Notes 1 - 10

1. General information

Centrica plc is a Company domiciled and incorporated in the United Kingdom under the Companies Act 1985. The address of the registered office is given on the Contact us page. The nature of the Group’s operations and its principal activities are set out in note 6 and in the Directors’ Report - Business Review.

The consolidated Financial Statements of Centrica plc are presented in pounds sterling. Operations and transactions conducted in currencies other than pounds sterling are included in the consolidated Financial Statements in accordance with the foreign currencies accounting policy set out in note 2.

2. Summary of significant accounting policies

The principal accounting policies applied in the preparation of these consolidated Financial Statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

Basis of preparation

The consolidated Financial Statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and therefore comply with Article 4 of the EU IAS Regulation.

The consolidated Financial Statements have been prepared on the historical cost basis, except for derivative financial instruments and available-for-sale investments, and the assets and liabilities of the Group pension schemes that have been measured at fair value. The carrying values of recognised assets and liabilities that are hedged items in fair value hedges, and are otherwise carried at cost, are adjusted to record changes in the fair values attributable to the risks that are being hedged. The principal accounting policies adopted are set out below.

The preparation of Financial Statements in conformity with IFRS requires the use of certain critical accounting estimates. It requires management to exercise its judgement in the processes of applying the Group’s accounting policies. The areas involving a higher degree of judgement, complexity or areas where assumptions and estimates are significant to the consolidated Financial Statements are described in note 3.

(a) Standards, amendments and interpretations effective in 2007

In the current year the Group has adopted IFRS 7, Financial Instruments: Disclosures, which is effective for annual reporting periods beginning on or after 1 January 2007, and the related amendments to IAS 1, Presentation of Financial Statements. The impact of the adoption of IFRS 7 and the changes to IAS 1 has been to expand the disclosures provided in these Financial Statements regarding the Group’s financial instruments and management of capital.

Four interpretations issued by the International Financial Reporting Interpretations Committee are effective for the current period. These are IFRIC 7, Applying the Restatement Approach under IAS 29, Financial Reporting in Hyperinflationary Economies; IFRIC 8, Scope of IFRS 2; IFRIC 9, Re-assessment of Embedded Derivatives; and IFRIC 10, Interim Financial Reporting and Impairment. The adoption of these interpretations has not led to any changes in the Group’s accounting policies.

(b) Standards, amendments and interpretations that are not yet effective and that have not been early adopted by the Group

At the date of authorisation of these Financial Statements, the following standards, amendments to existing standards and interpretations which have not been applied in these Financial Statements were in issue but not yet effective:

• IAS 23 (Amendment), Borrowing Costs, effective from 1 January 2009. The amendment to this standard is subject to EU endorsement. It requires an entity to capitalise borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset (one that takes a substantial period of time to get ready for use or sale) as part of the cost of that asset. The option of immediately expensing such borrowing costs will be removed. The Group intends to apply IAS 23 (Amended) from 1 January 2008, subject to endorsement by the EU. Subject to being endorsed, it will require a change to the Group’s existing accounting policy, where such costs are immediately expensed;
• IFRS 8, Operating Segments, effective from 1 January 2009. This standard replaces IAS 14, Segment Reporting and requires segmental information reported to be based on that which Directors use internally for evaluating the performance of operating segments. The Group will apply IFRS 8 from 1 January 2009. The impact of adopting IFRS 8 is under assessment;
• IFRS 3 (Revised), Business Combinations was issued on 10 January 2008 and is subject to EU endorsement. It is applicable to business combinations effected on or after 1 January 2010, with earlier application permitted. The impact of adopting IFRS 3 in future periods will be considered in the event of a future business combination; and
• IAS 27 (Revised), Consolidated and Separate Financial Statements was issued on 10 January 2008 and is subject to EU endorsement. The revised standard is effective for annual periods beginning on or after 1 July 2009. The impact of adopting IAS 27 in future periods is under assessment.

The Directors anticipate that the adoption of the following amendments to standards and interpretations in future periods, which were also in issue but not effective at the date of authorisation of these Financial Statements, will have no material impact on the Financial Statements of the Group:

• IAS 1 (Amendment), Presentation of Financial Statements, effective from 1 January 2009, subject to EU endorsement;
• IAS 32 (Amendment), Financial Instruments: Presentation and IAS 1 (Amendment), Presentation of Financial Statements, effective from 1 January 2009, subject to EU endorsement;
• IFRS 2 (Amendment), Share Based Payment - Vesting Conditions and Cancellations, effective from 1 January 2009, subject to EU endorsement;
• IFRIC 11, IFRS 2 - Group and Treasury Share Transactions, effective for annual periods beginning on or after 1 March 2007;
• IFRIC 12, Service Concession Arrangements, effective for annual periods beginning on or after 1 January 2008;
• IFRIC 13, Customer Loyalty Programmes, effective for annual periods beginning on or after 1 July 2008; and
• IFRIC 14, IAS 19 - The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction, effective for annual periods beginning on or after 1 January 2008.

(c) Changes of accounting presentation

The Group has adopted the following changes of accounting presentation in the year:

• Domestic energy suppliers are given energy savings targets by the Government related to the size of their customer base. Costs incurred by British Gas Residential under such energy saving programmes are presented as part of cost of sales in the Income Statement. Previously such costs were presented as operating costs. The Directors consider the change of accounting presentation better reflects the nature of the costs as a direct cost of supplying energy to domestic customers. The impact of the change of accounting presentation is to report £91 million of costs in the year within cost of sales. The impact on comparatives is to reclassify £90 million from operating costs to cost of sales.
• Capitalised exploration and evaluation costs associated with oil and gas activities, such as licence acquisition costs, exploratory drilling costs, trenching and sampling costs, are presented as intangible assets. Previously the Group presented such capitalised costs as property, plant and equipment. The Directors consider the change of accounting presentation better reflects the nature of such costs. The impact of the change in accounting presentation is to report £41 million of exploration and evaluation costs within intangible assets as at 31 December 2007 and £29 million in investing cash outflows relating to purchases of intangible assets for the year ending 31 December 2007. The impact on comparatives is to reclassify £24 million of capitalised costs from property, plant and equipment to intangible assets as at 31 December 2006 and to reclassify £23 million of investing cash outflows from purchases of property, plant and equipment to purchases of intangible assets for the year ending 31 December 2006.

(d) Change to reported segments

In 2007 the Group changed its reportable segments creating a Power generation segment and an Industrial and commercial reportable segment. Prior to 2007 these two segments were reported together as Industrial sales and wholesaling.

The new Power generation segment comprises the Group’s UK generation assets including the Spalding power station, associated emissions activity, as well as flexible volume power procurement contracts. Beginning in 2007, sales of generated power from Centrica Energy to other Group segments is transferred and reported at fair value. Prior to 2007, the sale of generated power from Centrica Energy to other Group segments was transferred and reported at cost. As a result of the change, Power generation and Industrial and commercial are now reported separately. Consequently, the basis on which operating costs are allocated to other Group segments has also changed. Prior period comparatives have not been restated as it is impracticable to provide this information on an equivalent basis. For the purpose of comparison, had the Group continued with its previous basis of segmental reporting with inter-segment transfers of power reported on a cost basis, and operating costs allocated to segments with reference to the cost methodology, the Power generation and Industrial and commercial segments together would have reported gross segment revenues of £1,027 million, inter-segment revenue of £185 million and externally reported segment revenue of £842 million and an operating profit before exceptional items and certain remeasurements of £130 million (loss of £8 million after exceptional items and certain re-measurements) for the year ending 31 December 2007. In addition for the year ending 31 December 2007, British Gas Residential would have reported an increase to operating profit of £61 million, British Gas Business would have reported an increase to operating profit of £9 million, Gas production and development would have reported an increase in operating profit of £24 million and Accord energy trading would have reported an increase in operating profit of £1 million, all before exceptional items and certain re-measurements.

(e) Income statement presentation

The Group’s Income Statement and segmental note separately identify the effects of re-measurement of certain financial instruments, and items which are exceptional, in order to provide readers with a clear and consistent presentation of the Group’s underlying performance, as described below.

Certain re-measurements

As part of its energy procurement activities the Group enters into a range of commodity contracts designed to achieve security of energy supply. These contracts comprise both purchases and sales and cover a wide range of volumes, prices and timescales. The majority of the underlying supply comes from high volume long-term contracts which are complemented by short-term arrangements. These short-term contracts are entered into for the purpose of balancing energy supplies and customer demand and to optimise the price paid by the Group. Short-term demand can vary significantly as a result of factors such as weather, power generation profiles and short-term movements in market prices.

Many of the energy procurement contracts are held for the purpose of receipt or delivery of commodities in accordance with the Group’s purchase, sale or usage requirements and are therefore out of scope of IAS 39, Financial Instruments: Recognition and Measurement. However, a number of contracts are considered to be derivative financial instruments and are required to be fair valued under IAS 39, primarily because their terms include the ability to trade elements of the contracted volumes on a net-settled basis.

The Group has shown the fair value adjustments arising on these contracts separately in the certain re-measurements column. This is because the intention of management is, subject to short-term demand balancing, to use these energy supplies to meet customer demand. Accordingly, management believe the ultimate net charge to cost of sales will be consistent with the price of energy agreed in these contracts and that the fair value adjustments will reverse as the energy is supplied over the life of the contract. This makes the fair value re-measurements very different in nature from costs arising from the physical delivery of energy in the period.

At the balance sheet date the fair value represents the difference between the prices agreed in the respective contracts and the actual or anticipated market price of acquiring the same amount of energy on the open market. The movement in the fair value taken to certain re-measurements in the Income Statement represents the unwind of the contracted volume delivered or consumed during the period, combined with the change in fair value of future contracted energy as a result of movements in forward energy prices during the year.

These adjustments represent the significant majority of the items included in certain re-measurements. In addition to these, however, the Group has identified a number of comparable contractual arrangements where the difference between the price which the Group expects to pay or receive under a contract and the market price is required to be fair valued by IAS 39. These additional items relate to cross-border transportation or transmission capacity, storage capacity and contracts relating to the sale of energy by-products, on which economic value has been created which is not wholly recognised under the requirements of IAS 39. For these arrangements the related fair value adjustments are also included under certain re-measurements.

These arrangements are managed separately from proprietary energy trading activities where trades are entered into speculatively for the purpose of making profits in their own right. These proprietary trades are included in the results before certain re-measurements.

Exceptional items

As permitted by IAS 1, Presentation of Financial Statements, certain items are presented separately. The items that the Group separately presents as exceptional are items which are of a non-recurring nature and, in the judgement of the Directors, need to be disclosed separately by virtue of their nature, size or incidence in order to obtain a clear and consistent presentation of the Group’s underlying business performance. Items which may be considered exceptional in nature include disposals of businesses, business restructurings, the renegotiation of significant contracts and asset write-downs.

Basis of consolidation

The Group Financial Statements consolidate the Financial Statements of the Company and entities controlled by the Company (its subsidiaries) made up to 31 December each year, and incorporate the results of its share of jointly controlled entities and associates using the equity method of accounting.

Control is achieved where the Company has the power to govern the financial and operating policies of an investee entity so as to obtain benefits from its activities.

The results of subsidiaries acquired or disposed of during the year are consolidated from the effective date of acquisition or up to the effective date of disposal, as appropriate. Where necessary adjustments are made to the financial statements of subsidiaries, associates and jointly controlled entities to bring the accounting policies used into line with those used by the Group.

All intra-group transactions, balances, income and expenses are eliminated on consolidation.

Interests in joint ventures

A jointly controlled entity is a joint venture which involves the establishment of an entity to engage in economic activity, which the Group jointly controls with its fellow venturers. Under the equity method, investments in jointly controlled entities are carried at cost plus post-acquisition changes in the Group’s share of net assets of the jointly controlled entity, less any impairment in value in individual investments. The Income Statement reflects the Group’s share of the results of operations after tax of the jointly controlled entity.

Certain of the Group’s exploration and production activity is conducted through joint ventures where the venturers have a direct interest in and jointly control the assets of the venture. The results, assets, liabilities and cash flows of these jointly controlled assets are included in the consolidated Financial Statements in proportion to the Group’s interest.

Interests in associates

An associate is an entity in which the Group has an equity interest and over which it has the ability to exercise significant influence. Under the equity method, investments in associates are carried at cost plus post-acquisition changes in the Group’s share of the net assets of the associate, less any impairment in value in individual investments. The Income Statement reflects the Group’s share of the results of operations after tax of the associate.

Revenue

Revenue is recognised to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. Revenue includes amounts receivable for goods and services provided in the normal course of business, net of discounts, rebates, VAT and other sales related taxes.

Energy supply: Revenue is recognised on the basis of energy supplied during the period. Revenue for energy supply activities includes an assessment of energy supplied to customers between the date of the last meter reading and the year end (unread). Unread gas and electricity is estimated using historical consumption patterns, taking into account the industry reconciliation process for total gas and total electricity usage by supplier, and is included in accrued energy income within trade and other receivables.

Proprietary energy trading: Revenue comprises both realised (settled) and unrealised (fair value changes) net gains and losses from trading in physical and financial energy contracts.

Storage services: Storage capacity revenues are recognised evenly over the contract period, whilst commodity revenues for the injection and withdrawal of gas are recognised at the point of gas flowing into or out of the storage facilities.

Home services and fixed-fee service contracts: Where the Group has an ongoing obligation to provide services, revenues are apportioned on a time basis and amounts billed in advance are treated as deferred income and excluded from current revenue. For one-off services, such as installations, revenue is recognised at the date of service provision. Revenue from fixed-fee service contracts is recognised on a straight-line basis over the life of the contract, reflecting the benefits receivable by the customer, which span the life of the contract as a result of emergency maintenance being available throughout the contract term.

Gas production: Revenue associated with exploration and production sales (of natural gas, crude oil and condensates) is recognised when title passes to the customer. Revenue from the production of natural gas, oil and condensates in which the Group has an interest with other producers is recognised based on the Group’s working interest and the terms of the relevant production sharing arrangements (the entitlement method). Differences between production sold and the Group’s share of production are not significant.

Power generation: Revenue is recognised on the basis of power supplied during the period.

Interest income: Interest income is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying value.

Cost of sales

Energy supply includes the cost of gas and electricity produced and purchased during the period taking into account the industry reconciliation process for total gas and total electricity usage by supplier, and related transportation, distribution, royalty costs and bought in materials and services.

Home services’ and fixed-fee service contracts cost of sales includes direct labour and related overheads on installation work, repairs and service contracts in the period.

Employee share schemes

The Group has a number of employee share schemes, detailed in the Directors’ Report - Corporate Responsibility Review, the Remuneration Report and in note 33, under which it makes equity-settled share-based payments to certain employees. Equity-settled share-based payments are measured at fair value at the date of grant (excluding the effect of non market-based vesting conditions). The fair value determined at the grant date is expensed on a straight-line basis together with a corresponding increase in equity over the vesting period, based on the Group’s estimate of the number of awards that will vest and adjusted for the effect of non market-based vesting conditions.

Fair value is measured using methods appropriate to each of the different schemes as follows:

LTIS: awards up to 2005	A Black-Scholes valuation augmented by a Monte Carlo simulation to predict the total shareholder return performance
LTIS: EPS awards after 2005	Market value on the date of grant
LTIS: TSR awards after 2005	A Monte Carlo simulation to predict the total shareholder return performance
Sharesave	Black-Scholes
ESOS	Black-Scholes using an adjusted option life assumption to reflect the possibility of early exercise
SAS, SIP, DMSS and RSS	Market value on the date of grant

Foreign currencies

The consolidated Financial Statements are presented in pounds sterling, which is the functional currency of the Company and the Group’s presentational currency. Each entity in the Group determines its own functional currency and items included in the Financial Statements of each entity are measured using that functional currency. Transactions in foreign currencies are initially recorded at the functional currency rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated at the functional currency rate of exchange ruling at the balance sheet date. All differences are included in the Income Statement for the period with the exception of exchange differences on foreign currency borrowings that provide a hedge against a net investment in a foreign entity. These are taken directly to equity until the disposal of the net investment, at which time they are recognised in the Income Statement. Non-monetary items that are measured in terms of historical cost in a currency other than the functional currency of the entity concerned are translated using the exchange rates as at the dates of the initial transactions.

For the purpose of presenting consolidated Financial Statements, the assets and liabilities of the Group's foreign subsidiary undertakings, jointly controlled entities and associates are translated into pounds sterling at exchange rates prevailing on the balance sheet date. The results of foreign subsidiary undertakings, jointly controlled entities and associates are translated into pounds sterling at average rates of exchange for the relevant period. Exchange differences arising from the retranslation of the opening net assets and the results are transferred to the Group’s forgein currency translation reserve, a separate component of equity, and are reported in the Statement of Recognised Income and Expense. In the event of the disposal of an undertaking with assets and liabilities denominated in a foreign currency, the cumulative translation difference arising in the foreign currency translation reserve is charged or credited to the Income Statement on disposal.

Exchange differences on foreign currency borrowings, foreign currency swaps and forward exchange contracts used to hedge foreign currency net investments in foreign subsidiary undertakings, jointly controlled entities and associates are taken directly to reserves and are reported in the Statement of Recognised Income and Expense. All other exchange movements are recognised in the Income Statement for the period.

Business combinations and goodwill

The acquisition of subsidiaries is accounted for using the purchase method. The cost of the acquisition is measured as the cash paid and the aggregate of the fair values, at the date of exchange, of other assets given, liabilities incurred or assumed, and equity instruments issued by the Group in exchange for control of the acquiree, plus any costs directly attributable to the business combination. The acquiree’s identifiable assets, liabilities and contingent liabilities that meet the conditions for recognition under IFRS 3, Business Combinations are recognised at their fair value at the acquisition date, except for non-current assets (or disposal groups) that are classified as held for resale in accordance with IFRS 5, Non-Current Assets Held for Sale and Discontinued Operations, which are recognised and measured at fair value less costs to sell.

Goodwill arising on a business combination represents the excess of the cost of acquisition over the Group’s interest in the fair value of the identifiable assets and liabilities of a subsidiary, jointly controlled entity or associate at the date of acquisition. Goodwill is initially recognised as an asset at cost and is subsequently measured at cost less any accumulated impairment losses. If, after reassessment, the Group’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities exceeds the cost of the business combination, the excess is recognised immediately in the Income Statement.

The interest of minority shareholders in the acquiree is initially measured at the minority’s proportion of the net fair value of the assets, liabilities and contingent liabilities recognised.

Goodwill which is recognised as an asset is reviewed for impairment, annually, or more frequently if events or changes in circumstances indicate that the carrying amount may be impaired. Any impairment is recognised immediately in the Income Statement and is not subsequently reversed.

For the purpose of impairment testing, goodwill is allocated to each of the Group’s cash-generating units or groups of cash-generating units that expect to benefit from the business combination in which the goodwill arose. Cash-generating units to which goodwill has been allocated are tested for impairment annually, or more frequently when there is an indication that the unit may be impaired. If the recoverable amount of the cash-generating unit or groups of cash-generating units is less than the carrying amount of the unit, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the unit and then to the other assets of the unit pro-rata on the basis of the carrying amount of each asset in the unit.

On disposal of a subsidiary, associate or jointly controlled entity, the attributable amount of goodwill is included in the determination of the profit or loss on disposal.

Other intangible assets

Intangible assets acquired separately are measured on initial recognition at cost. Intangible assets include emissions trading schemes, renewable obligation certificates and certain exploration and evaluation expenditures, the accounting policies for which are dealt with separately below. For purchased application software, for example investments in customer relationship management and billing systems, cost includes contractors’ charges, materials, directly attributable labour and directly attributable overheads.

Capitalisation begins when expenditure for the asset is being incurred and activities necessary to prepare the asset for use are in progress. Capitalisation ceases when substantially all the activities that are necessary to prepare the asset for use are complete. Amortisation commences at the point of commercial deployment. The cost of intangible assets acquired in a business combination is their fair value as at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortisation and any accumulated impairment losses. The useful lives of intangible assets are assessed to be either finite or indefinite. Intangible assets with finite lives are amortised over the useful economic life and assessed for impairment whenever there is an indication that the intangible asset may be impaired. The amortisation period and the amortisation method for an intangible asset are reviewed at least at each financial year-end. Changes in the expected useful life or the expected pattern of consumption of future economic benefits embodied in the asset are accounted for on a prospective basis by changing the amortisation period or method, as appropriate, and treated as changes in accounting estimates.

Intangible assets are derecognised on disposal, or when no future economic benefits are expected from their use.

Intangible assets with indefinite useful lives are tested for impairment annually either individually or at the cash-generating unit level. Such intangibles are not amortised. The useful life of an intangible asset with an indefinite useful life is reviewed annually to determine whether the indefinite life assessment continues to be supportable. If not, the change in the useful life assessment from indefinite to finite is made on a prospective basis.

The amortisation period for the principal categories of intangible assets are as follows:

Application software	up to 10 years
Licences	up to 20 years
Consents	up to 25 years
Contractual customer relationships	up to 20 years
Identifiable acquired brand	Indefinite

EU Emissions Trading Scheme and renewable obligations certificates

Granted CO₂ emissions allowances received in a period are initially recognised at nominal value (nil value). Purchased CO₂ emissions allowances are initially recognised at cost (purchase price) within intangible assets. A liability is recognised when the level of emissions exceed the level of allowances granted. The liability is measured at the cost of purchased allowances up to the level of purchased allowances held, and then at the market price of allowances ruling at the balance sheet date, with movements in the liability recognised in operating profit. Forward contracts for the purchase or sale of CO₂ emissions allowances are measured at fair value with gains and losses arising from changes in fair value recognised in the Income Statement. The intangible asset is surrendered at the end of the compliance period reflecting the consumption of economic benefit. As a result no amortisation is recorded during the period.

Purchased renewable obligation certificates are initially recognised at cost within intangible assets. A liability for the renewables obligation is recognised based on the level of electricity supplied to customers, and is calculated in accordance with percentages set by the UK Government and the renewable obligation certificate buyout price for that period. The intangible asset is surrendered at the end of the compliance period reflecting the consumption of economic benefit. As a result no amortisation is recorded during the period.

Property, plant and equipment

Property, plant and equipment is included in the Balance Sheet at cost, less accumulated depreciation and any provisions for impairment.

The initial cost of an asset comprises its purchase price or construction cost and any costs directly attributable to bringing the asset into operation. The purchase price or construction cost is the aggregate amount paid and the fair value of any other consideration given to acquire the asset.

Freehold land is not depreciated. Other property, plant and equipment, except upstream production assets, are depreciated on a straight-line basis at rates sufficient to write off the cost, less estimated residual values, of individual assets over their estimated useful lives. The depreciation periods for the principal categories of assets are as follows:

Freehold and leasehold buildings	up to 50 years
Plant	5 to 20 years
Power stations and wind farms	up to 30 years
Equipment and vehicles	3 to 10 years
Storage	up to 28 years

Assets held under finance leases are depreciated over their expected useful economic lives on the same basis as for owned assets, or where shorter, the lease term.

The carrying values of property, plant and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable.

Residual values and useful lives are re-assessed annually and if necessary changes are accounted for prospectively.

Exploration, evaluation and production assets

Centrica uses the successful efforts method of accounting for exploration and evaluation expenditure. Exploration and evaluation expenditure associated with an exploration well, including acquisition costs related to exploration and evaluation activities, are initially capitalised as intangible assets. Certain expenditures such as geological and geophysical exploration costs are expensed. If the prospects are subsequently determined to be successful on completion of evaluation, the relevant expenditure including licence acquisition costs is transferred to property, plant and equipment and depreciated on a unit of production basis. If the prospects are subsequently determined to be unsuccessful on completion of evaluation, the associated costs are expensed in the period in which that determination is made.

All field development costs are capitalised as property, plant and equipment. Such costs relate to the acquisition and installation of production facilities and include development drilling costs, project-related engineering and other technical services costs. Property, plant and equipment, including rights and concessions related to production activities, are depreciated from the commencement of production in the fields concerned, using the unit of production method, based on all of the proven and probable reserves of those fields. Changes in these estimates are dealt with prospectively.

The net carrying value of fields in production and development is compared on a field-by-field basis with the likely discounted future net revenues to be derived from the remaining commercial reserves. An impairment loss is recognised where it is considered that recorded amounts are unlikely to be fully recovered from the net present value of future net revenues. Exploration and production assets are reviewed annually for indicators of impairment.

Decommissioning costs

Provision is made for the net present value of the estimated cost of decommissioning gas production facilities at the end of the producing lives of fields, and storage facilities and power stations at the end of the useful life of the facilities, based on price levels and technology at the balance sheet date.

When this provision gives access to future economic benefits, a decommissioning asset is recognised and included within property, plant and equipment. Changes in these estimates and changes to the discount rates are dealt with prospectively and reflected as an adjustment to the provision and corresponding decommissioning asset included within property, plant and equipment. For gas production facilities and offshore storage facilities the decommissioning asset is amortised using the unit of production method, based on proven and probable reserves. For power stations the decommissioning asset is amortised on a straight-line basis over the useful life of the facility. The unwinding of the discount on the provision is included in the Income Statement within interest expense.

Leases

The determination of whether an arrangement is, or contains, a lease is based on the substance of the arrangement and requires an assessment of whether the fulfilment of the arrangement is dependent on the use of a specific asset or assets and the arrangement conveys a right to use the asset. Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Assets held under finance leases are capitalised and included in property, plant and equipment at their fair value, or if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The obligations relating to finance leases, net of finance charges in respect of future periods, are included within bank loans and other borrowings, with the amount payable within 12 months included in bank overdrafts and loans within current liabilities. Lease payments are apportioned between finance charges and reduction of the finance lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income.

Payments under operating leases are charged to the Income Statement on a straight-line basis over the term of the relevant lease.

Impairment of property, plant and equipment and intangible assets excluding goodwill

At each balance sheet date, the Group reviews the carrying amounts of its intangible assets and property, plant and equipment to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of any impairment loss. Where the asset does not generate cash flows that are independent from other assets, the Group estimates the recoverable amount of the cash-generating unit to which the asset belongs. An intangible asset with an indefinite useful life is tested for impairment annually and whenever there is an indication that the asset may be impaired.

Recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset concerned.

If the recoverable amount of an asset (or cash-generating unit) is estimated to be less than its carrying amount, the carrying amount of the asset (cash-generating unit) is reduced to its recoverable amount. An impairment loss is recognised immediately as an expense.

An impairment loss is reversed only if there has been a change in the estimate used to determine the asset’s recoverable amount since the last impairment loss was recognised. Where an impairment loss subsequently reverses, the carrying amount of the asset (cash-generating unit) is increased to the revised estimate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset (cash-generating unit) in prior years. A reversal of an impairment loss is recognised as income immediately. After such a reversal the depreciation or amortisation charge, where relevant, is adjusted in future periods to allocate the asset’s revised carrying amount, less any residual value, on a systematic basis over its remaining useful life.

Non-current assets held for sale

Non-current assets (and disposal groups) classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. No depreciation is charged in respect of non-current assets classified as held for sale.

Non-current assets and disposal groups are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset (or disposal group) is available for immediate sale in its present condition. Management must be committed to the sale which should be expected to qualify for recognition as a completed sale within one year from the date of classification.

Inventories

Inventories, excluding inventories of gas and oil, are valued on a first-in, first-out basis, at the lower of cost and estimated net realisable value after allowance for redundant and slow-moving items. Inventories of gas and oil are valued on a weighted average basis, at the lower of cost and estimated net realisable value.

Take-or-pay contracts

Where payments are made to external suppliers under take-or-pay obligations for gas not taken, they are treated as prepayments and included within other receivables, as they generate future economic benefits.

Pensions and other post-retirement benefits

The Group operates a number of defined benefit pension schemes. The cost of providing benefits under the defined benefit schemes is determined separately for each scheme using the projected unit credit actuarial valuation method. Actuarial gains and losses are recognised in full in the period in which they occur. They are recognised outside the Income Statement and presented in the Statement of Recognised Income and Expense.

The cost of providing retirement pensions and other benefits is charged to the Income Statement over the periods benefiting from employees’ service. Past service cost is recognised immediately to the extent that the benefits are already vested, and otherwise is amortised on a straight-line basis over the average period until the benefits become vested. The difference between the expected return on scheme assets and the change in present value of scheme obligations resulting from the passage of time is recognised in the Income Statement within interest income or interest expense.

The retirement benefit obligation/asset recognised in the Balance Sheet represents the present value of the defined benefit obligation of the schemes as adjusted for unrecognised past service cost, and the fair value of the schemes’ assets.

Provisions

Provisions are recognised when the Group has a present obligation (legal or constructive) as a result of a past event, that can be reliably measured, and it is probable that the Group will be required to settle that obligation. Provisions are measured at the Directors’ best estimate of the expenditure required to settle the obligation at the balance sheet date, and are discounted to present value where the effect is material. Where discounting is used, the increase in the provision due to the passage of time is recognised in the Income Statement included within interest expense.

Taxation

Current tax, including UK corporation tax, UK petroleum revenue tax and foreign tax, is provided at amounts expected to be paid (or recovered) using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date.

Deferred tax is recognised in respect of all temporary differences identified at the balance sheet date, except to the extent that the deferred tax arises from the initial recognition of goodwill (if amortisation of goodwill is not deductible for tax purposes) or the initial recognition of an asset or liability in a transaction which is not a business combination and at the time of the transaction affects neither accounting profit nor taxable profit and loss. Temporary differences are differences between the carrying amount of the Group’s assets and liabilities and their tax base.

Deferred tax liabilities may be offset against deferred tax assets within the same taxable entity or qualifying local tax group. Any remaining deferred tax asset is recognised only when, on the basis of all available evidence, it can be regarded as probable that there will be suitable taxable profits, within the same jurisdiction, in the foreseeable future, against which the deductible temporary difference can be utilised.

Deferred tax is provided on temporary differences arising on subsidiaries, jointly controlled entities and associates, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax is measured at the average tax rates that are expected to apply in the periods in which the asset is realised or liability settled, based on tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Measurement of deferred tax liabilities and assets reflects the tax consequences expected to fall from the manner in which the asset or liability is recovered or settled.

Financial instruments

Financial assets and financial liabilities are recognised in the Group Balance Sheet when the Group becomes a party to the contractual provisions of the instrument. Financial assets are de-recognised when the Group no longer has the rights to cash flows, the risks and rewards of ownership or control of the asset. Financial liabilities are de-recognised when the obligation under the liability is discharged, cancelled or expires.

(a) Trade receivables

Trade receivables are recognised and carried at original invoice amount less an allowance for any uncollectible amounts. Provision is made when there is objective evidence that the Group may not be able to collect the trade receivable. Balances are written off when recoverability is assessed as being remote.

(b) Share capital

Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares are shown in equity as a deduction from the proceeds received. Own equity instruments that are reacquired (treasury shares) are deducted from equity. No gain or loss is recognised in the Income Statement on the purchase, sale, issue or cancellation of the Group’s own equity instruments.

(c) Cash and cash equivalents

Cash and cash equivalents comprise cash in hand and current balances with banks and similar institutions, which are readily convertible to known amounts of cash and which are subject to insignificant risk of changes in value and have an original maturity of three months or less.

For the purpose of the consolidated Cash Flow Statement, cash and cash equivalents consist of cash and cash equivalents as defined above, net of outstanding bank overdrafts.

(d) Interest-bearing loans and other borrowings

All interest-bearing loans and other borrowings are initially recognised at fair value net of directly attributable transaction costs. After initial recognition, interest-bearing loans and other borrowings are subsequently measured at amortised cost using the effective interest method, except when they are the hedged item in an effective fair value hedge relationship where the carrying value is also adjusted to reflect the fair value movements associated with the hedged risks. Such fair value movements are recognised in the Income Statement. Amortised cost is calculated by taking into account any issue costs, and any discount or premium.

(e) Units issued by The Consumers’ Waterheater Income Fund

Prior to deconsolidation as explained in note 3, units issued by The Consumers’ Waterheater Income Fund which contain redemption rights providing unit holders with the right to redeem units back to the Fund for cash or another financial asset are treated as a financial liability and recorded at the present value of the redemption amount. Gains and losses related to changes in the carrying value of the financial liability up to the date of deconsolidation are included in the Income Statement within discontinued operations.

(f) Other financial assets

Available-for-sale financial assets are those non-derivative financial assets that are designated as available-for-sale, which are initially recognised at fair value, and included within other financial assets within the Balance Sheet. Available-for-sale financial assets are subsequently recognised at fair value with gains and losses arising from changes in fair value recognised directly in equity and presented in the Statement of Recognised Income and Expense, until the asset is disposed of or is determined to be impaired, at which time the cumulative gain or loss previously recognised in equity is included in the Income Statement for the period. Accrued interest or dividends arising on available-for-sale financial assets are recognised in the Income Statement.

Impairment losses recognised in the Income Statement for equity investments classified as available-for-sale are not subsequently reversed through the Income Statement. Impairment losses recognised in the Income Statement for debt instruments classified as available-for-sale are subsequently reversed if an increase in the fair value of the instrument can be objectively related to an event occurring after the recognition of the impairment loss.

(g) Derivative financial instruments

The Group routinely enters into sale and purchase transactions for physical delivery of gas, power and oil. A portion of these transactions take the form of contracts that were entered into and continue to be held for the purpose of receipt or delivery of the physical commodity in accordance with the Group’s expected sale, purchase or usage requirements, and are not within the scope of IAS 39.

Certain purchase and sales contracts for the physical delivery of gas, power and oil are within the scope of IAS 39 because they net settle or contain written options. Such contracts are accounted for as derivatives under IAS 39 and are recognised in the Balance Sheet at fair value. Gains and losses arising from changes in fair value on derivatives that do not qualify for hedge accounting are taken directly to the Income Statement for the year.

The Group uses a range of derivatives for both trading and to hedge exposures to financial risks, such as interest rate, foreign exchange and energy price risks, arising in the normal course of business. The use of derivative financial instruments is governed by the Group’s policies approved by the Board of Directors. Further detail on the Group’s risk management policies is included within the Directors’ Report - Governance and in note 4 to the Financial Statements.

The accounting treatment for derivatives is dependent on whether they are entered into for trading or hedging purposes. A derivative instrument is considered to be used for hedging purposes when it alters the risk profile of an underlying exposure of the Group in line with the Group’s risk management policies and is in accordance with established guidelines, which require that the hedging relationship is documented at its inception, ensure that the derivative is highly effective in achieving its objective, and require that its effectiveness can be reliably measured. The Group also holds derivatives which are not designated as hedges and are held for trading.

All derivatives are recognised at fair value on the date on which the derivative is entered into and are re-measured to fair value at each reporting date. Derivatives are carried as assets when the fair value is positive and as liabilities when the fair value is negative. Derivative assets and derivative liabilities are offset and presented on a net basis only when both a legal right of set-off exists and the intention to net settle the derivative contracts is present.

The Group enters into certain energy derivative contracts covering periods for which observable market data does not exist. The fair value of such derivatives is estimated by reference in part to published price quotations from active markets, to the extent that such observable market data exists, and in part by using valuation techniques, whose inputs include data, which is not based on or derived from observable markets. Where the fair value at initial recognition for such contracts differs from the transaction price, a fair value gain or fair value loss will arise. This is referred to as a day-one gain or day-one loss. Such gains and losses are deferred and amortised to the Income Statement based on volumes purchased or delivered over the contractual period until such time observable market data becomes available. When observable market data becomes available, any remaining deferred day-one gains or losses are recognised within the Income Statement. Recognition of the gain or loss that results from changes in fair value depends on the purpose for issuing or holding the derivative. For derivatives that do not qualify for hedge accounting, any gains or losses arising from changes in fair value are taken directly to the Income Statement and are included within gross profit or interest income and interest expense. Gains and losses arising on derivatives entered into for speculative energy trading purposes are presented on a net basis within revenue.

Embedded derivatives: Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of the host contracts and the host contracts are not carried at fair value, with gains or losses reported in the Income Statement. The closely related nature of embedded derivatives is re-assessed when there is a change in the terms of the contract which significantly modifies the future cash flows under the contract. Where a contract contains one or more embedded derivatives and providing that the embedded derivative significantly modifies the cash flows under the contract, the option to fair value the entire contract may be taken and the contract will be recognised at fair value with changes in fair value recognised in the Income Statement.

(h) Hedge accounting

For the purposes of hedge accounting, hedges are classified either as fair value hedges, cash flow hedges or hedges of net investments in foreign operations.

Fair value hedges: A derivative is classified as a fair value hedge when it hedges the exposure to changes in the fair value of a recognised asset or liability. Any gain or loss from re-measuring the hedging instrument at fair value is recognised immediately in the Income Statement. Any gain or loss on the hedged item attributable to the hedged risk is adjusted against the carrying amount of the hedged item and recognised in the Income Statement. The Group discontinues fair value hedge accounting if the hedging instrument expires or is sold, terminated or exercised, the hedge no longer qualifies for hedge accounting or the Group revokes the designation. Any adjustment to the carrying amount of a hedged financial instrument for which the effective interest method is used is amortised to the Income Statement. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged.

Cash flow hedges: A derivative is classified as a cash flow hedge when it hedges exposure to variability in cash flows that is attributable to a particular risk either associated with a recognised asset, liability or a highly probable forecast transaction. The portion of the gain or loss on the hedging instrument which is effective is recognised directly in equity while any ineffectiveness is recognised in the Income Statement. The gains or losses that are recognised directly in equity are transferred to the Income Statement in the same period in which the highly probable forecast transaction affects income, for example when the future sale of physical gas or physical power actually occurs. Where the hedged item is the cost of a non-financial asset or liability, the amounts taken to equity are transferred to the initial carrying amount of the non-financial asset or liability on its recognition. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised without replacement or rollover, no longer qualifies for hedge accounting or the Group revokes the designation.

At that point in time, any cumulative gain or loss on the hedging instrument recognised in equity remains in equity until the highly probable forecast transaction occurs. If the transaction is no longer expected to occur, the cumulative gain or loss recognised in equity is recognised in the Income Statement.

Net investment hedges: Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the effective portion of the hedge is recognised in equity, any gain or loss on the ineffective portion of the hedge is recognised in the Income Statement. On disposal of the foreign operation, the cumulative value of any gains or losses recognised directly in equity is transferred to the Income Statement.

3. Critical accounting judgements and key sources of estimation uncertainty

(a) Critical judgements in applying the Group’s accounting policies

In the process of applying the Group’s accounting policies as described in note 2, management has made the following judgements that have the most significant effect on the amounts recognised in the Financial Statements (apart from those involving estimations which are dealt with below).

The Consumers’ Waterheater Income Fund

The Group has deconsolidated The Consumers’ Waterheater Income Fund (the ‘Fund’) with effect from 1 December 2007, the date of an Internalisation Agreement entered into between Centrica and the Fund.

Centrica created the Fund in 2002 to refinance the water heater assets acquired with the Enbridge Services acquisition. The Group consolidated the Fund in accordance with the requirements of SIC-12, Consolidation - Special Purpose Entities, as the substance of the agreements put in place by Centrica indicated that the Fund was created for and on behalf of the Group. These agreements both predetermined the Fund’s activities and provided Centrica with operational control, via responsibilities for servicing the Fund’s asset portfolio and administering the Fund’s activities.

In October 2006 the Trustees of the Fund appointed an independent Chief Executive Officer. The activities undertaken by the Fund started to change following this appointment through the independent acquisition of an immaterial business in late 2006, and the independent acquisition of the Toronto Hydro water heater rental business in February 2007, which provided the Fund with a limited number of rental customers held outside of the original contractual arrangements entered into with Centrica. Almost all the significant parts of the relationship, however, remained predetermined or controlled by Centrica. These changes in the conduct of the Fund were judged not to be sufficiently material to alter the Fund’s status as a subsidiary in the 2006 Group accounts.

In 2007 the Trustees of the Fund have sought further changes in the conduct of the Fund. The Fund has recruited an independent Chief Financial Officer and has made further small acquisitions outside of the original contractual arrangements entered into with Centrica. On 1 December 2007, the existing Administration Agreement was replaced, at the instigation of the Fund, by a new Internalisation Agreement, which provides the Fund with access rights to key operational data and provides a basis for employees and business infrastructure to transfer to the Fund, such that it is capable of independent operation from Centrica. Subsequent to this Agreement the Fund has independently refinanced its activities. The Directors believe that the Internalisation Agreement represents a change to the original contractual arrangements with the Fund, and demonstrates that the Fund has both the desire and the ability to manage its own affairs. Accordingly, in 2007 the Directors judge that the Fund’s activities are no longer predetermined such that its activities are being conducted on behalf of Centrica, and thus the Fund ceases to represent a subsidiary of the Centrica Group.

The Group has deconsolidated the Fund with effect from 1 December 2007, the date the Internalisation Agreement became effective and the date of the resultant loss of control, recognising an exceptional profit on disposal amounting to £227 million. The Fund’s activities represented a separate major line of business of the Direct Energy segment, and contributed materially to Group borrowings. In order to provide a clear presentation of the impact of deconsolidating the Fund, the results in the current year and prior year have been presented as a discontinued operation distinct from continuing operations within the Group Income Statement. The details of the disposal and discontinued results are provided in note 35.

Finance lease - Third-party power station tolling arrangement

The Group has entered into a long-term tolling arrangement with the Spalding power station. The contract provides Centrica with the right to nominate 100% of the plant output until 2021 in return for a mix of capacity payments and operating payments. The capacity payments comprise both fixed-price and market-priced elements and are dependent on plant availability. Centrica holds an option to extend the tolling arrangement for a further 8 years, notice of which must be provided to the power station operator by 30 September 2020. If the extension option is exercised, Centrica is granted an option to purchase the station at the end of the extended tolling period. The option to purchase must be exercised by serving notice to the generator between 30 September 2027 and 30 September 2028. Should Centrica exercise the purchase option the generator can exercise an option to retain the station. Should both options be exercised the valuation of the options, and hence ownership of the asset, will be determined by an expert panel, appointed by both parties. Market-based compensation will be payable to Centrica if ownership is retained by the generator. The Directors have judged that the arrangement should be accounted for as a finance lease as the lease term is judged to be a major part of the economic life of the power station and the present value of the minimum lease payments at inception date of the arrangement amounted to a large part of the fair value of the power station at that time. Details of the finance lease asset, finance lease creditor and interest charges are included in notes 17, 25 and 10 respectively.

EU Emissions Trading Scheme

The Group has been subject to the European Emissions Trading Scheme (EU ETS) since 1 January 2005. IFRIC 3, Emission Rights was withdrawn by the IASB in June 2005, and has not yet been replaced by definitive guidance. The Group has adopted an accounting policy, which recognises CO₂ emissions liabilities when the level of emissions exceeds the level of allowances granted by the Government in the period. The liability is measured at the cost of purchased allowances up to the level of purchased allowances held, and then at market price of allowances ruling at the balance sheet date. Movements in the liability are reflected within operating profit. Forward contracts for sales and purchases of allowances are measured at fair value.

Petroleum revenue tax (PRT)

The definitions of an income tax in IAS 12, Income Taxes, have led management to judge that PRT should be treated consistently with other income taxes. The charge for the year is presented within taxation on profit from continuing operations in the Income Statement. Deferred amounts are included within deferred tax assets and liabilities in the Balance Sheet.

(b) Key sources of estimation uncertainty

The key assumptions concerning the future, and other key sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are discussed below.

Revenue recognition - unread gas and electricity meters

Revenue for energy supply activities includes an assessment of energy supplied to customers between the date of the last meter reading and the year end (unread). Unread gas and electricity is estimated applying industry standards and using historical consumption patterns taking into account the industry reconciliation process for total gas and electricity usage by supplier. Management applies judgement to the measurement of the estimated energy supplied to customers and to the valuation of that energy consumption. An assessment is made of any factors that are likely to materially affect the ultimate economic benefits which will flow to the Group, including delays in processing, bill cancellation and re-bill rates and any customer or industry data quality issues. In the period subsequent to the implementation of the new billing system, operational exceptions have been running at a higher level and this has been taken account of in the judgements made. To the extent that the economic benefits are not expected to flow to the Group, the value of the revenue is not recognised. The judgements applied, and the assumptions underpinning these judgements, are considered to be appropriate. However, a change in these assumptions would have an impact on the amount of revenue recognised.

Industry reconciliation process - cost of sales

The industry reconciliation process is required as differences arise between the estimated quantity of gas and electricity the Group deems to have supplied and billed customers, and the estimated quantity the industry system operator deems the individual suppliers, including the Group, to have supplied to customers. This difference in deemed supply is referred to as imbalance. The reconciliation process can result in either a higher or lower value of industry deemed supply than has been estimated as being supplied to customers by the Group, but in practice tends to result in a higher value of deemed supply. The Group then reviews the difference to ascertain whether there is evidence that its estimate of amounts supplied to customers is inaccurate or whether the difference arises from other causes. The Group’s share of the resulting imbalance is included within commodity costs charged to cost of sales. Management estimates the level of recovery of imbalance which will be achieved either through subsequent customer billing or through the developing industry settlement process.

Determination of fair values - energy derivatives

Derivative contracts are carried in the Balance Sheet at fair value, with changes in fair value recorded in either the Income Statement or equity. Fair values of energy derivatives are estimated by reference in part to published price quotations in active markets and in part by using valuation techniques. More detail on the assumptions used in determining fair valuations is provided in notes 4 and 28.

Gas and liquids reserves

The volume of proven and probable gas and liquids reserves is an estimate that affects the unit of production depreciation of producing gas and oil property, plant and equipment as well as being a significant estimate affecting decommissioning estimates and impairment calculations. The factors impacting gas and liquids estimates, and the process for estimating reserve quantities, are described within the Gas and Liquids Reserves (unaudited) section of this report.

The impact of a change in estimated proven and probable reserves is dealt with prospectively by depreciating the remaining book value of producing assets over the expected future production. If proven and probable reserves estimates are revised downwards, earnings could be affected by higher depreciation expense or an immediate write-down (impairment) of the asset’s book value.

Decommissioning costs

The estimated cost of decommissioning at the end of the producing lives of fields is reviewed periodically and is based on proven and probable reserves, price levels and technology at the balance sheet date. Provision is made for the estimated cost of decommissioning at the balance sheet date. The payment dates of total expected future decommissioning costs are uncertain and dependent on the lives of the facilities, but are currently anticipated to be between 2008 and 2042.

Impairment of goodwill and indefinite lived intangible assets

The Group determines whether goodwill and indefinite lived intangible assets are impaired at least on an annual basis. This requires an estimation of the value in use of the cash-generating units to which goodwill and indefinite lived intangibles are allocated. Estimating the value in use requires the Group to make an estimate of the expected future cash flows from the cash-generating unit and also to choose a suitable discount rate in order to calculate the present value of those cash flows. Further detail on the assumptions used in determining value in use calculations is provided in note 16.

Pensions and other post-retirement benefits

The Group operates a number of defined benefit pension schemes. The cost of providing benefits under the defined benefit schemes is determined separately for each scheme under the projected unit credit actuarial valuation method. Actuarial gains and losses are recognised in full in the period in which they occur. The key assumptions used for the actuarial valuation are based on the Group’s best estimate of the variables that will determine the ultimate cost of providing post-employment benefits, on which further detail is provided in note 34.

4. Financial risk management

The Group’s normal operating, investing and financing activities expose it to a variety of financial risks: market risk (including commodity price risk, currency risk, interest rate risk and equity price risk), credit risk and liquidity risk. The Group’s overall risk management process is designed to identify, manage and mitigate business risk, which includes, among others, financial risk. Further detail on the Group’s overall risk management process is included within the Directors’ Report - Governance.

Financial risk management is overseen by the Group Financial Risk Management Committee (FRMC) according to objectives, targets and policies set by the Board. Commodity price risk management, and the associated credit risk management, is carried out in accordance with individual business unit financial risk management policies, as approved by the FRMC and the Board. Treasury risk management, including management of currency risk, interest rate risk, equity price risk and liquidity risk, and the associated credit risk management, is carried out by a central Group Treasury function in accordance with the Group’s financing and treasury policy, as approved by the Board. Downstream credit risk management is carried out in accordance with business unit credit policies.

(a) Market risk management

Market risk is the risk of loss that results from changes in market prices (commodity prices, foreign exchange rates, interest rates and equity prices). The level of market risk to which the Group is exposed at a point in time varies depending on market conditions, expectations of future price or market rate movements and the composition of the Group’s physical asset and contract portfolios.

(i) Commodity price risk management

The Group is exposed to commodity price risk in its energy procurement, downstream and proprietary energy trading activities.

Energy procurement and downstream activities

The Group’s energy procurement and downstream activities consist of downstream positions, equity gas and liquids production and power generation, strategic procurement and sales contracts, market-traded purchase and sales contracts and derivative positions taken on with the intent of securing gas and power for the Group’s downstream customers in the UK, Europe and North America from a variety of sources at an optimal cost. The Group actively manages commodity price risk by optimising its asset and contract portfolios making use of volume flexibility.

The Group is exposed to commodity price risk in its energy procurement and downstream activities because the cost of procuring gas and electricity to serve its downstream customers varies with wholesale commodity prices. The risk is primarily that market prices for commodities will fluctuate between the time that sales prices are fixed or tariffs are set and the time at which the corresponding procurement cost is fixed, thereby potentially reducing expected margins or making sales unprofitable.

The Group uses specific volumetric limits to manage the exposure to market prices associated with the Group’s energy procurement and downstream activities to an acceptable level. Volumetric limits are supported by a Profit at Risk (PaR) methodology in the UK and a Value at Risk (VaR) methodology in North America and Europe to measure the Group’s exposure to commodity price risk. PaR measures the estimated potential loss in a position or portfolio of positions associated with the movement of a commodity price for a given confidence level, over the remaining term of the position or contract portfolio. VaR measures the estimated potential loss for a given confidence level, over a predetermined holding period. The standard confidence level used is 95%.

The Group measures and manages the commodity price risk associated with the Group’s entire energy procurement and downstream portfolio. Only certain of the Group’s energy procurement and downstream contracts constitute financial instruments under IAS 39 (note 2). As a result, while the Group manages the commodity price risk associated with both financial and non-financial energy procurement and downstream contracts, it is the notional value of energy contracts being carried at fair value that represents the exposure of the Group’s energy procurement and downstream books to commodity price risk according to IFRS 7. This is because energy contracts that are financial instruments under IAS 39 are accounted for on a fair value basis and changes in fair value immediately impact profit or equity. Conversely, energy contracts that are not financial instruments under IAS 39 are accounted for as executory contracts and changes in fair value do not immediately impact profit or equity, and as such, are not exposed to commodity price risk as defined by IFRS 7. So while the PaR or the VaR associated with energy procurement and downstream contracts outside the scope of IAS 39 is monitored for internal risk management purposes, these measures are not required to comply with IFRS 7.

The carrying value of energy contracts used in energy procurement and downstream activities at 31 December 2007 is disclosed in note 21 and a sensitivity analysis that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in the fair value or future cash flows of financial instruments associated with the Group’s energy procurement and downstream activities as a result of changes in commodity prices is provided below in section (v).

Proprietary energy trading

The Group’s proprietary energy trading activities consist of physical and financial commodity purchases and sales contracts taken on with the intent of benefiting in the short-term from changes in market prices or differences between buying and selling prices. The Group conducts its trading activities over the counter and through exchanges in the UK, North America and parts of the rest of Europe. The Group is exposed to commodity price risk as a result of its proprietary energy trading activities because the value of its trading assets and liabilities will fluctuate with changes in market prices for commodities.

The Group sets volumetric and VaR limits to manage the commodity price risk exposure associated with the Group’s proprietary energy trading activities. The VaR used measures the estimated potential loss for a 95% confidence level over a one-day holding period. The holding period used is based on market liquidity and the number of days the Group would expect it to take to close off a trading position.

As with any modelled risk measure, there are certain limitations that arise from the assumptions used in the VaR analysis. VaR assumes that the future will behave like the past and that the Group’s trading positions can be unwound or hedged within the predetermined holding period. Furthermore the use of a 95% confidence level, by definition, does not take into account changes in value that might occur beyond this confidence level.

The VaR, before taxation, associated with the Group’s proprietary energy trading activities at 31 December 2007 was £9 million (2006: £8 million). The carrying value of energy contracts used in proprietary energy trading activities at 31 December 2007 is disclosed in note 21.

(ii) Currency risk management

The Group is exposed to currency risk on foreign currency denominated forecast transactions, firm commitments, monetary assets and liabilities (transactional exposure) and on its net investments in foreign operations (translational exposure).

Transactional currency risk

The Group is exposed to transactional currency risk on transactions denominated in currencies other than the underlying functional currency of the commercial operation transacting. The Group’s primary functional currencies are pounds sterling in the UK, Canadian dollars in Canada, US dollars in the US and euros in Europe. The risk is that the functional currency value of cash flows will vary as a result of movements in exchange rates. Transactional exposure arises from the Group’s energy procurement activities in the UK and in Canada, where a proportion of transactions are denominated in euros or US dollars and on certain capital commitments denominated in foreign currencies. In addition, in order to optimise the cost of funding, the Group has, in certain cases, issued foreign currency denominated debt, primarily in US dollars, euros or Japanese yen.

It is the Group’s policy to hedge all material transactional exposures using forward contracts to fix the functional currency value of non-functional currency cash flows. At 31 December 2007, there were no material unhedged non-functional currency monetary assets or liabilities, firm commitments or probable forecast transactions (2006: £nil).

Translational currency risk

The Group is exposed to translational currency risk as a result of its net investments in North America and Europe. The risk is that the pounds sterling value of the net assets of foreign operations will decrease with changes in foreign exchange rates. The Group’s policy is to protect the pounds sterling book value of its net investments in foreign operations, subject to certain targets monitored by the FRMC, by holding foreign currency debt, entering into foreign currency derivatives or a mixture of both.

The Group measures and manages the currency risk associated with all transactional and translational exposures. In contrast, IFRS 7 requires disclosure of currency risk arising on financial instruments denominated in a currency other than the functional currency of the commercial operation transacting only. As a result, for the purposes of IFRS 7, currency risk excludes the Group’s net investments in North America and Europe as well as foreign currency denominated forecast transactions and firm commitments. A sensitivity analysis that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in the fair value or future cash flows of foreign currency denominated financial instruments as a result of changes in foreign exchange rates is provided below in section (v).

(iii) Interest rate risk management

In the normal course of business the Group borrows to finance its operations. The Group is exposed to interest rate risk because the fair value of fixed rate borrowings and the cash flows associated with floating rate borrowings will fluctuate with changes in interest rates. The Group’s policy is to manage the interest rate risk on long-term recourse borrowings by ensuring that the exposure to floating interest rates remains within a 30% to 70% range, including the impact of interest rate derivatives. Note 25 details the interest rates on the Group’s bank overdrafts, loans and other borrowings by the earlier of contractual re-pricing and maturity date and a sensitivity analysis that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in interest rates is provided below in section (v).

(iv) Equity price risk management

The Group is exposed to equity price risk because certain available-for-sale financial assets, held by the Law Debenture Trust on behalf of the Company as security in respect of the Centrica Unapproved Pension Scheme, are linked to equity indices (note 34). Investments in equity indices are inherently exposed to less risk than individual equity investments because they represent a naturally diverse portfolio. Note 34 details the Group’s other retirement benefit assets and liabilities.

(v) Sensitivity analysis

A financial instrument is defined in IAS 32 as any contract that gives rise to a financial asset of one entity (effectively the contractual right to receive cash or another financial asset from another entity) and a financial liability (effectively the contractual obligation to deliver cash or another financial asset to another entity) or equity instrument (effectively a residual interest in the assets of an entity) of another. IFRS 7 requires disclosure of a sensitivity analysis that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in market variables (commodity prices, foreign exchange rates, interest rates and equity prices) as a result of changes in the fair value or cash flows associated with the Group’s financial instruments. The sensitivity analysis provided discloses the effect on profit or loss and equity at 31 December 2007 assuming that a reasonably possible change in the relevant risk variable had occurred at 31 December 2007 and been applied to the risk exposures in existence at that date to show the effects of reasonably possible changes in price on profit or loss and equity to the next annual reporting date. The reasonably possible changes in market variables used in the sensitivity analysis were determined based on implied volatilities where available or historical data.

The sensitivity analysis has been prepared based on 31 December 2007 balances and on the basis that the balances, the ratio of fixed to floating rates of debt and derivatives, the proportion of energy contracts that are financial instruments, the proportion of financial instruments in foreign currencies and the hedge designations in place at 31 December 2007 are all constant. Excluded from this analysis are all non-financial assets and liabilities and energy contracts that are not financial instruments under IAS 39. The sensitivity to foreign exchange rates relates only to monetary assets and liabilities denominated in a currency other than the functional currency of the commercial operation transacting, and excludes the translation of the net assets of foreign operations to pounds sterling, but not the corresponding impact of net investment hedges.

The sensitivity analysis provided is hypothetical only and should be used with caution as the impacts provided are not necessarily indicative of the actual impacts that would be experienced because the Group’s actual exposure to market rates is constantly changing as the Group’s portfolio of commodity, debt, foreign currency and equity contracts changes. Changes in fair values or cash flows based on a variation in a market variable cannot be extrapolated because the relationship between the change in market variable and the change in fair value or cash flows may not be linear. In addition, the effect of a change in a particular market variable on fair values or cash flows is calculated without considering interrelationships between the various market rates or mitigating actions that would be taken by the Group. The sensitivity analysis provided below excludes the impact of proprietary energy trading assets and liabilities because the VaR associated with the Group’s proprietary energy trading activities has already been provided above in section (i).

The impacts of reasonably possible changes in commodity prices on profit and equity, both after taxation, based on the assumptions provided above are as follows:

	2007			2006
Energy prices	Base price (i)	Reasonably possible increase in variable	Reasonably possible decrease in variable	Base price (i)	Reasonably possible increase in variable	Reasonably possible decrease in variable
The base price represents the average forward market price over the duration of the active market curve used in the sensitivity analysis provided.
UK gas (p/therm)	51	+12	-12	35	+6	-6
UK power (£/MWh)	52	+11	-11	35	+9	-9
UK coal (US$/tonne)	101	+15	-15	70	+10	-10
UK emissions (€/tonne)	24	+5	-5	7	+4	-4
UK oil (US$/bbl)	88	+14	-14	66	+7	-7
North American gas (p/therm)	38	+4	-4	36	+6	-6
North American power (£/MWh)	28	+5	-5	29	+5	-5

	2007		2006
Incremental profit/(loss)	Impact on profit £m	Impact on equity £m	Impact on profit £m	Impact on equity £m
UK energy prices (combined) - increase	34	56	91	67
UK energy prices (combined) - decrease	(34)	(56)	(91)	(67)
North American energy prices (combined) - increase	103	54	78	95
North American energy prices (combined) - decrease	(103)	(54)	(78)	(95)

The impacts of reasonably possible changes in interest rates on profit and equity, both after taxation, based on the assumptions provided above are as follows:

	2007			2006
Interest rates and incremental profit/(loss)	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m
UK interest rates	+0.50	5	4	+0.50	1	-
	-0.50	(5)	(4)	-0.50	(1)	-
US interest rates	+0.50	-	2	+0.25	1	3
	-0.50	-	(2)	-0.25	(1)	(3)
Canadian interest rates	+0.50	(2)	-	+0.25	-	-
	-0.50	2	-	-0.25	-	-

The impacts of reasonably possible changes in foreign currency rates relative to pounds sterling on profit and equity, both after taxation, based on the assumptions provided above are as follows:

	2007			2006
Foreign exchange rates and incremental profit/(loss)	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m
US dollar	+10	(32)	14	+5	(1)	(1)
	-10	28	(12)	-5	1	1
Canadian dollar	+10	3	12	+5	(1)	5
	-10	1	(10)	-5	1	(5)
Euro	+10	(1)	18	+5	(1)	8
	-10	1	(17)	-5	1	(8)

The impacts of reasonably possible changes in equity prices on profit and equity, both after taxation, based on the assumptions provided above are as follows:

	2007			2006
Equity prices and incremental profit/(loss)	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m	Reasonably possible change in variable %	Impact on profit £m	Impact on equity £m
FTSE 100	+5	-	1	+5	-	1
	-5	-	(1)	-5	-	(1)

(b) Credit risk management

Credit risk is the risk of loss associated with a counterparty’s inability or failure to discharge its obligations under a contract. The Group is exposed to credit risk in its treasury, trading, energy procurement and downstream activities.

Treasury, trading and energy procurement activities

Counterparty credit exposures are monitored by individual counterparty and by category of credit rating, and are subject to approved limits. The majority of significant exposures are with A-rated counterparties or better. The Group uses master netting agreements to reduce credit risk and net settles payments with counterparties where net settlement provisions exist. In addition, the Group employs a variety of other methods to mitigate credit risk: margining, various forms of bank and parent company guarantees and letters of credit.

100% of the Group’s credit risk associated with its treasury, trading and energy procurement activities is with counterparties in related energy industries or with financial institutions. The Group measures and manages the credit risk associated with the Group’s entire treasury, trading and energy procurement portfolio. In contrast, IFRS 7 defines credit risk as the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation and requires disclosure of information about the exposure to credit risk arising from financial instruments only. Only certain of the Group’s energy procurement contracts constitute financial instruments under IAS 39 (note 2). As a result, while the Group manages the credit risk associated with both financial and non-financial energy procurement contracts, it is the carrying value of financial assets within the scope of IAS 39 (note 28) that represents the maximum exposure to credit risk in accordance with IFRS 7 because credit losses associated with contracts that are not recognised on the Balance Sheet will not be recognised as such in the Income Statement.

Downstream activities

In the case of business customers credit risk is managed by checking a company’s creditworthiness and financial strength both before commencing trade and during the business relationship. For residential customers, creditworthiness is ascertained normally before commencing trade by reviewing an appropriate mix of internal and external information to determine the payment mechanism required to reduce credit risk to an acceptable level. Certain customers will only be accepted on a prepayment basis.

In some cases, an ageing of receivables is monitored and used to manage the exposure to credit risk associated with both business and residential customers. In other cases, credit risk is monitored and managed by grouping customers according to method of payment or profile.

Note 21 provides further detail of the Group’s exposure to credit risk on derivative financial instruments, note 20 provides detail of the Group’s exposure to credit risk on trade and other receivables, note 23 provides detail of the Group’s exposure to credit risk on cash and cash equivalents and note 28 provides the carrying value of all financial assets representing the Group’s maximum exposure to credit risk.

(c) Liquidity risk management

Liquidity risk is the risk that the Group will not have sufficient funds to meet it obligations as they come due. Cash forecasts identifying the Group’s liquidity requirements are produced regularly and are stress-tested for different scenarios to ensure sufficient financial headroom exists for at least a 12-month period to safeguard the Group’s ability to continue as a going concern.

In order to manage liquidity risk it is the Group’s policy to maintain committed facilities of at least £1,000 million less available surplus cash resources, to raise at least 50% of its net debt (excluding non-recourse debt) over £200 million in the long-term debt market, to hold a maximum of £400 million of debt maturing in the same calendar year (excluding finance leases and non-recourse borrowings) and to maintain an average term to maturity in the recourse long-term debt portfolio greater than three years.

At 31 December 2007, the Group had undrawn committed bank borrowing facilities of £1,300 million (2006: £1,300 million), 321% (2006: 76%) of the Group’s net debt over £200 million has been raised in the long-term debt market, the average term to maturity of the long-term debt portfolio was 7.1 years (2006: 7.3 years) and there is no calendar year where more than £400 million of debt (excluding finance leases and non-recourse borrowings) will be maturing (2006: same).

5. Capital management

The Group’s objective when managing capital is to maintain an optimal capital structure and strong credit rating to minimise the cost of capital. In addition, in a number of areas in which the Group operates, the Group’s strong capital structure and good credit standing are important elements of the Group’s competitive position.

At 31 December 2007, the Group’s long-term credit rating was A3 for Moody’s Investor Services Inc. (2006: A3) and A for Standard & Poor’s Rating Services (2006: A).

The Group monitors capital, using a medium-term view of 3-5 years, on the basis of a number of financial ratios generally used by industry and by the rating agencies. This includes monitoring gearing ratios, interest cover and cash flow to debt ratios. The Group is not subject to externally imposed capital requirements but as is common for most companies the level of debt that can be raised is restricted by the Company’s Articles of Association. Net debt is limited to the greater of £5 billion and a gearing ratio of three times adjusted capital and reserves. This restriction can be amended or removed by the shareholders of the Company passing an ordinary resolution. As a result of the volatility introduced to the Group’s reserves resulting from IAS 39, Financial Instruments: Recognition and Measurement, and IAS 19, Employee Benefits, changes are being sought to the definition of reserves in the Articles of Association at this year’s Annual General Meeting.

The Group’s capital structure is managed against the various financial ratios as required to maintain strong credit ratings.

In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares, repurchase shares, issue debt or repay debt.

6. Segmental analysis

(i) Primary reporting format - business segments

The Group’s business segments are distinguished on the basis of the internal management reporting system, and reflect the day-today management of the business. The products and services included within each segment are described in the Directors’ Report - Business Review.

Group revenue from continuing operations is derived from the following activities:

	2007 £m	2006 (restated) (vii) £m
Inter-segment revenue arising in Gas production and development is derived from sales of gas produced for other Group segments. Beginning in 2007, sales of generated power from Power generation to other Group segments is transferred and reported at fair value. Prior to 2007, the sale of generated power from Centrica Energy to other Group segments was transferred and reported at cost. Inter-segment revenue arising within Centrica Storage represents the provision of storage facilities to other Group companies, on an arm’s length basis. In 2007, the Group changed its reportable segments creating a Power generation reportable segment and an Industrial and commercial reportable segment. Prior to 2007, these two segments were reported together as Industrial sales and wholesaling. The change to reported segments is detailed in note 2. Prior period comparatives have not been restated as it is impracticable to provide this information on an equivalent basis. The external revenue presented for Accord energy trading comprises both realised (settled) and unrealised (fair value changes) from trading in physical and financial energy contracts. Inter-segment revenue arising in Accord represents the recharge of brokerage fees to other Group segments. Gross segment revenue and intersegment revenue for Accord have both been increased by £18 million in 2006 to reflect the recharge of brokerage fees as inter-segment revenue to be consistent with the presentation provided in 2007. Direct Energy was disclosed as North American Energy and Related Services in the 2006 Annual Report and Accounts. This change was made to align with internal management reporting. Restated to present The Consumers’ Waterheater Income Fund as a discontinued operation as explained in note 3. Discontinued operations previously formed part of the Direct Energy segment. Direct Energy gross segment revenue inclusive of gross revenue from discontinued operations amounted to £4,034 million (2006: £4,097 million).
Sales of goods	14,621	14,840
Rendering of services	1,693	1,539
Other income	28	24
Group revenue	16,342	16,403

7. Costs of continuing operations

Analysis of costs by nature	2007 £m	2006 (restated) (i),(ii) £m
Restated to present costs incurred under the Group’s energy savings programmes in cost of sales and to reflect the deconsolidation of The Consumers’ Waterheater Income Fund. Note 2 details the change of accounting presentation and note 3 explains the deconsolidation of the Fund. Employee costs have been increased by £41 million in 2006 to reflect certain employee costs previously reported in other operating costs to align with the current year’s presentation of such costs.
Transportation, distribution and metering costs	(2,775)	(2,658)
Commodity costs	(7,740)	(8,547)
Depreciation, amortisation and write-downs	(415)	(407)
Employee costs	(415)	(366)
Other costs relating to energy consumption and provision of services	(872)	(786)
Total cost of sales	(12,217)	(12,764)
Depreciation, amortisation and write-downs	(150)	(149)
Employee costs (ii)	(901)	(967)
(Loss)/profit on disposal of property, plant and equipment and other intangible assets	(7)	17
Profit on disposal of businesses	2	3
Write-down of inventory	-	(1)
Impairment of trade receivables (note 20)	(184)	(179)
Foreign exchange gains	-	3
Other operating costs	(950)	(977)
Total operating costs before exceptional items	(2,190)	(2,250)
Exceptional items (note 8)	-	(331)
Total operating costs	(2,190)	(2,581)

Auditors’ remuneration	2007 £m	2006 £m
Includes fees in respect of review performed on the interim Financial Statements.
Fees payable to the Company’s auditor for the audit of the Company’s annual accounts and Group consolidation	2.2	2.2
Fees payable to the Company’s auditor and its other services:
The auditing of other accounts within the Group pursuant to legislation (including that of countries and territories outside the UK) (i)	1.2	1.2
Other services pursuant to legislation (i)	0.5	0.5
Other services relating to taxation	-	0.1
All other services	0.5	0.7
	4.4	4.7
Fees in respect of pension schemes:
Audit	0.1	0.1

It is the Group’s policy to seek competitive tenders for all major consultancy and advisory projects. Appointments are made taking into account factors including expertise, experience and cost. In addition, the Board has approved a detailed policy defining the types of work for which the auditors can tender and the approvals required. In the past, the auditors have been engaged on assignments additional to their statutory audit duties where their expertise and experience with the Group are particularly important, including tax advice and due diligence reporting on acquisitions.

8. Exceptional items and certain re-measurements

(a) Exceptional items (note 2)	2007 £m	2006 £m
Systems write-down costs in 2006 comprised the write-down of certain major systems developments following a review of their existing and required future functionality. The cost comprises write-downs in British Gas Residential (£178 million) and British Gas Services (£18 million). A tax credit of £59 million was recognised in respect of these costs. Business restructuring costs in 2006 comprised £67 million from staff reductions at the corporate centre (£3 million), British Gas Residential (£16 million) and British Gas Services (£48 million), and £20 million related to the closure of the head office of British Gas Residential. A tax credit of £20 million was recognised in respect of these costs. Centrica Storage operations at Rough suffered a major interruption caused by a fire in February 2006. Our investment in emergency shutdown systems and prompt management action mitigated the damage to ensure no loss of life. Following a full assessment of the work needed to restore operations, the costs of the incident resulted in an exceptional charge before taxation of £48 million (of which £24 million was recognised within Other operations). A tax credit of £14 million was recognised in respect of the charge.
Exceptional items recognised in continuing operations
Systems write-down (i)	-	(196)
Business restructuring costs (ii)	-	(87)
Rough storage incident (iii)	-	(48)
Total exceptional items recognised in continuing operations	-	(331)
Tax credit on exceptional items (i),(ii),(iii)	-	93
Total exceptional items recognised in continuing operations after taxation	-	(238)
Discontinued operations:
Profit on disposal of The Consumers’ Waterheater Income Fund (Note 35)	227	–
Total exceptional items recognised	227	(238)

(b) Certain re-measurements (note 2)	2007 £m	2006 £m
As energy is delivered or consumed from previously contracted positions, the related fair value recognised in the opening Balance Sheet (representing the difference between forward energy prices at the opening balance sheet date and the contract price of energy to be delivered) is charged or credited to the Income Statement. Represents fair value losses arising from the change in fair value of future contracted sales and purchase contracts as a result of changes in forward energy prices between reporting dates (or date of inception and the reporting date, where later). Comprises movements in fair value arising on proprietary trades in relation to cross-border transportation or storage capacity, on which economic value has been created which is not wholly accounted for under the provisions of IAS 39. Certain re-measurements included within Group operating profit also include the Group’s share of the certain re-measurements relating to the energy procurement activities of joint ventures. Certain re-measurements included within discontinued operations comprise re-measurement of the publicly traded units of The Consumers’ Waterheater Income Fund. All other re-measurements are included within results before exceptional items and certain re-measurements.
Certain re-measurements recognised in relation to energy contracts
Net gains/(losses) arising on delivery of contracts (i)	352	(287)
Net losses arising on market price movements and new contracts (ii)	(95)	(623)
Net losses arising on proprietary trades in relation to cross-border transportation or capacity contracts (iii)	(13)	(6)
Net re-measurement of energy contracts included within gross profit	244	(916)
Net losses arising on re-measurement of joint ventures’ energy contracts (iv)	(9)	(15)
Net re-measurement included within Group operating profit	235	(931)
Taxation on certain re-measurements	(60)	270
Net re-measurement after taxation	175	(661)
Discontinued operations:
Fair value (losses)/gains arising on re-measurement of the publicly traded units of
The Consumers’ Waterheater Income Fund (v)	(19)	37
Total certain re-measurements	156	(624)

9. Directors and employees

(a) Employee costs	2007 £m	2006 (restated) (i) £m
Employee costs have been increased by £41 million in 2006 to reflect certain employee costs previously reported in other operating costs to align with the current presentation of such costs.
Wages and salaries	1,074	1,079
Social security costs	88	90
Other pension and retirement benefits costs	123	141
Deferred and Matching Share Scheme	4	-
Executive Share Option Scheme	2	3
Long Term Incentive Scheme	12	9
Sharesave Scheme	8	8
Share Incentive Plan	2	2
Share Award Scheme	3	1
	1,316	1,333

Details of Directors’ remuneration, share-based payments and pension entitlements in the Remuneration Report form part of these Financial Statements. Details of employee share-based payments are given within the Valuing our people section of the Corporate Responsibility Review, the Remuneration Report and in note 33. Details of the remuneration of key management personnel are given in note 37.

(b) Average number of employees during the year	2007 Number	2006 Number
Direct Energy was disclosed as North American Energy and Related Services in the 2006 Annual Report and Accounts. This change was made to align with internal management reporting.
British Gas Residential	9,227	11,061
British Gas Business	2,008	1,717
British Gas Services	15,186	14,560
Centrica Energy	1,053	956
Centrica Storage	191	193
Direct Energy (i)	4,839	5,059
European Energy	214	198
Other operations	1,190	1,549
	33,908	35,293
UK	28,829	30,029
North America	4,839	5,059
Rest of world	240	205
	33,908	35,293

The average number of employees during the year provided above is based on headcount. In 2006, the average number of employees during the year was disclosed on a full-time equivalent basis totalling 33,933. The equivalent figure in 2007 is 32,634.

10. Net interest

	2007						2006 (restated) (i)
	Interest expense £m		Interest income £m		Total £m		Interest expense £m		Interest income £m		Total £m
Restated to present The Consumers’ Waterheater Income Fund as a discontinued operation as explained in note 3. Includes £nil (2006: £66 million) interest payable on borrowings related to a bank’s interest in Centrica Gas Production LP, a limited partnership, which was formed during 2005. The bank ceased to be a limited partner during 2006 and the arrangement with the bank was brought to an end on 11 August 2006. Includes £40 million of net interest expense incurred on termination of the Humber finance lease. The Group has reached agreement with Her Majesty’s Revenue and Customs (HMRC) on a technical matter concerning intra-group transfer pricing of gas produced within the UK Continental Shelf dating back to 2000. The terms of the settlement resulted in a net charge of £13 million, comprising finance costs of £19 million on corporation tax deemed to have been paid late net of an associated £6 million tax credit.
Continuing operations
Cost of servicing net debt
Interest income	-		83		83		-		40		40
Interest expense on bank loans and overdrafts (ii)	(92)		-		(92)		(155)		-		(155)
Interest expense on finance leases (including tolling agreements) (iii)	(87)		-		(87)		(47)		-		(47)
	(179)		83		(96)		(202)		40		(162)
Gains/(losses) on revaluation
Fair value (losses)/gains on hedges	(6)		5		(1)		(1)		3		2
Fair value (losses)/gains on other derivatives	(107)		42		(65)		(8)		25		17
Net foreign exchange translation of monetary assets and liabilities	-		58		58		(20)		-		(20)
	(113)		105		(8)		(29)		28		(1)
Other interest
Notional interest arising on discounted items	(20)		55		35		(15)		26		11
Interest on supplier early payment arrangements	-		15		15		-		11		11
Other interest (iv)	(19)		-		(19)		-		-		-
	(39)		70		31		(15)		37		22
Interest (expense)/income	(331)		258		(73)		(246)		105		(141)