INTERNATIONAL RETAIL GROUP ACCOUNTING MANUAL. CONSOLIDATION PRINCIPLES.

CONSOLIDATION PRINCIPLES. Scope of consolidated financial statements

The principles to be adopted by group companies for preparing consolidated financial statements are presented below.

The consolidated financial statements include all enterprises that are controlled directly or indirectly by the parent company. According to IAS 27, control is presumed to exist when the parent owns, directly or indirectly through its subsidiaries, more than one half of the voting rights of an enterprise unless, in exceptional circumstances, it can be clearly demonstrated that such ownership does not constitute control. Control also exists even if the parent owns half or less of the voting rights of an enterprise when it has:

• power over more than one half of the voting rights by virtue of an agreement with other investors;
• power to govern the financial and operating policies of the enterprise under a clause in the articles of association or under an agreement;
• power to appoint the majority of the members of the board of directors or equivalent governing body;
• power to cast the majority of votes at meetings of the board of directors or equivalent governing body.

For the purposes of assessing the existence of control, potential voting rights shall also be taken into account.

Potential voting rights are those arising from warrants, call options, debt or equity instruments that, if exercised or converted, may give an enterprise additional voting rights or reduce the voting rights of others. When assessing potential voting rights, the rights currently exercisable or convertible and those owned by other parties shall be taken into account; those that will be exercisable or convertible only after a future date or after the occurrence of a determined event are ignored. When assessing whether potential voting rights contribute to control, all the facts and circumstances that affect the exercise or conversion shall be examined, except the intention of management and the investor's financial capability to exercise or convert.

The interpretation SIC 12 of the international accounting standards states that special purpose entities or SPEs shall be treated as subsidiaries and hence consolidated. These entities act in the interests of the parent company or its subsidiaries, who, despite not having an interest in the SPE's capital or an investment in the SPE that satisfies the conditions specified in IAS 27, enjoy all the benefits of the SPE's activities and bear the risks.

The following circumstances indicate the existence of this kind of relationship:

• the activities of the SPE are conducted on behalf of an enterprise according to its specific business needs so that this enterprise obtains benefits from the SPE's operation;
• the enterprise has the decision-making powers to obtain the majority of the benefits of the activities of the SPE, including through provisions contained in its articles of association and without continuous intervention (termed an "autopilot mechanism");
• in substance, the enterprise has rights to obtain the majority of the benefits of the SPE and is exposed to risks incident to the activities of the SPE;
• the enterprise retains the right to any residual net amounts after completing the activities conducted by the SPE and bears the risks.

CONSOLIDATION PRINCIPLES (Continued).Consolidation methods.

IAS 31 governs the reporting of investments in companies in which the enterprise has joint control with other parties (joint ventures). Companies which are neither subsidiaries nor joint ventures but over which the investor has a significant influence are termed associates (associated companies) and excluded from consolidation. According to IAS 28, there is a presumption of significant influence when the investor holds, directly or indirectly, 20% or more of the voting rights of the investee. The scope of consolidation, defined in accordance with the criteria presented above, shall be updated continuously for intervening changes (acquisitions, company formations, disposals, mergers, transfers between group companies, ecc.).

Consolidation methods

Consolidated financial statements are a set of financial statements presenting the assets and liabilities, financial position and results of a group of enterprises as if they were those of a single enterprise. Subsidiaries shall be consolidated on a line-by-line basis. Investments in joint ventures shall be reported using the equity method. Investments in associates shall be reported using the equity method. Investments in other enterprises are reported at cost.

Line-by-line consolidation

Companies over which an enterprise has control, as defined in paragraph 7.1, are consolidated on a line-by-line basis.

A subsidiary shall be included in the consolidation even if its business activities are dissimilar from those of other enterprises within the group. In this case the notes to the financial statements shall disclose additional information about such a subsidiary's various business activities.

A subsidiary may be excluded from the consolidation when there is evidence that:

• Control is temporary because the subsidiary has been acquired exclusively with a view to its disposal within 12 months of acquisition;
• Management is actively seeking a buyer for the investment.

The parent company loses control when it no longer has the power to govern the subsidiary's financial and operating policies such as to obtain benefit from its activities. In this case, the investor must cease to use the line-by-line method of consolidation for this investment. If the investment is not sold to third parties, the investor must adopt a different accounting treatment depending on whether the investee becomes an associate, joint venture or other enterprise.

Steps in the line-by-line consolidation

Line-by-line consolidation involves combining like assets, liabilities, income and expenses of the parent company and its subsidiaries on a line-by-line basis. The following are then eliminated:

• the carrying amount of the parent's investment in each subsidiary against the parent's corresponding portion of equity of each subsidiary;
• receivables and payables between companies included in the consolidation;
• income and expenses on transactions between such companies;
• gains and losses arising on transactions between such companies and relating to amounts included in equity (meaning unrealised profits);

In order that the consolidated financial statements present financial information about the Group as that of a single enterprise, it is necessary to identify the minority interests in the net profit for the period and equity of consolidated subsidiaries. If there are any potential voting rights, these interests are determined without considering the possible exercise of options or possible conversions.

Consolidation of investments; The consolidation process calls for the elimination of the carrying amount of investments included in the consolidation and the parent's share of their equity. This elimination is carried out on the basis of the carrying amounts on the date on which the enterprise is included in the consolidation for the first time. The acquirer shall allocate the cost of an acquisition at the date of acquisition to the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the recognition criteria set out below and are measured at fair value at that date, except for Assets held for sale (carried at fair value less costs to sell).

The criteria that must be satisfied for their separate recognition are as follows:

• assets other than intangible assets: achievement of probable future benefits for the acquirer and reliable measurement of fair value;
• liabilities other than contingent liabilities: outflow of future resources to settle the obligations and reliable measurement of fair value;
• intangible assets or contingent liabilities: reliable measurement of fair value.

 Since the acquirer recognises the assets, liabilities and contingent liabilities at their fair value at the date of acquisition, the minority interests in the acquired enterprise are determined as a proportion of the fair value of these net assets. Goodwill is the excess of the cost of the business combination over the acquirer's interest in the net fair value of the assets and liabilities. If its elimination gives rise to a difference, this may be:

• Negative difference - badwill if the carrying amount of the investment is lower than the investor's interest in the fair value of the acquiree's assets, liabilities and contingent liabilities. In this case, the acquirer must reassess the measurement of the acquiree's assets, liabilities and contingent liabilities and recognise any remaining difference (negative goodwill) immediately in the income statement.
• Positive difference - goodwill if the carrying amount of the investment is higher than the investor's interest in the fair value of the acquiree's assets, liabilities and contingent liabilities. This usually represents goodwill which shall be classified as "Goodwill" under intangible assets and shall not be amortised. Instead this goodwill shall be tested for impairment annually or more often if events or changes in circumstances indicate the possible existence of an impairment loss.

Treatment of dividends; Dividends received from subsidiaries and reported in the investor's income statement shall be reversed upon consolidation in order to prevent them from being counted twice, once as dividends and once as the investor's share of the investee's net profit for the period. It is therefore necessary to make a consolidation adjustment, involving a debit to Income from equity investments and a credit to Retained earnings.

Elimination of intragroup profits/losses; For the purposes of the consolidated financial statements, the Group's net profit or loss shall result solely from transactions with third parties. This means that profits/losses arising on intragroup transactions shall be eliminated during the consolidation process by allocating the adjustment on a pro-rata basis between the Group and minority interests, after adjustment for any tax.

Profits/losses arising on intragroup transactions included in the carrying amount of inventories of consolidated companies represent unrealised gains/losses for the Group as a whole and hence shall be eliminated. The portion of unrealised gains is deducted from the consolidated results, with a related adjustment to taxes already provided. The tax (relating to deferred tax assets since intragroup profit has been reversed) shall be calculated using the purchasing enterprise's tax rate. Losses on intragroup transactions are also eliminated, unless these losses are regarded as final.

Profits and losses arising on the intragroup transfer of equity investments are eliminated.

Enterprises operating in hyperinflationary economies; The financial statements of subsidiaries operating in hyperinflationary economies are restated to adjust them for changes in the purchasing power of the local currency in accordance with the rules contained in IAS 29 "Financial reporting in hyperinflationary economies".

This standard does not establish an absolute rate at which hyperinflation is deemed to arise, but provides examples of a few situations that are indicative of hyperinflation such as:

• the general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency;
• the general population regards monetary amounts not in terms of the local currency, but in terms of a relatively stable foreign currency;
• sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power;
• interest rates, wages and prices are linked to a price index; and
• the cumulative inflation rate over three years is approaching, or exceeds, 100%.

The preparation of inflation-adjusted financial statements involves the following steps:

• selection of a general price index;
• identification of monetary and non-monetary items;
• restatement of non-monetary items;

restatement of the income statement.

CONSOLIDATION PRINCIPLES (Continued)

Balance sheet amounts not already expressed in a current measuring unit are restated by applying a general price index. IAS 29 does not specify which price index shall be used. The most reliable indicators of changes in the general level of prices are the general consumer price index and the general wholesale price index. These two indexes shall display the same long-term pattern. Once the index has been selected, it is necessary to calculate conversion factors, based on the increase in the general level of prices, for adjusting historical costs to reflect current purchasing power.

All non-monetary items shall be restated, except for those carried at amounts current at the balance sheet date such as net realisable value and market value. Some non-monetary items are carried at amounts current at dates other than that of acquisition or that of the balance sheet, for example property, plant and equipment that has been revalued at some earlier date. In these cases, the carrying amounts are restated from the date of the revaluation.

IAS 29 requires that all items in the income statement are expressed in terms of the measuring unit current at the balance sheet date.

In a period of inflation, if monetary assets exceed monetary liabilities there is a loss of purchasing power.

Conversely, if monetary liabilities exceed monetary assets there is an increase in purchasing power.

 Reporting currency

International Retail Group has adopted the …………. (“...….”) as its official reporting currency for all internal and external reporting documents and for its consolidated financial statements.

The current exchange rate method is used for translating financial statements expressed in currencies other than that chosen for the consolidated financial statements. Under this method, balance sheet items are translated at the period-end exchange rate, while income statement items are translated at average exchange rates for the period.

Companies operating in hyperinflationary economies must adopt the full monetary adjustment method for translating their financial statements, using the period-end exchange rate for the income statement as well.

The exchange differences arising from the translation of opening equity at exchange rates ruling at period end relative to those in force at the end of the previous period are directly booked to consolidated equity.

The difference between net profit or loss for the period translated at average rates and that arising from translation at closing rates is also booked to consolidated equity.

Reporting period

The reference date of the consolidated financial statements is the same as that of the individual financial statements of the parent company International Retail Group (1 January - 31 December). If the balance sheet date of an enterprise included in the consolidation is not the same as that of the consolidated financial statements, this enterprise must prepare a report at the same date as the consolidated financial statements.

Under IAS 27, if the subsidiary's balance sheet date differs by less than three months from that of the consolidated financial statements, the subsidiary's financial statements may be used for consolidation even if referring to a different date provided suitable adjustments are made for the effects of significant transactions that occur between the dates of the subsidiary's and parent's financial statements.