Accounting policies

The application of then prevailing UK GAAP to the business combination with Lattice Group plc in 2002/03 resulted in the transaction being treated as a merger, and merger accounting has been retained under IFRS. Under US GAAP, purchase accounting was applied rather than merger accounting, with Lattice Group plc considered to be the acquired entity.

Unlike IFRS, our results under US GAAP include the results of Lattice Group plc from 21 October 2002, the date of the business combination, and not prior to that date.

The recognition of Lattice Group plc’s assets and liabilities at fair value under US GAAP resulted in £3,824 million of goodwill being recognised. The assets acquired included the four regional gas distribution networks that were disposed of in 2005/06. The higher book value of these assets under US GAAP resulted in a significantly lower gain in 2005/06 (by some £2 billion) recognised on disposal under US GAAP as compared with IFRS.

These assets are recorded in the US GAAP balance sheet in accordance with the principles of Statement of Financial Accounting Standards (SFAS) 71 on accounting for the effects of certain types of regulation. SFAS 71 provides that certain costs may be deferred on the balance sheet (referred to as regulatory assets) if it is probable that the costs will be recovered through future increases in regulated revenue rates. An entity applying SFAS 71 does not need absolute assurance prior to capitalising a cost, only reasonable assurance. If the principles of SFAS 71 were not applicable, it is likely that this would result in the full or partial non-recognition of these regulatory assets and thereby materially alter the view given by the accounts.

The total carrying value of regulatory assets, under US GAAP, at 31 March 2007 amounted to £2,880 million (2006: £3,051 million, 2005: £3,350 million).

Under US GAAP, all derivatives are recorded at fair value except those that qualify for exemptions, such as normal purchase rules for commodity contracts. Changes in fair values of derivatives not designated as a hedge under US GAAP are recorded through earnings. We apply a hedging strategy in accordance with IFRS requirements, however, many of these hedges do not meet the requirements to achieve hedge accounting under US GAAP. This results in a much greater volatility in the US GAAP income statements. Under IFRS, the Company did not adopt IAS 39 until 1 April 2005 and, therefore, did not record derivatives at fair value in the year ended 2004/05. Upon adoption of IAS 39, the Company recorded its outstanding derivatives at fair value and took advantage of certain transition accommodations that allowed for hedge accounting. These transition alternatives were not available under US GAAP.

Differences exist in the measurement of pension obligations, plan assets, and periodic pension expense. The primary difference is that under US GAAP, we include actuarial gains and losses as a component of periodic pension expense while, under IFRS, these items are recorded directly to equity reserves and are not recycled through the income statement. Differences in key assumptions used to measure plan assets and obligations also create differences.

SFAS 158 on pensions accounting was adopted on 31 March 2007. It requires deferred actuarial gains and losses in respect of defined benefit pension plans and other post-retirement benefits previously recorded in the balance sheet to instead be recorded initially within accumulated other comprehensive income within equity. Subsequently, actuarial gains and losses are recycled out of other comprehensive income and into the income statement using the same basis as deferred gains and losses were previously amortised from the balance sheet.

On adoption on 31 March 2007, net assets under US GAAP increased by £51 million, comprising an increase in pension and other post-retirement benefit obligations of £196 million, a derecognition of intangibles of £41 million more than offset by the recognition of regulatory assets of £274 million and net tax of £14 million. As a consequence, the differences reported between IFRS and US GAAP in respect of these items reduced by the same amount.

There was no change in the amounts reported in the income statement under US GAAP, nor in the amounts recorded within other comprehensive income with respect to the accumulated minimum pension obligation during 2006/07, 2005/06 and 2004/05.

SFAS 123(R) was adopted on 1 April 2006. It requires all share-based payments to employees, including grants of employee stock options, to be recognised in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123(R) is similar to our existing accounting treatment under IFRS in accordance with IFRS 2, and to the method previously adopted under SFAS 148.

SFAS 151 was adopted on 1 April 2006, clarifying that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognised as current period expense.

SFAS 153 was adopted on 1 April 2006. It removed an exemption which previously permitted exchanges of similar productive assets to be accounted for at the carrying value of the assets relinquished. All nonmonetary transactions subsequent to 1 April 2006 (apart from those without commercial substance) must be recorded at fair value.

SFAS 154 was adopted on 1 April 2006. It requires retrospective application to comparative financial statements for material errors and for changes in accounting principle that occur subsequent to that date, other than where (as in the case of SFAS 158 above) a new standard requires a different treatment.

FASB Interpretation No. (FIN) 48 on uncertain tax positions is an interpretation of SFAS 109 on accounting for taxes and seeks to reduce the diversity of the reporting of uncertain tax positions so that these can be more easily compared. The interpretation also requires qualitative and quantitative disclosures, including discussion of reasonably possible changes that might occur in unrecognised tax benefits over the following 12 months, a description of open tax years by major jurisdiction, and a roll-forward of all unrecognised tax benefits.

FIN 48 is effective for financial years beginning after 15 December 2006 and any impact of adopting it will be reported as an adjustment to the opening balance of retained earnings in the year of adoption. We are currently evaluating the impact, if any, that FIN 48 will have on our results and financial position under US GAAP.

SFAS 155 provides a fair value measurement option for certain hybrid financial instruments, which allows the recording of an entire financial instrument at fair value rather than accounting for the host instrument and the embedded derivative separately. SFAS 155 is effective for financial years beginning after 15 September 2006.

SFAS 157 seeks to increase the consistency and comparability of fair value estimates. This statement defines fair value, establishes a consistent framework for measuring fair value where other pronouncements require or permit it and also expands disclosure about fair value measurements. This statement does not require any new fair value measurements.

SFAS 157 is effective for financial years beginning after 15 November 2007. We are currently evaluating the impact, if any, that SFAS 157 will have on our reported financial results and position under US GAAP.

SFAS 159 permits an entity to choose to designate certain financial instruments to be recorded at their fair value through profit and loss and is effective for financial years beginning after 15 November 2007. This standard is similar to certain amendments to IFRS adopted by National Grid in 2006/07 which did not have a material impact on our financial results or position as we have not chosen to use this option under IFRS.