bat plc annual report 2007 - Notes on the accounts: Notes 9-11

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9 Intangible assets

Included in computer software and assets in the course of development above are internally developed assets with a carrying value of £104 million (2006: £80 million). The costs of internally developed assets include capitalised expenses of third party consultants as well as software licence fees from third party suppliers.

From August 2006, the Group purchased minority interests in its subsidiary in Chile for a cost of £91 million, raising the Group shareholding from 70.4 per cent to 96.6 per cent. The goodwill arising on this transaction was £80 million and the minority interests in Group equity were reduced by £11 million. In addition, a number of smaller acquisitions of minority interests were made during 2007 in Africa and Middle East, Europe, and Asia-Pacific.

Impairment testing for intangible assets with indefinite lives including goodwill

Goodwill of £7,942 million (2006: £7,350 million) included in intangible assets in the balance sheet is mainly the result of the following acquisitions: Rothmans Group £4,067 million (2006: £3,889 million); Imperial Tobacco Canada £2,046 million (2006: £1,768 million); and ETI (Italy) £1,212 million (2006: £1,113 million). The principal allocations of goodwill in the Rothmans’ acquisition are to the cash-generating units of Continental Europe and South Africa, with the remainder mainly relating to operations in the domestic and export market in the United Kingdom and operations in Asia-Pacific.

Goodwill has been allocated for impairment testing purposes to 13 (2006: 13) individual cash-generating units – four in Europe, one in Africa and Middle East, three in Asia-Pacific, three in Latin America and two in America-Pacific. The carrying amounts of goodwill allocated to the cash-generating units of South Africa (£814 million, 2006: £803 million), Continental Europe (£1,112 million, 2006: £1,020 million), Canada (£2,046 million, 2006: £1,768 million) and Italy (£1,218 million, 2006: £1,119 million) are considered significant in comparison with the total carrying amount of goodwill.

The recoverable amount of all cash-generating units has been determined on a value-in-use basis. The key assumptions for the recoverable amount of all units are the long term growth rate and the discount rate. The long term growth rate is a nominal rate used purely for the impairment testing of goodwill under IAS36 Impairment of Assets and does not reflect long term planning assumptions used by the Group for investment proposals or for any other assessments. The discount rate is based on the weighted average cost of capital, taking into account the cost of capital and borrowings, to which specific market-related premium adjustments are made. These assumptions have been applied to the individual cash flows of each unit as compiled by local management in the different markets.

The valuation uses cash flow projections based on detailed financial budgets approved by management covering a two year period, with cash flow beyond two years extrapolated by a nominal growth rate of 3 per cent per annum for the years 3 to 10, whereafter a zero per cent growth rate has been assumed. This long term growth rate used does not exceed the expected long term average growth rate for the markets in which the cash-generating units operate. In some instances, such as recent acquisitions or start-up ventures, the valuation is expanded to reflect the medium term plan of management, spanning five years or beyond, with the cash flow beyond these years to year 10, extrapolated by the growth rate of 3 per cent, as above.

Pre-tax discount rates of between 7.9 per cent and 18.7 per cent (2006: 8.1 per cent to 17.9 per cent) were used, based on the Group’s weighted average cost of capital, together with any premium applicable for country/area inflation and economical and political risks. The pre-tax discount rates used for the cash-generating units which are significant in comparison with the total carrying amount of goodwill are 12.1 per cent for South Africa (2006: 12.1 per cent), 9.3 per cent for Continental Europe (2006: 9.8 per cent), 10.0 per cent for Canada (2006: 10.0 per cent) and 10.7 per cent for Italy (2006: 10.7 per cent).

Aside from the amounts written off and shown as part of restructuring costs (see note 3b), no impairment charges were recognised in 2007 (2006: £nil). If discounted cash flows per cash-generating unit should fall by 10 per cent, or the discount rate was increased at an after-tax rate of 1 per cent, there would be no impairment.

10 Property, plant and equipment

Assets held under finance leases are secured under finance lease obligations in note 21.

Bank borrowings are secured by property, plant and equipment to the value of £8 million (2006: £15 million).

11 Investments in associates and joint ventures

On 25 April 2006, Reynolds American Inc. announced an agreement to acquire Conwood, the second largest manufacturer of smokeless tobacco products in the US, for US$3.5 billion, and the acquisition was completed on 31 May 2006. The acquisition was funded principally with debt, and the fair value of the assets acquired and liabilities assumed were US$4.1 billion and US$0.6 billion respectively. Included in the assets were US$2.5 billion in respect of goodwill and US$1.4 billion in respect of brands.

The Group’s share of non-current assets above includes £529 million (2006: £540 million) of goodwill and £290 million (2006: £300 million) of brands arising from the Conwood acquisition. In addition, the non-current assets above include £1,187 million (2006: £1,207 million) of goodwill and £463 million (2006: £479 million) of brands arising from the Reynolds American transaction in 2004.

Details of the Group’s contingent liabilities are set out in note 30. In addition to US litigation involving Group companies, which is covered by the R.J. Reynolds Tobacco Company (RJRT) indemnity referred to in note 30, Reynolds American Inc. (RAI) group companies are named in litigation which does not involve Group companies. While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, it is not impossible that the results of operations or cash flows of RAI, in particular quarterly or annual periods, could be materially affected by this and by the final outcome of any particular litigation. However, having regard to the contingent liability disclosures on litigation made by RAI in its public financial reports, the Directors are satisfied with the carrying value included above for RAI.

The Group’s share of the RAI results for the year to 31 December 2007 includes £18 million (2006: £24 million) in respect of external legal fees and other external product liability defence costs.