1 (17) Profit before intangibles amortisation and integration costs - (18) (45) - (1) 10 (15) (1) (15) - 1 (84) Intangible assets amortisation - - - - - - - - - (409) - (409) Integration costs - - - - - 121 - - - - - 121 Profit before tax - (18) (45) - (1) (111) (15) (1) (15) 409 1 204 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Prop- Other Soft erty ware 31 plant deve- Inves- Share Emplo- December In- and Con- lop- tment based yee Ban- 2004 Divi- come equip- solid- ment prop- pay- bene- cassu- Good- dends Tax ment Leases TPF JVs ation costs erty ment fits rance will Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Assets Cash and - - - - - - - - - - - - - - balances at central banks Items in the - - - - - - - - - - - - - - course of collection from other banks Treasury bills - - - - - - - - - - - - - - and other eligible bills Loans and advances to banks - - - - (2) - - - - - - 186 - 184 Loans and advances to customers - - - (132) (1,340) (41) 4,554 - (449) - - (810) - 1,782 Debt securities - - - - - 153 465 - - - - 2,079 - 2,697 Equity - - - - - - - - - - - 1,763 - 1,763 shares Intangible fixed assets - - - - - - - 725 - - - - 941 1,666 Property, plant and equipment - - (60) (153) (8) 75 - (168) 447 - - 1 - 134 Settlement - - - - - - - - - - - - - - balances Other assets - - - (12) - 34 25 - - - (4) 216 (76) 183 Prepayments and accrued income - - - 3 (12) 15 19 - 1 - - 20 - 46 Long-term assurance assets - - - - - - - - - - - (3,800) - (3,800) Total assets - - (60) (294) (1,362) 236 5,063 557 (1) - (4) (345) 865 4,655 Liabilities Deposits by - - - - - - - - - - - - - - banks Items in the - - - - - - - - - - - - - - course of transmission to other banks Customer accounts - - - - (1,015) - - - - - - (732) - (1,747) Debt securities in issue - - - - - - 5,039 - - - - - - 5,039 Settlement - - - - - - - - - - - - - - balances and short positions Other liabilities (1,308) - - 6 (16) 31 (166) - - - - 85 - (1,368) Accruals and deferred income - - - 19 (3) 198 214 - - 20 - 11 - 459 Post-retirement benefit liabilities - - - - - 14 - - - - 1,025 - - 1,039 Provisions for liabilities and charges - deferred taxation liabilities - 109 - (90) 6 3 - 164 1 (6) (1,008) 12 (3) (812) - other provisions - - - - - - - - - - - 4,142 - 4,142 Subordinated - - - - - - - - - - - - - - liabilities Minority interests - - - - (334) - - 6 - - - (9) - (337) Shareholders' funds 1,308 (109) (60) (229) - (10) (24) 387 (2) (14) (21) (54) 868 2,040 Long-term assurance liabilities - - - - - - - - - - (3,800) - (3,800) Total liabilities - - (60) (294) (1,362) 236 5,063 557 (1) - (4) (345) 865 4,655 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Prop- Soft- erty ware 30 plant deve- Inves- Share Emplo- June In- and Con- lop- tment based yee Ban- 2004 Divi- come equip- Other solid- ment prop- pay- bene- cassu- Good- (unaudited) dends Tax ment Leases TPF JVs ation costs erty ment fits rance will Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Assets Cash and balances at central banks - - - - - - 1 - - - - 16 - 17 Items in the - - - - - - - - - - - - - - course of collection from other banks Treasury bills - - - - - - - - - - - - - - and other eligible bills Loans and advances to banks - - - - (2) - 75 - - - - 118 - 191 Loans and advances to customers - - - (120) (1,327) (48) 3,949 - (417) - - (586) - 1,451 Debt securities - - - - - 123 89 - - - - 1,999 - 2,211 Equity - - - - - - - - - - - 1,695 - 1,695 shares Intangible fixed assets - - - - - - - 822 - - - (1) 410 1,231 Property, plant and equipment - - - (130) (7) 79 - (114) 415 - - - - 243 Settlement - - - - - - - - - - - - - - balances Other assets - - - (23) - 40 (8) - - - (3) 227 - 233 Prepayments and accrued income - - - - (4) 15 16 - 1 - - 13 - 41 Long-term assurance assets - - - - - - - - - - - (3,531) - (3,531) Total assets - - - (273) (1,340) 209 4,122 708 (1) - (3) (50) 410 3,782 Liabilities Deposits by banks - - - - - - - - - - - 3 - 3 Items in the - - - - - - - - - - - - - - course of transmission to other banks Customer accounts - - - - (990) - - - - - (595) - (1,585) Debt securities in issue - - - - - - 3,838 - - - - - - 3,838 Settlement - - - - - - - - - - - - - - balances and short positions Other liabilities (529) - - 2 (27) 27 267 - - - - 336 - 76 Accruals and deferred income - - - 20 12 176 15 - - 12 - 2 - 237 Post-retirement benefit liabilities - - - - - - - - - - 618 - - 618 Provisions for liabilities and charges - deferred taxation liabilities - 109 - (82) 7 6 - 209 - (4) (603) (1) - (359) - other provisions - - - - - - - - - - - 3,818 - 3,818 Subordinated - - - - - - - - - - - - - - liabilities Minority interests - - - - (342) - 6 - - - (12) - (348) Shareholders' funds 529 (109) - (213) - - 2 493 (1) (8) (18) (70) 410 1,015 Long-term assurance liabilities - - - - - - - - - - - (3,531) - (3,531) Total liabilities - - - (273) (1,340) 209 4,122 708 (1) - (3) (50) 410 3,782 ANALYSIS OF IFRS ADJUSTMENTS EXCLUDING IAS 32, IAS 39 AND IFRS 4 Prop- Soft erty ware plant deve- Inves- Share Emplo- 1 In- and Con- lop- tment based yee Ban- January Divi- come equip- Other solid- ment prop- pay- bene- cassu- Good- 2004 dends Tax ment Leases TPF JVs ation costs erty ment fits rance will Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Assets Cash and - - - - - - - - - - - - - - balances at central banks Items in the - - - - - - - - - - - - - - course of collection from other banks Treasury bills - - - - - - - - - - - - - - and other eligible bills Loans and advances to banks - - - - (2) - - - - - - 1,013 - 1,011 Loans and advances to customers - - - (147) (1,310) (55) 3,163 - (448) - - (541) - 662 Debt securities - - - - - 111 12 - - - - 1,076 - 1,199 Equity - - - - - - - - - - - 1,745 - 1,745 shares Intangible fixed assets - - - - - - - 896 - - - - - 896 Property, plant and equipment - - - (127) (7) 83 - (78) 448 - - 1 - 320 Settlement - - - - - - - - - - - - - - balances Other assets - - - - - 49 - - - - (10) 208 - 247 Prepayments and accrued income - - - - (4) 16 11 1 - - - 8 - 32 Long-term assurance assets - - - - - - - - - - - (3,557) - (3,557) Total assets - - - (274) (1,323) 204 3,186 819 - - (10) (47) - 2,555 Liabilities Deposits by - - - - - - - - - - - - - - banks Items in the - - - - - - - - - - - - - - course of transmission to other banks Customer accounts - - - - (1,002) - - - - - (495) - (1,497) Debt securities in issue - - - - - - 3,129 - - - - - - 3,129 Settlement - - - - - - - - - - - - - - balances and short positions Other liabilities (1,059) - - (8) (23) 29 (156) - - - - 198 - (1,019) Accruals and deferred income - - - 10 8 169 211 - - 6 - - - 404 Post-retirement benefit liabilities - - - - - - - - - - 591 - - 591 Provisions for liabilities and charges - deferred taxation liabilities - 109 - (75) 7 6 - 243 - (2) (584) (4) - (300) - other provisions - - - - - - - - - - - 3,882 - 3,882 Subordinated - - - - - - - - - - - - - - liabilities Minority interests - - - - (313) - - 5 - - - (13) - (321) Shareholders' funds 1,059 (109) - (201) - - 2 571 - (4) (17) (58) - 1,243 Long-term assurance liabilities - - - - - - - - - - - (3,557) - (3,557) Total liabilities - - - (274) (1,323) 204 3,186 819 - - (10) (47) - 2,555 NOTES ON 2004 RESULTS 1. IFRS Earnings per share Earnings per share have been calculated based on the following: Full year First half 2004 2004 (unaudited) Â£m Â£m Earnings Profit attributable to ordinary shareholders 4,856 2,401 Add back dividends on dilutive convertible securities 66 - _______ _______ Diluted earnings attributable to ordinary shareholders 4,922 2,401 _______ _______ Weighted average number of ordinary shares In issue during the period 3,085 3,013 Effect of dilutive share options and convertible non-equity shares 73 18 _______ _______ Diluted weighted average number of ordinary shares during 3,158 3,031 the period _______ _______ Basic earnings per share 157.4p 79.7p Intangibles amortisation 1.2p 0.1p Integration costs 11.6p 4.1p _______ _______ Adjusted earnings per share 170.2p 83.9p _______ _______ Diluted earnings per share 155.9p 79.2p _______ _______ 2. Reconciliation of shareholders' funds 31 December 30 June 1 January 2004 2004 2004 Â£m Â£m Â£m UK GAAP shareholders' funds 31,865 30,407 26,098 Standards applicable to all periods: Proposed dividend 1,308 529 1,059 Goodwill and other intangibles 865 410 - Software development costs 551 702 814 Leasing (319) (295) (276) Share based payments (20) (12) (6) Other (159) (83) (72) Tax effect on above adjustments (77) (127) (167) Deferred tax (109) (109) (109) _______ _______ _______ Shareholders' funds under IFRS 33,905 31,422 27,341 _______ _______ _______ SECTION 3 2005 Results The financial information on pages 42 to 47 shows the effects of implementing IAS 32, IAS 39 and IFRS 4 on 1 January 2005. This therefore reflects all retrospective and prospective adjustments. 2005 results The implementation of IFRS has had a limited effect on the Group's restated results for 2004 and on its balance sheet as at 31 December 2004. However, the Group's 2005 results will also be affected by IAS 32 'Financial Instruments: Disclosure and Presentation', IAS 39 'Financial Instruments: Recognition and Measurement' and IFRS 4 'Insurance Contracts' which the Group has implemented from 1 January 2005. The key aspects of these standards, which are expected to have a more significant effect on the Group, are discussed below. Hedging - IAS 39 contains detailed criteria that must be met for derivatives to be accounted for as hedges and limits the circumstances in which hedge accounting is available. Hedge accounting is permitted for three types of hedge relationship: fair value hedge - the hedge of changes in the fair value of a recognised asset or liability or firm commitment; cash flow hedge - the hedge of variability in cash flows from a recognised asset or liability or a forecasted transaction; and the hedge of a net investment in a foreign entity. The Group has designated derivatives in both fair value and cash flow hedges. The Group, however, has not amended its overall approach to asset and liability management and its other hedging activities in the light of IFRS. It continues to use derivatives to hedge risk positions if economically beneficial even where hedge accounting conditions are not met. As IAS 39 requires all derivatives to be measured at fair value, such 'economic hedges' will introduce volatility into the Group's results. Even where transactions qualify for hedge accounting, IAS 39 will give greater volatility than UK GAAP - in income from hedge ineffectiveness and in shareholders' funds reflecting changes in the fair value of derivatives in cash flow hedges taken to equity. Loan impairment - the significant change, on implementation of IAS 39, in the way loan losses are measured is the explicit requirement to discount expected recoveries. As a result provisions are higher initially but the difference between the discounted and undiscounted amounts emerges as interest income over the recovery period. Effective interest - under UK GAAP, loan origination fees were recognised when received unless charged in lieu of interest. Interest income and expense were recognised on an accruals basis. IAS 39 requires the amortised cost of a financial instrument to be calculated using the effective interest method. The effective interest rate is the rate that discounts estimated future cash flows over an instrument's expected life to its net carrying value. It takes into account all fees and points paid that are an integral part of the yield, transaction costs and all other premiums and discounts. This GAAP difference results in certain lending fees being deferred over the life of the asset and changes the way interest is recognised to a constant yield basis. Capital instruments - IAS 32 does not contain the UK GAAP concept of 'non-equity shares'. Instruments that have the characteristics of debt must be classified as liabilities. As a result, most of the Group's preference shares and non-equity minority interests have been reclassified as liabilities on implementation of IAS 32. For 2004, this reclassification would have increased interest expense by Â£402 million with a corresponding reduction in preference share dividends of Â£239 million and in non-equity minority interests of Â£126 million, net of tax of Â£37 million. The changes in the classification of debt and equity instruments and in hedge accounting, loan impairment and effective interest calculations are expected to lead to a reduction in the Group's profit before tax. We estimate that the total impact on 2004 adjusted earnings per share, had all IFRS applied, would have been a reduction of around 5%. We expect a similar IFRS impact for 2005 relative to UK GAAP adjusted earnings per share. Balance sheet and capital ratios at 1 January 2005 The implementation of all IFRS has resulted in an increase of Â£113 billion in the Group's total assets and a reduction in shareholders' funds of Â£892 million. The rules for offset under IFRS are more restrictive than those in UK GAAP. IAS 32's criteria for a financial asset and financial liability to be offset include a requirement that the reporting entity must intend either to settle the asset and liability on a net basis or to realise the asset and settle the liability simultaneously. As a result there is significant gross up of assets and liabilities (Â£104 billion at 1 January 2005). In addition, there will be an increase in interest income and a corresponding increase in interest expense (but with no effect on net interest income). The Group's tier 1 capital ratio is 6.7% compared with 7.0% reported under UK GAAP; the total capital ratio is 11.6% compared with 11.7% under UK GAAP. IFRS CONSOLIDATED OPENING BALANCE SHEET AT 1 JANUARY 2005 At Effect At 31 December of IAS 1 January 2004 32/ 2005 IAS 39 Â£m Â£m Â£m Assets Cash and balances at central banks 4,293 - 4,293 Items in the course of collection from other banks 2,629 - 2,629 Treasury bills and other eligible bills 6,110 (1) 6,109 Loans and advances to banks 58,444 4,618 63,062 Loans and advances to customers 347,251 32,540 379,791 Debt securities 93,908 (62) 93,846 Equity shares 4,723 508 5,231 Intangible fixed assets 19,242 - 19,242 Property, plant and equipment 16,428 (3) 16,425 Settlement balances 5,682 - 5,682 Other assets 22,438 72,493 94,931 Prepayments and accrued income 6,974 (1,685) 5,289 _______ _______ _______ Total assets 588,122 108,408 696,530 _______ _______ _______ Liabilities Deposits by banks 99,081 6,143 105,224 Items in the course of transmission to other banks 802 - 802 Customer accounts 283,315 28,852 312,167 Debt securities in issue 63,999 1,125 65,124 Settlement balances and short positions 32,990 164 33,154 Other liabilities 24,784 73,467 98,251 Accruals and deferred income 16,047 (1,775) 14,272 Post-retirement benefit liabilities 2,940 - 2,940 Provisions for liabilities and charges - deferred taxation liabilities 2,061 (235) 1,826 - other provisions 4,340 47 4,387 Subordinated liabilities 20,366 7,044 27,410 Minority interests 3,492 (2,541) 951 Shareholders' funds 33,905 (3,883) 30,022 _______ _______ _______ Total liabilities 588,122 108,408 696,530 _______ _______ _______ ANALYSIS OF IAS 32, IAS 39 AND IFRS 4 IFRS ADJUSTMENTS Pro- Class visio- ifica- ning Hed- Rev- tion/ Emb- & ging enue Insu- 1 mea- edded imp- mea- Dere- Re- rance January Other Debt/ sure- deriva- air- sure- cogni- cogni- cont- 2005 Offset IAS 39 equity ment tives ment ment tion tion racts Other Total Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Â£m Assets Cash and - - - - - - - - - - - - balances at central banks Items in the - - - - - - - - - - - - course of collection from other banks Treasury bills and other eligible bills - - - (1) - - - - - - - (1) Loans and advances to banks 4,425 165 - - - - 4 - - 23 1 4,618 Loans and advances to customers 28,566 162 - (31) - (82) 518 4,022 (615) - - 32,540 Debt securities - 678 - (241) - - 50 (580) - 31 - (62) Equity shares - - - 507 - - - - - - 1 508 Intangible - - - - - - - - - - - - fixed assets Property, plant and equipment - - - - - - - - (3) - - (3) Settlement - - - - - - - - - - - - balances Other assets 71,476 - - (18) 114 - 734 302 - (113) (2) 72,493 Prepayments and accrued income 4 (1,005) - (1) 3 - (593) 25 (90) (29) 1 (1,685) Total assets 104,471 - - 215 117 (82) 713 3,769 (708) (88) 1 108,408 Liabilities Deposits by banks 4,425 207 - - - - 10 1,501 - - - 6,143 Items in the - - - - - - - - - - - - course of transmission to other banks Customer accounts 28,566 160 - (2) (39) - (11) 177 - - 1 28,852 Debt securities in issue - 79 - (25) - - (1,060) 2,131 - - - 1,125 Settlement balances and short positions - 164 - - - - - - - - - 164 Other liabilities 71,476 - (60) 17 158 - 1,614 311 4 (53) - 73,467 Accruals and deferred income 4 (1,052) - (4) (2) - (651) (181) 220 (109) - (1,775) Post-retirement - - - - - - - - - - - - benefit liabilities Provisions for liabilities and charges - deferred taxation liabilities - - - 65 - (24) 12 (51) (283) 46 - (235) - other provisions 47 - 47 Subordinated liabilities - 442 5,820 - - - 782 - - - - 7,044 Minority interests - - (2,493) - - - - - - (48) - (2,541) Shareholders' funds - - (3,267) 164 - (58) 17 (119) (649) 29 - (3,883) Total liabilities 104,471 - - 215 117 (82) 713 3,769 (708) (88) 1 108,408 RECONCILIATION OF SHAREHOLDERS' FUNDS 31 December 2004 Â£m UK GAAP shareholders' funds 31,865 Standards applicable to all periods: Proposed dividend 1,308 Goodwill and other intangibles 865 Software development costs 551 Leasing (319) Share based payments (20) Other (159) Tax effect on above adjustments (77) Deferred tax (109) _______ Shareholders' funds under IFRS 33,905 Standards applicable from 1 January 2005: Non-equity shares reclassified to debt (3,192) Revenue recognition (932) Derecognition (170) Securities 229 Other (53) Tax effect on cumulative IFRS adjustments 235 _______ Shareholders' funds under IFRS 30,022 Equity - minority interests 951 _______ Equity under IFRS at 1 January 2005 30,973 _______ REGULATORY RATIOS The regulatory capital ratios for the Group at 1 January 2005 are set out below. These incorporate adjustments arising from the first time adoption of all IFRS, including IAS 32 and IAS 39 and have been computed in accordance with the FSA's policy statement 05/5. UK GAAP IFRS Tier 1 capital (Â£ million) 22,694 21,612 _______ _______ Total capital (Â£ million) 37,758 37,679 _______ _______ Tier 1 capital ratio (%) 7.0 6.7 _______ _______ Total capital ratio (%) 11.7 11.6 _______ _______ An analysis of the movement in Tier 1 capital ratio is set out below. % Tier 1 ratio: reported under UK GAAP at 31 December 2004 7.0 IFRS transitional adjustments (0.40) Non-specific provisions (0.05) Dividend 0.40 Pensions (0.25) (0.3) Tier 1 ratio: at 1 January 2005 under IFRS 6.7 SECTION 4 The bases of preparation of the IFRS results is shown on page 49. The Group's provisional IFRS accounting policies are set out on pages 50 to 58 of this Report. A description of the key differences between UK GAAP and IFRS accounting policies is shown on pages 59 to 64. The IFRS financial information has been examined by the Group's auditors, Deloitte & Touche LLP, and their special purpose reports are set out on page 67 to 69. Note Financial information contained in this document does not constitute statutory accounts within the meaning of section 240 of the Companies Act 1985 ('the Act'). The statutory accounts for the year ended 31 December 2004 will be filed with the Registrar of Companies and have been reported on by the auditors under section 235 of the Act. The report of the auditors was unqualified and did not contain a statement under section 237(2) or (3) of the Act BASES OF PREPARATION First time adoption of International Financial Reporting Standards ('IFRS') The Group prepared its 2004 consolidated financial statements in accordance with accounting standards issued by the UK Accounting Standards Board, the pronouncements of the Urgent Issues Task Force, relevant Statements of Recommended Accounting Practice and in compliance with the Companies Act 1985. The Group will henceforth prepare its consolidated financial statements in accordance with International Financial Reporting Standards, International Accounting Standards and interpretations issued by the International Financial Reporting Interpretation Committee and its predecessor body (together 'IFRS'). The standards applied, which will be adopted for the first time for the purpose of preparing consolidated financial statements for the year ending 31 December 2005, will be those issued by the International Accounting Standards Board ('IASB') and endorsed by the European Union (or where there is a reasonable expectation of endorsement) as at 31 December 2005. The EU has not endorsed IAS 39 as issued by the IASB. The EU has relaxed some of the hedging requirements and introduced a prohibition on the designation of non-trading financial liabilities at fair value through profit or loss. The Group has not applied the relaxed hedge accounting requirements nor has it designated any non-trading financial liabilities at fair value through profit or loss. The financial information in this announcement has therefore been prepared in accordance with all extant IFRS. The IASB has proposed amendments to the fair value option in IAS 39. The EU is expected to accept these amendments and endorse later this year a revised standard that would permit, subject to certain restrictions, designation of non-trading financial liabilities at fair value through profit or loss. It is anticipated that the transitional arrangements for the revised fair value option will permit designation from 1 January 2005 for companies applying the standard for the first time from that date. If endorsed by the EU, the Group will consider, at that time, applying the fair value option in respect of certain issued structured notes which contain embedded derivatives. As required by IFRS 1, the Group has applied IFRS expected to be extant at 31 December 2005 in preparing its preliminary consolidated financial statements with effect from 1 January 2004. As permitted by IFRS 1 the Group has not restated its 2004 profit and loss account and balance sheet for the standards relating to financial instruments and insurance contracts (IAS 32, IAS 39 and IFRS 4). Further standards and interpretations may be issued that could be applicable for financial years beginning on or after 1 January 2005 or that are applicable to later accounting periods but with an option for earlier adoption. The Group's first annual financial statements under IFRS may, therefore, be prepared using different accounting policies than those used in preparing the financial information in this announcement. Furthermore, IFRS is currently being applied in the EU and other jurisdictions for the first time. It contains many new and revised standards, and practice in applying these standards and their interpretation is still developing. It should be noted therefore that the financial information included in this announcement is subject to change. The relevant UK tax legislation has not yet been finalised and it is possible that the tax estimates included in this announcement will have to be revised as relevant elections are made in respect of the large number of UK companies in the Group. PROVISIONAL ACCOUNTING POLICIES 1. Adoption of International Financial Reporting Standards The consolidated financial statements have, for the first time, been prepared in accordance with International Financial Reporting Standards (IFRS) adopted by the International Accounting Standards Board (IASB), and interpretations issued by the International Financial Reporting Interpretations Committee of the IASB. The date of transition to IFRS for the Group and the date of its opening IFRS balance sheet was 1 January 2004. On initial adoption of IFRS, the Group applied the following exemptions from the requirements of IFRS and from their retrospective application as permitted by IFRS 1 'First-time Adoption of International Financial Reporting Standards' (IFRS 1): Business combinations - the Group has applied IFRS 3 'Business Combinations' to business combinations that occurred on or after 1 January 2004. Business combinations before that date have not been restated. Under previous GAAP ('UK GAAP'), goodwill arising on acquisitions after 1 October 1998 was capitalised and amortised over its estimated useful economic life. Goodwill arising on acquisitions before 1 October 1998 was deducted from equity. The carrying amount of goodwill in the Group's opening IFRS balance sheet was Â£13,131 million, its carrying value under UK GAAP as at 31 December 2003. Fair value or revaluation as deemed cost - under UK GAAP, the Group's freehold and long leasehold property occupied for its own use was recorded at valuation on the basis of existing use value. The Group has elected to use this valuation as at 31 December 2003 as deemed cost for its opening IFRS balance sheet. At this date, the carrying value under UK GAAP of freehold and long leasehold property occupied for own use was Â£2,391 million. Compound financial instruments - the Group has not separated compound instruments between liability and equity components, as required by IAS 32, where the liability component was not outstanding at 1 January 2004. UK GAAP does not permit compound instruments to be separated between liability and equity components on issue. Derecognition - the Group has applied the derecognition requirements of IAS 39 to transactions occurring on or after 1 January 1992. Share based payments - IFRS 2 'Share-based Payment' has been applied to equity instruments granted after 7 November 2002. Implementation of IAS 32, IAS 39 and IFRS 4 - as allowed by IFRS 1, the Group has not restated its 2004 consolidated income statements and balance sheets to comply with IAS 32, IAS 39 and IFRS 4. In preparing the Group's 2004 full year and half year consolidated income statements and balance sheets, UK GAAP principles then current have been applied to financial instruments. The main differences between UK GAAP and IFRS on financial instruments are summarised on pages 59 to 64. 2. Accounting convention The financial statements have been prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held for trading financial assets and financial liabilities, financial assets that are designated at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged. PROVISIONAL ACCOUNTING POLICIES (continued) 3. Basis of consolidation The consolidated financial statements incorporate the financial statements of the holding company (The Royal Bank of Scotland Group plc) and entities (including certain special purpose entities) controlled by the Group (its subsidiaries). Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. Any excess of the cost (the fair value of assets given, liabilities incurred or assumed and equity instruments issued by the Group plus any directly attributable costs) of an acquisition over the fair value of the net assets acquired is recognised as goodwill. The interest of minority shareholders is stated at their share of the fair value of the subsidiary's net assets. The results of subsidiaries acquired are included in the consolidated income statement from the date control passes to the Group. The results of subsidiaries sold are included up until the Group ceases to control them. All intra-group balances, transactions, income and expenses are eliminated on consolidation. The consolidated accounts are prepared using uniform accounting policies. 4. Revenue recognition Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those at fair value through profit or loss is determined using the effective interest rate method. The effective interest rate method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees receivable, that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows. Financial assets and financial liabilities held for trading and financial assets designated as fair value through profit or loss are recorded at fair value. Changes in fair value are recognised in profit or loss together with dividends and interest receivable and payable. Commitment and utilisation fees are determined as a percentage of the outstanding facility. If it is unlikely that a specific lending arrangement will be entered into, such fees are taken to profit or loss over the life of the facility otherwise they are deferred and included in the effective interest rate on the advance. Fees in respect of services are recognised as the right to consideration accrues through the provision of the service to the customer. The arrangements are generally contractual and the cost of providing the service is incurred as the service is rendered. The price is usually fixed and always determinable. The application of this policy to significant fee types is outlined below. Payment services: this comprises income received for payment services including cheques cashed, direct debits, Clearing House Automated Payments (the UK electronic settlement system) and BACS payments (the automated clearing house that processes direct debits and direct credits). These are generally charged on a per transaction basis. The income is earned when the payment or transaction occurs. Payment services income is usually charged to the customer's account, monthly or quarterly in arrears. Accruals are raised for services provided but not charged at period end. Card related services: fees from credit card business include: Commission received from retailers for processing credit and debit card transactions: income is accrued to the income statement as the service is performed. Interchange received: as issuer, the Group receives a fee (interchange) each time a cardholder purchases goods and services. The Group also receives interchange fees from other card issuers for providing cash advances through its branch and Automated Teller Machine networks. These fees are accrued once the transaction has taken place. An annual fee payable by a credit card holder is charged at the beginning of each year but is deferred and taken to profit or loss over the period of the service i.e. 12 months. Insurance brokerage: this is made up of fees and commissions received from the agency sale of insurance. Commission on the sale of an insurance contract is earned at the inception of the policy as the insurance has been arranged and placed. However, provision is made where commission is refundable in the event of policy cancellation in line with estimated cancellations. Investment management fees: fees charged for managing investments are recognised as revenue as the services are provided. Incremental costs that are directly attributable to securing an investment management contract are deferred and charged as expense as the related revenue is recognised. 5. Pensions and other post-retirement benefits The Group provides post-retirement benefits in the form of pensions and healthcare plans to eligible employees. The cost of defined benefit pension schemes and healthcare plans is assessed by independent professionally qualified actuaries and recognised on a systematic basis over employees' service lives. For defined benefit schemes, scheme liabilities are measured on an actuarial basis using the projected unit credit method and discounted at a rate that reflects the current rate of return on a high quality corporate bond of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). The current service cost and any past service costs together with the expected return on scheme assets less the unwinding of the discount on the scheme liabilities is charged to operating expenses. Actuarial gains and losses are recognised in full in the period in which they occur outside profit or loss and presented in the statement of recognised income and expense. Contributions to defined contribution pension schemes are recognised in the income statement when payable. 6. Intangible assets and goodwill Intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss using methods that best reflect the economic benefits over their estimated useful economic lives and included in Depreciation and amortisation. The estimated useful economic lives are as follows: Core deposit intangibles 7 years Computer software 3-5 years Other 5-10 years Expenditure on internally generated goodwill and brands is written off as incurred. Acquired goodwill being the excess of the cost of an acquisition over the Group's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary, associate or joint venture acquired is initially recognised at cost and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisition of subsidiaries is included in the balance sheet caption 'Intangible fixed assets' and that on associates and joint ventures within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill. PROVISIONAL ACCOUNTING POLICIES (continued) 7. Property, plant and equipment Items of property, plant and equipment are stated at cost less accumulated depreciation (see below) and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately. Property that is being constructed or developed for future use as investment property is classified as property, plant and equipment and stated at cost until construction or development is complete, at which time it is reclassified as investment property. Depreciation is charged to profit or loss on a straight-line basis so as to write off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases (except investment property - see note 20)) over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and long leasehold buildings 50 years Short leaseholds unexpired period of the lease Property adaptation costs 10 to 15 years Computer equipment up to 5 years Other equipment 4 to 15 years 8. Impairment of intangible assets and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Irrespective of any indications of impairment, intangible assets (excluding goodwill) with indefinite useful lives are tested annually for impairment by comparing their carrying value with their recoverable amount. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent from those of other assets or groups of assets, recoverable amount is determined for the cash-generating unit to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset that have not been reflected in the estimation of future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed that which it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed. 9. Foreign currencies The Group's consolidated financial statements are presented in sterling which is the functional currency of the Company. Transactions in foreign currencies are translated into sterling at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into sterling at the rates of exchange ruling at the balance sheet date. Foreign exchange differences arising on translation are recognised in profit or loss except for differences arising on financial liabilities hedging net investments in foreign operations. Non-monetary items denominated in foreign currencies that are stated at fair value are translated into sterling at foreign exchange rates ruling at the dates the values were determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example equity shares, which are included in the fair value reserve in equity unless the asset is the hedged item in a fair value hedge. PROVISIONAL ACCOUNTING POLICIES (continued) The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into sterling at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on translation of foreign operations are recognised directly in equity. 10. Leases Contracts to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer. Other contracts to lease assets are classified as operating leases. Finance lease receivables are stated in the balance sheet at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment. Unguaranteed residual values are subject to regular review to identify potential impairments. If there has been a reduction in the estimated unguaranteed residual value, the income allocation is revised and any reduction in respect of amounts accrued is recognised immediately. Rental income from operating leases is credited to the income statement on a receivable basis over the term of the lease. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see note 7). 11. Insurance General insurance General insurance comprises short-duration contracts and includes principally property and liability insurance contracts. Due to the nature of the products sold - retail based property and casualty, motor, home and personal health insurance contracts - the insurance protection is provided on an even basis throughout the term of the policy. Premiums from general insurance contracts are recognised in the accounting period in which they begin. Unearned premiums represent the proportion of the net premiums that relate to periods of insurance after the balance sheet date and are calculated over the period of exposure under the policy, on a daily basis, 24th's basis or allowing for the estimated incidence of exposure under policies which are longer than twelve months. Provision is made where necessary for the estimated amount of claims over and above unearned premiums including that in respect of future written business on discontinued lines under the run-off of delegated underwriting authority arrangements. It is designed to meet future claims and related expenses and is calculated across related classes of business on the basis of a separate carry forward of deferred acquisition expenses after making allowance for investment income. Acquisition expenses relating to new and renewed business for all classes are deferred over the period during which the premiums are unearned. The principal acquisition costs so deferred are commissions payable, costs associated with the telesales and underwriting staff and prepaid claims handling costs in respect of delegated claims handling arrangements for claims which are expected to occur after the balance sheet date. Claims and the related reinsurance are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date, and claims handling expenses. The related reinsurance receivable is recognised at the same time. Life assurance The Group's long-term assurance contracts include whole-life, term assurance, endowment assurances, flexible whole life, pension and annuity contracts that are expected to remain in force for an extended period of time. Contracts under which the Group does not accept significant insurance risk are classified as investment contracts. The value placed on the Group's long-term life assurance business, comprising those contracts that involve significant insurance risk together with the related assets, represents the present value of profits inherent in in-force policies. In calculating the value of in-force policies, future surpluses expected to emerge are estimated using appropriate assumptions as to future mortality, persistency and levels of expenses, which are then discounted at a risk-adjusted rate. Changes in this value, which is determined on a post-tax basis, are included in operating profit. The Group has reinsurance treaties that transfer significant insurance risk. Within net assets, the reinsurance cash flows are recognised when they become payable. For most contracts this effectively spreads the cost of reinsurance over the life of the reinsured contracts. 12. Taxation Provision is made for taxation at current enacted rates on taxable profits, arising in income or in equity, taking into account relief for overseas taxation where appropriate. Deferred taxation is accounted for in full for all temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes, except in relation to overseas earnings where remittance is controlled by the Group, and goodwill Deferred tax assets are only recognised to the extent that it is probable that they will be recovered. 13. Financial assets Financial assets are classified into held-to-maturity investments; available-for-sale financial assets; held for trading; designated as fair value through profit or loss; or loans and receivables. Held-to-maturity investments - a financial asset is classified as held-to-maturity investments only if it has fixed or determinable payments, a fixed maturity and the Group has the positive intention and ability to hold to maturity. Held-to-maturity investments are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see note 4 above) less any impairment losses. Held-for-trading - a financial asset is classified as held-for-trading if it is acquired principally for the purpose of the selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial assets are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses on held-for-trading financial assets are recognised in profit or loss as they arise. Designated at fair value through profit or loss - financial assets that the Group designates on initial recognition as being at fair value through profit and loss are recognised at fair value with transaction costs being recognised in profit or loss and are subsequently measured at fair value. Gains and losses on financial assets that are designated at fair value through profit or loss are recognised in profit or loss as they arise. Loans and receivables - non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables except those that are classified as held-to-maturity, held for trading or designated as fair value through profit or loss. Loans and receivables are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at adjusted cost using the effective interest method (see note 4 above) less any impairment losses. Available-for-sale - financial assets that are not classified as held-to- maturity; held for trading; designated at fair value through profit or loss; or loans and receivables are classified as available for sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Exchange differences resulting from retranslating the amortised cost of currency monetary available-for-sale financial assets are recognised in profit or loss. Other changes in the fair value of available-for-sale financial assets are reported in a separate component of shareholders' equity. Interest calculated using the effective interest rate (see note 4 above) is recognised in profit or loss. Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; all other regular way purchases are recognised on trade date. Fair value for a net open position in a financial asset that is quoted in an active market is the current bid price times the number of units of the instrument held. Fair values for financial assets not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial assets. 14. Impairment of financial assets The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets classified as held-to-maturity, available-for-sale or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset. Financial assets carried at amortised cost - if there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivable or as held-to-maturity investments has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition. Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective assessment of impairment, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of current observable data, to reflect the effects of current conditions not affecting the period of historical experience. Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If in a subsequent period the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment. Financial assets carried at fair value - when a decline in the fair value of a financial asset classified as available-for-sale has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in profit or loss. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on available-for-sale equity instruments are not reversed through profit or loss, but those on available-for-sale debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event. 15. Financial liabilities A financial liability is classified as held-for-trading if it is incurred principally for the purpose of selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise. All other financial liabilities are measured at amortised cost using the effective interest method (see note 4 above). Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument held or issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities. 16. Sale and repurchase transactions Securities which have been sold with an agreement to repurchase continue to be shown on the balance sheet and the sale proceeds recorded as a deposit where the Group retains substantially all the risks and rewards of ownership of the securities. Securities acquired in reverse sale and repurchase transactions are not recognised on the balance sheet and the purchase price is treated as a loan if the Group is not exposed to the risks and rewards of ownership. 17. Capital instruments The Group classifies a financial instrument that it issues as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms. An instrument is classified as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate. 18. Derivatives and hedging Derivative financial instruments are recognised initially, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative's components using appropriate pricing or valuation models. A derivative embedded in a contract is accounted for as stand-alone derivative if its economic characteristics are not closely related to the economic characteristics of the host contract; unless the entire contract is carried at fair value through profit or loss. Gains and losses arising from changes in fair value of a derivative are recognised as they arise in profit or loss unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a forecast transaction (cash flow hedges); and hedges of the net investment in a foreign entity. Hedge relationships are formally documented at inception. The documentation includes identification of the hedged item and the hedging instrument, details the risk that is being hedged and the way in which effectiveness will be assessed at inception and during the period of the hedge. If the hedge is not highly effective in offsetting changes in fair values or cash flows attributable to the hedged risk, consistent with the documented risk management strategy, hedge accounting is discontinued. Fair value hedge - in a fair value hedge, the gain or loss on the hedging instrument is recognised in profit or loss. The gain or loss on the hedged item attributable to the hedged risk is recognised in profit or loss and adjusts the carrying amount of the hedged item. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting or if the hedging instrument expires or is sold, terminated or exercised or if hedge designation is revoked. If the hedged item is one for which the effective interest rate method is used, any cumulative adjustment is amortised to profit or loss over the life of the hedged item using a recalculated effective interest rate. If the hedged item is an equity share, the adjustment remains in equity until the share is sold. Cash flow hedge - where a derivative financial instrument is designated as a hedge of the variability in cash flows of a recognised asset or liability or a highly probable forecast transaction, the effective portion of the gain or loss on the hedging instrument is recognised directly in equity. The ineffective portion is recognised in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity in the same periods in which the asset or liability affects profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same time as the hedged transaction. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss recognised in equity is recognised in profit or loss when the hedged cash flow occurs or, if the forecast transaction results in the recognition of a financial asset or financial liability, in the same periods during which the asset or liability affects profit or loss. Where a forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss is recognised in profit or loss immediately. Hedge of net investment in a foreign operation - where a foreign currency liability hedges a net investment in a foreign operation, the portion of foreign exchange differences arising on translation of the liability determined to be an effective hedge is recognised directly in equity. Any ineffective portion is recognised in profit or loss. 19. Share-based payments The Group grants options over shares in The Royal Bank of Scotland Group plc to its employees under various share option schemes. The Group has applied IFRS 2 'Share-based Payment' to grants under these schemes after 7 November 2002 that had not vested on 1 January 2005. The expense for these transactions is measured based on the fair value on the date the options are granted. The fair value is estimated using valuation techniques which take into account the option's exercise price, its term, the risk free interest rate and the expected volatility of the market price of The Royal Bank of Scotland Group plc's shares. Vesting conditions are not taken into account when measuring fair value, but are reflected by adjusting the number of options included in the measurement of the transaction such that the amount recognised reflects the number that actually vest. The fair value is expensed on a straight-line basis over the vesting period. 20. Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. It is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices in an active market for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease. Lease incentives granted are recognised as an integral part of the total rental income. SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES UK GAAP IFRS (a) Goodwill Goodwill arising on acquisitions after Goodwill is recorded at cost 1 October 1998 is capitalised and less any accumulated impairment amortised over its estimated useful losses. Goodwill is tested economic life. Goodwill arising on annually for impairment or more acquisitions before 1 October 1998 was frequently if events or changes deducted from equity. Goodwill is in circumstances indicate that reviewed for impairment at the end of it might be impaired. the first full year following an The carrying amount of goodwill acquisition and subsequently if events in the Group's opening IFRS or changes in circumstances indicated balance sheet (as at 1 January that its carrying value might not be 2004) was Â£13,131 million, its recoverable, carrying value under UK GAAP as at 31 December 2003. (b) Intangibles other than goodwill Computer software development costs Most computer software development Computer software development costs are written off as incurred. costs are capitalised if they create an identifiable intangible asset. They are amortised over their estimated useful life of three years. Net computer software development costs of Â£818 million were recognised on transition to IFRS. Other intangibles An intangible asset acquired in a An intangible asset is business combination is capitalised recognised as an asset separately from goodwill only if it can separately from goodwill if it be disposed of separately from the is separable or it arises from revenue-earning activity to which it contractual or other legal contributes and its value can be rights regardless of whether measured reliably. these rights are transferable or separable. Core deposit intangibles of Â£268 million, mortgage servicing rights of Â£81 million, customer relationships of Â£162 million and other intangibles of Â£18 million were recognised in business combinations that took place in 2004. (c) Leasing Finance lease income is recognised so IFRS requires a level rate of as to give a level rate of return on return on the net investment in the net cash investment in the lease; the lease. Tax cash flows are tax cash flows are taken into account not reflected in the pattern of in allocating income. income recognition. Assets held under operating leases are Assets held on operating leases depreciated on a straight-line or are depreciated on a reverse-annuity basis. straight-line basis. (d) Dividends Dividends payable on ordinary shares Dividends are recorded in the are recorded in the period to which period in which they are they relate. declared. (e) Consolidation UK GAAP requires consolidation of All entities controlled by the entities controlled by the reporting Group are consolidated together entity. Control is the ability to with special purpose entities direct the financial and operating (SPEs) where the substance of policies of an entity. the relationship between the reporting entity and the SPE indicates that it is controlled by the reporting entity. SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES (continued) (f) Life assurance To reflect the distinct nature of Assets, liabilities, income and long-term assurance assets and expense of life assurance business liabilities attributable to are consolidated on a line-by-line policyholders, they are shown basis. separately on the consolidated balance sheet; the results of life assurance business are presented as a single contribution to profit Movements in embedded value are not before tax. grossed up i.e. they are included net Changes in embedded value of tax in profit before tax. determined on a post-tax basis are grossed up for inclusion in the income statement. (g) Associates and joint ventures An associate is an entity in which The definitions of associate and the reporting entity holds a joint venture are similar to those in participating interest and over UK GAAP. However, significant whose operating and financial influence is defined as the power to policies it exercises a participate in the financial and significant influence in practice. operating policies of the associate. A joint venture is an entity in A joint venture is an entity where which the reporting entity in the strategic financial and operating practice shares control with other decisions require the unanimous investors. Associates are consent of the parties sharing accounted for using the equity control. Associates are accounted for method and joint ventures using using the equity method. The Group the gross equity method. proportionately consolidates its joint ventures. (h) Property, plant and equipment The Group's freehold and long The Group's freehold and long leasehold property occupied for leasehold property occupied for its its own use is recorded at own use is recorded at cost less valuation on the basis of existing depreciation. use value. The Group has elected to use the UK GAAP valuation as at 31 December 2003 as deemed cost for freehold and long leasehold property occupied for its own use in its opening IFRS balance sheet (1 January 2004). (i) Investment property Investment property is revalued Investment property is stated at fair annually to open market value and value. Any gain or loss arising from changes in market value reflected a change in fair value is recognised in the Statement of Total in profit or loss. Recognised Gains and Losses. (j) Share-based payments No expense is recognised for The Group has applied IFRS 2 options over The Royal Bank of 'Share-based Payment' to grants of Scotland Group plc shares granted options over shares after 7 November to employees. 2002 that had not vested on 1 January 2005. The expense for these transactions is measured based on the fair value on the date the options are granted. The fair value is expensed on a straight-line basis over the vesting period. (k) Pensions Pension scheme assets are measured Pension scheme assets are measured at at fair value using mid-market fair value using bid prices. prices. (l) Income tax Deferred tax is not accounted for Deferred tax is provided on fixed in relation to revaluations of asset revaluations and on taxable fixed assets where there is no gains and losses on fixed asset sales commitment to dispose of the asset rolled over into the tax cost of or in relation to taxable gains or replacement assets. losses on sales of fixed assets that are rolled over into the tax cost of replacement fixed assets. SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES (continued) IMPLEMENTATION OF IAS 32, IAS 39 and IFRS 4 UK GAAP IFRS (m) Financial instruments: financial assets Loans are measured at cost Under IAS 39, financial assets are less provisions for bad and classified into held-to-maturity; doubtful debts, derivatives available-for-sale; held for trading; held for trading are carried designated as fair value through profit or at fair value and hedging loss; and loans and receivables. Financial derivatives are accounted for assets classified as held-to-maturity or in accordance with the as loans and receivables are carried at treatment of the item being amortised cost. Other financial assets are hedged (see Derivatives and measured at fair value. Changes in the hedging below). fair value of available-for-sale financial Debt securities and equity assets are reported in a separate shares intended for use on a component of shareholders' equity. Changes continuing basis in the in the fair value of financial assets held Group's activities are for trading or designated as fair value classified as investment are taken to profit or loss. Financial securities are stated at cost assets can be classified as less provision for any held-to-maturity only if they have a fixed permanent diminution in maturity and the reporting entity has the value. The cost of dated positive intention and ability to hold to investment securities is maturity. Trading financial assets are adjusted for the amortisation held for the purpose of selling in the of premiums or discounts. near term. IFRS allows any financial asset Other debt securities and to be designated as fair value through equity shares are carried at profit or loss on initial recognition. fair value. Unquoted debt financial assets that are not classified as held-to-maturity, held for trading or designated as fair value through profit or loss are categorised as loans and receivables. All other financial assets are classified as available-for-sale. (n) Financial instruments: financial liabilities Under UK GAAP, short IAS 39 requires all financial liabilities positions in securities and to be measured at amortised cost except trading derivatives are those held for trading and those that were carried at fair value; all designated as fair value through profit or other financial liabilities loss on initial recognition. are recorded at amortised On implementation of IAS 39, no financial cost. liabilities were designated at fair value through profit or loss. SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES (continued) IMPLEMENTATION OF IAS 32, IAS 39 and IFRS 4 (continued) (o) Liabilities and equity Under UK GAAP all shares were There is no concept of non-equity classified as shareholders' funds. shares in IFRS. Instruments are An analysis of shareholders' funds classified between equity and between equity and non-equity liabilities in accordance with the interests is given. substance of the contractual arrangements. A non-derivative instrument is classified as equity if it does not include a contractual obligation either to deliver cash or to exchange financial instruments with another entity under potentially unfavourable conditions, and, if the instrument will or may be settled by the issue of equity, settlement does not involve the issue of a variable number of shares. On implementation of IAS 32, non-equity shares with a balance sheet value of Â£3,192 million and Â£2,568 million of non-equity minority interests were reclassified as liabilities. (p) Effective interest rate and lending fees Under UK GAAP, loan origination IAS 39 requires the amortised cost of fees are recognised when received a financial instrument to be unless they are charged in lieu of calculated using the effective interest. interest method. The effective interest rate is the rate that discounts estimated future cash flows over an instrument's expected life to its net carrying value. It takes into account all fees and points paid that are an integral part of the yield, transaction costs and all other premiums and discounts. On implementation of IAS 39, the carrying value of financial assets was reduced by Â£708 million and financial liabilities increased by Â£224 million, deferred tax was reduced by Â£283 million and shareholder's equity reduced by Â£649 million. (q) Derivatives and hedging Under UK GAAP non-trading Under IAS 39, all derivatives are derivatives are accounted for on measured at fair value. Hedge an accruals basis in accordance accounting is permitted for three with the accounting treatment of types of hedge relationship: fair the underlying transaction or value hedge - the hedge of changes in transactions being hedged. If a the fair value of a recognised asset non-trading derivative transaction or liability or firm commitment; cash is terminated or ceases to be an flow hedge - the hedge of variability effective hedge, it is re-measured in cash flows from a recognised asset at fair value and any gain or loss or liability or a forecasted amortised over the remaining life transaction; and the hedge of a net of the underlying transaction or investment in a foreign entity. In a transactions being hedged. If a fair value hedge the gain or loss on hedged item is derecognised the the derivative is recognised in related non-trading derivative is profit or loss as it arises offset by remeasured at fair value and any the corresponding gain or loss on the gain or loss taken to the income hedged item attributable to the risk statement. hedged. In a cash flow hedge and in the hedge of a net investment in a foreign entity, the element of the derivative's gain or loss that is an effective hedge is SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES (continued) IMPLEMENTATION OF IAS 32, IAS 39 and IFRS 4 (continued) (q) Derivatives and hedging (continued) Embedded derivatives are not recognised directly in equity. The bifurcated from the host ineffective element is taken to the contract. income statement. Certain conditions must be met for a relationship to qualify for hedge accounting. These include designation, documentation and prospective and actual hedge effectiveness. On implementation of IAS 39, non-trading derivatives were remeasured at fair value. A derivative embedded in a contract is accounted for as stand-alone derivative if its economic characteristics are not clearly and closely related to the economic characteristics of the host contract; unless the entire contract is carried at fair value through profit or loss. (r) Loan impairment Under UK GAAP provisions for bad IFRS require impairment losses on and doubtful debts are made so financial assets carried at amortised as to record impaired loans at cost to be measured as the difference their ultimate net realisable between the asset's carrying amount and value. the present value of estimated future Specific provisions are cash flows discounted at the asset's established against individual original effective interest rate. There advances or portfolios of is no concept of specific and general smaller balance homogeneous provision - under IFRS impairment is advances and the general assessed individually for individually provision covers advances significant assets but can be assessed impaired at the balance sheet collectively for other assets. Once an date but which have not been impairment loss has been recognised on identified as such. Interest a financial asset or group of financial receivable from loans and assets, interest income is recognised advances is credited to the on the carrying amount using the rate income statement as it accrues of interest at which estimated future unless there is significant cash flows were discounted in measuring doubt that it can be impairment. collected. (s) Offset Under UK GAAP an intention to For a financial asset and financial settle net is not a requirement liability to be offset, IFRS require for set off; the entity must that an entity must intend to settle on have the ability to insist on a net basis or to realise the asset and net settlement and that ability settle the liability simultaneously. is assured beyond doubt. On implementation of IAS 32, the balance sheet value of financial assets and financial liabilities increased by Â£104 billion. SIGNIFICANT DIFFERENCES BETWEEN UK GAAP AND IFRS ACCOUNTING POLICIES (continued) IMPLEMENTATION OF IAS 32, IAS 39 and IFRS 4 (continued) (t) Insurance contracts All contracts within the life IFRS 4 requires life assurance assurance business are accounted products to be classified between for as insurance contracts and the insurance contracts and investment obligations to policyholders contracts. The latter are accounted presented as Long-term assurance for in accordance with IAS 39. liabilities attributable to Insurance contracts continue to be policyholders. accounted for using the embedded value methodology. The value placed on in-force The value of in-force policies policies includes future excludes any amounts that reflect investment margins. future investment margins. (u) Linked presentation FRS 5 'Reporting the Substance of There is no linked presentation under Transactions' allows qualifying IFRS. If substantially all the risks transactions to be presented using and rewards have been retained, the the linked presentation. gross assets and related funding are presented separately. (v) Extinguishment of liabilities Under UK GAAP, recognition of a A financial liability is removed from financial liability ceases once the balance sheet when, and only any transfer of economic benefits when, it is extinguished i.e. when to the creditor is no longer the obligation specified in the likely. contract is discharged or cancelled or expires. Tesco Personal Finance (TPF) TPF is a business partnership with Tesco PLC. In the Group's UK GAAP financial information, this company was treated as a subsidiary and fully consolidated. The Group has been in discussions with the Financial Reporting Review Panel (FRRP) about how this company should be accounted for under UK GAAP. The view of the FRRP is that TPF meets the UK GAAP definition of a joint venture and the Group should account for it using the gross equity method. Such a change in the treatment of TPF is not material in the context of the Group's financial statements and has no effect on profit attributable to ordinary shareholders and earnings per ordinary share. In the discussion of divisional performance in the Group's 2004 Operating and Financial Review, the effect is confined to the Retail Direct Division of which TPF forms part. Under IFRS, TPF qualifies as a joint venture and the Group will account for it from 1 January 2004 using proportionate consolidation; the gross equity method is not available under IFRS. The table below illustrates the effect on the Group's 2004 UK GAAP financial information of accounting for TPF using the gross equity method. Also shown is the effect on the Group's 2004 financial information of incorporating TPF using proportionate consolidation (ignoring all other adjustments arising from the transition to IFRS). Summary profit Year ended 31 December 2004 and loss account Per the Including TPF Including TPF Group's using the using statutory equity method proportionate accounts consolidation Â£m Â£m Â£m Net interest income 9,208 9,069 9,138 Non-interest income 13,546 13,376 13,408 Total 22,754 22,445 22,546 income Operating expenses 10,846 10,699 10,772 Operating profit before provisions 8,428 8,266 8,294 Provisions 1,511 1,456 1,484 Profit on ordinary activities before tax 6,917 6,810 6,810 Tax on profit on ordinary activities 2,155 2,125 2,125 Minority interests (including non-equity) 250 173 173 Profit attributable to ordinary shareholders 4,256 4,256 4,256 Retained profit 2,419 2,419 2,419 Basic earnings per ordinary share 138.0p 138.0p 138.0p Adjusted earnings per ordinary share 172.5p 172.5p 172.5p Tesco Personal Finance (TPF) (continued) Summary balance sheet 31 December 2004 Per the Including TPF Including TPF Group's using the using statutory equity proportionate accounts method consolidation Â£m Â£m Â£m Loans and advances to customers 345,469 342,790 344,129 Other assets 22,255 22,486 22,255 Total assets 583,467 581,077 582,105 Customer accounts 285,062 283,032 284,047 Minority interests 3,829 3,494 3,495 Total liabilities 583,467 581,077 582,105 SPECIAL PURPOSE AUDIT REPORT TO THE BOARD OF DIRECTORS OF THE ROYAL BANK OF SCOTLAND GROUP PLC ON THE PRELIMINARY COMPARATIVE FINANCIAL INFORMATION PREPARED IN ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS ('IFRS') We have audited the accompanying preliminary consolidated IFRS balance sheet of The Royal Bank of Scotland Group plc ('the Company') and its subsidiaries (together 'the Group') as at 31 December 2004 and the preliminary summary consolidated IFRS income statement for the year ended 31 December 2004, the opening balance sheets as at 1 January 2004 and 1 January 2005, the Analysis of IFRS adjustments and the related Notes set out on pages 9, 11, 13, 33, 35, 37, 39, 40 and 44 to 46 of the IFRS Transition Report ('the preliminary comparative IFRS financial information'). This report has been prepared for, and only for, the Company for the purpose of assisting with the Group's transition to IFRS and for no other purpose. Our audit work was undertaken so that we might state to the Company's board of directors those matters we are required to state to them in an auditors' 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 Company for our audit work, for our report, or for the opinions we have formed. Respective responsibilities of directors and auditors The Company's directors are responsible for ensuring that the Group maintains proper accounting records and for the preparation of the preliminary comparative IFRS financial information on the basis set out in the Bases of Preparation section on page 49, which describes how IFRS will be applied, including the assumptions the directors have made about the standards and interpretations expected to be effective, and the policies expected to be adopted, when the Group prepares its first complete set of IFRS financial statements for the year ending 31 December 2005. Our responsibility is to audit the preliminary IFRS financial information in accordance with relevant United Kingdom legal and regulatory requirements and auditing standards and report to you our opinion as to whether the preliminary IFRS financial information is prepared, in all material respects, on the basis set out in the Bases of Preparation section. We read the other information contained in the IFRS Transition Report and consider its implications for our report if we become aware of any apparent misstatements or material inconsistencies with the preliminary comparative IFRS financial information. Basis of audit opinion We conducted our audit in accordance with United Kingdom auditing standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the preliminary comparative IFRS financial information. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the preliminary comparative IFRS financial information and of whether the accounting policies are appropriate to the circumstances of the Group, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the preliminary comparative IFRS financial information is free from material misstatement, whether caused by fraud or other irregularity or error. Emphasis of matter Without qualifying our opinion, we draw attention to the fact that the Bases of Preparation section on page 49 explains why there is a possibility that the preliminary comparative IFRS financial information may require adjustment before constituting the final comparative IFRS financial information. Moreover, we draw attention to the fact that, under IFRS, only a complete set of financial statements comprising an income statement, balance sheet, statement of changes in equity, cash flow statement, together with comparative financial information and explanatory notes, can provide a true and fair presentation of the Group's financial position, results of operations and cash flows in accordance with IFRS. Opinion In our opinion, the preliminary comparative IFRS financial information has been prepared, in all material respects, in accordance with the basis set out in the Bases of Preparation section on page 49, which describes how IFRS will be applied, including the assumptions the directors have made about the standards and interpretations expected to be effective, and the policies expected to be adopted, when Group prepares the first complete set of IFRS financial statements as at 31 December 2005. Deloitte & Touche LLP Chartered Accountants Edinburgh 7 June 2005 SPECIAL PURPOSE REVIEW REPORT TO THE BOARD OF DIRECTORS OF THE ROYAL BANK OF SCOTLAND GROUP PLC ON THE PRELIMINARY COMPARATIVE FINANCIAL INFORMATION FOR THE SIX MONTHS ENDED 30 JUNE 2004 PREPARED IN ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS ('IFRS') We have reviewed the accompanying preliminary IFRS consolidated financial information of The Royal Bank of Scotland Group plc (the Company') and its subsidiaries (together 'the Group') for the six months ended 30 June 2004 which comprises the summary consolidated income statement, the consolidated balance sheet, the divisional performance disclosures, the Analysis of IFRS Adjustments and the related Notes set out on pages 10, 12, 14 to 32, 34, 36, 38 and 40 of the IFRS Transition Report ('the preliminary half year comparative IFRS financial information'). Responsibilities of directors and auditors The Company's directors are responsible for the preparation of the preliminary half year comparative IFRS financial information on the basis set out in the Bases of Preparation section on page 49, which describes how IFRS will be applied, including the assumptions the directors have made about the standards and interpretations expected to be effective, and the policies expected to be adopted, when the Group prepares its first complete set of IFRS financial statements for the year ending 31 December 2005. Our responsibility is to report our conclusion on the preliminary half year comparative IFRS financial information based on our review. This report has been prepared for, and only for, the Company for the purpose of assisting with the Group's transition to IFRS and for no other purpose. Our review work was undertaken so that we might state to the Company's board of directors those matters we are required to state to them in an independent review 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 board of directors for our review work, for this report, or for the conclusions we have formed. Review work performed We conducted our review in accordance with the guidance contained in Bulletin 1999/4 issued by the Auditing Practices Board for use in the United Kingdom. A review consists principally of making enquiries of group management and applying analytical procedures to the preliminary half year IFRS financial information and underlying financial data and based thereon, assessing whether the accounting policies and presentation have been consistently applied unless otherwise disclosed. A review excludes audit procedures such as tests of control and verification of assets, liabilities and transactions. It is substantially less in scope than an audit performed in accordance with United Kingdom auditing standards and therefore provides a lower level of assurance than an audit. Accordingly, we do not express an audit opinion on the preliminary half year comparative IFRS financial information. Emphasis of matter Without modifying our review conclusion, we draw attention to the fact that the Bases of Preparation section on page 49 explains why there is a possibility that the preliminary comparative IFRS financial information may require adjustment before constituting the final comparative IFRS financial information. Moreover, we draw attention to the fact that, under IFRS, only a complete set of financial statements comprising an income statement, balance sheet, statement of changes in equity, cash flow statement, together with comparative financial information and explanatory notes, can provide a true and fair presentation of the Company's and the Group's financial position, results of operations and cash flows in accordance with IFRS Review conclusion On the basis of our review we are not aware of any material modifications that should be made to the preliminary half year comparative IFRS financial information for the six months ended 30 June 2004 which has been prepared in accordance with the basis set out in the Bases of Preparation section on page 49. Deloitte & Touche LLP Chartered Accountants Edinburgh 7 June 2005 FORWARD-LOOKING STATEMENTS Certain sections in this document contain 'forward-looking statements' as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words 'expect', 'estimate', 'project', 'anticipate', 'should', 'intend', 'plan', 'probability', 'risk', 'Value-at-Risk ('VaR')', 'target', 'goal', 'objective', 'will', 'endeavour', 'outlook', 'optimistic', 'prospects' and similar expressions or variations on such expressions and sections such as 'Group Chief Executive's review' and 'Financial review'. In particular, this document includes forward-looking statements relating, but not limited, to the Group's potential exposures to various types of market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. Such statements are subject to risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: general economic conditions in the UK and in other countries in which the Group has significant business activities or investments, including the United States; the monetary and interest rate policies of the Bank of England, the Board of Governors of the Federal Reserve System and other G-7 central banks; inflation; deflation; unanticipated turbulence in interest rates, foreign currency exchange rates, commodity prices and equity prices; changes in UK and foreign laws, regulations and taxes; changes in competition and pricing environments; natural and other disasters; the inability to hedge certain risks economically; the adequacy of loss reserves; acquisitions or restructurings; technological changes; changes in consumer spending and saving habits; and the success of the Group in managing the risks involved in the foregoing. The forward-looking statements contained in this document speak only as of the date of this report, and the Group does not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESTATEMENTS During the first half of 2005, the following businesses were transferred between divisions: i. The corporate and institutional businesses of The Royal Bank of Scotland International offshore were moved from Wealth Management to Corporate Banking and Financial Markets. ii. Manufacturing now supports certain offshore businesses of Wealth Management. iii.The cards businesses in the US comprising the credit card business acquired from People's Bank and Lynk have been transferred from Retail Direct to Citizens. iv. The Primeline business has been transferred from Retail Direct to Retail Banking. During the second half of 2004, certain activities were transferred from Ulster Bank to Manufacturing. Divisional results for 2004 have been restated to reflect these changes which do not effect the Group's results. With effect from 1 January 2005, the basis of internal funds transfer pricing between Group Centre and divisions for certain activities was refined. Prior year figures have been restated to reflect this change which affects Retail Banking, Retail Direct, Wealth Management and the Centre. Figures under UK GAAP Year ended 31 Previously Transfer of Re-allocation of Restated December 2004 reported businesses pension costs Â£m Â£m Â£m Â£m Corporate Banking and Financial Markets - Net interest income 2,545 81 - 2,626 - Non-interest income 4,964 79 - 5,043 - Staff costs 1,642 22 44 1,708 - Other costs 412 9 - 421 Contribution 4,265 129 (44) 4,350 _______ _______ _______ _______ Retail Banking - Net interest income 3,112 11 - 3,123 - Non-interest income 1,630 27 - 1,657 - Staff costs 834 1 75 910 - Other costs 240 21 - 261 Contribution 3,279 16 (75) 3,220 _______ _______ _______ _______ Retail Direct - Net interest income 938 (87) - 851 - Non-interest income 1,191 (57) - 1,134 - Staff costs 259 (26) 14 247 - Other costs 453 (19) - 434 - Provisions 377 (37) - 340 Contribution 1,040 (62) (14) 964 _______ _______ _______ _______ Manufacturing - Staff costs 794 26 50 870 - Other costs 1,645 31 - 1,676 Contribution (2,439) (57) (50) (2,546) _______ _______ _______ _______ Wealth Management - Net interest income 497 (94) - 403 - Non-interest income 451 (81) - 370 - Staff costs 299 (44) 7 262 - Other costs 164 (45) - 119 - Provisions 17 1 - 18 Contribution 468 (87) (7) 374 _______ _______ _______ _______ Ulster Bank - Staff costs 158 1 17 176 - Other costs 77 - - 77 Contribution 468 (1) (17) 450 _______ _______ _______ _______ Citizens - Net interest income 1,540 54 - 1,594 - Non-interest income 601 51 - 652 - Staff costs 551 21 - 572 - Other costs 473 23 - 496 - Provisions 80 37 - 117 Contribution 1,037 24 - 1,061 _______ _______ _______ _______ Centre - Funding costs 284 (17) - 267 - Department costs 595 (21) (207) 367 Contribution (879) 38 207 (634) _______ _______ _______ _______ Group profit is unaffected by these changes. Figures under UK GAAP Half year ended Previously Transfer of Re-allocation of Restated 30 June 2004 reported businesses pension costs Â£m Â£m Â£m Â£m Corporate Banking and Financial Markets - Net interest income 1,228 40 - 1,268 - Non-interest income 2,454 37 - 2,491 - Staff costs 813 11 22 846 - Other costs 210 4 - 214 Contribution 2,041 62 (22) 2,081 _______ _______ _______ _______ Retail Banking - Net interest income 1,514 6 - 1,520 - Non-interest income 817 12 - 829 - Staff costs 403 - 37 440 - Other costs 100 10 - 110 Contribution 1,642 8 (37) 1,613 _______ _______ _______ _______ Retail Direct - Net interest income 453 (38) - 415 - Non-interest income 544 (14) - 530 - Staff costs 120 (6) 7 121 - Other costs 225 (5) - 220 - Provisions 172 (15) - 157 Contribution 480 (26) (7) 447 _______ _______ _______ _______ Manufacturing - Staff costs 377 31 24 432 - Other costs 745 50 - 795 Contribution (1,122) (81) (24) (1,227) _______ _______ _______ _______ Wealth Management - Net interest income 243 (46) - 197 - Non-interest income 210 (37) - 173 - Staff costs 141 (22) 4 123 - Other costs 79 (22) - 57 Contribution 231 (39) (4) 188 _______ _______ _______ _______ Ulster Bank - Staff costs 95 (18) 9 86 - Other costs 68 (33) - 35 Contribution 170 51 (9) 212 _______ _______ _______ _______ Citizens - Net interest income 645 21 - 666 - Non-interest income 244 11 - 255 - Staff costs 242 4 - 246 - Other costs 184 6 - 190 - Provisions 40 15 - 55 Contribution 423 7 - 430 _______ _______ _______ _______ Centre - Funding costs 122 (9) - 113 - Department costs 287 (9) (103) 175 Contribution (409) 18 103 (288) _______ _______ _______ _______ Group profit is unaffected by these changes. CONTACTS Sir Fred Goodwin Group Chief Executive 020 7672 0008 0131 523 2033 Fred Watt Group Finance Director 020 7672 0008 0131 523 2028 Richard O'Connor Head of Investor Relations 020 7672 1758 For media enquiries: Howard Moody Group Director, Communications 020 7672 1916 07768 033562 Carolyn McAdam Head of Group Communications 020 7672 1915 07796 274968 8 June 2005 END This information is provided by RNS The company news service from the London Stock Exchange

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