AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 7, 2004
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

                April 30, 2007
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON,
Washington, D.C. 20549
                             ---------------------

                                   FORM 
Form 20-F
(Mark One)
[ ]  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
     EXCHANGE ACT OF 1934
                                       OR
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934 for the fiscal year ended December 31, 2003
                                       OR
[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 for the transition period from                to

                           
(Mark One)
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
or
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended December 31, 2006
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from           to
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Exchange Act).  Yes o     No o
Commission file number 1-16055
PEARSON PLC
               (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                                 ENGLAND AND WALES
                  (JURISDICTION OF INCORPORATION OR ORGANIZATION)

                                     
(Exact name of Registrant as specified in its charter)
England and Wales
(Jurisdiction of incorporation or organization)
80 STRAND
                              LONDON, ENGLANDStrand
London, England WC2R 0RL
                      (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

     
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:

                                                                    NAME OF EACH EXCHANGE
                       TITLE OF CLASS                                ON WHICH REGISTERED
                       --------------                               ---------------------

*Ordinary
Title of ClassName of Each Exchange on Which Registered
*Ordinary Shares, 25p par valueNew York Stock Exchange
American Depositary Shares, each Representing One Ordinary Share, 25p per Ordinary ShareNew York Stock Exchange


                             ---------------------
*   Not for trading, but only in connection with the registration of American
    Depositary Shares, pursuant to the requirements of the SEC.
                             ---------------------
     
* Not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the SEC.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
                             ---------------------
     
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
                             ---------------------
     Indicate the number of outstanding shares of each of the issuer'sissuer’s classes of capital or common stock at the close of the period covered by the annual report:
Ordinary Shares, 25p par value..............................  802,388,000
value806,108,760
     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes þ         No o
     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes o         No þ
     Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes Xþ         No ___o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer”, in Rule 12b-2 of the Exchange Act. (Check one):
þLarge accelerated fileroAccelerated fileroNon-accelerated filer
     Indicate by check mark which financial statement item the Registrant has elected to follow:
                          Item 17  X      Item 18  ___
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

Item 17þItem 18o
     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
Yes o                           No þ
TABLE OF CONTENTS

                                                              PAGE
                                                              ----

            Introduction....................................  iii
            
Page
Introduction4
Forward-Looking Statements......................  iii

                              Statements4
PART I
ITEM
Item 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND
  ADVISERS..................................................    1
ITEM
Identity of Directors, Senior Management and Advisers6
Item 2.    OFFER STATISTICS AND EXPECTED TIMETABLE..........    1
ITEM
Offer Statistics and Expected Timetable6
Item 3.    KEY INFORMATION..................................    1
            
Key Information6
Selected Consolidated Financial Data............    1
            Data6
Dividend Information............................    3
            Information8
Exchange Rate Information.......................    4
            Information9
Risk Factors....................................    4
ITEMFactors9
Item 4.    INFORMATION ON THE COMPANY.......................    6
            Pearson.........................................    6
            
Information on the Company13
Pearson13
Overview of Operating Divisions.................    6
            Divisions14
Our Strategy....................................    6
            Strategy14
Operating Divisions.............................    7
                 Divisions15
Pearson Education..........................    7
                 Education15
The FT Group...............................    8
                 Group16
The Penguin Group..........................   10
            Competition.....................................   11
            Group17
Operating Cycles18
Competition18
Intellectual Property...........................   11
            Property19
Raw Materials...................................   11
            Materials19
Government Regulation...........................   11
            Regulation19
Licenses, Patents and Contracts.................   12
            Contracts19
Recent Developments.............................   12
            Developments19
Organizational Structure........................   12
            Structure20
Property, Plant and Equipment...................   12
ITEMEquipment20
Item 4A.
Unresolved Staff Comments21
Item 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS.....   13
            
Operating and Financial Review and Prospects21
General Overview................................   14
            Overview21
Results of Operations...........................   19
            Operations27
Liquidity and Capital Resources.................   32
            Resources40
Accounting Principles...........................   34
ITEMPrinciples43
Item 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES.......   36
            
Directors, Senior Management and Employees43
Directors and Senior Management.................   36
            Management43
Compensation of Senior Management...............   38
            Management45
Share Options of Senior Management..............   43
            Management51
Share Ownership of Senior Management............   46
            Management52
Employee Share Ownership Plans..................   46
            Plans53
Board Practices.................................   47
            Employees.......................................   47
ITEMPractices53
Employees54
Item 7.    MAJOR SHAREHOLDERS AND RELATED PARTY
  TRANSACTIONS..............................................   48
ITEM
Major Shareholders and Related Party Transactions55
Item 8.    FINANCIAL INFORMATION............................   48
            
Financial Information55
Legal Proceedings...............................   48
ITEMProceedings55
Item 9.    THE OFFER AND LISTING............................   49
ITEM
The Offer and Listing56
Item 10.   ADDITIONAL INFORMATION...........................   49
ITEM
Additional Information57
Memorandum and Articles of Association57
Material Contracts61
Exchange Controls62
Tax Considerations62
Documents on Display64
Item 11.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
  MARKET RISK...............................................   57
            Introduction....................................   57
            
Quantitative and Qualitative Disclosures About Market Risk64
Introduction64
2
Page
Interest Rates..................................   58
            Rates65
Currency Exchange Rates.........................   58



                                        i


                                                              PAGE
                                                              ----
Rates
65
Forward Foreign Exchange Contracts..............   58
ITEMContracts66
Derivatives66
Item 12.   DESCRIPTION OF SECURITIES OTHER THAN EQUITY
  SECURITIES................................................   59

                          
Description of Securities Other Than Equity Securities67
PART II
ITEM
Item 13.   DEFAULTS, DIVIDEND ARREARAGES AND
  DELINQUENCIES.............................................   60
ITEM
Defaults, Dividend Arrearages and Delinquencies67
Item 14.   MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
  HOLDERS AND USE OF PROCEEDS...............................   60
ITEM
Material Modifications to the Rights of Security Holders and Use of Proceeds67
Item 15.   CONTROLS AND PROCEDURES..........................   60
ITEM
Controls and Procedures67
Disclosure Controls and Procedures67
Management’s Annual Report on Internal Control Over Financial Reporting67
Change in Internal Control Over Financial Reporting68
Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT..................   60
ITEM
Audit Committee Financial Expert68
Item 16B. CODE OF ETHICS....................................   60
ITEM
Code of Ethics68
Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES............   60
ITEM
Principal Accountant Fees and Services68
Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
  COMMITTEES................................................   61
ITEM
Exemptions from the Listing Standards for Audit Committees69
Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
  AFFILIATED PURCHASES......................................   61

                             
Purchases of Equity Securities by the Issuer and Affiliated Purchases69
PART III
ITEM
Item 17.   FINANCIAL STATEMENTS.............................   62
ITEM
Financial Statements69
Item 18.   FINANCIAL STATEMENTS.............................   62
ITEM
Financial Statements69
Item 19.   EXHIBITS.........................................   62

Exhibits69
Exhibit 8.1
Exhibit 12.1
Exhibit 12.2
Exhibit 13.1
Exhibit 13.2
Exhibit 15


                                        ii

3
INTRODUCTION
      In this Annual Report on Form 20-F (the "Annual Report"“Annual Report”) references to "Pearson"“Pearson”, the “Company” or the "Group"“Group” are references to Pearson plc, its predecessors and its consolidated subsidiaries, except as the context otherwise requires. "Ordinary
Shares"“Ordinary Shares” refer to the ordinary share capital of Pearson of par value 25p each. "ADSs"“ADSs” refer to American Depositary Shares which are Ordinary Shares deposited pursuant to the Deposit Agreement dated March 21, 1995, amended and restated as of August 8, 2000 among Pearson, The Bank of New York as depositary (the "Depositary"“Depositary”) and owners and holders of ADSs (the "Deposit Agreement"“Deposit Agreement”). ADSs are represented by American Depositary Receipts ("ADRs"(“ADRs”) delivered by the Depositary under the terms of the Deposit Agreement.
      We have prepared the financial information contained in this Annual Report in accordance with generally accepted accounting principles in the United
Kingdom, or UK GAAP,European Union (“EU”)-adopted International Financial Reporting Standards (“IFRS”), which differsdiffer in certain significant respects from generally accepted accounting principles in the United States, or US GAAP. We describe these differences in "Item“Item 5. Operating and Financial Review and Prospects --— Accounting Principles"Principles”, and in Note 34note 36 to our consolidated financial statements included in "Item“Item 17. Financial Statements"Statements” of this Annual Report. Unless we indicate otherwise, any reference in this Annual Report to our consolidated financial statements is to the consolidated financial statements and the related notes, included elsewhere in this Annual Report.
      We publish our consolidated financial statements in sterling. We have included, however, references to other currencies. In this Annual Report:

     -  references to "sterling", "pounds", "pence" or "L" are to the lawful
        currency of the United Kingdom,

     -  references to "euro" or "E" are to the euro, the lawful currency of the
        participating Member States in the Third Stage of the European Economic
        and Monetary Union of the Treaty Establishing the European Commission,
        and

     -  references to "US dollars", "dollars", "cents" or "$"
• references to “sterling”, “pounds”, “pence” or “£” are to the lawful currency of the United Kingdom,
• references to “euro” or “€” are to the euro, the lawful currency of the participating Member States in the Third Stage of the European Economic and Monetary Union of the Treaty Establishing the European Commission, and
• references to “US dollars”, “dollars”, “cents” or “$” are to the lawful currency of the United States.
      For convenience and except where we specify otherwise, we have translated some sterling figures into US dollars at the rate of L1.00£1.00 = $1.78,$1.96, the noon buying rate in The City of New York for cable transfers and foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes on December 31, 2003.29, 2006, the last business day of 2006. We do not make any representation that the amounts of sterling have been, could have been or could be converted into dollars at the rates indicated. On March 30, 2007 the noon buying rate for sterling was £1.00 = $1.97.
FORWARD-LOOKING STATEMENTS
      You should not rely unduly on forward-looking statements in this Annual Report. This Annual Report, including the sections entitled "Item“Item 3. Key Information --— Risk Factors"Factors”, "Item“Item 4. Information on the Company"Company” and "Item“Item 5. Operating and Financial Review and Prospects"Prospects”, contains forward-looking statements that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terms such as "may"“may”, "will"“will”, "should"“should”, "expect"“expect”, "intend"“intend”, "plan"“plan”, "anticipate"“anticipate”, "believe"“believe”, "estimate"“estimate”, "predict"“predict”, "potential"“potential”, "continue"“continue” or the negative of these terms or other comparable terminology. Examples of these forward-looking statements include, but are not limited to, statements regarding the following:

     -  operations and prospects,

     -  growth strategy,

     -  funding needs and financing resources,

     -  expected financial position,

     -  market risk,

     -  currency risk,

     -  US federal and state spending patterns,

                                       iii


     -  debt levels, and

     -  
• operations and prospects,
• growth strategy,
• funding needs and financing resources,
• expected financial position,
• market risk,
4
• currency risk,
• US federal and state spending patterns,
• debt levels, and
• general market and economic conditions.
      These forward-looking statements are only predictions. They involve known and unknown risks, uncertainties and other factors that may cause our or our industry'sindustry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. In evaluating them, you should consider various factors, including the risks outlined under "Item“Item 3. Key Information --— Risk Factors"Factors”, which may cause actual events or our industry'sindustry’s results to differ materially from those expressed or implied by any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

                                        iv

5
PART I
ITEM 1.     IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
      Not applicable.
ITEM 2.     OFFER STATISTICS AND EXPECTED TIMETABLE
      Not applicable.

ITEM 3.  KEY INFORMATION

SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 3.     KEY INFORMATION
Selected consolidated financial data
      The tabletables below showsshow selected consolidated financial data under IFRS and US GAAP. Under US GAAP, the consolidated financial data has been presented for each of the years in the five-year period ended December 31, 2006. The Company adopted IFRS on January 1, 2003. As a result, in accordance with the instructions of Form 20-F, selected consolidated financial data under IFRS is only presented for each of the years in the four-year period ended December 31, 2006. The selected consolidated profit and loss account data for the years ended December 31, 2003, 20022006, 2005 and 20012004 and the selected consolidated balance sheet data as at December 31, 20032006 and 2002 have been derived from our consolidated financial statements included
in "Item 17. Financial Statements" in this Annual Report, which have been
audited by PricewaterhouseCoopers LLP, independent auditors. The selected
consolidated profit and loss account data for the years ended December 31, 2000
and 1999, and the selected consolidated balance sheet data as at December 31,
2001, 2000 and 19992005 have been derived from our audited consolidated financial statements for those periods and as of those dates, which are not included in “Item 17. Financial Statements” in this Annual Report.
      Our consolidated financial statements have been prepared in accordance with UK GAAP,IFRS, which differs from US GAAP in certain significant respects. See "Item“Item 5. Operating and Financial Review and Prospects --— Accounting Principles"Principles” and Note 34note 36 to ourthe consolidated financial statements. The consolidated financial statements contain a reconciliation to US GAAP of profit/lossprofit for the financial
year, shareholders'shareholders’ funds and certain other financial data.
      The selected consolidated financial information should be read in conjunction with "Item“Item 5. Operating and Financial Review and Prospects"Prospects” and our consolidated financial statements and the related notes appearing elsewhere in this Annual Report. The information provided below is not necessarily indicative of the results that may be expected from future operations.

                                        1

      For convenience, we have translated the 20032006 amounts into US dollars at the rate of L1.00£1.00 = $1.78,$1.96, the noon buying rate in The City of New York on December 31, 2003.

29, 2006.
6
                     
  Year ended December 31
   
  2006 2006 2005 2004 2003
           
    IFRS IFRS IFRS IFRS
  IFRS £ £ £ £
  $
  (In millions, except for per share amounts)
IFRS information:
                    
Consolidated Income Statement data
                    
Total sales  8,109   4,137   3,808   3,479   3,651 
Total operating profit  1,058   540   516   382   401 
Profit after taxation from continuing operations  892   455   330   248   249 
Profit for the financial year  919   469   644   284   275 
Basic earnings per equity share(4)  $1.10   55.9p  78.2p  32.9p  31.7p
Diluted earnings per equity share(5)  $1.09   55.8p  78.1p  32.9p  31.7p
Dividends per ordinary share  $0.57   29.3p  27.0p  25.4p  24.2p
Consolidated Balance Sheet data at period end
                    
Total assets (Fixed assets plus Current assets)  14,137   7,213   7,600   6,578   6,736 
Shareholders funds  6,813   3,476   3,564   2,800   2,969 
Long-term obligations(6)  (3,632)  (1,853)  (2,500)  (2,403)  (1,982)
Capital stock(1)  396   202   201   201   201 
Number of equity shares outstanding
(millions of ordinary shares)		  806   806   804   803   802 
                          
  Year ended December 31
   
  2006 2006 2005 2004 2003 2002
             
    £ £ £ £ £
  $  
  (I n millions, except for per share amounts)
US GAAP information(7):
                        
Consolidated Income Statement data
                        
Total sales(8)  8,292   4,231   3,892   3,562   3,774   3,896 
Total operating profit(2)  902   460   364   269   361   408 
Profit after taxation from continuing operations  823   420   182   170   197   185 
Net income for the year  668   341   411   182   173   189 
Profit from continuing operations for the year(3)  780   398   164   153   159   187 
(Loss)/profit from discontinued operations(3)  (112)  (57)  8   29   17   24 
Profit/(loss) on disposal of discontinued operations(3)  —   —   239   —   (3)  (1)
Basic earnings per equity share(4) $0.84   42.7p  51.5p  22.8p  21.8p  23.7p
Diluted earnings per equity share(5) $0.83   42.6p  51.4p  22.8p  21.8p  23.7p
Basic earnings from continuing operations per equity                        
 Share(1)(4) $0.98   49.9p  20.5p  19.2p  20.0p  23.5p
Diluted earnings from continuing operations per equity Shares(3)(5) $0.97   49.8p  20.5p  19.2p  20.0p  23.5p
Basic (loss)/earnings per share from discontinued operations(3)(4) $(0.14)  (7.2)p  31.0p  3.6p  1.8p  2.9p
Diluted (loss)/earnings per share from discontinued operations(3)(5) $(0.14)  (7.2)p  30.9p  3.6p  1.8p  2.9p
Dividends per ordinary share $0.57   29.3p  27.0p  25.4p  24.2p  22.7p
7
                         
  Year ended December 31
   
  2006 2006 2005 2004 2003 2002
             
    £ £ £ £ £
  $  
  (I n millions, except for per share amounts)
Consolidated Balance Sheet data at period end
                        
Total assets  14,351   7,322   7,800   7,040   7,101   6,767 
Shareholders’ funds  7,019   3,581   3,838   3,218   3,333   4,155 
Long-term obligations(6)  (3,622)  (1,848)  (2,397)  (2,392)  (1,951)  (2,026)

                                                         YEAR ENDED DECEMBER 31
                                         -------------------------------------------------------
                                          2003     2003      2002       2001      2000     1999
                                         ------    -----    -------    -------    -----    -----
                                           $         L         L          L         L        L
                                               (IN MILLIONS, EXCEPT FOR PER SHARE AMOUNTS)

UK GAAP INFORMATION:
CONSOLIDATED PROFIT AND LOSS ACCOUNT
  DATA
STATUTORY MEASURES
Total sales............................   7,205    4,048      4,320      4,225    3,874    3,332
Total sales from continuing
  operations(1)........................   7,205    4,048      4,320      4,225    3,689    2,977
Profit/(loss) after taxation...........     137       77        (89)      (403)     173      341
Profit/(loss) for
(1) Capital stock and the financial year...      98       55       (111)      (423)     174      335
Total operating profit/(loss)..........     402      226        143        (47)     209      330
Basic earnings/(loss) per equity
  share(2).............................   12.3C     6.9P      (13.9)p    (53.2)p  23.9p    49.0p
Diluted earnings/(loss) per equity
  share(3).............................   12.3C     6.9P      (13.9)p    (53.2)p  23.4p    48.3p
CONSOLIDATED BALANCE SHEET DATA
Total assets (Fixed assets plus Current
  assets)..............................  11,383    6,395      6,852      8,241    8,990    5,529
Net assets.............................   5,602    3,147      3,530      3,973    4,398    1,527
Long-term obligations(4)...............   2,401    1,349      1,737      2,616    2,715    2,286
Capital stock..........................     358      201        200        200      199      153
Numbernumber of equity shares outstanding (millions of ordinary shares)........     802      802        802        801      798      613


                                                         YEAR ENDED DECEMBER 31
                                        ---------------------------------------------------------
                                         2003      2003      2002       2001       2000     1999
                                        ------    ------    ------    --------    ------    -----
                                          $         L         L          L          L         L
                                               (IN MILLIONS, EXCEPT FOR PER SHARE AMOUNTS)
are the same under both IFRS and US GAAP.
(2) Total operating profit under US GAAP INFORMATION(5):
Profit/(loss)includes a loss of £2m in 2006 (2005: £nil; 2004: profit of £14m) on the sale of fixed assets and investments. Additionally, the US GAAP operating profit includes the operating profit impact of the GAAP adjustments discussed in note 36 in “Item 17. Financial Statements”.
(3) Discontinued operations under both IFRS and US GAAP comprise the results of Pearson Government Solutions for all years presented, Recoletos Grupo de Comunicacion SA for 2005, 2004, 2003 and 2002 and the results of RTL Group for 2002. Discontinued operations under US GAAP also include the results of the Forum Corporation for 2003 and 2002.
(4) Basic earnings per equity share is based on profit/loss for the financial year(6).............................     326       183       198      (1,500)    1,362      198
Profit/(loss) from continuing
  operationsperiod and the weighted average number of ordinary shares in issue during the period.
(5) Diluted earnings per equity share is based on diluted earnings for the financial period and the diluted weighted average number of ordinary shares in issue during the period. Diluted earnings comprise earnings adjusted for the tax benefit on the conversion of share options by employees and the weighted average number of ordinary shares adjusted for the dilutive effect of share options.
(6) Long-term obligations comprise any liabilities with a maturity of more than one year, (1).................................     331       186       257        (475)      (30)     177
(Loss)/profit from discontinued
  operations(1).......................      --        --       (37)        (40)    1,403       21
Lossincluding medium and long-term borrowings, derivative financial instruments, pension obligations and deferred income tax liabilities.
(7) See note 36 to the consolidated financial statements included in this Annual Report entitled “Summary of principal differences between International Financial Reporting Standards and United States of America generally accepted accounting principles”.
(8) Commencing in 2006, the Company has included within Sales, shipping and handling fees and costs, distribution income and subrights income, which were previously reflected on disposal of discontinued
  operations(1).......................      (5)       (3)       (1)       (985)       --       --
Basic earnings/(loss) per equity
  share...............................   40.9C     23.0P     24.9p      (188.6)p  187.2p    28.9p
Diluted earnings/(loss) per equity
  share(3)............................   40.9C     23.0P     24.9p      (188.6)p  185.0p    28.7p
Basic earnings/(loss) from continuing
  operations per equity share(1)......   41.7C     23.4P     32.3p       (59.7)p    (4.1)p  25.8p
Diluted earnings/(loss) from
  continuing operations per equity
  shares(1)(3)........................   41.7C     23.4P     32.3p       (59.7)p    (4.1)p  25.6p
Basic (loss)/earnings per share from
  discontinued operations(1)..........    (0.7)C    (0.4)P    (4.8)p    (128.9)p  192.8p     3.1p
Diluted (loss)/earnings per share from
  discontinued operations(1)..........    (0.7)C    (0.4)P    (4.8)p    (128.9)p  190.6p     3.1p
Total assets..........................  11,358     6,381     6,767       8,280    10,066    6,104
Shareholders' funds...................   5,967     3,352     3,708       4,155     6,018    2,615
a net basis within operating expenses. Sales figures for all prior years presented have been revised for comparative purposes (2006: £94m; 2005: £84m; 2004: £83m; 2003: £94m; and 2002: £109m).


- ---------------

(1)  Discontinued operations under UK GAAP comprise the results of the RTL
Dividend information
      The Group for 2002, 2001 and 2000. Before the formation in July 2000 of the RTL
     Group, in which Pearson had an equity interest, Pearson's television
     operations were wholly owned subsidiaries. Discontinued operations under US
     GAAP comprise the results of the Forum Corporation for 2003 and both the
     Forum Corporation and the RTL Group for 2002, 2001 and 2000.

                                        2


(2)  Basic earnings/loss per equity share is based on profit/loss for the
     financial period and the weighted average number of ordinary shares in
     issue during the period.

(3)  Diluted earnings/loss per equity share is based on diluted earnings/loss
     for the financial period and the diluted weighted average number of
     ordinary shares in issue during the period. Diluted earnings/loss comprise
     earnings/loss adjusted for the tax benefit on the conversion of share
     options by employees and the weighted average number of ordinary shares
     adjusted for the dilutive effect of share options. Under UK GAAP in 2002
     and 2001 the Group made a retained loss for the financial year,
     consequently the effect of share options is anti-dilutive and there is no
     difference between the basic loss per share and the diluted loss per share.

(4)  Long-term obligations are comprised of medium and long-term borrowings plus
     amounts falling due after more than one year related to obligations under
     finance leases.

(5)  See Note 34 to the consolidated financial statements included in this
     Annual Report entitled "Summary of principal differences between United
     Kingdom and United States of America generally accepted accounting
     principles".

(6)  The loss of L1,500 million in 2001, profit of L1,362 million in 2000 and
     profit of L198 million in 1999 are after charging goodwill amortization of
     L527 million, L288 million and L171 million respectively. Since 2002,
     goodwill has no longer been subject to amortization under US GAAP. See Note
     34 in "Item 17. Financial Statements." The 2002 profit also incorporates a
     post-tax charge of L21 million in respect of the cumulative effect of a
     change in accounting principle. See Note 34 in "Item 17. Financial
     Statements."

DIVIDEND INFORMATION

     We paypays dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. OurThe board of directors normally declares an interim dividend in July or August of each year to be paid in OctoberSeptember or November. OurOctober. The board of directors normally recommends a final dividend following the end of the fiscal year to which it relates, to be paid in the following May or June, subject to shareholders'shareholders’ approval at our annual general meeting. At ourthe annual general meeting on April 30, 200427, 2007 our shareholders approved a final dividend of 14.8p18.8p per ordinary share for the year ended December 31, 2003.2006.
8
      The table below sets forth the amounts of interim, final and total dividends paid in respect of each fiscal year indicated, and is translated into cents per ordinary share at the noon buying rate in The Citythe city of New York on each of the respective payment dates for interim and final dividends. The final dividend for the 20032006 fiscal year will be paid inon May 2004.



FISCAL YEAR                                    INTERIM     FINAL     TOTAL     INTERIM     FINAL     TOTAL
- -----------                                    --------    ------    ------    --------    ------    ------
                                                (PENCE PER ORDINARY SHARE)      (CENTS PER ORDINARY SHARE)

2003.........................................    9.4        14.8      24.2       16.7       26.4      43.1
2002.........................................    9.1        14.3      23.4       14.7       23.0      37.7
2001.........................................    8.7        13.6      22.3       12.6       19.7      32.3
2000.........................................    8.2        13.2      21.4       13.3       18.7      32.0
1999.........................................    7.7        12.4      20.1       12.6       18.7      31.3

11, 2007.
                         
Fiscal year Interim Final Total Interim Final Total
             
  (Pence per ordinary share) (Cents per ordinary share)
2006
  10.5   18.8   29.3   20.6   36.8   57.4 
2005  10.0   17.0   27.0   17.2   29.2   46.4 
2004  9.7   15.7   25.4   18.6   30.2   48.8 
2003  9.4   14.8   24.2   16.7   26.4   43.1 
2002  9.1   14.3   23.4   14.7   23.0   37.7 
      Future dividends will be dependent on our future earnings, financial condition and cash flow, as well as other factors affecting us.

                                        3


EXCHANGE RATE INFORMATIONthe Group.
Exchange rate information
      The following table sets forth, for the periods indicated, information concerning the noon buying rate for sterling, expressed in dollars per pound sterling. The average rate is calculated by using the average of the noon buying rates in The Citythe city of New York on each day during a monthly period and on the last day of each month during an annual period. On December 31, 2003,29, 2006, the noon buying rate for sterling was L1.00£1.00 = $1.78.



MONTH                                                         HIGH      LOW
- -----                                                         -----    -----

April 2004..................................................  $1.86    $1.77
March 2004..................................................  $1.87    $1.79
February 2004...............................................  $1.90    $1.82
January 2004................................................  $1.85    $1.79
December 2003...............................................  $1.78    $1.72
November 2003...............................................  $1.72    $1.67


YEAR ENDED DECEMBER 31                                          AVERAGE RATE
- ----------------------                                          ------------

2003........................................................       $1.63
2002........................................................       $1.51
2001........................................................       $1.45
2000........................................................       $1.52
1999........................................................       $1.62



RISK FACTORS

     $1.96. On March 30, 2007 the noon buying rate for sterling was £1.00 = $1.97.
         
Month High Low
     
March 2007 $1.97  $1.92 
February 2007 $1.97  $1.94 
January 2007 $1.98  $1.93 
December 2006 $1.98  $1.95 
November 2006 $1.97  $1.89 
October 2006 $1.91  $1.85 
     
Year ended December 31 Average rate
   
2006 $1.84 
2005 $1.81 
2004 $1.83 
2003 $1.63 
2002 $1.51 
Risk factors
You should carefully consider the risk factors described below, as well as the other information included in this Annual Report. Our business, financial condition or results from operations could be materially adversely affected by any or all of these risks, or by other risks that we presently cannot identify.

OUR RELIANCE ON INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS THAT MAY NOT BE
ADEQUATELY PROTECTED UNDER CURRENT LAWS IN SOME JURISDICTIONS MAY ADVERSELY
AFFECT OUR RESULTS AND OUR ABILITY TO GROW.
Our intellectual property and proprietary rights may not be adequately protected under current laws in some jurisdictions and that may adversely affect our results and our ability to grow.
      Our products are largely comprised ofcomprise intellectual property delivered through a variety of media, including newspapers, books and the internet. We rely on trademark, copyright and other intellectual property laws to establish and protect our proprietary rights in these products. However, we
      We cannot assure
yoube sure that our proprietary rights will not be challenged, invalidated or circumvented. Our intellectual property rights in jurisdictionscountries such as the United StatesUS and the United Kingdom, which are theUK, jurisdictions withcovering the largest proportionsproportion of
9
our operations, are well established. However, we also conduct business in other countries where the extent of effective legal protection for intellectual property rights is uncertain, and this uncertainty could affect our future growth. Moreover, despite trademark and copyright protection, third parties may be able to copy, infringe or otherwise profit from our proprietary rights without our authorization.
      These unauthorized activities may be more easily facilitated by the internet. The lack of internet-specific legislation relating to trademark and copyright protection creates an additional challenge for us in protecting our proprietary rights relating to our online business processes and other digital technology rights. WE OPERATE INThe loss or diminution in value of these proprietary rights or our intellectual property could have a material adverse effect on our business and financial performance. In that regard, Penguin Group (USA) Inc. and Pearson Education have joined three other major US publishers in a suit brought under the auspices of the Association of American Publishers to challenge Google’s plans to copy the full text of all books ever published without permission from the publishers or authors. This lawsuit seeks to demarcate the extent to which search engines, other internet operators and libraries may rely on the fair-use doctrine to copy content without authorization from the copyright proprietors, and may give publishers and authors more control over online users of their intellectual property. If the lawsuit is unsuccessful, publishers and authors may be unable to control copying of their content for purposes of online searching, which could have an adverse impact on our business and financial performance.
Our US educational textbook and testing businesses may be adversely affected by changes in state educational funding resulting from either general economic conditions, changes in government educational funding, programs and legislation (both at the federal and state level), and/or changes in the state procurement process.
      The results and growth of our US educational textbook and testing business is dependent on the level of US and state educational funding, which in turn is dependent on the robustness of state finances and the level of funding allocated to educational programs. Federal and/or state legislative changes can also affect the funding available for educational expenditure, e.g. the No Child Left Behind Act.
      Similarly changes in the state procurement process for textbooks, learning material and student tests, particularly in the adoptions market can also affect our markets. For example, changes in curricula, delays in the timing of the adoptions and changes in the student testing process can all affect these programs and therefore the size of our market in any given year.
      There are multiple competing demands for educational funds and there is no guarantee that states will fund new textbooks or testing programs, or that we will win this business.
Our newspaper businesses may be adversely affected by reductions in advertising revenues and/or circulation either because of competing news information distribution channels, particularly online and digital formats, or due to weak general economic conditions.
      Changes in consumer purchasing habits, as readers look to alternative sources and/or providers of information, such as the internet and other digital formats, may change the way we distribute our content. We might see a decline in print circulation in our more mature markets as readership habits change and readers migrate online, although we see further opportunities for growth in our less mature markets outside Europe. If the migration of readers to new digital formats occurs more quickly than we expect, this is likely to affect print advertising spend by our customers, adversely affecting our profitability.
      Our newspaper businesses are highly geared and remain dependent on advertising revenue; relatively small changes in revenue, positive or negative, have a disproportionate effect on profitability. We are beginning to see an increase in advertising revenues compared to prior years, however any downturn in corporate and financial advertising spend would negatively impact our results.
10
A control breakdown in our school testing businesses could result in financial loss and reputational damage.
      There are inherent risks associated with our school testing businesses, both in the USA and the UK. A HIGHLY COMPETITIVE ENVIRONMENT THAT IS SUBJECT TO RAPID CHANGE
AND WE MUST CONTINUE TO INVEST AND ADAPT TO REMAIN COMPETITIVE.breakdown in our testing and assessment products and processes could lead to a mis-grading of student tests and/or late delivery of test results to students and their schools. In either event we may be subject to legal claims, penalty charges under our contracts, non-renewal of contracts and/or in the case of our UK testing business, the suspension or withdrawal of our accreditation to conduct tests. It is also possible that such events would result in adverse publicity, which may affect our ability to retain existing contracts and/or obtain new customers.
Our professional services and school testing businesses involve complex contractual relationships with both government agencies and commercial customers for the provision of various testing services. Our financial results, growth prospects and/or reputation may be adversely affected if these contracts and relationships are not managed.
      These businesses are characterized by multi-million pound contracts spread over several years. As in any contracting business, there are inherent risks associated with the bidding process, start-up, operational performance and contract compliance (including penalty clauses) which could adversely affect our financial performance and/or reputation.
      Several of these businesses are dependent on either single or a small number of large contracts. Failure to retain these contracts at the end of the contract term would adversely impact our future revenue growth. At Edexcel, our UK Examination board and testing business, any change in UK Government policy to exam marking and student testing could have a significant impact on our present business model.
We operate in a highly competitive environment that is subject to rapid change and we must continue to invest and adapt to remain competitive.
      Our education, business information and book publishing businesses operate in highly competitive markets. These markets continue toconstantly change in response to competition, technological innovations and other factors. In recent years, some ofTo remain competitive we continue to invest in our authors, products, services and people. There is no guarantee that these investments will generate the markets in which we operate have experienced significant consolidation. Further
consolidation could placeanticipated returns or protect us from being placed at a competitive disadvantage with respect to scale, resources and our ability to develop and exploit new media technologies.

                                        4


WE MAY NOT BE ABLE TO ACHIEVE CONTINUED GROWTH IN OUR OPERATIONS OR STRENGTHEN
OUR FINANCIAL POSITION DUE TO ECONOMIC AND POLITICAL FORCES BEYOND OUR CONTROL.

     Politicalopportunities.
      Specific competitive threats we face at present include:
• Students seeking cheaper sources of content, e.g. on-line, used books or re-imported textbooks.
• Competition from major publishers and other educational material and service providers in our US educational textbook and testing businesses.
• Penguin — Authors’ advances in consumer publishing. We compete with other publishing businesses to purchase the rights to author manuscripts. Our competitors may bid to a level at which we could not generate a sufficient return on our investment, and so, typically, we would not purchase these rights.
• People — the investments we make in our employees, combined with our employment policies and practices, we believe are critical factors enabling us to recruit and retain the very best people in our business sectors. However, some of our markets are presently undergoing radical restructuring with several of our competitors up for sale, particularly in the Education sector. New owners, particularly private equity, may try to recruit our key talent as part of this industry restructuring.
At Penguin, changes in product distribution channels, increased book returns and/or customer bankruptcy may restrict our ability to grow and affect our profitability.
      New distribution channels, e.g. digital format, the internet, used books, combined with the concentration of retailer power pose multiple threats (and opportunities) to our traditional consumer publishing models, potentially impacting both sales volumes and economic factors beyond our controlpricing.
11
      Penguin’s financial performance can inhibitalso be negatively affected if book return rates increase above historical average levels. Similarly, the growthbankruptcy of our operations or weaken our financial position. These factors include a significant weakening ofmajor retail customer would disrupt short-term product supply to the global advertising environment, particularly in
financial advertising, US state and federal government spending patterns for
educational materials, the US economy and heightened political tensions
affecting the United Kingdom and the United States, foreign currency exchange
rate risks, trade protection measures, tax and regulatory or other economic
conditions. In particular, during 2003, the ongoing weak advertising environment
caused by a general decline in corporate earnings and an uncertain economic
environment resultedmarket as well as result in a continuing decline in advertising revenue. For
additional information about this decline, please see "Operating and Financial
Review and Prospects -- Results of Operations -- Year ended December 31, 2003
compared to year ended December 31, 2002", pages 19 - 25.

     The deterioration in the fiscal position of many US states, due to the
recent weak economic environment, has resulted in expenditure reductions as the
US states attempt to eliminate projected fiscal deficits for 2004 and beyond.
There is a risk that any further expenditure cuts in education will lead to
either delayed adoptions or lower expenditure on our textbooks or testing
services. While we believe our education businesses will benefit from various US
federal education programs including the "No Child Left Behind" initiative,
reduced expenditures by US states for educational materials could adversely
affect the financial performance of Pearson Education.

WE OPERATE IN MARKETS WHICH ARE DEPENDENT ON INFORMATION TECHNOLOGY SYSTEMS AND
TECHNOLOGICAL CHANGE.large debt write off.
We operate in markets which are dependent on Information Technology systems and technological change.
      All our businesses, to a greater or lesser extent, are dependent on technologytechnology. We either as a provider ofprovide software and/or internet services to our customers or as a user ofwe use complex information technology systems and products to support our business activities, particularly in business information publishing, back-office processing and infrastructure.
      We face several technological risks associated with software product development and service delivery in our educational businesses, Information Technologyinformation technology security (including virus and hacker attacks), e-commerce, Enterprise Resource Planningenterprise resource planning system implementations and upgradesupgrades. The failure to recruit and retain staff with relevant skills may constrain our ability to grow as we combine traditional publishing products with online and service offerings.
Operational disruption to our business caused by a major disaster and/or external threat such as Avian Flu, restricting our ability to supply products and services to our customers.
      Across all our businesses we manage complex operational and logistical arrangements including distribution centers, third-party print sites, data centers and large office facilities. Failure to recover from a major disaster, e.g. fire, flood etc, at a key facility or the disruption of supply from a key third-party vendor could restrict our ability to service our customers. Similarly external threats, such as Avian Flu, terrorist attacks, strikes etc, could all affect our business and employees, disrupting our daily business activities.
      We have developed business continuity arrangements, including IT disaster recovery plans, to minimize any business disruption in the event of a major disaster. However, despite regular updates and testing of these plans there is no guarantee that our financial performance will not be adversely affected in the event of a major disaster and/or external threat to our business. Insurance coverage may minimize any losses in a key data center.

WE OPERATE IN SEVERAL MARKETS WITH RISKS WHICH ARE INHERENTLY GREATER THAN OUR
PUBLISHING AND NEWSPAPER BUSINESS AND WHICH, IF UNMANAGED, COULD ADVERSELY
AFFECT OUR FINANCIAL RESULTS AND POTENTIALLY DAMAGE OUR REPUTATION.

     Withcertain circumstances.
Investment returns outside our traditional core US and UK markets may be lower than anticipated.
      To minimize dependence on our core markets, particularly the previous acquisition and continuedUS, we are seeking growth of Pearson NCS andopportunities outside these markets, building on our acquisition of London Qualifications in 2003,existing substantial international presence. Certain markets we have moved into new markets and
products, some of whichmay target for growth are inherently riskiermore risky than our traditional publishingmarkets. Political, economic, currency and newspaper businesses. Where larger contractscorporate governance risks (including fraud) as well as unmanaged expansion are involved, thisall factors which could limit our returns on investments made in these non-traditional markets.
Our reported earnings and cash flows may be adversely affected by changes in our pension costs and funding requirements.
      We operate a number of pension plans throughout the world, the principal ones being in the UK and US. The major plans are self-administered with the plans’ assets held independently of the Group. Regular valuations, conducted by independent qualified actuaries, are used to determine pension costs and funding requirements.
      It is our policy to ensure that each pension plan is adequately funded, over time, to meet its ongoing and future liabilities. Our earnings and cash flows may resultbe adversely affected by the need to provide additional funding to eliminate pension fund deficits in our defined benefit plans. Our greatest exposure relates to our UK defined benefit pension plan. Pension fund deficits have/may arise because of inadequate investment returns, increased member life expectancy, changes in actuarial assumptions and changes in pension regulations, including accounting rules and minimum funding requirements.
      The latest valuation of our UK defined benefit pension plan has been completed and future funding arrangements have been agreed between the Company and the pension fund Trustee. Additional payments
12
amounting to £100m will be made by the Company in 2007. We review these arrangements every three years and are confident that the pension funding plans are sufficient to meet future liabilities without unduly affecting the development of the Company.
Social, environmental and ethical risk profile becoming more concentrated on certain key contracts.

     Within Pearson NCS, Pearson Government Solutions provides outsourcing
services
      We consider social, environmental and ethical (SEE) risks no differently to the US government andway we manage any other third parties. Services range from call
center operations to complete administrative functions. Contract values vary
significantly, from a few million tobusiness risk. Our 2006 risk assessments did not identify any significant under-managed SEE risks, nor have any of our most important SEE risks, many concerned with reputational risk, changed year on year. These are:
• Journalistic/author integrity;
• Ethical business behavior;
• Compliance with UN Global Compact principles on labor standards, human rights, environment and anti-corruption;
• Environmental impact;
• People;
• Data privacy.
Changes in our tax position can significantly affect our reported earnings and cash flows.
      There are several hundred million pounds sterling
over the termfactors which may affect our reported tax rate and/or level of the contract, which typically run for three to five years in
length. As in any long-term contracting business, there are inherent risks
associated with the bidding process, operational performance, contract
compliance (including penalty clauses), indemnification (if available) and
contract re-bidding. Substantially all US Government contracts are subject to
audit after completion by the contracting government entity, and audits can
result in delays in payment and, in certain circumstances, reductionstax payments in the payment received by a supplier.

     An inherent risk in our schools testing and assessment business is a
student grading failure due to control breakdown in our testing and assessment
products and processes.

                                        5


WE GENERATE A SUBSTANTIAL PROPORTION OF OUR REVENUE IN FOREIGN CURRENCIES,
PARTICULARLY THE US DOLLAR, AND FOREIGN EXCHANGE RATE FLUCTUATIONS COULD
ADVERSELY AFFECT OUR EARNINGS.

     future. The most important are as follows:
• Changes in corporate tax rates and/or other relevant tax laws in the UK and/or the US could have a material impact on our future reported tax rate and/or our future tax payments.
• A material shortfall in profits of our US businesses below the level projected in our strategic plans would require us to reconsider the amount of the deferred tax asset relating to US new operating losses in our balance sheet (£126m at December 31, 2006). This could lead to a material increase in the reported tax rate.
We generate a substantial proportion of our revenue in foreign currencies, particularly the US dollars (65% in
2003). Our earnings could be materiallydollar, and adversely affected by foreign exchange rate fluctuations could adversely affect our earnings and the strength of our balance sheet.
      As with any international business, our earnings can be materially affected by exchange rate movements. We are particularly if the value ofexposed to movements in the US dollar continues
to decline compared to sterling.sterling exchange rate as approximately 65% of our revenue is generated in US dollars. We estimate that if 2005 average rates had prevailed in 2006, sales for 2006 would have been £44m or 1% higher. This is predominantly a currency translation risk (i.e. non-cash flow item), and not a trading risk (i.e. cash flow item), as our currency trading flows are relatively limited. Pearson generates about two-thirds of its sales in the US and each five cent change in the average £:$ exchange rate for the full year (which in 2006 was £1:$1.84 and in 2005 was £1:$1.81) would have an impact of 1p on earnings per share. We estimate that a five cent change in the averageclosing exchange rate between the US dollar and sterling duringin any year could affect our earnings per shareshareholders’ funds by approximately 1 pence.

£85m.
ITEM 4.     INFORMATION ON THE COMPANY

PEARSON
Pearson
      Pearson is a global publishing company with its principal operations in the education, business information and consumer publishing markets. We have significant operations in the United States, where we generate over 65% of our revenues, and in the United Kingdom and continental Europe. We create and manage intellectual property, which we promote and sell to our customers under well-known brand names, to inform, educate and entertain. We deliver our content in a variety of forms and through a variety of channels,
13
including books, newspapers and internet services. We increasingly offer services as well as content, from test processing to training.
      Pearson was incorporated and registered in 1897 under the laws of England and Wales as a limited company and re-registered under the UK Companies Act as a public limited company in 1981. We conduct our operations primarily through our subsidiaries and other affiliates. Our principal executive offices are located at 80 Strand, London WC2R 0RL, United Kingdom (telephone: +44 (0) 20 7010 2000).

OVERVIEW OF OPERATING DIVISIONS
Overview of operating divisions
      Although our businesses increasingly share markets, brands, processes and facilities, they break down intoconsist of three core operations:

     PEARSON EDUCATION 
Pearson Educationis a global leader in educational publishing and
services.the world’s leading education company. We are a leading international publisher of textbooks, supplementary materials and electronic education programs for elementaryteachers and secondary school,
higher educationstudents of all ages, and business and professional markets worldwide. We alsowe play a major role in the testing and certification of school students and professionals, mainly in the US but increasingly in the UK.

     THE FT GROUPprofessionals. Pearson Education consists of ourthe following three operating segments:
• School — publisher, provider of testing and software services for primary and secondary schools;
• Higher Education — publisher of textbooks and related course materials for colleges and universities;
• Professional — publisher of texts, reference and interactive products for industry professionals. Provider of various testing and service arrangements for government departments and professional bodies.
The FT Groupis a leading provider of international newspaper,business and financial news, data, comment and analysis, in print and online
financial information, business magazine and professional publishing interests.
Our flagship product isonline. The FT Group comprises the Financial Times, known internationally for its
premium editorial content and international scope both in newspaper and internet
formats.

     THE PENGUIN GROUP following operating segments:
• FT Publishing — publisher of theFinancial Times, other business newspapers, magazines and financial information and intelligence;
• Interactive Data (“IDC”) — provider of financial and business information to financial institutions and retail investors.
The Penguin Groupis one of the premierworld’s foremost English language publishers in the
world, with brand imprints such as Penguin, Putnam, Berkley, Viking and Dorling
Kindersley ("DK").publishers. We publish the works of many authors in an extensive portfolio of fiction, non-fiction, reference and illustrated works. We publishworks under imprints including Penguin, Hamish Hamilton, Putnam, Berkley, Viking and Dorling Kindersley.
Our strategy
      Over the works of many authors, including
Maeve Binchy, Tom Clancy, Patricia Cornwell, Nick Hornby, Jamie Oliver, Nora
Roberts and Amy Tan.

OUR STRATEGY

     Since 1998past decade we have reshapedtransformed Pearson by divesting a range of non-core
interests and investing over $7 billion in education, consumer publishing and
business information companies. Today our portfolio transformation is largely
complete and each one of our businesses aims to benefit from educating,
informing and entertaining people in an increasingly knowledge-based economy.
Our strategy is:

     -  to focusfocusing on businessescompanies which provide "education"‘education’ in the broadest sense of the word.

     -  to provideword; companies that educate, inform and entertain. Through a combination of publishing, both in printorganic investment and online, and
        related services that make our publishing more valuable and take us into
        new, faster-growing markets.

                                        6


     -  to continue to invest in the growthacquisitions, we have built each one of our businesses including:

       -  extendinginto a leader in its market, and we have integrated our lead in education publishing, investing in new programs
          for students in Schooloperations where appropriate so that our businesses can share assets, brands, processes, facilities, technology and Higher Educationcentral services.
      Our goal is to produce sustainable growth on our three key financial measures — adjusted earnings per share, cash flow and in testing and
          software servicesreturn on invested capital — which we believe are, together, good indicators that help educators to personalise the learning
          process, both in the US and around the world;

       -  developing our fast-growing contracting businesses, which provide
          testing and other services to corporations and government agencies;

       -we are building the international reachlong-term value of Pearson.
      We do this by investing consistently in four areas, which are common to all our businesses:
• Content: We invest steadily in unique, valuable publishing content and keep replenishing it. Over the past five years, for example, we have invested $1.6bn in new content in our education business alone.
• Technology and services: We invested early and consistently in technology, believing that, in the digital world, content alone would not be enough. In 2006, we generated more than $1bn in sales from technology products and services, and our testing and assessment businesses, serving school students and professionals, made more than $1bn of sales, up from around $200m seven years ago.
14
• International markets: Though we currently generate two-thirds of our sales in the US, our brands, content and technology-plus-services models work around the world. All parts of Pearson are investing in selected emerging markets, where the demand for information and education is growing particularly fast.
• Efficiency: We have invested to become a leaner, more efficient company, through savings in our individual businesses and through a strong centralized operations structure. Over the past five years, we have increased our profit margins from 9.9% to 13.4% and reduced average working capital as a percentage of sales in Pearson Education and Penguin from 30.7% to 26.3%, freeing up cash for further investment.
      We believe this strategy can create a virtuous circle — efficiency, investment, market share gains and scale — which in turn can produce sustainable growth on our financial goals and the value of the Financial Times -- both in
          print through its four editions worldwide and online through FT.com --
          and enhancing the market positions of our network of national business
          newspapers around the world; and

       -  growing our position in consumer publishing, balancing our investment
          across our stable of best-selling authors, new talent and our own
          home-grown content.

     -  to foster a collaborative culture which facilitates greater productivity
        and innovation by sharing processes, costs, technology, talent and
        assets across our business.

     -  to capitalize on the growth prospects in our markets and on our leaner
        operations to improve profits, cash flows and returns on invested
        capital.

OPERATING DIVISIONS

PEARSON EDUCATIONCompany.
Operating divisions
Pearson Education
      Pearson Education is one of the world'sworld’s largest publishers of textbooks and paper and online teaching materials based on published sales figures and
independent estimates of sales. Pearson Educationmaterials. It serves the growing demands of teachers, students, parents and professionals throughout the world for stimulating and effective education programs. With federalprograms in print and state governments
under pressure to measure academic progress against clear objective standards,
the market for educational testing services in the United States has grown
significantly. Pearson Assessments & Testing enables us to combine testing and
assessment with our traditional educational curriculum services and products to
form one of the world's leading integrated education companies. Pearson
Assessments & Testing provides the entire spectrum of educational services --
from educational curriculum to testing and assessment to data management.online.
      We report Pearson Education'sEducation’s performance along the lines ofby the three marketsmarket segments it serves: School, Higher Education and Professional. In 2003,2006, Pearson Education had sales of L2,451 million£2,591m or 61%63% of Pearson'sPearson’s total sales (64% in
2002).

School

     In the United States, our(2005: 62%) and contributed 68% (2005: 63%) to Pearson’s total operating profit.
School
      Our School business includescontains a unique mix of publishing, testing and software operations.technology products, which are increasingly integrated. It generates around two-thirds of its sales in the US.
      In the US, we publish high quality curriculum programs for school students covering subjects such as reading, literature, maths, science and social studies. We publish under a range of well-known imprints that include Scott Foresman in the elementary school market and Prentice Hall in secondary. Our school testing business is the leading provider of test development, processing and scoring services to US states and the federal government, processing some 40 million tests each year. We are also the leading provider of electronic learning programs for schools, and of ‘Student Information Systems’ technology which enables schools and districts to record and manage information about student attendance and performance.
      In the US, more than 90% of government funds for schools comes from state or local government, with the remainder coming from federal sources. Our School company’s major customers are state education boards and local school districts.
      Outside of the United States,US, we have a growing English
Language Teaching business and we also publish school materials in local languages in a number of countries. InWe are the world’s leading provider of English Language Teaching materials for children and adults, published under the well-known Longman imprint. We are also a leading provider of testing, assessment and qualification services. Our key markets outside the US we publish for kindergarten
through 12th grade, with a comprehensive range of textbooks, supplementary
materials and electronic education programs. Pearson Education's premier
elementary school imprint, Pearson Scott Foresman, and premier secondary school
imprint, Pearson Prentice Hall, publish high quality programs covering subjects
such as reading, literature, math, science and social studies. We also publish
supplementary teaching aids for both elementary and secondary schools and
teacher-written activity books. We are a leading publisher in online assessment
and digital courseware through Pearson Education Technologiesinclude Canada, the UK, Australia, Italy, Spain, South Africa, Hong Kong and the Waterford
Early Reading Program. Through LessonLab, we provide professional development
for teachers in kindergarten through 12th grade with the use of the latest
technologies and software tools to improve classroom teaching.

     Pearson's Assessments & Testing operations make us a leading player in the
markets for test processing and scoring and the provision of enterprise software
solutions to schools. We score and process some 40 million student tests across
the United States every year.

                                        7


     With over 90% of education spending for kindergarten through 12th grade in
the United States financed at the state or local level, the School division's
major customers are state education boards and local school districts. In the
United States, 20 states, which account for over 50% of the total kindergarten
through 12th grade US school population of some 53 million students, buy
educational programs by means of periodic statewide "adoptions". These adoptions
cover programs in the core subject areas. Typically, a state committee selects a
short-list of education programs from which the school districts then make
individual choices. We actively seek to keep as many of our offerings as
possible on the approved list in each state, and we market directly to the
school districts. In the 30 states without adoptions, or "open territories",
local school districts choose education programs from the extensive range
available. We actively market to school districts in open territories as well.
At present our open territory state revenues exceed those from adoption states,
although we anticipate a more even split in 2005 due to the stronger adoption
calendar.

Middle East.
Higher Education
      Pearson Education is the United States'States’ largest publisher, by sales, of textbooks and related course materials for colleges and universities based on sales.universities. We publish across all of the main fields of study with imprints such as Pearson Prentice Hall, Pearson Addison Wesley, Pearson Allyn & Bacon and Pearson Benjamin Cummings. Our sales force markets primarily to collegeTypically, professors who
chooseor other instructors select or ‘adopt’ the texts to be purchasedtextbooks and online resources they recommend for their students, which students then purchase either in a bookstore or online. Today the majority of our textbooks are accompanied by their students. Over 1,330 of Pearson
Education's college textbooks have an interactive companion website with online services which include homework and assessment tools, study guides to reinforce text concepts, chat rooms and bulletin boards to
facilitate interaction between students and faculty. An increasing number of our
programs incorporate online course management systems that provide a powerful
set of easy-to-use tools that allowenable professors to create sophisticated web-basedonline courses. We have also introduced new
15
formats such as downloadable audio study guides and electronic textbooks which are sold on subscription. In addition, ourwe have a fast-growing custom publishing business which works with professors to produce textbooks and online resources specifically adapted for their particular course. In 2006, our Higher Education business generated approximately 80% of its sales in the US. Outside the US, we adapt our textbooks and technology services for individual markets, and we have a growing local publishing program. Our key markets outside the US include Canada, the UK, Benelux, Mexico, Germany, Hong Kong, Taiwan and Malaysia.
Professional
      Our Professional Weeducation businesses publish text, reference,educational materials and interactive productsprovide testing and qualifications services for IT industry
professionals, graphics and design users of all types, and consumers interested
in software applications and certification, professional business books, and
strategy guides for those who use PC and console games. Publishingadults. Our publishing imprints in
this area include Addison Wesley Professional, Prentice Hall PTR, and Cisco Press (our three high end imprints)(for IT professionals), Peachpit Press and New Riders Press (our
graphics(graphics and design imprints)professionals), Que/Sams (consumer and professional imprint), and Prentice Hall Financial Times (professional(for the business imprint) and BradyGames
(software game guides imprint)education market). We also generate revenues through our own
website -- InformIt. We also provide services to professional markets. We manage
significant commercialhave a fast-growing Professional Testing business, Pearson VUE, which manages major long-term contracts to implement and executeprovide qualification and assessment systems for individual professions, including IT professionalsservices through its network of test centers around the world. Key customers include major technology companies, the Graduate Management Admissions Council, the National Association of Securities Dealers and nurses.

     Our Government Solutions group manages and processes student loan
applications on behalf of the US Department of Education and has a number of
education, testing-related contracts with various government departments.UK’s Driving Standards Agency. We also provide a range of data collection and management services, including the
sale of scanners, to a wide range of customers. We also provide corporate
training courses to professionals.

     In 2003, our professional testing business entered into two significant
contracts. In November 2003, we were awarded a seven-year contract with the
Driving Standards Agency (DSA) of Great Britain and the Driver Vehicle Testing
Agency (DVTA) of Northern Ireland. Pearson Assessments & Testing will administer
and process the results of the driving theory section of the driving licence
examination, beginning in September 2004. Candidates will take the computerized
theory test at more than 150 examination centers throughout England, Scotland,
Wales and Northern Ireland. In December 2003, we were selected as the prime
contractor for a seven-year contract to develop and administer the Graduate
Management Admission Test (GMAT) worldwide. Commencing in January 2006, the GMAT
will be availableGroup announced that it had agreed to sell Pearson Government Solutions to Veritas Capital, a private equity firm. This operation is disclosed as discontinued in the years ended December 31, 2006, 2005 and 2004. The assets and liabilities of Pearson Government Solutions have been reclassified to non-current assets held for sale in the Group’s Consolidated Balance Sheet as at more than 400 Pearson test centers in 96 countries.

THE FT GROUPDecember 31, 2006.
The FT Group
      The FT Group one of the world's leading business information companies,
aims to provideprovides a broad range of business information,data, analysis and services to an audience of internationally-minded business people.people and financial institutions. In 2003,2006, the FT Group had sales of L757 million,£698m, or 19%17% of Pearson'sPearson’s total sales (17% in 2002)(2005: 17%), and contributed 21% of Pearson’s operating profit (2005: 25%). The
      It has two major parts: FT Group'sPublishing, our network of international and national business is

                                        8


global, producing a combination of news, data, comment, analysisnewspapers and context. In
addition to professionalonline services; and business consumers, individuals worldwide are
demanding such strategic business information. We believe that the FT Group is
well positioned to supplyInteractive Data Corporation, our 62%-owned financial information and benefit from these trends.company.
FT Publishing
      TheFinancial Times Newspaper

     The Financial Times is athe world’s leading international daily business newspaper. Its average daily circulation of 447,552430,469 copies in December 2003,2006, as reported by the Audit Bureau of Circulation, gives the Financial Times the second largest
circulation of any English language business daily in the world. The Financial
Times derivedis split as follows:
United Kingdom/ Republic of Ireland31%
Continental Europe27%
Americas31%
Asia9%
Rest of the World2%
      In 2006, approximately 65% of its revenue in 2003 from advertising and
approximately 35% from circulation. The geographic distribution70% of the Financial
Times average daily circulation in 2003 was:


United Kingdom/Republic of Ireland..........................     31%
Continental Europe, Africa and Middle East..................     32%
Americas....................................................     30%
Asia........................................................      7%



     The Financial Times is printed on contract in 21 cities around the world
and our sales mix is becoming increasingly international. The newspaper draws
upon an extensive network of international correspondents to produce unique,
informative and timely business information. For production and distribution,
the Financial Times uses computer-driven communications and printing technology
for timely delivery of the various editions of the newspaper to the appropriate
geographic markets. The Financial Times is distributedFT’s revenues were generated through independent
newsagents and direct delivery to homes and institutions.advertising. The FT seeks to make itsalso sells content available both in print and advertising online through FT.com, its internet service, and sales of electronic content to third
parties.FT.com. FT.com charges subscribers to accessfor detailed industry news, comment and analysis, whilstwhile providing general news and market data to a wider audience.
The business earns revenues by selling content directly, selling advertising and
through its subscription program. At the end of January 2004, FT.com had 74,000
paying subscribers. According to figures independently audited by ABCE, the site
has 3.5 million unique monthly users and 58.8 million page views.

Financial Times
      FT Publishing Our other business publishing interests include France's leading business
newspaper, Les Echos with circulation of 116,400 and lesechos.fr, its internet
service.also includes: FT Business, produceswhich publishes specialist information on the retail, personal and institutional finance industries and publishes the UK's premier personal finance
magazine, through titles includingInvestors Chronicle together with ,Money Management,Financial Advisor
AdviserandThe Banker for professional advisers and financial sector professionals.

Recoletos

     We own a 79% stake in Recoletos, a publicly quoted Spanish media group that
we built with its Spanish founding shareholders over several years. Recoletos'
publishing businesses in Spain, Portugal and Latin America include Marca, a
leading sports newspaper for the region with an average daily circulation of
391,000 in 2003, Expansion, Spain's; Les Echos, France’s leading business newspaper, and website,
Actualidad Economica, a weeklynumber of joint ventures and associates in business magazine,publishing.
16
      In August 2006, the Financial Times acquired Mergermarket, an online financial data and Telva,intelligence provider. The acquisition strengthens the FT Group, adding proprietary content, a monthly women's
magazine. Recoletos is also developing its internet activities as it seekspremium customer base, reliable growth from new revenue sources and attractive financial characteristics to extend the reach of its print-based products.organization.
Interactive Data Corporation
      Interactive Data Corporation Through our 61% interest in Interactive Data Corporation ("Interactive
Data"), we are one of the world'sis a leading global providersprovider of financial market data, analytics and business informationrelated services to financial institutions, active traders and retailindividual investors. Interactive
Data suppliesThe company’s businesses supply time-sensitive pricing, dividend, corporate action,evaluations and descriptive informationreference data for more than 3.5 million securities traded around the world, including hard-to-value instruments. Customers subscribe to Interactive
Data's services and use the company's analytical tools in supportinstruments such as illiquid bonds. We own 62% of their
trading, analysis, portfolio

                                        9


management, and valuation activities. In February 2003, Interactive Data acquired S&P ComStock, Inc. ("ComStock") from The McGraw-Hill Companies, Inc.,
allowing usCorporation; the remaining 38% is publicly traded.
Recoletos
      On April 8, 2005, the Group completed the sale to provide real-time information regarding securities traded aroundRetos Catera S.A. of our 79% stake in Recoletos, a publicly quoted Spanish media Group, for gross proceeds of€743m. Net cash proceeds of £371m were received resulting in a profit on disposal of £306m.
Joint Ventures and Associates
      As at 2006 year-end, the world to our institutional clients.

Joint Ventures and Associates

     The FT Group also hashad a number of other associates and joint ventures, including:

     A 50% interest in FT Deutschland, launched in February 2000, in partnership
with Gruner + Jahr, is our German language newspaper with a fully integrated
online business news, analysis and data service. Its circulation grew by 9% in
2003 to 92,000 copies.

     A 50% interest in The Economist Group, which publishes the world's leading
weekly business and current affairs magazine.

     A 50% interest in FTSE International, a joint venture with the London Stock
Exchange, which, among other things, publishes the FTSE index.

     A 32% interest in MarketWatch.com, Inc., a publicly traded financial media
company. In early 2004, our shareholding was reduced to 23% following
MarketWatch's issuance of shares to acquire Pinnacor Inc.

     A 33% interest in Vedomosti, a leading Russian business newspaper and a
partnership venture with Dow Jones and Independent Media.

     A 50% interest in Business Day and Financial Mail, publishers of South
Africa's leading financial newspaper and magazine.

THE PENGUIN GROUP
• 50% interest in The Economist Group, publisher of the world’s leading weekly business and current affairs magazine.
• 50% interest inFT Deutschland, a German language business newspaper with a fully integrated online business news, analysis and data service.
• 50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the important FTSE index.
• 33% interest inVedomosti, a leading Russian business newspaper.
• 50% interest inBusiness DayandFinancial Mail, publishers of South Africa’s leading financial newspaper and magazine.
• 14% interest inBusiness Standard, one of India’s leading business newspapers.
The Penguin Group
      Penguin is one of the world’s premier English language publishers in the world.book publishers. We publish an extensive backlist and frontlist of titles, including some of the
very best new fiction and non-fiction, literary prize winners, commercial bestsellers, classics and commercial
blockbusters. Our titles range from history and science to essential reference.
We are also one of the pre-eminent classics publishers and publish some of the
most highly prized and enduring brands in children's publishing, featuring
popular characters such as Spot, Peter Rabbit and Madeline, as well as the books
of Roald Dahl.children’s titles. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets --— the United States,US, the United Kingdom,UK, Australia, New Zealand, Canada, India and South Africa.
      Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley Books, Dorling Kindersley, Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Our leading children'schildren’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2003, Penguin's US
imprints placed 110 titles on The New York Times bestseller list. In the United
Kingdom, 60 Penguin titles featured on the Nielsen Bookscan top fifteen
bestseller list. Our illustrated reference business, Dorling Kindersley, or DK,
is the leading global publisher of high quality illustrated reference books. DK
has built a unique graphic style that is now recognized around the world. It
produces books for children and adults covering a huge variety of subjects
including childcare, health, gardening, food and wine, travel, business and
sports. Not only does DK's "lexigraphic" design approach make its books easily
translatable across cultures, but it has also formed the basis of a library of
2.5 million wholly-owned images which have many applications -- in print or
online.

     In 2003,2006, Penguin had sales of L840 million£848m, representing 21%20% of Pearson'sPearson’s total sales (19%(2005: 21%) and contributed 11% of Pearson’s operating profit (2005: 12%). Its largest market is the US, which generated around 60% of Penguin’s sales in 2002). Revenues are balanced between frontlist and backlist
titles, reducing Penguin's exposure to volatility in either market.2006. The Penguin Group earns over 90%around 99% of its revenues from the sale of hard cover and paperback books. The balance comes from audio books and from the sale and licensing of intellectual property rights, such as the Beatrix Potter series of fictional characters, and acting as a book distributor for a number of smaller publishing houses.

                                        10

      We sell directly to bookshops and through wholesalers. Retail bookshops normally maintain relationships with both publishers and wholesalers and use the channel that best serves the specific requirements of an order. We also sell online through third parties such as Amazon.com.
17
Operating cycles
      Pearson determines a normal operating cycle separately for each entity/cash generating unit within the Group with distinct economic characteristics. The Penguin Group's gateway internet site, Penguin.com, provides access“normal operating cycle” for each of the Group’s education businesses is primarily based on the expected period over which the educational programs and titles will generate cash flows, and also takes account of the time it takes to its focused websitesproduce the educational programs.
      Particularly for the US School and Higher Education businesses, which represent more than 50% (by sales) of our education publishing businesses, there are well established cycles operating in the United States, Canada, United Kingdommarket:
• The School market is primarily driven by an adoption cycle in which major state education boards ‘adopt’ programs and provide funding to schools for the purchase of these programs. There is an established and published adoption cycle with new adoptions taking place on average every 5 years for a particular subject. Once adopted, a program will typically sell over the course of the subsequent 5 years. The Company renews its pre-publication assets to meet the market adoption cycles. Therefore the operating cycle naturally follows the market cycle.
• The Higher Education market has a similar pattern, with colleges and professors typically refreshing their courses and selecting revised programs on a regular basis, often in line with the release of new editions or new technology offerings. The Company renews its pre-publication assets to meet the typical demand for new editions of, or revisions to, educational programs. Analysis of historical data shows that the average life cycle of Higher Education content is 5 years. Again the operating cycle mirrors the market cycle.
      A development phase of typically 12 to 18 months for Higher Education and Australia.
Websites have also been developedup to target certain niche audiences. For
example, Penguinclassics.com has an entire online service24 months for School precedes the period during which the Company receives and delivers against orders for the classics,products it has developed for the program.Non-US markets operate in a similar way although often with anthologies, original essays, interviewsless formal ‘adoption’ processes.
      The operating cycles in respect of the Professional and discussionsPenguin segments are more specialized in nature as they relate to educational or heavy reference products released into smaller markets (e.g. the financial training, IT and links to other
classics sites.

     During 2004, we intend to launch three new imprintstravel sectors). Nevertheless, in these markets, there is still a regular cycle of product renewal, in line with demand which management monitor. Typically the United States,life cycle is 5 years for Professional content and 4 years for Penguin Press and Sentinel and a new teenage imprint, Razorbill. 2004 will also
see us trial a US direct to consumer sales channel, expected to launch in the
final quarter.

     Penguin TV was incorporated into the Penguin Group during 2003, created
from the former Pearson Broadband Television Group. Penguin TV will specialize
in two areas: factual, non-fiction documentary programming and children's
programming.

COMPETITIONcontent.
Competition
      All of Pearson'sPearson’s businesses operate in highly competitive environments.
      Pearson Education competes with other publishers and creators of educational materials and services. These companies include some small niche
players and some large international companies, such asMcGraw-Hill, Reed Elsevier, Houghton Mifflin Riverdeep Group and Thomson.Thomson alongside smaller niche players that specialize in a particular academic discipline or focus on a learning technology. Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the school boards, educators and government officials making purchasing decisions.
      The FT Group'sGroup’s newspapers, magazines and magazineswebsites compete with newspapers and other information sources, such asThe Wall Street Journal, by offering timely and expert journalism.analysis and insight. It competes for advertisers with other forms of media based on the ability to offer an effective means for advertisers to reach their target audience. The efficiencyIDC competes with Reuters, Bloomberg and Thomson Financial on a global basis for the provision of its cost basefinancial data to the back office. In Europe Telekurs is also a competitive factor.direct competitor for these services.
      The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and HarperCollins.Hachette Livre. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers. Our scale is also a source of
competitive strength.

INTELLECTUAL PROPERTY
18
Intellectual property
      Our principal intellectual property assets consist of our trademarks and other rights in our brand names, particularly theFinancial Timesand the various imprints of Penguin and Pearson Education, as well as all copyrights in our content and our patents held in the testing business in the name of Pearson NCS. We believe we have taken all appropriate available legal steps to protect our intellectual property in all relevant jurisdictions.

RAW MATERIALS
Raw materials
      Paper is the principal raw material used by each of Pearson Education, the FT Group and the Penguin Group. We purchase most of our paper through our central purchasing department located in the United States. We have not experienced and do not anticipate difficulty in obtaining adequate supplies of paper for theirour operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, we have not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, we have a number of alternatives to minimize the impact on our operating margins, including modifying the grades of paper used in production.

GOVERNMENT REGULATION
Government regulation
      The manufacture of certain of our products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Our operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countries in which we conduct these operations
                                        11
 maintain controls on the repatriation of earnings and capital and restrict the means available to us for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material to us. Accordingly, these controls have not significantly affected our international operations. Regulatory authorities may have enforcement powers that could have an impact on us. We believe, however, that we have taken and continue to take measures to comply with all applicable laws and governmental regulations in the jurisdictions where we operate so that the risk of these sanctions does not represent a material threat to us.

LICENSES, PATENTS AND CONTRACTS
Licenses, patents and contracts
      We are not dependent upon any particular licenses, patents or new manufacturing processes that are material to our business or profitability. Likewise, we are not materially dependent upon any contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature.

RECENT DEVELOPMENTS

     In
Recent developments
      On February 2003, Interactive Data15, 2007 the Group completed the disposal of Pearson Government Solutions, its acquisitionGovernment services business, to Veritas Capital. Sale proceeds consist of ComStock
from$560m in cash, $40m in preferred stock and 10% of the equity of the business. The McGraw-Hill CompaniesGroup expects to report a post tax loss on the disposal, as the capital gain for $116 million in cash. ComStock focuses ontax purposes will exceed any book gain.
      On September 30, 2006, the Group acquired 100% of the voting rights of Mergermarket, a financial information company providing real-time information to institutional customers by providing coverage
for over 1.8 million securitiesfinancial institutions, corporations and their advisers. In addition, several other businesses were acquired in virtually all asset classes traded worldwide.

     In May 2003, we announced an agreement with Edexcel to modernize
examination marking2006 including Promissor, Paravia Bruno Mondadori (PBM), National Evaluation Systems (NES), PowerSchool and processingChancery in the UK. London Qualifications was formed
to take responsibility for all Edexcel's coursesEducation business and Higher Education
qualifications including GCSEs, GCE AQuote.com in IDC.
      On July 22, 2005, Pearson acquired 100% of the voting rights of AGS Publishing, an educational assessments and AS levels, GNVQs, NVQs and BTEC Higher
national certificates and diplomas. We own 75% of London Qualifications with the
Edexcel Foundation owning the remaining 25%.curriculum materials publisher.
      In December 2003, we filed an application with the Indian government
seeking approval for a 13.7% investment in Business Standard, a leading Indian
business newspaper. Approval is still pending but is expected to be receivedaddition, several other businesses were acquired in the first halfcurrent and prior years, none of 2004.

ORGANIZATIONAL STRUCTUREwhich were individually material to the Group.
19
Organizational structure
      Pearson plc is a holding company which conducts its business primarily through subsidiaries and other affiliates throughout the world. Below is a list of our significant subsidiaries as at December 31, 2006, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.

                                                                                             PERCENTAGE
NAME                                           COUNTRY OF INCORPORATION/ RESIDENCE     INTEREST/ VOTING POWER
- ----                                           -----------------------------------     ----------------------

PEARSON EDUCATION

Percentage
interest/voting
NameCountry of incorporation/residencepower
Pearson Education
Pearson Education Inc. ......................  IncUnited States (Delaware)100%
Pearson Education Ltd. ......................  LtdEngland and Wales100%
NCS Pearson Inc. ............................  IncUnited States (Minnesota)100%
FT GROUP
Group
The Financial Times Limited..................  LimitedEngland and Wales100%
Financial Times Business Ltd. ...............  LtdEngland and Wales100%
Mergermarket LtdEngland and Wales100%
Interactive Data Corporation.................  CorporationUnited States (Delaware)                          61%
Recoletos Grupo de Comunicacion SA...........  Spain                                             79%
62%
Les Echos SA.................................  SAFrance100%
THE PENGUIN GROUP

The Penguin Group
Penguin Group (USA) Inc. ....................  IncUnited States (Delaware)100%
The Penguin Publishing Co Ltd. ..............  LtdEngland and Wales100%
Dorling Kindersley Holdings Ltd. ............  LtdEngland and Wales100%


PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment
      Our headquarters isare located at leasehold premises in London, England. We own or lease approximately 280650 properties in 24more than 50 countries worldwide, the majority of which are located in the United Kingdom and the United States.

                                        12

      All of the properties owned and leased by us are suitable for their respective purposes and are in good operating condition. These properties consist mainly of offices, distribution centers and computer centers.
      The vast majority of our printing is carried out by third party suppliers. We operate two small digital print operations as part of our Pearson Assessment and Testing businesses. These operations provide short-run and print-on-demand products, typically custom client applications.
We own the following principal properties:

GENERAL USE OF PROPERTY                        LOCATION                                 AREA IN SQUARE FEET
- -----------------------                        --------                                 -------------------

Warehouse....................................  
General use of propertyLocationArea in square feet
WarehousePittstown, Pennsylvania, USA510,000
Warehouse....................................  LaPorte, Indianapolis, USA(1)                  437,000
Warehouse....................................  
WarehouseKirkwood, New York, USA409,000
Offices......................................  
OfficesIowa City, Iowa, USA310,000
Offices......................................  
OfficesOld Tappan, New Jersey, USA                    211,900
210,112
Warehouse/office.............................   OfficesCedar Rapids, Iowa, USA205,000
Offices......................................  
Warehouse/ OfficesReading, Massachusetts, USA(1)                 158,527
Offices......................................  USA177,822
OfficesLondon, UK                                     152,986
155,000
Printing/Processing..........................   ProcessingOwatonna, Minnesota, USA128,000
Printing/Processing..........................   ProcessingColumbia, Pennsylvania, USA                    121,400
Offices......................................  121,370
OfficesEagan, Minnesota, USA109,500
Offices......................................  
OfficesMesa, Arizona, USA96,000


- ---------------

(1)  Held for sale.
20
      We lease the following principal properties:

GENERAL USE OF PROPERTY                        LOCATION                                 AREA IN SQUARE FEET
- -----------------------                        --------                                 -------------------

General use of propertyLocationArea in square feet
Warehouses/Offices...........................  OfficesLebanon, Indiana, USA                         1,091,400
Warehouse/Offices............................  1,091,435
OfficesCranbury, New Jersey, USA                       886,700
Warehouse....................................  886,747
Warehouse/OfficesIndianapolis, Indiana, USA737,850
Warehouse/Offices............................  Rugby, UK                                       476,000
Offices......................................  OfficesNewmarket, Ontario, Canada518,128
OfficesUpper Saddle River, New Jersey, USA474,801
Offices......................................  
Warehouse/OfficesRugby, UK446,077
OfficesHudson St., New York, USA                       302,000
Offices......................................  431,278
OfficesLondon, UK                                      273,000
282,917
Warehouse/Offices............................  OfficesAustin, Texas, USA                              226,100
Warehouse....................................  226,076
OfficesBoston, Massachusetts, USA225,299
WarehouseScoresby, Victoria, Australia                   215,280
Offices......................................  215,820
OfficesBoston, Massachusetts, USA191,360
OfficesGlenview, Illinois, USA187,500
OfficesBloomington, Minnesota, USA                     151,056
Offices......................................  153,240
OfficesParsippany, New Jersey, USA                     143,800
Offices......................................  Avenue of the Americas,143,777
OfficesHarlow, UK137,900
OfficesChester, Virginia, USA123,200
Warehouse/OfficesQuarry Bay, Hong Kong121,748
WarehouseSan Antonio Zomeyucan, Mexico113,638
OfficesLondon, UK112,000
OfficesNew York, New York, USA           101,000
Offices......................................  Harlow, UK                                       98,000
Offices......................................  Bedford, Massachusetts,107,939
OfficesLawrence Kansas, Kansas, USA                      80,348
Offices......................................  Madrid, Spain                                    72,839
Offices......................................  Camberwell, Victoria, Australia                  52,656
105,000
Capital Expenditures
      See Item 5. “Operating and Financial Review and Prospects — Liquidity and Capital Resources” for description of the Company’s capital expenditures.
ITEM 4A.     UNRESOLVED STAFF COMMENTS
      There are no unresolved staff comments.
ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS
      The following discussion and analysis is based on and should be read in conjunction with the consolidated financial statements, including the related notes, appearing elsewhere in this Annual Report. The financial statements have been prepared in accordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP. Note 3436 to our consolidated financial statements, included in "Item“Item 17. Financial Statements"Statements”, provides a description of the significant differences between UK GAAPIFRS and US GAAP as they relate to our business and provides a reconciliation to US GAAP.

                                        13


GENERAL OVERVIEW

INTRODUCTION
General overview
Introduction
      Sales declined from L4,320 millioncontinuing operations increased from £3,808m in 20022005 to L4,048 million£4,137m in 2003, a
decrease2006, an increase of 6%9%. IncreasedThe increase reflected growth across all the businesses together with additional contributions from acquisitions made in both 2005 and 2006. The year on year growth was impacted by exchange rates, in particular the US dollar. The average US dollar exchange rate weakened in 2006, which had the effect of reducing reported sales
21
in 2006 by £44m when compared to the book businesses could not offset the
absenceequivalent figure at constant 2005 rates. Reported operating profit increased by 5% from £516m in 2005 to £540m in 2006. All parts of the one-off Transportation Security Administration, or TSA, contractGroup contributed to recruit 64,000 security personnel for US airports,the operating profit increase through good sales growth and improved margins which contributed over
L250 million to sales in 2002. This contract was awarded in March 2002 and was
substantially completed by the end of 2002. Sales were also adversely affected
by adverse trading conditions for the advertising and technology-related
businesses. The impact of the sales decline wasmore than offset by cost reductions and,
together with a reducedan increased charge for goodwill amortization, this resulted in a 58%
increase inintangible amortization. Included within operating profit from L143 million in 20022005 was the profit on the sale of MarketWatch of £40m. There were no equivalent disposals in 2006. Reported operating profit in 2006 was £7m lower than the equivalent figure reported at constant 2005 exchange rates.
      Profit before taxation in 2006 of £466m compares to L226 million in 2003.

     A L152 milliona profit before taxation of £446m in 2003 compares to a loss before
taxation of L25 million in 2002.2005. The increase of L177 million£20m reflects the improved operating profit performance of L83 million,offset by a reduction in losses on
sale of businesses and investments of L43 million and a fallsmall increase in net finance costs. Net finance costs of L51 million.increased from £70m in 2005 to £74m in 2006. The improved operating profit was mainly drivenGroup’s net interest payable increased by the
reduced charge for goodwill amortization and the absence of any goodwill
impairments£17m in 2003. The goodwill amortization charge fell by L66 million in
2003 mainly2006 due to Family Education Networkthe strong rise in US dollar floating interest rates and our investment in
Marketwatch.com, where the final amortization charges were incurredan increase in the first
halfGroup’s average net debt largely reflecting the cost of 2003. Losses onacquisitions made in 2006. Partially offsetting this effect was finance income relating to post retirement plans of £4m in 2006 compared to a cost of £7m in 2005. The adoption of IAS 39‘Financial Instruments: Recognition and Measurement’in our financial statements as at January 1, 2005 has the potential to introduce increased volatility into the net finance cost although the effect in 2006 was not significantly different from that in 2005. IAS 39 related items and foreign exchange gains and losses together reduced net finance costs by £16m in 2006 compared to a reduction of £14m in 2005.
      In December 2006 the Group announced the sale of businesses and investmentsits Government contracting business, Pearson Government Solutions. The sale was completed in 2002,
principally on the sale of the Forum business, were not repeated in 2003 and
finance costs benefited from the reduction in average net debt and a general
fall in interest rates. Net finance costs also fell in 2003 compared to 2002 as
the previous year charge included L37 million for cancellation of certain swap
contractsFebruary 2007 and the early repaymentresults of debt followingthis business have been shown in discontinued operations in the re-balancingconsolidated income statement for 2006, 2005 and 2004. In 2005 the Group sold its 79% interest in Recoletos Grupo de Comunicacion S.A. The results of Recoletos have been consolidated for the Group's debt portfolio onperiod to February 28, 2005 and have been shown as discontinued operations in the receipt of proceeds from the RTL disposal at the
start of that year.consolidated income statement for 2005 and 2004.
      Net cash inflowgenerated from operating activities declineddecreased to £456m in 2006 from L529 million£487m in 2002 to L359 million2005. Cash generation in 2003. Two significant factors adversely affected2006 would have shown an otherwise improved performance. Penguin's publishing schedule was particularly
concentrated inimprovement on 2005 but for the fourth quarter, pushing collections into 2004, and the TSA
has not yet paid $151 million relating to 2002 sales. We are discussing the
post-contract audit and payment with the TSA. We expect this process to be
completed in 2004, and that we will receive payment of this outstanding amount,
although the timingrelative weakness of the receipt remains uncertain. Capital expenditure was
held below depreciationUS dollar which reduced the value of our cash flows in 2003 and, onsterling. On an average basis, excluding the effect of
the TSA contract, the use of working capital improved slightlycontinued to improve. Capital expenditure in 2006 was in line with 2005 levels at constant exchange rates. The net cash outflow in respect of businesses acquired increased from 2002. Cash
spend on interest£246m in 2005 to £363m in 2006. There were no significant disposals in 2006 to match the proceeds received from the sale of Recoletos and tax reducedMarketwatch in 2005 resulting in a decrease in cash proceeds from disposals of £420m. Dividends from joint ventures and associates increased by L76 million£31m largely due to special dividends received from 2002. Cash outflow on
acquisitions net of disposal proceeds was L11 million and, after dividendsthe Economist. Dividends paid of L188 million and£235m in 2006 (including £15m paid to minority interests) compares to £222m in 2005. After a favorable currency movement of L117 million,£126m, overall net borrowings (excluding finance leases) fell 3%increased by 6% from L1,408 million£996m at the end of 20022005 to L1,361 million£1,059m at the end of 2003.

OUTLOOK

     In 2004, we2006.
Outlook
      Pearson reported record results in 2006 and our strong trading has continued in the early part of 2007. We have made a good start in the major school textbook adoptions; continued to roll out our groundbreaking online learning and assessment platforms in Higher Education; published a string of bestsellers in Penguin; and achieved steady growth in both advertising and circulation at FT Publishing.
      We are trading in line with expectations for 2007 and expect to makeachieve good underlying earnings growth, cash conversion ahead of our 80% threshold, and a further progressincrease in improving our earnings per
share, cash flow and return on invested capital at constant 2003 exchange rates.
At this stagecapital. As always, our sales and profits will be concentrated in the outlooksecond half of the year.
      Our expectations for our major businesses is as follows:

Pearson Education

     Revenues at Pearson Education'sthe full year remain:
Pearson Education
      School business are expected to be broadly
in line with 2003, asachieve underlying sales growth in testing and digital learning offset lower sales
in US school publishing. School business publishingthe4-6% range with margins are expected to
decline by 1 to 2 percentage points but progress is expected elsewhere in the
School business. We are continuing to invest in our programs in key subjects and
in 2005, based on the current state adoption schedule, we expect revenues at our
School business to grow significantly with a margin recovery. Full
implementation of No Child Left Behind from 2005 and improving state budgets in
the US should benefit our testing and digital learning business.

     In 2004, we expect our USimproving; Higher Education sales to grow in the 4%3-5% range with stable margins; Professional revenues to 6%be broadly level with margins improving;
22
FT Group
      Financial Times Group profit to grow strongly with our cost measures, integration actions and revenue diversification pushing margins into double digits at FT Publishing. IDC revenues to grow in the6-9% range gaining share with a strong publishing schedule, our online services and
custom publishing. We expect our Professional businesses to show sales and
profitnet income growth in 2004, eventhe high single-digits to low double-digits (headline growth under US GAAP);
The Penguin Group
      Penguin margins to improve further, as we invest in our new professional testing
centers.

                                        14


FT Group

     Advertising trends at our business newspapers have shown improvement in the
first few months of 2004 with the rate of decline slowing. Forward bookings are
running a little ahead of the comparative period in 2003 at all our business
newspapers. Although the outlook for our business newspapers remains uncertain,
we expect the cost actions we have taken to reduce the losses at the Financial
Times in 2004 even without an advertising recovery. Recoletos has reported a
pick-up in advertising revenues in April, following the impact of the Madrid
bombings in March, and announced the launch of a network of Spanish-language
newspapers in the United States. We expect Interactive Data to deliver another
strong performance.

The Penguin Group

     Penguin faces tough sales and profit comparisons after another record year
in 2003, but we expect to grow faster than the consumer publishing market with
another strong publishing schedule. In 2004, Penguin will increase investment in its publishing investment and in initiativesefficiency programs continue to reach new readers. We expect Penguin to
deliver a good cash performance, even though its publishing schedule will again
be concentrated in the fourth quarter.

SALES INFORMATION BY OPERATING DIVISIONbear fruit.
Sales information by operating division
      The following table shows sales information for each of the past three years by operating division:
              
  Year ended December 31
   
  2006 2005 2004
       
  £m £m £m
Education:            
 School  1,455   1,295   1,087 
 Higher Education  795   779   729 
 Professional  341   301   290 
FT Group:            
 FT Publishing  366   332   318 
 IDC  332   297   269 
Penguin  848   804   786 
          
Total  4,137   3,808   3,479 
          

                                                              YEAR ENDED DECEMBER 31
                                                              -----------------------
                                                              2003     2002     2001
                                                              -----    -----    -----
                                                               LM       LM       LM

Pearson Education...........................................  2,451    2,756    2,604
FT Group....................................................    757      726      801
The Penguin Group...........................................    840      838      820
                                                              -----    -----    -----
TOTAL.......................................................  4,048    4,320    4,225
                                                              =====    =====    =====

Sales information by geographic market supplied


SALES INFORMATION BY GEOGRAPHIC MARKET SUPPLIED
      The following table shows sales information for each of the past three years by geographic region:
              
  Year ended December 31
   
  2006 2005 2004
       
  £m £m £m
 European countries  1,089   951   820 
 North America  2,642   2,451   2,309 
 Asia Pacific  298   300   263 
 Other countries  108   106   87 
          
Total  4,137   3,808   3,479 
          

                                                              YEAR ENDED DECEMBER 31
                                                              -----------------------
                                                              2003     2002     2001
                                                              -----    -----    -----
                                                               LM       LM       LM

United Kingdom..............................................    474      411      433
Continental Europe..........................................    463      419      446
North America...............................................  2,742    3,139    2,975
Asia Pacific................................................    255      249      241
Rest of World...............................................    114      102      130
                                                              -----    -----    -----
TOTAL.......................................................  4,048    4,320    4,225
                                                              =====    =====    =====

Exchange rate fluctuations


EXCHANGE RATE FLUCTUATIONS
      We earn a significant proportion of our sales and profits in overseas currencies, principally the US dollar. Sales and profits are translated into sterling in the consolidated financial statements using average rates. The average rate used for the US dollar was $1.63$1.84 in 2003, $1.512006, $1.81 in 20022005, and $1.44$1.83 in 2001.2004. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. The GroupPearson generates approximately 65% of its sales in US dollars andthe US. We estimate that a five cent change in the averageclosing exchange rate forbetween the fullUS dollar and sterling in any year has an impact of approximately 1 pence oncould affect our reported earnings per share.share by 1p and shareholders’ funds by approximately £85m. See "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk” for more information. 15


CRITICAL ACCOUNTING POLICIESTheyear-end US dollar rate for 2006 was £1:$1.96 compared to £1:$1.72 for 2005. The weakening in the US dollar reduced our shareholders’ funds by £417m (see note 27 of “Item 17. Financial
23
Statements”) in 2006. Theyear-end rate for 2005 was £1:$1.72 compared to £1:$1.92 for 2004 resulting in an increase in shareholders’ funds of £327m in 2005.
Critical accounting policies
      Our consolidated financial statements, included in Item“Item 17. "Financial
Statements"Financial Statements”, are prepared based on the accounting policies described in Notenote 1 to the consolidated financial statements. These financial statements which are prepared in conformityaccordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP.
      The preparation of our consolidated financial statements in conformityaccordance with UK GAAP,IFRS, and the reconciliation of these financial statements to US GAAP as described in Note 34,note 36, requires management to make estimates and assumptions that affect the carrying value of assets and liabilities at the date of the consolidated financial statements and the reported amount of sales and expenses during the periods reported in these financial statements. Certain of our accounting policies require the application of management judgment in selecting assumptions when making significant estimates about matters that are inherently uncertain. Management bases its estimates on historical experience and other assumptions that it believes are reasonable.
      We believe that the following are ourthe more critical accounting policies used in the preparation of our consolidated financial statements that could have a significant impact on our future consolidated results of operations, financial position and cash flows. Actual results could differ from estimates.
Revenue recognition
      Revenue Recognition

     Sales representcomprises the amountfair value of the consideration received or receivable for the sale of goods orand services net of value addedvalue-added tax and other sales taxes, rebates and excluding any trade discounts, and after eliminating sales within the Group. Revenue is recognized as follows:
      Revenue from the sale of books is recognized when title passes. A provision for anticipated returns provided to external customers and associates.is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period.
      Circulation and advertising revenue is recognized when the newspaper or other publication is published. Subscription revenue is recognized on astraight-line basis over the life of the subscription.

     Revenue from
      Where a contractual arrangement consists of two or more elements that can be provided to customers either on astand-alone basis or as an optional extra and fair value exists for each separate element, such as the saleprovision of bookssupplementary materials with textbooks, revenue in such multiple element arrangements is recognized when the goodseach product has been delivered and all other relevant revenue recognition criteria are shipped,
when persuasive evidence of an arrangement exists, when the fee is fixed and
determinable, and when collectibility is probable. A provision for sales returns
is made so as to allocate these returns to the same period as the original sales
are recorded. The returns provision is an estimate based on historical return
rates. If these estimates do not reflect actual returns in future periods then
revenues could be under or over stated for a particular period.achieved.
      Revenue from long-term service contracts,multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognized over the contract term as the services are delivered.performance occurs. The assumptions, risks, and uncertainties inherent inlong-term contract accounting can affect the amounts and timing of revenue and related expenses reported. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated aslong-term contracts with revenues recognized on a percentage of completion basis. Losses on long-term services contracts are recognized in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. Changes in
conditions may result in revisions to estimated costs and earnings during the
course of the contract and the cumulative impact of such revisions are reflected
in the accounting period in which the facts that require the revision became
known.
      On certain contracts, where the Group acts as agent, only commissions and fees receivable for services rendered are recognized as revenue. Any third party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not included in revenue.

Pre-publication Costs
24
Pre-publication assets
      Pre-publication costs represent direct costs incurred in the development of educational programs and titles prior to their publication. Some of these pre-publicationThese costs are expensedrecognized as incurred. Wherecurrent intangible assets where the title has a useful life in excesswill generate probable future economic benefits within their normal operating cycle and costs can be measured reliably.Pre-publication assets are amortized upon publication of one year
these costs are carried forward in stock. The costs are then amortizedthe title over estimated usefuleconomic lives of five years or less, commencing upon publicationbeing the estimated expected operating life cycle of the title, usually with a higher proportion of the amortization taken in the earlier years
to match the sales profileyears. The investment inpre-publication has been disclosed as part of the products.cash generated from operating activities in the cash flow statement. The assessment of useful lifethe recoverability ofpre-publication assets and the calculationdetermination of the amortization profile involve a significant amountdegree of estimationjudgment based on historical trends and management judgment, as management must estimate the sales cycle and lifeestimation of a
particular title. The overstatement of useful livestheir future potential sales. An incorrect amortization profile could result in excess amounts being carried forward in stockas intangible assets that would otherwise have been written off to the profit and loss accountincome statement in an earlier period. Reviews are performed regularly to estimate recoverability ofpre-publication costs.

                                        16


Royalty Advances
Royalty advances
      Advances of royalties to authors are included within debtorstrade and other receivables when the advance is paid less any provision required to bring the amount down to its net realizable value. The royalty advance is expensed at the contracted royalty rate
as the related revenues are earned. The realizable value of royalty advances
held within debtors is regularly reviewed by reference to anticipated future
sales of books or subsidiary publishing rights but still relies on a degree of management judgment in determining the profitability of individual author contracts. If the estimated realizable value of author contracts is overstated then this will have an adverse effect on operating profits as these excess amounts will be written-off.

Defined Benefit Pensionswritten off. The pension costrecoverability of royalty advances is based upon an annual detailed management review of the Group'sage of the advance, the future sales projections for new authors and prior sales history of repeat authors. The royalty advance is expensed at the contracted or effective royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. Royalty advances which will be consumed after one year are held innon-current assets.
Defined benefit pension obligations
      The liability in respect of defined benefit pension schemes,
principallyplans is the UK-based scheme, is charged to the profit and loss account in
order to apportion the cost of pensions over the service livespresent value of the employees
indefined benefit obligation at the schemes.balance sheet date minus the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting estimated future cash flows using yields on high quality corporate bonds which have terms to maturity approximating the terms of the related liability.
      The determination of the pension costs, as well ascost and defined benefit obligation of the Group’s defined benefit pension assets and obligation, dependschemes depends on the selection of certain assumptions (see note 24 in “Item 17 — Financial Statements”) which include the discount rate, expected long-terminflation rate, ofsalary growth, longevity and expected return on scheme assets,
and salary inflation rates, used by the actuaries to calculate such amounts.
These assumptions are described in further detail in Note 10 to the consolidated
financial statements. Although we believe the assumptions are appropriate,
differencesassets. Differences arising from actual experience or future changes in assumptions may
materially affect the pensions costs recordedwill be reflected in subsequent periods (actuarial gains and losses).
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognized immediately in the profitstatement of recognized income and loss accounts.
In particular, a reduction inexpense.
      The service cost, representing benefits accruing over the realized long-termyear, is included as an operating cost and the unwinding of the discount rate ofon the scheme liabilities and the expected return on scheme assets as a financing charge or financing income.
      Obligations for contributions to defined contribution pension plans are recognized as an expense in the income statement as incurred.
Income taxes
      Deferred income tax is provided, using the liability method on temporary differences arising between the tax bases of assets and a further reductionliabilities and their carrying amounts in the consolidated financial statements. Deferred
25
income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realized or the deferred income tax liability is settled.
      Deferred tax assets are recognized to the discount ratesextent that it is probable that future taxable profits will resultbe available against which the temporary differences can be utilized.
      Deferred income tax is provided in higher
pension costsrespect of the undistributed earnings of subsidiaries, other than where it is intended that those undistributed earnings will not be remitted in future periods.the foreseeable future.
      Deferred Taxtax is recognized in the income statement, except when the tax relates to items charged or credited directly to equity, in which case the tax is also recognized in equity.
      The Group is subject to income taxes in numerous jurisdictions. Significant judgment is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognizes liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
      Deferred tax assets and liabilities require management judgment in determining the amounts to be recognized, and inrecognized. In particular, significant judgment is used when assessing the extent to which deferred tax assets canshould be recognized. Under Financial Reporting Standard 19
Deferred Tax, the UK generally accepted accounting principle which we adopted in
2002, we recognize a deferred tax asset in respect of tax losses and other
timing differences. We recognize deferred tax assetsrecognized with consideration given to the extent that they are
recoverable, based on the probability that there will be future taxable income
against which these tax losses and other timing differences may be utilized. We
regularly review our deferred tax assets to ensure that they are recoverable and
have exercised significant judgments when considering the timing and level of future taxable income our business plans andtogether with any future tax planning strategies
in our assessment of recoverability. If a deferred tax asset is not considered
recoverable, a valuation allowance is recorded tostrategies.
Goodwill
      Goodwill represents the extent that recoverability
is not deemed probable.

Amortization and Impairment of Goodwill

     In accordance with UK GAAP, capitalized goodwill is amortized over its
estimated useful life, not exceeding 20 years. The estimated useful life is
determined after taking into account such factors as the nature and ageexcess of the business andcost of an acquisition over the stabilityfair value of the industryGroup’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of associates is included in investments in associates. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. The recoverable amounts of cash generating units have been determined based on value in use calculations. These calculations require the use of estimates. Goodwill is allocated to cash generating units for the purpose of impairment testing. The allocation is made to those cash generating units that are expected to benefit from the business combination in which the acquired business
operates as well as typical life spansgoodwill arose. Gains and losses on the disposal of an entity include the acquired products to which the
goodwill attaches. The estimated useful lives ascribed to goodwill range from 3
to 20 years. Goodwill relating to acquisitions in the more established book
publishing businesses is typically written off over 20 years whilecarrying amount of goodwill relating to less established businesses, for example internet-related
businesses, where there is no consistent record of profitability, are being
written off over 3 to 5 years. The charge for goodwill amortization is a
significant item in arriving at our operating profit in the financial
statements,entity sold.
IFRS and the estimation of useful life can therefore have a material
effect on the results. Under US GAAP, we ceased amortization of goodwill in 2002
and test goodwill for impairment at least annually.

     Under UK GAAP, the carrying value of goodwill is subject to an impairment
review at the end of the first full year following an acquisition and at any
other time if events or changes in circumstances indicate that the carrying
value may not be recoverable whereas under US GAAP it is tested at least
annually. Changes in circumstances resulting in a more frequent impairment
review may include, but are not limited to, a significant change in the extent
or manner in which acquired assets are being used to support the business,
continued operating losses and projection of future losses associated with the
use of assets or businesses acquired,

                                        17


significant changes in legal or regulatory environments affecting the use and
value of the assets, and adverse economic or industry trends.

     If the carrying value of assets is deemed not recoverable, we will
determine the measurement of any impairment charge on anticipated discounted
future cash flows. Significant assumptions are selected by management which
impact the calculation of the anticipated future cash flows, with the most
critical assumptions being discount rates, the period utilized for the cash
flows, and terminal values. Discount rates are generally based on our Group cost
of capital adjusted for any inherent risk associated with the specific business.
Terminal values incorporate management's estimate of the future life cycle of
the business and of the cash flow for the period determined. Although we believe
our assumptions to be appropriate, actual results may be materially different
and changes to our assumptions and estimates may result in a materially
different valuation of the assets. Our cash flow assumptions underlying these
projections are also consistent with management's operating and strategic plans
for these businesses.

     Under UK GAAP, impairments of goodwill will be evaluated on a discounted
cash flow basis for each acquisition, where there is a triggering event to
indicate a potential impairment or where there has been a previous impairment.
Impairment evaluations under US GAAP will be prepared at a reporting unit level
as defined by Statement of Financial Accounting Standards ("SFAS") No. 142 and
will incorporate a two-stage impairment test. It is possible that an impairment
may be required under one set of accounting principles and not the other.

Investments

     Management reviews the carrying value of investments annually and records a
charge to profit if an other-than-temporary decline in the carrying value is
deemed to have arisen. To assess the recoverability of the carrying value of our
investments and to determine if a write-down in carrying value is
other-than-temporary, we consider several factors such as the investee's ability
to sustain an earnings capacity which would justify the carrying amount, the
current fair value (using quoted market prices, when available), the length of
time and the extent to which the fair value has been below carrying value, the
financial condition and prospects of the investees, and the overall economic
outlook for the industry. The evaluation of such factors involves significant
management judgment and estimates in determining when a decline in value is
other-than-temporary and ascribing fair value where there is no quoted market
value. Changes in such estimates could have a material impact on our financial
position and results of operations.

UK GAAP AND US GAAP
      We prepare our financial statements in accordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP. Our profitProfit attributable to equity holders of the Company and equity shareholders’ funds under IFRS and US GAAP were as follows for the financial year ended December 31, 2003 under UK GAAP was L55 million compared
with a profit of L183 million under US GAAP for the same year. The loss for the
financial year ended December 31, 2002 under UK GAAP was L111 million, compared
with a profit of L198 million under US GAAP for the same year. The loss for the
financial year ended December 31, 2001 under UK GAAP was L423 million compared
with a loss of L1,500 million under US GAAP for the same year.

     Equity shareholders' funds at December 31, 2003 under UK GAAP were L2,952
million compared with L3,352 million under US GAAP. Equity shareholders' funds
at December 31, 2002 under UK GAAP were L3,338 million compared with L3,708
million under US GAAP.respective period:
              
  Year ended December 31
   
  2006 2005 2004
       
  £m £m £m
Profit for the year
            
 IFRS  446   624   262 
 US GAAP  341   411   182 
Equity shareholders’ funds
            
 IFRS  3,476   3,564     
 US GAAP  3,581   3,838     
      The main differences between UK GAAPIFRS and US GAAP relate to goodwill and intangible assets, acquisition and disposal adjustments, derivatives, pensions, and stock based compensation.compensation and taxation. These differences are
26
discussed in further detail under "--“ — Accounting Principles"Principles” and in Note 34note 36 to the consolidated financial statements.

                                        18


RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

CONSOLIDATED RESULTS OF OPERATIONS


Results of operations
Year ended December 31, 2006 compared to year ended December 31, 2005
Consolidated results of operations
Sales
      Our total sales decreasedfrom continuing operations increased by L272 million£329m, or 9%, to L4,048 million£4,137m in 2003,2006, from L4,320 million£3,808m in 2002.2005. The decreaseincrease reflected growth across all the businesses together with additional contributions from acquisitions made in both 2005 and 2006. The year on year growth was mainly attributableimpacted by movements in exchange rates, particularly in the US dollar. We estimate that had the 2005 average rates prevailed in 2006, sales would have been approximately £4,181m.
      Pearson Education had another strong year with an increase in sales of 9%. The School business was the biggest contributor to Pearson
Education's Professional business wherethis growth with an increase of 12%. Some of the shortfallSchool increase was due to the absence of
salescontribution from the L250 million TSA contractacquisitions made in 2006 and the effect of foreign currency
exchange. The strength of sterling compared to the US dollar had a significant
negative effect on sales, and2005 but we estimate that hadafter excluding these acquisitions and restating at constant exchange rates that the 2002 average rates
prevailed in 2003, salesgrowth would have been higher by L181 million. In constant
exchange rate terms6%. US School publishing sales were up 3% compared to an industry decline of 6% (source: Association of American Publishers) and the business took a leading share of the new US adoption market. School andtesting sales continued to improve even after growth in US school testing revenues of more than 20% in 2005. Higher Education businesses increased salesgrowth was more modest at 2% in 2003 by 8% and 6% respectively. The School businesstotal but was helped by the
acquisition of 75% of London Qualifications, the UK testing business,up 4% in the first half of 2003 that contributed additionalUS. Pearson’s US Higher Education business has grown faster than the industry for eight straight years. In the Professional business, sales of L89 million. Penguin saw
a small increaseincreased 13%, with testing sales ahead by more than 30% in sales even after2006 following the adverse effect of foreign currency
movements as the schedulesuccessful start up of new titles enabled Penguincontracts and a contribution from the newly acquired Promissor business. Professional publishing sales declined again in 2006 due to grow ahead of the industry despite tough conditions for backlist publishingcontinuedindustry-wide weakness in the US.technology-related publishing.
      The FT Group sales were slightly11% ahead of last year mainly due to Interactive Data
whereyear. FT Publishing sales increased forwere up by 10% driven by higher advertising revenues at the fourth consecutive yearFinancial Times particularly in a difficult marketplace
(even after excluding additionalthe online, luxury goods and corporate finance categories. IDC sales generatedwere up by 12% with consistent organic growth and aided by contributions from the acquisition of ComStock atIS.Teledata(re-branded Interactive Data Managed Solutions) and Quote.com.
      Penguin’s sales grew by 5% with a record number of best sellers in the beginning of 2003). Our business newspapersUS and UK, an increase in market share in the UK and continued to suffer
fromsuccess with the corporate advertising recession which have seen advertising volumes atpremium paperback format in the Financial Times newspaper fall almost two-thirds since their peak in 2000.US.
      Pearson Education, our largest business sector, accounted for 61%63% of our continuing business sales in 2003,2006, compared to 64%62% in 2002.2005. North America continued to be the most significant source of our sales although sales in the region decreased,and as a proportion of total continuing sales to 67%contributed 64% in 2003, compared to 72% in 2002. Some of this
decrease, however, reflects the comparative strength of sterlingboth 2006 and the euro
compared to the US dollar.

Cost of Sales and Net Operating Expenses2005.
Cost of goods sold and operating expenses
      The following table summarizes our cost of sales and net operating expenses:

                                                                 YEAR ENDED
                                                                DECEMBER 31
                                                              ----------------
                                                               2003      2002
                                                              ------    ------
                                                                LM        LM

COST OF SALES...............................................  (1,910)   (2,064)
                                                              ======    ======
Distribution costs..........................................    (239)     (233)
Administration and other expenses...........................  (1,724)   (1,888)
Other operating income......................................      51        59
                                                              ------    ------
NET OPERATING EXPENSES......................................  (1,912)   (2,062)
                                                              ======    ======

          
  Year ended
  December 31
   
  2006 2005
     
  £m £m
Cost of goods sold  1,917   1,787 
       
 Distribution costs  299   292 
 Administration and other expenses  1,504   1,351 
 Other operating income  (99)  (84)
       
Total  1,704   1,559 
       
27
Cost of Sales.goods sold. Cost of sales consists of costs for raw materials, primarily paper, productionprinting and binding costs, amortization ofpre-publication costs and royalty charges. Our cost of sales decreasedincreased by L154 million,£130m, or 7%, to L1,910 million£1,917m in 2003,2006, from L2,064 million£1,787m in 2002.2005. The decreaseincrease mainly reflected the decreaseincrease in sales over the period withalthough the overall gross margins remaining consistent. Cost of sales as a percentage
of sales improvedmargin also increased slightly from 53% in 2005 to 47%54% in 2002 from 48% in 2002.

     2006.
Distribution Costs.costs. Distribution costs consist primarily of shipping costs, postage and packing.

     packing and are typically a fairly constant percentage of sales.
Administration and Other Expenses.other expenses. Our administration and other expenses decreasedincreased by L164 million,£153m, or 9%11%, to L1,724 million£1,504m in 2003,2006, from L1,888 million£1,351m in 2002. Administration and other expenses as2005. As a percentage of sales decreasedthey increased to 43%36% in 2003,2006, from 44%35% in 2002. Included within administration and other expenses
is the charge for goodwill amortization and impairment relating to subsidiaries.
Total goodwill amortization, including that relating to associates (L7 million
in 2003; L48 million in 2002) decreased by L66 million to L264 million in 2003,
from L330 million in 2002.2005. The main reason for this decrease over last year is
Family Education Network

                                        19


and our interest in Marketwatch.com, where the final amortization charges were
incurred in the first half of 2003. In 2002, we also took a goodwill impairment
charge of L10 million relating to a subsidiary of Recoletos in Argentina while
in 2003 no impairment charges were deemed necessary. Also includedincrease in administration and other costs are the one-offcomes principally from additional employee benefit expense, additional property costs of integrating significant
recent acquisitions into our existing businesses. The last of these significant
acquisitions occurred in 2000 and the final costs of integration of L10 million
relating to Pearson NCS and Dorling Kindersley were incurred in 2002 with no
further charges in 2003.

     After excluding goodwill charges and integration costs, administration and
other expenses were L1,467 million in 2003 compared to L1,586 million in 2002.
The improvement of L129 million includes the beneficial effect of foreign
currency exchange, the results of cost saving measures taken in 2002 and 2003
and a reduced spend on internet enterprises.

     increased intangible amortization.
Other Operating Income.operating income. Other operating income mainly consists of freight recharges,sub-rights and licensing income and distribution commissions. Other operating income decreasedincreased 18% to L51 million£99m in 20032006 from L59 million£84m in 20022005, with the decrease comingincrease mainly due to profits made on the disposal of a building. See “Item 17. Financial Statements” note 36 (ix) for the treatment under US GAAP.
Other net gains and losses
      Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40m profit on the sale of our associate interest in MarketWatch. In 2006, there were no similar gains or losses.
Share of results of joint ventures and associates
      The contribution from our joint ventures and associates increased from £14m in 2005 to £24m in 2006. The increase was mainly due to an increase in circulation and revenue at both Pearson Education and Penguin where distribution
commissions we receive for distributing third parties' books has continued to
decline.

Operating Profit/LossThe Economist Group, who also recorded a gain on sale of its investment in Commonwealth Business Media Inc. There was also further reduction in losses at FT Deutschland.
Operating profit
      The total operating profit increased by £24m, or 5%, to £540m in 2003 of L226 million compares to a profit of
L143 million2006 from £516m in 2002.2005. This increase was principally due to a L76 million
reduction inincreases across all the total goodwill charge and the absence of integration costs.
Operating profit was adversely affected by the impact of reduced profits at
Pearson Education's Professional business, due to the absencebusinesses, after taking account of the prior year
TSA contract, but this was offset by growthone-off gain from the sale of MarketWatch at FT Publishing of £40m in School2005 and Higher Education,
Interactive Data and Penguin. In addition there were reduced lossesa charge of £7m in 2006 at Penguin relating to an adjustment to goodwill following disposals and rationalizationrecognition of the FT Knowledge business. In 2003, operating
profit was adversely affected by the weakening of the US dollar against
sterling.pre-acquisition tax losses. We estimate that had the 20022005 average rates prevailed in 2003,2006, operating profit before goodwill charges would have been L27 million greater.£7m higher.
      Operating profit attributable to Pearson Education increased by L31
million,£42m, or 41%13%, to L106 million£365m in 2003,2006, from L75 million£323m in 2002.2005. The increase was due to a L37 million reductioncontinued improvement in goodwill amortization, a L7 million
reductionSchool margins, the profit impact of strong sales and cost reductions in integration costs, increasestechnology publishing in profit reported by the School and
Higher Education businesses of L12 million and L6 million respectively and the
cessation of losses from FT Knowledge (a L12 million loss in 2002). Offsetting
these favorable variances was the sharp reduction in profits in the Professional business of L43 million caused by both the absence of the prior year
contribution from the TSA contract and further current year TSA contract
close-out costs.testing. Operating profit attributable to the FT Group decreased by £16m, or 12%, to £117m in 2006, from £133m in 2005. This decrease was attributable to the absence in 2006 of the £40m profit from the sale of MarketWatch that was recorded in 2005. After excluding this item profits increased by L45 million to
L50 million£24m, £7m at IDC and £17m at FT Publishing. The FT Publishing increase reflected thepick-up in 2003, from L5 million in 2002. The increase was largely due to a
L39 million reduction in goodwill amortization and impairment charges. In
addition a strong performance from Interactive Data was enough to offset the
increased losses at the Financial Times newspaper following a continuing decline
of the business advertising market.revenues. Operating profit attributable to the Penguin Group increaseddecreased by L4 million,£2m, or 6%3%, to L70 million£58m in 2003,2006, from L66 million£60m in 2002.2005. The profit increase
reflecteddecrease was attributable to an adjustment to goodwill of £7m caused by the continued growth in sales and improved margins.

     In 2003, we continued to integrate our book publishing operations around
the world. In Australia and Canada, the first two markets where we combined
Penguin and Pearson Education into one company, profits improved with operating
profit growth in double digits for both companies. In the UK, we are shortly to
move to a single shared warehouse and distribution center and, in the US, we
continue to consolidate back office operations.

Non-operating Items

     Profit before taxation on the salerecognition of fixed assets, investments, businesses
and associates was L6 million in 2003 compared to a loss of L37 million in 2002.
In 2003 the principal item was a profit of L12 million on the sale of an
associate investment in Unedisa by Recoletos. In 2002, the principal items were
a profit of L18 millionpreviously unrecognized tax losses relating to the completionacquisition of the sale of the RTL Group
and a provision of L40 million for the loss on sale of our Forum business, which
completedDorling Kindersley in January 2003. Other items in 2002 included a loss on sale of PH
Direct of
                                        20


L8m, a profit of L3 million on finalization of the sale of the Journal of
Commerce by the Economist and various smaller losses on investments and
property.

Net Finance Costs2000.
Net finance costs
      Net finance costs consist primarily of net interest expense relatedincreased from £70m in 2005 to our
borrowings. Our total net£74m in 2006. Net interest payable decreasedin 2006 was £94m, up from £77m in 2005. Although we were partly protected by L51 million, or 39%, to
L80 millionour fixed rate policy, the strong rise in 2003, from L131 million in 2002. Our average net debt decreased
by L157 million from L1,891 million in 2002 to L1,734 million in 2003, while our
year end indebtedness (excluding finance leases) decreased to L1,361 million in
2003 compared to L1,408 million in 2002 due to foreign exchange movements.
Interest decreased as a result of the lower average net debt and the effect of a
general fall inUS dollar floating interest rates during the year. The weightedhad an adverse effect. Year on year, average three month London Interbank Offered ("LIBOR") rate, reflecting ourLIBOR (weighted for the Group’s borrowings in US dollars, euroeuros and sterling fellat the year end) rose by 75 basis points, or 0.75%1.5% to 4.9%. The impact of
these falls was dampened by our treasury policyCombining the rate rise with an increase in 2003 of having 40-65% ofthe Group’s average net debt at fixed interest rates. As a result, ourof £40m, the Group’s average net interest rate
28
payable averaged approximately 4.6%rose by 1.1% to 7.0%. In 2006 the net finance income relating topost-retirement plans was an income of £4m compared to a cost of £7m in 2003, improving from 5.0%the previous year. Other net finance income relating to foreign exchange andshort-term fluctuations in 2002. During 2002 we
took an additional one-off chargethe market value of L37 million for cancellation of certain
swap contracts and the early repayment of debt following the re-balancing of the
Group's debt portfoliofinancial instruments remained fairly constant year on the receipt of the RTL Group proceeds.year with a £16m gain in 2006 compared to a £14m gain in 2005. For a more detailed discussion of our borrowings and interest expenses see "--“ — Liquidity and Capital Resources --— Capital Resources"Resources” and "-- Borrowing"“ — Borrowings” below and "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk”.
Taxation
      The overall taxationtotal tax charge for 2003 was L75 million,in 2006 of £11m represents just over 2% ofpre-tax profits compared to a charge of L64 million£116m or 26% ofpre-tax profits in 2002.2005. The low tax rate in 2006 was mainly accounted for by two factors. First, in the light of the announcement of the disposal of Government Solutions, we were able to recognize a deferred tax asset in relation to capital losses in the US where previously we were not confident that the benefit of the losses would be realized prior to their expiry. Second, in light of our trading performance in 2006 and our strategic plans, together with the expected utilization of US net operating losses in the Government Solutions sale, we havere-evaluated the likely utilization of operating losses both in the US and the UK; this has enabled us to increase the amount of the deferred tax asset carried forward in respect of such losses. The combined effect of these two factors was to create anon-recurring credit of £127m.
Minority interests
      Following the disposal of our 79% holding in Recoletos and the purchase of the remaining 25% minority stake in Edexcel in 2005, our minority interests now comprise mainly the minority share in IDC. In 2003January 2006 we increased our stake in IDC reducing the minority interest from 39% to 38%.
Discontinued operations
      In December 2006 the Group recorded a total pre-tax profitannounced the sale of L152 millionits Government contracting business, Pearson Government Solutions. The sale was completed in February 2007 and the high rateresults of tax came about mainly because there was only
very limited tax relief available for goodwill chargedthis business have been shown in discontinued operations in the consolidated income statement in both 2006 and 2005. Operating profit for Government solutions in 2006 was £22m compared to £20m in 2005. Following the disposal of Recoletos in 2005 its results were consolidated for the period up to February 28, 2005 and included in discontinued operations in 2005. The results for 2005 include an operating loss account.for the two months to February 28, 2005 of £3m. Thepre-tax profit on disposal of Recoletos reported in 2005 was £306m.
Profit for the year
      The total tax charge in 2003 also included credits of L56 million
relating to prior year items; these reflect a combination of settlements with
the Inland Revenue authorities and changes to deferred tax balances. In 2002
there was a total pre-tax loss of L25 million, which was also the result of only
very limited tax relief available for goodwill. In 2002 there was also a tax
credit of L45 million attributable to the resolution of the tax position on the
disposal in 1995 of the group's remaining interest in BSkyB.

Minority Interests

     Minority interests principally consist of the public's 39% interest in
Interactive Data and 21% interest in Recoletos.

Profit for the Financial Year

     The profit for the financial year after taxation and equity minority
interests in 20032006 was L55 million£469m compared to a lossprofit in 20022005 of L111 million.£644m. The overall changedecrease of L166 million£175m was mainlyto the absence of the profits on disposal of Recoletos and MarketWatch reported in 2005. After taking account of these disposals there was an increase in profit in 2006 due to improvement in operating profits and the sharp reduction in tax due to the reduced goodwill
amortization and impairment charges and lower interest payments. There was also
a profit on the salerecognition of fixed assets, investments, businesses and associateslosses in 2003 compared to the loss in 2002.

Earnings Per Ordinary Share2006.
Earnings per ordinary share
      The basic earnings per ordinary share, which is defined as the profit for the financial year divided by the weighted average number of shares in issue, was 6.9 pence55.9p in 20032006 compared to a loss of 13.9 pence78.2p in 20022005 based on a weighted average number of shares in issue of 794.4 million798.4m in 20032006 and 796.3
million797.9m in 2002. This increase2005. The decrease in earnings per share was due to the return toadditional profit for the financial
year2005 described above and was not significantly affected by the decreasemovement in the weighted average number of shares.

     In 2003 the
      The diluted earnings per ordinary share of 55.8p in 2006 and 78.1p in 2005 was also 6.9 pencenot significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant. The Group made a loss for
the financial year in 2002 and the effect of share options was therefore
anti-dilutive and a diluted loss per ordinary share was shown as being equal to
the basic loss of 13.9 pence.

                                        21


Exchange Rate Fluctuations
29
Exchange rate fluctuations
      The weakening of the US dollar against sterling on an average basis had a negative impact on reported sales and profits in 20032006 compared to 2002.2005. We estimate that if the 20022005 average rates had prevailed in 2003,2006, sales would have been higher by L181 million£44m and operating profit would have been higher by L27
million.£7m. See "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk” for a discussion regarding our management of exchange rate risks.

SALES AND OPERATING PROFIT BY DIVISION
Sales and operating profit by division
      The following table summarizestables summarize our sales and operating profit and results from
operations for each of Pearson'sPearson’s divisions. Results from operations areAdjusted operating profit is anon-GAAP measure and is included as they areit is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFASFAS 131. Since
1998See also note 2 of “Item 17. Financial Statements”.
      In our adjusted operating profit we have reshapedexcluded amortization and adjustment of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization and adjustment of acquired intangibles is the Pearson portfolio by divestingamortization or subsequent impairment of non-core interestsintangible assets acquired through business combinations. The charge is not considered to be fully reflective of the underlying performance of the Group. Other gains and investing in educational publishinglosses represent profits and testing, consumer publishinglosses on the sale of subsidiaries, joint ventures, associates and business information companies. During this periodinvestments that are included within continuing operations but which distort the performance for the year.
      Adjusted operating profit enables management to more easily track the underlying operational performance of transformation management
have used results from operations to track underlying core business performance.
An analysisthe Group. A reconciliation of operating profit to adjusted operating profit for continuing operations is included in the tabletables below:
                             
  Year Ended December 31, 2006
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,455   795   341   366   332   848   4,137 
   36%   19%   8%   9%   8%   20%   100% 
Total operating profit  167   161   37   35   82   58   540 
   31%   30%   7%   6%   15%   11%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  17   —   1   2   7   8   35 
Other net gains and losses including associates  —   —   —   (4)  —   —   (4)
Other net finance costs of associates  —   —   —   (1)  —   —   (1)
                      
Adjusted operating profit:
continuing operations		  184   161   38   32   89   66   570 
Adjusted operating profit:
discontinued operations		  —   —   22   —   —   —   22 
                      
Total adjusted operating profit  184   161   60   32   89   66   592 
                      
   31%   27%   10%   6%   15%   11%   100% 
30
                             
  Year Ended December 31, 2005
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,295   779   301   332   297   804   3,808 
   34%   20%   8%   9%   8%   21%   100% 
Total operating profit  142   156   25   58   75   60   516 
   28%   30%   5%   11%   14%   12%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  5   —   —   1   5   —   11 
Other net gains and losses including associates  —   —   —   (40)  —   —   (40)
Other net finance costs of associates  —   —   —   2   —   —   2 
                      
Adjusted operating profit:
continuing operations		  147   156   25   21   80   60   489 
Adjusted operating profit:
discontinued operations		  —   —   20   (3)  —   —   17 
                      
Total adjusted operating profit  147   156   45   18   80   60   506 
                      
   29%   31%   9%   3%   16%   12%   100% 

                                                                YEAR ENDED DECEMBER 31
                                                              --------------------------
                                                                 2003           2002
                                                              -----------    -----------
                                                               LM      %      LM      %
                                                              ----    ---    ----    ---

OPERATING PROFIT
Pearson Education...........................................   106     47      75     51
FT Group....................................................    50     22       5      4
The Penguin Group...........................................    70     31      66     45
                                                              ----    ---    ----    ---
CONTINUING OPERATIONS.......................................   226    100     146    100
                                                              ====    ===    ====    ===
COMPRISED OF:
GOODWILL AMORTIZATION
Pearson Education...........................................  (207)          (244)
FT Group....................................................   (36)           (65)
The Penguin Group...........................................   (21)           (18)
                                                              ----           ----
CONTINUING OPERATIONS.......................................  (264)          (327)
                                                              ====           ====
GOODWILL IMPAIRMENT
Pearson Education...........................................    --             --
FT Group....................................................    --            (10)
The Penguin Group...........................................    --             --
                                                              ----           ----
CONTINUING OPERATIONS.......................................    --            (10)
                                                              ====           ====
INTEGRATION COSTS
Pearson Education...........................................    --             (7)
FT Group....................................................    --             --
The Penguin Group...........................................    --             (3)
                                                              ----           ----
CONTINUING OPERATIONS.......................................    --            (10)
                                                              ====           ====
RESULTS FROM OPERATIONS
Pearson Education...........................................   313     64     326     66
FT Group....................................................    86     17      80     16
The Penguin Group...........................................    91     19      87     18
                                                              ----    ---    ----    ---
CONTINUING OPERATIONS.......................................   490    100     493    100
                                                              ====    ===    ====    ===

School


- ---------------

(1)  Discontinued operations contributed Lnil
      School business sales increased by £160m, or 12%, to both£1,455m in 2006, from £1,295m in 2005 and adjusted operating profit and
     results from operations in 2003. The equivalent figures in 2002 were Lnil
     and a loss of L3 million respectively. See Note 2.

                                        22


Pearson Education

     Pearson Education's sales decreasedincreased by L305 million,£37m, or 11%25%, to L2,451
million£184m in 20032006 from L2,756 million£147m in 2002, as good2005. In addition to strong underlying growth in oursales and profits, the School results in 2006 benefit from the inclusion of National Evaluation Systems (NES), Paravia Bruno Mondadori (PBM), Chancery and Higher Education businessesPowerSchool together with a number of smaller acquisitions all made in the first half of 2006 and from a full year contribution from AGS Publishing, acquired in July 2005. Offsetting these factors was reduced due to the effect of the weakening of the US dollar, andwhich we estimate reduced sales by £17m when compared to the Professionalequivalent figures at constant 2005 exchange rates.
      In the US school market, Pearson’s school publishing business could not fillgrew 3% against the gap left byAssociation of American Publishers’ estimate of a decline in the absenceindustry of 6%. New adoption market share was 33% in the adoptions where Pearson competed (and 30% of the TSA contract. Pearson Education's 2003 sales comprised 61% of Pearson's
total sales. Results from operations decreased by L13 million or 4% from L326
million in 2002 to L313 million in 2003. The decrease can be attributed to the
reduction at the Professional business caused by both the absence of the prior
year contribution from the TSA contract and further TSA contract close out costs
recognized this year. Offsetting this were strong performances in School and
Higher Education as margins improved and the cessation of losses at FT Knowledge
following disposals and reorganization of that business.new adoption market). The School business now has the number one or number two market share in reading, math, science and social studies. US School testing sales were up in the high single digits even after growth in excess of 20% in 2005. School testing benefited from further contract wins, market share gains and leadership in onscreen marking, online testing and embedded (formative) assessment. The acquisition of NES providing customized assessments for teacher certification in the US has allowed us to expand in an attractive adjacent market. The School technology business grew both through the acquisitions of Chancery and PowerSchool and through organic growth in the digital curriculum business which continued to grow while investing in a new generation of digital products to meet the demands of school districts for personalized classroom learning.
      The international School business, outside the US, continued to grow. The international testing business was again able to benefit from technology leadership. In the UK, we have marked over 9 million GCSE, AS and A-Level scripts on screen. In School publishing, the launch in the UK of ActiveTeach technology providing multimedia teaching resources has brought increased market share in math and science. The acquisition of PBM, one of Italy’s leading education publishers, has allowed us to expand our existing Italian business and integrate publishing, sales and marketing, distribution and back office operations. Our market leading school companies in Hong Kong and South Africa both outperformed their respective markets in 2006 and our worldwide English Language Training program for elementary schools,English Adventure(with Disney), was successfully launched in Asia and Latin America.
      School margins improved again in 2006 and were up by 1.2% points to 12.6% with continued efficiency gains in central costs, production, distribution and software development.
31
Higher Education
      Sales in Higher Education increased by L25 million,£16m, or 2%, to L1,176
million£795m in 2003,2006, from L1,151 million£779m in 2002 and results from operations2005. Adjusted operating profit increased by L12 million,£5m, or 10%3%, to L127 million£161m in 20032006 from L115 million£156m in 2002.2005. Both sales and resultsadjusted operating profit were adverselyaffected by the weakening of the US dollar which we estimate reduced sales by £8m when compared to the equivalent figures at constant 2005 exchange rates.
      In the US, the Higher Education sales were up by 4% (in US dollars) ahead of the Association of American Publishers’ estimate of industry growth once again. Over the past eight years, Pearson’s US Higher Education business has grown at an average annual rate of 7% compared to the industry’s average growth rate of 4%. In the US there was rapid growth in the online learning businesses with approximately 4.5 million US college students using one of our online programs. Of these approximately 2.3 million register for an online course on one of our ‘MyLab’ online homework and assessment programs, an increase of almost 30% on 2005. In psychology and economics, two of the three largest markets in US higher education, Pearson published successful first edition bestsellers: Cicarrelli’sPsychologytogether with MyPsychLab and Hubbard’sEconomicstogether with MyEconLab. Cicarrelli’sPsychologyincreased Pearson’s market share in the subject by 3% to 25% and is the bestselling launch of a first edition in the discipline in the past decade. Also in the US the custom publishing business, which builds customized textbooks and online services around the courses of individual faculties or professors, continued its strong progress with another year of double-digit growth.
      International Higher Education publishing sales grew by 3%, benefiting from good growth in local language publishing programs and an increasing focus on custom publishing and technology based assessment services with the MyLab suite of products.
      Higher Education margins remained constant year on year with only a small increase of 0.3% points to 20.3% in 2006.
Professional
      After excluding sales and adjusted operating profit from Government Solutions which were reported as discontinued in 2006, Professional sales increased by £40m, or 13%, to £341m in 2006 from £301m in 2005. Adjusted operating profit increased by £13m, or 52%, to £38m in 2006, from £25m in 2005. Sales were only slightly affected by the weakening US dollar, andwhich we estimate reduced sales by £2m when compared to the equivalent figures at constant 2005 exchange rates.
      Professional testing sales were up more than 30% in 2006 benefiting in particular from the acquisition of Promissor and the successful start-up of the Graduate Management Admissions Test with 220,000 examinations delivered in 400 test centers in 96 countries during the first year of the new contract. Professional Testing has moved into profitability in 2006 compared to a break-even position in 2005. Technology publishing profits were up in 2006 as cost actions offset sales weakness in a market that had 2002 average rates prevailedcontinues to decline. There was a strong performance in 2003 then sales would
have been approximately L72 millionother professional publishing with particular successes in the Wharton School Publishing and FT Press imprints.
      Overall margins in the Professional business were significantly higher than reportedat 11.1% in 2006 compared to 8.3% in 2005 as the testing business moved into profitability and results from
operations L8 million higher than reported. In the US our textbooktechnology publishing business grew as our Pearson Scott Foresmantook specific cost actions.
FT Publishing
      Sales at FT Publishing increased by £34m or 10%, from £332m in 2005 to £366m in 2006. Adjusted operating profit increased by £11m, from £21m in 2005 to £32m in 2006. Much of the sales and Pearson Prentice Hall imprintsprofit increase was again at the FT newspaper and FT.com where sales were up 8% and profit increased by £9m to £11m.
      The FT newspaper advertising revenues were up 9% for the year with rapid growth in online, luxury goods and corporate finance categories, all up more than 30% on 2005. FT worldwide circulation was up 1% to 430,469 copies per day (Source: ABC, average for six months to December 2006). FT.com’s paying subscribers were up 7% to 90,000 while the December audience was up 29% to 4.2 million. The FT continued
32
to benefit from international expansion with approximately three-quarters of the FT’s advertising booked in two or more international editions and almost half booked for all four editions worldwide. The FT’s ‘new newsroom’ has created an integrated multi-media newsroom that improves commissioning, reporting, editing and production efficiency and provided further cost savings in 2006.
      In September 2006, the FT Publishing business acquired Mergermarket, an online financial data and intelligence provider that contributed additional sales and profit in the last three months of 2006. FT Business showed good growth and improved margins driven by strong performances in events, UK retail financial titles (Investment AdviserandFinancial Adviser) and internationally withThe Banker. Les Echosachieved modest circulation and advertising growth in a weak market ahead of the overall basalFrench presidential elections in 2007.FT Deutschlandoutperformed the German newspaper market growth. Our new elementary
social studies program tookonce again increasing circulation by 2% and reducing losses.The Economist, in which Pearson owns a market share of50% stake, increased its contribution to FT Publishing’s adjusted operating profit with another good year that saw circulation increase by 9% to 1.2 million (for the July-December ABC period).
      Overall margins at FT Publishing continued to increase as the newspaper becomes more than 50%profitable and are now 8.7% compared to 6.3% in adoption states,
helping Pearson2005.
Interactive Data
      Interactive Data, grew its sales by 12% from £297m in 2005 to take the leading position£332m in new adoptions with a share of
approximately 29%. Sales at our supplementary publishing business were lower
than2006. Adjusted operating profit grew by 11% from £80m in 2002 as we discontinued some unprofitable product lines and were
affected by industry-wide weakness2005 to £89m in state budgets. Although the same pressures
reduced sales at our School digital learning business, strong cost management
enabled it to return to a small profit in 2003. In School testing, 2003 revenues
were a little ahead of 2002, and we won more than $300 million worth of new
multi-year contracts which we expect will boost sales from 2005, when the US
Federal Government's No Child Left Behind accountability measures become
mandatory.

     Outside the US, the School business sales increased with good growth in
English Language Teaching and in our School publishing operations in Hong Kong,
South Africa, the UK and Middle East. Our 75% owned UK testing business, London
Qualifications, contributed sales of L89 million following its acquisition in
the first half of 2003.

     The Higher Education business saw a decline in sales of L3 million, to L772
million in 2003, from L775 million in 2002. Results from operations increased by
L6 million, to L148 million in 2003, from L142 million in 2002.2006. Both sales and resultsadjusted operating profit were adversely affected by the weakening US dollar, which we estimate reduced sales by £4m and adjusted operating profit by £1m when compared to the equivalent figures at constant 2005 exchange rates.
      Interactive Data Pricing and Reference Data (formerly FT Interactive Data), IDC’s largest business (approximately two-thirds of IDC revenues) generated strong growth in North America and Europe. Growth was driven by sustained demand for fixed income evaluated pricing services and related reference data. Interactive Data Pricing and Reference Data continued to expand its market coverage, adding independent valuations of credit default swaps and other derivative securities. There was improved momentum at Interactive Data Real-Time Services (formerly Comstock) with new sales to institutional clients and lower cancellation rates and also at eSignal with continued growth in its base of direct subscription terminals. The acquisition of Quote.com in March 2006 has expanded eSignal’s suite of real-time market data platforms and analytics and added two financial websites which enabled eSignal to generate strong growth through online advertising in 2006. IS.Teledata, acquired at the end of 2005 and rebranded Interactive Data Managed Solutions, contributed a full year of sales and profit for the first time in 2006.
      IDC margins remained roughly constant year on year at 26.8% in 2006 compared to 26.9% in 2005.
The Penguin Group
      Penguin Group sales were up 5% to £848m in 2006 from £804m in 2005 and adjusted operating profit up 10% to £66m in 2006 from £60m in 2005. Both sales and adjusted operating profit were affected by the weakening US dollar which we estimate reduced sales by £13m and adjusted operating profit by £7m when compared to the equivalent figures at constant 2005 exchange rates.
      2006 was a record year for Penguin in terms of literary success and bestseller performance. In the US, Penguin placed 139 books on theNew York Timesbestseller list, 10 more than in 2005, and kept them there for 809 weeks overall, up 119 weeks from 2005. Penguin UK placed 59 titles in the BookScan Top Ten bestseller list, up by 5 from 2005, and kept them there for 361 weeks, up 42 weeks from 2005.
      Penguin authors won a large number of prestigious awards during 2006: a Pulitzer Prize for Fiction (Marchby Geraldine Brooks); a National Book Critics Circle Award (THEM: A Memoir of Parentsby Francine du Plessix Gray); the Michael L. Printz award (Looking for Alaskaby John Green); the Orange Prize for Fiction (On Beautyby Zadie Smith); and the Man Booker Prize (The Inheritance of Lossby Kiran Desai).
33
      Penguin UK’s focus on fiction in 2006 was rewarded with a substantial increase in market share, led by Marina Lewycka’sA Short History of Tractors in Ukrainian.In the US, the premium paperback format accelerated revenue growth and increased profitability in the important mass-market category. In India, Penguin continued its rapid growth and extended its market leadership and there was also strong growth and increased market share for Penguin in South Africa. 2006 also saw strong growth in online revenues and unique visitors to the Penguin and DK websites.
      Penguin continued to focus on efficiency and improvement in operating margins and has benefited from the Pearson-wide renegotiation of major global paper, print and binding contracts, the integration of warehouse and back office operations in Australia and New Zealand and is investing in India as a pre-production and design center for reference titles.
Results of operations
Year ended December 31, 2005 compared to year ended December 31, 2004
Consolidated results of operations
Sales
      Our total sales increased by £329m, or 9%, to £3,808m in 2005, from £3,479m in 2004. Sales growth was due to strong performance in our markets, helped in part by a favorable exchange rate impact. We estimate that had 2002the 2004 average rates prevailed in 2003 then2005, sales would have been approximately L49 million higher than reported and results from operations L10
million higher than reported. Though the industry growth slowed a little in
2003, we expect the long-term fundamentals of growing enrolments, a boom in
community colleges and£3,765m.
      Pearson Education had a strong demand for post-secondary qualificationsyear with an increase in sales of 13%. The School businesses were the biggest contributors to more
than offsetthis growth with an increase of 19%. Higher Education growth was 7% in total and 6% in the impact of state budget weakness and rising tuition fees.

     OurUS. Pearson’s US Higher Education business alsohas grown faster than the industry for seven straight years. The School publishing business benefited from a strong schedulelarge share of first editions including Faigley's Penguin Handbookthe new adoption market in English Composition, Wood
& Wood's Mastering World Psychologythe US and Jones & Wood's Created Equaltesting sales were up more than 20% as the business made significant market share gains and benefited from mandatory state testing in American
History. The usethe US under No Child Left Behind. In the Professional business sales increased 4%, with testing sales ahead of technology continues to distinguish our learning programs,
with almost one million students now following their courses through our
paid-for online sites, an increase of 30% on last year and a further 1.4
million using our free online services. Our market-leading custom publishing
business, which creates personalized textbook and online packages for individual
professors and faculties, grew revenuesfollowing the successful start-up of major new contracts. Worldwide sales of technology-related books were again lower than the previous year although weakness in the professional markets was partly offset by 35%, with sales exceeding $100m for
the first time. Outside the US, our Higher Education imprints saw strong growth in key markets including Europe consumer technology publishing.
      The FT Group sales were 7% in 2005 ahead of 2004. FT Publishing sales were up by 4% driven by higher advertising revenues at theFinancial Timesand Canada, solid local publishing and the
introduction of our custom publishing model.

     Sales and results from operationsIDC sales were significantly lower in our
Professional business, causedup by both the absence of the prior10% with organic growth at all its businesses aided by a full year contribution from the TSA contract and the further current year close out costs, together
with the impact of the weakening US dollar. Sales decreased by L281 million, to
L503 millionFutureSource, acquired in 2003, from L784 million in 2002. Results from operations
decreased by L43 million, to L38 million in 2003, from L81 million in 2002. The
$151 million receivable previously reported as outstanding from the TSA contract
remains unpaid.
                                        23


Like many federal government contracts, this is the subject of a government
audit. The audit is continuing, we are providing back-up information to support
its completion, and we are in discussions with the TSA about the audit and
payment. We currently expect this process to be completed inSeptember 2004, and that we
will receive payment of the $151 million, although the timing of the receipt of
the receivable remains uncertain. TSA apart, our Government Solutions business
grew by 39%, benefiting from new contracts with the Department of Health and the
USAC. The Professional Testing business, which had revenues of approximately
$100 million in 2003, 51% higher than in 2002 excluding TSA, won more than $600
million of new long-term contracts. These include testing learner drivers for
the UK's Driving Standards Agency, business school applicants for the Graduate
Management Admissions Test and securities professionals for the National
Association of Securities Dealers. In 2004 we will invest in the expansion of
our international network of testing centers to support these contracts, from
which we expect to generate significant revenue and profit growth from 2005. Our
worldwide technology publishing operations maintained margins despite a drop in
revenues. After a severe three-year technology recession, in which our
publishing revenues have fallen by 36%, the rate of decline now appears to be
slowing, particularly in the US.

FT Group

     Sales at the FT Group increased L31 million or 4%, from L726 million in
2002 to L757 million in 2003 and results from operations increased by L6
million, or 8%, from L80 million in 2002 to L86 million in 2003. The main
contributors to the sales increase were Interactive Data and Recoletos.
Interactive Data posted a 10% sales increase despite the negative impact of
exchange as it benefited from the acquisition of ComStock, in February 2003.
Recoletos sales growth resulted primarily from the strength of the euro, asUS dollar. Penguin’s sales grew by 2% with successful format innovation helping to offset the
reported growth in sales of 14% would have been only 4 % if the average rate for
the euro in 2002 had prevailed in 2003. For our business newspapers, 2003 was
the third year of a corporate advertising recession which has seen advertising
volumes at the Financial Times fall almost two-thirds since their peak in 2000.
To compensate for this, we have reduced the FT's cost base by more than L100
million over the same period.

     Results from operations at the Financial Times ("FT") decreased by L9
million over 2002 as advertising revenues fell by L23m and we invested some L10m
in the newspaper's continued expansion around the world. Advertising revenues
were down 15% as industry conditions remained tough for the FT's key advertising
categories of corporate finance, technology and business to business. The
advertising declines were significantly worse immediately before and during the
war in Iraq, but the rate of decline began to slow towards the end of the year,
helped by growth in US, online and recruitment advertising. The newspaper's
circulation in the six months ended January 31, 2004 was 433,000, 4% lower than
in the same period last year, although FT.com's subscribers are some 50% higher
at 74,000. The launch of our Asian edition in September 2003 completed the FT's
global network of four regional newspaper editions, backed up by a single
editorial, commercial and technology infrastructure and by FT.com.

     Results from operations at Les Echos decreased from 2002, reflecting
continuing declines in advertising revenues and investment in the newspaper's
relaunch. Average circulation for the year was down 4% to 116,400, but the
September 2003 relaunch generated a positive response, with newsstand sales in
the final quarter up 4% against a market decline of 6%. Despite a continued
decline in the advertising market, FT Business posted profit growth, due to
tight cost management.

     Results from operations at the FT's associates and joint ventures showed a
profit of L3 million (L6 million loss in 2002) with good progress at FT
Deutschland, our joint venture with Gruner + Jahr, and at the Economist Group,
in which Pearson owns a 50% interest. FT Deutschland's average circulation for
2003 was 92,000, an increase of 9% on the previous year and advertising revenues
increased in a declining market. The Economist Group increased its results from
operations despite further revenue declines, reflecting additional measures to
reduce costs. The Economist's circulation growth continued, with average weekly
circulation 3% higher at 908,000.

     Sales at Recoletos, were up 4% (at constant exchange rates) as its consumer
titles, including sports newspaper Marca, performed strongly, more than
offsetting further advertising revenue decline at business

                                        24


newspaper Expansion. Results from operations were 3% lower as Recoletos invested
in existing and new titles. Average circulation at Marca increased 3% to
391,000, and at Expansion fell 3% to 46,000.

     Interactive Data grew its sales in a declining market for the fourth
consecutive year. Sales increased by 10% and results from operations increased
by 16%, despite continuing weakness in the market for financial services as
institutions focused on containing costs. The performance was helped by strong
institutional renewal rates, which continue to run at more than 95%, the
addition of new asset classes to its core pricing services, the successful
launch of new services and the acquisition of ComStock. Interactive Data
continued to extend its range of services by marketing new products such as the
Fair Value Information service, which has been installedmass-market category in many leading
financial institutions, as well as by enhancing existing products at CMS
BondEdge with a new credit risk module and at eSignal with increased
international exchange data. Interactive Data further enhanced its product
offering with the acquisition of ComStock's real-time market data services.

The Penguin Group

     The Penguin Group increased sales to L840 million in 2003 from L838 million
in 2002 and increased its results from operations to L91 million in 2003 from
L87 million in 2002. In the US, our largest market, accountingdown a further 4% for around
two-thirds of sales, our best ever schedule of new titles enabled Penguin to
grow ahead of the industry despite tough conditions for backlist publishing. In
the UK our backlist performed well, helped by the relaunch of Penguin Classics
and BBC's The Big Read.

     Penguin's best-selling books included Sue Monk Kidd's debut novel The
Secret Life of Bees (2.3 million copies sold), John Steinbeck's East of Eden
(1.5 million), Al Franken's Lies and the Lying Liars Who Tell Them (1.1
million), Scott Berg's Kate Remembered (0.5 million), Paul Burrell's A Royal
Duty (0.9 million), Madonna's The English Roses and Mr Peabody's Apples (1.2
million) and Michael Moore's Stupid White Men (0.8 million). Dorling Kindersley
faced a tough backlist market but benefited from three major new titles: America
24/7, Tom Peters' Re-Imagine! and an e-Encyclopaedia published in association
with Google.

     We increased spending on authors' advances as we invested in a number of
new imprints including Portfolio (business books), Gotham (non-fiction), and The
Penguin Press (non-fiction), which has already signed almost 100 authors,
including Alexandra Fuller, Ron Chernow and John Berendt. We signed new
multi-book deals with a number of our most successful authors including
Catherine Coulter and Nora Roberts, whose books have spent a total of 71 weeks
at number one on the New York Times bestseller list.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

CONSOLIDATED RESULTS OF OPERATIONS

Sales

     Our total sales increased by L95 million to L4,320 million in 2002, from
L4,225 million in 2001. The increase was mainly attributable to Pearson
Education and in particular to strong performances in our Professional division
and Higher Education division. The L152 million increase at Pearson Education
and an L18 million increase at The Penguin Group was partially offset by the
decline in FT Group revenues principally due the continuing advertising
downturn. Sales were also adversely affected by the strength of sterling
compared to the US dollar. We estimate that had the 2001 average rates prevailed
in 2002, sales would have been higher by L163 million.2005.
      Pearson Education, our largest business sector, accounted for 64%62% of our sales in 2002,2005, compared to 62%61% in 2001.2004. North America continued to be the most significant source of our sales andalthough sales from the region continue to increasethere decreased, as a proportion of total sales, accounting for 73% of our sales,to 64% in 2005, compared to 70%66% in 2001.

                                        25


Cost of Sales and Net Operating Expenses2004.
Cost of goods sold and net operating expenses
      The following table summarizes our cost of sales and net operating expenses:

                                                                 YEAR ENDED
                                                                DECEMBER 31
                                                              ----------------
                                                               2002      2001
                                                              ------    ------
                                                                LM        LM

COST OF SALES...............................................  (2,064)   (1,902)
                                                              ======    ======
Distribution costs..........................................    (233)     (233)
Administration and other expenses...........................  (1,888)   (2,136)
Other operating income......................................      59        66
                                                              ------    ------
NET OPERATING EXPENSES......................................  (2,062)   (2,303)
                                                              ======    ======

          
  Year ended
  December 31
   
  2005 2004
     
  £m £m
Cost of goods sold  1,787   1,631 
       
 Distribution costs  292   226 
 Administration and other expenses  1,351   1,340 
 Other operating income  (84)  (83)
       
Total  1,559   1,483 
       
34
Cost of Sales.  goods sold.Cost of sales consists of costs for raw materials, primarily paper, productionprinting costs, amortization of pre-publication costs and royalty charges. Our cost of sales increased by L162 million,£156m, or 9%10%, to L2,064 million£1,787m in 2002,2005, from L1,902 million£1,631m in 2001.2004. The increase partly reflectsmainly reflected the increase in sales over the period but
there was a reduction inso the overall gross margins as cost of sales as a percentage
of sales increased to 48% in 2002 from 45% in 2001. The main reason for the
deterioration in overall gross margins was the sales mix effect with Pearson
Education contributing more of our group sales in 2002 than in 2001 and FT Group
(which has generally higher margins than the rest of the group) contributing a
smaller proportion of group sales in 2002 compared to 2001.

     margin stayed constant at 53%.
Distribution Costs.Distribution costs consist primarily of shipping costs, postage and packing.

     packing and are typically a fairly constant percentage of sales.
Administration and other expenses.Our administration and other expenses reducedincreased by L248m,£11m, or 12%1%, to L1,888 million£1,351m in 2002,2005, from L2,136 million£1,340m in 2001. Administration and other expenses2004, although as a percentage of sales they decreased to 44%35% in 2002,2005, from 51%39% in 2001. Administration and other expenses2004. The increase in 2002
included a charge of L10 million in respect of the costs of the integration of
DK and NCS, goodwill amortization of L282 million and a charge for goodwill
impairment of L10 million. In 2001, administration and other costs comes principally from additional employee benefit expense, but cost savings and more modest increases in other administration expenses included a
charge of L74 million in respect of the integration of DK and NCS, goodwill
amortization of L292 million and a charge for goodwill impairment of L58
million. Goodwill amortization, impairment and integration costs are described
further in the following paragraphs. Excluding these charges in 2002 and 2001,
administration and other expenses were 37% of sales in 2002 comparedhave enabled overall operating margins to 41% in
2001. The improvement in 2002 was mainly due to the lower level of expenditure
on our internet enterprises.

     Total goodwill amortization, including that relating to associates (L48
million in 2002; L83 million in 2001) decreased by L45 million to L330 million
in 2002, from L375 million in 2001. The main reason for this decrease over last
year is reduced amortization from the RTL Group following its disposal at the
beginning of 2002. Goodwill is amortized over its estimated useful life, not
exceeding 20 years, and thus this charge is expected to continue for the
foreseeable future.

     A charge for goodwill impairment of L10 million was incurred in 2002 in
respect of a subsidiary of Recoletos in Argentina. In 2001, L50 million of the
total impairment charge of L61 million related to DK and a further L11 million
of goodwill impairments were taken in various other businesses (including L3
million relating to an associate).

     Integration costs included within administration and other expenses are
primarily the costs for consolidation of property and systems and redundancy
programs relating to significant recent acquisitions. In 2002 the total
integration cost was L10 million of which L3 million related to DK and L7
million to NCS. In 2001 these costs totaled L74 million of which L45 million
related to DK and L29 million to NCS.

     improve.
Other Operating Income.  operating income.Other operating income mainly consists of freight recharges, sub-rights and licensing income and distribution commissions. Other operating
income decreased
Other net gains and losses
      Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40m profit on the sale of our associate interest in MarketWatch. In 2004, other gains and losses amounted to L59 million in 2002 from L66 million in 2001£9m, with the decrease comingprincipal items being profits on the sale of stakes in Capella and Business.com.
Share of results of joint ventures and associates
      The contribution from our joint ventures and associates increased from £8m in 2004 to £14m in 2005. The increase was due to profit improvement at both Pearson EducationThe Economist Group and Penguin where distribution
commissions we receive for distributing third parties' books has declined.

                                        26


Operating Profit/Lossa reduction in losses at FT Deutschland.
Operating profit
      The total operating profit increased by £134m, or 35%, to £516m in 2002 of L143 million compares to a loss of
L47 million2005 from £382m in 2001.2004. This £134m or 35% increase was principally due to increases across all the businesses, the one-off gain from the sale of MarketWatch of £40m and a reduction in
internet losses, reduced goodwill amortization and impairment, and lower
integration costs, as well as strong performances from Pearson Education's
Higher Education business, The Penguin Group, Interactive Data and Recoletos.
Offsetting these increases has been a decline in profit from advertising and
technology related businesses, L30 millionbeneficial impact of back office consolidation costs
and an adverse impact from currency movements. In 2002 operating profit was
adversely affected by the weakening of the US dollar against sterling.exchange. We estimate that had the 20012004 average rates prevailed in 2002,2005, operating profit would have been L20 million greater.£12m lower.
      Operating profit attributable to Pearson Education increased by L92 million£58m, or 22%, to L75 million£323m in 2002,2005, from a loss of L17 million£265m in 2001.2004. The increase iswas due to a reduced charge for goodwillstrong sales and integration costsimproved margins in both the School and the reduction in
internet losses, with increases in the Higher Education businesses and reduced
losses at FT Knowledge being offset by a shortfall in the School businesses. Operating profit attributable to the FT Group increased by L3 million£63m, or 90%, to L5
million£133m in 2002,2005, from L2 million£70m in 2001. The2004. £40m of the increase was largely due to reduced internet lossesthe profit from the sale of MarketWatch but there were also increases at IDC of £13m and strong performances from Interactive Data and
Recoletos. The increase was partly offset by the continued declineFT Publishing of the
business advertising market, which has adversely affected all of the FT Group's
business newspapers.£10m. Operating profit attributable to the Penguin Group increased by L100
million£13m, or 28%, to L66 million£60m in 2002,2005, from a loss of L34 million£47m in 2001.2004. The main
reasons were the absence of the goodwill impairment charge of L50 millionincrease at Penguin was due in 2002part to increased efficiencies and a significant reductionimproved margins and also due to exchange gains and one-off items in integration charges. The return to
profitability of DK was also a contributor to the increase.

     In 2002 we reduced costs across the Group and especially in those areas
(such as business and financial newspapers and technology publishing) where we
suffered most in the global slowdown. At the same time we ensured that we
continued to invest in product development to sustain future revenue growth and
invested a further L30 million in new back office systems and processes that we
believe will improve our2004. Penguin’s operating profit in 2004 was reduced by costs associated with disruption in UK distribution following the future.

Non-operating Items

     Losses before taxation on the sale of fixed assets, investments, businessesmove to a new warehouse and associates were L37 million in 2002 compared to L128 million in 2001. In
2002 the principal items were a profit of L18 million on the sale of the RTL
Group in January 2002 and a provision of L40 million for the loss on sale of our
Forum business, which completed in January 2003. Other items include a loss on
sale of PH Direct of L8m, a profit of L3 million on finalization of the sale of
the Journal of Commerce by the Economist and various smaller losses on
investments and property. In 2001, the most significant items were L36 million
for our share of the loss on sale of the Journal of Commerce by the Economist
Group, a loss on the sale of iForum of L27 million, L17 million for our share of
the net loss on disposals by the RTL Group and the disposal or closure of
various smaller businesses and investments totaling L48 million. In 2001 we also
sold FT Energy and received net cash proceeds of L43 million, although there was
no significant profit and loss impact as the proceeds were equivalent to the
carrying value of the business sold.

Amounts Written Off Investments

     In 2002, we continued to review our fixed asset investments and concluded
that there were no material impairments. In 2001 we wrote off L92 million of our
fixed asset investments. This charge followed a thorough review of our fixed
asset investments, principally in the internet and new media arenas, as a result
of general economic conditions and stock market declines. We provided L55
million against these investments reflecting the higher of net realizable value
and value in use. The biggest items were L17 million for Business.com and L10
million for TimeCruiser. We also reviewed the carrying value of Pearson shares
held to secure employee share option plans created at the time of more buoyant
stock markets. Following a decline in our share price, we

                                        27


determined that the most appropriate course of action was to write down our
investment in own shares to the market price on December 31, 2001 resulting in a
charge of L37 million.

Net Finance Costscosts associated with Penguin TV.
Net finance costs
      Net finance costs consist primarily ofreduced from £79m in 2004 to £70m in 2005. Net interest payable in 2005 was £77m, up from £74m in 2004. The Group’s net interest expense relatedrate payable rose by 0.9% to 5.9%. Although we were partly protected by our borrowings. Our total like for like netfixed rate policy, the strong rise in US dollar floating interest payable, excluding the swap
cancellation fee discussed below, decreased by L75 million, or 44%, to L94
million in 2002, from L169 million in 2001. Our average net debt decreased by
L748 million from L2,639 million in 2001 to L1,891 million in 2002, while ourrates had an adverse effect. Year on year, end indebtedness decreased to L1,408 million in 2002 compared to L2,379
million in 2001. The decrease in net debt follows the receipt of proceeds from
the RTL Group disposal and improved cash flow from operations. The weighted average three month LIBOR rate, reflecting our(weighted for the Group’s borrowings in US dollars, euro and sterling, fellsterling) rose by 160 basis points, or 1.6%1.9% to 3.4%. TheThis was largely offset by the £260m fall in average net debt, reflecting in particular the proceeds from the disposal of Recoletos and good cash generation. In addition, in 2005 we did not benefit from a one-off credit of £9m for interest on a repayment of tax that occurred in 2004. As at January 1, 2005 we adopted IAS 39‘Financial Instruments: Recognition and Measurement’in our financial statements. This has had the effect of these falls was
mitigatedintroducing increased volatility into the net finance cost and in 2005 the
35
adoption of IAS 39 reduced net finance costs by our existing portfolio of interest rate swaps, which converted over
half of our variable rate commercial paper and bank debt to a fixed rate basis.
As a result, our net interest rate payable averaged approximately 5.0% in 2002,
falling 1.4% from 2001. During 2002 we took an additional one off charge of L37
million for cancellation of certain swap contracts and the early repayment of
debt following the re-balancing of the group's debt portfolio on the receipt of
the RTL Group proceeds.£14m. For a more detailed discussion of our borrowings and interest expenses see "--“— Liquidity and Capital Resources --— Capital Resources"Resources” and "-- Borrowing"“— Borrowing” below and "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk”.
Taxation
      The overall taxation charge was L64 million in 2002, compared to a benefit
of L33 million in 2001. In 2002 the Group recorded a total pre-tax loss of L25
million but there was an overall tax charge for the year was £116m, representing a 26% rate on pre-tax profits of L64 million.£446m. This situation reflectscompares with a 2004 rate of 18% (or £55m on a pre-tax profit of £303m). In 2004, the tax charge reflected credits of £48m relating to previous years, a substantial element of which was non-recurring; adjustments relating to previous years in 2005 resulted in a credit of £18m. The 2005 rate benefited from the fact that there is only limited relief available for
goodwill amortization charged in the profit and loss account. The total tax
charge was reduced by a non-operating credit of L45 million attributable to the
resolution of the tax position on the disposal of the group's remaining interest
in BSkyB. In 2001 there was again only limited taxation relief available on
goodwill amortization and only limited taxation relief was recognized on
integration costs and losses from internet enterprises. Included in the tax
benefit in 2001 was L143 million attributable to settlement during the year of
the tax position on the BSkyB and Tussauds disposals which occurred in 1995 and
1998 respectively. The settlement resulted in the reversal of previously
established reserves.

Minority Interests

     Minority interests principally consisted of the public's 40% interest in
Interactive Data and the public's 21% interest in Recoletos.

Loss for the Financial Year

     The loss for the financial year after taxation and equity minority
interests in 2002 was L111 million compared to a loss in 2001 of L423 million.
The decrease in the loss of L312 million was due to the increase in operating
profit including reduced internet losses, goodwill amortization and impairment
and integration costs. There was also a significant reduction in amounts written
off investments and losses£40m on the sale of fixed assets, investments, businessesMarketwatch.com was free of tax.
Minority interests
      Following the disposal of our 79% holding in Recoletos in April 2005 and associatesthe purchase of the 25% minority stake in 2002Edexcel in February 2005, our minority interests now mainly comprise the 39% minority share in IDC.
Discontinued operations
      Following the announcement of the disposal of Government Solutions in December 2006, the results of the Pearson Government Solution business have been reclassified as discontinued in 2005 and 2004. The results for the year ended December 31, 2005 included an operating profit of £20m with a corresponding operating profit of £22m in 2004. The results of Recoletos have been consolidated for the period up to February 28, 2005 and included in discontinued operations in 2005 and 2004. The results for 2005 include an operating loss for the two months to February 28, 2005 of £3m compared to 2001an operating profit in the full year to December 31, 2004 of £26m. The pre-tax profit on disposal of Recoletos reported in 2005 was £306m.
Profit for the year
      The total profit for the year in 2005 was £644m compared to a profit in 2004 of £284m. The overall increase of £360m was mainly due to the profit on disposal of Recoletos and reduced finance charges which more
than made up for anMarketWatch together with significant improvement in operating profits reported across all the Pearson businesses. These increases were only partially offset by the increase in the tax charge in 2002.

Loss Per Ordinary Share2005.
Earnings per ordinary share
      The lossbasic earnings per ordinary share, which is defined as the lossprofit for the year divided by the weighted average number of shares in issue, was 13.9 pence78.2p in 20022005 compared to 53.2 pence32.9p in 20012004 based on a weighted average number of shares in issue of 796.3797.9 million in 20022005 and 795.4795.6 million in 2001.2004. This increase in earnings per share was due to the decrease in the overall lossadditional profit for the financial year described above and was not significantly affected by the increasemovement in the weighted average number of shares.

                                        28


     In 2002
      The diluted earnings per ordinary share of 78.1p in 2005 and 2001,32.9p in 2004 was not significantly different from the Group made a loss for the financial year andbasic earnings per share in those years as the effect of dilutive share options is anti-dilutive and therefore a diluted loss per share
iswas again not shown.

Exchange Rate Fluctuationssignificant.
Exchange rate fluctuations
      The weakeningstrengthening of the US dollar against sterling on an average basis had a negativepositive impact on reported sales and profits in 20022005 compared to 2001.2004. We estimate that if the 20012004 average rates had prevailed in 2002,2005, sales would have been higherlower by L163 million£43m and operating profit would have been higherlower by L20
million.£12m. See "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk” for a discussion regarding our management of exchange rate risks.

SALES AND OPERATING PROFIT BY DIVISION
36
Sales and operating profit by division
      The following table summarizestables summarize our sales and operating profit and results from
operations for each of Pearson'sPearson’s divisions. 

                                                                YEAR ENDED DECEMBER 31
                                                              --------------------------
                                                                 2002           2001
                                                              -----------    -----------
                                                               LM      %      LM      %

OPERATING PROFIT
Pearson Education...........................................    75     51     (17)    --
FT Group....................................................     5      4       2     --
The Penguin Group...........................................    66     45     (34)    --
                                                              ----    ---    ----    ---
CONTINUING OPERATIONS.......................................   146    100     (49)    --
                                                              ====    ===    ====    ===
COMPRISED OF:
GOODWILL AMORTIZATION
Pearson Education...........................................  (244)          (254)
FT Group....................................................   (65)           (67)
The Penguin Group...........................................   (18)           (19)
                                                              ----           ----
CONTINUING OPERATIONS.......................................  (327)          (340)
                                                              ====           ====
GOODWILL IMPAIRMENT
Pearson Education...........................................    --             (8)
FT Group....................................................   (10)            (3)
The Penguin Group...........................................    --            (50)
                                                              ----           ----
CONTINUING OPERATIONS.......................................   (10)           (61)
                                                              ====           ====
INTEGRATION COSTS
Pearson Education...........................................    (7)           (29)
FT Group....................................................    --             --
The Penguin Group...........................................    (3)           (45)
                                                              ----           ----
CONTINUING OPERATIONS.......................................   (10)           (74)
                                                              ====           ====
RESULTS FROM OPERATIONS
Pearson Education...........................................   326     66     274     64
FT Group....................................................    80     16      72     17
The Penguin Group...........................................    87     18      80     19
                                                              ----    ---    ----    ---
CONTINUING OPERATIONS.......................................   493    100     426    100
                                                              ====    ===    ====    ===



- ---------------

(1)  Discontinued operations contributed Lnil toAdjusted operating profit is a non-GAAP measure and is included as it is a losskey financial measure used by management to evaluate performance and allocate resources to business segments, as reported under FAS 131. See also note 2 of L3 million“Item 17. Financial Statements”.
      In our adjusted operating profit we have excluded amortization and adjustment of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization and adjustment of acquired intangibles is the amortization or subsequent impairment of intangible assets acquired through business combinations. The charge is not considered to results frombe fully reflective of the underlying performance of the Group. Other gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and investments that are included within continuing operations in 2002. The equivalent figures in
     2001 were profitsbut which distort the performance for the year.
      Adjusted operating profit enables management to more easily track the underlying operational performance of L2 million and L37 million respectively. See Note 2.

                                        29


Pearson Education

     Pearson Education's sales increased by L152 million, or 6%,the Group. A reconciliation of operating profit to L2,756
million in 2002 from L2,604 million in 2001, principally due to the sales from
our Professional business and its contract with the newly-formed TSA to recruit
64,000 security personnel for US airports. The contract was awarded in March
2002 and was substantially complete by the end of December 2002. Pearson
Education's 2002 sales comprised 64% of Pearson's total sales. Results from
operations increased by L52 million or 19% from L274 million in 2001 to L326
million in 2002. The increase can be attributed to the reduction in internet
losses with increasesadjusted operating profit is included in the Higher Education businesses and reduced losses at
FT Knowledge being offset by a shortfall in thetables below:
                             
  Year ended December 31, 2005
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,295   779   301   332   297   804   3,808 
   34%   20%   8%   9%   8%   21%   100% 
Total operating profit  142   156   25   58   75   60   516 
   28%   30%   5%   11%   14%   12%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  5   —   —   1   5   —   11 
Other net gains and losses including associates  —   —   —   (40)  —   —   (40)
Other net finance costs of associates  —   —   —   2   —   —   2 
                      
Adjusted operating profit:                            
continuing operations  147   156   25   21   80   60   489 
Adjusted operating profit:                            
discontinued operations  —   —   20   (3)  —   —   17 
                      
Total adjusted operating profit  147   156   45   18   80   60   506 
                      
   29%   31%   9%   3%   16%   12%   100% 
37
                             
  Year ended December 31, 2004
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,087   729   290   318   269   786   3,479 
   31%   21%   8%   9%   8%   23%   100% 
Total operating profit  112   133   20   8   62   47   382 
   29%   35%   5%   2%   16%   13%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  —   —   —   —   5   —   5 
Other net gains and losses including associates  (4)  (4)  (2)  (4)  —   5   (9)
Other net finance costs of associates  —   —   —   —   —   —   — 
                      
Adjusted operating profit:                            
continuing operations  108   129   18   4   67   52   378 
Adjusted operating profit:                            
discontinued operations  —   —   22   26   —   —   48 
                      
Total adjusted operating profit  108   129   40   30   67   52   426 
                      
   25%   30%   9%   7%   16%   13%   100% 
School
      School businesses and L20m of
back office consolidation costs.

     The School business sales decreased by L115 million, or 9%, to L1,151
million in 2002, from L1,266 million in 2001. In the US in 2002, our school
publishing revenues were affected by a slower adoption cycle than in 2001 and
our decision to compete in fewer adoptions in 2002. Overall our share of the US
school publishing market fell to 24.0% in 2002 compared to 24.5% in 2001. US
school testing revenues increased in 2002 but were offset by a decline in
revenues from the school software business primarily due to the deferral of a
number of contracts into 2003. Results from operations for the school business
decreased by L27 million or 16%, to L140 million in 2002 from L167 million in
2001. The decrease reflects the decline in sales and the fact that testing
revenues (with lower than average margins) made up for some of the shortfall in
publishing.

     The Higher Education business sales increased by L54£208m, or 19%, to £1,295m in 2005, from £1,087m in 2004 and adjusted operating profit increased by £39m, or 36%, to £147m in 2005 from £108m in 2004. The School results in 2005 benefit from the inclusion of AGS Publishing, acquired in July 2005 and the strengthening of the US dollar, which we estimate added £12m to sales and £2m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      In the US school market, Pearson’s school publishing business grew 12% ahead of the Association of American Publishers’ estimate of industry growth of 10.5%. New adoption market share was 33% in the adoptions where Pearson competed (and 24% of the total new adoption market). The School business now has leading positions in math, science, literature and foreign languages. School testing sales were up more than 20%, benefiting from significant market share gains and mandatory state testing under No Child Left Behind. School software also had a strong year with good sales and profit growth on curriculum and school administration services.
      Outside the US, the School publishing sales increased in high single digits. The worldwide English Language Teaching business benefited from strong demand for English language learning and investments in new products, includingEnglish Adventure(with Disney) for the primary school market,Skyfor secondary schools,Total Englishfor adult learners andIntelligent Business (withThe Economist) for the business markets. There was also strong growth in the international school testing markets. Four million UK GCSE, AS and A-Level scripts were marked onscreen and 2005 saw the first year of running the UK National Curriculum tests and a new contract for a national school testing pilot in Australia.
      School margins were up by 1.5% points to 11.4% with efficiency gains in central costs, production, distribution and software development.
Higher Education
      Sales in Higher Education increased by £50m, or 7%, to L775 million£779m in 2002,2005, from L721 million£729m in 2001. This increase2004. Adjusted operating profit increased by £27m, or 21%, to £156m in 2005 from £129m in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £14m to sales and £3m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
38
      In the US, the Higher Education sales were up by 6% ahead of the Association of American Publishers’ estimate of industry growth of 5%. 2005 is attributable
to a general increasethe seventh consecutive year that Pearson’s US Higher Education business has grown faster than the industry. The US business benefited from continued growth from market-leading authors in key academic disciplines including biology (Campbell & Reece), chemistry (Brown & LeMay), sociology (Macionis), marketing (Kotler & Keller), math (Tobey & Slater), developmental math (Martin-Gay) and English composition (Faigley’sPenguin Handbook). There was also expansion in the career and workforce education sector, with major publishing initiatives gaining market share in allied health, criminal justice, paralegal, homeland security and hospitality. The online learning and custom publishing businesses saw rapid growth. Approximately 3.6 million US college populationstudents are studying through one of our online programs, an increase of 20% on 2004; and our taking a greater share
of the overall market in 2002. The business also continued to benefit from its
lead in makingcustom publishing, which builds customized textbooks and online services an integral partaround the courses of its products. Theindividual faculties or professors, had double digit sales growth.
      International Higher Education publishing sales grew by 4%, benefiting from the local adaptation of global authors, including Campbell and Kotler, and the introduction of custom publishing business, which produces text books and course materials custom-made
for individual college professors continued its rapid growth. On a geographical
basis, salesonline learning capabilities into new markets in 2002Asia and the Middle East.
      Higher Education margins were particularly strongup by 2.3% points to 20%. Good margin improvement in the US and Europe. Results from
operationsin international publishing was helped by shared services and savings in central costs, technology, production and manufacturing.
Professional
      Professional sales (excluding discontinued businesses) increased by L15 million£11m, or 12%4%, to £301m in 2005 from L127 million£290m in 20012004. Adjusted operating profit increased by £7m, or 39%, to L142
million£25m in 2002.2005, from £18m in 2004. Sales benefited from the strengthening US dollar, which we estimate added £5m to sales when compared to the equivalent figures at constant 2004 exchange rates.
      Professional testing sales were up more than 40% in 2005 benefiting from the successful start-up of major new contracts including the Driving Standards Agency, National Association of Securities Dealers and the Graduate Management Admissions Council.
      Overall margins in the Professional business were a little lower in 2005 compared to 2004 mainly due to new contract start-up costs. Margins in the Professional publishing businesses were maintained despite falling sales.
FT Publishing
      Sales at FT Publishing (excluding discontinued businesses) increased by L226 million,£14m or 41%4%, from £318m in 2004 to L784 million£332m in 2002, from L558 million in 2001. Results from operations2005. Adjusted operating profit increased by L1 million or 1%,£17m, from £4m in 2004 to L81 million£21m in 2002,2005. Much of the sales and profit increase was at the FT newspaper; sales at the other business newspapers were broadly level with 2004 with a small increase in adjusted operating profit compared to 2004.
      FT newspaper sales were up 6% while adjusted operating profit increased £14m to register a profit of £2m in 2005 compared to a loss of £12m in 2004. FT advertising revenues were up 9% for the year with sustained growth in luxury goods and worldwide display advertising. FT.com advertising sales were up 27% as some of the FT’s biggest advertisers shifted to integrated print and online advertising. The FT’s worldwide circulation was 2% lower for the year at 426,453 average copies per day although the second half of the year showed improvement to 430,635 average copies per day. FT.com’s paying subscribers increased by 12% to 84,000 and the average unique monthly users was up 7% to 3.2m.
      Les Echos advertising and circulation revenues for 2005 were level with 2004 despite tough trading conditions. FT Business improved margins with growth in its international finance titles. Our share of the results of the FT’s joint ventures and associates improved asFT Deutschlandreduced its losses and increased its average circulation despite a weak advertising market in Germany andThe Economistincreased profits helped by an increase in circulation (10% to an average weekly circulation of 1,038,519 for the January-June ABC period).
39
Interactive Data
      Interactive Data, grew its sales by 10% from L80 million£269m in 2001.
A major investment2004 to £297m in 200 professional certification centers across2005. Adjusted operating profit grew by 19% from £67m in 2004 to £80m in 2005. Both sales and adjusted operating profit benefited from the strengthening US dollar, which we estimate added £2m to sales and £1m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      FT Interactive Data, IDC’s largest business (approximately two-thirds of IDC revenues) generated strong growth in North America and returned to growth in Europe. There was more modest growth at Comstock, IDC’s business providing real-time data for global financial institutions, and at CMS BondEdge, its fixed income analytics business. Renewal rates for IDC’s institutional businesses remain at around 95%. eSignal, IDC’s active trader services business, increased sales by 27% with continued growth in the subscriber base and a full year contribution from FutureSource, acquired in September 2004.
The Penguin Group
      The Penguin Group sales were up 2% to £804m in 2005 from £786m in 2004 and adjusted operating profit up 15% to £60m in 2005 from £52m in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £9m to sales and £6m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates. 2005 adjusted operating profit also benefited from reduced operating costs at our UK distribution center.
      In the US, (which opened for businesssuccessful format innovation helped to address weakness in the fourth quarter of 2002), along withmass-market category that saw a further decline of 4% for the industry in our higher-margin technology publishing businesses particularly2005. The first seven Penguin Premium paperbacks were published in 2005, priced at $9.99, and all became bestsellers, with authors including Nora Roberts, Clive Cussler and Catherine Coulter.
      Penguin authors received a number of awards during the year: A Pulitzer Prize (for Steve Coll’sGhost Wars), a National Book Award (William T. Vollman’sEurope Central), the Whitbread Book of the Year (Hilary Spurling’sMatisse the Master), the Whitbread Novel of the Year (Ali Smith’sThe Accidental) and the FT & Goldman Sachs Business Book of the Year Award (Thomas Friedman’sThe World is Flat). In 2005, there were 129 New York Times bestsellers and 54 top 10 bestsellers in the UK. Major bestselling authors include Patricia Cornwell, John Berendt, Sue Grafton, Jared Diamond, Jamie Oliver, Gillian McKeith, Jeremy Clarkson and Gloria Hunniford.
      In 2005, there was also a strong contribution from new imprints and first-time authors. The new imprint strategy continued to gather pace and Penguin published more than 150 new authors in the US and Europe, meant that profits grew considerably slower than revenues. In
the US, revenues were significantly higher thanapproximately 250 worldwide — its largest ever investment in 2001 principally due to the
contract with the TSA. This contract involved creatingnew talent. Sue Monk Kidd’s first novel,The Secret Life of Bees, has been a qualification,
assessment, staffing and placement system for 64,000 security screeners at over
400 airports in the US. In addition the contract provided human resource
services for airport security screeners, law enforcement officers and other TSA
personnel in compliance with federal law, regulation and policy allowing the TSA
to meet or exceed dated mandates or other legislative requirements. The contract
was awarded in March 2002 and was substantially complete by the end of December
2002. Gross billings under this contract in 2002 were L435 million ($700
million) of which L180 million ($290 million) was pass through costs recharged
directly to the TSA and not recognized as revenue in our financial statements.
Of the remaining L255 million ($410 million) of revenue recognized over L186
million ($300 million) was attributable to our Government Solutions business
with the balance being earned by the Assessments and Testing business.

     Industry conditions for FT Knowledge were particularly tough as major
corporations continued to cut back their training budgets. Sales at FT Knowledge
were down by L13 million, or 22%, to L46 million in 2002, from L59 million in
2001. Losses from operations were reduced by L11 million from L23 million in
2001 to L12 million in 2002 as we scaled back this business. In January 2003 we
sold the Forum business, a significant part of FT Knowledge.

FT Group

     Sales in the FT Group decreased by L75 million, or 9%, to L726 million in
2002, from L801 million in 2001. The decline in sales at the newspaper
businesses was principally due to lower advertising revenue. Sales were down in
each of the FT Group businesses except Interactive Data where sales were up by
L13 million or 6% from 2001.
                                        30


     The FT Group's results from operations increased by L8 million, or 11%, to
L80 million in 2002, from L72 million in 2001. The increase was in spite of the
significant reduction in revenue and was due to profit growth at Interactive
Data and Recoletos, successful cost reduction programs across the group, and
sharply lower internet losses of L34 million down from L60 million in 2001.
Excluding the benefit of lower internet losses the FT Group's profit declined by
L18 million or 14%.

     Sales at the Financial Times newspaper decreased by L47 million, or 19%, to
L224 million in 2002, from L271 million in 2001. Results from operations
declined by L18 million to a loss of L23 million in 2002, from a loss of L5
million in 2001. Industry conditions remained difficult for the FT's major
advertising categories, including financial services, technology and business to
business. Advertising volumes fell by 24% (on top of a 29% fall in 2001) The
average daily circulation for the newspaper in December 2002 was 473,587, 6%
lower than the equivalent period in 2001. Most of this decline was in the UK.

     Other FT Publishing businesses (Les Echos and FT Business) saw revenues
decline by L36 million, or 26%, in total from L141 million in 2001 to L105
million in 2002. Results from operations declined by L6 million, or 38%, from
L16 million in 2001 to L10 million in 2002. Les Echos saw advertising revenues
fall sharply and average daily circulation was 121,000 a 6% decline on 2001 but
well ahead of the decline in the overall market. FT Business saw falls in both
sales and profits even though its major titles Investors Chronicle, The Banker
and Financial Advisor all strengthened their market positions in 2002.

     Joint ventures and associate losses from operations within the FT Group
decreased by L16 million, or 73%, to an overall loss of L6 million in 2002, from
a loss of L22 million in 2001. FT Deutschland, our joint venture with Gruner +
Jahr, grew its advertising revenues slightly, in spite of a tough German
advertising market, and increased its circulation revenues by 14% to an average
daily circulation of 89,000 at the end of 2002. The Economist Group, in which
Pearson owns a 50% interest, offset falling advertising revenues with tight cost
controls and worldwide circulation grew by 6% to 881,259 in 2002.

     Sales at Recoletos decreased by L5 million, or 3%, to L148 million in 2002,
from L153 million in 2001. Results from operations increased by L11 million, or
61%, to L29 million in 2002, from L18 million in 2001. This increase was
primarily due to actions taken in 2001 to reduce costs and reduced internet
losses in 2002. After a successful re-launch Marca, Spain's leading sports
newspaper grew its circulation by 2% to 382,000 and increased advertising
revenues and profits. Circulation at business newspaper Expansion was 9% lower
and advertising revenues were 25% lower.

     Sales at Interactive Data increased by L13 million, or 6%, to L249 million
in 2002, from L236 million in 2001. Results from operations increased by L5
million, or 8%, to L70 million in 2002, from L65 million in 2001. Contract
renewal rates in Interactive Data's institutional business (which accounts for
approximately 90% of revenues) ran at 95%. Interactive Data also benefited from
increased adoption of evaluation services, the launch of several new products
and the acquisition of the Securities Pricing Services business from Merrill
Lynch in January 2002.

The Penguin Group

     Sales at The Penguin Group increased by L18 million, or 2%, to L838 million
in 2002, from L820 million in 2001. In the US Penguin published 24 titles that
became New York Times bestseller for almost two years; her second,The Mermaid Chair, reached number one bestsellers, more than any other publisher and
a 25% increase from 2001.in 2005.The Kite Runner, Khaled Hosseini’s first book, stayed on the New York Times bestseller list for all of 2005, selling an additional two million copies (three million in total). In the UK, Penguin posted its best performance on the
bestseller lists for a decade as 45 titles reached the Nielsen Bookscan top 15,
a 10% increase on 2001. Thisthere was also strong performance helped Penguin gain market share
in both the USfrom new fiction authors including Jilliane Hoffman, PJ Tracy, Karen Joy Fowler and UK.

     The Penguin Group's results from operations increased by L7 million, or 9%,
to L87 million in 2002, from L80 million in 2001. The increase was primarily due
to Dorling Kindersley, whose profits increased by L15 million as it benefited
from its integration with Penguin. The increase in profits at DK was partially
offset by a L10 million investment in consolidatingMarina Lewycka.
Liquidity and improving back office
systems and processes.

                                        31


DISCONTINUED OPERATIONS

     On December 24, 2001, we announced the disposal of our 22% stake in the
television business, RTL Group. The sale was completed on January 30, 2002 for
cash proceeds of E1.5 billion and the results of the television business have
now been shown in discontinued operations. RTL Group was included in our results
as an associate, rather than a subsidiary and only our share of profit before
interest, net interest and taxation is reflected in our financial results. Our
stake in RTL Group resulted in an operating loss of L3 million in 2002 compared
to a profit of L2 million in 2001. The 2002 figures include only the results up
to the date of disposal in January 2002.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS AND FINANCINGcapital resources
Cash flows and financing
      Net cash inflow from operating activities decreased by L170 million,£32m, or 32%5%, to L359 million£621m in 2003,2006, from L529 million£653m in 2002. The main reasons for
this decrease were2005. This reduction was entirely due to the TSA contract where we incurred additional close-out
expenditure (payment of TSA creditors) without receiving the $151 million
outstanding receivable, the concentration of the Penguin publishing schedule in
the fourth quarter which pushed cash collections from debtors into 2004, and the
weaknessweakening of the US dollar which reducedcompared to sterling. The majority of the valueGroup’s cash flows arise in US dollars, so any weakening of ourthe US dollar reduces the Group’s cash flows in sterling terms. The deteriorationclosing rate for translation of dollar cash flows was $1.96 in the cash impact from year-end2006 ($1.72 in 2005). Underlying working capital changes reflects the TSA contract and Penguin phasing effects discussed above.efficiency continued to improve. On an average basis, excluding the effect of the TSA contract, the working capital to sales ratio for our book publishing businesses improved slightly from 30.7%27.4% in 2005 to 30.6%. Compared to 2001, the26.3% in 2006. The net cash inflow from operating activities in 20022005 increased by L39 million,£129m, or 8%25%, to L529 million£653m from L490 million. This£524m in 2004, even though 2004 included receipt of a $151m receivable in respect of the TSA contract. Part of this increase was due to the strengthening of the US dollar during that period. The closing rate for translation of dollar cash flows was
40
$1.72 in 2005, compared to $1.92 in 2004. The improvement in cash flow from operating activities also reflected more efficient use of working capital. On an average basis, the reduced spending on internet enterprises partly offset by
increased spending on pensions and other post retirement benefits of some L50
million.working capital to sales ratio for our book publishing businesses improved from 29.4% in 2004 to 27.4% in 2005.
      Net interest paid was £82m in 2006 compared to £72m in 2005 and £85m in 2004. The 14% increase in 2006 over 2005 reflected the higher average debt resulting from the acquisitions made in the year and higher interest rates (particularly in the US). The 15% reduction in 2005 over 2004 was primarily due to the reduced to L76 million in 2003 from L140 million in 2002
and L156 million in 2001 as the full year effectdebt following receipt of the 2002 debt repayment
usingproceeds from the proceedssale of the RTL Group sale flowed throughRecoletos and the L37 million of
swap close-out costs did not recur.

     In 2003 we again held capital expenditure below the level of depreciation
while continuing to upgrade our facilities and equipment.MarketWatch.
      Capital expenditure reducedon property, plant and equipment was £68m in 2005 compared to L105 million£76m in 2003 from L126 million2005 and £101m in 2002 and L165 million2004. The reduction in 2001. Capital2006 compared to 2005 is due to the movement in US dollar exchange rates. The higher expenditure in 2001 included costs associated with a warehouse
integration program at Pearson Education in New Jersey2004 reflected up-front expenditure on Professional testing contracts.
      The acquisition of subsidiaries, joint ventures and the capital costs of
consolidating various of our UK offices on one site in London. The purchase of
investmentsassociates accounted for a cash outflow of only L4 million£367m in 20032006 against L21
million£253m in 20022005 and L35 million£51m in 2001, as no additional investment2004. In 2006, the principal acquisition was madeof Mergermarket for £109m. The balance relates to various smaller bolt-on acquisitions (primarily in Pearson plc shares during 2003 to meet obligations under the executiveschool segment) including those of National Evaluation Systems and employee share plans.

     The acquisition of subsidiaries accounted for a cash outflow of L94 million
in 2003 against L87 million in 2002 and L128 million in 2001.Paravia Bruno Mondadori. The principal acquisitions in 20032005 were of ComStockAGS for £161m within the School business and IS. Teledata for £29m by Interactive Data. The principal acquisitions in 2004 were of KAT and Dominie Press for £10m within our education businesses and FutureSource by Interactive Data for net cash of L68
million and 75% of London Qualifications by Pearson Education for net cash of
L16 million. The largest acquisition in 2002 was the purchase of Merrill Lynch's
Securities Pricing Services by Interactive Data for net cash of L30 million. The
largest item in 2001 was a L30 million payment of deferred consideration
relating to the acquisition of Forum in 1999.£9m. The sale of subsidiaries and associates produced a cash inflow of L53 million£10m in 20032006 against L923 million£430m in 20022005 and L42 million£31m in 2001.2004. The disposal in 2006 relates entirely to the proceeds from the take-up of share options issued to minority shareholders. The principal disposaldisposals in 2003 was the sale2005 were of Unedisa by Recoletos. Virtually all theRecoletos for net cash proceeds of £371m and MarketWatch for net cash proceeds of £54m. The proceeds in 20022004 relate primarily to the sale of the RTL Group and most of the proceeds in 2001 to the sale of FT Energy.Argentaria Cartera by Recoletos.
      The cash inflowoutflow from financing of L65 million largely£348m in 2006 primarily reflects the issue inpayment of the year ofGroup dividend (at a $300 million bond as we took advantage of favorable market
conditions, offset byhigher dividend per share than 2005) and the repayment of a E250 million bond.$250m bond at its maturity date. The cash outflow from financing of L663
million£321m in 2002 was due2005 reflects the improved Group dividend (compared to 2004) and the repayment of loansbank borrowings following the sale of Recoletos. The cash outflow from financing of £261m in 2004 reflects the payment of the Group dividend and bonds usingthe repayment of one€550m bond offset by the proceeds from the sale of RTL Group. The 2001 inflow of L2 million reflects the issue of $500 millionnew $350m and E250 million bonds offset by the repayment of loan facilities.$400m bonds. Bonds are issued as part of our overall financing program to support general corporate expenditure.

                                        32


CAPITAL RESOURCES
Capital resources
      Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements ofin the educational bookmaterials business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December. Based on a review of historical trends in working capital requirements and of forecast monthly balance sheets for the next 12 months, we believe that we have sufficient funds available for the Group’s present requirements, with an appropriate level of headroom given our portfolio of businesses and current plans. Our ability to expand and grow our business in accordance with current plans and to meet long-term capital requirements beyond this 12-month period will depend on many factors, including the rate, if any, at which our cash flow increases and the availability of public and private debt and equity financing, including our ability to secure bank lines of credit. We cannot be certain that additional financing, if required, will be available on terms favorable to us, if at all.
      At December 31, 2003,2006, our net debt (excluding finance leases) was L1,361
million£1,059m compared to net debt of L1,408 million£996m at December 31, 2002.2005. Net debt is defined as all short-term, medium-term and long-term borrowing (including finance leases), less all cash and liquid resources. Liquid resources comprise short-term deposits of less than
one year90 days and investments that are readily realizable and held on a short-term basis. Short-term, medium-term and long-term borrowing amounted to L1,922
million£1,743m at December 31, 2003,2006, compared to L1,983 million£1,959m at December 31, 2002.2005. At December 31, 2003,2006, cash and liquid resources were L561 million,£592m, compared to L575 million£902m at December 31, 2002.2005. Some of the cash at December 31, 2006 was being held to fund a€591m bond repayment due on February 1, 2007.
41
Contractual obligations
      The following table summarizes the maturity of our borrowings and our obligations under non-cancelable operating leases.

                                                                AT DECEMBER 31, 2003
                                                 --------------------------------------------------
                                                                                    TWO TO    AFTER
                                                          LESS THAN     ONE TO       FIVE     FIVE
                                                 TOTAL    ONE YEAR     TWO YEARS    YEARS     YEARS
                                                 -----    ---------    ---------    ------    -----
                                                  LM         LM           LM          LM       LM

Gross borrowings:
  Bank loans, overdrafts and commercial
     paper.....................................    204       119           85         --         --
  Variable rate loan notes.....................     --        --           --         --         --
  Bonds........................................  1,718       456           --        582        680
Lease obligations..............................  1,073       119          109        251        594
                                                 -----       ---          ---        ---      -----
TOTAL..........................................  2,995       694          194        833      1,274
                                                 =====       ===          ===        ===      =====



     The group
                      
  At December 31, 2006
   
    Less than One to Two to After five
  Total one year two years five years years
           
  £m £m £m £m £m
Gross borrowings:                    
 Bank loans, overdrafts and commercial paper  173   173   —   —   — 
 Variable rate loan notes  —   —   —   —   — 
 Bonds  1,566   421   105   444   596 
Lease obligations  1,369   123   113   276   857 
                
Total
  3,108   717   218   720   1,453 
                
      At December 31, 2006 the Group had capital commitments for fixed assets, including finance leases already under contract, of L9 million.£nil (2005: £1m). There are contingent liabilities in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities in respect of legal claims. None of these claims or guarantees is expected to result in a material gain or loss.
      The Group is committed to a fee of 0.0675% per annum, payable quarterly in arrears on the unused amount of the Group’s bank facility.
Off-Balance sheet arrangements
      The Group does not have any off-balance sheet arrangements, as defined by the SEC Final Rule 67(FR-67), "Disclosure “Disclosure in Management'sManagement’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations"Obligations”, that have or are reasonably likely to have a material current or future effect on the Group'sGroup’s financial position or results of operations.

     The group is committed to a quarterly fee of 0.1875% on the unused amount
of the group's bank facility.

BORROWINGS
Borrowings
      We have in place a $1,850 million term$1.75bn revolving credit facility, which matures in July 2005.May 2011. At December 31, 2003,2006, approximately $1,701 million$1.75bn was available under this facility. This included allocations to refinance short-term borrowings not directly drawn under the facility. The credit facility contains two key covenants measured for each 12 month period ending June 30 and December 31:

                                        33

      We must maintain the ratio of our profit before interest and tax to our net interest payable at no less than 3:1; and
      We must maintain the ratio of our net debt to our EBITDA, which we explain below, at no more than 4:1.

     The covenants provide for the exclusion from the ratio calculations of
specified amounts of internet related expenditures. "EBITDA"
      “EBITDA” refers to earnings before interest, taxes, depreciation and amortization. We are currently in compliance with these covenants.

TREASURY POLICY
Treasury policy
      We hold financial instruments for two principal purposes: to finance our operations and to manage the interest rate and currency risks arising from our operations and from our sources of financing.
      We finance our operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets. We borrow principally in US dollars, sterling and euro at both floating and fixed rates of interest, using derivatives, where
42
appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally interest rate swaps, interest rate caps and collars, currency swaps and forward foreign exchange contracts. For a more detailed discussion of our borrowing and use of derivatives, see "Item“Item 11. Quantitative and Qualitative Disclosures About Market Risk"Risk”.

RELATED PARTIES
Related parties
      There were no significant or unusual related party transactions in 2003,
20022006, 2005 or 2001.2004. Refer to Note 30note 34 in “Item 17. Financial Statements”.
Accounting principles
      For a summary of the financial statements.

ACCOUNTING PRINCIPLES

     The following summarizes the principal differences between UK GAAPIFRS and US GAAP in respect of our financial statements. See Note 34 to our consolidated
financial statements appearing elsewhere in this Annual Report.

     Prior to January 1, 1998, under UK GAAP, goodwill was written off to the
profit and loss reserve in the year of acquisition. Underrecent US GAAP as well as UK
GAAP from January 1, 1998, goodwill is recognized as an asset and amortization
expense is recorded over useful lives ranging between 3 and 20 years. Under US
GAAP, goodwill arising from acquisitions completed subsequent to July 1, 2001 is
no longer amortized, however it is tested for impairment at the reporting unit
level at least annually or more frequently when a triggering event occurs. In
addition, amortization for all goodwill balances ceased as of January 1, 2002
under US GAAP. Intangible assets under UK GAAP are recognized only when they may
be disposed of without also disposing of the business to which they relate, and
for that reason it is rare that intangible assets are separately identified and
recorded apart from goodwill. Under US GAAP, there is no similar requirement
with respect to acquired intangible assets, and they should be recognized
separately from goodwill when they arise from separate contractual or legal
rights or can be separately identified and be sold, transferred, licensed,
rented or exchanged regardless of intent. Under US GAAP, intangible assets such
as publishing rights, non-compete agreements, software, databases, patents and
non-contractual customer relationships such as advertising relationships have
been recognized and are being amortized over a range of useful lives between 2
and 25 years. The difference in goodwill and intangible assets also creates a
difference in the gain or loss recognized on the disposal of a business due to
amortization expense taken with respect to the goodwill prior to adoption of
SFAS 142 and intangible assets, as UK GAAP requires that goodwill which had not
been capitalized and amortized be removed from the profit and loss reserve upon
disposal and factored into the gain or loss on disposal calculation.

     Under UK GAAP, the Group reviews the recoverability of goodwill where there
is a triggering event to indicate a potential impairment or where there has been
a previous impairment. These reviews are based on estimated discounted future
cash flows from operating activities compared with the carrying value of
goodwill, and any impairment is recognized on the basis of such comparison.
Under US GAAP, a two stage impairment test is required at least annually under
SFAS 142, which was adopted by the Group as of January 1, 2002. The Group
                                        34


performed the transitional impairment test under SFAS 142 by comparing the
carrying value of each reporting unit with its fair value as determined by
discounted future cash flows. The Group also completed the annual impairment
tests required by SFAS 142 at the end of both 2003 and 2002. For further detailsIFRS pronouncements refer to Note 34note 36 in "Item“Item 17. Financial Statements."

     Under UK GAAP, FRS 19, "Deferred Taxation", which was adopted for the year
ended December 31, 2002 requires a form of full provision to be made for
deferred taxes. Deferred taxes are to be accounted for on all timing differences
with deferred tax assets recognized to the extent that they are more likely than
not recoverable against future taxable profits. Deferred tax assets not
considered recoverable are adjusted for through a separate valuation allowance
in the balance sheet. Under US GAAP, deferred taxes are accounted for in
accordance with SFAS 109, "Accounting for Income Taxes" with a full provision
also made for deferred taxes on all timing differencesStatements”.
ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and a valuation allowance
established for the amount of the deferred tax assets not considered
recoverable. This is similar to the treatment required under FRS 19. The primary
differences relate to the deferred tax on intangible assets which are not
recorded under UK GAAP and changes in estimates in respect of deferred tax
balances relating to business combinations in prior years, which are required to
be adjusted against goodwill under US GAAP. Deferred tax may also arise in
relation to timing differences of other adjustments required under US GAAP.

     The disposal of our stake in RTL Group was announced on December 24, 2001
and the sale was completed on January 30, 2002 for E1.5 billion. Under UK GAAP
the sale gave rise to a small gain in 2002 and no entries were booked in the
2001 financial statements relating to the disposal. Under US GAAP the sale
realized a loss of L985 million principally due to the higher value of goodwill
capitalized in 2000. This loss was recognized under US GAAP in 2001.

     Under UK GAAP, there are no specific criteria which must be fulfilled in
order to record derivative contracts such as interest rate swaps, currency swaps
and forward currency contracts as a hedging instrument. Accordingly, based upon
our intention and stated policy with respect to entering into derivative
transactions, they have been recorded as hedging instruments for UK GAAP. This
means that unrealized gains and losses on these instruments are typically
deferred and recognized when realized. Under US GAAP, we have adopted SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities". During 2003,
2002 and 2001, our derivative contracts did not meet the prescribed criteria for
hedge accounting, and have been recorded at market value at each period end,
with changes in their fair value being recorded in the profit and loss account.

     Under UK GAAP, the cost of providing pension benefits is expensed over the
average expected useful service lives of eligible employees, using long-term
actuarial assumptions. Under US GAAP, the annual pension costs comprise the
estimated cost of benefits accruing in the period, and actuarial assumptions are
adjusted annually to reflect current market and economic conditions.
Additionally, under US GAAP, part of the difference between plan assets and plan
liabilities is recognized on the balance sheet. Unrecognized gains or losses are
spread over the employees' remaining service lifetimes.

     Under UK GAAP, no compensation costs associated with non-qualified stock
option plans are recognized if the value of the option at the date of grant is
equal to or greater than the market value on that date. Under US GAAP, we have
adopted the fair value method of accounting for options. Compensation expense is
determined based upon the fair value at the grant date, and has been estimated
using the Black Scholes model. Compensation cost is recognized over the service
life of the awards, which is normally equal to the vesting period. Compensation
expense is also recognized under US GAAP with respect to UK qualified non-
compensatory plans, such as the Save as You Earn option plan and the Worldwide
Save for Shares plan, as these plans offer employees a discount of greater than
15% of market value at the date of grant.

     For a further explanation of the differences between UK GAAP and US GAAP
see Note 34 to the consolidated financial statements.

RECENT U.S. ACCOUNTING PRONOUNCEMENTS

     In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". SFAS 150
improves the accounting for certain financial instruments that,

                                        35


under previous guidance, companies could only account for as equity and requires
that these instruments be classified as liabilities in statements of financial
position. The statement is effective prospectively for financial instruments
entered into or modified after May 31, 2003 and otherwise is effective for
pre-existing instruments as of January 1, 2004. These requirements currently
have no material effect on the financial position and results of the Group under
US GAAP.

     In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest
Entities -- an interpretation of ARB No. 51", which clarifies the application of
the consolidation rules to certain variable interest entities. In general, a
variable interest entity is a corporation, partnership, trust, or any other
legal structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns, or both. A revision (FIN 46R) was issued in December 2003 which
deferred the effective date for public companies to the end of the first
reporting period ending after March 15, 2004, except that all public companies
must, at a minimum, apply the provisions to entities that were previously
considered "special-purpose entities' by the end of the first reporting period
ending after December 15, 2003. The adoption of FIN 46R did not have any impact
on the financial position, cash flows or results of the Group under US GAAP as
at December 31, 2003 under the transitional arrangements. Currently the Group is
evaluating FIN 46R for transactions entered into prior to February 1, 2003 and
does not believe there will be any material impact upon full adoption in 2004.

     In November 2003, the EITF reached a final consensus on Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This EITF
provides guidance on when and how to separate elements of an arrangement that
may involve the delivery or performance of multiple products, services and
rights to use assets into separate units of accounting. The guidance in the
consensus is effective for revenue arrangements entered into in fiscal periods
beginning after June 15, 2003 and will apply to the Group for any arrangements
entered into after January 1, 2004. Currently, this is not expected to have a
material effect on the financial position and results of the Group under US
GAAP.

RECENT UK AND INTERNATIONAL ACCOUNTING PRONOUNCEMENTS

     In December, 2003, UITF 38, "Accounting for ESOP trusts", was issued by the
Urgent Issues Task Force of the UK Accounting Standards Board. The consensus is
that parent company shares held in trust should be treated as treasury shares
and deducted from shareholders' funds rather than being held as fixed asset
investments. This extract should be adopted for financial statements relating to
accounting periods ending on or after June 22, 2004. The Group will adopt the
accounting treatment required by this Abstract in its financial statements for
the period ending December 31, 2004.

     The Group will be required to comply with International Financial Reporting
Standards ("IFRS") with effect from January 1, 2005. An initial evaluation of
the impact on the financial statements of Pearson plc has been made. A program
of work is underway to enable the preparation of financial statements, in
compliance with IFRS, for the two comparative years ended December 31, 2003 and
2004, as well as for periods from January 1, 2005 onwards.

ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

DIRECTORS AND SENIOR MANAGEMENTsenior management
      We are managed by a board of directors and a chief executive who reports to the board and manages through a management committee. We refer to the executive
director members of the board of directors the most senior executives from each
of our three main operating divisions and the chairman of the board of directors as our "senior management"“senior management”.

                                        36

      The following table sets forth information concerning senior management, as of April 2004.

2007.

NAME                                        AGE                     POSITION
- ----                                        ---                     --------

Dennis Stevenson..........................  58     
NameAgePosition
Glen Moreno63Chairman
Marjorie Scardino.........................  57     Scardino60Chief Executive
David Bell................................  57     Arculus60Non-executive Director
David Bell60Director for People and Chairman of theThe FT Group
Terry Burns...............................  60     Burns63Non-executive Director
Patrick Cescau............................  55     Cescau58Non-executive Director
Rona Fairhead.............................  42     Fairhead45Chief Executive of The FT Group
Robin Freestone48Chief Financial Officer
Peter Jovanovich..........................  55     Chief Executive, Pearson Education

Susan Fuhrman63Non-executive Director
Ken Hydon62Non-executive Director
John Makinson.............................  49     Makinson52Chairman and Chief Executive Officer, Penguin Group
Reuben Mark...............................  65     
Rana Talwar59Non-executive Director
Vernon Sankey.............................  54     Non-executive Director
Rana Talwar...............................  56     Non-executive Director



     DENNIS STEVENSON 
Glen Morenowas appointed a non-executive director in 1986 and became
chairman in 1997.on October 1, 2005. He is a member of our treasury committee. He is also chairman
of HBOS plc and athe senior independent non-executive director of Manpower Inc. in the US.

     MARJORIE SCARDINO Man Group plc and also a director of Fidelity International Limited and a trustee of The Prince of Liechtenstein Foundation.
Marjorie Scardinojoined the board and became chief executive in January 1997. She is a member of Pearson’s nomination committee. She trained and practiced as a lawyer and was chief executive of The Economist Group from 1993 until joining Pearson. She sits on the board of Recoletos and is also a non-executive director of Nokia Corporation.

     DAVID BELL 
David Arculusbecame a non-executive director in February 2006 and currently serves on the audit and nomination committees and as chairman of the personnel committee. He is a non-executive director of Telefonica SA, and was previously chairman of O2 plc from 2004 until it was acquired by Telefonica in early 2006. His previous roles include chairman of Severn Trent plc, chairman of IPC Group, chief operating officer
43
of United Business Media plc, group managing director of EMAP plc and non-executive director of Barclays Bank plc.
David Bellbecame a director in March 1996. He is chairman of the FT Group, having previously been chief executive of theFinancial Timesfrom 1993 to 1998. In July 1998, he was appointed ourPearson’s director for people with responsibility for the recruitment, motivation, development and reward of employees across the Pearson Group. He also sits on the board of Recoletos and is also a non-executive director of VITEC Group plc and chairman of Sadlers Wells and Crisis, a charity for the International Youth Foundation.

     TERRY BURNS homeless.
Terry Burnsbecame a non-executive director in May 1999 and ourthe senior independent director in February this year.2004. He currently serves on the auditnomination and personnel committees. He was the UK government'sgovernment’s chief economic advisor from 1980 until 1991 and Permanent Secretary of HM Treasury from 1991 until 1998. He is non-executive chairman of Abbey National plc and Glas Cymru Limited and a non-executive director of The British Land Company PLC.

     PATRICK CESCAU Banco Santander Central Hispano. He has been chairman of Marks and Spencer Group plc since July 2006, having previously been deputy chairman from October 1, 2005.
Patrick Cescaubecame a non-executive director in April 2002. He joined the audit committee in January 2005, and is also a member of the nomination committee. He joined Unilever in 1973, latterly serving as Finance Director until January 2001, at which time he was appointed to his current position as Director of Unilever'sUnilever’s Foods Division. He is a directorcurrently group chief executive of Unilever plc and Unilever NV, and will
become chairman of Unilever plc and vice chairman of Unilever NV with effect
from 30 September 2004.

     RONA FAIRHEAD Unilever.
Rona Fairheadbecame a director andin June 2002. She was appointed chief executive of the FT Group on June 12, 2006 having previously been chief financial officer inof Pearson from June 2002.2002 and was appointed to the Interactive Data Corporation board on 15 February 2007. She had served as deputy finance director of Pearson from October 2001. From 1996 until 2001, she worked at ICI plc, where she served as executive vice president, group control and strategy, and as a member of the executive committee from 1998. Prior to that, she worked for Bombardier Inc. in finance, strategy and operational roles. She is also a non-executive director of HSBC Holdings plc.
Robin Freestonebecame a director of Pearson on June 12, 2006 and was appointed chief financial officer, having previously served as deputy chief financial officer since 2004. He was previously group financial controller of Amersham plc (now part of GE), having joined Amersham as chief financial officer of their health business in 2000. Prior to that he held a number of senior financial positions with ICI, Zeneca and Henkel. He is also a non-executive director of eChem Limited.
Susan Fuhrmanbecame a non-executive director in July 2004. She is a member of the audit and nomination committees. She is president of Teachers College at Columbia University, America’s oldest and largest graduate school of education having previously been dean of the Graduate school of Education at the University of Pennsylvania. She is a member of the Board of Trustees of the Carnegie Foundation for the Advancement of Teaching and an officer of the National Academy of Education.
Ken Hydonbecame a non-executive director in February 2006 and currently serves on the nomination committee and as chairman of the audit committee. He is a non-executive director of Tesco plc, Reckitt Benckiser plc and Royal Berks NHS Foundation Trust. He was previously finance director of Vodafone Group plc and of Harvard Business School Publishing in the US.

     PETER JOVANOVICH was appointed to the board in June 2002. He became chief
executivesubsidiaries of Pearson Education in 1998. Prior to this he was president of the
McGraw-Hill Educational and Professional Group, chairman of Harcourt Brace
Jovanovich and chief executive of Addison Wesley Longman Inc. He also serves on
the board of the Association of American Publishers and the board of the Alfred
Harcourt Foundation.

     JOHN MAKINSON Racal Electronics.
John Makinsonbecame chairman of the Penguin Group in May 2001 and its chief executive officer in June 2002. He was appointed chairman of Interactive Data Corporation in December 2002 and also sits on the board of Recoletos.2002. He served as PearsonPearson’s Finance Director from March 1996 until June 2002. From 1994 to 1996 he was managing 37
director of theFinancial Times, and prior to that he founded and managed the investor relations firm Makinson Cowell. He is also a non-executive director of George Weston Limited in Canada.

     REUBEN MARK became a non-executive director in 1988 and currently serves on
the audit committee and as chairman of the personnel committee. He became chief
executive of the Colgate Palmolive Company in 1984, and chairman in 1986. He has
held these positions since then. He is also a director of Time Warner Inc.

     VERNON SANKEY became a non-executive director in 1993 and currently serves
as chairman of the audit committee and as a member of the treasury committee. He
was previously chief executive of Reckitt & Colman plc and is deputy chairman of
Photo-Me International plc and Beltpacker plc. He is also a non-executive
director of Taylor Woodrow plc, Zurich Financial Services AG and a board member
of the UK's Food Standards Agency.

     RANA TALWAR 
Rana Talwarbecame a non-executive director in March 2000 and currently serves on the personnel and treasurynomination committees. He is currently chairman of Sabre Capital.Capital Worldwide and Centurion Bank and a non-executive director of Schlumberger Limited and Fortis Bank. He served as group chief executive of Standard Chartered plc from 1998 until 2001, and was at Citicorp from 1969 to 1997, where he held a number of senior international management roles. COMPENSATION OF SENIOR MANAGEMENTHe retired from the board at the 2007 AGM.
44
Compensation of senior management
      It is the role of the Personnel Committeepersonnel committee to approve the remuneration and benefits packages of the executive directors, the chief executives of the principal operating companies and other members of the Pearson Management Committee, as well as to ensure senior management receives the development they
need and that succession plans are being made.Committee. The committee also notestakes note of the remuneration for those executives with base pay over a certain level, representing approximately the top 50 executives of the company.

REMUNERATION POLICY
Remuneration policy
      Pearson seeks to generate a performance culture by developingoperating incentive programs that support its business goals and rewardingreward their achievement. It is the company'scompany’s policy that total remuneration (base compensation plus short-term andshort-and long-term incentives) should reward both shortshort- and long-term results, delivering competitive rewards for target performance, but outstanding rewards for exceptional company performance.
      The company'scompany’s policy is that base compensation should provide the appropriate rate of remuneration for the job, taking into account relevant recruitment markets and business sectors and geographic regions. Benefit programs should ensure that Pearson retains a competitive recruiting advantage.
      Share ownership is encouraged throughout the company. Equity-based reward programs align the interests of directors, and employees in general, with those of shareholders by linking rewards with Pearson'sdirectly to Pearson’s financial success.

     The main elements of remuneration are base salary and other emoluments,
annual bonus with bonus share matching, and long-term incentives in the form of
restricted shares or options.performance.
      Total remuneration is made up of fixed and performance-linked elements.elements, with each element supporting different objectives. Base salary reflects competitive market level, role and individual contribution. Annual incentives motivate the achievement of annual strategic goals. Bonus share matching encourages executive directors and other senior executives to acquire and hold Pearson shares and aligns executives and shareholders’ interests. Long-term incentives drive long-term earnings and share price growth and value creation and align executives’ and shareholders’ interests.
      Consistent with its policy, the committee places considerable emphasis on the performance-linked elements of remuneration that comprisei.e. annual bonus,incentive, bonus share matching and long-term incentives.

BASE SALARY
      The committee will continue to review the mix of fixed and performance-linked remuneration on an annual basis, consistent with its overall philosophy.
      Our policy is that the base salariesremuneration of the executive directors should be competitive with those of directors and executives in similar positions in comparable companies. We use a range of UK companies of comparable size and global
reach in different sectors including the media sector insector. Some are of a similar size to Pearson, while others are larger, but the UK andmethod which the committee’s independent advisers use to make comparisons on remuneration takes this into account. All have very substantial overseas operations. We also use selected media companies in North America to make this comparison.America. We use these companies because they represent the wider executive talent pool from which we might expect to recruit externally and the pay market to which we might be vulnerable if our salaries wereremuneration was not competitive.
Base salary
      Our normal policy is to review salaries annually.

                                        38


OTHER EMOLUMENTS

     Other emoluments may include benefits such as company car, healthcare,annually, taking into account the remuneration of directors and where relevant, amounts paidexecutives in respectsimilar positions in comparable companies, individual performance and levels of housing costs.pay and pay increases throughout the company.
Allowances and benefits
      It is the company'scompany’s policy that its benefit programs should be competitive in the context of the local labourlabor market, but as an international company we require executives to operate worldwide and recognize the requirements, circumstances and mobility of individual executives.

ANNUAL BONUSthat recruitment also operates worldwide.
45
Annual incentives
      The committee establishes the annual bonusincentive plans for the executive directors and the chief executives of the company'scompany’s principal operating companies, and
other members of the Pearson Management Committee, including performance measures and targetstargets. The committee also establishes the target and maximum levels of individual incentive opportunity based on an assessment by the amountcommittee’s independent advisers of bonus that can be earned.market practice for comparable companies and jobs.
      The performance targetsmeasures relate to the company'scompany’s main drivers of business performance at both the corporate and operating company level. Although atPerformance is measured separately for each item. For each performance measure, the datecommittee establishes thresholds, targets and maxima for different levels of publicationpayout. With the exception of this report no decisions had been
madethe CEO, 10% of the total annual incentive opportunity for 2004, the executive directors and other members of the Pearson Management Committee is based on performance against personal objectives as agreed with the CEO.
      For 2007, the financial performance measures for Pearson plc are likely to be drawn
from those in previous years, namelysales, growth in underlying sales and adjusted earnings per share operating cash conversion andfor continuing operations at constant exchange rates, average working capital as a ratio to sales and return on invested capital.operating cash flow. For subsequent years, the measures will be set at the time.

     The
      For 2007, there are no changes to the executive directors’ individual incentive opportunities. For the CEO, the target annual bonusincentive opportunity foris 100% of base salary and the maximum is 150%. For the other executive directors and other members of the Pearson Management Committee, the target is up to 75% of salary. Individuals may
receivesalary and the maximum is twice target.
      The incentive plans are discretionary and the committee reserves the right to make adjustments up to twice their target bonus (i.e. a maximum of 150% of salary) based
on performance in excess of target.

     The committee may award individual discretionary bonuses.or down taking into account exceptional factors.
      The committee will continue to review the bonusannual incentive plans on an annual basiseach year and to revise the bonus limitsperformance measures, targets and targetsindividual incentive opportunities in light of the current conditions.

     In the UK, bonuses
      Annual incentive payments do not form part of pensionable earnings.
      For 2006, annual incentives for Marjorie Scardino, David Bell, Rona Fairhead and Robin Freestone were based on the financial performance of Pearson plc. In the US,
bonuses upcase of John Makinson, 70% of his annual incentive was based on the performance of Penguin Group and 20% on the financial performance of Pearson plc. In the case of David Bell, Rona Fairhead, Robin Freestone and John Makinson, 10% of their annual incentives was based on performance against personal objectives.
      For Pearson plc, the performance measures were earnings per share growth, operating cash flow, sales and average working capital as a ratio to 50% of base salary are pensionable under the supplemental
executive retirement plan,sales. Underlying growth in adjusted earnings per share at constant exchange rates consistent with US market practice.

BONUS SHARE MATCHING

     The company encouragesreported adjusted earnings per share of 40.2p was better than target but below the level of performance required for maximum payout. Average working capital as a ratio to sales and operating cash flow of £575m were at and above maximum respectively. Sales at £4,423m were below target but above threshold.
      For Penguin Group, the performance measures were sales, operating profit, operating cash flow and average working capital as a ratio to sales. For working capital as a ratio to sales and operating cash flow, performance was better than that required for maximum payout. Sales and operating profit were both above target but below maximum.
      None of the executive directors andwas directly covered by the plans for the other senior executives to
hold Pearson shares in many ways.operating companies where the same performance measures applied.
Bonus share matching
      The annual bonus share matching plan permits executive directors and senior executives around the Groupcompany to invest up to 50% of any after taxafter-tax annual bonus in Pearson shares. IfFor awards made since 2006, if these shares are held and the company'scompany’s adjusted earnings per share increase in real terms by at least 3% per annum compound over a five-year period, the company will match them on a gross basis of one share for every two held after
46
one held. Half the matching shares will vest if the company’s adjusted earnings per share increase in real terms by at least 3% per annum compound over the first three years.
      Real growth is measured against the UK Government’s Index of Retail Prices (All Items). We choose to test our earnings per share growth against UK inflation over three and five years and
another one for two originally held (i.e. a totalto measure the company’s financial progress over the period to which the entitlement to matching shares relates.
The long-term incentive plan
      At the annual general meeting in April 2006, shareholders approved the renewal of one-for-one) after five
years.

THE LONG-TERM INCENTIVE PLANthe long-term incentive plan first introduced in 2001.
      Executive directors, senior executives and other executives and managers are eligible to participate in Pearson's long-term incentivethe plan introduced in 2001. The
plan consists of two parts:which can deliver restricted stock options and/or restricted stock.stock options. The aim is to give the committee a range of tools with which to link corporate performance to management'smanagement’s long-term reward in a flexible way. It is not the committee’s intention to grant stock options in 2007.
      Restricted stock granted to executive directors vests only when stretching corporate performance targets over a specified period have been met. Awards vest on a sliding scale based on performance over the period. There is no retesting. The principles underlying itcommittee determines the performance measures and targets governing an award of restricted stock prior to grant.
      The performance measures that applied for 2006 and that will apply for the 2007 awards and subsequently for the executive directors are focused on delivering and improving returns to shareholders. These are relative total shareholder return, return on invested capital and earnings per share growth.
      Pearson wishes to encourage executives and managers to build up a long-term holding of shares so as follows:

     -to demonstrate their commitment to the Personnel Committeecompany. To achieve this, for awards of restricted stock that are subject to performance conditions over a three-year period, 75% of the award vests at the end of the three-year period. The remaining 25% of the award only vests if the participant retains the after-tax number of shares that vest at year three for a further two years.
      The committee establishes guidelines that set outeach year the maximum expected value of individual awards each year using an economic valuation
        methodology for fixingtaking into account assessments by the relative values of both option grants and
        restricted stock awards;

     -  the maximum expected value of awards for executive directors is based on
        assessmentcommittee’s independent advisers of market practice for comparable companies;

     -companies, directors’ total remuneration relative to the market and the potential value of awards should the performance target be met in full.
      Restricted stock may be granted without performance conditions to satisfy recruitment and retention objectives. Restricted stock awards that are not subject to performance conditions will not be granted to any of the current executive directors.
      Where shares vest, participants receive additional shares representing the gross value of dividends that would have been paid on these shares during the performance period and reinvested. The expected value of awards made on this basis take this into account.
      In any rolling 10-year period, no more than 10% of Pearson equity will be issued, or be capable of being issued, under all Pearson'sPearson’s share plans, in any ten-year period
        commencing in January 1997;
                                        39


     -  awardsand no more than 5% of restricted stock are satisfied using existing shares.

     For stock options, within this overall 10% limit, up to 1.5%Pearson equity will be issued, or be capable of new issue
equity may be placedbeing issued, under option under the plan in any year, subject to the
company's earnings per share performance. No options may be granted unless the
company's adjusted earnings per share increase in real terms by at least 3% per
annum over the three-year period prior to grant.

     The vesting of restricted stock is normally dependent on the satisfaction
of a stretching corporate performance target over a three-year period.

SHAREHOLDING POLICYexecutive or discretionary plans.
Shareholding policy
      As previously noted, in line with the policy of encouraging widespread employee ownership, the company encourages executive directors as well as other
senior management, to build up a substantial shareholding in the company.
However,
      Given the share retention features of the annual bonus share matching and long-term incentive plans and the volatility of the stock market, we do not think it is appropriate to specify a particular relationship of shareholding to salary.

SERVICE AGREEMENTS

     Executive
47
Service agreements
      In accordance with long established policy, all continuing executive directors have rolling service agreements with the company. Otherunder which, other than by termination in accordance with the terms of these agreements, employment continues until retirement. It is normal policyThese service agreements provide that the company may terminate these agreements by giving 12 months'months’ notice, although there may be circumstances when a longer
notice period may be justified. The agreements alsoand in some instances they specify the compensation payable by way of liquidated damages in circumstances where the company terminates the agreements without notice or cause. We feel that these notice periods and provisions for liquidated damages are adequate compensation for loss of office and in line with the market. The compensation payable in these circumstances is typically 100% of annual salary, 100% of other benefits and a proportion of potential bonus.

     Peter Jovanovich's service agreement provides for compensation on
termination of employment by the company without cause of 200% of annual salary
plus target bonus, reflecting US employment practice and the terms agreed with
him before his appointment as a director of the company in June 2002.

RETIREMENT BENEFITS

     We describe in turn
Retirement benefits
      Following are the retirement benefits for each of the executive directors.

     MARJORIE SCARDINO has both
      Executive directors participate in the approved pension arrangements set up for Pearson employees. Marjorie Scardino, John Makinson, Rona Fairhead and Robin Freestone will also receive benefits under unapproved arrangements because of the cap on the amount of benefits that can be provided from the approved arrangements in the US and the UK.
      The pension arrangements for all the executive directors include life insurance cover while in employment, and entitlement to a pension in the event of ill-health or disability. A pension for their spouse and/or dependants is also available on death.
      In the US, the approved defined benefit and defined contribution pension
arrangements. Thearrangement is the Pearson Inc. Pension Plan (the US Plan) is an approved defined
benefitPlan. This plan providingprovides a lump sum convertible to a pension on retirement. The lump sum is accrued at 6% of capped compensation butuntil December 31, 2001 when further benefit accruals of benefit in
this plan ceased on 31 December 2001.

     The defined contribution arrangements are an approved 401(k) plan in the US
and an unfunded, unapproved defined contribution arrangement. In addition, from
2004 a funded defined contribution plan replaces part of the unfunded plan.

     The US plan has a normalceased. Normal retirement is age of 65. Early65 although early retirement after age
55 is possible with the company's consent and onsubject to a reduced pension. The US plan
also providesreduction for early payment. No increases are guaranteed for pensions in payment. There is a spouse'sspouse’s pension on death in service from age 55 and the option to provide a death in retirement broadly equivalent to 50% ofpension by reducing the member's early retirementmember’s pension.
      The US plan does not guarantee any increases toapproved defined contribution arrangement in the pension once it comes into
payment.

     DAVID BELLUS is a member401(k) plan. At retirement, the account balances will be used to provide benefits. In the event of death before retirement, the Final Pay Section ofaccount balances will be used to provide benefits for dependants.
      In the UK, the approved plan is the Pearson Group Pension Plan (the UK Plan), to which he contributes 5% of his pensionable
salary.

     He is eligible for a pension fromand executive directors participate in either the UK Plan of two-thirds of his final
base salary at normalFinal Pay or the Money Purchase 2003 section. Normal retirement age (age 62) dueis 62 but, subject to his previous service with
the Financial Times. Earlycompany consent, retirement is possible after age 5050. The accrued pension is possible, with company
consent, andreduced on a pension from the plan that is scaled downretirement prior to reflect the
shorter period of service completed. If retiring before age 60, the pension will
be further reduced by an actuarial factor to reflect the longer period over
which it is expected to be paid.

                                        40


     On death before normal retirement age, a pension will be paid to the
spouse, or in the absence of a spouse to a financial dependent nominated by the
member. The pension will be one-third of annual base salary. On death after
leaving service but before retirement, a pension of 50% of the deferred pension
will be payable to the spouse or nominated financial dependent. On death in
retirement the pension payable is 60% of the director's pension (ignoring any
pension commuted for a lump sum at retirement). Children's pensions may also be
payable to dependent children.60. Pensions in payment are guaranteed in the UK plan
to increase each year at 5% or the increase in the Index of Retail Prices,
whichever is lower.

     RONA FAIRHEAD is also a member of the Final Pay Section of the UK Plan, but
her pensionable salary is restricted to the earnings cap introduced by the
Finance Act 1989. In addition, the company contributes into a Funded Unapproved
Retirement Benefits Scheme, or FURBS.

     The UK Plan provides her with a pension that accrues at one-thirtieth of
the earnings cap for each year of service.

     Early retirement after age 50 is possible, with company consent, and on a
pension from the plan that is scaled down to reflect the shorter period of
service completed. If retiring before age 60, the pension will be further
reduced by an actuarial factor to reflect the longer period over which it is
expected to be paid. Under the company's FURBS arrangements, early retirement is
possible with company consent from age 50 onwards. The benefit payable will be
the amount of the member's fund at the relevant date.

     On death before normal retirement age, a pension will be paid to the
spouse, or in the absence of a spouse to a financial dependent nominated by the
member. The pension will be one-third of the earnings cap at the time of death.
On death after leaving service but before retirement, a pension of 50% of the
deferred pension will be payable to the spouse or nominated financial dependent.
On death in retirement the pension payable is 60% of the director's pension
(ignoring any pension commuted for a lump sum at retirement). Children's
pensions may also be payable to dependent children. Pensions in payment are
guaranteed in the UK plan to increase each year at 5% or the increase in the
Index of Retail Prices, whichever is lower.

     In addition, the proceeds of the FURBS will be paid at retirement.

     PETER JOVANOVICH has both defined benefit and defined contribution pension
arrangements in the US. The Pearson Inc. Pension Plan (the US Plan) is an
approved defined benefit plan providing a lump sum convertible to a pension on
retirement. The lump sum is accrued at 6% of capped compensation, but accruals
of benefit in this plan ceased on 31 December 2001. In addition, there is an
unfunded, unapproved Supplemental Executive Retirement Plan (the US SERP)
providing an annual pension accrual of 2% of final average earnings, less
benefits accrued in the US Plan and US Social Security.

     The defined contribution arrangements are an approved 401(k) plan and a
funded, unapproved 401(k) excess plan. For 2003, Peter Jovanovich's pension
arrangements included a new unfunded, unapproved, defined contribution plan as
his participation in the US SERP ceased.

     The US Plan has a normal retirement age of 65. Early retirement after age
55 is possible, with company consent and on a reduced pension for early payment.
The US Plan and the US SERP also provide a spouse's pension on death in service
from age 55 and death in retirement broadly equivalent to 50% of the member's
early retirement pension. The US Plan does not guarantee any increases to the
pension once it comes into payment.

     JOHN MAKINSON is also a member of the Final Pay Section of the UK Plan, and
his pensionable salary is also restricted to the earnings cap. The company has
been paying contributions into a FURBS, but the contributions ceased on 31
December 2001. During 2002, the company established an Unfunded Unapproved
Retirement Benefits Scheme (UURBS) for him.

     The UURBS tops up the pensions payable from the UK Plan and the closed
FURBS to a target pension of two-thirds of Revalued Base Salary on retirement at
age 62. Revalued Base Salary is defined as L450,000 indexed in line with the
increase in the Index of Retail Prices.

     Early retirement after age 50 is possible, with company consent and based
on a uniform accrual from 1 April 1994. In that event, the pension from the UK
Plan, the FURBS and the UURBS in aggregate will be scaled down

                                        41


to reflect the shorter period of service completed. If retiring before age 60,
the pension will be further reduced by an actuarial factor to reflect the longer
period over which it is expected to be paid.

     On death in service before normal retirement age, a pension from the UK
Plan, the FURBS and the UURBS in aggregate will be paid to the spouse, or in the
absence of a spouse to a financial dependent nominated by the member. The
pension will be one-third of Revalued Base Salary. On death after leaving
service but before retirement, a pension of 50% of the deferred pension will be
payable to the spouse or nominated financial dependent. On death in retirement
the pension payable is 60% of the director's pension (ignoring any pension
commuted for a lump sum at retirement). Children's pensions may also be payable
to dependent children. The pension in payment is guaranteed to increase each year at 5% or the increase in the Index of Retail Prices, whicheverif lower. Pensions for a member’s spouse, dependant children and/or nominated financial dependant are payable in the event of death.
      Members of the Pearson Group Pension Plan who joined after May 1989 are subject to an upper limit of earnings that can be used for pension purposes, known as the earnings cap. This limit, £108,600 as at April 5, 2006, was abolished by the Finance Act 2004. However the Pearson Group Pension Plan has retained its own ‘cap’, which will increase annually in line with the UK Government’s Index of Retail Prices (All Items).
      In response to the UK Government’s plans for pensions simplification and so-called‘A-Day’ effective from April 2006, UK executive directors and other members of the Pearson Group Pension Plan who are, or become, affected by the lifetime allowance were offered a cash supplement as an alternative to further accrual of pension benefits on a basis that is lower.

CHAIRMAN'S REMUNERATIONbroadly cost neutral to the company.
Marjorie Scardino
      Marjorie Scardino participates in the Pearson Inc. Pension Plan and the approved 401(k) plan.
      Additional pension benefits will be provided through an unfunded unapproved defined contribution plan and a funded defined contribution plan approved by HM Revenue and Customs as a corresponding plan to
48
replace part of the unfunded plan. The account balance of the unfunded unapproved defined contribution plan is determined by reference to the value of a notional cash account that increases annually by a specified notional interest rate. This plan provides the opportunity to convert a proportion of this notional cash account into a notional share account reflecting the value of a number of Pearson ordinary shares. The number of shares in the notional share account is determined by reference to the market value of Pearson shares at the date of conversion.
David Bell
      David Bell is a member of the Pearson Group Pension Plan. He is eligible for a pension of two-thirds of his final base salary at age 62 due to his long service but early retirement with a reduced pension before that date is possible, subject to company consent.
Rona Fairhead
      Rona Fairhead is a member of the Pearson Group Pension Plan. Her pension accrual rate is 1/30th of pensionable salary per annum, restricted to the plan earnings cap.
      Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on her behalf. In the event of death before retirement, the proceeds of the FURBS account will be used to provide benefits for her dependants. Since April 2006, she has received a taxable and non-pensionable cash supplement in replacement of the FURBS.
Robin Freestone
      Robin Freestone is a member of the Money Purchase 2003 section of the Pearson Group Pension Plan. Company contributions are 16% of pensionable salary per annum, restricted to the plan earnings cap.
      Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on his behalf. In the event of death before retirement, the proceeds of the FURBS account will be used to provide benefits for his dependants. Since April 2006, he has received a taxable and non-pensionable cash supplement in replacement of the FURBS.
John Makinson
      John Makinson is a member of the Pearson Group Pension Plan under which his pensionable salary is restricted to the plan earnings cap. The company ceased contributions on December 31, 2001 to his FURBS arrangement. During 2002 it set up an Unfunded Unapproved Retirement Benefits Scheme (UURBS) for him. The UURBS tops up the pension payable from the Pearson Group Pension Plan and the closed FURBS to target a pension of two-thirds of a revalued base salary on retirement at age 62. The revalued base salary is defined as £450,000 effective at June 1, 2002, increased at January 1, each year by reference to the increase in the UK Government’s Index of Retail Prices (All Items). In the event of his death a pension from the Pearson Group Pension Plan, the FURBS and the UURBS will be paid to his spouse or nominated financial dependant. Early retirement is possible from age 50, with company consent. The pension is reduced to reflect the shorter service, and before age 60, further reduced for early payment.
Executive directors’ non-executive directorships
      Our policy is that executive directors may, by agreement with the board, serve as non-executives of other companies and retain any fees payable for their services.
      The following executive directors served as non-executive directors elsewhere for the period covered by this report as follows: Marjorie Scardino (Nokia Corporation and MacArthur Foundation); David Bell (VITEC Group plc); Rona Fairhead (HSBC Holdings plc); Robin Freestone (eChem) and John Makinson (George Weston Limited).
49
Chairman’s remuneration
      Our policy is that the chairman'schairman’s pay should be set at a level that is competitive with those of chairmen in similar positions in comparable companies. He is not entitled to anany annual bonus,or long-term incentive, retirement or other benefits. He
      In accordance with the terms of his appointment, the committee intends to review the chairman’s remuneration in 2007. Any change to current remuneration is eligiblesubject to participatethe approval of the full board and will be set out in the company's worldwide savereport on directors’ remuneration for shares plan on the
same terms as all other eligible employees.

     The chairman's salary has remained unchanged since 1999 at L275,000 per
year. He has voluntarily given up any consideration for awards under the
long-term incentive plans that have been developed since then and for which he
might have been eligible. During 2003, the committee reviewed his remuneration
with advice from Towers Perrin on practice relating to chairmen's remuneration
and on the increase in the remuneration of chairmen in comparable positions
since the last review. After considering all the circumstances, the committee's
view was that the current appropriate total pay level was around L425,000 per
year.

     Having been informed of the committee's view, the chairman indicated that
he thought it was not appropriate for him to receive an increase of this
magnitude in cash -- a view which the committee accepted. Instead, the committee
recommended to the board that the chairman's salary should be increased to
L325,000 with effect from January 1, 2004 and that he should receive a share
award of 30,000 shares in 2004. This award is linked to the company's share
price and will not be released to him unless the Pearson share price reaches
L9.00 within a maximum period of three years.

NON-EXECUTIVE DIRECTORS2007.
Non-Executive directors
      Fees for non-executive directors are determined by the full board having regard to market practice and within the restrictions contained in the company'scompany’s articles of association. Non-executive directors receive no other pay or benefits (other than reimbursement for expenses incurred in connection with their directorship of the company) and do not participate in the company'scompany’s equity-based incentive plans. SinceThe level and structure of non-executive directors’ fees effective from January 2000, non-executive directors have received an annual fee of
L35,000 each. One overseas-based director2005 is paid a supplement of L7,000 per
annum. The non-executive directors who chair the personnel and audit committees
each receive an additional fee of L5,000 per annum.

     In the case of Patrick Cescau, his fee is paid over to his employer. For
those non-executive directors who retain their fees personally, L10,000as follows:
Fees payable from
January 1, 2005
(£)
Basic non-executive director fee45,000
Chairmanship of audit and personnel committees10,000
Membership of audit and personnel committees5,000
Senior independent director’s fee10,000
Overseas meetings (per meeting)2,500
      One-third of the totalbasic fee, or all of the entire fee in the case of Rana Talwar, is payablepaid in the form
of Pearson shares whichthat the non-executive directors have committed to retain for the period of their directorships.
      Patrick Cescau’s fee is paid over to his employer.
      The board intends to review the level and structure of non-executive directors’ fees in 2007. Any changes to existing arrangements will be set out in the report on directors’ remuneration for 2007.
      Non-executive directors serve Pearson under letters of appointment and do not have service contracts. There is no entitlement to compensation on the termination of their directorships.

                                        42


REMUNERATION OF SENIOR MANAGEMENT
Remuneration of senior management
      Excluding contributions to pension funds and related benefits, senior management remuneration for 20032006 was as follows:
                     
  Salaries/ Annual      
  Fees incentive(1) Allowances(2) Benefits Total
           
  £000 £000 £000 £000 £000
Chairman
                    
Glen Moreno  425   —   —   —   425 
Executive directors
                    
Marjorie Scardino  830   1,067   50   15   1,962 
David Bell  425   512   —   17   954 
Rona Fairhead  470   573   —   19   1,062 
Robin Freestone (appointed June 12, 2006)  209   243   —   8   460 
John Makinson  490   627   183   26   1,326 
                
Senior management as a group
  2,849   3,022   233   85   6,189 
                
50

                                                      SALARIES/FEES    BONUS(1)    OTHER(2)    TOTAL
                                                      -------------    --------    --------    -----
                                                          L'000         L'000       L'000      L'000

CHAIRMAN
Lord Stevenson......................................        275           --          --         275
EXECUTIVE DIRECTORS
(1) For the full year, Robin Freestone’s remuneration was: salary/fees — £315,170; annual incentive — £329,438; benefits — £13,980; total — £658,588.
(2) Allowances for Marjorie Scardino...................................        625          200          54         879Scardino include £40,190 in respect of housing costs and a US payroll supplement of £9,646. John Makinson is entitled to a location and market premium in relation to the management of the business of the Penguin Group in the US and received £183,125 for 2006.
(3) Benefits include company car, car allowance and health care. Marjorie Scardino, Rona Fairhead, David Bell..........................................        360          115          16         491
Rona Fairhead.......................................        363          116          14         493
Peter Jovanovich....................................        530          156           9         695Bell and John Makinson.......................................        450          127         232         809
                                                          -----          ---         ---       -----
SENIOR MANAGEMENT AS A GROUP........................      2,603          714         325       3,642
                                                          =====          ===         ===       =====
Makinson have the use of a chauffeur.
(4) No amounts as compensation for loss of office and no expense allowances chargeable to UK income tax were paid during the year.


- ---------------

(1)  For Pearson plc, the 2003 performance measures in the annual bonus plan
     were growth in underlying sales, growth in adjusted earnings per share,
     trading cash conversion and average working capital as a ratio to sales.

     In the case
Share options of Peter Jovanovich and John Makinson, part of their bonuses
     also related to the performance of Pearson Education and Penguin Group
     respectively. For both businesses, the performance measures were growth in
     underlying sales, trading margin, trading cash conversion and average
     working capital as a ratio to sales.

(2)  Other emoluments include company car and healthcare benefits and, in the
     case of Marjorie Scardino, include L37,030 in respect of housing costs.
     John Makinson is entitled to a location and market premium in relation to
     thesenior management of the business of the Penguin Group in the US. He received
     L206,586 for 2003.

SHARE OPTIONS OF SENIOR MANAGEMENT
      This table sets forth for each director the number of share options held as of December 31, 20032006 as well as the exercise price, rounded to the nearest whole penny/cent, and the range of expiration dates of these options.

                                       NUMBER OF                               EARLIEST
DIRECTOR                                OPTIONS     
Number ofExerciseEarliest
DirectorOptions(1)PriceExercise DateExpiry Date
Marjorie Scardino(2)176,556a*973.3p09/14/0109/14/08
5,660a*1090.0p09/14/0109/14/08
37,583c*1372.4p06/08/0206/08/09
37,583c*1647.5p06/08/0206/08/09
36,983c3224.3p05/03/0305/03/10
41,550d*1421.0p05/09/0205/09/11
41,550d*1421.0p05/09/0305/09/11
41,550d*1421.0p05/09/0405/09/11
41,550d*1421.0p05/09/0505/09/11
Total
460,565—
David Bell20,496a*973.3p09/14/0109/14/08
1,142b494.8p08/01/0702/01/08
373b507.6p08/01/0802/01/09
297b629.6p08/01/0902/01/10
18,705c*1372.4p06/08/0206/08/09
18,705c*1647.5p06/08/0206/08/09
18,686c3224.3p05/03/0305/03/10
16,350d*1421.0p05/09/0205/09/11
16,350d*1421.0p05/09/0305/09/11
16,350d*1421.0p05/09/0405/09/11
16,350d*1421.0p05/09/0505/09/11
Total
143,804—
Rona Fairhead1,904b494.8p08/01/0702/01/08
20,000d*822.0p11/01/0211/01/11
20,000d*822.0p11/01/0311/01/11
20,000d*822.0p11/01/0411/01/11
Total
61,904—
51
Number ofExerciseEarliest
DirectorOptions(1)PriceExercise DateExpiry Date
Robin Freestone1,866b507.6p08/01/0802/01/09
Total
1,866—
John Makinson73,920a*676.4p09/12/0009/12/07
30,576a*973.3p09/14/0109/14/08
4,178b424.8p08/01/1002/01/11
21,477c*1372.4p06/08/0206/08/09
21,477c*1647.5p06/08/0206/08/09
21,356c3224.3p05/03/0305/03/10
19,785d*1421.0p05/09/0205/09/11
19,785d*1421.0p05/09/0305/09/11
19,785d*1421.0p05/09/0405/09/11
19,785d*1421.0p05/09/0505/09/11
Total
252,124—
(1) EXERCISE PRICE    EXERCISE DATE    EXPIRY DATE
- --------                               ---------    ---    --------------    -------------    -----------

Dennis Stevenson.....................     2,512      Shares under option are designated as:a executive;b 687p          01/08/03        01/02/04
                                        -------
TOTAL................................     2,512                    --
                                        =======worldwide save for shares;c premium priced; andd long-term incentive; and* where options are exercisable.
aExecutive
The plans under which these options were granted were replaced with the introduction of the long-term incentive plan in 2001. No executive options have been granted to the directors since 1998. All options that remain outstanding are exercisable (all performance conditions having already been met prior to 2005) and lapse if they remain unexercised at the tenth anniversary of the date of grant.
bWorldwide save for shares
The acquisition of shares under the worldwide save for shares plan is not subject to the satisfaction of a performance target.
cPremium priced
The plan under which these options were granted was replaced with the introduction of the long-term incentive plan in 2001. No Premium Priced Options (PPOs) have been granted to the directors since 1999. The share price targets for the three-year and five-year tranches of PPOs granted in 1999 have already been met prior to 2006. The share price target for the seven-year tranche of PPOs granted in 1999 was not met in 2006 and the options lapsed. The share price target for the outstanding PPOs granted in 2000 has yet to be met. The secondary real growth in earnings per share target for any PPOs to become exercisable has already been met prior to 2006.
All PPOs that remain outstanding lapse if they remain unexercised at the tenth anniversary of the date of grant.
dLong-term incentive
All options that remain outstanding are exercisable and lapse if they remain unexercised at the tenth anniversary of the date of grant.
(2) In addition, Marjorie Scardino....................   176,556     a*           974p          14/09/01        14/09/08
                                          5,660     a*          1090p          14/09/01        14/09/08
                                          2,839      b           687p          01/08/05        01/02/06
                                          2,224      b           425p          01/08/06        01/02/07
                                         37,583      c          1373p          08/06/02        08/06/09
                                         37,583      c          1648p          08/06/02        08/06/09
                                         37,583      c          1922p          08/06/02        08/06/09
                                         36,983      c          2764p          03/05/03        03/05/10
                                         36,983      c          3225p          03/05/03        03/05/10
                                         41,550     d*          1421p          09/05/02        09/05/11
                                         41,550     d*          1421p          09/05/03        09/05/11
                                         41,550      d          1421p          09/05/04        09/05/11
                                         41,550      d          1421p          09/05/05        09/05/11
                                        -------
TOTAL................................   540,194                    --
                                        =======
Scardino contributes US$1,000 per month (the maximum allowed) to the US employee stock purchase plan. The terms of this plan allow participants to make monthly contributions for one year and to acquire shares at the end of that period at a price that is the lower of the market price at the beginning or the end of the period, both less 15%.


                                        43


                                       NUMBER OF                               EARLIEST
DIRECTOR                                OPTIONS     (1)    EXERCISE PRICE    EXERCISE DATE    EXPIRY DATE
- --------                               ---------    ---    --------------    -------------    -----------

David Bell...........................    20,496     a*           974p          14/09/01        14/09/08
                                            501     b*           687p          01/08/03        01/02/04
                                            184      b           913p          01/08/04        01/02/05
                                            202      b          1428p          01/08/03        01/02/04
                                            202      b           957p          01/08/04        01/02/05
                                            272      b           696p          01/08/05        01/02/06
                                            444      b           425p          01/08/06        01/02/07
                                         18,705      c          1373p          08/06/02        08/06/09
                                         18,705      c          1648p          08/06/02        08/06/09
                                         18,705      c          1922p          08/06/02        08/06/09
                                         18,686      c          2764p          03/05/03        03/05/10
                                         18,686      c          3225p          03/05/03        03/05/10
                                         16,350     d*          1421p          09/05/02        09/05/11
                                         16,350     d*          1421p          09/05/03        09/05/11
                                         16,350      d          1421p          09/05/04        09/05/11
                                         16,350      d          1421p          09/05/05        09/05/11
                                        -------
TOTAL................................   181,188                    --
                                        -------
Rona Fairhead........................    19,997     d*           822p          01/11/02        01/11/11
                                         19,998     d*           822p          01/11/03        01/11/11
                                         20,005      d           822p          01/11/04        01/11/11
                                        -------
TOTAL................................    60,000                    --
                                        -------
Peter Jovanovich.....................     8,250     a*           758p          12/09/00        12/09/07
                                        102,520     a*           677p          12/09/00        12/09/07
                                         32,406      c          1373p          08/06/02        08/06/09
                                         32,406      c          1648p          08/06/02        08/06/09
                                         32,406      c          1922p          08/06/02        08/06/09
                                         33,528      c          2764p          03/05/03        03/05/10
                                         33,528      c          3225p          03/05/03        03/05/10
                                         31,170     d*         $21.00          09/05/02        09/05/11
                                         31,170     d*         $21.00          09/05/03        09/05/11
                                         31,170      d         $21.00          09/05/04        09/05/11
                                         31,170      d         $21.00          09/05/05        09/05/11
                                         19,998     d*         $11.97          01/11/02        01/11/11
                                         19,998     d*         $11.97          01/11/03        01/11/11
                                         20,004      d         $11.97          01/11/04        01/11/11
                                        -------
TOTAL................................   459,724                    --
                                        =======



                                        44


                                       NUMBER OF                               EARLIEST
DIRECTOR                                OPTIONS     (1)    EXERCISE PRICE    EXERCISE DATE    EXPIRY DATE
- --------                               ---------    ---    --------------    -------------    -----------

John Makinson........................    56,000     a*           567p          06/05/97        06/05/04
                                         20,160     a*           487p          20/04/98        20/04/05
                                         36,736     a*           584p          08/08/99        08/08/06
                                         73,920     a*           677p          12/09/00        12/09/07
                                         30,576     a*           974p          14/09/01        14/09/08
                                          1,920      b           957p          01/08/08        01/02/09
                                          4,178      b           425p          01/08/10        01/02/11
                                         21,477      c          1373p          08/06/02        08/06/09
                                         21,477      c          1648p          08/06/02        08/06/09
                                         21,477      c          1922p          08/06/02        08/06/09
                                         21,356      c          2764p          03/05/03        03/05/10
                                         21,356      c          3225p          03/05/03        03/05/10
                                         19,785     d*          1421p          09/05/02        09/05/11
                                         19,785     d*          1421p          09/05/03        09/05/11
                                         19,785      d          1421p          09/05/04        09/05/11
                                         19,785      d          1421p          09/05/05        09/05/11
                                        -------
TOTAL................................   409,773                    --
                                        =======



- ---------------

(1)  Shares under option are designated as: A executive; B worldwide save for
     shares; C premium priced; and D long-term incentive; and * where options
     are exercisable.

A   EXECUTIVE

     Subject to any performance condition being met, executive options become
     exercisable on the third anniversary
Share ownership of the date of grant and lapse if they
     remain unexercised at the tenth.

     Options granted prior to 1996 are not subject to performance conditions
     representing market best practice at that time.

     The exercise of options granted since 1996 is subject to a real increase in
     the company's adjusted earnings per share over any three-year period prior
     to exercise.

B   WORLDWIDE SAVE FOR SHARES

     The acquisition of shares under the worldwide save for shares plan is not
     subject to the satisfaction of a performance target.

C   PREMIUM PRICED

     Subject to the performance conditions being met, Premium Priced Options
     (PPOs) become exercisable on the third anniversary of the date of grant and
     lapse if they remain unexercised at the tenth.

     PPOs were granted in three tranches.  For these to become exercisable, the
     Pearson share price has to stay above the option price for 20 consecutive
     days within three, five and seven years respectively. In addition, for
     options to be exercisable, the company's adjusted earnings per share have
     to increase in real terms by at least 3% per annum over the three-year
     period prior to exercise.

D   LONG-TERM INCENTIVE

     Options granted in 2001 were based on pre-grant earnings per share growth
     of 75% against a target of 16.6% over the period 1997 to 2000 and are not
     subject to further performance conditions on exercise.

     Long-term incentive options granted on May 9, 2001 become exercisable in
     tranches on the first, second, third and fourth anniversary of the date of
     grant and lapse if they remain unexercised at the tenth. The fourth

                                        45


     tranche lapses if any of the options in the first, second or third tranche
     are exercised prior to the fourth anniversary of the date of grant.

     Long-term incentive options granted on November 1, 2001 become exercisable
     in tranches on the first, second and third anniversary of the date of grant
     and lapse if they remain unexercised at the tenth.

(2)  In addition to the above listed options both Marjorie Scardino and Peter
     Jovanovich participate in the Pearson US Employee Stock Purchase Plan
     saving the maximum amount of US$12,000 per annum.

SHARE OWNERSHIP OF SENIOR MANAGEMENTsenior management
      The table below sets forth the number of ordinary shares and restricted shares held by each of our directors as at March 31, 2004.2007. Additional information with respect to share options held by, and bonus
52
awards for, these persons is set out above in "Remuneration“Remuneration of Senior Management"Management” and "Share“Share Options for Senior Management"Management”. The total number of ordinary shares held by senior management as of March 31, 20042007 was 444,497734,913 representing less than 1% of the issued share capital on March 31, 2004.

2007.
         
  Ordinary Restricted
As at March 31, 2007 shares(1) shares(2)
     
Glen Moreno  110,000   — 
Marjorie Scardino  216,777   1,668,675 
David Arculus (appointed February 28, 2006)  1,317   — 
David Bell  109,578   658,625 
Terry Burns  7,349   — 
Patrick Cescau  2,758   — 
Rona Fairhead  62,593   750,046 
Robin Freestone (appointed June 12, 2006)  2,089   153,435 
Susan Fuhrman  4,163   — 
Ken Hydon (appointed February 28, 2006)  6,317   — 
John Makinson  172,872   724,562 
Reuben Mark (resigned April 21, 2006)  16,908   — 
Vernon Sankey (resigned April 21, 2006)  5,563   — 
Rana Talwar (resigned April 27, 2007)  18,683   — 

AS AT 31 MARCH 2004                                         ORDINARY SHARES(1)    RESTRICTED SHARES(2)
- -------------------                                         ------------------    --------------------

Lord Stevenson............................................       163,268                     --
Marjorie Scardino.........................................        93,733                643,566
David Bell................................................        56,492                326,095
Lord Burns................................................         3,371                     --
Patrick Cescau............................................            --                     --
Rona Fairhead.............................................         9,622                279,594
Peter Jovanovich..........................................        56,450                453,587
John Makinson.............................................        39,214                393,894
Reuben Mark...............................................        13,870                     --
Vernon Sankey.............................................         3,230                     --
Rana Talwar...............................................         5,247                     --



- ---------------

(1) Amounts include shares acquired by individuals under the annual bonus share matching plan and amounts purchased in the market by individuals.(2) Restricted shares comprise awards made under the annual bonus share matching andlong-term incentive plans. The number of shares shown represents the maximum number of shares which may vest, subject to the performance conditions being fulfilled.
Employee share matching plan and amounts purchased in the market by individuals.

(2)  Restricted shares comprise awards made under the reward, annual bonus share
     matching and long-term incentive plans. The number of shares shown
     represents the maximum number of shares which may vest, subject to the
     performance conditions being fulfilled.

EMPLOYEE SHARE OWNERSHIP PLANS

ALL-EMPLOYEE SHARE AWARDS

     Since 1999, we have made share awards to all employees at the discretion of
the board. No award was made in 2002. In 2004, the board has made an award of 10
shares to all employees employed at 1 March 2004.

WORLDWIDE SAVE FOR SHARES PLANownership plans
Worldwide save for shares & US employee share purchase plans
      In 1998, we introduced a worldwide save for shares plan. Under this plan, our employees around the world have the option to save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the commencement of the employee'semployee’s participation in the plan.
      In the United States, this plan operates as a stock purchase plan under Section 423 of the US Internal Revenue Code of 1986. This plan was introduced in 2000 following Pearson'sPearson’s listing on the New York Stock Exchange. Under it, participants save a portion of their monthly salary for a period of twelve
months. Atover six month periods, at the end of this period, the employee haswhich they have the option to purchase ADRs representing ordinary shares with their

                                        46
 accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.

BOARD PRACTICES
Board Practices
      Our board currently comprises the chairman, who is part-time,apart-timenon-executive, five executive directors and five six (this will be 5 following the resignation of Rana Talwar after April 27, 2007)non-executive directors. Our articles of association provide that at every annual general meeting,one-third of the board of directors, or the number nearest toone-third, shall retire from office. The directors to retire each year are the directors who have been longest in office since their last election or appointment. A retiring director is eligible forre-election. If at any annual general meeting, the place of a retiring director is not filled, the retiring director, if willing, is deemed to have beenre-elected, unless at or prior to such meeting it is expressly resolved not to fill the vacated office, or unless a resolution for there-election of that director has been put to the meeting and
53
lost. Our articles of association also provide that every director be subject tore-appointment by shareholders at the next annual general meeting following their appointment.
      Details of our approach to corporate governance and an account of how we comply with NYSE requirements can be found on our website (www.pearson.com/investor/corpgov.htm).
      The board of directors has established the following committees, all of which have written terms of reference setting out their authority and duties:

AUDIT COMMITTEE

     Vernon Sankey chairs this committee and Terry Burns and Reuben Mark are
members. The
Audit committee
      This committee provides the board with a vehicle to appraise our financial management and reporting and to assess the integrity of our accounting procedures and financial controls. Vernon SankeyKen Hydon chairs this committee and its other members are David Arculus, Patrick Cescau and Susan Fuhrman. Ken Hydon is also the designated Audit
Committeeaudit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission. Our internal and external auditors have direct access to the committee to raise any matter of concern and to report the results of work directed by the committee. The committee reports to the full board of directors.

PERSONNEL COMMITTEE
Personnel committee
      This committee is chaired by Reuben Mark and its other members are Terry
Burns and Rana Talwar. All three are non-executive directors. The committee meets regularly to decide the remuneration and benefits of the executive directors and the chief executives of our three operating divisions. The committee also recommends the chairman'schairman’s remuneration to the board of directors for its decision and reviews management development and succession plans. NOMINATION COMMITTEEDavid Arculus chairs this committee and its other members are Terry Burns, Rana Talwar and, since 1 January 2007, Glen Moreno.
Nomination committee
      This committee is chaired by Dennis Stevenson and comprises all directors.
The committee meets from time to time as necessary to consider the appointment of new directors. Its composition and chairmanship are currently under
consideration.

TREASURY COMMITTEE

     ThisThe committee is chaired by Dennis StevensonGlen Moreno and also comprises Rona
Fairhead, Vernon SankeyMarjorie Scardino and Rana Talwar. Theall of thenon-executive directors.
Treasury committee
      Following a review of the board committees by the new chairman during 2006, it was decided to disband the treasury committee, setsdividing its responsibilities between the policies for ourboard (with regard to approval of treasury departmentpolicies) and reviews its procedures on a regular basis.

EMPLOYEESthe audit committee (to monitor compliance with these policies).
Employees
      The average numbers of persons employed by us during each of the three fiscal years ended 20032006 were as follows:

     -  30,868 in fiscal 2003

     -  30,359 in fiscal 2002, and

     -  29,027 in fiscal 2001.

                                        47

• 34,341 in fiscal 2006
• 32,203 in fiscal 2005, and
• 33,086 in fiscal 2004.
      We, through our subsidiaries, have entered into collective bargaining agreements with employees in various locations. Our management has no reason to believe that we would not be able to renegotiate any such agreements on satisfactory terms. We encourage employees to contribute actively to the business in the context of their particular job roles and believe that the relations with our employees are generally good.
54
      The table set forth below shows for 20032006, 2005 and 2004 the average number of persons employed in each of our operating divisions in the United Kingdom, the United
States, other locations and in total.



BUSINESS UNIT                                                UK        US      OTHER    TOTAL
- -------------                                               -----    ------    -----    ------

Pearson Education.........................................  1,443    14,438    4,097    19,978
FT Group..................................................  1,885     1,397    2,362     5,644
The Penguin Group.........................................  1,223     2,115      980     4,318
Other.....................................................    414       513        1       928
                                                            -----    ------    -----    ------
TOTAL PEARSON.............................................  4,965    18,463    7,440    30,868
                                                            =====    ======    =====    ======

divisions.
             
Average number employed 2006 2005 2004
       
School  11,064   10,133   10,403 
Higher Education  4,368   4,196   4,087 
Professional  3,754   3,809   3,368 
Penguin  3,943   4,051   4,085 
FT Publishing  2,285   1,952   1,989 
IDC  2,200   1,956   1,826 
Other  1,669   1,573   1,365 
Continuing operations  29,283   27,670   27,123 
          
Discontinued operations  5,058   4,533   5,963 
          
Total  34,341   32,203   33,086 
          
ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
      To our knowledge, as of March 31, 2004,February 28, 2007, the only beneficial owners of 3% or more of our issued and outstanding ordinary share capital were The Capital Group
CompaniesFranklin Resources Inc. which owned 112,304,891103,908,285 ordinary shares representing 14.0%12.9% of our outstanding ordinary shares, Franklin Resources Inc.FMR Corp. and Fidelity International Limited which owned 56,515,05549,800,888 ordinary shares representing 7.04% of our outstanding ordinary shares,
Telefonica Contenidos SA, which owned 38,853,403 ordinary shares representing
4.84%6.2% of our outstanding ordinary shares and Legal and General Group plc which owned 24,046,75928,868,364 ordinary shares representing 3.0%3.6% of our outstanding ordinary shares. On February 29, 2004,28, 2007, record holders with registered addresses in the United States held 16,482,52736,623,444 ADRs, which represented 2.05%4.5% of our outstanding ordinary shares. Because some of these ADRs are held by nominees, these numbers may not accurately represent the number of beneficial owners in the United States.
      Loans and equity advanced to joint ventures and associates during the year and as at December 31, 2006 are shown in note 13 in “Item 17. Financial Statements.” Amounts due from joint ventures and associates are set out in note 19 and dividends receivable from joint ventures and associates are set out in note 13 in “Item 17. Financial Statements”. There were no other related party transactions in 2006.
ITEM 8.     FINANCIAL INFORMATION
      The financial statements filed as part of this Annual Report are included on pages F-1 through F-63F-70 hereof.
      Other than those events described in Note 31note 35 in “Item 17. Financial Statements” of this Form 20-F and seasonal fluctuations in borrowings, there has been no significant change to our financial condition or results of operations since December 31, 2003.2006. Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements of the educational book business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December.
      Our policy with respect to dividend distributions is described in response to "Item“Item 3. Key Information"Information” above.

LEGAL PROCEEDINGS
Legal Proceedings
      We and our subsidiaries are defendants in a number of legal proceedings including, from time to time, government and arbitration proceedings, which are incidental to our and their operations. We do not expect that the outcome of pending proceedings, either individually or in the aggregate, will have a significant effect on our financial position or profitability nor have any such proceedings had any such effect in the recent past. To our knowledge, there are no material proceedings in which any member of senior management or any of
55
our affiliates is a party adverse to us or any of our subsidiaries or in respect of which any of those persons has a material interest adverse to us or any of our subsidiaries.

     On December 11, 2003, Interactive Data, our 61% owned subsidiary, announced
a $125,000 settlement with the SEC, without admitting or denying their formal
findings, arising out of an investigation by the SEC into the management of
certain unaffiliated bond funds. There will be costs associated with Interactive
Data's increased record-keeping obligations. However, we do not expect the SEC
settlement to have a material effect on the results of operations or financial
condition of Interactive Data or on Pearson as a whole.

                                        48

ITEM 9.     THE OFFER AND LISTING
      The principal trading market for our ordinary shares is the London Stock Exchange. Our ordinary shares also trade in the United States in the form of ADSs evidenced by ADRs under a sponsored ADR facility with The Bank of New York as depositary. We established this facility in March 1995 and amended it in August 2000 in connection with our New York Stock Exchange listing. Each ADS represents one ordinary share.
      The ADSs trade on the New York Stock Exchange under the symbol "PSO"“PSO”.
      The following table sets forth the highest and lowest middle market quotations, which represent the average of closing bid and asked prices, for the ordinary shares, as derived from the Daily Official List of the London Stock Exchange and the average daily trading volume on the London Stock Exchange:

     -  on an annual basis for our five most recent fiscal years,

     -  
• on an annual basis for our five most recent fiscal years,
• on a quarterly basis for our most recent quarter and two most recent
        fiscal years, and

     -  on a monthly basis for the six most recent months.



                                                              ORDINARY SHARES
                                                              ----------------      AVERAGE DAILY
REFERENCE PERIOD                                               HIGH      LOW       TRADING VOLUME
- ----------------                                              ------    ------    -----------------
                                                                 (IN PENCE)       (ORDINARY SHARES)

Five Most Recent Fiscal Years
  2003......................................................    680       430         6,631,800
  2002......................................................    922       505         6,164,500
  2001......................................................  1,726       645         5,245,000
  2000......................................................  2,302     1,470         2,686,700
  1999......................................................  2,004     1,173         1,910,700
Most Recent Quarter and Two Most Recent Fiscal Years
2004  First quarter.........................................    657       584         7,039,600
2003  Fourth quarter........................................    680       579         6,786,300
       Third quarter........................................    639       550         6,160,400
       Second quarter.......................................    606       497         6,402,900
       First quarter........................................    604       430         7,182,800
2002  Fourth quarter........................................    740       523         6,570,900
       Third quarter........................................    690       505         6,783,200
       Second quarter.......................................    914       653         5,507,900
       First quarter........................................    922       694         5,732,400
Most Recent Six Months
       April 2004...........................................    680       623         8,846,800
       March 2004...........................................    631       594         7,559,000
       February 2004........................................    634       584         7,777,300
       January 2004.........................................    657       610         5,748,100
       December 2003........................................    662       604         7,910,800
       November 2003........................................    680       610         7,423,200
two most recent fiscal years, and
• on a monthly basis for the six most recent months.
              
  Ordinary  
  shares  
    Average daily
Reference period High Low trading volume
       
    (Ordinary shares)
  (In pence)  
Five most recent fiscal years
            
 2006  811   671   5,004,500 
 2005  695   608   5,296,700 
 2004  682   579   6,219,200 
 2003  680   430   6,631,800 
 2002  922   505   6,164,500 
Most recent quarter and two most recent fiscal years
            
 2007 First quarter  842   762   5,864,200 
 2006 Fourth quarter  796   742   3,979,500 
 Third quarter  767   689   3,900,700 
 Second quarter  798   688   5,728,800 
 First quarter  812   671   6,395,400 
 2005 Fourth quarter  692   616   4,947,900 
 Third quarter  695   652   4,860,700 
 Second quarter  668   628   5,823,300 
 First quarter  662   608   5,626,100 
Most recent six months
            
 March 2007  872   783   8,538,000 
 February 2007  834   790   4,812,500 
 January 2007  842   762   6,380,300 
 December 2006  781   742   4,378,900 
 November 2006  789   751   3,509,000 
 October 2006  796   761   4,099,600 
56
ITEM 10.     ADDITIONAL INFORMATION

MEMORANDUM AND ARTICLES OF ASSOCIATION
Memorandum and articles of association
      We summarize below the material provisions of our memorandum and articles of association, as amended, which have been filed as an exhibit to thisour annual report.report on Form 20-F for the year ended December 31, 2003. The summary below is qualified entirely by reference to the Memorandum and Articles of Association. We have multiple business objectives and purposes and are authorized to do such things as the board may consider to further our interests or incidental or conducive to the attainment of our objectives and purposes.

                                        49


DIRECTORS' POWERS
Directors’ powers
      Our business shall be managed by the board of directors and the board may exercise all such of our powers as are not required by law or by the Articles of Association to be exercised by resolution of the shareholders in general meeting.

INTERESTED DIRECTORS
Interested directors
      A director shall not be disqualified from contracting with us by virtue of his or her office or from having any other interest, whether direct or indirect, in any contract or arrangement entered into by or on behalf of us. An interested director must declare the nature of his or her interest in any contract or arrangement entered into by or on behalf of us in accordance with the Companies Act 1985. Provided that the director has declared his interest and acted in accordance with law, no such contract or arrangement shall be avoided and no director so contracting or being interested shall be liable to account to us for any profit realisedrealized by him from the contract or arrangement by reason of the director holding his office or the fiduciary relationship thereby established. A director may not vote on any contract or arrangement or any other proposal in which he or she has, together with any interest of any person connected with him or her, an interest which is, to his or her knowledge, a material interest, otherwise than by virtue of his or her interests in shares, debentures or other securities of or otherwise in or through us. If a question arises as to the materiality of a director'sdirector’s interest or his or her entitlement to vote and the director does not voluntarily agree to abstain from voting, that question will be referred to the chairman of the board or, if the chairman also is interested, to a person appointed by the other directors who is not interested. The ruling of the chairman or that other person, as the case may be, will be final and conclusive. A director will not be counted in the quorum at a meeting in relation to any resolution on which he or she is prohibited from voting.
      Notwithstanding the foregoing, a director will be entitled to vote, and be counted in the quorum, on any resolution concerning any of the following matters:

     -  the giving of any guarantee, security or indemnity in respect of money
        lent or obligations incurred by him or her or by any other person at the
        request of or for the benefit of us or any of our subsidiaries;

     -  the giving of any guarantee, security or indemnity to a third party in
        respect of a debt or obligation of ours or any of our subsidiaries for
        which he or she has assumed responsibility in whole or in part and
        whether alone or jointly with others under a guarantee or indemnity or
        by the giving of security;

     -  any proposal relating to us or any of our subsidiaries where we are
        offering securities in which a director is or may be entitled to
        participate as a holder of securities or in the underwriting or
        sub-underwriting of which a director is to participate;

     -  any proposal relating to an arrangement for the benefit of our employees
        or any of our subsidiaries that does not award him or her any privilege
        or benefit not generally awarded to the employees to whom such
        arrangement relates; and

     -  
• the giving of any guarantee, security or indemnity in respect of money lent or obligations incurred by him or her or by any other person at the request of or for the benefit of us or any of our subsidiaries;
• the giving of any guarantee, security or indemnity to a third party in respect of a debt or obligation of ours or any of our subsidiaries for which he or she has assumed responsibility in whole or in part and whether alone or jointly with others under a guarantee or indemnity or by the giving of security;
• any proposal relating to us or any of our subsidiaries where we are offering securities in which a director is or may be entitled to participate as a holder of securities or in the underwriting orsub-underwriting of which a director is to participate;
• any proposal relating to an arrangement for the benefit of our employees or any of our subsidiaries that does not award him or her any privilege or benefit not generally awarded to the employees to whom such arrangement relates; and
• any proposal concerning insurance that we propose to maintain or purchase for the benefit of directors or for the benefit of persons, including directors.
57
      Where proposals are under consideration concerning the appointment of two or more directors to offices or employment with us or any company in which we are interested, these proposals may be divided and considered separately and each of these directors, if not prohibited from voting under the proviso of the fourth clause above, will be entitled to vote and be counted in the quorum with respect to each resolution except that concerning his or her own appointment.

BORROWING POWERS
Borrowing powers
      The board of directors may exercise all powers to borrow money and to mortgage or charge our undertaking, property and uncalled capital and to issue debentures and other securities, whether outright or as collateral security for any of our or any third party'sparty’s debts, liabilities or obligations. The board of directors must restrict the borrowings in order to secure that the aggregate amount of undischarged monies borrowed by us (and any of our subsidiaries), but excluding anyintra-group debts, shall not at any time exceed a sum equal to twice the aggregate
                                        50
 of the adjusted capital and reserves, unless the shareholders in general meeting sanction an excession of this limitation.

OTHER PROVISIONS RELATING TO DIRECTORS
Other provisions relating to directors
      Under the articles of association, directors are paid out of our funds for their services as we may from time to time determine by ordinary resolution and, in the case ofnon-executive directors, up to an aggregate of L500,000£500,000 or such other amounts as resolved by the shareholders at a general meeting. Directors currently are not required to be qualified by owning our shares. WhileChanges to the Companies Act, 1985 states that nowhich came into force on April 7, 2007, now permit the appointment of a director may be appointed after he reaches the
age of 70 our articles of association provide for the reappointment, after
retirement, of directors attaining the age of 70. This is permissible under the
Companies Act 1985.

ANNUAL GENERAL MEETINGS AND EXTRAORDINARY GENERAL MEETINGS

     Shareholders'or over.
Annual general meetings and extraordinary general meetings
      Shareholders’ meetings may be either annual general meetings or extraordinary general meetings. However, the following matters are ordinarily transacted at an annual general meeting:

     -  sanctioning or declaring dividends;

     -  consideration of the accounts and balance sheet;

     -  ordinary reports of the board of directors and auditors and any other
        documents required to be annexed to the balance sheet;

     -  as holders of ordinary shares vote for the election of one-third of the
        members of the board of directors at every annual general meeting, the
        appointment or election of directors in the place of those retiring by
        rotation or otherwise;

     -  appointment or reappointment of, and determination of the remuneration
        of, the auditors; and

     -  
• sanctioning or declaring dividends;
• consideration of the accounts and balance sheet;
• ordinary reports of the board of directors and auditors and any other documents required to be annexed to the balance sheet;
• as holders of ordinary shares vote for the election ofone-third of the members of the board of directors at every annual general meeting, the appointment or election of directors in the place of those retiring by rotation or otherwise;
• appointment or reappointment of, and determination of the remuneration of, the auditors; and
• the renewal, limitation, extension, variation or grant of any authority of or to the board, pursuant to the Companies Act 1985, to allot securities.
      Business transacted at an extraordinary general meeting may also be transacted at an annual general meeting.
      We hold a general meeting as our annual general meeting within fifteen months after the date of the preceding annual general meeting, at a place and time determined by the board. The board may call an extraordinary general meeting at any time and for any reason. The board must convene an extraordinary general meeting if requested to do so by shareholders holding not less thanone-tenth of our issued share capital.
      Three shareholders present in person and entitled to vote will constitute a quorum for any general meeting. If a quorum for a meeting convened at the request of shareholders is not present within fifteen minutes of the appointed time, the meeting will be dissolved. In any other case, the general meeting will be adjourned to the same day in the next week, at the same time and place, or to a time and place that the chairman fixes. If at that rescheduled meeting a quorum is not present within fifteen minutes from the time
58
appointed for holding the meeting, the shareholders present in person or by proxy will be a quorum. The chairman or, in his absence, the deputy chairman or any other director nominated by the board, will preside as chairman at every general meeting. If no director is present at the general meeting or no director consents to act as chairman, the shareholders present shall elect one of their number to be chairman of the meeting.

ORDINARY SHARES
Ordinary shares
      Certificates representing ordinary shares are issued in registered form and, subject to the terms of issue of those shares, are issued following allotment or receipt of the form of transfer bearing the appropriate stamp duty by our registrar, Lloyds Bank Registrars, theThe Causeway, Worthing, West Sussex BN99 6DA, United Kingdom, telephone number +44-1903-502-541.

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SHARE CAPITAL
Share capital
      Any share may be issued with such preferred, deferred or other special rights or other restrictions as we may determine by way of a shareholders'shareholders’ vote in general meeting. Subject to the Companies Act 1985, any shares may be issued on terms that they are, or at our or the shareholders'shareholders’ option are, liable to be redeemed on such terms and in such manner as we, before the issue of the shares, may by special resolution of the shareholders, determine.
      There are no provisions in the Articles of Association which discriminate against any existing or prospective shareholder as a result of such shareholder owning a substantial number of shares.
      Subject to the terms of the shares which have been issued, the directors may from time to time make calls upon the shareholders in respect of any moneys unpaid on their shares, provided that (subject to the terms of the shares so issued) no call on any share shall be payable at less than fourteen clear days from the last call. The directors may, if they see fit, receive from any shareholder willing to advance the same, all and any part of the moneys uncalled and unpaid upon any shares held by him.

CHANGES IN CAPITAL
Changes in capital
      We may from time to time, by ordinary resolution:

     -  consolidate and divide our share capital into shares of a larger amount
        than its existing shares; or

     -  sub-divide all of or any of our existing shares into shares of smaller
        amounts than is fixed by the Memorandum of Association, subject to the
        Companies Act 1985; or

     -  
• consolidate and divide our share capital into shares of a larger amount than its existing shares; or
• sub-divide all of or any of our existing shares into shares of smaller amounts than is fixed by the Memorandum of Association, subject to the Companies Act 1985; or
• cancel any shares which, at the date of passing of the resolution, have not been taken, or agreed to be taken, by any person and diminish the amount of our share capital by the amount of the shares so cancelled.
      We may, from time to time, by ordinary resolution increase our share capital and, by special resolution, decrease our share capital, capital redemption reserve fund and any share premium account in any way.

VOTING RIGHTS
Voting rights
      Every holder of ordinary shares present in person at a meeting of shareholders has one vote on a vote taken by a show of hands. On a poll, every holder of ordinary shares who is present in person or by proxy has one vote for every ordinary share of which he or she is the holder. Voting at any meeting of shareholders is by a show of hands unless a poll is properly demanded before the declaration of the results of a show of hands. A poll may be demanded by:

     -  the chairman of the meeting;

     -  at least three shareholders present in person or by proxy and entitled
        to vote;

     -  any shareholder or shareholders present in person or by proxy
        representing not less than one-tenth of the total voting rights of all
        shareholders having the right to vote at the meeting; or

     -  any shareholder or shareholders present in person or by proxy holding
        shares conferring a right to vote at the meeting being shares on which
        the aggregate sum paid up is equal to not less than one-tenth of the
        total sum paid up on all shares conferring that right.

DIVIDENDS
• the chairman of the meeting;
• at least three shareholders present in person or by proxy and entitled to vote;
• any shareholder or shareholders present in person or by proxy representing not less thanone-tenth of the total voting rights of all shareholders having the right to vote at the meeting; or
59
• any shareholder or shareholders present in person or by proxy holding shares conferring a right to vote at the meeting being shares on which the aggregate sum paid up is equal to not less thanone-tenth of the total sum paid up on all shares conferring that right.
Dividends
      Holders of ordinary shares are entitled to receive dividends out of our profits that are available by law for distribution, as we may declare by ordinary resolution, subject to the terms of issue thereof. However, no dividends may be declared in excess of an amount recommended by the board of directors. The board may pay interim dividends to the shareholders as it deems fit. We may invest or otherwise use all dividends left unclaimed for six months after having been declared for our benefit, until claimed. All dividends unclaimed for a period of twelve years after having been declared will be forfeited and revert to us.

                                        52

      The directors may, with the sanction of a resolution of the shareholders, offer any holders of ordinary shares the right to elect to receive ordinary shares credited as fully paid, in whole or in part, instead of cash in respect of such dividend.
      The directors may deduct from any dividend payable to any shareholder all sums of money (if any) presently payable by that shareholder to us on account of calls or otherwise in relation to our shares.

LIQUIDATION RIGHTS
Liquidation rights
      In the event of our liquidation, after payment of all liabilities, our remaining assets would be used to repay the holders of ordinary shares the amount they paid for their ordinary shares. Any balance would be divided among the holders of ordinary shares in proportion to the nominal amount of the ordinary shares held by them.

OTHER PROVISIONS OF THE ARTICLES OF ASSOCIATION
Other provisions of the articles of association
      Whenever our capital is divided into different classes of shares, the special rights attached to any class may, unless otherwise provided by the terms of the issue of the shares of that class, be varied or abrogated, either with the written consent of the holders ofthree-fourths of the issued shares of the class or with the sanction of an extraordinary resolution passed at a separate meeting of these holders.
      In the event that a shareholder or other person appearing to the board of directors to be interested in ordinary shares fails to comply with a notice requiring him or her to provide information with respect to their interest in voting shares pursuant to section 212 of the Companies Act 1985, we may serve that shareholder with a notice of default. After service of a default notice, that shareholder shall not be entitled to attend or vote at any general meeting or at a separate meeting of holders of a class of shares or on a poll until he or she has complied in full with our information request.
      If the shares described in the default notice represent at leastone-fourth of 1% in nominal value of the issued ordinary shares, then the default notice may additionally direct that in respect of those shares:

     -  we will not pay dividends (or issue shares in lieu of dividends); and

     -  
• we will not pay dividends (or issue shares in lieu of dividends); and
• we will not register transfers of shares unless the shareholder is not himself in default as regards supplying the information requested and the transfer, when presented for registration, is in such form as the board of directors may require to the effect that after due and careful inquiry, the shareholder is satisfied that no person in default is interested in any of the ordinary shares which are being transferred or the transfer is an approved transfer, as defined in our articles of association.
      No provision of our articles of association expressly governs the ordinary share ownership threshold above which shareholder ownership must be disclosed. Under the Companies Act 1985, any person who acquires, either alone or, in specified circumstances, with others:

     -  a material interest in our voting share capital equal to or in excess of
        3%; or

     -  a non-material interest equal to or in excess of 10%,

     
• a material interest in our voting share capital equal to or in excess of 3%; or
• a non-material interest equal to or in excess of 10%,
60
comes under an obligation to disclose prescribed particulars to us in respect of those ordinary shares. A disclosure obligation also arises where a person'sperson’s notifiable interests fall below the notifiable percentage, or where, above that level, the percentage of our voting share capital in which a person has a notifiable interest increases or decreases.

LIMITATIONS AFFECTING HOLDERS OF ORDINARY SHARES OR ADSS
Limitations affecting holders of ordinary shares or ADSs
      Under English law and our memorandum and articles of association, persons who are neither UK residents nor UK nationals may freely hold, vote and transfer ordinary shares in the same manner as UK residents or nationals.
      With respect to the items discussed above, applicable UK law is not materially different from applicable US law.

                                        53


MATERIAL CONTRACTS
Material contracts
      The following summaries are not intended to be complete and reference is made to the contracts themselves, which are included, or incorporated by reference, as exhibits to this annual report. We have entered into the following contracts outside the ordinary course of business during the two year period immediately preceding the date of this annual report:

ISSUANCE OF $300,000,000 4.625% SENIOR NOTES DUE 2018

     We
Issuance of $350,000,000 4.70% Guaranteed Senior Notes due 2009 and $400,000,000 5.70% Guaranteed Senior Notes due 2014
      Our wholly-owned subsidiary, Pearson Dollar Finance plc, issued US $300 million$350m principal amount of 4.625%4.70% senior notes due 20182009 and $400m principal amount of 5.70% senior notes due 2014, in each case fully and unconditionally guaranteed by Pearson plc, under an indenture dated June 23, 2003May 25, 2004 between usPearson Dollar Finance plc, Pearson plc and The Bank of New York, as trustee. The firstsemi-annual interest payment was made on December 15, 2003.
We1, 2004. Pearson Dollar Finance may redeem the notes at any time, in whole or in part, at ourits option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than thean insolvency or bankruptcy of usPearson Dollar Finance plc, Pearson plc or a principal subsidiary of Pearson plc (as defined in the indenture), the holders of at least 25% of the principal amount of the then outstanding notes may declare the notes, along with accrued but unpaid interest and other amounts described in the indenture, as immediately due and payable. In the event of an insolvency or bankruptcy of Pearson Dollar Finance plc, Pearson plc or a principal subsidiary of Pearson plc (as defined in the indenture), the principal of all outstanding notes shall become due and payable immediately.
The indenture limits our ability to create liens to secure certain types of debt intended to be listed or traded on an exchange.

EXECUTIVE EMPLOYMENT CONTRACTS
Issuance of $300,000,000 4.625% Senior Notes due 2018
      We issued $300m principal amount of 4.625% senior notes due 2018 under an indenture dated June 23, 2003 between us and The Bank of New York, as trustee. The firstsemi-annual interest payment was made on December 15, 2003. We may redeem the notes at any time, in whole or in part, at our option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than the insolvency or bankruptcy of us or a principal subsidiary (as defined in the indenture), the holders of at least 25% of the principal amount of the then outstanding notes may declare the notes, along with accrued, but unpaid, interest and other amounts described in the indenture, as immediately due and payable.
      The indenture limits our ability to create liens to secure certain types of debt intended to be listed or traded on an exchange.
61
Executive employment contracts
      We have entered into agreements with each of our executive directors pursuant to which such executive director is employed by us. These agreements describe the duties of such executive director and the compensation to be paid by us. See "Item“Item 6. Directors, Senior Management & Employees --— Compensation of Senior Management"Management”. Each agreement may be terminated by us on 12 months'months’ notice or by the executive director on six months'months’ notice. In the event we terminate any executive director without giving the full 12 months'months’ advance notice, the executive director is entitled to receive liquidated damages equal to 12 months base salary and benefits together with a proportion of potential bonus. In the
case of Peter Jovanovich, his service agreement provides for compensation on
termination of employment by the company without cause of 200% of annual salary
plus target bonus, reflecting US employment practice and the terms agreed with
him in his employment and confirmed in October 2000 before his appointment as a
director of the company.

EXCHANGE CONTROLS
Exchange controls
      There are no UK government laws, decrees, regulations or other legislation which restrict or which may affect the import or export of capital, including the availability of cash and cash equivalents for use by us or the remittance of dividends, interest or other payments to nonresident holders of our securities, except as otherwise described under "--“ — Tax Considerations"Considerations” below.

TAX CONSIDERATIONS
Tax considerations
      The following is a discussion of the material US federal income tax considerations and UK tax considerations arising from the acquisition, ownership and disposition of ordinary shares and ADSs by a US holder. A US holder is:

     -  an individual citizen or resident of the US,

     -  a corporation created or organized in or under the laws of the United
        States or any of its political subdivisions, or

     -  an estate or trust the income of which is subject to US federal income
        taxation regardless of its source.

                                        54

• an individual citizen or resident of the US,
• a corporation created or organized in or under the laws of the United States or any of its political subdivisions, or
• an estate or trust the income of which is subject to US federal income taxation regardless of its source.
      This discussion deals only with ordinary shares and ADSs that are held as capital assets by a US holder, and does not address tax considerations applicable to US holders that may be subject to special tax rules, such as:

     -  dealers or traders in securities or currencies,

     -  financial institutions or other US holders that treat income in respect
        of the ordinary shares or ADSs as financial services income,

     -  insurance companies,

     -  tax-exempt entities,

     -  US holders that hold the ordinary shares or ADSs as a part of a straddle
        or conversion transaction or other arrangement involving more than one
        position,

     -  US holders that own, or are deemed for US tax purposes to own, 10% or
        more of the total combined voting power of all classes of our voting
        stock,

     -  US holders that have a principal place of business or "tax home" outside
        the United States, or

     -  US holders whose "functional currency"
• dealers or traders in securities or currencies,
• financial institutions or other US holders that treat income in respect of the ordinary shares or ADSs as financial services income,
• insurance companies,
• tax-exempt entities,
• US holders that hold the ordinary shares or ADSs as a part of a straddle or conversion transaction or other arrangement involving more than one position,
• US holders that own, or are deemed for US tax purposes to own, 10% or more of the total combined voting power of all classes of our voting stock,
• US holders that have a principal place of business or “tax home” outside the United States, or
• US holders whose “functional currency” is not the US dollar.
      For US federal income tax purposes, holders of ADSs will be treated as the owners of the ordinary shares represented by those ADSs.

     The discussion below is based upon current UK law and the provisions of the
US Internal Revenue Code of 1986, or the Code, and regulations, rulings and
judicial decisions as of the date of this Annual Report; any such authority may
be repealed, revoked or modified, perhaps with retroactive effect, so as to
result in tax consequences different from those discussed below. This discussion
is also based on the Income Tax Treaty between the United Kingdom and the United
States, which came into force in March 2003 (the "New Income Tax Treaty"). The
New Income Tax Treaty replaced the 1975 Income Tax Treaty between the United
Kingdom and the United States (the "Old Income Tax Treaty"), and is effective in
relation to withholding tax from 1 May 2003, for United Kingdom income and
capital gains tax from 6 April 2003 (individuals) and 1 April 2003 (Companies)
and for US income tax from 1 January 2004. Under the Old Income Tax Treaty a US
holder was entitled to claim a tax credit from the UK Inland Revenue in respect
of dividends received from us, subject to a notional withholding tax. The
payment of such tax credits was specifically abolished with effect from 1 May
2003. However, a UK holder is entitled to have the Old Income Tax Treaty apply
in its entirety for a period of twelve months after the effective dates of the
New Income Tax Treaty. Notwithstanding this, for the purposes of this discussion
it is assumed that the New Income Tax Treaty applies.
      In addition, the following discussion assumes that The Bank of New York will perform its obligations as depositary in accordance with the terms of the depositary agreement and any related agreements.

     BECAUSE
Because US ANDand UK TAX CONSEQUENCES MAY DIFFER FROM ONE HOLDER TO THE NEXT,
THE DISCUSSION SET OUT BELOW DOES NOT PURPORT TO DESCRIBE ALL OF THE TAX
CONSIDERATIONS THAT MAY BE RELEVANT TO YOU AND YOUR PARTICULAR SITUATION.
ACCORDINGLY, YOU ARE ADVISED TO CONSULT YOUR OWN TAX ADVISOR AS TO THEtax consequences may differ from one holder to the next, the discussion set out below does not purport to describe all of the tax considerations that may be relevant to you and your particular situation. Accordingly, you are advised to consult your own tax advisor as to the US FEDERAL, STATE AND LOCAL,federal, state
62
and local, UK AND OTHER, INCLUDING FOREIGN, TAX CONSEQUENCES OF
INVESTING IN THE ORDINARY SHARES OR ADSS. THE STATEMENTS OFand other, including foreign, tax consequences of investing in the ordinary shares or ADSs. The statements of US ANDand UK TAX LAW
SET OUT BELOW ARE BASED ON THE LAWS AND INTERPRETATIONS IN FORCE AS OF THE DATE
OF THIS ANNUAL REPORT, AND ARE SUBJECT TO ANY CHANGES OCCURRING AFTER THAT DATE.

UK INCOME TAXATION OF DISTRIBUTIONStax law set out below are based on the laws and interpretations in force as of the date of this Annual Report, and are subject to any changes occurring after that date.
UK income taxation of distributions
      The United Kingdom does not impose dividend withholding tax on dividends paid to US holders.

US INCOME TAXATION OF DISTRIBUTIONS
US income taxation of distributions
      Distributions that we make with respect to the ordinary shares or ADSs, other than distributions in liquidation and distributions in redemption of stock that are treated as exchanges, will be taxed to US holders as ordinary dividend income to the extent that the distributions do not exceed our current and accumulated earnings and profits. The amount of any distribution will equal the amount of the cash distribution. Distributions, if any, in 55
excess of our current and accumulated earnings and profits will constitute anon-taxable return of capital to a US holder and will be applied against and reduce the US holder'sholder’s tax basis in its ordinary shares or ADSs. To the extent that these distributions exceed the tax basis of the US holder in its ordinary shares or ADSs, the excess generally will be treated as capital gain.
      Dividends that we pay will not be eligible for the dividends received deduction generally allowed to US corporations under Section 243 of the Code.
      In the case of distributions in pounds, the amount of the distributions generally will equal the US dollar value of the pounds distributed, determined by reference to the spot currency exchange rate on the date of receipt of the distribution by the US holder in the case of shares or by The Bank of New York in the case of ADSs, regardless of whether the US holder reports income on a cash basis or an accrual basis. The US holder will realize separate foreign currency gain or loss only to the extent that this gain or loss arises on the actual disposition of pounds received. For US holders claiming tax credits on a cash basis, taxes withheld from the distribution are translated into US dollars at the spot rate on the date of the distribution; for US holders claiming tax credits on an accrual basis, taxes withheld from the distribution are translated into US dollars at the average rate for the taxable year.

     As a result of the Jobs and Growth Tax Relief Reconciliation Act of 2003
(referred to here as the 2003 Tax Act), a
      A distribution by the Company to noncorporate shareholders before 20092011 will be taxed as net capital gain at a maximum rate of 15%, provided certain holding periods are met, to the extent such distribution is treated as a dividend under U.S. federal income tax principles.

UK INCOME TAXATION OF CAPITAL GAINS
UK income taxation of capital gains
      Under the New Income Tax Treaty, each country generally may tax capital gains in accordance with the provisions of its domestic law. Under present UK law, a US holder that is not a resident, and, in the case of an individual, not ordinarily resident, in the United Kingdom for UK tax purposes and who does not carry on a trade, profession or vocation in the United Kingdom through a branch or agency to which ordinary shares or ADSs are attributable will not be liable for UK taxation on capital gains or eligible for relief for allowable losses, realized on the sale or other disposal (including redemption) of these ordinary shares or ADSs.

US INCOME TAXATION OF CAPITAL GAINS
US income taxation of capital gains
      Upon a sale or exchange of ordinary shares or ADSs to a person other than Pearson, a US holder will recognize gain or loss in an amount equal to the difference between the amount realized on the sale or exchange and the US holder'sholder’s adjusted tax basis in the ordinary shares or ADSs. Any gain or loss recognized will be capital gain or loss and will belong-term capital gain or loss if the US holder has held the ordinary shares or ADSs for more than one year. As a result of the 2003 Tax Act, long-termLong-term capital gain of a noncorporate US holder is generally taxed at a maximum rate of 15%. Thislong-term capital gain rate which reflects a reduction from the prior maximum rate of 20%, is scheduled to expire under the 2003 Tax Act, in 2009.2011.
      Gain or loss realized by a US holder on the sale or exchange of ordinary shares or ADSs generally will be treated asUS-source gain or loss for US foreign tax credit purposes.

ESTATE AND GIFT TAX
63
Estate and gift tax
      The current Estate and Gift Tax Convention, or the Convention, between the United States and the United Kingdom generally relieves from UK Inheritance Tax (the equivalent of US Estate and Gift Tax) the transfer of ordinary shares or of ADSs where the transferor is domiciled in the United States, for the purposes of the Convention. This relief will not apply if the ordinary shares or ADSs are part of the business property of an individual'sindividual’s permanent establishment in the United Kingdom or pertain to the fixed base in the United Kingdom of a person providing independent personal services. If no relief is given under the Convention, inheritance tax may be charged on the amount by which the value of the transferor'stransferor’s estate is reduced as a result of any transfer made by way of gift or other gratuitous transfer by an individual, in general within seven years of death, or on the death of an individual. In the unusual case where ordinary shares or ADSs are subject to both UK Inheritance Tax

                                        56
 and US Estate or Gift Tax, the Convention generally provides for tax paid in the United Kingdom to be credited against tax payable in the United States or for tax paid in the United States to be credited against tax payable in the United Kingdom based on priority rules set forth in the Convention.

STAMP DUTY
Stamp duty
      No stamp duty or stamp duty reserve tax (SDRT) will be payable in the United Kingdom on the purchase or transfer of an ADS, provided that the ADS, and any separate instrument or written agreement of transfer, remain at all times outside the United Kingdom and that the instrument or written agreement of transfer is not executed in the United Kingdom. Stamp duty or SDRT is, however, generally payable at the rate of 1.5% of the amount or value of the consideration or, in some circumstances, the value of the ordinary shares, where ordinary shares are issued or transferred to a person whose business is or includes issuing depositary receipts, or to a nominee or agent for such a person.
      A transfer for value of the underlying ordinary shares will generally be subject to either stamp duty or SDRT, normally at the rate of 0.5% of the amount or value of the consideration. A transfer of ordinary shares from a nominee to its beneficial owner, including the transfer of underlying ordinary shares from the Depositary to an ADS holder, under which no beneficial interest passes is subject to stamp duty at the fixed rate of L5.00£5.00 per instrument of transfer.

CLOSE COMPANY STATUS
Close company status
      We believe that the close company provisions of the UK Income and Corporation Taxes Act 1988 do not apply to us.

DOCUMENTS ON DISPLAY
Documents on display
      Copies of our Memorandum and Articles of Association, the material contracts described above and filed as exhibits to this Annual Report and certain other documents referred to in this Annual Report are available for inspection at our registered office at 80 Strand, London WC2R 0RL (c/o the Company Secretary), or, in the United States, at the registered office of Pearson Inc. at 1330 Avenue of the Americas, 7th Floor, New York, New York, during usual business hours upon reasonable prior request.
ITEM 11.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTRODUCTION
Introduction
      Our principal market risks are changes in interest rates and currency exchange rates. Following an evaluation of these positions, we selectively enter into derivative financial instruments to manage our risk exposure. For this purpose, we primarily use interest rate swaps, interest rate caps and collars, forward rate agreements, currency swaps and forward foreign exchange contracts. Managing market risks is the responsibility of the Chief Financial Officer, who acts pursuant to policies approved by ourthe board of directors. A TreasuryThe Audit Committee of the board receives regular reports on our treasury activities, which outsideand we periodically meet with external advisers alsoto review periodically.our activities.
64
      We have a policy of not undertaking any speculative transactions, and we do not hold theour derivative and other financial instruments for purposes other than
trading.trading purposes.
      We have formulated our policies for hedging exposures to interest rate and foreign exchange risk, and have used derivatives to ensure compliance with these policies. Although the majority of our derivative contracts were transacted without regard to existing US GAAP requirements on hedge accounting, during 20032006 and 2005 we sought to gain qualificationqualified for hedge accounting under US GAAP foron a limited number of our key derivative contracts, but did not meet the prescribed hedge
designation requirements.contracts.
      The following discussion addresses market risk only and does not present other risks that we face in the normal course of business, including country risk, credit risk and legal risk. See Note 19 for discussion of treasury policy
in these areas.

                                        57


INTEREST RATES

     Our
Interest rates
      The Group’s financial exposuresexposure to interest rates arisearises primarily from our
borrowings, particularly those in US dollars. We manage ourits borrowings. The Group manages its exposure by borrowing at fixed and variable rates of interest, and by entering into derivative instruments.transactions. Objectives approved by ourthe board concerning the proportion of debt outstanding at fixed rates govern ourthe use of these financial instruments.

     Our
      The Group’s objectives are applied to core net debt, which is measured at the year-end and comprises borrowings net of year-end cash and other liquid funds. Those objectives are that for between 40%
and 65%Our objective is to maintain a proportion of currentforecast core net debt the rate of interest should bein fixed or capped form for the next four years. Within this target range the proportionyears, subject to a maximum of 65% and a minimum that is hedged is
triggeredstarts at 40% and falls by a formula based on historical interest rate frequencies.10% each year.
      The principal method to hedgeof hedging interest rate risk is to enter into an agreement with a bank counterparty to pay a fixed-rate and receive a variable rate, known as a swap. Under interest rate swaps, we agreethe Group agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and variable-rate amounts calculated by reference to an agreed notional principal amount. The majority of thesethe company’s swap contracts are US dollar denominated, and some of them have deferred start dates, in order to maintain the desired risk profile as other contracts mature. The variable rates received are normally based on three-month andor six-month LIBOR, and the dates on which these rates are set do not necessarily exactly match those of the hedged borrowings. We believeManagement believes that our portfolio of these types of swaps is an efficient hedge of our portfolio of variable rate borrowings.
      In addition, from time to time, we issuethe Group issues bonds or other capital market instruments to refinance existing debt. To avoid the fixed rate on a single transaction unduly influencing our overall net interest expense, itour practice is our
normal practice to enter into a related derivative contract effectively converting the interest rate profile of the bond transaction to that of the debt
which it is refinancing. Most often this is a variable interest rate denominated
in US dollars.rate. In severalsome cases, the bond issue was denominated in a different currency thanto the debt being refinancedGroup’s desired borrowing risk profile and we havethe Group entered into a related cross currency interest rate and currency swap in order to maintain an unchanged borrowingthis risk profile.

CURRENCY EXCHANGE RATESprofile, which is predominantly borrowings denominated in US dollars.
      The Group’s accounting objective in its use of interest rate derivatives is to minimize the impact on the income statement of changes in the mark-to-market value of its derivative portfolio as a whole. It uses duration calculations to estimate the sensitivity of the derivatives to movements in market rates. The Group also identifies which derivatives are eligible for fair value hedge accounting (which reduces significantly the income statement impact of changes in the market value of a derivative). The Group then divides the total portfolio betweenhedge-accounted and pooled segments, so that the expected movement on the pooled segment is minimized.
Currency exchange rates
      Although we arethe Group is based in the United Kingdom, we haveit has significant investments in overseas operations. The most significant currency in which we
tradethe Group trades is the US dollar, followed by the euro and sterling.

     Ourdollar.
      The Group’s policy is to managealign approximately the currency composition of ourits core net borrowings in
US dollars, euro and sterling in order to approximate the percentages of those
currencies as reflected in ourwith its forecast operating profit. We use externalprofit (from February 2007, the policy is amended slightly to align core net borrowings with forecast operating profit before depreciation and currency swaps to manage this exposure.amortization). This policy aims to dampen the impact of
65
changes in foreign exchange rates on consolidated interest cover and earnings. While long-term core borrowingThis policy applies only to currencies that account for more than 15% of group operating profit, which currently is now limited toonly the US dollars,
euro and sterling, wedollar. However, the Group still borrowborrows small amounts in other currencies, typically for seasonal working capital needs. In addition, the Group currently expects to hold its legacy borrowings in euros and sterling to their maturity dates: the Group’s policy does not require existing currency debt to be terminated to match declines in that currency’s share of group operating profit. At December 31, 20032006 the splitGroup’s net borrowings/(cash) in our main currencies (taking into account the effect of aggregate net borrowings in core
currencies wascross currency rate swaps) were: US dollar 81%,£979m, euro 10%£158m and sterling 9%. We are also exposed£30m.
      The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange rates in our cash transactionsmovements on it to be taken to reserves) for the purposes of reporting under IFRS and our investments in overseas
transactions. Cash transactions -- typically for purchases, sales, interest or
dividends -- require cash conversions between currencies. Fluctuations in
currency exchange rates affect the cash amounts that we pay or receive.US GAAP.
      Investments in overseas operations are consolidated for accounting purposes by translating values in one currency to another currency, in particular from US dollars to sterling. Fluctuations in currency exchange rates affect the currency values recorded in our accounts, particularly those in sterling, although they do not give rise to any realized gain or loss, nor to any currency cash flows.

FORWARD FOREIGN EXCHANGE CONTRACTS

     We use
      The Group is also exposed to currency exchange rates in its cash transactions and its investments in overseas operations. Cash transactions — typically for purchases, sales, interest or dividends — require cash conversions between currencies. Fluctuations in currency exchange rates affect the cash amounts that the Group pays or receives.
Forward foreign exchange contracts
      The Group uses forward foreign exchange contracts where a specific major project or forecasted cash flow, including acquisitions and disposals, arises from a business decision that has used a specific foreign exchange rate. Our

                                        58
The Group’s policy is to effect routine transactional conversions between currencies, for example to collect receivables or settle payables, at the relevant spot exchange rate.

     We seek
      The Group seeks to offset purchases and sales in the same currency, even if they do not occur simultaneously. In addition, ourits debt and cash portfolios management gives rise to temporary currency shortfalls and surpluses. Both of these activities require us to use usingshort-dated foreign exchange swaps between currencies.
      Although we prepare ourthe Group prepares its consolidated accountsfinancial statements in sterling, wesignificant sums have been invested
significant sums in overseas assets, particularly in the United States. Therefore, fluctuations in currency exchange rates, particularly between the US dollar and sterling, and alsoto a lesser extent between the euro and sterling, are likely to affect shareholders'shareholders’ funds and other accounting values.

ITEM 12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     Not applicable.

                                        59


                                    PART II

ITEM 13.  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     None.

ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
          PROCEEDS

     Not applicable.

ITEM 15.  CONTROLS AND PROCEDURES

     An evaluation of the effectiveness of the design
Derivatives
      Under both IFRS and operation of our
disclosure controls and procedures as of December 31, 2003 was carried out by us
under the supervision and with the participation of our management, including
the Chief Executive Officer and Chief Financial Officer. Based on that
evaluation the Chief Executive Officer and Chief Financial Officer concluded
that Pearson's disclosure controls and procedures have been designed to provide,
and are effective in providing, reasonable assurance that the information
required to be disclosed by us in reports filed under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in the U.S. Securities and Exchange Commission's rules and
forms. A controls system, no matter how well designed and operated cannot
provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected. Subsequent to the date of the most
recent evaluation of our internal controls, there were no significant changes in
our internal controls or in other factors that could significantly affect the
internal controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.

ITEM 16A.  AUDIT COMMITTEE FINANCIAL EXPERT

     The members of the Board of Directors of Pearson plc have determined that
Vernon Sankey is an audit committee financial expert within the meaning of the
applicable rules and regulations of the US Securities and Exchange Commission.

ITEM 16B.  CODE OF ETHICS

     Pearson has adopted a code of ethics (the Pearson code of business conduct)
which applies to all employees including the Chief Executive Officer and Chief
Financial Officer. This code of ethics is available on our website
(www.pearson.com/investor/corpgov.htm). The information on our website is not
incorporated by reference into this report.

ITEM 16C.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

     In 2003, the audit committee adopted a revised policy for auditor services.
The policy requires all audit engagements to be approved by the audit committee.
The policy permits the auditors to be engaged for other services provided the
engagement is specifically approved in advance by the committee or alternatively
meets the detailed criteria of specific pre-approved services and is notified to
the committee.

                                        60


     The Group Chief Financial Officer or Group Controller can procure
pre-approved services, as defined in the audit committee's policy for auditor
services, of up to amount of L100,000 per engagement, subject to a cumulative
limit of L500,000 per year. The limit of L100,000 will be subject to annual
review by the audit committee. Where pre-approval has not been granted for a
service or where the amount is above these limits, specific case by case
approval must be obtained from the Audit Committee prior to the engagement of
our auditor.



AUDITORS' REMUNERATION                                        2003    2002
- ----------------------                                        ----    ----
                                                               LM      LM

Statutory audit and audit-related regulatory reporting
  services..................................................   3       3
Non-audit services..........................................   2       3
Non-audit services were as follows:
Tax compliance services.....................................   1       2
Tax advisory services.......................................   1       1



- ---------------

NOTE   Included in statutory audit fees are amounts relating to the parent
company of L20,000 (2002:L20,000). Audit-related regulatory reporting fees are
L200,000 (2002:L200,000). Non-audit fees in the UK in 2003 are L341,000
(2002:L231,000) and are in respect of tax advisory and tax compliance services.
The remainder of the non-audit fees relate to overseas subsidiaries.

ITEM 16D.  EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     Not applicable.

ITEM 16E.  PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES

     Not applicable.

                                        61


                                    PART III

ITEM 17.  FINANCIAL STATEMENTS

     The financial statements filed as part of this Annual Report are included
on pages F-1 through F-63 hereof.

ITEM 18.  FINANCIAL STATEMENTS

     We have elected to respond to Item 17.

ITEM 19.  EXHIBITS



 1.1  Memorandum and Articles of Association of Pearson plc.
 2.1  Indenture dated June 21, 2001 between Pearson plc and The
      Bank of New York, as trustee.+
 2.2  Indenture dated June 23, 2003 between Pearson plc and The
      Bank of New York, as trustee.
 4.1  Letter Agreement dated October 9, 2000 between Pearson plc
      and Peter Jovanovich.#
 8.1  List of Significant Subsidiaries.
12.1  Certification of Chief Executive Officer.
12.2  Certification of Chief Financial Officer.
13.1  Certification of Chief Executive Officer.
13.2  Certification of Chief Financial Officer.



- ---------------

+   Incorporated by reference to the Form 20-F of Pearson plc for the year ended
    December 31, 2001 and filed June 10, 2002.

#   Incorporated by reference to the Form 20-F of Pearson plc for the year ended
    December 31, 2002 and filed June 5, 2003.

                                        62


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



                                                              PAGE
                                                              ----

Report of Independent Auditors..............................   F-2
Consolidated Profit and Loss Account for the Year Ended
  December 31, 2003.........................................   F-3
Consolidated Balance Sheet as at December 31, 2003..........   F-4
Consolidated Cash Flow Statement for the Year Ended December
  31, 2003..................................................   F-5
Statement of Total Recognized Gains and Losses for the Year
  Ended December 31, 2003...................................   F-6
Reconciliation of Movements in Equity Shareholders' Funds
  for the Year Ended December 31, 2003......................   F-6
Notes to the Accounts.......................................   F-7



                                       F-1


                         REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of Pearson plc:

     In our opinion, the accompanying consolidated balance sheets and the
related consolidated profit and loss accounts, statements of total recognized
gains and losses, reconciliations of movements in equity shareholders' funds,
and consolidated cash flow statements present fairly, in all material respects,
the financial position of Pearson plc and its subsidiaries at 31 December 2003
and 2002, and the results of their operations and their cash flows for each of
the three years in the period ended 31 December 2003, in conformity with
accounting principles generally accepted in the United Kingdom. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

     Accounting principles generally accepted in the United Kingdom vary in
certain significant respects from accounting principles generally accepted in
the United States of America. Information relating to the nature and effect of
such differences is presented in Note 34 to the consolidated financial
statements.

     As discussed in Note 34 to the consolidated financial statements, the Group
changed its method of accounting for deferred taxes in 2002 in accordance with
principles generally accepted in the United Kingdom. The change has been
accounted for by restating comparative information at December 31, 2001 and
2000, and for the years then ended.

PricewaterhouseCoopers LLP
Chartered Accountants
And Registered Auditors

London, United Kingdom

February 27, 2004

                                       F-2


                      CONSOLIDATED PROFIT AND LOSS ACCOUNT
                          YEAR ENDED 31 DECEMBER 2003
                          (ALL FIGURES IN L MILLIONS)



                                                              NOTE     2003     2002     2001
                                                              -----    -----    -----    -----

SALES (INCLUDING SHARE OF JOINT VENTURES)...................           4,066    4,331    4,240
Less: share of joint ventures...............................             (18)     (11)     (15)
                                                                       -----    -----    -----
SALES.......................................................    2a     4,048    4,320    4,225
GROUP OPERATING PROFIT......................................             226      194       20
SHARE OF OPERATING PROFIT/(LOSS) OF JOINT VENTURES AND
  ASSOCIATES................................................  2c/d        --      (51)     (67)
                                                                       -----    -----    -----
TOTAL OPERATING PROFIT......................................    2b       226      143      (47)
                                                                       -----    -----    -----
Loss on sale of fixed assets and investments................    4a        (2)     (13)     (12)
Profit/(loss) on sale of subsidiaries and associates........    4b         8      (27)     (63)
Profit on sale of a subsidiary by an associate..............    4c        --        3      (53)
                                                                       -----    -----    -----
NON OPERATING ITEMS.........................................               6      (37)    (128)
                                                                       -----    -----    -----
PROFIT BEFORE INTEREST AND TAXATION.........................             232      106     (175)
Amounts written off investments.............................              --       --      (92)
Net finance costs...........................................     5       (80)    (131)    (169)
                                                                       -----    -----    -----
PROFIT/(LOSS) BEFORE TAXATION...............................             152      (25)    (436)
Taxation....................................................     7       (75)     (64)      33
                                                                       -----    -----    -----
PROFIT/(LOSS) AFTER TAXATION................................              77      (89)    (403)
Equity minority interests...................................             (22)     (22)     (20)
                                                                       -----    -----    -----
PROFIT/(LOSS) FOR THE FINANCIAL YEAR........................              55     (111)    (423)
DIVIDENDS ON EQUITY SHARES..................................     8      (192)    (187)    (177)
                                                                       -----    -----    -----
LOSS RETAINED...............................................            (137)    (298)    (600)
                                                                       =====    =====    =====
BASIC EARNINGS/(LOSS) PER SHARE.............................     9       6.9P   (13.9)p  (53.2)p
DILUTED EARNINGS/(LOSS) PER SHARE...........................     9       6.9P   (13.9)p  (53.2)p
DIVIDENDS PER SHARE.........................................     8      24.2P    23.4p    22.3p



     There is no difference between the profit/(loss) before taxation and the
loss retained for the year stated above and their historical cost equivalents.

                                       F-3

                           CONSOLIDATED BALANCE SHEET
                             AS AT 31 DECEMBER 2003
                          (ALL FIGURES IN L MILLIONS)



                                                              NOTE     2003      2002
                                                              ----    ------    ------

FIXED ASSETS
Intangible assets...........................................   11      3,260     3,610
Tangible assets.............................................   12        468       503
Investments: joint ventures.................................   13
  Share of gross assets.....................................               7         7
  Share of gross liabilities................................              (1)       --
                                                                      ------    ------
                                                                           6         7
Investments: associates.....................................   14         58       106
Investments: other..........................................   15         80        84
                                                                      ------    ------
                                                                       3,872     4,310
                                                                      ------    ------
CURRENT ASSETS
Stocks......................................................   16        683       734
Debtors.....................................................   17      1,132     1,057
Deferred taxation...........................................   21        145       174
Investments.................................................               2         2
Cash at bank and in hand....................................   18        561       575
                                                                      ------    ------
                                                                       2,523     2,542
                                                                      ------    ------
CREDITORS -- AMOUNTS FALLING DUE WITHIN ONE YEAR
Short-term borrowing........................................   19       (575)     (249)
Other creditors.............................................   20     (1,129)   (1,114)
                                                                      ------    ------
                                                                      (1,704)   (1,363)
                                                                      ------    ------
NET CURRENT ASSETS..........................................             819     1,179
                                                                      ------    ------
TOTAL ASSETS LESS CURRENT LIABILITIES.......................           4,691     5,489
CREDITORS -- AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR
Medium and long-term borrowing..............................   19     (1,347)   (1,734)
Other creditors.............................................   20        (45)      (60)
                                                                      ------    ------
                                                                      (1,392)   (1,794)
                                                                      ------    ------
PROVISIONS FOR LIABILITIES AND CHARGES......................   22       (152)     (165)
                                                                      ------    ------
NET ASSETS..................................................           3,147     3,530
                                                                      ======    ======
CAPITAL AND RESERVES
Called up share capital.....................................   23        201       200
Share premium account.......................................   24      2,469     2,465
Profit and loss account.....................................   24        282       673
                                                                      ------    ------
Equity shareholders' funds..................................           2,952     3,338
Equity minority interests...................................             195       192
                                                                      ------    ------
                                                                       3,147     3,530
                                                                      ======    ======



     The company balance sheet is shown in note 32.

     The financial statements were approved by the board of directors on 27
February 2004 and signed on its behalf by


              Dennis Stevenson,                               Rona Fairhead,
                  Chairman                                Chief financial officer



                                       F-4


                        CONSOLIDATED CASH FLOW STATEMENT
                          YEAR ENDED 31 DECEMBER 2003
                          (ALL FIGURES IN L MILLIONS)



                                                              NOTE    2003    2002    2001
                                                              ----    ----    ----    ----

NET CASH INFLOW FROM OPERATING ACTIVITIES...................   27      359     529     490
                                                                      ----    ----    ----
DIVIDENDS FROM JOINT VENTURES AND ASSOCIATES................             9       6      25
                                                                      ----    ----    ----
Interest received...........................................            11      11      31
Interest paid...............................................           (86)   (151)   (187)
Debt issue costs............................................            (1)     --      (1)
Dividends paid to equity minority interests.................           (19)     (1)     (9)
                                                                      ----    ----    ----
RETURNS ON INVESTMENTS AND SERVICING OF FINANCE.............           (95)   (141)   (166)
                                                                      ----    ----    ----
Taxation....................................................           (44)    (55)    (71)
                                                                      ----    ----    ----
Purchase of tangible fixed assets...........................          (105)   (126)   (165)
Sale of tangible fixed assets...............................             8       7      36
Purchase of investments.....................................            (4)    (21)    (35)
Sale of investments.........................................            --       3      22
                                                                      ----    ----    ----
CAPITAL EXPENDITURE AND FINANCIAL INVESTMENT................          (101)   (137)   (142)
                                                                      ----    ----    ----
Purchase of subsidiaries....................................   25      (94)    (87)   (128)
Net cash acquired with subsidiaries.........................            34       1      83
Purchase of joint ventures and associates...................            (5)    (40)    (26)
Sale of subsidiaries........................................   26       (4)      3      41
Net overdrafts/(cash) disposed with subsidiaries............             1      (1)     --
Sale of associates..........................................            57     920       1
                                                                      ----    ----    ----
ACQUISITIONS AND DISPOSALS..................................           (11)    796     (29)
                                                                      ----    ----    ----
EQUITY DIVIDENDS PAID.......................................          (188)   (181)   (174)
                                                                      ----    ----    ----
NET CASH (OUTFLOW)/INFLOW BEFORE MANAGEMENT OF LIQUID
  RESOURCES AND FINANCING...................................           (71)    817     (67)
                                                                      ----    ----    ----
Liquid resources acquired...................................           (85)    (65)    (48)
Collateral deposit reimbursed...............................            --      22      47
                                                                      ----    ----    ----
MANAGEMENT OF LIQUID RESOURCES..............................           (85)    (43)     (1)
                                                                      ----    ----    ----
Issue of equity share capital...............................             5       6      20
Capital element of finance leases...........................            (3)     (5)     (7)
Loan facility advanced/(repaid).............................             1    (507)   (521)
Bonds advanced..............................................           180      --     507
Bonds repaid................................................          (159)   (167)     --
Collateral deposit reimbursed...............................            54      17      --
Net movement in other borrowings............................           (13)     (7)      3
                                                                      ----    ----    ----
FINANCING...................................................            65    (663)      2
                                                                      ----    ----    ----
(DECREASE)/INCREASE IN CASH IN THE YEAR.....................   27      (91)    111     (66)
                                                                      ====    ====    ====



                                       F-5


                 STATEMENT OF TOTAL RECOGNIZED GAINS AND LOSSES
                          YEAR ENDED 31 DECEMBER 2003
                          (ALL FIGURES IN L MILLIONS)



                                                              2003    2002    2001
                                                              ----    ----    ----

Profit/(loss) for the financial year........................    55    (111)   (423)
Other net gains and losses recognised in reserves:
Exchange differences........................................  (254)   (317)     26
Taxation on exchange differences............................    --       5      (6)
                                                              ----    ----    ----
TOTAL RECOGNISED GAINS AND LOSSES RELATING TO THE YEAR......  (199)   (423)   (403)
                                                              ----    ----    ----
Prior year adjustment.......................................    --     209     240
                                                              ----    ----    ----
TOTAL RECOGNISED GAINS AND LOSSES...........................  (199)   (214)   (163)
                                                              ====    ====    ====



     Included within profit/(loss) for the financial year is a loss for the year
of L10m (2002: loss of L13m) relating to joint ventures and a profit of L6m
(2002: a loss of L39m) relating to associates. The prior year adjustment in 2002
related to the adoption of FRS 19 "Deferred tax".

           RECONCILIATION OF MOVEMENTS IN EQUITY SHAREHOLDERS' FUNDS
                          YEAR ENDED 31 DECEMBER 2003
                          (ALL FIGURES IN L MILLIONS)



                                                              2003    2002     2001
                                                              -----   -----    -----

Profit/(loss) for the financial year........................     55    (111)    (423)
Dividends on equity shares..................................   (192)   (187)    (177)
                                                              -----   -----    -----
                                                               (137)   (298)    (600)
Exchange differences net of taxation........................   (254)   (312)      20
Goodwill written back on sale of subsidiaries and
  associates................................................     --     144       37
Goodwill written back on sale of subsidiaries and associates
  by an associate...........................................     --      --       36
Shares issued...............................................      5       6       18
Replacement options granted on acquisition of subsidiary....     --       1        2
                                                              -----   -----    -----
Net movement for the year...................................   (386)   (459)    (487)
Equity shareholders' funds at beginning of the year.........  3,338   3,797    4,284
                                                              -----   -----    -----
EQUITY SHAREHOLDERS' FUNDS AT END OF THE YEAR...............  2,952   3,338    3,797
                                                              =====   =====    =====



                                       F-6


                             NOTES TO THE ACCOUNTS

1   ACCOUNTING POLICIES

     Accounting policies have been consistently applied and the amendment to FRS
5 -- Application Note G "Revenue recognition" has been applied in respect of
multiple element arrangements as set out in note 1d below. The impact of this
revision has not given rise to a material adjustment to these financial
statements. The transitional arrangements of FRS 17 "Retirement benefits" which
require additional disclosures in respect of retirement benefits have been
adopted, as set out in note 10.

     A. BASIS OF ACCOUNTING -- The accounts are prepared under the historical
cost convention and in accordance with the Companies Act and applicable
accounting standards. A summary of the significant accounting policies is set
out below.

     B. BASIS OF CONSOLIDATION -- The consolidated accounts include the accounts
of all subsidiaries made up to 31 December. Where companies have become or
ceased to be subsidiaries or associates during the year, the Group results
include results for the period during which they were subsidiaries or
associates.

     The results of the Group includes the Group's share of the results of joint
ventures and associates, and the consolidated balance sheet includes the Group's
interest in joint ventures and associates at the book value of attributable net
assets and attributable goodwill.

     C. GOODWILL -- From 1 January 1998 goodwill, being either the net excess of
the cost of shares in subsidiaries, joint ventures and associates over the value
attributable to their net assets on acquisition or the cost of other goodwill by
purchase, is capitalised and amortised through the profit and loss account on a
straight-line basis over its estimated useful life not exceeding 20 years.
Estimated useful life is determined after taking into account such factors as
the nature and age of the business and the stability of the industry in which
the acquired business operates, as well as typical life spans of the acquired
products to which the goodwill attaches. Goodwill is subject to an impairment
review at the end of the first full year following an acquisition, and at any
other time if events or changes in circumstances indicate that the carrying
value may not be recoverable. Goodwill arising on acquisitions before 1 January
1998 has been deducted from reserves and is charged or credited to the profit
and loss account on disposal or closure of the business to which it relates.

     D. SALES -- Sales represent the amount of goods and services, net of value
added tax and other sales taxes, and excluding trade discounts and anticipated
returns, provided to external customers and associates.

     Revenue from the sale of books is recognised when the goods are shipped.
Anticipated returns are based primarily on historical return rates.

     Circulation and advertising revenue is recognised when the newspaper or
other publication is published.

     Subscription revenue is recognised on a straight-line basis over the life
of the subscription.

     Where a contractual arrangement consists of two or more separate elements
that can be provided to customers either on a stand-alone basis or as an
optional extra, such as the provision of supplementary materials with textbooks,
revenue is recognised for each element as if it were an individual contractual
arrangement.

     Revenue from long-term contracts, such as contracts to process qualifying
tests for individual professions and government departments, is recognised over
the contract term based on the percentage of services provided during the
period, compared to the total estimated services to be provided over the entire
contract. Losses on contracts are recognised in the period in which the loss
first becomes foreseeable. Contract losses are determined to be the amount by
which estimated direct and indirect costs of the contract exceed the estimated
total revenues that will be generated by the contract.

     On certain contracts, where the Group acts as agent, only commissions and
fees receivable for services rendered are recognised as revenue. Any third party
costs incurred on behalf of the principal that are rechargeable under the
contractual arrangement are not included in revenue.

                                       F-7

                       NOTES TO THE ACCOUNTS (CONTINUED)

     E. PENSION COSTS -- The regular pension cost of the Group's defined benefit
pension schemes is charged to the profit and loss account in accordance with
SSAP 24 "Accounting for pension costs" in order to apportion the cost of
pensions over the service lives of employees in the schemes. Variations arising
from a significant reduction in the number of employees are adjusted in the
profit and loss account to the extent that the year's regular pension cost,
reduced by other variations, exceeds contributions payable for that year. Other
variations are apportioned over the expected service lives of current employees
in the schemes. The pension cost of the Group's defined contribution schemes is
the amount of contributions payable for the year.

     F. POST-RETIREMENT BENEFITS OTHER THAN PENSIONS -- Post-retirement benefits
other than pensions are accounted for on an accruals basis to recognise the
obligation over the expected service lives of the employees concerned.

     G. TANGIBLE FIXED ASSETS -- The cost of tangible fixed assets other than
freehold land is depreciated over estimated economic lives in equal annual
amounts. Generally, freeholds are depreciated at 1% to 5% per annum, leaseholds
at 2% per annum, or over the period of the lease if shorter, and plant and
equipment at various rates between 5% and 33% per annum.

     H. LEASES -- Finance lease rentals are capitalised at the net present value
of the total amount of rentals payable under the leasing agreement (excluding
finance charges) and depreciated in accordance with policy g above. Finance
charges are written off over the period of the lease in reducing amounts in
relation to the written down carrying cost. Operating lease rentals are expensed
as incurred.

     I. FIXED ASSET INVESTMENTS -- Fixed asset investments are stated at cost
less provisions for diminution in value.

     J. SHARE SCHEMES -- Shares held by employee share ownership trusts are
shown at cost less any provision for permanent diminution in value. The costs of
funding and administering the trusts are charged to the profit and loss account
in the period to which they relate. The cost of shares acquired by the trusts or
the fair market value of the shares at the date of the grant, less any
consideration to be received from the employee, is charged to the profit and
loss account over the period to which the employee's performance relates. Where
awards are contingent upon future events (other than continued employment) an
assessment of the likelihood of these conditions being achieved is made at the
end of each reporting period and an appropriate provision made.

     K. STOCKS -- Stocks and work in progress are stated at the lower of cost
and net realisable value.

     L. PRE-PUBLICATION COSTS -- Pre-publication costs represent direct costs
incurred in the development of titles prior to their publication. These costs
are carried forward in stock where the title to which they relate has a useful
life in excess of one year. These costs are amortised upon publication of the
title over estimated economic lives of five years or less, being an estimate of
the expected life cycle of the title, with a higher proportion of the
amortisation taken in the earlier years.

     M. ROYALTY ADVANCES -- Advances of royalties to authors are included within
debtors when the advance is paid less any provision required to bring the amount
down to its net realisable value. The royalty advance is expensed at the
contracted royalty rate as the related revenues are earned.

     N. NEWSPAPER DEVELOPMENT COSTS -- Revenue investment in the development of
newspaper titles consists of measures to increase the volume and geographical
spread of circulation. These measures include additional and enhanced editorial
content, extended distribution and remote printing. These extra costs arising
are expensed as incurred.

     O. DEFERRED TAXATION -- Provision is made in full for deferred tax that
arises from timing differences that have originated but not reversed by the
balance sheet date on transactions or events that result in an obligation to pay
more tax in the future. Deferred tax assets are recognised to the extent that it
is regarded as more likely than not that there will be taxable profits from
which the underlying timing differences can be deducted. Deferred tax is
measured at the average tax rates that are expected to apply in the periods in
which the timing differences are expected to reverse, based on tax rates and
laws that have been enacted or substantially enacted by the balance
                                       F-8

                       NOTES TO THE ACCOUNTS (CONTINUED)

sheet date. Deferred tax assets and liabilities are not discounted. No deferred
tax is provided in respect of any future remittance of earnings of foreign
subsidiaries or associates where no commitment has been made to remit such
earnings.

     P. FINANCIAL INSTRUMENTS -- Interest and the premium or discount on the
issue of financial instruments is taken to the profit and loss account so as to
produce a constant rate of return over the period to the date of expected
redemption.

     The Group uses derivative financial instruments to manage its exposure to
interest rate and foreign exchange risks. These include interest rate swaps,
currency swaps and forward currency contracts. Amounts payable or receivable in
respect of interest rate derivatives are accrued with net interest payable over
the period of the contract. Where the derivative instrument is terminated early,
the gain or loss is spread over the remaining maturity of the original
instrument. Where the underlying exposure ceases to exist, any termination gain
or loss is taken to the profit and loss account. Foreign currency borrowings and
their related derivatives are carried in the balance sheet at the relevant
exchange rates at the balance sheet date. Gains or losses in respect of the
hedging of overseas subsidiaries are taken to reserves. Gains or losses arising
from foreign exchange contracts are taken to the profit and loss account in line
with the transactions which they are hedging. Premiums paid on contracts
designed to manage currency exposure on specific acquisitions or disposals are
charged to the profit and loss account.

     The company participates in offset arrangements with certain banks whereby
cash and overdraft amounts are offset against each other.

     Q. FOREIGN CURRENCIES -- Profit and loss accounts in overseas currencies
are translated into sterling at average rates. Balance sheets are translated
into sterling at the rates ruling at 31 December. Exchange differences arising
on consolidation are taken directly to reserves. Other exchange differences are
taken to the profit and loss account where they relate to trading transactions
and directly to reserves where they relate to investments.

     The principal overseas currency for the Group is the US dollar. The average
rate for the year against sterling was $1.63 (2002: $1.51) and the year end rate
was $1.79 (2002: $1.61).

     R. LIQUID RESOURCES -- Liquid resources comprise short-term deposits of
less than one year and investments which are readily realisable and held on a
short-term basis.

     S. RETAINED PROFITS OF OVERSEAS SUBSIDIARIES AND ASSOCIATES -- No provision
is made for any additional taxation, less double taxation relief, which would
arise on the remittance of profits retained where there is no intention to remit
such profits.

                                       F-9

                       NOTES TO THE ACCOUNTS (CONTINUED)

2A  ANALYSIS OF SALES



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education...........................................   2,451      2,756      2,604
FT Group....................................................     757        726        801
The Penguin Group...........................................     840        838        820
                                                               -----      -----      -----
Continuing operations.......................................   4,048      4,320      4,225
                                                               =====      =====      =====
GEOGRAPHICAL MARKETS SUPPLIED
United Kingdom..............................................     474        411        433
Continental Europe..........................................     463        419        446
North America...............................................   2,742      3,139      2,975
Asia Pacific................................................     255        249        241
Rest of world...............................................     114        102        130
                                                               -----      -----      -----
Continuing operations.......................................   4,048      4,320      4,225
                                                               =====      =====      =====


                                       2003                          2002                          2001
                            ---------------------------   ---------------------------   ---------------------------
                            TOTAL BY    INTER-    TOTAL   TOTAL BY    INTER-    TOTAL   TOTAL BY    INTER-    TOTAL
                             SOURCE    REGIONAL   SALES    SOURCE    REGIONAL   SALES    SOURCE    REGIONAL   SALES
                            --------   --------   -----   --------   --------   -----   --------   --------   -----
                                                          (ALL FIGURES IN L MILLIONS)

GEOGRAPHICAL SOURCE OF
  SALES
United Kingdom............     720       (29)       691      644       (25)       619      686       (20)       666
Continental Europe........     339        (4)       335      304        (4)       300      315        (5)       310
North America.............   2,758       (39)     2,719    3,144       (36)     3,108    2,976       (35)     2,941
Asia Pacific..............     230        (1)       229      226        (2)       224      221        (6)       215
Rest of world.............      77        (3)        74       69        --         69       93        --         93
                             -----       ---      -----    -----       ---      -----    -----       ---      -----
Continuing operations.....   4,124       (76)     4,048    4,387       (67)     4,320    4,291       (66)     4,225
                             =====       ===      =====    =====       ===      =====    =====       ===      =====



- ---------------

NOTE  The table above analyses sales by the geographical region from which the
products and services originate. Inter-regional sales are those made between
Group companies in different regions.

     Included within sales for 2003 is an amount of L127m attributable to
acquisitions made during the year.

                                       F-10

                       NOTES TO THE ACCOUNTS (CONTINUED)

2B  ANALYSIS OF TOTAL OPERATING PROFIT



                                                                    2003
                                   ----------------------------------------------------------------------
                                   RESULTS FROM    INTEGRATION      GOODWILL       GOODWILL     OPERATING
                                    OPERATIONS        COSTS       AMORTISATION    IMPAIRMENT     PROFIT
                                   ------------    -----------    ------------    ----------    ---------
                                                        (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education................      313              --            (207)           --           106
FT Group.........................       86              --             (36)           --            50
The Penguin Group................       91              --             (21)           --            70
                                       ---             ---            ----           ---           ---
Continuing operations............      490              --            (264)           --           226
                                       ===             ===            ====           ===           ===
GEOGRAPHICAL MARKETS SUPPLIED
United Kingdom...................      (46)             --             (31)           --           (77)
Continental Europe...............       29              --             (10)           --            19
North America....................      466              --            (218)           --           248
Asia Pacific.....................       33              --              (5)           --            28
Rest of world....................        8              --              --            --             8
                                       ---             ---            ----           ---           ---
Continuing operations............      490              --            (264)           --           226
                                       ===             ===            ====           ===           ===


                                                                    2002
                                   ----------------------------------------------------------------------
                                   RESULTS FROM    INTEGRATION      GOODWILL       GOODWILL     OPERATING
                                    OPERATIONS        COSTS       AMORTISATION    IMPAIRMENT     PROFIT
                                   ------------    -----------    ------------    ----------    ---------
                                                        (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education................      326              (7)           (244)           --            75
FT Group.........................       80              --             (65)          (10)            5
The Penguin Group................       87              (3)            (18)           --            66
                                       ---             ---            ----           ---          ----
Continuing operations............      493             (10)           (327)          (10)          146
Discontinued operations..........       --              --              (3)           --            (3)
                                       ---             ---            ----           ---          ----
                                       493             (10)           (330)          (10)          143
                                       ---             ---            ----           ---          ----
GEOGRAPHICAL MARKETS SUPPLIED
United Kingdom...................      (72)             (5)            (25)           --          (102)
Continental Europe...............       40              --              (8)           --            32
North America....................      495              (5)           (288)           --           202
Asia Pacific.....................       31              --              (6)           --            25
Rest of world....................       (1)             --              --           (10)          (11)
                                       ---             ---            ----           ---          ----
Continuing operations............      493             (10)           (327)          (10)          146
Discontinued operations..........       --              --              (3)           --            (3)
                                       ---             ---            ----           ---          ----
                                       493             (10)           (330)          (10)          143
                                       ===             ===            ====           ===          ====



                                       F-11

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                    2001
                                   ----------------------------------------------------------------------
                                   RESULTS FROM    INTEGRATION      GOODWILL       GOODWILL     OPERATING
                                    OPERATIONS        COSTS       AMORTISATION    IMPAIRMENT      LOSS
                                   ------------    -----------    ------------    ----------    ---------
                                                        (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education................      274             (29)           (254)           (8)          (17)
FT Group.........................       72              --             (67)           (3)            2
The Penguin Group................       80             (45)            (19)          (50)          (34)
                                       ---             ---            ----           ---          ----
Continuing operations............      426             (74)           (340)          (61)          (49)
Discontinued operations..........       37              --             (35)           --             2
                                       ---             ---            ----           ---          ----
                                       463             (74)           (375)          (61)          (47)
                                       ===             ===            ====           ===          ====
GEOGRAPHICAL MARKETS SUPPLIED
United Kingdom...................      (37)            (33)            (27)          (55)         (152)
Continental Europe...............       45              --              (6)           --            39
North America....................      397             (41)           (302)           (3)           51
Asia Pacific.....................       24              --              (4)           --            20
Rest of world....................       (3)             --              (1)           (3)           (7)
                                       ---             ---            ----           ---          ----
Continuing operations............      426             (74)           (340)          (61)          (49)
Discontinued operations..........       37              --             (35)           --             2
                                       ---             ---            ----           ---          ----
                                       463             (74)           (375)          (61)          (47)
                                       ===             ===            ====           ===          ====



- ---------------

NOTE  Integration costs in 2002 include amounts in respect of the Dorling
Kindersley and NCS acquisitions. Integration costs, goodwill amortisation and
goodwill impairment are included as "other items" in the profit and loss
account. Discontinued operations related to the withdrawal of the Group from the
television business.

     Included within operating profit for 2003 is an amount of L12m attributable
to acquisitions made during the year.

2C  SHARE OF OPERATING LOSS OF JOINT VENTURES



                                                                      2003
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT     LOSS
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................       --             --            --            --           --
FT Group.............................      (11)            --            --            --          (11)
The Penguin Group....................        1             --            --            --            1
                                           ---            ---           ---           ---          ---
Continuing operations................      (10)            --            --            --          (10)
                                           ===            ===           ===           ===          ===


                                                                      2002
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT     LOSS
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................       (1)            --            --            --           (1)
FT Group.............................      (13)            --            --            --          (13)
The Penguin Group....................        1             --            --            --            1
                                           ---            ---           ---           ---          ---
Continuing operations................      (13)            --            --            --          (13)
                                           ===            ===           ===           ===          ===



                                       F-12

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                      2001
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT     LOSS
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................       --             --            --            --           --
FT Group.............................      (20)            --            --            --          (20)
The Penguin Group....................        1             --            --            --            1
                                           ---            ---           ---           ---          ---
Continuing operations................      (19)            --            --            --          (19)
                                           ===            ===           ===           ===          ===



2D  SHARE OF OPERATING PROFIT/(LOSS) OF ASSOCIATES



                                                                      2003
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT    PROFIT
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................        1             --            --            --            1
FT Group.............................       16             --            (7)           --            9
The Penguin Group....................       --             --            --            --           --
                                           ---            ---           ---           ---          ---
Continuing operations................       17             --            (7)           --           10
                                           ===            ===           ===           ===          ===


                                                                      2002
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT     LOSS
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................        3             --            (1)           --            2
FT Group.............................        7             --           (44)           --          (37)
The Penguin Group....................       --             --            --            --           --
                                           ---            ---           ---           ---          ---
Continuing operations................       10             --           (45)           --          (35)
Discontinued operations..............       --             --            (3)           --           (3)
                                           ---            ---           ---           ---          ---
                                            10             --           (48)           --          (38)
                                           ===            ===           ===           ===          ===


                                                                      2001
                                       ------------------------------------------------------------------
                                       RESULTS FROM   INTEGRATION     GOODWILL      GOODWILL    OPERATING
                                        OPERATIONS       COSTS      AMORTISATION   IMPAIRMENT     LOSS
                                       ------------   -----------   ------------   ----------   ---------
                                                          (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education....................        3             --            (1)           (3)          (1)
FT Group.............................       (2)            --           (47)           --          (49)
The Penguin Group....................       --             --            --            --           --
                                           ---            ---           ---           ---          ---
Continuing operations................        1             --           (48)           (3)         (50)
Discontinued operations..............       37             --           (35)           --            2
                                           ---            ---           ---           ---          ---
                                            38             --           (83)           (3)         (48)
                                           ===            ===           ===           ===          ===



                                       F-13

                       NOTES TO THE ACCOUNTS (CONTINUED)

2E  ANALYSIS OF CAPITAL EMPLOYED



                                                              NOTE    2003     2002
                                                              ----   ------   ------
                                                                     (ALL FIGURES IN
                                                                       L MILLIONS)

BUSINESS SECTORS
Pearson Education...........................................          3,487    3,914
FT Group....................................................            432      410
The Penguin Group...........................................            596      605
                                                                     ------   ------
Continuing operations.......................................          4,515    4,929
                                                                     ======   ======
GEOGRAPHICAL LOCATION
United Kingdom..............................................            464      557
Continental Europe..........................................            219      258
North America...............................................          3,691    3,971
Asia Pacific................................................            120      125
Rest of world...............................................             21       18
                                                                     ------   ------
Continuing operations.......................................          4,515    4,929
                                                                     ======   ======
RECONCILIATION OF CAPITAL EMPLOYED TO NET ASSETS
Capital employed............................................          4,515    4,929
Add: deferred taxation......................................   21       145      174
Less: provisions for liabilities and charges................   22      (152)    (165)
Less: net debt excluding finance leases.....................   27    (1,361)  (1,408)
                                                                     ------   ------
Net assets..................................................          3,147    3,530
                                                                     ======   ======



3   ANALYSIS OF CONSOLIDATED PROFIT AND LOSS ACCOUNT



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

COST OF SALES...............................................  (1,910)    (2,064)    (1,902)
                                                              ======     ======     ======
GROSS PROFIT................................................   2,138      2,256      2,323
                                                              ======     ======     ======
Distribution costs..........................................    (239)      (233)      (233)
Administration and other expenses...........................  (1,724)    (1,888)    (2,136)
Other operating income (see below)..........................      51         59         66
                                                              ------     ------     ------
NET OPERATING EXPENSES......................................  (1,912)    (2,062)    (2,303)
                                                              ======     ======     ======
Analysed as:
Net operating expenses -- before other items................  (1,655)    (1,760)    (1,879)
Net operating expenses -- other items
- -- Integration costs........................................      --        (10)       (74)
- -- Goodwill amortisation....................................    (257)      (282)      (292)
- -- Goodwill impairment......................................      --        (10)       (58)
                                                              ------     ------     ------
NET OPERATING EXPENSES......................................  (1,912)    (2,062)    (2,303)
                                                              ======     ======     ======



- ---------------

NOTE  Other items are all included in administration and other expenses.

                                       F-14

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

OTHER OPERATING INCOME
Income from other investments
Unlisted....................................................       4          2          2
Other operating income (mainly royalties, rights and
  commission income)........................................      47         57         64
                                                                 ---        ---        ---
                                                                  51         59         66
                                                                 ===        ===        ===
PROFIT/(LOSS) BEFORE TAXATION IS STATED AFTER CHARGING
Amortisation of pre-publication costs.......................     158        170        161
Depreciation................................................     111        122        125
Operating lease rentals
- -- Plant and machinery......................................      14         11         31
- -- Properties...............................................     113        101         99
- -- Other....................................................       9         13         17
Auditors' remuneration
Statutory audit and audit-related regulatory reporting
  services..................................................       3          3          2
Non-audit services..........................................       2          3          5
NON-AUDIT SERVICES WERE AS FOLLOWS
Tax compliance services.....................................       1          2         --
Tax advisory services.......................................       1          1          1
Acquisition related work....................................      --         --          4



- ---------------

NOTE  Included in statutory audit fees are amounts relating to the parent
company of L20,000 (2002: L20,000). Audit-related regulatory reporting fees are
L200,000 (2002: L200,000). Non-audit fees in the UK in 2003 are L341,000 (2002:
L231,000) and are in respect of tax advisory and tax compliance services. The
remainder of the non-audit fees relate to overseas subsidiaries.

4A  LOSS ON SALE OF FIXED ASSETS AND INVESTMENTS



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Net loss on sale of property................................      (1)        (3)        (2)
Net loss on sale of investments.............................      (1)       (10)       (10)
Continuing operations.......................................      (2)       (13)       (12)
                                                                 ---        ---        ---
Taxation....................................................      --          6          1
                                                                 ===        ===        ===



4B  PROFIT/(LOSS) ON SALE OF SUBSIDIARIES AND ASSOCIATES



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Profit on sale of Unidesa...................................      12         --         --
Loss on sale of Forum.......................................      (1)       (40)        --
Loss on sale of PH Direct...................................      --         (8)        --
Loss on sale of iForum......................................      --         --        (27)
Net (loss)/profit on sale of other subsidiaries and
  associates................................................      (3)         3        (36)
                                                                 ---        ---        ---
Continuing operations.......................................       8        (45)       (63)
Profit on sale of the RTL Group -- discontinued
  operations................................................      --         18         --
                                                                 ---        ---        ---
                                                                   8        (27)       (63)
                                                                 ---        ---        ---
Taxation....................................................      (3)        (6)         4
                                                                 ===        ===        ===



                                       F-15

                       NOTES TO THE ACCOUNTS (CONTINUED)

4C  PROFIT ON SALE OF A SUBSIDIARY BY AN ASSOCIATE



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Profit/(loss) on sale of Journal of Commerce by the
  Economist -- continuing operations........................      --          3        (36)
Loss on sale of subsidiaries and associates by the RTL
  Group -- discontinued operations..........................      --         --        (17)
                                                                 ---        ---        ---
                                                                  --          3        (53)
                                                                 ===        ===        ===



5   NET FINANCE COSTS



                                            2003                           2002                           2001
                                ----------------------------   ----------------------------   ----------------------------
                                RESULTS FROM   OTHER           RESULTS FROM   OTHER           RESULTS FROM   OTHER
                         NOTE    OPERATIONS    ITEMS   TOTAL    OPERATIONS    ITEMS   TOTAL    OPERATIONS    ITEMS   TOTAL
                         ----   ------------   -----   -----   ------------   -----   -----   ------------   -----   -----
                                                            (ALL FIGURES IN L MILLIONS)

Net interest payable
- -- Group...............   6         (81)         --     (81)       (94)         --     (94)       (163)        --    (163)
- -- Associates..........               1          --       1         --          --      --          (6)        --      (6)
Early repayment of debt
  and termination of
  swap contracts.......              --          --      --         --         (37)    (37)         --         --      --
                                    ---         ---     ---        ---         ---    ----        ----        ---    ----
Total net finance
  costs................             (80)         --     (80)       (94)        (37)   (131)       (169)        --    (169)
                                    ===         ===     ===        ===         ===    ====        ====        ===    ====



6   NET INTEREST PAYABLE -- GROUP



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

INTEREST PAYABLE AND SIMILAR CHARGES
BANK LOANS, OVERDRAFTS AND COMMERCIAL PAPER
On borrowing repayable wholly within five years not by
  instalments...............................................     (60)      (54)      (100)
On borrowing repayable wholly or partly after five years....     (31)      (51)       (72)
OTHER BORROWINGS
On borrowing repayable wholly within five years not by
  instalments...............................................      (2)       --        (16)
                                                                 ---      ----       ----
                                                                 (93)     (105)      (188)
                                                                 ---      ----       ----
INTEREST RECEIVABLE AND SIMILAR INCOME
On deposits and liquid funds................................      12        11         23
Amortisation of swap proceeds...............................      --        --          2
                                                                 ---      ----       ----
NET INTEREST PAYABLE........................................     (81)      (94)      (163)
                                                                 ===      ====       ====



                                       F-16

                       NOTES TO THE ACCOUNTS (CONTINUED)

7   TAXATION



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

ANALYSIS OF (CHARGE)/BENEFIT IN THE YEAR
CURRENT TAXATION
UK corporation tax for the year.............................      (9)        11        (28)
Adjustments in respect of prior years.......................      10         58        147
                                                                 ---        ---        ---
                                                                   1         69        119
Overseas tax for the year...................................     (59)       (63)       (43)
Adjustments in respect of prior years.......................       3         --         (6)
Associates..................................................      (5)        (4)        (9)
                                                                 ---        ---        ---
                                                                 (60)         2         61
                                                                 ===        ===        ===
DEFERRED TAXATION
Origination and reversal of timing differences
UK..........................................................      (4)       (11)         4
Overseas....................................................     (54)       (56)       (32)
Adjustments in respect of prior years.......................      43          1         --
                                                                 ---        ---        ---
                                                                 (15)       (66)       (28)
                                                                 ---        ---        ---
TAXATION....................................................     (75)       (64)        33
                                                                 ===        ===        ===



- ---------------

NOTE  Included in the adjustment in respect of prior years in 2003 is a tax
benefit of L44m (2002: L45m) relating to a prior year acquisition of a
subsidiary and the disposal of a subsidiary and a fixed asset investment.

     The current tax charge for the year is different from the standard rate of
corporation tax in the UK (30%). The differences are explained below:



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Profit/(loss) before tax....................................     152       (25)      (436)
                                                                 ---      ----       ----
Expected (charge)/benefit at UK corporation tax rate of 30%
  (2002: 30%)...............................................     (46)        8        131
Effect of overseas tax rates................................       8        11         37
Effect of tax losses........................................      (5)       (7)        (1)
Timing differences..........................................      64        55        (98)
Non-deductible goodwill amortisation........................     (90)     (111)      (149)
US state taxes..............................................      (4)      (10)        (6)
Adjustments in respect of prior years and other items.......      13        56        147
                                                                 ---      ----       ----
CURRENT TAX (CHARGE)/BENEFIT FOR THE YEAR...................     (60)        2         61
                                                                 ===      ====       ====


                                                               2003       2002       2001
                                                              ------     ------     ------
                                                              (ALL FIGURES IN PERCENTAGES)

TAX RATE RECONCILIATION
UK tax rate.................................................   30.0       30.0       30.0
Effect of overseas tax rates................................    1.3        2.8        4.5
Other items.................................................   (0.1)        --       (0.5)
                                                               ----       ----       ----
TAX RATE REFLECTED IN ADJUSTED EARNINGS.....................   31.2       32.8       34.0
                                                               ====       ====       ====



- ---------------

                                       F-17

                       NOTES TO THE ACCOUNTS (CONTINUED)

     NOTE  Both the current and the total tax charge on profit (or loss) before
tax will continue to be affected by the fact that there is only very limited tax
relief available on the goodwill amortisation charged in the accounts.

     The current tax charge will continue to be affected by the utilisation of
tax losses and by the impact of other timing differences, in both cases mainly
in the United States. Following the adoption of FRS 19 these factors will have
only a very limited impact on the total tax rate; as shown in note 21, the Group
has recognised a total deferred tax asset of L145m at 31 December 2003 (2002:
L174m).

     In both 2003 and 2002 the tax charge was materially affected by adjustments
in respect to prior years; it is not practicable to forecast the possible effect
of such items in future years as this will depend on progress in agreeing the
Group's tax returns with the tax authorities.

     The total charge in future years will also be affected by any changes to
corporation tax rates and/or any other relevant legislative changes in the
jurisdictions in which the Group operates and by the mix of profits between the
different jurisdictions.

8   DIVIDENDS ON EQUITY SHARES



                                                2003                2002                2001
                                          ----------------    ----------------    ----------------
                                          PENCE PER           PENCE PER           PENCE PER
                                            SHARE      LM       SHARE      LM       SHARE      LM
                                          ---------    ---    ---------    ---    ---------    ---

Interim paid............................     9.4        73       9.1        72       8.7        68
Final proposed..........................    14.8       119      14.3       115      13.6       109
                                            ----       ---      ----       ---      ----       ---
DIVIDENDS FOR THE YEAR..................    24.2       192      23.4       187      22.3       177
                                            ====       ===      ====       ===      ====       ===



- ---------------

NOTE  Dividends in respect of the company's shares held by employee share trusts
(see note 15) have been waived.

9   EARNINGS/(LOSS) PER SHARE



                                                  2003                2002                2001
                                            -----------------   -----------------   -----------------
                                                    EARNINGS/           EARNINGS/           EARNINGS/
                                                     (LOSS)              (LOSS)              (LOSS)
                                                    PER SHARE           PER SHARE           PER SHARE
                                     NOTE    LM        (P)       LM        (P)       LM        (P)
                                     ----   -----   ---------   -----   ---------   -----   ---------

Profit/(loss) for the financial
  year.............................            55      6.9       (111)    (13.9)     (423)    (53.2)
Taxation on conversion of ordinary
  shares...........................            --       --         --        --        (1)       --
                                            -----     ----      -----     -----     -----     -----
Diluted earning/(loss).............            55      6.9       (111)    (13.9)     (424)    (53.2)
                                            =====     ====      =====     =====     =====     =====
Weighted average number of shares
  (millions)
- -- for basic earnings and adjusted
  earnings.........................         794.4               796.3               795.4
Effect of dilutive share options...           0.9                  --                  --
Weighted average number of shares
  (millions)
                                            -----               -----               -----
- -- for diluted earnings............         795.3               796.3               795.4
                                            =====               =====               =====



- ---------------

NOTE  In 2002 and 2001 the Group made a loss for the financial year (after
taking into account goodwill amortisation). Consequently, the effect of share
options was anti-dilutive and there was no difference between the loss per share
and the diluted loss per share.

                                       F-18

                       NOTES TO THE ACCOUNTS (CONTINUED)

     There is no difference between the profit for the financial year and the
diluted profit for the financial year. Therefore the diluted earnings per share
is 6.9p (2002: a loss of 13.9p). The weighted average number of shares in 2003
is lower than in 2002 as a result of own shares purchased to hedge share
schemes.

10A EMPLOYEE INFORMATION

     The details of the emoluments of the directors of Pearson plc are shown on
pages 55 to 69.



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

STAFF COSTS
Wages and salaries..........................................   1,027      1,106      1,090
Social security costs.......................................      99        106        104
Post-retirement costs.......................................      62         59         39
                                                               -----      -----      -----
                                                               1,188      1,271      1,233
                                                               =====      =====      =====


                                                             UK        US      OTHER    TOTAL
                                                            -----    ------    -----    ------

AVERAGE NUMBER EMPLOYED 2003
Pearson Education.........................................  1,443    14,438    4,097    19,978
FT Group..................................................  1,885     1,397    2,362     5,644
The Penguin Group.........................................  1,223     2,115      980     4,318
Other.....................................................    414       513        1       928
                                                            -----    ------    -----    ------
                                                            4,965    18,463    7,440    30,868
                                                            =====    ======    =====    ======
AVERAGE NUMBER EMPLOYED 2002
Pearson Education.........................................  1,326    14,459    4,250    20,035
FT Group..................................................  1,914     1,140    2,169     5,223
The Penguin Group.........................................  1,305     2,167      890     4,362
Other.....................................................    204       534        1       739
                                                            -----    ------    -----    ------
                                                            4,749    18,300    7,310    30,359
                                                            =====    ======    =====    ======
AVERAGE NUMBER EMPLOYED 2001
Pearson Education.........................................  1,505    12,610    4,344    18,459
FT Group..................................................  2,075     1,121    2,340     5,536
The Penguin Group.........................................  1,333     2,293      768     4,394
Other.....................................................    193       444        1       638
                                                            -----    ------    -----    ------
                                                            5,106    16,468    7,453    29,027
                                                            =====    ======    =====    ======



10B PENSIONS

     SSAP 24 ACCOUNTING  The Group operates a number of pension schemes
throughout the world, the principal ones being in the UK and US. The major
schemes are self-administered with the schemes' assets being held independently
of the Group. Pension costs are assessed in accordance with the advice of
independent qualified actuaries. The UK scheme is a hybrid scheme with both
defined benefit and defined contribution

                                       F-19

                       NOTES TO THE ACCOUNTS (CONTINUED)

sections but, predominantly, consisting of defined benefit liabilities. There
are a number of defined contribution schemes, principally overseas. The cost of
the schemes is as follows:



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

UK GROUP SCHEME
Regular pension cost
- -- Defined benefit sections.................................      10         11          9
- -- Defined contribution sections............................       7          7          6
Variation cost..............................................       6         --         (5)
                                                                 ---        ---        ---
                                                                  23         18         10
                                                                 ---        ---        ---
OTHER SCHEMES
Defined benefit schemes.....................................       7          6         11
Defined contribution schemes................................      27         30         14
                                                                 ---        ---        ---
                                                                  34         36         25
                                                                 ---        ---        ---
                                                                  57         54         35
                                                                 ===        ===        ===



- ---------------

NOTE  From 1 January 2003 the UK Group scheme only offers defined contribution
benefits to new joiners. The main US defined benefit scheme was closed to the
majority of active members in 2001. The changes to these schemes will give rise
to a reduction in defined benefit and an increase in defined contribution costs.

     Included in note 22, there is a pension provision of L29m (2002: L36m) as
measured in accordance with SSAP 24.

     A full actuarial valuation of the UK Group scheme was performed as at 1
January 2001 using the projected unit method of valuation. This valuation has
been updated to 1 January 2003 for the purposes of determining the 2003 SSAP 24
cost for the UK Group scheme. The market value of the assets of the scheme at 1
January 2003 was L976m. The major assumptions used to determine the SSAP 24
charge are as follows:



                                                                   UK GROUP
                                                                    SCHEME
                                                                ---------------
                                                                (ALL FIGURES IN
                                                                 PERCENTAGES)

Inflation...................................................          2.5
Rate of increase in salaries................................          4.5
Rate of inflation-linked increase for pensions in payment
  and deferred pensions.....................................          2.5
Return on investments.......................................          7.0
Level of funding............................................         96.0



     The funding policy differs from the accounting policy to the extent that
more conservative assumptions are used for funding purposes. Furthermore, in
2003 the Group paid an additional one-off contribution of L5m into the scheme
which was designed to ensure that the scheme was fully funded. The next full
triennial valuation is due to be carried out as at 1 January 2004.

     The date of the most recent valuation of the US plan was 31 December 2002.

     FRS 17 DISCLOSURES  The disclosures required under the transitional
arrangements of FRS 17 for the Group's defined benefit schemes and the UK Group
hybrid scheme are set out below. The disclosures for the UK Group hybrid scheme
are in respect of both the defined benefit and defined contribution sections.

     For the purpose of these disclosures, the latest full actuarial valuations
of the UK Group scheme and other schemes have been updated by independent
actuaries to 31 December 2003. The assumptions used are shown below.

                                       F-20

                       NOTES TO THE ACCOUNTS (CONTINUED)

     Weighted average assumptions have been shown for the other schemes.



                                             2003                 2002                 2001
                                      ------------------   ------------------   ------------------
                                      UK GROUP    OTHER    UK GROUP    OTHER    UK GROUP    OTHER
                                       SCHEME    SCHEMES    SCHEME    SCHEMES    SCHEME    SCHEMES
                                      --------   -------   --------   -------   --------   -------
                                                       ALL FIGURES IN PERCENTAGES

Inflation...........................    2.75      3.00       2.25      3.00       2.50      3.00
Rate of increase in salaries........    4.75      4.50       4.25      4.50       4.50      4.50
Rate of inflation-linked increase
  for pensions in payment and
  deferred pensions.................    2.75        --       2.25        --       2.50        --
Rate used to discount scheme
  liabilities.......................    5.50      6.10       5.70      6.75       6.00      7.20



     The assets of the UK Group scheme and the expected rate of return on these
assets, and the assets of the other defined benefit schemes and the expected
rate of return on these assets shown as a weighted average, are as follows:



                              LONG-TERM                      LONG-TERM                      LONG-TERM
                            RATE OF RETURN                 RATE OF RETURN                 RATE OF RETURN
                             EXPECTED AT      VALUE AT      EXPECTED AT      VALUE AT      EXPECTED AT      VALUE AT
                             31 DEC 2003     31 DEC 2003    31 DEC 2002     31 DEC 2002    31 DEC 2001     31 DEC 2001
                                  %              LM              %              LM              %              LM
                            --------------   -----------   --------------   -----------   --------------   -----------

UK GROUP SCHEME
Equities..................       7.75             589           8.00             472           7.50             657
Bonds.....................       5.00             262           4.75             284           5.30             293
Properties................       6.50             107           6.50             112           6.30             102
Other.....................       6.50             133           6.50             108           6.30              42
                                               ------                         ------                         ------
Total market value of
  assets..................                      1,091                            976                          1,094
Present value of scheme
  liabilities.............                     (1,316)                        (1,189)                        (1,167)
                                               ------                         ------                         ------
Deficit in the scheme.....                       (225)                          (213)                           (73)
Related deferred tax
  asset...................                         68                             64                             22
                                               ------                         ------                         ------
NET PENSION LIABILITY.....                       (157)                          (149)                           (51)
                                               ======                         ======                         ======
OTHER SCHEMES
Equities..................       9.00              41           9.75              33           9.50              37
Bonds.....................       6.00              25           6.00              23           6.50              24
Other.....................       2.80               1           2.75               1             --              --
                                               ------                         ------                         ------
Total market value of
  assets..................                         67                             57                             61
Present value of scheme
  liabilities.............                       (104)                           (96)                           (95)
                                               ------                         ------                         ------
Deficit in the schemes....                        (37)                           (39)                           (34)
Related deferred tax
  asset...................                         13                             14                             12
                                               ------                         ------                         ------
NET PENSION LIABILITY.....                        (24)                           (25)                           (22)
                                               ======                         ======                         ======



- ---------------

NOTE  The measurement of the deficit in the scheme for FRS 17 follows a
different approach to SSAP 24. The FRS 17 measurement date is 31 December 2003.
Although the rise in stock markets in 2003 increased the market value of the UK
Group scheme assets, this is more than offset by the increase in the present
value of the UK Group scheme liabilities, which is largely caused by the fall in
bond yields and increase in the inflation assumption in 2003. This has resulted
in an increased deficit in the UK Group scheme under FRS 17.

                                       F-21

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                        UK     DEFINED
                                                      GROUP    BENEFIT             DEFINED      2003
                                                      SCHEME    OTHER    TOTAL   CONTRIBUTION   TOTAL
                                                      ------   -------   -----   ------------   -----
                                                                (ALL FIGURES IN L MILLIONS)

OPERATING CHARGE
Current service cost................................    (20)      (1)     (21)       (27)        (48)
Past service cost...................................     --       (1)      (1)        --          (1)
                                                       ----      ---     ----        ---         ---
TOTAL OPERATING CHARGE..............................    (20)      (2)     (22)       (27)        (49)
                                                       ----      ---     ----        ---         ---
OTHER FINANCE INCOME/(CHARGE)
Expected return on pension scheme assets............     65        5       70         --          70
Interest on pension scheme liabilities..............    (66)      (7)     (73)        --         (73)
                                                       ----      ---     ----        ---         ---
Net charge..........................................     (1)      (2)      (3)        --          (3)
                                                       ----      ---     ----        ---         ---
NET PROFIT AND LOSS IMPACT..........................    (21)      (4)     (25)       (27)        (52)
                                                       ====      ===     ====        ===         ===
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES
Actual return less expected return on pension scheme
  assets............................................     80        8       88
Experience losses arising on the scheme
  liabilities.......................................     (1)      (8)      (9)
Changes in assumptions underlying
  the present value of the scheme liabilities.......    (95)      (6)    (101)
Exchange differences................................     --        3        3
                                                       ----      ---     ----
ACTUARIAL LOSS......................................    (16)      (3)     (19)
                                                       ====      ===     ====
MOVEMENT IN DEFICIT DURING THE YEAR
Deficit in scheme at beginning of the year..........   (213)     (39)    (252)
Current service cost................................    (20)      (1)     (21)
Past service cost...................................     --       (1)      (1)
Contributions.......................................     25        9       34
Other finance charge................................     (1)      (2)      (3)
Actuarial loss......................................    (16)      (3)     (19)
                                                       ----      ---     ----
DEFICIT IN SCHEME AT END OF THE YEAR................   (225)     (37)    (262)
                                                       ====      ===     ====
Related deferred tax asset..........................     68       13       81
                                                       ----      ---     ----
NET PENSION DEFICIT.................................   (157)     (24)    (181)
                                                       ====      ===     ====



     In 2003, the company contributions to the UK Group scheme were 17.1% of
pensionable salaries, plus L1m in respect of the new Money Purchase section
introduced with effect from 1 January 2003. In addition, a one-off contribution
of L5m was paid into this scheme to improve the funding position. The 17.1%
contribution rate will be reviewed following completion of the 1 January 2004
funding actuarial valuation.

                                       F-22

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                    UK      DEFINED
                                                  GROUP     BENEFIT               DEFINED       2002
                                                  SCHEME     OTHER     TOTAL    CONTRIBUTION    TOTAL
                                                  ------    -------    -----    ------------    -----
                                                              (ALL FIGURES IN L MILLIONS)

OPERATING CHARGE
Current service cost............................    (19)       (3)      (22)        (30)         (52)
Past service cost...............................     --        (1)       (1)         --           (1)
                                                   ----       ---      ----         ---          ---
TOTAL OPERATING CHARGE..........................    (19)       (4)      (23)        (30)         (53)
                                                   ----       ---      ----         ---          ---
OTHER FINANCE INCOME/(CHARGE)
Expected return on pension scheme assets........     73         5        78          --           78
Interest on pension scheme liabilities..........    (68)       (6)      (74)         --          (74)
                                                   ----       ---      ----         ---          ---
Net income/(charge).............................      5        (1)        4          --            4
                                                   ----       ---      ----         ---          ---
NET PROFIT AND LOSS IMPACT......................    (14)       (5)      (19)        (30)         (49)
                                                   ====       ===      ====         ===          ===
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES
Actual return less expected return on
  pension scheme assets.........................   (165)      (11)     (176)
Experience gains and (losses) arising on
  the scheme liabilities........................     17        (1)       16
Changes in assumptions underlying the present
  value of the scheme liabilities...............      3        (4)       (1)
Exchange differences............................     --         2         2
                                                   ----       ---      ----
ACTUARIAL LOSS..................................   (145)      (14)     (159)
                                                   ====       ===      ====
MOVEMENT IN DEFICIT DURING THE YEAR
Deficit in scheme at beginning of the year......    (73)      (34)     (107)
Current service cost............................    (19)       (3)      (22)
Past service cost...............................     --        (1)       (1)
Contributions...................................     19        14        33
Other finance income/(charge)...................      5        (1)        4
Actuarial loss..................................   (145)      (14)     (159)
                                                   ----       ---      ----
DEFICIT IN SCHEME AT END OF THE YEAR............   (213)      (39)     (252)
                                                   ====       ===      ====
Related deferred tax asset......................     64        14        78
                                                   ----       ---      ----
NET PENSION DEFICIT.............................   (149)      (25)     (174)
                                                   ====       ===      ====



     The contribution rate for 2002 for the UK Group scheme was 17.1% of
pensionable salaries.

     The experience gains and losses of both the UK Group scheme and other
schemes are shown below:



                                                               2003      2002
                                                              ------    -------
                                                               (ALL FIGURES IN
                                                                 L MILLIONS)

HISTORY OF EXPERIENCE GAINS AND LOSSES
Difference between the actual and expected return on scheme
  assets....................................................    L88M    L(176)m
As a percentage of year end assets..........................      8%        17%
Experience gains and (losses) on scheme liabilities.........   L(9)M       L16m
As a percentage of year end liabilities.....................      1%         1%
Total amount recognised in statement of total recognised
  gains and losses..........................................  L(19)M    L(159)m
As a percentage of year end liabilities.....................      1%        12%



                                       F-23

                       NOTES TO THE ACCOUNTS (CONTINUED)

     If the above amounts had been recognised in the financial statements, the
Group's net assets and profit and loss reserve at 31 December 2003 would be as
follows:



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

Net assets excluding pension liability (see note below).....  3,176     3,566
FRS 17 pension liability....................................   (181)     (174)
                                                              -----     -----
NET ASSETS INCLUDING FRS 17 PENSION LIABILITY...............  2,995     3,392
                                                              =====     =====
Profit and loss reserve excluding pension reserve (see note
  below)....................................................    311       709
FRS 17 pension reserve......................................   (181)     (174)
                                                              -----     -----
PROFIT AND LOSS RESERVE INCLUDING FRS 17 PENSION RESERVES...    130       535
                                                              =====     =====



- ---------------

NOTE  The net assets and profit and loss reserve exclude the pension liability
of L29m (2002: L36m) included within provisions (see note 22).

10C OTHER POST-RETIREMENT BENEFITS

     UITF 6 ACCOUNTING  The Group provides certain healthcare and life assurance
benefits principally for retired US employees and their dependants. These plans
are unfunded. Retirees are eligible for participation in the plans if they meet
certain age and service requirements. Plans that are available vary depending on
the business division in which the retiree worked. Plan choices and retiree
contributions are dependent on retirement date, business division, option chosen
and length of service. The valuation and costs relating to other post-
retirement benefits are assessed in accordance with the advice of independent
qualified actuaries. The cost of the benefits and the major assumptions used,
based on a measurement date of 31 December 2002, are as follows:



                                                               2003       2002       2001
                                                              ------     ------     ------
                                                              (ALL FIGURES IN L MILLIONS)

Other post-retirement benefits..............................      5          5          4
                                                              (ALL FIGURES IN PERCENTAGES)
Inflation...................................................                          3.0
Initial rate of increase in healthcare rates................                         12.0
Ultimate rate of increase in healthcare rates (2007)........                          5.0
Rate used to discount scheme liabilities....................                          6.8



     Included in note 22, there is a post-retirement medical benefits provision
of L51m (2002: L56m). In accordance with UITF 6, the cost of post-retirement
benefits, and related provisions, are based on the equivalent US GAAP standard,
FAS 106.

     FRS 17 DISCLOSURES  The disclosures required under the transitional
arrangements of FRS 17 are set out below. For the purpose of these disclosures
the valuation of the schemes has been updated to 31 December 2003 using the
assumptions listed below.



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                              (ALL FIGURES IN PERCENTAGES)

Inflation...................................................    3.00       3.00       3.00
Initial rate of increase in healthcare rates................   12.00      12.00      10.00
Ultimate rate of increase in healthcare rates (2008; 2007;
  2006).....................................................    5.00       5.00       5.00
Rate used to discount scheme liabilities....................    6.10       6.75       7.20



                                       F-24

                       NOTES TO THE ACCOUNTS (CONTINUED)

     The value of the unfunded liability is as follows:



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Present value of unfunded liabilities.......................     (61)       (63)       (63)
Related deferred tax asset..................................      21         22         22
                                                                 ---        ---        ---
NET POST-RETIREMENT HEALTHCARE LIABILITY....................     (40)       (41)       (41)
                                                                 ===        ===        ===
OPERATING CHARGE
Current service cost........................................      (1)        (1)
Past service cost...........................................      --         --
                                                                 ---        ---
TOTAL OPERATING CHARGE......................................      (1)        (1)
                                                                 ===        ===
OTHER FINANCE CHARGE
Interest on pension scheme liabilities......................      (4)        (4)
                                                                 ---        ---
Net charge..................................................      (4)        (4)
                                                                 ---        ---
NET PROFIT AND LOSS IMPACT..................................      (5)        (5)
                                                                 ===        ===
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES
Experience gains arising on the scheme liabilities..........       3          3
Changes in assumptions underlying the present value of the
  scheme liabilities........................................      (6)        (7)
Exchange differences........................................       6          5
                                                                 ---        ---
ACTUARIAL GAIN..............................................       3          1
                                                                 ===        ===
MOVEMENT IN DEFICIT DURING THE YEAR
Deficit in scheme at beginning of the year..................     (63)       (63)
Current service cost........................................      (1)        (1)
Contributions...............................................       4          4
Other finance charge........................................      (4)        (4)
Actuarial gain..............................................       3          1
                                                                 ---        ---
DEFICIT IN SCHEME AT END OF THE YEAR........................     (61)       (63)
                                                                 ===        ===
Related deferred tax asset..................................      21         22
                                                                 ---        ---
NET POST-RETIREMENT DEFICIT.................................     (40)       (41)
                                                                 ===        ===
The experience gains and losses for the schemes are shown
  below:
HISTORY OF EXPERIENCE GAINS AND LOSSES
Experience gains on scheme liabilities......................     L3M        L3m
As a percentage of year end liabilities.....................       5%         4%
Total amount recognised in statement of total recognised
  gains and losses..........................................     L3M        L1m
As a percentage of year end liabilities.....................       5%         2%



                                       F-25

                       NOTES TO THE ACCOUNTS (CONTINUED)

     If the above amounts had been recognised in the financial statements, the
Group's net assets and profit and loss reserves at 31 December 2003 would be as
follows:



                                                              2003     2002
                                                              -----    -----
                                                               (ALL FIGURES
                                                              IN L MILLIONS)

Net assets excluding post-retirement healthcare liability
  (see note below)..........................................  3,198    3,586
FRS 17 post-retirement healthcare liability.................    (40)     (41)
                                                              -----    -----
NET ASSETS INCLUDING FRS 17 POST-RETIREMENT HEALTHCARE
  LIABILITY.................................................  3,158    3,545
                                                              =====    =====
Profit and loss reserve excluding post-retirement healthcare
  reserve (see note below)..................................    333      729
FRS 17 post-retirement healthcare reserve...................    (40)     (41)
                                                              -----    -----
PROFIT AND LOSS RESERVE INCLUDING FRS 17 POST-RETIREMENT
  HEALTHCARE RESERVE........................................    293      688
                                                              =====    =====



- ---------------

NOTE  The net assets and profit and loss reserve exclude the post-retirement
healthcare liability of L51m (2002: L56m) included within provisions (see note
22).

11  INTANGIBLE FIXED ASSETS



                                                                 GOODWILL
                                                              --------------
                                                               (ALL FIGURES
                                                              IN L MILLIONS)

COST
AT 31 DECEMBER 2001.........................................      4,866
Exchange differences........................................       (383)
Additions...................................................         63
Disposals...................................................        (59)
                                                                  -----
AT 31 DECEMBER 2002.........................................      4,487
Exchange differences........................................       (321)
Additions...................................................        157
Disposals...................................................        (99)
                                                                  -----
AT 31 DECEMBER 2003.........................................      4,224
                                                                  =====
AMORTISATION
AT 31 DECEMBER 2001.........................................       (673)
Exchange differences........................................         70
Provided in the year........................................       (282)
Provision for impairment....................................        (10)
Disposals...................................................         18
                                                                  -----
AT 31 DECEMBER 2002.........................................       (877)
Exchange differences........................................         75
Provided in the year........................................       (257)
Disposals...................................................         95
                                                                  -----
AT 31 DECEMBER 2003.........................................       (964)
                                                                  =====
NET CARRYING AMOUNT
At 31 December 2002.........................................      3,610
                                                                  -----
AT 31 DECEMBER 2003.........................................      3,260
                                                                  =====



                                       F-26

                       NOTES TO THE ACCOUNTS (CONTINUED)

12  TANGIBLE FIXED ASSETS



                                                  FREEHOLD AND      PLANT       ASSETS IN
                                                   LEASEHOLD         AND        COURSE OF
                                                    PROPERTY      EQUIPMENT    CONSTRUCTION    TOTAL
                                                  ------------    ---------    ------------    -----
                                                             (ALL FIGURES IN L MILLIONS)

COST
AT 31 DECEMBER 2001.............................      316            719             7         1,042
Exchange differences............................      (16)           (37)           --           (53)
Reclassifications...............................       --              3            (3)           --
Owned by subsidiaries acquired..................       --             14            --            14
Capital expenditure.............................       21             89            16           126
Disposals.......................................      (10)           (74)           --           (84)
                                                      ---           ----           ---         -----
AT 31 DECEMBER 2002.............................      311            714            20         1,045
Exchange differences............................      (19)           (33)           (3)          (55)
Reclassifications...............................        1              9           (10)           --
Owned by subsidiaries acquired..................        5             19            --            24
Owned by subsidiaries disposed..................       (2)            (6)           --            (8)
Capital expenditure.............................       12             77            15           104
Disposals.......................................      (15)           (63)           --           (78)
                                                      ---           ----           ---         -----
AT 31 DECEMBER 2003.............................      293            717            22         1,032
                                                      ===           ====           ===         =====
DEPRECIATION
AT 31 DECEMBER 2001.............................      (90)          (410)           --          (500)
Exchange differences............................        5             25            --            30
Provided in the year............................      (17)          (105)           --          (122)
Owned by subsidiaries acquired..................       --            (14)           --           (14)
Disposals.......................................        6             58            --            64
                                                      ---           ----           ---         -----
AT 31 DECEMBER 2002.............................      (96)          (446)           --          (542)
Exchange differences............................       10             27            --            37
Provided in the year............................      (16)           (95)           --          (111)
Owned by subsidiaries acquired..................       --            (14)           --           (14)
Owned by subsidiaries disposed..................        1              4            --             5
Disposals.......................................        7             54            --            61
AT 31 DECEMBER 2003.............................      (94)          (470)           --          (564)
                                                      ===           ====           ===         =====
NET BOOK VALUE
At 31 December 2002.............................      215            268            20           503
                                                      ---           ----           ---         -----
AT 31 DECEMBER 2003.............................      199            247            22           468
                                                      ===           ====           ===         =====



FREEHOLD AND LEASEHOLD PROPERTY -- Net book value includes freehold of L120m
(2002: L130m) and short leases of L79m (2002: L85m).

CAPITAL COMMITMENTS -- The Group had capital commitments for fixed assets,
including finance leases, already under contract amounting to L1m at 31 December
2003 (2002: L12m).

OTHER NOTES -- The net book value of Group tangible fixed assets includes L5m
(2002: L7m) in respect of assets held under finance leases. Depreciation on
these assets charged in 2003 was L2m (2002: L2m).

                                       F-27

                       NOTES TO THE ACCOUNTS (CONTINUED)

13  JOINT VENTURES



                                                                  2003                  2002
                                                           ------------------    ------------------
                                                                        BOOK                  BOOK
                                                           VALUATION    VALUE    VALUATION    VALUE
                                                           ---------    -----    ---------    -----
                                                                 (ALL FIGURES IN L MILLIONS)

Unlisted joint ventures..................................      6          6          7          7



- ---------------

NOTE  The valuations of unlisted joint ventures are directors' valuations as at
31 December 2003. If realised at these values there would be an estimated
liability for taxation of Lnil (2002: Lnil). The Group had no capital
commitments to subscribe for further capital and loan stock.



                                                              SHARE OF                TOTAL NET
                                                               EQUITY     RESERVES     ASSETS
                                                              --------    --------    ---------
                                                                 (ALL FIGURES IN L MILLIONS)

SUMMARY OF MOVEMENTS
AT 31 DECEMBER 2002.........................................     61         (54)           7
Exchange differences........................................      7          (5)           2
Additions...................................................      7          --            7
Retained loss for the year..................................     --         (10)         (10)
                                                                 --         ---          ---
AT 31 DECEMBER 2003.........................................     75         (69)           6
                                                                 ==         ===          ===


                                         2003                      2002                      2001
                                ----------------------    ----------------------    ----------------------
                                OPERATING    TOTAL NET    OPERATING    TOTAL NET    OPERATING    TOTAL NET
                                  LOSS        ASSETS        LOSS        ASSETS        LOSS        ASSETS
                                ---------    ---------    ---------    ---------    ---------    ---------
                                                       (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education.............      --           --           (1)          --           --            1
FT Group......................     (11)           2          (13)           3          (20)           3
The Penguin Group.............       1            4            1            4            1            3
                                   ---          ---          ---          ---          ---          ---
                                   (10)           6          (13)           7          (19)           7
                                   ---          ---          ---          ---          ---          ---
GEOGRAPHICAL MARKETS SUPPLIED
  AND LOCATION OF NET ASSETS
United Kingdom................       1            4            1            4           (1)           3
Continental Europe............     (11)           2          (13)           3          (18)           3
North America.................      --           --           (1)          --           --            1
                                   ---          ---          ---          ---          ---          ---
                                   (10)           6          (13)           7          (19)           7
                                   ===          ===          ===          ===          ===          ===


                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

RECONCILIATION TO RETAINED LOSS
Operating loss of joint ventures............................     (10)       (13)       (19)
Taxation....................................................      --         --         (6)
                                                                 ---        ---        ---
RETAINED LOSS FOR THE YEAR..................................     (10)       (13)       (25)
                                                                 ===        ===        ===



                                       F-28

                       NOTES TO THE ACCOUNTS (CONTINUED)

14  ASSOCIATES



                                                            2003                       2002
                                                   -----------------------    -----------------------
                                                   VALUATION    BOOK VALUE    VALUATION    BOOK VALUE
                                                   ---------    ----------    ---------    ----------

Listed associates................................      27            9            17           17
Unlisted associates..............................     192           49           214           88
Loans............................................      --           --             1            1
                                                      ---          ---           ---          ---
                                                      219           58           232          106
                                                      ===          ===           ===          ===



- ---------------

NOTE  Principal associates are listed in Item 4 -- Information on the Company.
The valuations of unlisted associates are directors' valuations as at 31
December 2003. If realised at these values there would be an estimated liability
for taxation of Lnil (2002: Lnil). The Group had no capital commitments to
subscribe for further capital and loan stock.



                                        SHARE OF                                              TOTAL NET
                                         EQUITY     LOANS    RESERVES    TOTAL    GOODWILL     ASSETS
                                        --------    -----    --------    -----    --------    ---------
                                                          (ALL FIGURES IN L MILLIONS)

SUMMARY OF MOVEMENTS
AT 31 DECEMBER 2001...................     228         1         7        236        657         893
Exchange differences..................      (2)       --         1         (1)        (3)         (4)
Additions.............................      20        --        --         20          1          21
Disposals.............................    (182)       --        (1)      (183)      (575)       (758)
Retained profit for the year..........      --        --         2          2         --           2
Goodwill amortisation.................      --        --        --         --        (48)        (48)
                                          ----       ---       ---       ----       ----        ----
AT 31 DECEMBER 2002...................      64         1         9         74         32         106
Exchange differences..................       1         1        --          2         (1)          1
Disposals.............................     (16)       --        (5)       (21)       (24)        (45)
Loan repayment........................      --        (2)       --         (2)        --          (2)
Retained profit for the year..........      --        --         5          5         --           5
Goodwill amortisation.................      --        --        --         --         (7)         (7)
                                          ----       ---       ---       ----       ----        ----
AT 31 DECEMBER 2003...................      49        --         9         58         --          58
                                          ====       ===       ===       ====       ====        ====



                                       F-29

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                   2003                    2002                    2001
                                           ---------------------   ---------------------   ---------------------
                                           OPERATING   TOTAL NET   OPERATING   TOTAL NET   OPERATING   TOTAL NET
                                            PROFIT      ASSETS       LOSS       ASSETS       LOSS       ASSETS
                                           ---------   ---------   ---------   ---------   ---------   ---------
                                                                (ALL FIGURES IN L MILLIONS)

BUSINESS SECTORS
Pearson Education........................       1           4           2           8          (1)         10
FT Group.................................       9          54         (37)         98         (49)        120
                                              ---         ---         ---         ---         ---         ---
Continuing operations....................      10          58         (35)        106         (50)        130
Discontinued operations..................      --          --          (3)         --           2         763
                                              ---         ---         ---         ---         ---         ---
                                               10          58         (38)        106         (48)        893
                                              ===         ===         ===         ===         ===         ===
GEOGRAPHICAL MARKETS SUPPLIED AND
  LOCATION OF NET ASSETS/(LIABILITIES)
United Kingdom...........................      10          20          11           9           4          12
Continental Europe.......................       2          39          (1)         92           2          72
North America............................      (3)         (7)        (45)         (5)        (59)         36
Rest of world............................       1           6          --          10           3          10
                                              ---         ---         ---         ---         ---         ---
Continuing operations....................      10          58         (35)        106         (50)        130
Discontinued operations..................      --          --          (3)         --           2         763
                                              ---         ---         ---         ---         ---         ---
                                               10          58         (38)        106          48         893
                                              ===         ===         ===         ===         ===         ===


                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

RECONCILIATION TO RETAINED PROFIT
Operating profit of associates (before goodwill
  amortisation).............................................      17         10         38
Interest....................................................       1         --        (53)
Profit on sale of subsidiaries..............................      --          3         (9)
Taxation....................................................      (5)        (4)       (25)
Dividends (including tax credits) from unlisted
  associates................................................      (8)        (7)        --
Other.......................................................      --         --         (8)
                                                                 ---        ---        ---
RETAINED PROFIT FOR THE YEAR................................       5          2        (57)
                                                                 ===        ===        ===



     The aggregate of the Group's share in its associates is shown below:



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

SALES.......................................................     234        141       700
Fixed assets................................................      24         28       270
Current assets..............................................     116        130       384
Liabilities due within one year.............................     (70)       (76)     (360)
Liabilities due after one year or more......................     (12)        (8)      (58)
                                                                 ---        ---      ----
NET ASSETS..................................................      58         74       236
                                                                 ===        ===      ====



                                       F-30

                       NOTES TO THE ACCOUNTS (CONTINUED)

15  OTHER FIXED ASSET INVESTMENTS



                                                            2003                       2002
                                                   -----------------------    -----------------------
                                                   VALUATION    BOOK VALUE    VALUATION    BOOK VALUE
                                                   ---------    ----------    ---------    ----------
                                                              (ALL FIGURES IN L MILLIONS)

Listed...........................................     73            59           67            64
Unlisted.........................................     21            21           20            20
                                                      --            --           --            --
                                                      94            80           87            84
                                                      ==            ==           ==            ==



- ---------------

NOTE  The valuations of unlisted investments are directors' valuations as at 31
December 2003. If realised at valuation there would be an estimated liability
for taxation of Lnil (2002: Lnil).



                                                              OWN SHARES
                                                                 HELD       OTHER    TOTAL
                                                              ----------    -----    -----
                                                              (ALL FIGURES IN L MILLIONS)

COST
At 31 December 2001.........................................      91         107      198
Exchange differences........................................      --          (4)      (4)
Additions...................................................      17           4       21
Disposals...................................................      --         (10)     (10)
                                                                 ---         ---     ----
At 31 December 2002.........................................     108          97      205
                                                                 ---         ---     ----
Exchange differences........................................      --          (5)      (5)
Additions...................................................      --           4        4
Disposals...................................................      (2)         --       (2)
                                                                 ---         ---     ----
AT 31 DECEMBER 2003.........................................     106          96      202
                                                                 ===         ===     ====
PROVISION
At 31 December 2001.........................................     (59)        (55)    (114)
Provided during the year....................................      (7)         --       (7)
                                                                 ---         ---     ----
At 31 December 2002.........................................     (66)        (55)    (121)
                                                                 ---         ---     ----
Provided during the year....................................      (3)         --       (3)
Disposals...................................................       2          --        2
                                                                 ---         ---     ----
AT 31 DECEMBER 2003.........................................     (67)        (55)    (122)
                                                                 ===         ===     ====
NET BOOK VALUE
At 31 December 2002.........................................      42          42       84
                                                                 ---         ---     ----
AT 31 DECEMBER 2003.........................................      39          41       80
                                                                 ===         ===     ====



- ---------------

NOTE  The Pearson Employee Share Trust and Pearson plc Employee Share Ownership
Trusts hold 7.5m (2002: 7.9m) Pearson plc ordinary shares which had a market
value of L46m at 31 December 2003 (2002: L45m) and a nominal value of L2m at 31
December 2003 (2002: L2m). These shares have been acquired by the trusts, using
funds provided by Pearson plc, to meet obligations under various executive and
employee option and restricted share plans. Under these plans the participants
become entitled to shares after a specified number of years and subject to
certain performance criteria being met. Pearson aims to hedge its liability
under the plans by buying shares through the trusts to meet the anticipated
future liability. Dividends on the shares held by the trusts have been waived.
The amount of dividend waived on the ESOP shares was L2m (2002: L1m).

     The Group operates a worldwide Save As You Earn scheme together with a
similar scheme for US employees that allows the grant of share options at a
discount to the market price of the option granted. The

                                       F-31

                       NOTES TO THE ACCOUNTS (CONTINUED)

Group has made use of the exemption under UITF 17 not to recognise any
compensation charge in respect of these options.

     Employer's National Insurance and similar taxes arise on the exercise of
certain share options. In accordance with UITF 25 a provision is made,
calculated using the market price of the company's shares at the balance sheet
date, pro-rated over the vesting period of the options.

16  STOCKS



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

Raw materials...............................................    24        22
Work in progress............................................    30        36
Finished goods..............................................   270       297
Pre-publication costs.......................................   359       379
                                                               ---       ---
                                                               683       734
                                                               ===       ===



- ---------------

NOTE  The replacement cost of stocks is not materially different from book
value.

17  DEBTORS



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

AMOUNTS FALLING DUE WITHIN ONE YEAR
Trade debtors...............................................    822       778
Associates..................................................      1         1
Royalty advances............................................    110       109
Other debtors...............................................     61        51
Prepayments and accrued income..............................     38        44
                                                              -----     -----
                                                              1,032       983
                                                              =====     =====
AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR
Royalty advances............................................     83        63
Other debtors...............................................     16        10
Prepayments and accrued income..............................      1         1
                                                              -----     -----
                                                                100        74
                                                              -----     -----
                                                              1,132     1,057
                                                              =====     =====



18  CASH AT BANK AND IN HAND



                                                               2003                2002
                                                         ----------------    ----------------
                                                         GROUP    COMPANY    GROUP    COMPANY
                                                         -----    -------    -----    -------
                                                             (ALL FIGURES IN L MILLIONS)

Cash, bank current accounts and overnight deposits.....   309        --       417        --
Certificates of deposit and commercial paper...........     8        --        15        --
Term bank deposits.....................................   244        75       143         8
                                                          ---       ---       ---       ---
                                                          561        75       575         8
                                                          ===       ===       ===       ===



                                       F-32

                       NOTES TO THE ACCOUNTS (CONTINUED)

19   FINANCIAL INSTRUMENTS

     Treasury policy  The Group holds financial instruments for two principal
purposes: to finance its operations and to manage the interest rate and currency
risks arising from its operations and its sources of finance. The Group finances
its operations by a mixture of cash flows from operations, short-term borrowings
from banks and commercial paper markets, and longer term loans from banks and
capital markets. The Group borrows principally in US dollars, euros and
sterling, at both floating and fixed rates of interest, using derivatives, where
appropriate, to generate the desired effective currency profile and interest
rate basis. The derivatives used for this purpose are principally interest rate
swaps, interest rate caps and collars, currency swaps and forward foreign
exchange contracts. The main risks arising from the Group's financial
instruments are interest rate risk, liquidity and refinancing risk, counterparty
risk and foreign currency risk. These risks are managed by the chief financial
officer under policies approved by the board which are summarised below. These
policies have remained unchanged, except as disclosed, since the beginning of
2003. A treasury committee of the board receives reports on the Group's treasury
activities, policies and procedures, which are reviewed periodically by a group
of external professional advisers. The treasury department is not a profit
centre and its activities are subject to internal audit.

     Interest rate risk  The Group's exposure to interest rate fluctuations on
its borrowings is managed by borrowing on a fixed rate basis and by entering
into interest rate swaps, interest rate caps and forward rate agreements. Since
October 2002 the Group's policy objective has been to set a target proportion of
its forecast borrowings (taken at the year end, with cash netted against
floating rate debt) to be hedged (i.e. fixed or capped) over the next four years
within a 40% to 65% range. At the end of 2003 that ratio was 61%. A 1% change in
the Group's variable rate US dollar, euro and sterling interest rates would have
a L5m effect on profit before tax.

     Liquidity and refinancing risk  The Group's objective is to procure
continuity of funding at a reasonable cost. To do this it seeks to arrange
committed funding for a variety of maturities from a diversity of sources. The
Group's policy objective has been that the weighted average maturity of its core
gross borrowings (treating short-term advances as having the final maturity of
the facilities available to refinance them) should be between three and 10
years. At the end of 2003 the average maturity of gross borrowings was 4.9 years
and non-banks provided L1,718m (89%) of them (up from 4.8 years and down from
90% respectively at the beginning of the year). The Group believes that ready
access to different funding markets also helps to reduce its liquidity risk, and
that published credit ratings and published financial policies improve such
access. The Group manages the amount of its net debt, and the level of its net
interest cover, principally by the use of a target range for its interest cover
ratio. All of the Group's credit ratings remained unchanged during the year. The
long-term ratings are Baa1 from Moody's and BBB+ from Standard & Poor's, and the
short-term ratings are P2 and A2 respectively. The Group continues to operate on
the basis that the board will take such action as it believes necessary to
support and protect its current credit ratings. The Group also maintains undrawn
committed borrowing facilities. At the end of 2003 these amounted to L950m and
their weighted average maturity was 1.5 years.

     Credit Risk  Credit risk represents the possibility that the Group would
suffer a loss if a counterparty was to default on its obligations to the Group.
Credit risk exposure arises primarily from the placement of surplus cash funds
with financial institutions, as well as from interest rate, currency swap and
foreign exchange products. The Group's risk of loss on deposit or derivative
contracts with individual banks is managed in part through the use of
counterparty limits. These limits, which take published credit limits (among
other things) into account, are approved by the chief financial officer.

     For derivative financial instruments, total credit exposure consists of
current and potential exposure. Current credit exposure represents the
replacement cost of the transaction. Potential credit exposure is a
statistically based estimate of the future replacement cost of the transaction.
The Group has established policies and procedures to manage the level and
composition of its credit risk on both a transaction and a portfolio basis. In
addition, for a currency swap that transforms a major part of the 6.125%
eurobonds due 2007 into a US dollar liability (a higher value derivative
contract than is usual in the portfolio) the Group has entered into mark to
market agreements, whose effect is to reduce significantly the counterparty risk
of the transaction.

                                       F-33

                       NOTES TO THE ACCOUNTS (CONTINUED)

     Additional financial instruments which potentially subject the Group to
concentrations of credit risk consist of accounts receivable. Management
believes the concentration of credit risk associated with accounts receivable is
minimal due to the dispersion over many customers and different businesses.

     Currency risk  Although the Group is based in the UK, it has its most
significant investment in overseas operations. The most significant currency for
the Group is the US dollar, followed by the euro and sterling. The Group's
policy on routine transactional conversions between currencies (for example, the
collection of receivables, and the settlement of payables or interest) remains
that these should be effected at the relevant spot exchange rate. No unremitted
profits are hedged with foreign exchange contracts as the company judges it
inappropriate to hedge non-cash flow translational exposure with cash flow
instruments. However, the Group does seek to create a 'natural hedge' though its
policy of aligning approximately the currency composition of its core borrowings
in US dollars, euros and sterling with the split between those currencies of its
forecast operating profit. This policy aims to dampen the impact of changes in
foreign exchange rates on consolidated interest cover and earnings. Long-term
core borrowing is limited to these three major currencies. However, the Group
still borrows small amounts in other currencies, typically for seasonal working
capital needs. At the year end the split of aggregate net borrowings in its
three core currencies was US dollar 81%, euro 10% and sterling 9%.

A.   MATURITY OF BORROWINGS AND OTHER FINANCIAL LIABILITIES

     The maturity profile of the Group's borrowings and other financial
liabilities is shown below:



                                                               2003                2002
                                                         ----------------    ----------------
                                                         GROUP    COMPANY    GROUP    COMPANY
                                                         -----    -------    -----    -------
                                                             (ALL FIGURES IN L MILLIONS)

MATURITY OF BORROWINGS
SHORT-TERM
Bank loans and overdrafts..............................    119       262       101       175
5% Euro Bonds 2003.....................................     --        --       148       148
9.5% Sterling Bonds 2004...............................    108        --        --        --
4.625% Euro Bonds 2004.................................    348       348        --        --
                                                         -----     -----     -----     -----
TOTAL DUE WITHIN ONE YEAR, OR ON DEMAND................    575       610       249       323
                                                         -----     -----     -----     -----
MEDIUM AND LONG-TERM
Loans or instalments thereof repayable:
From one to two years..................................     85        --       458       338
From two to five years.................................    582       443       616       371
After five years not by instalments....................    680       680       660       660
                                                         -----     -----     -----     -----
TOTAL DUE AFTER MORE THAN ONE YEAR.....................  1,347     1,123     1,734     1,369
                                                         -----     -----     -----     -----
TOTAL BORROWINGS.......................................  1,922     1,733     1,983     1,692
                                                         =====     =====     =====     =====



- ---------------

NOTE  At 31 December 2003 L85m (2002: L91m) of debt, including commercial paper,
currently classified from one to two years would be repayable within one year if
refinancing contracts were not in place. The short-term bank loans and
overdrafts of the Group are lower than those of the company because of bank
offset arrangements.

                                       F-34

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                     2003                            2002
                                         -----------------------------   -----------------------------
                                          GROUP    GROUP OTHER            GROUP    GROUP OTHER
                                         FINANCE    FINANCIAL    GROUP   FINANCE    FINANCIAL    GROUP
                                         LEASES    LIABILITIES   TOTAL   LEASES    LIABILITIES   TOTAL
                                         -------   -----------   -----   -------   -----------   -----
                                                          (ALL FIGURES IN L MILLIONS)

MATURITY OF OTHER FINANCIAL LIABILITIES
Amounts falling due:
In one year or less or on demand.......      3           5          8        4          11         15
In more than one year but not more than
  two years............................      1          14         15        2           8         10
In more than two years but not more
  than five years......................      1           7          8        1          16         17
In more than five years................     --          21         21       --          22         22
                                           ---         ---        ---      ---         ---        ---
                                             5          47         52        7          57         64
                                           ===         ===        ===      ===         ===        ===



B.  BORROWINGS BY INSTRUMENT



                                                                 2003              2002
                                                            ---------------   ---------------
                                                            GROUP   COMPANY   GROUP   COMPANY
                                                            -----   -------   -----   -------
                                                               (ALL FIGURES IN L MILLIONS)

UNSECURED
5% Euro Bonds 2003........................................     --       --      148      148
9.5% Sterling Bonds 2004..................................    108       --      120       --
4.625% Euro Bonds 2004....................................    348      348      338      338
7.375% US Dollar notes 2006...............................    139       --      154       --
6.125% Euro Bonds 2007....................................    343      343      370      370
10.5% Sterling Bonds 2008.................................    100      100      100      100
7% Global Dollar Bonds 2011...............................    278      278      310      310
7% Sterling Bonds 2014....................................    235      235      250      250
4.625% US Dollar notes 2018...............................    167      167       --       --
Variable rate loan notes..................................     --       --        1        1
Bank loans and overdrafts and commercial paper............    204      262      192      175
                                                            -----    -----    -----    -----
TOTAL BORROWINGS..........................................  1,922    1,733    1,983    1,692
                                                            =====    =====    =====    =====



C.   UNDRAWN COMMITTED BORROWING FACILITIES



                                                              2003      2002
                                                              -----    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

Expiring within one year....................................    --        --
Expiring between one and two years..........................   950        --
Expiring in more than two years.............................    --     1,059
                                                               ---     -----
                                                               950     1,059
                                                               ===     =====



- ---------------

NOTE  All of the above committed borrowing facilities incur commitment fees at
market rates. In addition to the above facilities, there are a number of
short-term overdrafts that are utilised in the normal course of the business.

                                       F-35

                       NOTES TO THE ACCOUNTS (CONTINUED)

D.   CURRENCY AND INTEREST RATE RISK PROFILE



                                                                              2003
                                                    --------------------------------------------------------
                                                                                     FIXED RATE BORROWINGS
                                                                                    ------------------------
                                                                                                 WEIGHTED
                                                                                    WEIGHTED      AVERAGE
                                                                  TOTAL     TOTAL   AVERAGE     PERIOD FOR
                                                                 VARIABLE   FIXED   INTEREST   WHICH RATE IS
                                                    BORROWINGS     RATE     RATE      RATE     FIXED - YEARS
                                                    ----------   --------   -----   --------   -------------
                                                        LM          LM       LM        %

CURRENCY AND INTEREST RATE RISK PROFILE OF
  BORROWINGS
US dollar.........................................    1,427         864      563      5.9           3.2
Sterling..........................................      201          61      140      8.0           9.0
Euro..............................................      292         166      126      5.3           1.7
Other currencies..................................        2           2       --       --            --
                                                      -----       -----      ---
                                                      1,922       1,093      829
                                                      =====       =====      ===


                                                                              2002
                                                    --------------------------------------------------------
                                                                                     FIXED RATE BORROWINGS
                                                                                    ------------------------
                                                                                                 WEIGHTED
                                                                                    WEIGHTED      AVERAGE
                                                                  TOTAL     TOTAL   AVERAGE     PERIOD FOR
                                                                 VARIABLE   FIXED   INTEREST   WHICH RATE IS
                                                    BORROWINGS     RATE     RATE      RATE     FIXED - YEARS
                                                    ----------   --------   -----   --------   -------------
                                                        LM          LM       LM        %

CURRENCY AND INTEREST RATE RISK PROFILE OF
  BORROWINGS
US dollar.........................................    1,350         752      598       5.9          4.0
Sterling..........................................      241         161       80      10.5          5.5
Euro..............................................      380         305       75       5.2          1.5
Other currencies..................................       12          12       --        --           --
                                                      -----       -----      ---
                                                      1,983       1,230      753
                                                      =====       =====      ===



- ---------------

NOTE  The figures shown in the tables above take into account interest rate,
currency swaps and forward rate contracts entered into by the Group. Variable
rate borrowings bear interest at rates based on relevant national LIBOR
equivalents.



                                                                            2003
                                                              ---------------------------------
                                                                 OTHER      TOTAL      TOTAL
                                                               FINANCIAL    FIXED   NO INTEREST
                                                              LIABILITIES   RATE       PAID
                                                              -----------   -----   -----------
                                                                 (ALL FIGURES IN L MILLIONS)

CURRENCY AND INTEREST RATE RISK PROFILE OF OTHER FINANCIAL
  LIABILITIES
US dollar...................................................      35           4        31
Sterling....................................................       5           1         4
Euro........................................................      12          --        12
                                                                  --        ----        --
                                                                  52           5        47
                                                                  ==        ====        ==



                                       F-36

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                            2002
                                                              ---------------------------------
                                                                 OTHER      TOTAL      TOTAL
                                                               FINANCIAL    FIXED   NO INTEREST
                                                              LIABILITIES   RATE       PAID
                                                              -----------   -----   -----------
                                                                 (ALL FIGURES IN L MILLIONS)

CURRENCY AND INTEREST RATE RISK PROFILE OF OTHER FINANCIAL
  LIABILITIES
US dollar...................................................      45           5        40
Sterling....................................................       8           2         6
Euro........................................................      11          --        11
                                                                  --        ----        --
                                                                  64           7        57
                                                                  ==        ====        ==


                                                                            2003
                                                      ------------------------------------------------
                                                                                      OTHER
                                                      US DOLLAR   STERLING   EURO   CURRENCIES   TOTAL
                                                      ---------   --------   ----   ----------   -----
                                                                (ALL FIGURES IN L MILLIONS)

CURRENCY AND INTEREST RATE RISK PROFILE OF FINANCIAL
  ASSETS
Cash at bank and in hand............................     150         54       40        65        309
Short-term deposits.................................     112         20      104        16        252
Other financial assets..............................      44          7        7         1         59
                                                         ---         --      ---        --        ---
                                                         306         81      151        82        620
                                                         ===         ==      ===        ==        ===
Fixed rate..........................................       6          2       --        --          8
Floating rate.......................................     259         72      144        78        553
No interest received................................      41          7        7         4         59
                                                         ---         --      ---        --        ---
                                                         306         81      151        82        620
                                                         ===         ==      ===        ==        ===



- ---------------

NOTE  The US dollar fixed rate asset is fixed for 12 years at a rate of 8.2%.
The Sterling fixed rate asset is fixed for 6 years at a rate of 7.0%.



                                                                            2002
                                                      ------------------------------------------------
                                                                                      OTHER
                                                      US DOLLAR   STERLING   EURO   CURRENCIES   TOTAL
                                                      ---------   --------   ----   ----------   -----
                                                                (ALL FIGURES IN L MILLIONS)

CURRENCY AND INTEREST RATE RISK PROFILE OF FINANCIAL
  ASSETS
Cash at bank and in hand............................     279          9       67        62        417
Short-term deposits.................................       2         18      127        11        158
Other financial assets..............................      28          6       --        --         34
                                                         ---         --      ---        --        ---
                                                         309         33      194        73        609
                                                         ===         ==      ===        ==        ===
Floating rate.......................................     281         27      193        73        574
No interest received................................      28          6        1        --         35
                                                         ---         --      ---        --        ---
                                                         309         33      194        73        609
                                                         ===         ==      ===        ==        ===



                                       F-37

                       NOTES TO THE ACCOUNTS (CONTINUED)

E.   CURRENCY EXPOSURES

     The table below shows the extent to which Group companies have monetary
assets and liabilities in currencies other than their local currency.



                                                                          2003
                                                       NET FOREIGN MONETARY ASSETS/(LIABILITIES)
                                                  ----------------------------------------------------
                                                                                     OTHER
                                                  US DOLLAR    STERLING    EURO    CURRENCIES    TOTAL
                                                  ---------    --------    ----    ----------    -----
                                                               (ALL FIGURES IN L MILLIONS

FUNCTIONAL CURRENCY OF ENTITY
US dollar.......................................     --            3        --          6          9
Sterling........................................     20           --         7          6         33
Euro............................................     --           --        --          5          5
Other currencies................................      5           (8)        5         --          2
                                                     --           --        --         --         --
                                                     25           (5)       12         17         49
                                                     ==           ==        ==         ==         ==


                                                                            2002
                                                         NET FOREIGN MONETARY ASSETS/(LIABILITIES)
                                                      ------------------------------------------------
                                                                                      OTHER
                                                      US DOLLAR   STERLING   EURO   CURRENCIES   TOTAL
                                                      ---------   --------   ----   ----------   -----
                                                                (ALL FIGURES IN L MILLIONS)

FUNCTIONAL CURRENCY OF ENTITY
US dollar...........................................     --           2       --         2          4
Sterling............................................     48          --       41         8         97
Euro................................................     --           1       --         6          7
Other currencies....................................      4           4        5        --         13
                                                         --          --       --        --        ---
                                                         52           7       46        16        121
                                                         ==          ==       ==        ==        ===



F.   FAIR VALUES OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

     The table below shows the book value and the fair value of the Group's
financial assets and financial liabilities.



                                                                  2003                      2002
                                                         -----------------------   -----------------------
                                                         BOOK VALUE   FAIR VALUE   BOOK VALUE   FAIR VALUE
                                                         ----------   ----------   ----------   ----------
                                                                     ALL FIGURES IN L MILLIONS

PRIMARY FINANCIAL INSTRUMENTS HELD OR ISSUED TO FINANCE
  THE GROUP'S OPERATIONS
Other financial assets.................................        59           59           34           34
Other financial liabilities............................       (52)         (52)         (64)         (64)
Cash at bank and in hand...............................       309          309          417          417
Short-term deposits....................................       252          252          158          158
Short-term borrowings..................................      (575)        (619)        (249)        (253)
Medium and long-term borrowings........................    (1,347)      (1,553)      (1,734)      (1,877)
                                                           ------       ------       ------       ------
DERIVATIVE FINANCIAL INSTRUMENTS HELD TO MANAGE THE
  INTEREST RATE AND CURRENCY PROFILE
Interest rate swaps....................................        --           (4)          --           26
Currency swaps.........................................        --           26           --           32
Foreign exchange contracts.............................        --           --           --            4
                                                           ------       ------       ------       ------



- ---------------

                                       F-38

                       NOTES TO THE ACCOUNTS (CONTINUED)

NOTE  Other financial assets, other financial liabilities, cash at bank and in
hand and short-term deposits: the fair value approximates to the carrying value
due to the short maturity periods of these financial instruments. Medium and
long-term borrowings: the fair value is based on market values or, where these
are not available, on the quoted market prices of comparable debt issued by
other companies. Interest rate swaps: the fair value of interest rate swaps is
based on market values. At 31 December 2003 the notional principal value of
these swaps was L2,394m (2002: L1,605m). Currency swaps: the fair value of these
contracts is based on market values. At 31 December 2003 the Group had L1,096m
(2002: L758m) of such contracts outstanding.

G.   HEDGES

     The Group's policy on hedges is explained on page F-33. The table below
shows the extent to which the Group has off-balance sheet (unrecognised) gains
and losses in respect of financial instruments used as hedges at the beginning
and end of the year. It also shows the amount of such gains and losses which
have been included in the profit and loss account for the year and those gains
and losses which are expected to be included in next year's or later profit and
loss accounts.



                                                                                           UNRECOGNISED
                                                                                            TOTAL NET
                                                             UNRECOGNISED   UNRECOGNISED      GAINS/
                                                                GAINS          LOSSES        (LOSSES)
                                                             ------------   ------------   ------------
                                                                    (ALL FIGURES IN L MILLIONS)

Gains and losses on hedges at 31 December 2002.............      113            (51)            62
Gains and losses arising in previous years that were
  recognised in 2003.......................................       (9)            --             (9)
                                                                 ---            ---            ---
GAINS AND LOSSES ARISING BEFORE 31 DECEMBER 2002 THAT WERE
  NOT RECOGNISED IN 2003...................................      104            (51)            53
Gains and losses arising in 2003 that were not recognised
  in 2003..................................................      (22)            (9)           (31)
                                                                 ---            ---            ---
UNRECOGNISED GAINS AND LOSSES ON HEDGES AT 31 DECEMBER
  2003.....................................................       82            (60)            22
Of which:
Gains and losses expected to be recognised in 2004.........        4             --              4
                                                                 ---            ---            ---
Gains and losses expected to be recognised in 2005 or
  later....................................................       78            (60)            18
                                                                 ===            ===            ===



                                       F-39

                       NOTES TO THE ACCOUNTS (CONTINUED)

20  OTHER CREDITORS



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

AMOUNTS FALLING DUE WITHIN ONE YEAR
Trade creditors.............................................    407       376
Taxation....................................................     55        24
Social security and other taxes.............................      4        13
Other creditors.............................................     85        83
Accruals and deferred income................................    456       499
Obligations under finance leases............................      3         4
Dividends...................................................    119       115
                                                              -----     -----
                                                              1,129     1,114
                                                              =====     =====
AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR
Other creditors.............................................     34        31
Accruals and deferred income................................      9        26
Obligations under finance leases............................      2         3
                                                              -----     -----
                                                                 45        60
                                                              =====     =====



21  DEFERRED TAXATION



                                                              (ALL FIGURES IN
                                                                L MILLIONS)
                                                              ---------------

SUMMARY OF MOVEMENTS
At 31 December 2002.........................................        174
Exchange differences........................................        (39)
Held by subsidiary acquired.................................        (15)
Transfers...................................................         40
Net release in the year.....................................        (15)
                                                                    ---
AT 31 DECEMBER 2003.........................................        145
                                                                    ===


                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

DEFERRED TAXATION DERIVES FROM
Capital allowances..........................................   (21)      (47)
Tax losses carried forward..................................   168       170
Taxation on unremitted overseas earnings....................    (4)      (16)
Other timing differences....................................     2        67
                                                               ---       ---
                                                               145       174
                                                               ===       ===
DEFERRED TAXATION NOT PROVIDED
Relating to gains subject to roll-over relief...............     1         1
                                                               ===       ===



- ---------------

NOTE  The Group has calculated deferred tax not provided on rolled over gains in
2003, taking into account the indexation allowance which would be deductible on
a disposal of the asset into which the gain was rolled. The recovery of the
deferred tax asset relating to tax losses carried forward is dependent on future
taxable profits arising mainly in the US. The Group regularly reviews its
projections of these future taxable profits to ensure that recoverability of the
asset is still foreseeable.
                                       F-40

                       NOTES TO THE ACCOUNTS (CONTINUED)

22  PROVISIONS FOR LIABILITIES AND CHARGES



                                POST-        DEFERRED                    REORGANIS-
                              RETIREMENT   CONSIDERATION   INTEGRATION     ATIONS     LEASES   OTHER   TOTAL
                              ----------   -------------   -----------   ----------   ------   -----   -----
                                                       (ALL FIGURES IN L MILLIONS)

AT 31 DECEMBER 2001.........     123             25             29           29         19      14      239
Exchange differences........     (11)            (4)            (2)          (2)        (2)     --      (21)
Subsidiaries
  acquired/disposed.........       2             --             --           --         (1)      1        2
Deferred consideration
  arising on acquisitions...      --              3             --           --         --      --        3
Released....................      --             --             --           (3)        (1)     (1)      (5)
Provided....................      59             --              8            9          7       1       84
Utilised....................     (81)           (13)           (18)         (14)        (4)     (7)    (137)
                                 ---            ---            ---          ---         --      --     ----
AT 31 DECEMBER 2002.........      92             11             17           19         18       8      165
Exchange differences........     (13)            --             --           (1)        (1)      1      (14)
Subsidiaries acquired.......       4             --             --           --         --      --        4
Transfers...................      --              1              3           (4)        --      --       --
Deferred consideration
  arising on acquisitions...      --             24             --           --         --      --       24
Released....................      --             --             --           --         (1)     (1)      (2)
Provided....................      62             --             --            8          3       1       74
Utilised....................     (65)            (7)           (11)         (10)        (5)     (1)     (99)
                                 ---            ---            ---          ---         --      --     ----
AT 31 DECEMBER 2003.........      80             29              9           12         14       8      152
                                 ===            ===            ===          ===         ==      ==     ====



- ---------------

NOTE

A   Post-retirement provisions are in respect of pensions, L29m (2002: L36m) and
post-retirement medical benefits, L51m (2002: L56m).

B   Deferred consideration. During the year, additional deferred consideration
of L24m was incurred mainly relating to the acquisition of Lesson Lab.

C   Integration. During the year, L11m of this balance has been utilised,
primarily in relation to properties, severance and IT systems. The remaining
provision should be utilised in the next two years.

D   Reorganisations. L8m has been provided during the year mostly relating to
redundancies at the Financial Times and the relaunch of Les Echos in Berlinois
format. L10m has been utilised, mainly in respect of redundancies.

E   Lease commitments. These relate primarily to onerous lease contracts,
acquired as part of the purchase of subsidiaries, which have various expiry
dates up to 2010. The provision is based on current occupancy estimates.

                                       F-41

                       NOTES TO THE ACCOUNTS (CONTINUED)

23  SHARE CAPITAL



                                                               NUMBER
                                                              OF SHARES
                                                               (000'S)    LM
                                                              ---------   ---

AUTHORISED
Ordinary shares of 25p each
AT 31 DECEMBER 2002.........................................  1,174,000   294
                                                              =========   ===
AT 31 DECEMBER 2003.........................................  1,178,000   295
                                                              =========   ===
CALLED UP, ALLOTTED AND FULLY PAID
AT 31 DECEMBER 2001.........................................    800,589   200
Issued under share option and employee share schemes........      1,073    --
                                                              ---------   ---
AT 31 DECEMBER 2002.........................................    801,662   200
Issued under share option and employee share schemes........        726     1
                                                              ---------   ---
AT 31 DECEMBER 2003.........................................    802,338   201
                                                              =========   ===



- ---------------

NOTE  The consideration received in respect of shares issued during the year was
L5m (2002: L6m).

                                       F-42

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                                           ORIGINAL
                                                                NUMBER                   SUBSCRIPTION
                                                      WHEN     OF SHARES                   EXERCISE
                                                     GRANTED    (000'S)     PRICE (P)       PERIOD
                                                     -------   ---------   -----------   ------------

OPTIONS OUTSTANDING AT 31 DECEMBER 2002
Worldwide Save for Shares plans....................   1995          20             390     2000-03
                                                      1996          60             517     2001-04
                                                      1997         114             530     2000-05
                                                      1998         360             687     2001-06
                                                      1999         544         913-970     2001-07
                                                      2000         217       688-1,793     2001-08
                                                      2001         532       957-1,096     2004-09
                                                      2002       1,466             696     2005-10
                                                                ------
                                                                 3,313
                                                                ======
Discretionary share option plans...................   1994         171         567-635     1997-04
                                                      1995         194         487-606     1998-05
                                                      1996         282         584-654     1999-06
                                                      1997       1,156         677-758     2000-07
                                                      1998       1,781       847-1,090     2001-08
                                                      1999       3,681     1,081-1,922     2002-09
                                                      2000      10,432        64-3,224     2000-10
                                                      2001      14,599       822-1,421     2002-11
                                                                ------
                                                                32,296
                                                                ======
OPTIONS OUTSTANDING AT 31 DECEMBER 2003
Worldwide Save for Shares plans....................   1996           9             517     2003-04
                                                      1997          39             530     2004-05
                                                      1998         319             687     2003-06
                                                      1999         137         913-926     2004-07
                                                      2000         169       688-1,644     2003-08
                                                      2001         350       957-1,096     2004-09
                                                      2002         573             696     2005-10
                                                      2003       2,273         425-426     2006-11
                                                                ------
                                                                 3,869
                                                                ======
Discretionary share option plans...................   1994         148         567-635     1997-04
                                                      1995         154         487-606     1998-05
                                                      1996         248         584-654     1999-06
                                                      1997       1,023         677-758     2000-07
                                                      1998       1,637       847-1,090     2001-08
                                                      1999       3,260     1,081-1,922     2002-09
                                                      2000       8,510        64-3,224     2000-10
                                                      2001      13,437       822-1,421     2002-11
                                                                ------
                                                                28,417
                                                                ======



- ---------------

NOTE  The subscription prices have been rounded up to the nearest whole penny.
The figures include replacement options granted to employees of Dorling
Kindersley and the Family Education Network following their acquisition. The
discretionary share option plans include all options granted under the Pearson
Executive Share Option Plans, the Pearson Reward Plan, the Pearson Special Share
Option Plan and the Pearson Long Term Incentive Plan.

                                       F-43

                       NOTES TO THE ACCOUNTS (CONTINUED)

24  RESERVES



                                                               SHARE      PROFIT
                                                              PREMIUM    AND LOSS
                                                              ACCOUNT    ACCOUNT
                                                              -------    --------
                                                                (ALL FIGURES IN
                                                                  L MILLIONS)

SUMMARY OF MOVEMENTS
At 31 December 2001.........................................   2,459      1,138
Exchange differences net of taxation........................      --       (312)
Premium on issue of equity shares...........................       6         --
Goodwill written back on disposal of an associate...........      --        144
Replacement options granted on acquisition of a
  subsidiary................................................      --          1
Loss retained for the year..................................      --       (298)
                                                               -----      -----
AT 31 DECEMBER 2002.........................................   2,465        673
                                                               =====      =====
ANALYSED AS
Joint ventures and associates...............................                (45)
Group excluding joint ventures and associates...............                718
                                                                          =====
SUMMARY OF MOVEMENTS
At 31 December 2002.........................................   2,465        673
Exchange differences net of taxation........................      --       (254)
Premium on issue of equity shares...........................       4         --
Loss retained for the year..................................      --       (137)
                                                               -----      -----
AT 31 DECEMBER 2003.........................................   2,469        282
                                                               =====      =====
ANALYSED AS
Joint ventures and associates...............................                (60)
Group excluding joint ventures and associates...............                342



- ---------------

NOTE  Cumulative goodwill relating to acquisitions made prior to 1998, which was
deducted from reserves, amounts to L961m (2002: L1,031m). During 2003 Pearson
plc received L5m on the issue of shares in respect of the exercise of options
awarded under various share option plans. Employees paid L5m to the Group for
the issue of these shares. The Group has taken advantage of the exemption
available by UITF 17 and has not incurred a charge on options granted at a
discount to market value for its Inland Revenue approved SAYE schemes and
similar overseas schemes. Included in exchange differences are exchange gains of
L74m (2002: L70m) arising on borrowings denominated in, or swapped into, foreign
currencies designated as hedges of net investments overseas.

                                       F-44

                       NOTES TO THE ACCOUNTS (CONTINUED)

25  ACQUISITIONS

     All acquisitions have been consolidated applying acquisition accounting
principles.

A.   ACQUISITION OF SUBSIDIARIES



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

Tangible fixed assets.......................................     10       --
Associates..................................................     --       (3)
Stocks......................................................     --       (2)
Debtors.....................................................     32        2
Creditors...................................................    (95)      (4)
Provisions..................................................     (4)      (3)
Deferred taxation...........................................    (15)      --
Net cash and short-term deposits acquired...................     34       25
                                                               ----      ---
                                                                (38)      15
Equity minority interests...................................     (8)      (4)
                                                               ----      ---
Net (liabilities)/assets acquired at fair value.............    (46)      11
                                                               ----      ---
FAIR VALUE OF CONSIDERATION
Cash........................................................    (87)     (74)
Deferred cash consideration.................................    (24)      (3)
Net prior year adjustments..................................     --        3
                                                               ----      ---
Total consideration.........................................   (111)     (74)
                                                               ----      ---
GOODWILL ARISING............................................    157       63
                                                               ====      ===


                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

ACQUISITION FAIR VALUES
Book value of net (liabilities)/assets acquired.............   (32)       25
Fair value adjustments......................................   (14)      (14)
                                                               ---       ---
FAIR VALUE TO THE GROUP.....................................   (46)       11
                                                               ===       ===



- ---------------

NOTE  All the fair value adjustments above relate to acquisitions made in 2003.
They include a write-off of certain fixed assets and recognition of a pension
scheme liability. These fair value adjustments are provisional and will be
finalised in the 2004 financial statements.

B.  CASH FLOW FROM ACQUISITIONS



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Cash -- current year acquisitions...........................    87         74           52
Deferred payments for prior year acquisitions and other
  items.....................................................     7         13           76
                                                                --         --          ---
NET CASH OUTFLOW............................................    94         87          128
                                                                ==         ==          ===



                                       F-45

                       NOTES TO THE ACCOUNTS (CONTINUED)

26. DISPOSALS

A.   DISPOSAL OF SUBSIDIARIES



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Intangible fixed assets.....................................      (4)       (41)       (53)
Tangible fixed assets.......................................      (3)        --         (7)
Stocks......................................................      (2)        (3)        (2)
Debtors.....................................................      (9)        (2)       (15)
Creditors...................................................      10         (3)        14
Taxation....................................................      --         --         (5)
Provisions..................................................      --          1          1
Net overdraft/(cash)........................................       1         (1)        --
Equity minority interest....................................      --          3         --
                                                                 ---        ---        ---
Net assets disposed of......................................      (7)       (46)       (67)
Proceeds received...........................................       1         11         49
Deferred consideration......................................       2         --         --
Costs.......................................................      (1)        (7)        (7)
Net prior year adjustments..................................       1         (3)        (1)
                                                                 ---        ---        ---
LOSS ON SALE................................................      (4)       (45)       (26)
Goodwill written back from reserves.........................      --         --        (37)
                                                                 ---        ---        ---
NET LOSS ON SALE............................................      (4)       (45)       (63)
                                                                 ===        ===        ===



B.  CASH FLOW FROM DISPOSALS



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

Cash -- current year disposals..............................       1         11         49
Costs paid..................................................      (2)        (3)        (8)
Deferred receipts and payments from prior year disposals and
  other amounts.............................................      (3)        (5)        --
                                                                 ---        ---        ---
NET CASH (OUTFLOW)/INFLOW...................................      (4)         3         41
                                                                 ===        ===        ===



27  NOTES TO CONSOLIDATED CASH FLOW STATEMENT



                                                                                     2001
                                                                       ---------------------------------
                                                         2003   2002   CONTINUING   DISCONTINUED   TOTAL
                                                         ----   ----   ----------   ------------   -----
                                                                   (ALL FIGURES IN L MILLIONS)

A. RECONCILIATION OF OPERATING PROFIT TO NET CASH
   INFLOW FROM OPERATING ACTIVITIES
Total operating profit.................................  226     143       (49)           2         (47)
Share of operating loss of joint ventures and
  associates...........................................   --      51        69           (2)         67
Depreciation...........................................  111     122       125           --         125
Goodwill amortisation and impairment...................  257     292       350           --         350
(Increase)/decrease in stocks..........................   (8)     43        (6)          --          (6)
Increase in debtors....................................  (96)   (111)      102           --         102
(Decrease)/increase in creditors.......................  (68)     64      (103)          --        (103)
Decrease in operating provisions.......................  (20)    (50)        3           --           3
Other and non-cash items...............................  (43)    (25)       (1)          --          (1)
                                                         ---    ----      ----          ---        ----
NET CASH INFLOW FROM OPERATING ACTIVITIES..............  359     529       490           --         490
                                                         ===    ====      ====          ===        ====



                                       F-46

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                          DEBT DUE   DEBT DUE
                                                             SHORT-TERM    WITHIN     AFTER     FINANCE
                             CASH   OVERDRAFTS   SUB-TOTAL    DEPOSITS    ONE YEAR   ONE YEAR   LEASES    TOTAL
                             ----   ----------   ---------   ----------   --------   --------   -------   ------
                                                         (ALL FIGURES IN L MILLIONS)

B. ANALYSIS OF NET DEBT
AT 31 DECEMBER 2002........   417       (77)        340         158         (172)     (1,734)      (7)    (1,415)
Exchange differences.......     6        31          37           9          (40)        111       --        117
Other non-cash items.......    --        --          --          --         (459)        458       (1)        (2)
Net cash flow..............  (114)       23         (91)         85          119        (182)       3        (66)
                             ----      ----         ---         ---         ----      ------      ---     ------
AT 31 DECEMBER 2003........   309       (23)        286         252         (552)     (1,347)      (5)    (1,366)
                             ====      ====         ===         ===         ====      ======      ===     ======
AT 31 DECEMBER 2001........   300       (60)        240          93         (105)     (2,607)     (14)    (2,393)
Exchange differences.......   (15)        4         (11)         (2)          (6)        150        1        132
Acquired with subsidiary...    --        --          --          24           --          --       --         24
Other non-cash items.......    --        --          --          --         (148)        146        1         (1)
Net cash flow..............   132       (21)        111          43           87         577        5        823
                             ----      ----         ---         ---         ----      ------      ---     ------
AT 31 DECEMBER 2002........   417       (77)        340         158         (172)     (1,734)      (7)    (1,415)
                             ====      ====         ===         ===         ====      ======      ===     ======
AT 31 DECEMBER 2000........   425      (110)        315          91           (2)     (2,705)     (16)    (2,317)
Exchange differences.......   (10)        1          (9)          1           --         (16)      --        (24)
Acquired with subsidiary...    --        --          --          --           --           1       --          1
Other non-cash items.......    --        --          --          --         (100)         99       (5)        (6)
Net cash flow..............  (115)       49         (66)          1           (3)         14        7        (47)
                             ----      ----         ---         ---         ----      ------      ---     ------
AT 31 DECEMBER 2001........   300       (60)        240          93         (105)     (2,607)     (14)    (2,393)
                             ====      ====         ===         ===         ====      ======      ===     ======



- ---------------

NOTE  Finance leases are included within other creditors in the balance sheet
(see note 20).



                                                               2003       2002       2001
                                                              -------    -------    -------
                                                               (ALL FIGURES IN L MILLIONS)

C. RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET DEBT
(Decrease)/increase in cash in the year.....................     (91)       111        (66)
Decrease in net debt from management of liquid resources....      85         43          1
Decrease in net debt from other borrowings..................     (63)       664         11
Decrease in finance leases..................................       3          5          7
Acquired with subsidiary....................................      --         24         --
Debt issue costs............................................      --         --          1
Other non-cash items........................................      (2)        (1)        (6)
Exchange differences........................................     117        132        (24)
                                                              ------     ------     ------
Movement in net debt in the year............................      49        978        (76)
Net debt at beginning of the year...........................  (1,415)    (2,393)    (2,317)
                                                              ------     ------     ------
NET DEBT AT END OF THE YEAR.................................  (1,366)    (1,415)    (2,393)
                                                              ======     ======     ======



28  CONTINGENT LIABILITIES

     There are contingent Group and company liabilities that arise in the normal
course of business in respect of indemnities, warranties and guarantees in
relation to former subsidiaries and in respect of guarantees in relation to
subsidiaries and associates. In addition, there are contingent liabilities of
the Group in respect of legal claims. None of these claims are expected to
result in a material gain or loss to the Group.

                                       F-47

                       NOTES TO THE ACCOUNTS (CONTINUED)

29  COMMITMENTS UNDER LEASES

     At 31 December 2003 the Group had commitments under leases, other than
finance leases, to make payments in 2004 as follows:



                                                              LAND AND
                                                              BUILDINGS    OTHER
                                                              ---------    -----
                                                               (ALL FIGURES IN
                                                                 L MILLIONS)

FOR LEASES EXPIRING
In 2004.....................................................      7          2
Between 2005 and 2008.......................................     28         14
Thereafter..................................................     64          1
                                                                 --         --
                                                                 99         17
                                                                 ==         ==



30  RELATED PARTIES

     JOINT VENTURES AND ASSOCIATES -- Loans and equity advanced to joint
ventures and associates during the year and at the balance sheet date are shown
in notes 13 and 14. Amounts falling due from joint ventures and associates are
set out in note 17. Dividends receivable from joint ventures and associates are
set out in notes 13 and 14.

     There were no other related party transactions in 2003.

31  POST BALANCE SHEET EVENTS

     There were no significant post balance sheet events.

                                       F-48

                       NOTES TO THE ACCOUNTS (CONTINUED)

32  COMPANY BALANCE SHEET AS AT 31 DECEMBER 2003



                                                              NOTE      2003       2002
                                                              -----    -------    -------
                                                              (ALL FIGURES IN L MILLIONS)

FIXED ASSETS
Tangible fixed assets.......................................   33          --         --
Investments: subsidiaries...................................   33       6,343      6,422
Investments: own shares held................................   33          33         39
                                                                       ------     ------
                                                                        6,376      6,461
                                                                       ------     ------
CURRENT ASSETS
Debtors:
Amounts due from subsidiaries -- due within one year........            1,394        971
Amounts due from subsidiaries -- due after more than one
  year......................................................              944      1,453
Taxation....................................................                3         10
Other debtors...............................................               --          1
Cash at bank and in hand....................................   18          75          8
                                                                       ------     ------
                                                                        2,416      2,443
                                                                       ------     ------
CREDITORS -- AMOUNTS FALLING DUE WITHIN ONE YEAR
Short-term borrowing........................................   19        (610)      (323)
Amounts due to subsidiaries.................................           (2,860)    (2,641)
Other creditors.............................................               (1)        (1)
Accruals and deferred income................................              (16)       (13)
Dividends...................................................    8        (119)      (115)
                                                                       ------     ------
                                                                       (3,606)    (3,093)
                                                                       ------     ------
NET CURRENT LIABILITIES.....................................           (1,190)      (650)
                                                                       ------     ------
TOTAL ASSETS LESS CURRENT LIABILITIES.......................            5,186      5,811
                                                                       ------     ------
CREDITORS -- AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR
Medium and long-term borrowing..............................   19      (1,123)    (1,369)
Amounts due to subsidiaries.................................             (234)      (393)
Provisions for liabilities and charges......................               (2)        (2)
                                                                       ------     ------
                                                                       (1,359)    (1,764)
                                                                       ------     ------
NET ASSETS..................................................            3,827      4,047
                                                                       ======     ======
CAPITAL AND RESERVES
Called up share capital.....................................   23         201        200
Share premium account.......................................   33       2,469      2,465
Special reserve.............................................   33         397        397
Other reserves..............................................   33          50         50
Profit and loss account.....................................   33         710        935
                                                                       ------     ------
EQUITY SHAREHOLDERS' FUNDS..................................            3,827      4,047
                                                                       ======     ======



     The financial statements were approved by the board of directors on 27
February 2004 and signed on its behalf by


              Dennis Stevenson,                                Rona Fairhead,
                   Chairman                               Chief Financial Officer



                                       F-49

                       NOTES TO THE ACCOUNTS (CONTINUED)

33  NOTES TO THE COMPANY BALANCE SHEET



                                                               2003      2002
                                                              ------    ------
                                                              (ALL FIGURES IN
                                                                L MILLIONS)

TANGIBLE FIXED ASSETS (LEASEHOLD PROPERTY)
Cost........................................................      1         1
Depreciation................................................     (1)       (1)
                                                               ----      ----
NET BOOK VALUE..............................................     --        --
                                                               ====      ====



- ---------------

NOTE  The company had no capital commitments for fixed assets at the end of
2003.



                                                              (ALL FIGURES IN
                                                                L MILLIONS)

INVESTMENT IN SUBSIDIARIES
AT 31 DECEMBER 2001.........................................       5,384
External acquisition........................................           2
Subscription for additional share capital in subsidiaries...       1,085
Disposal to subsidiary......................................         (16)
Provision for diminution in value...........................         (32)
Revaluations................................................          (1)
                                                                   -----
AT 31 DECEMBER 2002.........................................       6,422
External acquisition........................................          15
Disposal to subsidiary......................................         (22)
Provision for diminution in value...........................         (33)
Revaluations................................................         (39)
                                                                   -----
AT 31 DECEMBER 2003.........................................       6,343
                                                                   =====



- ---------------

NOTE  Shares are stated at cost less provisions for diminution in value or
directors' valuations.

                                       F-50

                       NOTES TO THE ACCOUNTS (CONTINUED)

     OWN SHARES HELD -- Amounts included within own shares held relate to
Pearson plc ordinary shares held in respect of the Pearson plc Employee Share
Ownership Trusts (see note 15).



                                                      SHARE                          PROFIT
                                                     PREMIUM   SPECIAL    OTHER     AND LOSS
                                                     ACCOUNT   RESERVE   RESERVES   ACCOUNT    TOTAL
                                                     -------   -------   --------   --------   -----
                                                               (ALL FIGURES IN L MILLIONS)

RESERVES
SUMMARY OF MOVEMENTS
AT 31 DECEMBER 2001................................   2,459      397        50       1,179     4,085
Exchange differences...............................      --       --        --         (46)      (46)
Premium on issue of equity shares..................       6       --        --          --         6
Loss for the financial year........................      --       --        --         (11)      (11)
Dividends on equity shares.........................      --       --        --        (187)     (187)
                                                      -----      ---        --       -----     -----
AT 31 DECEMBER 2002................................   2,465      397        50         935     3,847
Exchange differences...............................      --       --        --         (23)      (23)
Premium on issue of equity shares..................       4       --        --          --         4
Loss for the financial year........................      --       --        --         (10)      (10)
Dividends on equity shares.........................      --       --        --        (192)     (192)
                                                      -----      ---        --       -----     -----
AT 31 DECEMBER 2003................................   2,469      397        50         710     3,626
                                                      =====      ===        ==       =====     =====



- ---------------

NOTE  The special reserve represents the cumulative effect of cancellation of
the company's share premium account. As permitted by section 230(4) of the
Companies Act 1985, only the Group's profit and loss account has been presented.

34. SUMMARY OF PRINCIPAL DIFFERENCES BETWEEN UNITED KINGDOM AND UNITED STATES OF
    AMERICA GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

     The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United Kingdom
("UK GAAP"), which differ in certain significant respects from generally
accepted accounting principles in the United States of America ("US GAAP"). Such
differences involve methods for measuring the amounts shown in the financial
statements.

     The following is a summary of the adjustments to consolidated profit for
the financial year and consolidated shareholders' funds that would have been
required in applying the significant differences between UK and US GAAP.

                                       F-51

                       NOTES TO THE ACCOUNTS (CONTINUED)

RECONCILIATION OF CONSOLIDATED PROFIT/(LOSS) FOR THE FINANCIAL YEAR



                                                                       YEAR ENDED DECEMBER 31
                                                                       ----------------------
                                                              NOTE     2003    2002     2001
                                                              -----    ----    ----    ------
                                                                        LM      LM       LM

PROFIT/(LOSS) FOR THE FINANCIAL YEAR UNDER UK GAAP..........             55    (111)     (423)
US GAAP adjustments:
  Goodwill amortization and impairment......................     (i)    257     285        (7)
  Intangible amortization...................................     (i)   (104)   (120)     (168)
  Discontinued operations...................................    (ii)     (3)      2    (1,010)
  Disposal adjustments......................................   (iii)     (8)     (2)       (3)
  Pensions and other post-retirement benefits...............    (iv)     (3)      7        14
  Deferred taxation.........................................     (v)    (27)      1         2
  Leases....................................................    (vi)     (2)      3        --
  Options...................................................   (vii)    (30)    (46)      (33)
  Derivatives...............................................  (viii)     35     187       (64)
  Capitalized costs.........................................    (ix)     --       1         1
  Restructuring costs.......................................     (x)     --      --        (3)
  Acquisition adjustments...................................    (xi)     --      (2)       13
  Partnerships and associates...............................   (xii)      5      42        16
  Fixed asset investments...................................   (xiv)     --      --         6
  Interest in shares of Pearson plc.........................    (xv)     --      --        37
  Minority interests........................................   (xvi)     (4)     (7)        4
  Taxation effect of US GAAP adjustments....................     (v)     12     (21)      118
                                                                       ----    ----    ------
Total US GAAP adjustments...................................            128     330    (1,077)
                                                                       ----    ----    ------
PROFIT/(LOSS) FOR THE FINANCIAL YEAR UNDER US GAAP..........            183     219    (1,500)
                                                                       ====    ====    ======
  Cumulative effect of change in accounting principle (less
     (benefit from) applicable taxes L(9)m).................    (iv)     --     (21)       --
                                                                       ----    ----    ------
PROFIT FOR THE FINANCIAL YEAR UNDER US GAAP AFTER CUMULATIVE
  EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE..................            183     198    (1,500)
                                                                       ====    ====    ======
Profit/(loss) from continuing operations (less charge
  for/(benefit from) applicable taxes 2003: L89m, 2002:
  L78m, 2001: L(124)m)......................................            186     257      (475)
(Loss)/profit from discontinued operations prior to the
  measurement date (less charge for/(benefit from)
  applicable taxes 2003: Lnil, 2002: L(2)m, 2001: L(21)m)...             --     (37)      (40)
Loss on disposal of discontinued operations (less charge
  for/(benefit from) applicable taxes 2003: L2m, 2002:
  L(4)m, 2001 L60m).........................................             (3)     (1)     (985)
                                                                       ----    ----    ------
PROFIT/(LOSS) FOR THE FINANCIAL YEAR UNDER US GAAP..........            183     219    (1,500)
                                                                       ====    ====    ======
  Cumulative effect of change in accounting principle (less
     (benefit from) applicable taxes L(9)m).................    (iv)     --     (21)       --
                                                                       ----    ----    ------
PROFIT FOR THE FINANCIAL YEAR UNDER US GAAP AFTER CUMULATIVE
  EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE..................            183     198    (1,500)
                                                                       ====    ====    ======



                                       F-52

                       NOTES TO THE ACCOUNTS (CONTINUED)



                                                                        YEAR ENDED DECEMBER 31
                                                                       ------------------------
                                                              NOTE     2003     2002      2001
                                                              -----    -----    -----    ------

PRESENTATION OF EARNINGS PER EQUITY SHARE UNDER US GAAP.....  (xvii)
Earnings per equity share...................................              (P)      (p)       (p)
Basic:
Continuing operations.......................................            23.4     32.3     (59.7)
Discontinued operations.....................................            (0.4)    (4.8)   (128.9)
Cumulative effect of change in accounting principle.........              --     (2.6)       --
                                                                       -----    -----    ------
Total.......................................................            23.0     24.9    (188.6)
                                                                       =====    =====    ======
Diluted:
Continuing operations.......................................            23.4     32.3     (59.7)
Discontinued operations.....................................            (0.4)    (4.8)   (128.9)
Cumulative effect of change in accounting principle.........              --     (2.6)       --
                                                                       -----    -----    ------
Total.......................................................            23.0     24.9    (188.6)
                                                                       =====    =====    ======
Average shares outstanding (millions).......................           794.4    796.3     795.4
Dilutive effect of stock options (millions).................             0.9      0.4        --
                                                                       -----    -----    ------
Average number of shares outstanding assuming dilution
  (millions)................................................           795.3    796.7     795.4
                                                                       =====    =====    ======



     In 2001 the Group recorded a loss for the financial year. Consequently the
effect of share options is anti-dilutive and has been excluded from the
calculation of diluted loss per share. Anti-dilutive options in 2001 were 7.8
million.

                                       F-53

                       NOTES TO THE ACCOUNTS (CONTINUED)

RECONCILIATION OF CONSOLIDATED SHAREHOLDERS' FUNDS



                                                                         YEAR ENDED
                                                                        DECEMBER 31
                                                                       --------------
                                                              NOTE     2003     2002
                                                              -----    -----    -----
                                                                        LM       LM

SHAREHOLDERS' FUNDS UNDER UK GAAP...........................           2,952    3,338
US GAAP adjustments:
  Goodwill..................................................     (i)     354      222
  Intangibles...............................................     (i)     410      508
  Discontinued operations...................................    (ii)      --        3
  Disposal adjustments......................................   (iii)      (4)       2
  Pensions and other post-retirement benefits...............    (iv)    (304)    (295)
  Deferred taxation.........................................     (v)      29       58
  Leases....................................................    (vi)      (5)      (3)
  Options...................................................   (vii)      32       30
  Derivatives...............................................  (viii)      21       57
  Capitalized costs.........................................    (ix)      --       --
  Restructuring costs.......................................     (x)      --       --
  Acquisition adjustments...................................    (xi)      25        1
  Partnerships and associates...............................   (xii)      (5)      (8)
  Ordinary dividends........................................  (xiii)     119      115
  Fixed asset investments...................................   (xiv)     (18)     (19)
  Interest in shares of Pearson plc.........................    (xv)     (69)     (71)
  Minority interests........................................   (xvi)     (22)     (20)
  Taxation effect of US GAAP adjustments....................     (v)    (163)    (210)
                                                                       -----    -----
Total US GAAP adjustments...................................             400      370
                                                                       -----    -----
SHAREHOLDERS' FUNDS UNDER US GAAP...........................           3,352    3,708
                                                                       =====    =====



     A summary of the principal differences and additional disclosures
applicable to the Group are set out below:

(I)  GOODWILL AND INTANGIBLES

     Both UK GAAP and US GAAP require purchase consideration to be allocated to
the net assets acquired at their fair value on the date of acquisition, with the
difference between the consideration and the fair value of the identifiable net
assets recorded as goodwill. Under UK GAAP, prior to the implementation of FRS
10 "Goodwill and Intangible Assets", for periods ending prior to January 1,
1998, the Group has written off goodwill directly to the profit and loss reserve
in the year of acquisition. If a subsidiary or a business is subsequently sold
or closed, previously written off goodwill which was the result of the initial
acquisition is taken into account in determining the profit or loss on sale or
closure.

     For the purposes of US GAAP, all goodwill written off against reserves
under UK GAAP has been reinstated as an asset on the balance sheet. Prior to
July 1, 2001, goodwill was amortized over its estimated useful life. In July
2001, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standard ("SFAS") 142, "Goodwill and Other Intangible
Assets" which required that goodwill no longer be amortized. Additionally, under
US GAAP, all goodwill arising on acquisitions prior to June 30, 2001 was
capitalized and amortized over a period not to exceed 20 years. The group also
adopted the provisions of SFAS 142, "Goodwill and Other Intangible Assets", on
January 1, 2002. As a result, all goodwill is no longer subject to amortization
subsequent to the date of adoption, but is subject to the impairment testing
provisions of SFAS 142. The 2003 and 2002 US GAAP adjustments reverse the
amortization expense recorded under UK GAAP.

                                       F-54

                       NOTES TO THE ACCOUNTS (CONTINUED)

     Under UK GAAP, the Group periodically reviews the recoverability of
goodwill, not identified with impaired long-lived assets, based on estimated
discounted future cash flows from operating activities compared with the
carrying value of goodwill and recognizes any impairment on the basis of such
comparison. Under US GAAP, the Group performed the transitional impairment test
under SFAS 142 as of January 1, 2002 by comparing the carrying value of each
reporting unit to its fair value as determined by discounted future cash flows.
The Group has also completed the subsequent annual impairment tests required by
SFAS 142.

     Under UK GAAP in order to recognize an intangible asset, the Group must be
able to dispose of it without disposing of the business to which it relates.
Accordingly under UK GAAP no acquired intangible assets have been recognized.
Under US GAAP, acquired assets such as publishing rights, know-how, patents and
advertising relationships have been recognized as intangible assets as required
under SFAS 142 and are being amortized over a range of estimated useful lives of
between 2 and 25 years. The identified intangibles have been valued based on
independent appraisals and management evaluation and analysis.

(II)  DISCONTINUED OPERATIONS

     Following the further deterioration in the corporate training market during
2002, management undertook a review of the FT Knowledge business. As a result of
this review, in September 2002 the Board of Directors approved a plan to dispose
of Forum and restructure the remaining parts of FT Knowledge. The sale of Forum
to the Institute for International Research Support Services Inc ("IRR") was
completed in January 2003. In accordance with the provisions of SFAS 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" the results of
the Forum Corporation have been reclassified as a discontinued operation.

     In connection with the decision to dispose of Forum in 2002, a loss on
disposal was booked under US GAAP reflecting the excess of the carrying value of
the investment over the disposal proceeds. The goodwill associated with the
Forum business was deemed to be impaired under US GAAP prior to the sale of the
business. The GAAP difference on the loss on sale reflects the difference in the
carrying value of goodwill at the disposal date and provisions for future
operating losses being removed from the disposal calculation under US GAAP.

     In early December 2001, the Board of Directors approved a plan to dispose
of the Group's investment in RTL. On December 24, 2001, the Group announced the
agreed sale of its 22% interest in RTL to Bertlesmann AG for cash consideration
of E1.5 billion. In accordance with the provisions of Accounting Principles
Board ("APB") 30, "Reporting the Results of Operations, Reporting the effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions", the results of operations of RTL have been
reclassified as a discontinued operation.

     In 2001, in connection with the disposal of the RTL investment, L985m was
accrued as a loss on disposal reflecting the excess of the carrying value of the
investment of L1,967m over the E1.5 billion proceeds to be received. Also
included in the loss on disposal is the Group's share of the results of RTL
(including goodwill amortization) from the measurement date to the actual
disposal date of January 30, 2002 of approximately L30m.

     Summary financial information for RTL, for the year ended December 31, 2001
is presented in the table below:



                                                                 2001
                                                                ------
                                                                  LM

Net revenues................................................     2,093
Loss from operations........................................    (4,528)
Net loss....................................................    (4,625)



                                       F-55

                       NOTES TO THE ACCOUNTS (CONTINUED)

(III)  DISPOSAL ADJUSTMENTS

     In 2003, 2002 and 2001 gains and losses were recognized under UK GAAP on
the disposal of a number of the Group's businesses and assets. Adjustments made
to reconcile US GAAP and UK GAAP have an effect on the net assets of these
businesses and, accordingly, a corresponding impact on the gain or loss on
disposal.

     To the extent that goodwill previously written off under UK GAAP was
brought to account in the disposal calculation and, under US GAAP, a portion of
that goodwill was previously amortized, the carrying value of the goodwill being
disposed of will be lower on a US GAAP basis giving rise to either additional
profit on disposal or a decrease in the loss on disposal under US GAAP.
Additionally, under US GAAP, it is necessary to factor into the disposal
calculation any cumulative translation adjustment associated with the business,
whereas under UK GAAP this is not required.

     Differences can arise on the treatment of property disposals and sale and
leaseback transactions. The timing of recognition of profits or losses on these
transactions can differ between UK GAAP and US GAAP, as prescribed by SFAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."

(IV)  PENSIONS AND OTHER POST-RETIREMENT BENEFITS

     The Group operates defined benefit pension plans for its employees and
former employees throughout the world. The largest defined benefit scheme is a
funded scheme operated in the UK.

     Under UK GAAP the cost of providing pension benefits is expensed over the
average expected service lives of eligible employees in accordance with the
provisions of Statement of Standard Accounting Practice ("SSAP") 24 "Accounting
for Pension Costs". SSAP 24 aims to produce an estimate of cost based on
long-term actuarial assumptions. Variations from the regular pension cost
arising from, for example, experience deficiencies or surpluses, are charged or
credited to the profit and loss account over the expected average remaining
service lives of current employees in the schemes.

     Under US GAAP, the annual pension cost comprises the estimated cost of
benefits accruing in the period as determined in accordance with SFAS 87
"Employers Accounting for Pensions", which requires readjustment of the
significant actuarial assumptions annually to reflect current market and
economic conditions. Therefore, different assumptions are used in the SFAS 87
calculation of pensions. Under SFAS 87, part of the surplus (the excess of plan
assets over plan liabilities), the majority of which for the Group is
attributable to prior acquisitions, has been recognized in the balance sheet.
The remainder of the unrecognized surplus is spread over the employees'
remaining service lifetimes. Additionally, under US GAAP, where an accumulated
benefit obligation exists in excess of plan assets and a prepaid pension asset
has been recognized, an additional minimum pension liability has been booked as
a reduction to equity. Under UK GAAP, there is no requirement to recognize a
minimum pension liability in respect of the unfunded accumulated benefit
obligation.

     In 2002, the Group elected to change the measurement date of its defined
benefit plans under US GAAP from 30 September to 31 December. As a result the
2002 profit and loss charge under US GAAP for pension plans includes a pre-tax
charge of L30 million reflecting the cumulative effect of this change in
accounting principle.

     Additionally, the Pearson Inc. Pension Equity Plan (one of the US defined
benefit plans) was suspended as at December 31, 2001 and employees no longer
earn additional defined benefits for future services. In accordance with SFAS
88, "Employer's Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits", the Group recognized a curtailment
gain in 2001 reflecting the reduction in the projected benefit obligation as
credits, and final average compensation under the pension formula were frozen as
of December 31, 2001. Under UK GAAP this gain is being spread over the expected
remaining service lives of the employees in the scheme as of January 1, 2002.

                                       F-56

                       NOTES TO THE ACCOUNTS (CONTINUED)

(V)  DEFERRED TAXATION

     Financial Reporting Standard ("FRS") 19, the UK standard on deferred tax,
was adopted for the first time in 2002. The Group previously provided deferred
tax using the liability method under SSAP ("Statement of Standard Accounting
Practice") 15 and only recognized deferred tax liabilities to the extent that it
was probable that the liabilities would crystallize. Deferred tax assets were
only recognized to the extent that their recoverability was assured beyond
reasonable doubt. Under FRS 19 the recognition criteria for deferred tax assets
changed resulting in the recognition of a deferred tax asset under UK GAAP in
respect of US tax losses and other timing differences that are regarded as
recoverable against future profits. The adoption of FRS 19 also had an impact on
capitalized goodwill since the restatement of deferred tax balances acquired had
a corresponding effect upon the goodwill recognized on those acquisitions. A
prior year adjustment was made in the 2002 financial statements to reflect the
adoption of FRS 19 and comparative figures were restated.

     Under UK GAAP, a provision is recorded for deferred taxation under the
liability method, at the expected applicable rates, to the extent that such
taxation is expected to crystallize within the foreseeable future. This means
that the full potential liability is not necessarily provided. Additionally,
deferred tax assets are recognized only when they are expected to be recoverable
within the foreseeable future.

     Under US GAAP, deferred taxation is provided for on a full liability basis.
Under the full liability method, deferred tax assets or liabilities are
recognized for differences between the financial and taxation basis of assets
and liabilities and for tax loss carry forwards at the statutory rate at each
reporting date. A valuation allowance is established when it is more likely than
not that some portion or all of the deferred taxation assets will not be
realized. The reconciling items in 2003, 2002 and 2001 reflect the impact of
recording the full provision and deferred tax assets, net of valuation
allowance. The reconciling item in 2003 also incorporates the effect of a change
in estimate in respect of deferred tax assets relating to a purchase business
combination in prior years, which was recorded through the profit and loss
account under UK GAAP, but which was required to be adjusted against goodwill
under US GAAP.

     The recognized deferred tax asset is based upon the expected future
utilization of tax loss carryforwards and the reversal of other temporary
differences. For financial reporting purposes, the Group has recognized a
valuation allowance for those benefits for which realization does not meet the
more likely than not criteria.

     The valuation allowance has been recognized in respect of the tax loss
carryforwards. The Group continually reviews the adequacy of the valuation
allowance and is recognizing these benefits only as reassessment indicates that
it is more likely than not that the benefits will be realized.

(VI)  LEASES

     UK GAAP defines a finance (capital) lease as one that transfers
substantially all risks and rewards of ownership of an asset to the lessee. US
GAAP sets out certain defined criteria, and if any one of the criteria are met,
the lease must be treated as a capital lease. Accordingly, the Group has certain
leases for which the classification is operating under UK GAAP and finance
(capital) under US GAAP. Adjustments also arise due to the timing of recognition
of lease related costs being different under UK and US GAAP.

(VII)  OPTIONS

     Under UK GAAP, the Group does not recognize compensation costs under share
option schemes that have not been approved by the Inland Revenue unless the
exercise price is at a discount to the open market value at date of grant.

     Under US GAAP, the compensation expense associated with all stock-based
awards is recognized in accordance with SFAS 123, "Accounting For Stock-Based
Compensation". Under SFAS 123, compensation expense is determined based upon the
fair value at the grant date for awards, and has been estimated using the Black
Scholes model. Such compensation cost is recognized over the service life of the
awards. Under US

                                       F-57

                       NOTES TO THE ACCOUNTS (CONTINUED)

GAAP, the total compensation charge for stock-based compensation schemes was
L33m in 2003, L53m in 2002 and L42m in 2001.

     Under UK GAAP, UITF 25, "National Insurance Contributions on share option
gains", requires that a provision be made for the employer's share of the
National Insurance Contributions ("NIC") on outstanding share options that are
expected to be exercised. Under US GAAP, EITF 00-16, "Recognition and
Measurement of Employer Payroll Taxes on Employee Stock-Based Compensation",
requires that the NIC liability on employee stock compensation be recognized on
the date of the event triggering the measurement and payment of tax, which is
deemed to be the exercise date.

     Under UK GAAP, compensation cost is charged to the income statement with
the offsetting amount recorded as either a reduction of the own shares held as
an asset on the balance sheet or a liability that is transferred to
shareholders' funds upon exercise or expiration of the option. Under US GAAP,
compensation cost is charged to the income statement with the offsetting amount
recorded directly to shareholders' funds. Accordingly, as part of the
reconciliation from UK to US GAAP, the amount credited to a liability account
under UK GAAP has been transferred to shareholders' funds.

(VIII)  DERIVATIVES

     Under UK GAAP, the Group's derivatives are recorded as hedging instruments.
Amounts payable or receivable in respect of interest rate swaps are accrued with
net interest payable over the period of the contract. Unrealized gains and
losses on currency swaps and forward currency contracts are deferred and
recognized when paid.

     Under US GAAP, the Group is required to record all derivative instruments on the balance sheet at fair value. Derivatives not classified as hedges are adjusted to fair value through earnings. Changes in fair value of the derivatives that the Group has designated and that qualify as effective hedges are recorded in either other comprehensive income or earnings. Any ineffective portion of derivatives that are classified as hedges is immediately recognized in earnings.
      In 2003, as in 20022006 and 2001,2005 the Group did not meetmet the prescribed designation requirements and hedge effectiveness tests under US GAAP for some of its derivative contracts,contracts. As a result, the movements in the fair value of the effective portion of fair value hedges and net investment hedges have been offset in earnings and other comprehensive income respectively by the corresponding movement in the fair value of the underlying hedged item.
66
      In line with the Group’s treasury policy, none of these instruments were considered trading instruments and each instrument was transacted solely to match an underlying financial exposure.
Quantitative information about market risk
      The sensitivity of the Group’s derivative portfolio to changes in interest rates is found in note 16 to the financial statements.
ITEM 12.     DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
      Not applicable.
PART II
ITEM 13.     DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
      None.
ITEM 14.     MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
      None.
ITEM 15.     CONTROLS AND PROCEDURES
Disclosure controls and procedures
      An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2006 was carried out by us under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation the Chief Executive Officer and Chief Financial Officer concluded that Pearson’s disclosure controls and procedures have been designed to provide, and are effective in providing, reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow such timely decision regarding required disclosures. A controls system, no matter how well designed and operated cannot provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected, and that such information is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow such timely decisions regarding required disclosure.
Management’s annual report on internal control over financial reporting
      The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS, including the reconciliations required under US GAAP.
      Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
      Management has assessed the effectiveness of internal control over financial reporting, as at December 31, 2006, and has concluded that such internal control over financial reporting was effective.
67
      PricewaterhouseCoopers LLP, which has audited the consolidated financial statements of the Company for the year ended December 31, 2006, has also audited management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of the Company’s internal control over financial reporting under Auditing Standard No. 2 of the Public Company Accounting Oversight Board (United States). Their audit report is included under “Item 17. Financial Statements” page F-2.
Change in internal control over financial reporting
      During the period covered by this Annual Report on Form 20-F, Pearson has made no changes to its internal control over financial reporting that have materially affected or are reasonably likely to materially affect Pearson’s internal control over financial reporting.
ITEM 16A.     AUDIT COMMITTEE FINANCIAL EXPERT
      The members of the Board of Directors of Pearson plc have determined that Vernon Sankey was an audit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission for the period until April 21, 2006. The members of the Board of Directors of Pearson plc have determined that Ken Hydon is an audit committee financial expert, for subsequent periods.
ITEM 16B.     CODE OF ETHICS
      Pearson has adopted a code of ethics (the Pearson code of business conduct) which applies to all employees including the Chief Executive Officer and Chief Financial Officer and other senior financial management. This code of ethics is available on our website (www.pearson.com/investor/corpgov.htm). The information on our website is not incorporated by reference into this report.
ITEM 16C.     PRINCIPAL ACCOUNTANT FEES AND SERVICES
      In 2003, the audit committee adopted a revised policy for external auditor services. The policy requires all audit engagements undertaken by our external auditors, PricewaterhouseCoopers LLP, to be approved by the audit committee. The policy permits the auditors to be engaged for other services provided the engagement is specifically approved in advance by the committee or alternatively meets the detailed criteria of specific pre-approved services and is notified to the committee.
      The Group Chief Financial Officer can procure pre-approved services, as defined in the audit committee’s policy for auditor services, of up to an amount of £100,000 per engagement, subject to a cumulative limit of £500,000 per year. The limit of £100,000 will be subject to annual review by the audit committee. Where pre-approval has not been granted for a service or where the amount is above these limits, specific case by case approval must be obtained from the audit committee prior to the engagement of our auditor.
         
Auditors’ Remuneration 2006 2005
     
  £m £m
Audit fees  5   4 
Audit-related fees  4   — 
Tax fees  1   1 
All other fees  1   2 
68
ITEM 16D.     EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
      Not applicable.
ITEM 16E.     PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASES
Maximum
number
Total number ofof shares that
units purchasedmay yet be
as part of publiclypurchased under
Total number ofAverage priceannounced plansthe plans or
Periodshares purchasedpaid per shareor programsprograms
March 1, 2006 - March 31, 2006900,000£ 7.40N/AN/A
May 1, 2006 - May 31, 2006900,000£ 7.67N/AN/A
August 1, 2006 - August 31, 2006900,000£ 7.43N/AN/A
December 1, 2006 - December 31, 20062,000,000£ 7.73N/AN/A
      Purchases of shares were made to satisfy obligations under Pearson employee share award programs. All purchases were made in open-market transactions. None of the foregoing share purchases was made as part of a publicly announced plan or program.
PART III
ITEM 17.     FINANCIAL STATEMENTS
      The financial statements filed as part of this Annual Report are included on pages F-1 through F-79 hereof.
ITEM 18.     FINANCIAL STATEMENTS
      We have elected to respond to Item 17.
ITEM 19.     EXHIBITS
1.1Memorandum and Articles of Association of Pearson plc.†
2.1Indenture dated June 23, 2003 between Pearson plc and The Bank of New York, as trustee.†
2.2Indenture dated May 25, 2004 among Pearson Dollar Finance plc, as Issuer, Pearson plc, Guarantor, and the Bank of New York, as Trustee, Paying Agent and Calculation Agent.#
4.1Letter Agreement dated January 28, 2005 between Pearson plc and Peter Jovanovich.#
8.1List of Significant Subsidiaries.
12.1Certification of Chief Executive Officer.
12.2Certification of Chief Financial Officer.
13.1Certification of Chief Executive Officer.
13.2Certification of Chief Financial Officer.
15Consent of PricewaterhouseCoopers LLP.
†  Incorporated by reference from the Form 20-F of Pearson plc for the year ended December 31, 2003 and filed May 7, 2004.
# Incorporated by reference from the Form 20-F of Pearson plc for the year ended December 31, 2004 and filed June 27, 2005.
69
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting FirmF-2
Consolidated Income Statement for the year ended December 31, 2006, 2005 and 2004F-4
Statement of Recognized Income and Expense for the year ended December 31, 2006, 2005 and 2004F-5
Consolidated Balance Sheet as at December 31, 2006 and 2005F-5
Consolidated Cash Flow Statement for the year ended December 31, 2006, 2005 and 2004F-7
Notes to the Consolidated Financial StaetmentsF-8
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Pearson plc
      We have completed an integrated audit of Pearson plc’s December 31, 2006 consolidated financial statements and of its internal control over financial reporting as of December 31, 2006 and an audit of its December 31, 2005 and December 31, 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
      In our opinion, the accompanying consolidated income statements and the related consolidated balance sheets, consolidated statements of cash flows and, consolidated statements of recognised income and expense present fairly, in all material respects, the financial position of Pearson plc and its subsidiaries (the “Group”) at December 31, 2006 and 2005 and the results of their operations and cash flows for each of the three years in the period ended December 31, 2006, in conformity with International Financial Reporting Standards (IFRSs) as adopted by the European Union. These financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.
      As discussed in Note 1, the Group adopted International Accounting Standard (IAS) 32 “Financial Instruments: Disclosure and Presentation”, and IAS 39 “Financial Instruments: Recognition and Measurement”, prospectively from 1 January 2005. As discussed in Note 31 to the consolidated financial statements, during the year ended December 31, 2006, the Group reclassified investment in pre-publication assets from cash used in investing activities to cash generated from operations.
      IFRSs as adopted by the European Union vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 36 to the consolidated financial statements.
Internal control over financial reporting
      Also, in our opinion, management’s assessment, included in Managements’ annual report on internal control over financial reporting as set out in “Item 15. Controls and Procedures”, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Group’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Group’s internal control over financial reporting based on our audit.
      We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment,
F-2
testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting standards and principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting standards and principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
London
United Kingdom
April 30, 2007
F-3
CONSOLIDATED INCOME STATEMENT
YEAR ENDED 31 DECEMBER 2006
(All figures in £ millions)
                 
  Notes 2006 2005 2004
         
Continuing operations
                
Sales  2   4,137   3,808   3,479 
Cost of goods sold  5   (1,917)  (1,787)  (1,631)
             
Gross profit
      2,220   2,021   1,848 
Operating expenses  5   (1,704)  (1,559)  (1,483)
Other net gains and losses  4   —   40   9 
Share of results of joint ventures and associates  13   24   14   8 
             
Operating profit
  2   540   516   382 
Finance costs  7   (133)  (132)  (96)
Finance income  7   59   62   17 
             
Profit before tax
      466   446   303 
Income tax  8   (11)  (116)  (55)
             
Profit for the year from continuing operations
      455   330   248 
Profit for the year from discontinued operations  3   14   314   36 
             
Profit for the year
      469   644   284 
             
Attributable to:
                
Equity holders of the Company      446   624   262 
Minority interest      23   20   22 
             
Earnings per share for profit from continuing and discontinued operations attributable to the equity holders of the Company during the year
(expressed in pence per share)
                
— basic  9   55.9p   78.2p   32.9p 
— diluted  9   55.8p   78.1p   32.9p 
             
Earnings per share for profit from continuing operations attributable to the equity holders of the Company during the year(expressed in pence per share)
                
— basic  9   54.1p   38.9p   29.0p 
— diluted  9   54.0p   38.8p   29.0p 
             
F-4
CONSOLIDATED STATEMENT OF RECOGNISED INCOME AND EXPENSE
YEAR ENDED 31 DECEMBER 2006
(All figures in £ millions)
                 
  Notes 2006 2005 2004
         
Net exchange differences on translation of foreign operations  27   (417)  327   (203)
Actuarial gains/(losses) on defined benefit pension and post-retirement medical plans  24   107   26   (61)
Taxation on items charged to equity  8   12   12   9 
             
Net (expense)/income recognised directly in equity
      (298)  365   (255)
Profit for the year      469   644   284 
             
Total recognised income and expense for the year
      171   1,009   29 
             
Attributable to:
                
Equity holders of the Company      148   989   7 
Minority interest      23   20   22 
             
Effect of transition adjustment on adoption of IAS 39
                
Attributable to:                
Equity holders of the Company      —   (12)  — 
             
CONSOLIDATED BALANCE SHEET
AS AT 31 DECEMBER 2006
(All figures in £ millions)
             
  Notes 2006 2005
       
Assets
            
Non-current assets            
Property, plant and equipment  11   348   384 
Intangible assets  12   3,581   3,854 
Investments in joint ventures and associates  13   20   36 
Deferred income tax assets  14   417   385 
Financial assets — Derivative financial instruments  16   36   79 
Other financial assets  15   17   18 
Other receivables  19   124   108 
          
       4,543   4,864 
Current assets
            
Intangible assets — Pre-publication  17   402   426 
Inventories  18   354   373 
Trade and other receivables  19   953   1,031 
Financial assets — Derivative financial instruments  16   50   4 
Financial assets — Marketable securities      25   — 
Cash and cash equivalents (excluding overdrafts)  20   592   902 
          
       2,376   2,736 
Non-current assets classified as held for sale  29   294   — 
          
       2,670   2,736 
          
Total assets
      7,213   7,600 
          
F-5
CONSOLIDATED BALANCE SHEET (CONTINUED)
AS AT 31 DECEMBER 2006
(All figures in £ millions)
             
  Notes 2006 2005
       
Liabilities
            
Non-current liabilities            
Financial liabilities—Borrowings  21   (1,148)  (1,703)
Financial liabilities—Derivative financial instruments  16   (19)  (22)
Deferred income tax liabilities  14   (245)  (204)
Retirement benefit obligations  24   (250)  (389)
Provisions for other liabilities and charges  22   (29)  (31)
Other liabilities  23   (162)  (151)
          
       (1,853)  (2,500)
Current liabilities
            
Trade and other liabilities  23   (998)  (974)
Financial liabilities—Borrowings  21   (595)  (256)
Current income tax liabilities      (74)  (104)
Provisions for other liabilities and charges  22   (23)  (33)
          
       (1,690)  (1,367)
Liabilities directly associated with non-current assets classified as held for sale  29   (26)  — 
          
Total liabilities
      (3,569)  (3,867)
          
Net assets
      3,644   3,733 
          
Equity
            
Share capital  25   202   201 
Share premium  25   2,487   2,477 
Treasury shares  26   (189)  (153)
Other reserves  27   (592)  (175)
Retained earnings  27   1,568   1,214 
          
Total equity attributable to equity holders of the Company
      3,476   3,564 
Minority interest      168   169 
Total equity
      3,644   3,733 
          
These financial statements have been approved for issue by the board of directors on 9 March 2007 and signed on its behalf by
Robin Freestone, Chief financial officer
F-6
CONSOLIDATED CASH FLOW STATEMENT
YEAR ENDED 31 DECEMBER 2006
(All figures in £ millions)
                 
  Notes 2006 2005 2004
         
Cash flows from operating activities
                
Cash generated from operations  31   621   653   524 
Interest paid      (106)  (101)  (98)
Tax paid      (59)  (65)  (45)
             
Net cash generated from operating activities
      456   487   381 
             
Cash flows from investing activities
                
Acquisition of subsidiaries, net of cash acquired  28   (363)  (246)  (41)
Acquisition of joint ventures and associates      (4)  (7)  (10)
Purchase of property, plant and equipment (PPE)      (68)  (76)  (101)
Proceeds from sale of PPE      8   3   4 
Purchase of intangible assets      (29)  (24)  (24)
Purchase of other financial assets      —   (2)  (1)
Disposal of subsidiaries, net of cash disposed  30   10   376   7 
Disposal of joint ventures and associates      —   54   24 
Disposal of other financial assets      —   —   17 
Interest received      24   29   13 
Dividends received from joint ventures and associates      45   14   12 
             
Net cash (used in)/generated from investing activities
      (377)  121   (100)
             
Cash flows from financing activities
                
Proceeds from issue of ordinary shares  25   11   4   4 
Purchase of treasury shares  26   (36)  (21)  (10)
Proceeds from borrowings      84   —   473 
Short-term investments required      —   —   (5)
Liquid resources acquired      (24)  —   — 
Repayments of borrowings      (145)  (79)  (524)
Finance lease principal payments      (3)  (3)  (2)
Dividends paid to Company’s shareholders  10   (220)  (205)  (195)
Dividends paid to minority interests      (15)  (17)  (2)
             
Net cash used in financing activities
      (348)  (321)  (261)
Effects of exchange rate changes on cash and cash equivalents      (44)  13   (4)
             
Net (decrease)/increase in cash and cash equivalents
      (313)  300   16 
             
Cash and cash equivalents at beginning of year      844   544   528 
             
Cash and cash equivalents at end of year
  20   531   844   544 
             
F-7
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
General information
      Pearson plc (the Company) and its subsidiaries (together the Group)are involved in the provision of information for the educational sector, consumer publishing and business information.
      The Company is a limited liability company incorporated and domiciled in England. The address of its registered office is 80 Strand, London WC2R 0RL.
      The Company has its primary listing on the London Stock Exchange but is also listed on the New York Stock Exchange.
      These consolidated financial statements were approved for issue by the board of directors on 9 March 2007.
1Accounting policies
      The principal accounting policies applied in the preparation of these consolidated financial statements are set out below.
a.     Basis of preparation
      These consolidated financial statements have been prepared in accordance with EU-adopted International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee (IFRIC) interpretations and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS. The Group transitioned from UK GAAP to IFRS on 1 January 2003.
      These consolidated financial statements have been prepared under the historical cost convention as modified by the revaluation of financial assets and liabilities (including derivative instruments) at fair value.
(1) Interpretations and amendments to published standards effective in 2006 — The following amendments and interpretations to standards are mandatory for the Group’s accounting periods beginning on or after 1 January 2006:
• IAS 21 ‘The Effects of Changes in Foreign Currency’;
• IAS 39 (Amendment) ‘Cash Flow Hedge Accounting of Forecast Intragroup Transactions’;
• IAS 39 (Amendment) ‘The Fair Value Option’;
• IAS 39 and IFRS 4 (Amendment) ‘Financial Guarantee Contracts’;
• IFRS 6 ‘Exploration for and Evaluation of Mineral Resources’;
• IFRIC 4 ‘Determining whether an Arrangement contains a Lease’;
• IFRIC 5 ‘Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds’;
• IFRIC 6 ‘Liabilities arising from Participating in a Specific Market — Waste Electrical and Electronic Equipment’.
      Management assessed the relevance of these amendments and interpretations with respect to the Group’s operations and concluded that they are not relevant or material to the Group.
(2) Standards, interpretations and amendments to published standards that are not yet effective —Certain new standards, amendments and interpretations to existing standards have been published that are
F-8
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
mandatory for the Group’s accounting periods beginning on or after 1 January 2007 or later periods. The Group has not early adopted any of the new pronouncements which are as follows:
• IFRS 7 ‘Financial Instruments: Disclosures’ (effective from 1 January 2007). IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specific minimum disclosures about credit risk, liquidity risk and market risk.
• A complementary amendment to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’(effective from 1 January 2007). The amendment to IAS 1 introduces disclosures about the level and the management of the capital of an entity.
• IFRS 8 ‘Operating Segments’ (effective 1 January 2009). IFRS 8 requires an entity to adopt the ‘management approach’ to reporting on the financial performance of its operating segments, revise explanations of the basis on which the segment information is prepared and provide reconciliations to the amounts recognised in the income statement and balance sheet.
• Management is currently assessing the impact of IFRS 7, IFRS 8 and the complementary amendment to IAS 1 on the Group’s financial statements.
      In addition, management has assessed the relevance of the following amendments and interpretations with respect to the Group’s operations:
• IFRIC 8 ‘Scope of IFRS 2’ (effective for annual periods beginning on or after 1 May 2006). IFRIC 8 requires consideration of transactions involving the issuance of equity instruments — where the identifiable consideration received is less than the fair value of the equity instruments issued — to establish whether or not they fall within the scope of IFRS 2. The Group will apply IFRIC 8 from 1 January 2007, but it is not expected to have any impact on the Group’s accounts;
• IFRIC 10 ‘Interim Financial Reporting and Impairment’ (effective for annual periods beginning on or after 1 November 2006). IFRIC 10 prohibits impairment losses recognised in an interim period on goodwill, investments in equity instruments and investments in financial assets carried at cost to be reversed at a subsequent balance sheet date. The Group will apply IFRIC 10 from 1 January 2007;
• IFRIC 7 ‘Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies’(effective for annual reporting periods beginning on or after 1 March 2006). IFRIC 7 provides guidance on how to apply the requirements of IAS 29 in a reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency, when the economy was not hyperinflationary in the prior period. As none of the Group entities have a currency of a hyperinflationary economy as their functional currency, IFRIC 7 is not relevant to the Group’s operations; and
• IFRIC 9 ‘Reassessment of Embedded Derivatives’ (effective for annual periods beginning on or after 1 June 2006). IFRIC 9 requires an entity to assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative when the entity first becomes a party to the contract. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case reassessment is required. The Group does not expect IFRIC 9 to have a material impact.
(3) Critical accounting assumptions and judgements —The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting assumptions. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas requiring a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the
F-9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
consolidated financial statements, are discussed in the relevant accounting policies under the following headings:
• Intangible assets:Goodwill
• Intangible assets:Pre-publication assets
• Royalty advances
• Taxation
• Employee benefits:Retirement benefit obligations
• Revenue recognition.
b.Consolidation
(1) Business combinations —The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets and contingent assets acquired and identifiable liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. For material acquisitions, the fair value of the acquired intangible assets is determined by an external, independent valuer. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets acquired, after the identification of purchased intangible assets, is recorded as goodwill. See note 1e(1)for the accounting policy on goodwill.
(2) Subsidiaries —Subsidiaries are entities over which the Group has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. Subsidiaries are fully consolidated from the date on which control is transferred to the Group and are de-consolidated from the date that control ceases.
(3) Joint ventures and associates —Joint ventures are entities in which the Group holds an interest on a long-term basis and which are jointly controlled, with one or more other venturers, under a contractual arrangement. Associates are entities over which the Group has significant influence but not the power to control the financial and operating policies, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in joint ventures and associates are accounted for by the equity method and are initially recognised at cost. The Group’s investment in associates includes related goodwill.
      The Group’s share of its joint ventures’ and associates’ post-acquisition profits or losses is recognised in the income statement, and its share of post-acquisition movements in reserves is recognised in reserves. The Group’s share of its joint ventures’ and associates’ results is recognised as a component of operating profit as these operations form part of the core publishing business of the Group and an integral part of existing wholly owned businesses. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in a joint venture or associate equals or exceeds its interest in the joint venture or associate, the Group does not recognise further losses, unless the Group has incurred obligations or made payments on behalf of the joint venture or associate.
c.Foreign currency translation
(1) Functional and presentation currency — Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
(2) Transactions and balances — Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of
F-10
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
monetary assets and liabilities denominated in foreign currencies, are recognised in the income statement, except when deferred in equity as qualifying net investment hedges.
      Translation differences on other non-monetary items such as equities held at fair value are reported as part of the fair value gain or loss through the income statement. Fair value adjustments on non-monetary items such as equities classified as available for sale financial assets, are included in the fair value reserve in equity.
(3) Group companies — The results and financial position of all Group companies that have a functional currency different from the presentation currency are translated into the presentation currency as follows:
      i) assets and liabilities are translated at the closing rate at the date of the balance sheet;
      ii) income and expenses are translated at average exchange rates;
      iii) all resulting exchange differences are recognised as a separate component of equity.
      On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders’ equity. The Group treats specific inter-company loan balances, which are not intended to be repaid in the foreseeable future, as part of its net investment. When a requirementforeign entity is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.
      At the date of transition to obtain hedge accounting
under UK GAAP. ConsequentlyIFRS the cumulative translation differences for foreign operations have been deemed to be zero. Any gains and losses on disposals of foreign operations will exclude translation differences arising prior to the transition date.
      The principal overseas currency for the Group is the US dollar. The average rate for the year against sterling was $1.84 (2005: $1.81) and the year end rate was $1.96 (2005: $1.72).
d.     Property, plant and equipment
      Property, plant and equipment is stated at historical cost less depreciation. Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives as follows:
      Buildings (freehold): 20-50 years
      Buildings (leasehold): 50 years (or over the period of the lease if shorter)
      Plant and equipment: 3-20 years
      The asset’s residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
      The carrying value of an asset is written down to its recoverable amount if the carrying value of the asset is greater than its estimated recoverable amount.
e.     Intangible assets
(1) Goodwill — Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of associates is included in investments in associates. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. The recoverable amounts of cash generating units have been determined based on value in use calculations. These calculations require the use of estimates (see note 12). Goodwill is allocated to cash generating units for the purpose of impairment testing. The allocation is made to those cash
F-11
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
generating units that are expected to benefit from the business combination in which the goodwill arose. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. IFRS 3 ‘Business Combinations’ has not been applied retrospectively to business combinations before the date of transition to IFRS. Subject to the transition adjustments to IFRS required by IFRS 1, the accounting for business combinations before the date of transition has been grandfathered.
(2) Acquired software — Software separately acquired for internal use is capitalised at cost. Software acquired in material business combinations is capitalised at its fair value as determined by an independent valuer. Acquired software is amortised on a straight line basis over its estimated useful life of between three and five years.
(3) Internally developed software — Internal and external costs incurred during the preliminary stage of developing computer software for internal use are expensed as incurred. Internal and external costs incurred to develop computer software for internal use during the application development stage are capitalised if the Group expects economic benefits from the development. Capitalisation in the application development stage begins once the Group can reliably measure the expenditure attributable to the software development and has demonstrated its intention to complete and use the software. Internally developed software is amortised on a straight-line basis over its estimated useful life of between three and five years.
(4) Acquired intangible assets — Acquired intangible assets comprise publishing rights, customer lists and relationships, technology, trade names and trademarks. These assets are capitalised on acquisition at cost and included in intangible assets. Intangible assets acquired in material business combinations are capitalised at their fair value as determined by an independent valuer. Intangible assets are amortised over their estimated useful lives of between two and 20 years, using a depreciation method that reflects the pattern of their consumption.
(5) Pre-publication assets — Pre-publication costs represent direct costs incurred in the development of educational programmes and titles prior to their publication. These costs are recognised as current intangible assets where the title will generate probable future economic benefits within their normal operating cycle and costs can be measured reliably. Pre-publication assets are amortised upon publication of the title over estimated economic lives of five years or less, being the estimated expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years. The investment in pre-publication assets has been disclosed as part of the cash generated from operations in the cash flow statement(see note 31).
      The assessment of the recoverability of pre-publication asset and the determination of the amortisation profile involve a significant degree of judgement based on historical trends and management estimation of future potential sales. An incorrect amortisation profile could result in excess amounts being carried forward as intangible assets that would otherwise have been written off to the income statement in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication assets. The carrying amount of pre-publication assets is set out in note 17.
f.     Other financial assets
      Other financial assets, designated as available for sale investments, are non-derivative financial assets measured at estimated fair value. Changes in the fair value are recorded in equity in the fair value reserve. On the subsequent disposal of the asset, the net fair value gains or losses are taken through the income statement.
g.     Inventories
      Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first in first out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads. Net realisable value is the estimated selling price
F-12
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
in the ordinary course of business, less estimated costs necessary to make the sale. Provisions are made for slow moving and obsolete stock.
h.     Royalty advances
      Advances of royalties to authors are included within trade and other receivables when the advance is paid less any provision required to adjust the advance to its net realisable value. The realisable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts. If the estimated realisable value of author contracts is overstated then this will have an adverse effect on operating profits as these excess amounts will be written off. The recoverability of royalty advances is based upon an annual detailed management review of the age of the advance, the future sales projections for new authors and prior sales history of repeat authors. The royalty advance is expensed at the contracted or effective royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. Royalty advances which will be consumed after one year are held in non-current assets.
i.     Newspaper development costs
      Investment in the development of newspaper titles consists of measures to increase the volume and geographical spread of circulation. The measures include additional and enhanced editorial content, extended distribution and remote printing. These cost are expensed as incurred as they do not meet the criteria under IAS 38 to be capitalised as intangible assets.
j.     Cash and cash equivalents
      Cash and cash equivalents in the cash flow statement include cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are included in borrowings in current liabilities in the balance sheet.
k.     Share capital
      Ordinary shares are classified as equity.
      Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.
      Where any Group company purchases the Company’s equity share capital (Treasury shares) the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to the Company’s equity holders.
l.     Borrowings
      Borrowings are recognised initially at fair value, which is proceeds received net of transaction costs incurred. Borrowings are subsequently stated at amortised cost with any difference between the proceeds (net of transaction costs) and the redemption value being recognised in the income statement over the period of the borrowings using the effective interest method. Accrued interest is included as part of borrowings. Where a debt instrument is in a fair value hedging relationship, an adjustment is made to its carrying value to reflect the hedged risk. Interest on borrowings is expensed as incurred.
F-13
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
m.     Derivative financial instruments
      Derivatives are initially recognised at fair value at the date of transition to IAS 39(1 January 2005)or, if later, on the date a derivative is entered into. Derivatives are subsequently remeasured at their fair value. The fair value of derivatives has been determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models. The Group designates certain of the derivative instruments within its portfolio to be hedges of the fair value of its bonds(fair value hedges) or hedges of net investments in foreign operations (net investment hedges).
      Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair valuesvalue of the hedged asset or liability that are attributable to the hedged risk.
      The effective portion of changes in the fair value of derivatives that are designated and qualify as net investment hedges are recognised in equity. Gains and losses accumulated in equity are included in the income statement when the corresponding foreign operation is disposed of. Gains or losses relating to the ineffective portion are recognised immediately in finance income or finance costs in the income statement.
      Certain derivatives do not qualify or are not designated as hedging instruments. Such derivatives are classified at fair value and any movement in their fair value is recognised in finance income or finance costs in the income statement immediately.
n.     Taxation
      Current tax is recognised on the amounts expected to be paid or recovered under the tax rates and laws that have been enacted or substantively enacted at the balance sheet date.
      Deferred income tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred income tax liability is settled.
      Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised.
      Deferred income tax is provided in respect of the undistributed earnings of subsidiaries other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future.
      Current and deferred tax are recognised in the income statement, except when the tax relates to items charged or credited directly to equity, in which case the tax is also recognised in equity.
      The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these derivativematters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
      Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, significant judgement is used when assessing the extent to which deferred tax assets should be recognised with consideration given to the timing and level of future taxable income together with any future tax planning strategies.
F-14
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
o.     Employee benefits
(1) Retirement benefit obligations — The liability in respect of defined benefit pension plans is the present value of the defined benefit obligations at the balance sheet date less the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting estimated future cash flows using yields on high quality corporate bonds which have terms to maturity approximating the terms of the related liability.
      The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes depends on the selection of certain assumptions, which include the discount rate, inflation rate, salary growth, longevity and expected return on scheme assets. Differences arising from actual experience or future changes in assumptions will be reflected in subsequent periods (actuarial gains and losses).
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognised immediately in the statement of recognised income and expense.
      The service cost, representing benefits accruing over the year, is included in the income statement as an operating cost. The unwinding of the discount rate on the scheme liabilities and the expected return on scheme asset are presented as finance costs or finance income.
      Obligations for contributions to defined contribution pension plans are recognised as an operating expense in the income statement as incurred.
(2) Other post-retirement obligations — The Group provides certain healthcare and life assurance benefits. The principal plans are unfunded. The expected costs of these benefits are accrued over the period of employment, using an accounting methodology which is the same as that for defined benefit pension plans. The liabilities and costs relating to other post-retirement obligations are assessed annually by independent qualified actuaries.
(3) Share-based payments — The Group has a number of employee option and share plans. The fair value of options or shares granted is recognised as an employee expense after taking into account the Group’s best estimate of the number of awards expected to vest. Fair value is measured at the date of grant and is spread over the vesting period of the option or share. The fair value of the options granted is measured using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the award. The fair value of shares awarded is measured using the share price at the date of grant unless another method is more appropriate. Any proceeds received are credited to share capital and share premium when the options are exercised. The Group has applied IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the date of transition to IFRS.
p.     Provisions
      Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are discounted to present value where the effect is material.
      The Group recognises a provision for deferred consideration in the period that an acquisition is made and the Group becomes legally committed to making the payment.
      The Group recognises a provision fore integration and reorganisation costs in the period in which the Group becomes legally or constructively committed to making the payment.
      The Group recognises a provision for onerous lease contracts through earningswhen the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under US GAAP. In linethe contract. The
F-15
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
provision is based on the present value of future payments for surplus leased properties under non-cancellable operating leases, net of estimated sub-leasing revenue.
q.     Revenue recognition
      Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services net of value-added tax and other sales taxes, rebates and discounts, and after eliminating sales within the Group. Revenue is recognised as follows:
      Revenue from the sale of books is recognised when title passes. A provision for anticipated returns is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period.
      Circulation and advertising revenue is recognised when the newspaper or other publication is published. Subscription revenue is recognised on a straight-line basis over the life of the subscription.
      Where a contractual arrangement consists of two or more elements that can be provided to customers either on a stand-alone basis or as an optional extra and fair value exists for each separate element, such as the provision of supplementary materials with textbooks, revenue in such multiple element arrangements is recognised when each product has been delivered and all other relevant revenue recognition criteria are achieved.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. The assumptions, risks, and uncertainties inherent in long-term contract accounting can affect the Group's treasury policy,amounts and timing of revenue and related expenses reported. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated as long-term contracts with revenue recognised on a percentage of completion basis. Losses on contracts are recognised in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated total costs of the contract exceed the estimated total revenues that will be generated by the contract.
      On certain contracts, where the Group acts as agent, only commissions and fees receivable for services rendered are recognised as revenue. Any third party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not trading instrumentsincluded in revenue.
      Income from recharges of freight and other activities which are transacted solelyincidental to match underlying financial exposures.

     The principal methodthe normal revenue generating activities is included in other income.
r.     Leases
      Leases of property, plant and equipment where the Group uses to manage its interest rate risk is to
enter into swaps to pay a fixed ratehas substantially all the risks and receive a floating rate. The majorityrewards of these contractsownership are US dollar denominated, and someclassified as finance leases. Finance leases are capitalised at the commencement of them have a deferred
start date, in order to maintain the desired risk profile as other contracts
mature. The variable rates received are normally based on 3 month and 6 month
LIBOR,lease at the lower of the fair value of the leased property and the dates on which these rates are set do not necessarily exactly
match thosepresent value of the borrowings thatminimum lease payments. Each lease payment is allocated between the liability and finance charges to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are being hedged.included in financial liabilities — borrowings. The Group believes that its
portfoliointerest element of such swapsthe finance cost is an efficient economic hedgecharged to the income statement over the lease period to produce a constant periodic rate of its portfoliointerest on the remaining balance of variable rate borrowings.

(IX)  CAPITALIZED COSTSthe liability for each period. The group has capitalized certain amountsproperty, plant and equipment acquired under UK GAAP for computer
hardware, purchased software, software licencesfinance leases is depreciated over the shorter of the useful life of the asset or the lease term.
      Leases where a significant portion of the risks and consulting services. Under
US GAAP, certainrewards of these costs cannot be capitalized and must be expensedownership are retained by the lessor are classified as incurred. The resulting adjustment takes into considerationoperating leases by the treatmentlessee. Payments made under operating leases (net of these costs, as well as any depreciation taken in subsequent periods.

(X)  RESTRUCTURING COSTS

     Certain restructuring costsincentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
F-16
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
s.     Dividends
      Dividends are recorded in prior periods under UK GAAP did not
meet the criteria specified under US GAAP to be recorded as a liabilityGroup’s financial statements in those
periods. Under US GAAP these costs have beenthe period in which they are approved by the Company’s shareholders. Interim dividends are recorded in the period in which they are approved and paid.
t.     Non-current assets held for sale and discontinued operations
      Non-current assets are classified as assets held for sale and stated at the obligation exists.
                                       F-58
lower of carrying amount and fair value less costs to sell if it is intended to recover their carrying amount principally through a sale transaction rather than through continuing use. No depreciation is charged in respect of non-current assets classified as held for sale. Amounts relating to non-current assets held for sale are classified as discontinued operations in the income statement.
u.     Trade receivables
      Trade receivables are stated at fair value less provision for bad and doubtful debts and anticipated future sales returns (see also note 1q).
2     Segment information
      Due to the differing risks and rewards associated with each business segment and the different customer focus of each segment, the Group’s primary segment reporting format is by business. The Group is organised into the following five business segments:
School — publisher, provider of testing and software services for primary and secondary schools;
Higher Education — publisher of textbooks and related course materials for colleges and universities;
Penguin — publisher with brand imprints such as Penguin, Putnam, Berkley, Viking, Dorling Kindersley;
FT Publishing — publisher of theFinancial Times, other business newspapers, magazines and specialist information;
Interactive Data Corporation (IDC) — provider of financial and business information to financial institutions and retail investors.
      The remaining business group, Professional, brings together a number of education publishing, testing and services businesses that publish texts, reference and interactive products for industry professionals and does not meet the criteria for classification as a ‘segment’ under IFRS. For more detail on the services and products included in each business segment refer to the Business Review.
F-17
NOTES TO THE ACCOUNTS (CONTINUED)

     The total restructuring chargeCONSOLIDATED FINANCIAL STATEMENTS (Continued)
Primary reporting format — business segments
                                     
      Higher     FT     2006
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,455   795   341   848   366   332   —   4,137 
Sales (inter-segment)      1   —   —   18   —   —   —   19 
                            
Operating profit before joint ventures and associates      161   161   36   58   18   82   —   516 
Share of results of joint ventures and associates      6   —   1   —   17   —   —   24 
                            
Operating profit
      167   161   37   58   35   82   —   540 
                            
Finance costs  7                               (133)
Finance income  7                               59 
                            
Profit before tax
                                  466 
                            
Income tax  8                               (11)
                            
Profit for the year from continuing operations
                                  455 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      167   161   37   58   35   82   —   540 
Adjustment to goodwill on recognition of pre-acquisition deferred tax      —   —   —   7   —   —   —   7 
Amortisation of acquired intangibles      17   —   1   1   2   7   —   28 
Other net gains and losses of associates      —   —   —   —   (4)  —   —   (4)
Other net finance costs of associates      —   —   —   —   (1)  —   —   (1)
                            
Adjusted operating profit — continuing operations      184   161   38   66   32   89   —   570 
                            
Segment assets      2,684   1,347   580   954   317   314   703   6,899 
Joint ventures  13   5   —   —   3   4   —   —   12 
Associates  13   4   —   —   —   4   —   —   8 
                            
Assets — continuing operations      2,693   1,347   580   957   325   314   703   6,919 
Assets — discontinued operations      —   —   294   —   —   —   —   294 
                            
Total assets
      2,693   1,347   874   957   325   314   703   7,213 
                            
Total liabilities
      (662)  (268)  (177)  (269)  (300)  (131)  (1,762)  (3,569)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   124   88   30   38   19   20   —   319 
Depreciation  11   21   8   19   7   9   13   —   77 
Amortisation  12, 17   117   78   21   34   4   7   —   261 
                            
F-18
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                     
      Higher     FT     2005
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,295   779   301   804   332   297   —   3,808 
Sales (inter-segment)      —   —   —   16   —   —   —   16 
                            
Operating profit before joint ventures and associates      138   156   24   60   49   75   —   502 
Share of results of joint ventures and associates      4   —   1   —   9   —   —   14 
                            
Operating profit
      142   156   25   60   58   75   —   516 
                            
Finance costs  7                               (132)
Finance income  7                               62 
                            
Profit before tax
                                  446 
                            
Income tax  8                               (116)
                            
Profit for the year from continuing operations
                                  330 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      142   156   25   60   58   75   —   516 
Amortisation of acquired intangibles      5   —   —   —   1   5   —   11 
Other net gains and losses      —   —   —   —   (40)  —   —   (40)
Other net finance costs of associates      —   —   —   —   2   —   —   2 
                            
Adjusted operating profit — continuing operations      147   156   25   60   21   80   —   489 
                            
Segment assets      2,347   1,648   1,179   960   154   291   985   7,564 
Joint ventures  13   6   —   —   2   4   —   —   12 
Associates  13   6   —   —   —   18   —   —   24 
                            
Total assets
      2,359   1,648   1,179   962   176   291   985   7,600 
                            
Total liabilities
      (557)  (341)  (263)  (280)  (336)  (109)  (1,981)  (3,867)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   114   96   43   34   14   19   —   320 
Depreciation  11   26   8   17   7   11   11   —   80 
Amortisation  12, 17   91   78   20   24   3   5   —   221 
                            
F-19
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                     
      Higher     FT     2004
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,087   729   290   786   318   269   —   3,479 
Sales (inter-segment)      —   —   —   15   —   —   —   15 
                            
Operating profit before joint ventures and associates      109   133   20   46   4   62   —   374 
Share of results of joint ventures and associates      3   —   —   1   4   —   —   8 
                            
Operating profit
      112   133   20   47   8   62   —   382 
                            
Finance costs  7                               (96)
Finance income  7                               17 
                            
Profit before tax
                                  303 
                            
Income tax  8                               (55)
                            
Profit for the year from continuing operations
                                  248 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      112   133   20   47   8   62   —   382 
Amortisation of acquired intangibles          —   —   —   —   5   —   5 
Other net gains and losses      (4)  (4)  (2)  5   (4)  —   —   (9)
                            
Other net finance costs of associates      —   —   —   —       —   —     
Adjusted operating profit — continuing operations      108   129   18   52   4   67   —   378 
                            
Segment assets      1,860   1,224   1,345   892   502   247   461   6,531 
Joint ventures  13   7   —   —   5   2   —   —   14 
Associates  13   5   —   —   —   28   —   —   33 
                            
Total assets
      1,872   1,224   1,345   897   532   247   461   6,578 
                            
Total liabilities
      (439)  (286)  (212)  (259)  (435)  (110)  (1,823)  (3,564)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   104   79   62   36   15   12   —   308 
Depreciation  11   25   9   16   9   16   9   —   84 
Amortisation  12, 17   74   65   18   29   2   5   —   193 
                            
      In 2006, sales from the provision of goods were £3,117m (2005: £2,956m; 2004: 2,787m) and sales from the provision of services were £1,020m (2005: £852m; 2004: 692m). Sales from the Group’s educational publishing, consumer publishing and newspaper business are classified as being from the provision of goods and sales from its assessment and testing, marketpricing, corporate training and management service businesses are classified as being from the provision of services.
      Corporate costs are allocated to business segments on an appropriate basis depending on the nature of the cost and therefore the segment result is equal to the Group operating profit. Inter-segment pricing is determined on an arm’s length basis. Segment assets consist primarily of property, plant and equipment, intangible assets, inventories, receivables and deferred taxation and exclude cash and cash equivalents and derivative assets. Segment liabilities comprise operating liabilities and exclude borrowings and derivative liabilities. Corporate assets and liabilities comprise cash and cash equivalents, marketable securities, borrowings and derivative financial instruments. Capital expenditure comprises additions to property, plant and equipment and intangible assets, including pre-publication but excluding goodwill (see notes 11, 12 and 17).
F-20
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Property, plant and equipment and intangible assets acquired through business combinations were £173m (2005: £111m; 2004: £16m) (see notes 11, 12 and 17). Capital expenditure, depreciation and amortisation include amounts relating to discontinued operations. In April 2005, Pearson sold its 79% interest in 2003 was L14m (L36m in 2002 and L101m in
2001), with L28m remainingRecoletos Grupo de Communicación S.A.. This operation is disclosed as a short term liabilitydiscontinued operation in 2005 (see note 3). In December 2006 Pearson announced its intention to sell Pearson Government Solutions. This operation is disclosed as ata discontinued operation (see note 3) and the assets and liabilities are classified as held for sale (see note 29).
Secondary reporting format — geographic segments
      The Group’s business segments are managed on a worldwide basis and operate in the following main geographic areas:
                                     
  Sales Total assets Capital expenditure
       
  2006 2005 2004 2006 2005 2004 2006 2005 2004
                   
  (All figures in £ millions)
Continuing operations
                                    
European countries  1,089   951   820   1,608   1,711   1,112   70   63   79 
North America  2,642   2,451   2,309   4,908   5,476   4,716   231   242   208 
Asia Pacific  298   300   263   327   325   302   12   13   10 
Other countries  108   106   87   56   52   43   2   2   3 
                            
Total
  4,137   3,808   3,479   6,899   7,564   6,173   315   320   300 
                            
Discontinued operations
                                    
European countries  17   39   205   9   —   358   1   —   8 
North America  257   266   195   281   —   —   2   —   — 
Other countries  12   10   7   4   —   —   1   —   — 
                            
Total
  286   315   407   294   —   358   4   —   8 
Joint ventures and associates  —   —   —   20   36   47   —   —   — 
                            
Total
  4,423   4,123   3,886   7,213   7,600   6,578   319   320   308 
                            
      Sales are allocated based on the country in which the customer is located. This does not differ materially from the location where the order is received.
F-21
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3Discontinued operations
      On 11 December 31, 2003,2006, Pearson announced that it had agreed to sell Pearson Government Solutions to Veritas Capital, a private equity firm. This operation is disclosed as discontinued and relates primarily to staff severancethe assets and lease exit costs. For 2003, these
costsliabilities of Pearson Government Solutions have been accountedreclassified to non-current assets held for sale (see notes 29 and 35).
      Discontinued operations in accordance2005 also relate to the sale of Pearson’s 79% interest in Recoletos Grupo de Communicación S.A..
      An analysis of the results and cash flows of discontinued operations are as follows:
                             
  2006 2005     2004    
  Pearson Pearson     Pearson    
  Government Government 2005 2005 Government 2004 2004
  Solutions Solutions Recoletos Total Solutions Recoletos Total
               
  (All figures in £ millions)
Sales  286   288   27   315   217   190   407 
 ��                    
Operating profit/(loss)  22   20   (3)  17   22   26   48 
Net finance income  —   —   —   —   —   3   3 
                      
Profit/(loss) before tax
  22   20   (3)  17   22   29   51 
                      
Attributable tax (expense)/benefit  (8)  (8)  1   (7)  (8)  (7)  (15)
                      
Profit/(loss) after tax
  14   12   (2)  10   14   22   36 
Profit on disposal of discontinued operations before tax  —   —   306   306   —   —   — 
Attributable tax expense  —   —   (2)  (2)  —   —   — 
                      
Profit for the year from discontinued operations
  14   12   302   314   14   22   36 
                      
Operating cash flows  20   22   (6)  16   112   12   124 
Investing cash flows  (8)  (13)  —   (13)  (5)  17   12 
Financing cash flows  (1)  (1)  —   (1)  —   —   — 
                      
Total cash flows
  11   8   (6)  2   107   29   136 
                      
4Other net gains and losses
             
  2006 2005 2004
       
  (All figures in £ millions)
Profit on sale of interest in MarketWatch  —   40   — 
Other items  —   —   9 
          
Total other net gains and losses  —   40   9 
          
      Other net gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and other financial assets that are included within continuing operations.
F-22
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5Operating expenses
             
  2006 2005 2004
       
  (All figures in £ millions)
By function:
            
Cost of goods sold  1,917   1,787   1,631 
          
Operating expenses
            
Distribution costs  299   292   226 
Administrative and other expenses  1,504   1,351   1,340 
Other income  (99)  (84)  (83)
          
Total operating expenses
  1,704   1,559   1,483 
          
Total
  3,621   3,346   3,114 
          
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
By nature:
                
Utilisation of inventory  18   820   767   699 
Depreciation of property, plant and equipment  11   71   76   74 
Amortisation of intangible assets — pre-publication  17   210   192   168 
Amortisation of intangible assets — other  12   48   26   24 
Employee benefit expense  6   1,280   1,177   1,074 
Operating lease rentals      125   111   126 
Other property costs      121   84   69 
Royalties expensed      360   363   331 
Advertising, promotion and marketing      212   198   171 
Information technology costs      90   81   73 
Other costs      383   355   351 
Other income      (99)  (84)  (46)
             
Total
      3,621   3,346   3,114 
             
      During the year the Group obtained the following services from the Group’s auditor:
             
  2006 2005 2004
       
  (All figures in £ millions)
Audit services
            
Fees payable to the Company’s auditor for the audit of parent company and consolidated accounts  1   1   1 
Non-audit services
            
Fees payable to the Company’s auditor and its associates for other services:            
 — The audit of the Company’s subsidiaries pursuant to legislation  4   3   3 
 — Other services pursuant to legislation  4   —   — 
 — Tax services  1   1   2 
 — Services relating to corporate finance transactions  1   1   — 
 — All other services  —   1   — 
          
   11   7   6 
          
F-23
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      ‘Other services pursuant to legislation’ represents fees payable for services in relation to other statutory filings or engagements that are required to be carried out by the appointed auditor. In particular, this includes fees for reports under section 404 (S-404) of the US Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes-Oxley) which are required for the first time in 2006.
      ‘Services relating to corporate finance transactions’ relate to a carve-out audit of Pearson Government Solutions in 2006. In 2005 this largely related to due diligence work at IDC.
      ‘All other services’ in 2005 relate to IFRS transition work and Sarbanes-Oxley section 404 compliance services.
      Audit fees in relation to the IDC SEC filings have been entirely included in ‘The audit of the Company’s subsidiaries pursuant to legislation’. The audit fee relates to an integrated S-404 review and audit in which the audit work takes leverage from the results of S-404 testing. The fees for the S-404 review and the audit are not separate, therefore no IDC fees have been included in ‘Other services pursuant to legislation’.
6Employee information
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Employee benefit expense
                
Wages and salaries (including termination benefits and restructuring costs)      1,080   993   903 
Social security costs      111   100   89 
Share-based payment costs  24   25   23   25 
Pension costs — defined contribution plans  24   36   35   32 
Pension costs — defined benefit plans  24   29   25   24 
Other post-retirement benefits  24   (1)  1   1 
             
       1,280   1,177   1,074 
             
      The details of the emoluments of the directors of Pearson plc are shown in Item 6 of this Form 20-F.
             
  2006 2005 2004
       
  (Average number employed)
School  11,064   10,133   10,403 
Higher Education  4,368   4,196   4,087 
Professional  3,754   3,809   3,368 
Penguin  3,943   4,051   4,085 
FT Publishing  2,285   1,952   1,989 
IDC  2,200   1,956   1,826 
Other  1,669   1,573   1,365 
          
Continuing operations
  29,283   27,670   27,123 
          
Discontinued operations
  5,058   4,533   5,963 
          
   34,341   32,203   33,086 
          
F-24
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7Net finance costs
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Interest payable      (117)  (98)  (91)
Finance costs re employee benefits  24   —   (7)  (5)
Net foreign exchange losses      (2)  (9)  — 
Other losses on financial instruments in a hedging relationship:                
— fair value hedges      —   (1)  — 
— net investment hedges      (2)  —   — 
Other losses on financial instruments not in a hedging relationship:                
— derivatives      (12)  (17)  — 
             
Finance costs
      (133)  (132)  (96)
             
Interest receivable      23   21   17 
Finance income re employee benefits  24   4   —   — 
Net foreign exchange gains      21   21   — 
Other gains on financial instruments in a hedging relationship:                
— fair value hedges      —   1   — 
— net investment hedges      —   3   — 
Other gains on financial instruments not in a hedging relationship:                
— amortisation of transitional adjustment on bonds      8   7   — 
— derivatives      3   9   — 
             
Finance income
      59   62   17 
             
Net finance costs
      (74)  (70)  (79)
             
Analysed as:
                
Net interest payable      (94)  (77)  (74)
Finance income/(costs) re employee benefits  24   4   (7)  (5)
             
Net finance costs reflected in adjusted earnings      (90)  (84)  (79)
Other net finance income      16   14   — 
             
Total net finance costs
      (74)  (70)  (79)
             
F-25
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8Income tax
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Current tax
                
Charge in respect of current year      (88)  (68)  (57)
Recognition of previously unrecognised trading losses      23   —   — 
Other adjustments in respect of prior years      35   (1)  25 
             
Total current tax charge
      (30)  (69)  (32)
             
Deferred tax
                
In respect of timing differences      (73)  (66)  (46)
Recognition of previously unrecognised capital losses      76   —   — 
Recognition of previously unrecognised trading losses      37   —   — 
Other adjustments in respect of prior years      (21)  19   23 
             
Total deferred tax benefit/(charge)
  14   19   (47)  (23)
             
Total tax charge
      (11)  (116)  (55)
             
      In 2006, the Group has recognised a deferred tax asset in relation to capital losses in the US which will be utilised on the sale of Pearson Government Solutions. Previously it had not been possible to foresee the utilisation of these losses prior to their expiry. In addition, due to improved trading performance and revised strategic plans together with SFAS 146 "Accountingthe expected utilisation of US net operating losses in the Pearson Government Solutions sale, the Group has re-evaluated the likely utilisation of operating losses both in the US and UK and as a consequence has increased the amount of the deferred tax asset carried forward in respect of such losses. The combined effect of these two factors was to create a non-recurring tax benefit of £127m.
      The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the UK tax rate as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Profit before tax  466   446   303 
Tax calculated at UK rate  (140)  (134)  (91)
Effect of overseas tax rates  (19)  (20)  (6)
Joint venture and associate income reported net of tax  7   5   2 
Income not subject to tax  5   16   6 
Expenses not deductible for tax purposes  (18)  (9)  (5)
Utilisation of previously unrecognised tax losses  7   11   5 
Recognition of previously unrecognised tax losses  136   —   — 
Unutilised tax losses  (3)  (3)  (14)
Prior year adjustments  14   18   48 
          
Total tax charge
  (11)  (116)  (55)
          
UK  (15)  (26)  5 
Overseas  4   (90)  (60)
          
Total tax charge
  (11)  (116)  (55)
          
F-26
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The tax benefit/(charge) on items charged to equity is as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Deferred tax on share based payments  2   3   4 
Deferred tax on net investment hedges  3   —   — 
Deferred tax on actuarial gains and losses  9   —   — 
Current tax on foreign exchange gains and losses  (2)  9   5 
          
   12   12   9 
          
9Earnings per share
Basic
      Basic earnings per share is calculated by dividing the profit attributable to equity shareholders of the Company by the weighted average number of ordinary shares in issue during the year, excluding ordinary shares purchased by the Company and held as treasury shares.
Diluted
      Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares to take account of all dilutive potential ordinary shares and adjusting the profit attributable, if applicable, to account for Costs
Associated with Exit or Disposal Activities". In 2002 and 2001, these costs were
accounted forany tax consequences that might arise from conversion of those shares.
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Earnings      446   624   262 
Adjustments to exclude profit for the year from discontinued operations:                
Profit for the year from discontinued operations  3   (14)  (314)  (36)
Majority interest share of above      —   —   5 
             
Earnings — continuing operations
      432   310   231 
             
Earnings      446   624   262 
             
Weighted average number of shares (millions)      798.4   797.9   795.6 
Effect of dilutive share options (millions)      1.5   1.1   1.1 
Weighted average number of shares (millions) for diluted earnings      799.9   799.0   796.7 
             
             
  2006 2005 2004
       
Earnings per share from continuing and discontinued operations
            
Basic  55.9p  78.2p  32.9p
Diluted  55.8p  78.1p  32.9p
          
Earnings per share from continuing operations
            
Basic  54.1p  38.9p  29.0p
Diluted  54.0p  38.8p  29.0p
          
Earnings per share from discontinued operations
            
Basic  1.8p  39.3p  3.9p
Diluted  1.8p  39.3p  3.9p
          
F-27
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10Dividends
             
  2006 2005 2004
       
  (All figures in £ millions)
Final paid in respect of prior year 17p (2005: 15.7p; 2004: 14.8p)  136   125   119 
Interim paid in respect of current year 10.5p (2005: 10p; 2004: 9.7p)  84   80   76 
          
   220   205   195 
          
      A final dividend in accordance with Emerging Issues Task Force ("EITF") 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" and
Staff Accounting Bulletin ("SAB") 100, "Restructuring and Impairment Charges".
Compulsory severance costs are accrued after a planrespect of the financial year ending 31 December 2006 of 18.8p per share has been approved and will absorb an estimated £151m of shareholders’ funds. It will be paid on 11 May 2007 to shareholders who are on the required communicationsregister of members on 10 April 2007. These financial statements do not reflect this dividend.
11Property, plant and equipment
                 
      Assets in  
  Land and Plant and course of  
  buildings equipment construction Total
         
  (All figures in £ millions)
Cost
                
At 1 January 2005
  280   604   13   897 
Exchange differences  18   40   —   58 
Transfers  —   13   —   13 
Additions  32   41   1   74 
Disposals  (5)  (28)  —   (33)
Acquisition through business combination  3   6   —   9 
Reclassifications  —   7   (7)  — 
             
At 31 December 2005
  328   683   7   1,018 
             
Exchange differences  (20)  (54)  —   (74)
Transfers  —   (11)  (1)  (12)
Additions  12   52   13   77 
Disposals  (9)  (32)  —   (41)
Acquisition through business combination  9   12   —   21 
Reclassifications  —   8   (8)  — 
Transfer to non-current assets held for sale  (7)  (27)  —   (34)
             
At 31 December 2006
  313   631   11   955 
             
F-28
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                 
      Assets in  
  Land and Plant and course of  
  buildings equipment construction Total
         
  (All figures in £ millions)
Depreciation
                
At 1 January 2005  (106)  (436)  —   (542)
Exchange differences  (7)  (33)  —   (40)
Charge for the year  (17)  (63)  —   (80)
Disposals  —   30   —   30 
Acquisition through business combination  —   (2)  —   (2)
             
At 31 December 2005
  (130)  (504)  —   (634)
             
Exchange differences  10   41   —   51 
Transfers  —   5   —   5 
Charge for the year  (17)  (60)  —   (77)
Disposals  4   27   —   31 
Acquisition through business combination  —   (8)  —   (8)
Transfer to non-current assets held for sale  5   20   —   25 
             
At 31 December 2006
  (128)  (479)  —   (607)
             
Carrying amounts
                
At 1 January 2005  174   168   13   355 
At 31 December 2005  198   179   7   384 
At 31 December 2006
  185   152   11   348 
             
      Depreciation expense of £18m (2005: £19m) has been included in the income statement in cost of goods sold, £6m (2005: £7m) in distribution expenses and £53m (2005: £54m) in administrative and other expenses. In 2006 £6m (2005: £4m) relates to discontinued operations.
      The Group leases certain equipment under a number of finance lease agreements. The net carrying amount of leased plant and equipment included within property, plant and equipment was £4m (2005: £3m).
F-29
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12Intangible assets
                         
      Acquired Other Total  
      publishing intangibles intangibles  
  Goodwill Software rights acquired acquired Total
             
  (All figures in £ millions)
Cost
                        
At 1 January 2005  3,160   181   10   46   56   3,397 
Exchange differences  345   15   2   4   6   366 
Transfers  —   (13)  —   —   —   (13)
Additions  —   24   —   —   —   24 
Disposals  (6)  (10)  —   —   —   (16)
Acquisition through business combination  155   —   56   33   89   244 
                   
At 31 December 2005
  3,654   197   68   83   151   4,002 
                   
Exchange differences  (396)  (17)  (8)  (8)  (16)  (429)
Transfers  —   6   —   —   —   6 
Additions  —   29   —   —   —   29 
Disposals  (5)  (2)  —   —   —   (7)
Acquisition through business combination  246   4   36   117   153   403 
Adjustment on recognition of pre-acquisition deferred tax  (7)  —   —   —   —   (7)
Transfer to non-current assets held for sale  (221)  (16)  —   —   —   (237)
                   
At 31 December 2006
  3,271   201   96   192   288   3,760 
                   
                         
      Acquired Other Total  
      publishing intangibles intangibles  
  Goodwill Software rights acquired acquired Total
             
  (All figures in £ millions)
Amortisation
                        
At 1 January 2005  —   (111)  —   (8)  (8)  (119)
Exchange differences  —   (10)  —   —   —   (10)
Charge for the year  —   (18)  (5)  (6)  (11)  (29)
Disposals  —   10   —   —   —   10 
                   
At 31 December 2005
  —   (129)  (5)  (14)  (19)  (148)
                   
Exchange differences  —   13   1   2   3   16 
Transfers  —   (5)  —   —   —   (5)
Charge for the year  —   (23)  (11)  (17)  (28)  (51)
Disposals  —   1   —   —   —   1 
Acquisition through business combination  —   (1)  —   —   —   (1)
Transfer to non-current assets held for sale  —   9   —   —   —   9 
                   
At 31 December 2006
  —   (135)  (15)  (29)  (44)  (179)
                   
Carrying amounts
                        
At 1 January 2005  3,160   70   10   38   48   3,278 
At 31 December 2005  3,654   68   63   69   132   3,854 
At 31 December 2006
  3,271   66   81   163   244   3,581 
                   
F-30
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Other intangibles acquired include customer lists and relationships, software rights, technology, trade names and trademarks. Amortisation of £4m (2005: £4m) is included in the income statement in cost of goods sold and £47m (2005: £25m) in administrative and other expenses. In 2006 £3m of software amortisation (2005: £3m) relates to discontinued operations.
Impairment tests for cash-generating units containing goodwill
      Impairment tests have been made. carried out where appropriate as described below. The recoverable amount for each unit tested exceeds its carrying value.
      Goodwill is allocated to the Group’s cash-generating units identified according to the business segment. Goodwill has been allocated as follows:
             
  Notes    
       
    2006 2005
       
    )
    (All figures
    in £ millions
Higher Education      780   903 
School Book      683   714 
School Assessment and Testing      342   310 
School Technology      356   408 
Other Assessment and Testing      490   531 
Other Government Solutions      —   249 
Other Book      56   57 
          
Pearson Education total
      2,707   3,172 
          
Penguin US      156   179 
Penguin UK      114   114 
Pearson Australia      44   47 
          
Penguin total
      314   340 
          
IDC
      149   138 
          
Mergermarket  28   97   — 
Other FT Publishing      4   4 
FT Publishing total
      101   4 
          
Total goodwill — continuing operations
      3,271   3,654 
          
Goodwill held for sale  29   221   — 
          
Total goodwill
      3,492   3,654 
          
      Goodwill has been allocated for impairment purposes to 13 cash-generating units. The recoverable amount of each cash-generating unit is based on value in use calculations, with the exception of IDC which is assessed on a market value basis. Goodwill is tested for impairment annually. Following a review in 2006, the allocation of corporate items has been revised. The 2005 comparative has been revised accordingly.
      The value in use calculations use cash flow projections based on financial budgets approved by management covering a five year period. The key assumptions used by management in the value in use calculations were:
Discount rate — The discount rate is based on the risk-free rate for government bonds, adjusted for a risk premium to reflect the increased risk in investing in equities. The risk premium adjustment is assessed for each specific cash-generating unit. The average pre-tax discount rates used are in the range
F-31
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of 10.3% to 11.9% for the Pearson Education businesses, 7.8% to 10.3% for the Penguin businesses and 10.5% to 11.0% for the FT Publishing businesses.
Perpetuity growth rates — The cash flows subsequent to the approved budget period are based upon the long-term historic growth rates of the underlying territories in which the cash-generating unit operates and reflect the long-term growth prospects of the sectors in which the cash-generating unit operates. The perpetuity growth rates used vary between 2.5% and 3.5%. The perpetuity growth rates are consistent with appropriate external sources for the relevant markets.
Cash flow growth rates — The cash flow growth rates are derived from forecast sales growth taking into consideration past experience of operating margins achieved in the cash-generating unit. Historically, such forecasts have been reasonably accurate.
      The valuation of IDC is determined using an observable market price for each share. Other than goodwill there are no intangible assets with indefinite lives.
13Investments in joint ventures and associates
Joint ventures
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  12   14 
Exchange differences  (3)  (3)
Share of profit/(loss) after tax  3   (1)
Dividends  (4)  (4)
Additions and further investment  4   6 
       
At end of year
  12   12 
       
      Investments in joint ventures are accounted for using the equity method of accounting and are initially recognised at cost.
      The aggregate of the Group’s share in its joint ventures, none of which are individually significant, are as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Assets
        
Non-current assets  3   3 
Current assets  24   26 
       
Liabilities
        
Current liabilities  (15)  (17)
       
Net assets
  12   12 
       
Income  52   46 
Expenses  (49)  (47)
       
Profit/(loss)after income tax
  3   (1)
       
F-32
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Associates
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  24   33 
Exchange differences  (1)  — 
Share of profit after tax  21   15 
Dividends  (41)  (10)
Disposals  —   (14)
Distribution from associate in excess of carrying value  5   — 
       
At end of year
  8   24 
       
      There is no acquisition goodwill relating to the Group’s investments in associates.
      The Group’s interests in its principal associates, all of which are unlisted, were as follows:
                         
    %        
2006 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
    (All figures in £ millions )    
The Economist Newspaper Ltd  England   50   64   (64)  122   18 
Other          28   (20)  48   3 
                   
Total
          92   (84)  170   21 
                   
                         
    %        
2005 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
    (All figures in £ millions )    
The Economist Newspaper Ltd  England   50   79   (67)  105   12 
Other          42   (30)  49   3 
                   
Total
          121   (97)  154   15 
                   
      The interest held in associates is equivalent to voting rights.
14Deferred income tax
         
  2006 2005
     
  (All figures in £
  millions)
Deferred tax assets
        
Deferred tax assets to be recovered after more than 12 months  288   343 
Deferred tax assets to be recovered within 12 months  129   42 
       
   417   385 
       
Deferred tax liabilities
        
Deferred tax liabilities to be settled after more than 12 months  (245)  (204)
Deferred tax liabilities to be settled within 12 months  —   — 
       
   (245)  (204)
       
Net deferred tax
  172   181 
       
F-33
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Deferred tax assets to be recovered within 12 months relate to the utilisation of losses in the US. Included within the losses to be utilised in 2007 are capital and operating losses of £93m which it is anticipated will be utilised on the sale of Pearson Government Solutions.
      Deferred income tax assets and liabilities may be offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The Group has unrecognised deferred tax assets at 31 December 2006 in respect of UK losses of £35m and has not recognised a deferred tax asset amounting to £47m on the net pension deficit on UK plans on the basis that it is not sufficiently certain that suitable future profits will arise against which to offset the liability. None of these unrecognised deferred tax assets have expiry dates associated with them.
      The recognition of the deferred tax assets is supported by management’s forecasts of the future profitability of the relevant business units.
      The movement on the net deferred income tax account is as follows:
             
  Notes 2006 2005
       
    (All figures in
    £ millions)
At beginning of year      181   220 
Transition adjustment on adoption of IAS 39      —   5 
Exchange differences      (16)  21 
Acquisition through business combination  28   (26)  (21)
Income statement release/(charge)  8   19   (47)
Tax benefit to equity      14   3 
          
At end of year
      172   181 
          
      The movement in deferred income tax assets and liabilities during the year is as follows:
                     
      Goodwill    
  Capital Trading and    
  losses losses intangibles Other Total
           
  (All figures in £ millions)
Deferred income tax assets
                    
At 1 January 2005  —   150   37   172   359 
Transition adjustment on adoption of IAS 39  —   —   —   5   5 
Exchange differences  —   16   4   18   38 
Acquisition through business combination  —   —   —   1   1 
Transfer between current and deferred taxation  —   —   —   23   23 
Income statement charge  —   (32)  (6)  (6)  (44)
Tax benefit to equity  —   —   —   3   3 
                
At 31 December 2005
  —   134   35   216   385 
                
Exchange differences  —   (17)  (4)  (21)  (42)
Income statement release/(charge)  76   12   (6)  (19)  63 
Tax benefit to equity  —   —   —   11   11 
                
At 31 December 2006
  76   129   25   187   417 
                
F-34
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Other deferred tax assets include temporary differences on inventory, sales returns and other provisions.
             
  Goodwill and    
  intangibles Other Total
       
  (All figures in £ millions)
Deferred income tax liabilities
            
At 1 January 2005  (59)  (80)  (139)
Exchange differences  (8)  (9)  (17)
Acquisition through business combination  (24)  2   (22)
Transfer between current and deferred taxation  —   (23)  (23)
Income statement (charge)/release  (26)  23   (3)
          
At 31 December 2005
  (117)  (87)  (204)
          
Exchange differences  15   11   26 
Acquisition through business combination  (20)  (6)  (26)
Income statement charge  (27)  (17)  (44)
Tax benefit to equity  —   3   3 
          
At 31 December 2006
  (149)  (96)  (245)
          
      Other deferred tax liabilities include temporary differences in respect of depreciation and royalty advances.
15Other financial assets
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  18   15 
Exchange differences  (1)  1 
Additions  —   4 
Disposals  —   (2)
       
At end of year
  17   18 
       
      Other financial assets comprise non-current unlisted securities.
F-35
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16Derivative financial instruments
      The Group’s approach to the management of financial risks is set out in Item 11 of this Form 20-F. The Group’s outstanding derivative financial instruments are as follows:
             
  2006
   
  Gross  
  notional  
  amounts Assets Liabilities
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  953   20   (17)
Interest rate derivatives — not in a hedge relationship  1,026   9   (2)
Cross currency rate derivatives — in a net investment hedge relationship  230   40   — 
Cross currency rate derivatives — not in a hedge relationship  180   17   — 
          
Total
  2,389   86   (19)
          
Analysed as expiring:
            
In less than one year  976   50   — 
Later than one year and not later than five years  1,005   26   (4)
Later than five years  408   10   (15)
          
Total
  2,389   86   (19)
          
             
  2005
   
  Gross  
  notional  
  amounts Assets Liabilities
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  1,109   31   (16)
Interest rate derivatives — not in a hedge relationship  1,330   18   (6)
Cross currency rate derivatives — in a net investment hedge relationship  230   13   — 
Cross currency rate derivatives — not in a hedge relationship  180   21   — 
          
Total
  2,849   83   (22)
          
Analysed as expiring:
            
In less than one year  250   4   — 
Later than one year and not later than five years  1,823   57   (8)
Later than five years  776   22   (14)
          
Total
  2,849   83   (22)
          
      The carrying value of the above derivative financial instruments equals their fair value. Fair values are determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models.
      At the end of 2006, the currency split of themark-to-market values of rate derivatives, including the exchange of principal on cross currency rate derivatives, was US dollar £(247)m, euro £157m and sterling £157m (2005: US dollar £(269)m, euro £166m and sterling £164m).
      The fixed interest rates on outstanding rate derivative contracts at the end of 2006 range from 3.02% to 7.00% (2005: 3.02% to 7.23%) and the floating rates are based on LIBOR in US dollar, sterling and euro(EURIBOR).
F-36
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The Group’s portfolio of rate derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges significantly reduce the risk of income statement volatility.
      The following sensitivity analysis of derivative financial instruments to interest rate movements is based on the assumption of a 1% change in interest rates for all currencies and maturities, with all other variables held constant.
             
  2006
   
  Net carrying 1% rate 1% rate
  amount increase decrease
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  3   (28)  31 
Interest rate derivatives — not in a hedge relationship  7   1   (1)
Cross currency rate derivatives — in a net investment hedge relationship  40   —   — 
Cross currency rate derivatives — not in a hedge relationship  17   (1)  1 
          
Total
  67   (28)  31 
          
Effect of fair value hedge accounting  —   28   (31)
Sensitivity after the application of hedge accounting  67   —   — 
          
      Counterparty exposure from all derivatives is managed, together with that from deposits and bank account balances, within credit limits that reflect published credit ratings to ensure that there is no significant risk to any one counterparty. No single derivative transaction had a market value (positive or negative) at the balance sheet date that exceeded 3% of the Group’s consolidated total equity.
      At the year end the Group held an amount of £29m equivalent as collateral under amark-to-market agreement. This reflected the amount, at market rates prevailing at the end of October 2006, owed to the Group by a counterparty for a set of three related rate derivatives. Under these derivatives the Group is due to exchange $209m for€204m at the beginning of February 2007,with the repayment of the€591m bond. There are no restrictions on the Group’s use of these funds, which have been recorded in borrowings as a current bank loan.
      In accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’, the Group has reviewed all of its material contracts for embedded derivatives that are required to be separately accounted for if they do not meet certain requirements, and has concluded that there are no material embedded derivatives.
F-37
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
17Intangible assets — pre-publication
         
  2006 2005
     
  (All figures in
  £ millions)
Cost
        
At beginning of year  1,357   1,109 
Exchange differences  (148)  112 
Transfers  6   — 
Additions  213   222 
Disposals  (280)  (113)
Acquisition through business combination  4   27 
       
At end of year
  1,152   1,357 
       
Amortisation
        
At beginning of year  (931)  (753)
Exchange differences  111   (87)
Charge for the year  (210)  (192)
Disposals  280   113 
Acquisition through business combination  —   (12)
       
At end of year
  (750)  (931)
       
Carrying amounts
        
At end of year
  402   426 
       
      Included in the above are pre-publication assets amounting to £243m (2005: £261m)which will be realised in more than 12 months.
      Amortisation is included in the income statement in cost of goods sold. There was no amortisation relating to discontinued operations in 2006 and 2005.
18Inventories
         
  2006 2005
     
  (All figures in
  £ millions)
Raw materials  26   23 
Work in progress  28   43 
Finished goods  300   307 
       
   354   373 
       
      The cost of inventories, all relating to continuing operations, recognized as an expense and included in the income statement in cost of goods sold amounted to £820m (2005: £767m). In 2006 £46m (2005: £42m) of inventory provisions were charged in the income statement. None of the inventory is pledged as security.
F-38
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19Trade and other receivables
         
  2006 2005
     
  (All figures in £
  millions)
Current
        
Trade receivables  768   825 
Royalty advances  91   124 
Prepayments and accrued income  34   38 
Other receivables  58   42 
Receivables from related parties  2   2 
       
   953   1,031 
       
Non-current
        
Royalty advances  80   67 
Prepayments and accrued income  4   4 
Other receivables  40   37 
       
   124   108 
       
      Trade receivables are stated net of provisions for bad and doubtful debts and anticipated future sales returns of £284m (2005: £313m). The carrying amounts are stated at their fair value. Concentrations of credit risk with respect to trade receivables are limited due to the Group’s large number of customers, who are internationally dispersed.
20Cash and cash equivalents (excluding overdrafts)
         
  2006 2005
     
  (All figures in
  £ millions)
Cash at bank and in hand  421   393 
Short-term bank deposits  171   509 
       
   592   902 
       
      Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates.
      At the end of 2006 the currency split of cash and cash equivalents is US dollars 31% (2005: 31%), sterling 35% (2005: 38%), euros 21% (2005: 24%) and other 13% (2005: 7%).
      Cash and cash equivalents have fair values that approximate to their carrying amounts due to their short-term nature.
      Cash and cash equivalents include the following for the purpose of the cash flow statement:
         
  2006 2005
     
  (All figures in
  £ millions)
Cash and cash equivalents  592   902 
Bank overdrafts  (61)  (58)
       
   531   844 
       
F-39
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21Financial liabilities — Borrowings
      The Group’s current and non-current borrowings are as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Non-current
        
6.125% Euro Bonds 2007 (nominal amount€591m)
  —   436 
10.5% Sterling Bonds 2008 (nominal amount £100m)  105   107 
4.7% US Dollar Bonds 2009 (nominal amount $350m)  178   203 
7% Global Dollar Bonds 2011 (nominal amount $500m)  266   307 
7% Sterling Bonds 2014 (nominal amount £250m)  251   250 
5.7% US Dollar Bonds 2014 (nominal amount $400m)  206   238 
4.625% US Dollar notes 2018 (nominal amount $300m)  139   161 
Finance lease liabilities  3   1 
       
   1,148   1,703 
       
Current
        
Due within one year or on demand:
        
Bank loans and overdrafts  173   102 
7.375% US Dollar notes 2006  —   152 
6.125% Euro Bonds 2007 (nominal amount€591m)
  421   — 
Finance lease liabilities  1   2 
       
   595   256 
       
Total borrowings
  1,743   1,959 
       
Included in the non-current borrowings above is £12m of accrued interest (2005: £35m).
Included in the current borrowings above is £22m of accrued interest (2005: £3m).
All of the Group’s borrowings are unsecured. In respect of finance lease obligations (2006: £4m; 2005: £3m) the rights to the leased asset revert to the lessor in the event of default.
The maturity of the Group’s non-current borrowing is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Between one and two years  107   437 
Between two and five years  445   310 
Over five years  596   956 
       
   1,148   1,703 
       
F-40
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      As at 31 December 2006 the exposure of the borrowings of the Group to interest rate changes when the borrowings re-price is as follows:
                 
      One to More than
  Total One year five years five years
         
  (All figures in £ millions)
Carrying value of borrowings  1,743   595   552   596 
Effect of rate derivatives  —   629   (221)  (408)
             
   1,743   1,224   331   188 
             
      The carrying amounts and market values of non-current borrowings are as follows:
                     
    Carrying Market Carrying Market
  Effective amount value amount value
  interest Rate 2006 2006 2005 2005
           
    (All figures in £ millions)
6.125% Euro Bonds 2007  6.18%  —   —   436   419 
10.5% Sterling Bonds 2008  10.53%  105   106   107   113 
4.7% US Dollar Bonds 2009  4.86%  178   176   203   200 
7% Global Dollar Bonds 2011  7.16%  266   269   307   310 
7% Sterling Bonds 2014  7.20%  251   265   250   282 
5.7% US Dollar Bonds 2014  5.88%  206   203   238   234 
4.625% US Dollar notes 2018  4.69%  139   135   161   155 
Finance lease liabilities  n/a   3   3   1   1 
                
       1,148   1,157   1,703   1,714 
                
      The market values are based on clean market prices at the year end or, where these are not available, on the quoted market prices of comparable debt issued by other companies. The effective interest rates above relate to the underlying debt instruments.
      The carrying amounts of the Group’s borrowings are denominated in the following currencies:
         
  2006 2005
     
  (All figures in
  £ millions)
US dollar  966   1,165 
Sterling  356   357 
Euro  421   437 
       
   1,743   1,959 
       
      The maturity of the Group’s finance lease obligations is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Finance lease liabilities — minimum lease payments
        
Not later than one year  1   2 
Later than one year and not later than five years  3   1 
Later than five years  —   — 
Future finance charges on finance leases  —   — 
Present value of finance lease liabilities  4   3 
       
F-41
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The present value of finance lease liabilities is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Not later than one year  1   2 
Later than one year and not later than five years  3   1 
Later than five years  —   — 
       
   4   3 
       
      The carrying amount of the Group’s lease obligations approximates their fair value.
      The Group has the following undrawn committed borrowing facilities as at 31 December:
         
  2006 2005
     
  (All figures in
  £ millions)
Floating rate
        
— expiring within one year  —   — 
— expiring beyond one year  894   786 
       
   894   786 
       
      During the year, the Group renegotiated its revolving credit facility which increased the amount and extended the maturity date.
      In addition to the above facilities, there are a number of short-term facilities that are utilised in the normal course of business.
22Provisions for other liabilities and charges
                         
  Deferred   Re-      
  consideration Integration organizations Leases Other Total
             
  (All figures in £ millions)
At 1 January 2006  26   3   5   12   18   64 
Exchange differences  —   —   —   (2)  (2)  (4)
Charged to consolidated income statement
                        
— Additional provisions  —   —   1   4   7   12 
— Unused amounts reversed  (9)  —   (2)  —   (4)  (15)
On acquisition  17   —   —   —   3   20 
Utilised during year  (9)  (1)  (3)  (2)  (10)  (25)
                   
At 31 December 2006
  25   2   1   12   12   52 
                   
         
  2006 2005
     
  (All figures in
  £ millions)
Analysis of provisions
        
Non-current  29   31 
Current  23   33 
       
   52   64 
       
F-42
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Deferred consideration — Additional deferred consideration of £17m was incurred during the year relating to the acquisition of Mergermarket.
Lease commitments — These relate primarily to onerous lease contracts, acquired through business combinations, which have various expiry dates up to 2010. The provision is based on current occupancy estimates.
23Trade and other liabilities
         
  2006 2005
     
  (All figures in
  £ millions)
Trade payables  343   348 
Social security and other taxes  18   21 
Accruals  345   363 
Deferred income  276   237 
Other liabilities  178   156 
       
   1,160   1,125 
       
Less: non-current portion
        
Accruals  24   15 
Deferred income  47   51 
Other liabilities  91   85 
       
   162   151 
       
Current portion
  998   974 
       
      The carrying value of the Group’s trade and other liabilities approximates their fair value.
      The deferred income balances comprise:
      • multi-year obligations to deliver workbooks to adoption customers in school businesses;
      • advance payments in contracting businesses;
      • subscription income in school, newspaper and market pricing businesses; and
      • advertising income relating to future publishing days in newspaper businesses.
24Employee benefits
Retirement benefit obligations
      The Group operates a number of retirement benefit plans throughout the world, the principal ones being in the UK and US. The major plans are self-administered with the plans’ assets being held independently of the Group. Retirement benefit costs are incrementalassessed in accordance with the advice of independent qualified actuaries. The UK Group plan is a hybrid plan with both defined benefit and defined contribution sections but, predominantly, consisting of defined benefit liabilities. There are a number of defined contribution plans, principally overseas.
      The most recent actuarial valuation of the UK Group plan was completed as at 1 January 2006.
F-43
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The principal assumptions used for the UK Group plan are shown below. Weighted average assumptions have been shown for the other plans.
                         
  2006 2006 2005 2005 2004 2004
  UK Group Other UK Group Other UK Group Other
% plan plans plan plans plan plans
             
Inflation  3.00   2.91   2.80   2.95   2.80   2.98 
Expected rate of increase in salaries  4.70   4.37   4.50   4.43   4.80   4.44 
Expected rate of increase for pensions in payment and deferred pensions  2.10 to 4.60   —   2.50 to 4.00   —   2.80 to 4.00   — 
Rate used to discount plan liabilities  5.20   5.70   4.85   5.54   5.40   5.84 
Expected return on assets  6.40   7.18   6.40   7.31   6.60   7.23 
                   
      Assumptions regarding future mortality experience are set based on advice, published statistics and experience in each territory. In 2006, the Group used the PMFA92 (medium-cohort) series mortality tables for the UK Group plan modified for age-rating adjustments to recalibrate the tables against observed experience of the plan, and allowing for the future improvement effect from the medium cohort approach.
      The remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date is as follows for the UK Group plan:
         
  2006 2005
     
Male  20.9   19.5 
Female  21.3   21.5 
       
      The remaining average life expectancy in years of a pensioner retiring at age 65, 20 years after the balance sheet date, is as follows for the UK Group plan:
         
  2006 2005
     
Male  22.2   20.2 
Female  22.5   22.1 
       
      The amounts recognised in the income statement are as follows:
                     
    Defined      
  UK Group benefit   Defined 2006
  plan other Sub Total contribution Total
           
  (All figures in £ millions)
Current service cost  27   2   29   36   65 
                
Total operating costs
  27   2   29   36   65 
                
Expected return on plan assets  (85)  (7)  (92)  —   (92)
Interest on pension scheme liabilities  78   7   85   —   85 
                
Net finance income
  (7)  —   (7)  —   (7)
                
Net income statement charge
  20   2   22   36   58 
                
Actual return on plan assets
  153   13   166   —   166 
                
F-44
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     
    Defined      
  UK Group benefit Sub Defined 2005
  plan other Total contribution Total
           
  (All figures in £ millions)
Current service cost  25   2   27   35   62 
Curtailments  —   (2)  (2)  —   (2)
                
Total operating costs
  25   —   25   35   60 
                
Expected return on plan assets  (75)  (6)  (81)  —   (81)
Interest on pension scheme liabilities  79   6   85   —   85 
                
Net finance costs
  4   —   4   —   4 
                
Net income statement charge
  29   —   29   35   64 
                
Actual return on plan assets
  214   7   221   —   221 
                
                     
    Defined      
  UK Group benefit Sub Defined 2004
  plan other Total contribution Total
           
  (All figures in £ millions)
Current service cost  22   2   24   32   56 
                
Total operating costs
  22   2   24   32   56 
                
Expected return on plan assets  (71)  (6)  (77)  —   (77)
Interest on pension scheme liabilities  72   6   78   —   78 
                
Net finance costs
  1   —   1   —   1 
                
Net income statement charge
  23   2   25   32   57 
                
Actual return on plan assets
  135   9   144   —   144 
                
The total operating charge is included in administrative and other expenses.
The amounts recognised in the balance sheet are as follows:
                                 
  2006 2006 2006   2005 2005 2005  
  UK Other Other   UK Other Other  
  Group funded unfunded 2006 Group funded unfunded 2005
  plan plans plans Total plan plans plans Total
                 
  (All figures in £ millions)
Fair value of plan assets  1,528   105   —   1,633   1,390   110   —   1,500 
Present value of defined benefit obligation  (1,683)  (115)  (12)  (1,810)  (1,661)  (131)  (11)  (1,803)
                         
Net pension liability
  (155)  (10)  (12)  (177)  (271)  (21)  (11)  (303)
                         
Other post-retirement medical benefit obligation              (48)              (60)
Other pension accruals              (25)              (26)
                         
Total retirement benefit obligations
              (250)              (389)
                         
F-45
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The following gains/(losses) have been recognised in the statement of recognised income and expense:
             
  2006 2005 2004
       
  (All figures in £ millions)
Amounts recognised for defined benefit plans  102   21   (60)
Amounts recognised for post-retirement medical benefit plans  5   5   (1)
          
Total recognised in year
  107   26   (61)
          
Cumulative amounts recognised
  44   (63)  (89)
          
      The fair value of plan assets comprises the following:
                         
  2006 2006   2005 2005  
  UK Other   UK Other  
  Group funded 2006 Group funded 2005
% plan plans Total plan plans Total
             
Equities  46.6   3.9   50.5   47.4   4.3   51.7 
Bonds  23.8   2.1   25.9   24.7   2.0   26.7 
Properties  9.2   —   9.2   8.9   —   8.9 
Other  14.0   0.4   14.4   11.7   1.0   12.7 
      The plan assets do not include any of the Group’s own financial instruments, nor any property occupied by the Group.
F-46
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Changes in the values of plan assets and liabilities are as follows:
                         
  2006 UK     2005 UK    
  Group 2006 2006 Group 2005 2005
  plan Other Total plan Other Total
             
  (All figures in £ millions)
Fair value of plan assets
                        
Opening fair value of plan assets  1,390   110   1,500   1,198   82   1,280 
Exchange differences  —   (12)  (12)  —   9   9 
Expected return on plan assets  85   7   92   75   6   81 
Actuarial gains and losses  68   6   74   139   1   140 
Contributions by employer  43   2   45   35   10   45 
Contributions by employee  7   —   7   6   —   6 
Benefits paid  (65)  (8)  (73)  (63)  (6)  (69)
Acquisition through business combination  —   —   —   —   8   8 
                   
Closing fair value of plan assets
  1,528   105   1,633   1,390   110   1,500 
                   
Present value of defined benefit obligation
                        
Opening defined benefit obligation  (1,661)  (142)  (1,803)  (1,502)  (113)  (1,615)
Exchange differences  —   15   15   —   (12)  (12)
Current service cost  (27)  (2)  (29)  (25)  (2)  (27)
Curtailment  —   —   —   —   2   2 
Interest cost  (78)  (7)  (85)  (79)  (6)  (85)
Actuarial gains and losses  25   3   28   (112)  (7)  (119)
Contributions by employee  (7)  —   (7)  (6)  —   (6)
Benefits paid  65   8   73   63   6   69 
Acquisition through business combination  —   (2)  (2)  —   (10)  (10)
                   
Closing defined benefit obligation
  (1,683)  (127)  (1,810)  (1,661)  (142)  (1,803)
                   
      The history of the defined benefit plans is as follows:
                 
  2006 2005 2004 2003
         
  (All figures in £ millions)
Fair value of plan assets  1,633   1,500   1,280   1,164 
Present value of defined benefit obligation  (1,810)  (1,803)  (1,615)  (1,454)
             
Net pension liability
  (177)  (303)  (335)  (290)
             
Experience adjustments on plan assets  74   140   67   88 
Experience adjustments on plan liabilities  28   (119)  (127)  (113)
             
      The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan’s investment portfolio.
      The Group expects to contribute approximately £150m to its defined benefit plans in 2007, which includes an additional contribution of £100m to the UK Group plan.
F-47
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The effect of a one percentage point increase and decrease in the discount rate is as follows:
         
  2006 2006
  1% increase 1% decrease
     
  (All figures in £ millions)
Effect on:
        
(Decrease)/increase in defined benefit obligation  (242)  297 
Other post-retirement obligations
      The Group operates a number of post-retirement medical benefit plans, principally in the US. These plans are unfunded. The method of accounting and the frequency of valuations are similar to those used for defined benefit pension plans.
      The principal assumptions used are shown below:
             
% 2006 2005 2004
       
Inflation  3.00   3.00   3.00 
Initial rate of increase in healthcare rates  10.00   10.00   12.00 
Ultimate rate of increase in healthcare rates  5.00   5.00   5.00 
Rate used to discount scheme liabilities  5.85   5.60   5.60 
      The amounts recognised in the income statement are as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Current service cost  1   1   1 
          
Past service cost  (2)  —   — 
          
Total operating (income)/costs
  (1)  1   1 
          
Interest cost  3   3   4 
          
Net income statement charge
  2   4   5 
          
      The current and past service costs have been included in administrative and other expenses.
         
  2006 2005
     
  (All figures in
  £ millions)
Opening defined benefit obligation  (60)  (58)
Exchange differences  8   (7)
Reclassifications  (3)  — 
Current service cost  (1)  (1)
Past service cost  2   — 
Interest cost  (3)  (3)
Benefits paid  4   4 
Actuarial gains and losses  5   5 
       
Closing defined benefit obligation
  (48)  (60)
       
F-48
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows:
                         
  2006 2006 2005 2005 2004 2004
  1% increase 1% decrease 1% increase 1% decrease 1% increase 1% decrease
             
  (All figures in £ millions)
Effect on:
                        
Increase/(decrease) of aggregate of service cost and interest cost  0.1   (0.1)  0.2   (0.2)  0.2   (0.2)
(Decrease)/increase in defined benefit obligation  (4.7)  5.1   (4.7)  4.1   (4.1)  3.7 
Share-based payments
      The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans:
             
  2006 2005 2004
       
  (All figures in £ millions)
Pearson plans  18   13   15 
IDC plans  7   10   10 
          
Total share-based payment costs
  25   23   25 
          
      The Group operates the following equity-settled employee option and share plans:
Worldwide Save for Shares Plan — Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.
Employee Stock Purchase Plan — In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.
Long-Term Incentive Plan — This plan was introduced in 2001 and renewed in 2006 and consists of two parts: share options and/or restricted shares.
      Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.
      The vesting of restricted shares is normally dependent on continuing service and/or upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on market and/or non-market performance criteria. Restricted shares awarded to senior management in October 2006 vest dependent on relative shareholder return, return on invested capital and a combination of earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2006 vest depending on continuing service over a three-year period.
F-49
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Annual Bonus Share Matching Plan — This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held more than three years and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held after five years.
      In addition to the above, share options remain outstanding under Executive Share Option, Reward and Special Share Option Plans. These are legacy plans which were replaced with the introduction of the Long-Term Incentive Plan in 2001.
      The number and weighted average exercise prices of share options granted under the Group’s plans are as follows:
                 
  2006 2006 2005 2005
  Number of Weighted Number of Weighted
  share average share average
  options exercise options exercise
  000s price £ 000s price £
         
Outstanding at beginning of year  21,677   13.15   26,179   13.62 
Granted during the year  837   6.30   606   4.92 
Exercised during the year  (1,396)  5.36   (324)  6.01 
Forfeited during the year  (1,828)  15.39   (4,352)  15.75 
Expired during the year  (429)  6.72   (432)  9.17 
             
Outstanding at end of year
  18,861   13.36   21,677   13.15 
             
Options exercisable at end of year
  15,595   14.14   17,420   13.90 
             
      Options were exercised regularly throughout the year. The weighted average share price during the year was £7.45 (2005: £6.52). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the Group therefore recognises in the income statement the amount that otherwise would have been recognised for services received over the remainder of the original vesting period.
      The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:
                 
  2006 2006 2005 2005
  Number of Weighted Number of Weighted
  share average share average
Range of exercise prices options contractual options contractual
£ 000s life years 000s life years
         
0 — 5  1,649   1.94   2,773   2.32 
5 — 10  5,254   3.85   5,555   4.57 
10 — 15  7,638   3.63   8,237   4.64 
15 — 20  1,050   2.88   1,168   3.81 
20 — 25  424   3.19   930   3.80 
>25  2,846   3.22   3,014   4.22 
             
   18,861   3.42   21,677   4.19 
             
      In 2006 and 2005 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model.
F-50
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
         
  2006 2005
  Weighted Weighted
  average average
     
Fair value  £1.92   £2.41 
Weighted average share price  £7.66   £6.54 
Weighted average exercise price  £6.30   £5.08 
Expected volatility  23.12%  35.47%
Expected life  4.0 years   4.1 years 
Risk free rate  4.42%  4.48%
Expected dividend yield  3.52%  3.93%
Forfeiture rate  5.0%  6.3%
       
      The expected volatility is based on the historic volatility of the Company’s share price over the previous three to seven years depending on the vesting term of the options.
      The following shares were granted under restricted share arrangements:
                 
  2006 2006   2005
  Number Weighted 2005 Weighted
  of shares average Number average
  000s fair value of shares fair value
    £ 000s £
         
Annual Bonus Share Matching Plan  90   6.27   71   5.57 
Long-Term Incentive Plan  3,585   6.96   3,987   5.05 
      In 2005, the fair value of restricted shares awarded under the Annual Bonus Share Matching Plan and the Long-Term Incentive Plan was determined using a Black-Scholes model to reflect dividends foregone using a dividend yield of 3.85%. From 2006 onwards, participants of the Long-Term Incentive Plan are entitled to dividends during the vesting period. Following a review of the accounting policies for share-based payments in 2006, the restricted shares granted in 2006 under the Annual Bonus Share Matching Plan are valued using the share price at the date of grant discounted by the dividend yield (3.66%) to take into account any dividends foregone. The fair value of shares granted under the Long-Term Incentive Plan that vest unconditionally was determined using the share price at the date of grant. The number of shares to vest was adjusted based on historical experience to account for any potential forfeitures. Restricted shares with a market performance condition were valued by an independent actuary using a Monte Carlo model. Restricted shares with a non-market performance condition were fair valued based on the share price at the date of grant. Non-market performance conditions were considered by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria.
Subsidiary share option plans
      IDC, a 62% subsidiary of the Group, operates the following share-based payment plans:
2001 Employee Stock Purchase Plan In 2001, IDC adopted the 2001 Employee Stock Purchase Plan for all eligible employees worldwide. The 2001 Employee Stock Purchase Plan allows employees to purchase stock at a discounted price at specific times.
2000 Long-Term Incentive Plan Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-based awards to directors, officers and employees of IDC, as well as persons who provide consulting or other services to IDC. The exercise price for all options granted to date has been equal to the market price of
F-51
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.
      In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of IDC. The awarded shares are available for distribution, at no cost, at the end of a three-year vesting period. No performance criteria are attached to shares granted under this plan.
      The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan are as follows:
                         
    2006     2005  
  2006 Weighted 2006 2005 Weighted 2005
  Number average Weighted Number average Weighted
  of share exercise average of share exercise average
  options price exercise options price exercise
  000s $ price £ 000s $ price £
             
Outstanding at beginning of year  10,068   15.16   8.37   9,832   13.46   7.36 
Granted during the year  1,835   20.58   10.52   1,940   21.38   11.80 
Exercised during the year  (1,252)  12.88   6.58   (1,412)  11.57   6.39 
Forfeited during the year  (139)  19.02   9.72   (292)  16.86   9.31 
Expired during the year  (6)  11.46   5.86   —   —   — 
                   
Outstanding at end of year
  10,506   16.33   8.34   10,068   15.16   8.37 
                   
Options exercisable at end of year
  6,547   14.11   7.21   6,052   12.58   6.94 
                   
      The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:
                 
  2006 2006 2005 2005
  Number Weighted Number Weighted
  of share average of share average
Range of exercise prices options contractual options contractual
$ 000s life years 000s life years
         
0 — 4.4  30   3.1   33   4.2 
4.4 — 7.5  157   2.3   206   3.6 
7.5 — 12  2,164   4.4   2,685   5.3 
12 — 20  4,640   6.4   5,243   7.4 
>20  3,515   9.0   1,901   9.5 
             
   10,506   6.8   10,068   5.4 
             
      During the year IDC granted the following shares under restricted share arrangements:
                         
    2006        
  2006 Weighted 2006   2005 2005
  Number average Weighted 2005 Weighted Weighted
  of shares fair value average Number average average
  000s $ fair value of shares fair value fair value
      £ 000s $ £
             
2000 Long-Term Incentive Plan  196   20.82   10.64   148   20.57   11.35 
2001 Employee Stock Purchase Plan  206   3.98   2.03   178   3.68   2.03 
      Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant. The fair value of the options granted under the Long-Term Incentive Plan and
F-52
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
                 
  Long-Term Incentive Plan Employee Stock Purchase Plan
     
  2006 2005 2006 2005
  Weighted Weighted Weighted Weighted
  average average average average
         
Fair value  $ 6.57   $ 5.56   $ 3.98   $ 3.68 
Weighted average share price  $20.58   $21.38   $15.58   $15.46 
Weighted average exercise price  $20.58   $21.38   $15.58   $15.46 
Expected volatility  25.90%  24.50%  18.32%  20.00%
Expected life  4.7 years   4.0 years   0.5 years   0.5 years 
Risk free rate  4.56% to 5.11%  3.86%  3.66% to 5.22%  2.33%
Expected dividend yield  0.0%  0.0%  0.0%  0.0%
Forfeiture rate  0.0%  0.0%  0.0%  0.0%
             
      The expected volatility is based on the historic volatility of IDC’s share price over the vesting term of the options.
25Share capital and share premium
             
  Number Ordinary Share
  of shares shares premium
  000s £m £m
       
At 1 January 2005  803,250   201   2,473 
Issue of ordinary shares — share option schemes  770   —   4 
          
At 31 December 2005
  804,020   201   2,477 
          
Issue of ordinary shares — share option schemes  2,089   1   10 
          
At 31 December 2006
  806,109   202   2,487 
          
      The total authorised number of ordinary shares is 1,190m shares (2005: 1,186m shares) with a par value of 25p per share (2005: 25p per share). All issued shares are fully paid. All shares have the same rights.
26Treasury shares
                     
  Pearson plc IDC Total
       
  Number   Number    
  of shares   of shares    
  000s £m 000s £m £m
           
At 1 January 2005  4,623   105   3,145   27   132 
Purchase of treasury shares  626   5   1,407   16   21 
                
At 31 December 2005
  5,249   110   4,552   43   153 
                
Purchase of treasury shares  4,700   36   1,500   16   52 
Release of treasury shares  (1,188)  (16)  —   —   (16)
                
At 31 December 2006
  8,761   130   6,052   59   189 
                
      The Group holds its own shares in trust to satisfy its obligations under its restricted share plans (see note 24). These shares are held as treasury shares and have a par value of 25p per share.
      IDC hold their own shares in respect of share buy-back programmes. These shares are held as treasury shares and have a par value of $0.01.
F-53
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The nominal value of Pearson plc treasury shares amounts to £2.2m (2005: £2.1m). The nominal value of IDC treasury shares amounts to £0.3m (2005: £0.3m).
      At 31 December 2006 the market value of Pearson plc treasury shares was £67.6m (2005: £36.2m) and the market value of IDC treasury shares was £74.3m (2005: £60.2m).
27Other reserves and retained earnings
                     
        Total  
    Translation Fair value other Retained
  Notes reserve reserve reserves earnings
           
  (All figures in £ millions)
At 1 January 2005      (491)  —   (491)  749 
Net exchange differences on translation of foreign operations      327   —   327   — 
Cumulative translation adjustment disposed      (14)  —   (14)  — 
Profit for the year attributable to equity holders of the Company      —   —   —   624 
Dividends paid to equity holders of the Company  10   —   —   —   (205)
Equity settled transactions  24   —   —   —   23 
Actuarial gains on post-retirement plans  24   —   —   —   26 
Taxation on items charged to equity  8   —   —   —   12 
Transition adjustment on adoption of IAS 39      3   —   3   (15)
                
At 31 December 2005
      (175)  —   (175)  1,214 
                
Net exchange differences on translation of foreign operations      (417)  —   (417)  — 
Profit for the year attributable to equity holders of the Company      —   —   —   446 
Dividends paid to equity holders of the Company  10   —   —   —   (220)
Equity settled transactions  24   —   —   —   25 
Actuarial gains on post-retirement plans  24   —   —   —   107 
Treasury shares released under employee share plans  26   —   —   —   (16)
Taxation on items charged to equity  8   —   —   —   12 
                
At 31 December 2006
      (592)  —   (592)  1,568 
                
      The translation reserve includes exchange differences arising from the translation of the net investment in foreign operations and of borrowings and other currency instruments designated as hedges of such investments.
28Business combinations
      On 30 September 2006, the Group acquired 100% of the voting rights of Mergermarket, a financial information company providing information to financial institutions, corporations and their advisers. In addition, several other businesses were acquired in the current year including Promissor, Paravia Bruno Mondadori (PBM), National Evaluation Systems (NES), PowerSchool and Chancery in the Education business and Quote.com in IDC. None of these other acquisitions were individually material to the Group. In 2005, the amounts shown below mainly relate to existing contractual obligations that do not have any future economic
benefit (e.g. vacant lease provisions).

(XI)  ACQUISITION ADJUSTMENTS

     Acquisitionthe acquisition of AGS Publishing.
F-54
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The assets and liabilities arising from acquisitions are as follows:
                             
    2006 2005
       
    Mergermarket Mergermarket   Other Total Total
    Carrying Fair value Mergermarket Fair Fair Fair
  Notes amount adjs Fair value value value value
               
  (All figures in £ millions)
Property, plant and equipment  11   1   —   1   12   13   7 
Intangible assets  12   —   34   34   122   156   89 
Intangible assets — Pre-publication  17   —   —   —   4   4   15 
Inventories      —   —   —   14   14   10 
Trade and other receivables      11   —   11   13   24   32 
Cash and cash equivalents      14   —   14   14   28   3 
Trade and other liabilities      (21)  —   (21)  (31)  (52)  (42)
Financial liabilities — Borrowings      —   —   —   (3)  (3)  — 
Deferred income tax liabilities  14   —   (10)  (10)  (16)  (26)  (21)
Retirement benefit obligations  24   —   —   —   (2)  (2)  (2)
Provisions for other liabilities and charges  22   —   —   —   (3)  (3)  (1)
Equity minority interest      —   —   —   (9)  (9)  8 
                      
Net assets acquired at fair value
      5   24   29   115   144   98 
                      
Goodwill
              97   149   246   155 
                      
Total
              126   264   390   253 
                      
Satisfied by:
                            
Cash              (109)  (273)  (382)  (249)
Deferred consideration              (17)  —   (17)  (5)
Net prior year adjustments              —   9   9   1 
Total consideration
              (126)  (264)  (390)  (253)
                      
Book value of net assets acquired              5   43   48   58 
Fair value adjustments              24   72   96   40 
                      
Fair value to the Group
              29   115   144   98 
                      
      The fair value adjustments principallyrelating to the acquisition of Mergermarket are provisional and will be finalised during 2007. They include the valuation of intangible assets and the related deferred tax effect. Adjustments to 2005 provisional fair values largely relate to restructuringthe acquisition of AGS Publishing.
      Net cash outflow on acquisition:
             
  2006 2005 2004
       
  (All figures in £ millions)
Cash — Current year acquisitions  (382)  (249)  (39)
Deferred payments for prior year acquisitions and other items  (9)  —   (2)
Cash and cash equivalents acquired  28   3   — 
          
Cash outflow on acquisition
  (363)  (246)  (41)
          
      The goodwill arising on the acquisition of Mergermarket is attributable to the profitability of the acquired business and the significant synergies expected to arise.
      Mergermarket contributed £9m of sales and £2m to the Group’s profit before tax between the date of acquisition and the balance sheet date. Other businesses acquired contributed £15m to the Group’s profit before tax between the date of acquisition and the balance sheet date.
F-55
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      If the acquisitions had been completed on 1 January 2006, Group sales for the period would have been £4,199m and profit before tax would have been £478m.
29  Non-current assets classified as held for sale
      As described in note 3, on 11 December 2006 the Group announced the disposal of Pearson Government Solutions. This disposal was completed on 15 February 2007 (see note 35). The major classes of assets and liabilities comprising the operations classified as held for sale at the balance sheet date are as follows:
         
  Notes 2006
     
    (All figures in
    £ millions)
Property, plant and equipment  11   9 
Intangible assets — Goodwill  12   221 
Intangible assets — Other  12   7 
Inventories      1��
Trade and other receivables      56 
       
Non-current assets classified as held for sale
      294 
       
Other liabilities      (26)
       
Liabilities directly associated with non-current assets classified as held for sale
      (26)
       
Net assets classified as held for sale
      268 
       
30Disposals
             
  2006 2005 2004
       
  (All figures in £ millions)
Disposal of subsidiaries
            
Property, plant and equipment  —   (48)  — 
Investments in associates  —   (3)  — 
Deferred income tax assets  —   8   — 
Other financial assets  —   (2)  — 
Inventories  —   (4)  — 
Trade and other receivables  —   (59)  (4)
Trade and other liabilities  (1)  71   2 
Provisions for other liabilities and charges  —   3   — 
Cash and cash equivalents  —   (134)  1 
Equity minority interests  (4)  54   (4)
Attributable goodwill  (5)  (104)  (4)
Currency translation adjustment  —   14     
          
Net assets disposed of
  (10)  (204)  (9)
          
Proceeds received  10   513   8 
Costs  —   (3)  (2)
          
Profit on sale
  —   306   (3)
          
F-56
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  2006 2005 2004
       
Cash flow from disposals
            
Cash — Current year disposals  10   513   8 
Costs paid  —   (3)  (2)
Cash and cash equivalents/net debt disposed of  —   (134)  1 
          
Net cash inflow
  10   376   7 
          
      The 2006 disposal relates to share options exercised in IDC.
      2005 disposals relate mainly to the disposal of the Group’s 79% interest in Recoletos Grupo de Communicación S.A..
31  Cash generated from operations
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Net profit      469   644   284 
Adjustments for:
                
Tax      19   125   70 
Depreciation  11   77   80   84 
Amortisation of purchased intangible assets  12   28   11   5 
Adjustment on recognition of pre-acquisition deferred tax  12   7    —   — 
Amortisation of other intangible assets  12   23   18   20 
Investment in pre-publication assets  17   (213)  (222)  (181)
Amortisation of pre-publication assets  17   210   192   168 
Loss on sale of property, plant and equipment      2    —   4 
Profit on sale of investments      —   —   (16)
Net finance costs      74   70   76 
Share of results of joint ventures and associates  13   (24)  (14)  (10)
(Profit)/loss on sale of subsidiaries and associates      —   (346)  3 
Net foreign exchange(losses)/gains from transactions      (37)  39   (15)
Share-based payment costs  24   25   23   25 
Inventories      (16)  (17)  (12)
Trade and other receivables      (60)  (4)  (18)
Trade and other liabilities      54   71   61 
Provisions      (17)  (17)  (24)
          
Cash generated from operations
      621   653   524 
          
      Following a review of accounting presentation in 2006, the Group has chosen to reclassify investment in pre-publication assets as cash generated from operations. This aligns the classification in the cash flow with the treatment of comparable items in other industries and provides more relevant information on the Group cash flow. The impact of this change is to reduce cash generated from operations by £222m in 2005 (£181m in 2004) and increase net cash (used in)/generated from investing activities by £222m in 2005 (£181m in 2004).
F-57
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      In the cash flow statement, proceeds from sale of property, plant and equipment comprise:
         
  2006 2005
     
  (All figures in
  £ millions)
Net book amount  10   3 
Loss on sale of property, plant and equipment  (2)  — 
       
Proceeds from sale of property, plant and equipment
  8   3 
       
      The principal non-cash transactions are movements in finance lease obligations of £4m (2005: £nil).
32  Contingencies
      There are contingent Group liabilities that arise in the normal course of business in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities of the Group in respect of legal claims. None of these claims is expected to result in a material gain or loss to the Group.
33  Commitments
Capital commitments
      Capital expenditure contracted for at the balance sheet date but not yet incurred is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Property, plant and equipment  —   1 
       
      The Group leases various offices and warehouses under non-cancellable operating lease agreements. The leases have varying terms and renewal rights. The Group also leases various plant and equipment under operating lease agreements, also with varying terms. The lease expenditure charged to the income statement during the year is disclosed in note 5.
      The future aggregate minimum lease payments in respect of operating leases are as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Not later than one year  123   132 
Later than one year and not later than two years  113   117 
Later than two years and not later than three years  103   108 
Later than three years and not later than four years  90   97 
Later than four years and not later than five years  83   81 
Later than five years  857   915 
       
   1,369   1,450 
       
F-58
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
34  Related party transactions
Joint ventures and associates — Amounts advanced to joint ventures and associates during the year and at the balance sheet date are set out in note 13. Amounts falling due from joint ventures and associates are set out in note 19.
Key management personnelare deemed to be the members of the board of directors of Pearson plc. It is this board which has responsibility for planning, directing and controlling the activities of the Group. Key management personnel compensation is disclosed in the directors’ remuneration report.
      There were no other material related party transactions.
      No guarantees have been provided to related parties.
35  Events after the balance sheet date
      On 15 February 2007 the Group completed the disposal of Pearson Government Solutions, its Government services business, to Veritas Capital. Sale proceeds consist of $560m in cash, $40m in preferred stock and 10% of the equity of the business. The Group expects to make a post-tax loss on the disposal as the capital gain for tax purposes will exceed any book gain.
F-59
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
36Summary of principal differences between International Financial Reporting Standards and United States of America generally accepted accounting principles
      The accompanying consolidated financial statements have been prepared in accordance with EU-adopted International Financial Reporting Standards (“IFRS”), which differ in certain significant respects from generally accepted accounting principles in the United States of America (“US GAAP”). Such differences involve methods for measuring the amounts shown in the financial statements.
      The following is a summary of the adjustments to consolidated profit for the financial year and consolidated shareholders’ funds that would have been required in applying the significant differences between IFRS and US GAAP.
Reconciliation of consolidated profit for the financial year
                  
    Year ended December 31
     
  Note 2006 2005 2004
         
    £m £m £m
Profit for the financial year under IFRS
      446   624   262 
US GAAP adjustments:                
 Intangible amortization  (i)   (50)  (60)  (74)
 Discontinued operations  (iii)   (71)  —   (2)
 Leases  (v)   (5)  —   3 
 Disposal adjustments  (iv)   —   (119)  — 
 Pensions and other post-retirement benefits  (vi)   (19)  (26)  (23)
 Share-based payments  (vii)   —   (4)  (13)
 Derivative financial instruments  (viii)   (11)  (12)  (23)
 Acquisition adjustments  (xii)   (3)  1   — 
 Partnerships and associates  (x)   (1)  (2)  — 
 Minority interests  (xi)   1   2   — 
 Other      (2)  (9)  (1)
 Taxation effect of US GAAP adjustments  (xiv)   56   16   53 
             
Total US GAAP adjustments      (105)  (213)  (80)
             
Net income under US GAAP
      341   411   182 
             
Profit from continuing operations (less (benefit from)/charge for applicable taxes 2006: £(45)m, 2005: £100m, 2004: £2m)      398   164   153 
(Loss)/profit from discontinued operations (less charge for applicable taxes 2006: £8m; 2005: £8m, 2004: £15m)      (57)  8   29 
Profit on disposal of discontinued operations (less charge for applicable taxes 2006: £nil; 2005: £1m, 2004: £nil)      —   239   — 
             
Net income under US GAAP
      341   411   182 
             
F-60
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                 
    Year ended December 31
     
  Note 2006 2005 2004
         
Presentation of earnings per equity share under US GAAP
  (xiii)             
Earnings/(loss) per equity share      (p)  (p)  (p)
Basic:                
Continuing operations      49.9   20.5   19.2 
Discontinued operations      (7.2)  31.0   3.6 
             
Total      42.7   51.5   22.8 
             
Diluted:                
Continuing operations      49.8   20.5   19.2 
Discontinued operations      (7.2)  30.9   3.6 
             
Total      42.6   51.4   22.8 
             
Average shares outstanding (millions)      798.4   797.9   795.6 
Dilutive effect of stock options (millions)      1.5   1.1   1.1 
             
Average number of shares outstanding assuming dilution (millions)      799.9   799.0   796.7 
             
Reconciliation of consolidated shareholders’ funds
              
    Year ended
    December 31
     
  Note 2006 2005
       
    £m £m
Shareholders’ funds under IFRS
      3,476   3,564 
US GAAP adjustments:            
 Goodwill  (i)   76   81 
 Intangibles  (i),(ii)   158   231 
 Discontinued operations  (iii)   (64)  7 
 Leases  (v)   (5)  — 
 Pensions and other post-retirement benefits  (vi)   —   61 
 Derivative financial instruments  (viii)   5   15 
 Share-based payments  (vii)   (3)  — 
 Acquisition adjustments  (xii)   24   26 
 Partnerships and associates  (x)   9   15 
 Minority interests  (xi)   (26)  (30)
 Other      (8)  (6)
 Taxation effect of US GAAP adjustments  (xiv)   (61)  (126)
          
Total US GAAP adjustments      105   274 
          
Shareholders’ funds under US GAAP
      3,581   3,838 
          
F-61
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      A summary of the principal differences and additional disclosures applicable to the Group are set out below:
(i) Goodwill and other intangibles
      Both IFRS and US GAAP require purchase consideration to be allocated to the net assets acquired at their fair value on the date of acquisition, with the difference between the consideration and the fair value of the identifiable net assets recorded as goodwill.
      Goodwill is tested for impairment on an annual basis in accordance with IFRS 3‘Business Combinations’.
      For the purposes of US GAAP, all goodwill written off against reserves before the transition to IFRS has been reinstated as an asset on the balance sheet. Prior to July 1, 2001, goodwill was amortized over its estimated useful life. In July 2001, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (“FAS”) 142,“Goodwill and Other Intangible Assets”which required that goodwill no longer be amortized. SFAS 142 was effective for the Group on January 1, 2002. As a result, goodwill is no longer subject to amortization subsequent to the date of adoption, but is subject to the annual impairment testing provisions of FAS 142. Impairment reviews were performed and, consistent with IFRS, no reporting units were impaired.
      Under UK GAAP, before the transition to IFRS on January 1, 2003, intangible assets (other than goodwill) could only be recognized where they could be disposed of separately from the businesses to which they related. Consequently the Group did not recognize any acquired intangible assets other than goodwill prior to January 1, 2003. In accordance with IFRS 3, acquired intangible assets (such as publishing rights, customer relationships, technology and trademarks) in respect of acquisitions after January 1, 2003 have been capitalized and amortized over a range of estimated useful lives between 2 and 30 years. Under US GAAP, acquired intangible assets on all acquisitions have been capitalized and amortized. The identified intangibles have been valued based on independent appraisals and management evaluation and analysis.
      GAAP differences between IFRS and US GAAP arise from the following factors. In respect of acquisitions prior to January 1, 1998, goodwill has remained as a deduction to reserves under IFRS in accordance with the transition rules of IFRS 1 but has been capitalized under US GAAP. In respect of acquisitions between January 1, 1998 and December 31, 2002, no acquired intangible assets other than goodwill have been recognized under IFRS while they have been fully recognized under US GAAP. Amortization of goodwill ceased on December 31, 2001 under US GAAP but ceased a year later under IFRS. Also, contingent consideration is recognized as a cost of acquisition under IFRS, if it is probable that the contingent consideration will be paid and can be measured reliably. Under US GAAP, contingent consideration is only recognized when paid (see acquisition adjustments (xii) below).
F-62
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The movement of the US GAAP adjustments to goodwill and intangibles in the years ended December 31, 2006 and 2005 is as follows:
         
  Goodwill Intangible assets
     
  £m £m
Year ended December 31, 2004  129   267 
Foreign exchange differences  (9)  28 
Amortization  —   (60)
Net movement in deferred consideration  (39)  — 
Acquisitions  —   (4)
       
Year ended December 31, 2005  81   231 
       
Foreign exchange differences  1   (25)
Amortization  —   (50)
Net movement in deferred consideration  (4)  — 
Acquisitions  (2)  2 
       
Year ended December 31, 2006  76   158 
       
(ii) Pre-publication assets
      In accordance with IAS 1 ‘Presentation of Financial Statements’ the Group classifies its pre-publication assets as current intangibles under IFRS, as they are expected to be consumed within their normal identifiable operating cycle. Under IFRS an asset shall be disclosed as current when it is expected to be realized in, or is intended for sale or consumption in, the entity’s normal operating cycle, provided that the operating cycle is clearly identifiable. Where the operating cycle is not clearly identifiable its duration is assumed to be twelve months. Under US GAAP, these assets are classified as long-term assets, as the benefit will accrue to several future annual periods, in accordance with ARB 43 ‘Restatement & Revision of Accounting Research Bulletin (Working Capital)’. As a result of this difference in classification, non-current intangible assets are £402m higher under US GAAP in purchase accounting as2006 than under IFRS (2005: £426m higher) and current intangible assets under US GAAP are £nil for all periods presented.
      The Company determines a normal operating cycle under IFRS separately for each entity/ cash generating unit within the group with distinct economic characteristics. Each of its education businesses has an increase in goodwill under
EITF 95-3 "Recognitionoperating cycle which is clearly identifiable. The duration of Liabilities in Purchase Accounting". Under UK GAAP,
these costs were treated asthe cycle is primarily based on the expected period costsover which the educational programs and were recorded as exceptional items
intitles will generate cash flows, and also takes account of the profittime it takes to produce the educational programs. The pre-publication assets are amortized from the date of first delivery of the program. The normal operating cycle commences when pre-publication activity starts and loss account.typically ends 5 years after the date of first delivery for the School, Higher Education and Professional segments, and 4 years after the date of first delivery for the Penguin segment.
      Under US GAAP, consideration relatedthe Company’s investment in pre-publication assets has been classified as an investing activity, whereas under IFRS, investment in pre-publication assets has been classified as an operating activity. Consequently under US GAAP, net cash generated from operations, in respect of this item, is £213m higher in 2006 than under IFRS (£222m higher in 2005 and £181m higher in 2004) while the cash flow from investing activities in 2006 is £213m lower than under IFRS (£222m lower in 2005 and £181m lower in 2004).
(iii) Discontinued operations
      Discontinued operations comprise the differences between IFRS and US GAAP in respect of Pearson Government solutions for 2006, 2005 and 2004 and Recoletos for 2005 and 2004.
F-63
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The (loss)/profit before tax, assets and liabilities in respect of discontinued operations under US GAAP are as follows:
             
  2006 2005 2004
       
  £m £m £m
Total (loss)/profit before tax in respect of discontinued operations  (49)  17   49 
Assets in respect of discontinued operations  240   388   729 
Liabilities in respect of discontinued operations  (27)  (51)  (183)
      Under US GAAP, the Company has included the Cumulative Translation Adjustment (CTA) relating to the acquisitionassets held for sale in relation to Government Solutions in its impairment analysis as required by EITF 01-05. As the resulting carrying value exceeds the fair value less cost to sell, the Group has recognized an impairment loss of £70m in its US GAAP income statement for the year ended December 31, 2006. The CTA will be released to net income upon the completion of the disposal of Government Solutions in 2007.
      Under IFRS, the Group has measured its assets and liabilities that have been classified as held for sale at the lower of its carrying amount and fair value less costs to sell. IFRS does not require the CTA to be included in the carrying value when assessing an asset held for disposal for impairment. As a result, there is no impairment loss recognized in the Group’s financial statements under IFRS in 2006.
(iv) Disposal adjustments
      In 2005 and 2004 gains and losses were recognized under IFRS on the disposal of a number of the Group’s businesses contingentand assets. Adjustments made to reconcile US GAAP and IFRS have an effect on achieving specific earnings levelsthe net assets of these businesses and, accordingly, a corresponding impact on the gain or loss on disposal. There were no corresponding disposal adjustments in future periods2006.
      Under IFRS, goodwill previously written off to reserves, which has been grandfathered under the first time adoption provisions of IFRS 1, is recorded
only when the specified conditions are met and the consideration distributable,
in accordance with SFAS 141 "Business Combinations." Under UK GAAP, contingent
consideration isnot treated as part of the purchase pricecalculation of profit or loss on disposal when the business to which it relates is sold. This usually results in higher profits on disposal than under US GAAP, where the goodwill was capitalized and forms part of the calculation of profit or loss on disposal.
      Under both IFRS and US GAAP, it is necessary to factor into the disposal calculation any cumulative translation adjustment associated with the business. However, a GAAP difference arises on disposals of entities acquired before the adoption of IFRS as the translation reserve was reset to zero at the date of acquisition.the adoption of IFRS in accordance with the transitional provisions in IFRS 1. Under US GAAP, the translation reserve runs from the date of acquisition.
      The reconciling items between IFRS and US GAAP in respect of disposals are summarized as follows:
             
  2006 2005 2004
       
  £m £m £m
Difference in carrying value on disposal  —   (86)  — 
Cumulative translation adjustment  —   (33)  — 
          
Total US GAAP differences in respect of disposals
  —   (119)  — 
          
(v) Leases
      During the year, the Group cannot hedgedisposed of one of its properties in a sale and lease back transaction. The resulting lease qualifies under both IFRS and US GAAP as an operating lease. A GAAP difference arises as under US GAAP any gain that arises on the foreign-currency risk relatedsale is deferred and spread over the remaining life of the lease. In accordance with IAS 17, the gain on disposal was recognized immediately in the income statement as the transaction was established at fair value.
F-64
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
     (vi) Pensions and other post-retirement benefits
      The Group operates defined benefit pension plans for its employees and former employees throughout the world. The largest defined benefit plan is a funded plan operated in the UK.
      In 2006, the Group adopted FAS 158 ‘Employers’ accounting for defined benefit pension and other post retirement plans’, this applies in conjunction with FAS 87 ‘Employers’ Accounting for Pensions’. FAS 87 has been applied during 2004 and 2005.
      Under IFRS, the expense of defined benefit pension plan and other post-retirement benefits is charged to the income statement as an operating expense over the periods benefiting from the employee’s services. The charge is based on actuarial assumptions reflecting market conditions at the beginning of the financial year.
      Under IAS 19, the Group has recognized a purchase business combination because only directpension obligation representing the excess of the defined benefit obligation over the fair value of assets as at December 31, 2005 and December 31, 2006. Actuarial gains and losses, i.e. the difference between the expected development of the assets and liabilities and the actual development, are recognized immediately through the statement of recognized income and expenses.
      Under both FAS 158 and FAS 87, in addition to the pension expense items recognized under IFRS, actuarial gains and losses in excess of the corridor are recognized over the average remaining service life of employees. However, the unrecognized amount attributable to actuarial gains and losses falling within a 10% corridor (i.e. 10% of the greater of the market value of the plan assets or plan liabilities) is deferred and not spread. Under US GAAP this results in an £19m increase in the pension charge in 2006 (2005: £26m; 2004: £23m).
      Under FAS 87, the accrual or prepayment recognized in the balance sheet in respect of pensions represents the cumulative income statement charges net of contributions to the scheme since transition to the standard. In addition to this amount, FAS 87 requires that an additional minimum liability is recorded for any plan where the accumulated benefit obligation exceeds the fair value of the plan assets by an amount greater than the liability recognized in the balance sheet.
      Under FAS 158, the provision or surplus recognized on the balance sheet represents the difference between the fair value of plan assets and the projected benefit obligation.
      The adoption of FAS 158 resulted in the recognition of a pension obligation representing the excess of the defined benefit obligation over the fair value of assets. The effect was an increase in the pension liability under US GAAP of £44m. At December 31, 2006 there is no difference between the pension liabilities under IFRS and US GAAP. For the year ended December 31, 2005 the Group had recognized prepaid pension costs amounting to £57m and a minimum pension liability of an acquisition are
allowed£298m in respect of pensions and accrued pension costs amounting to £49m in respect of post-retirement benefit plans in line with FAS 87.
     (vii) Share-based payments
      Under both IFRS and US GAAP, the share-based payment charge is determined based on the fair value of the award at the grant date and is spread over the vesting period.
      Under both IFRS and US GAAP, the fair value of awards is determined at the date of grant using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the award. These models require assumptions to be made regarding share price volatility, dividend yield, risk-free rate of return and expected option lives.
      The Group adopted FAS 123(R) as at January 1, 2006 using the ‘Modified Prospective Application’ transition method. In 2006, differences between US GAAP and IFRS relate to the treatment of dual-indexed awards which are considered equity-settled under IFRS. Under US GAAP these awards are classified as liabilities and revalued to their fair value at each balance sheet date. On adoption the Group reclassified £1.2m relating to dual-indexed awards from equity to liabilities and revalued them. The revaluation of these awards
F-65
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
on adoption and at year-end resulted in an increase of the share-based payment charge by £1m. This increase was offset by differences in the IFRS and US GAAP charge due to the different treatment of forfeitures in prior years.
      In 2005, differences between the US GAAP and IFRS charge were mainly due to the different treatment of options with graded vesting features. Under IFRS the charge is recognized as the options gradually vest, whereas under US GAAP the charge is recognized on a straight-line basis over the vesting period resulting in an additional cost of £5m (2004: £13m). The remainder of the adjustment in 2005 relates to the treatment of forfeitures.
      Differences also arise between US GAAP and IFRS on the calculation of deferred tax on share-based payments. Whereas under IFRS the deferred tax benefit is calculated based on the intrinsic value of the option/share at the balance sheet date, FAS 123(R) requires the tax benefit to be calculated based on the compensation expense recognized during the year.
     (viii) Derivative financial instruments
      Prior to the adoption of IAS 39‘Financial Instruments: Recognition and Measurement’ on January 1, 2005, the Group’s derivatives were recorded as hedging instruments. Amounts payable or receivable in respect of interest rate swaps were accrued with net interest payable over the period of the contract. Unrealized gains and losses on currency swaps and forward currency contracts were deferred and recognized when paid. Following the adoption of IAS 39, derivatives are required to be recognized at fair value using market prices or established estimation techniques such as discounted cash flow or option valuation models.
      For both IFRS and US GAAP, the Group designates certain of the derivative financial instruments in its portfolio to be hedges of the fair value of its bonds (fair value hedges) or hedges of net investment in foreign operations (net investment hedges). Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the change in fair value of the hedged assets or liability attributable to the hedged risk. The effective portion of changes in the fair value of derivatives that are designated and qualify as net investment hedges are recognized in equity. Gains and losses accumulated in equity are included in the purchase price. Derivative gains andincome statement when the corresponding foreign operation is disposed of. Gains or losses do not
qualify as direct costs. As a result, gains relating to foreign-currency forward
contractsthe ineffective portion are recordedrecognized immediately in earningsthe income statement. Changes in the fair value of derivatives not in hedging relationships are recognized in the income statement.
      Under US GAAP, certain of the Group’s financial instruments met the designation and testing requirements for hedge accounting from January 1, 2004. Under IFRS, hedge accounting has only been available from the date of adoption of IAS 39, on January 1, 2005. This additional year of hedge accounting under US GAAP. These are reflectedGAAP gives rise to a difference between IFRS and US GAAP in respect of shareholders’ funds.
      On adoption of IAS 39 on January 1, 2005, certain of the Group’s derivative financial instruments were deemed to be in fair value hedging relationships for the purposes of calculating the transition adjustment. The Group has elected not to designate all of these derivatives as adjustmentshedges on an ongoing basis. In this circumstance, the transitional adjustment to the purchase pricecarrying value of those bonds deemed to be in fair value hedging relationships is being amortized over the life of the corresponding derivative financial instrument. This gives rise to a difference between IFRS and US GAAP, as this amortization is included in the income statement under UKIFRS with no corresponding entry under US GAAP.

(XII)  PARTNERSHIPS AND ASSOCIATES
     (ix) Revenue recognition
      The Group recharges some of its freight revenue to its customers. As this income is incidental to the Group’s main revenue generating business, this income is classified as other income under IFRS as disclosed in note 5 to these financial statements. Under US GAAP freight recharges should be recognized as revenue in accordance with EITF 00-10 ‘Accounting for Shipping and Handling Fees and Costs’. The Group has also
F-66
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
reclassified distribution and subrights income to revenue for all years presented. This resulted in an increase in sales under US GAAP of £94m in 2006 (2005: £84m; 2004: £83m).
     (x) Partnerships and associates
      There is no difference under UKbetween IFRS and US GAAP in the accounting for partnerships and associates. However, the accounts of partnerships and associates must be adjusted from UKIFRS to US GAAP, which has an impact on the results of the partnerships and associates, as well as the carrying value of the investment in these entities. Principal differences identified with respect to the Group'sGroup’s investments in partnerships and associates include: historic goodwill, amortization, pensions derivatives, and goodwill impairment charges.

     Asderivatives.
(xi) Minority interests
      Under IFRS, when less than 100% of December 31, 2003, the Group held a 32%subsidiary has been acquired, minority interest in MarketWatch.com,
Inc. ("MW.com"), a publicly traded financial media company. The Group's interest
has subsequently been reduced to 23% following their issuancebusiness combination is stated at the minority’s proportion of shares to
acquire Pinnacor. This investment is accounted for under the equity methodnet fair value of accounting.acquired assets, liabilities and contingent liabilities assumed. Under US GAAP, in accordance with Accounting Principles Board
Opinion ("APB") No. 18, "The Equity Method of Accounting for Investments in
Common Stock", the Group periodically reviews its equity method investments for
impairment. These reviews are performed to determine whether declines in market
values of investments below their carrying values are deemed to be other than
temporary. During 2001,minority interest is valued at historical book value. In the Group recorded a pre-tax write-down of MW.com
related to the market value declines of that company's stock as this declineyears ended December 31, 2006, 2005 and 2004, there was deemed to be "other than temporary" as defined in SFAS 121 "Accounting for the
Impairment of Long-lived Assets". No write-down was recorded under UKno difference between IFRS and US GAAP as
the Group did not deem the decline in value to be permanent. The investment is
now fully amortized under UK GAAP.

(XIII)  ORDINARY DIVIDENDS

     Under UK GAAP, ordinary dividends proposed are provided for in the year in
respectrecognition of which they are recommended by the board of directors although
approval of the final dividend will not take place until the Annual General
Meeting subsequent to the year-end. Under US GAAP, such dividends are provided
for in the year in which they are declared and approved by the board of
directors.
                                       F-59

                       NOTES TO THE ACCOUNTS (CONTINUED)

(XIV)  FIXED ASSET INVESTMENTS

     Under UK GAAP, fixed asset investments are stated at cost less provisions
for diminution in value, or as revalued by the directors. Under US GAAP, SFAS
115, "Accounting for Certain Investments in Debt and Equity Securities,"
requires debt and equity securities with readily ascertainable market values be
adjusted to market value at the end of each period. Unrealized market value
gains and losses are charged to earnings if the securities are traded for
short-term profit. Otherwise securities are classified as "available for sale"
and unrealized gains and losses are reported as a separate component of other
comprehensive income until realized. At December 31, 2003 and 2002minority interest. In all securities covered by SFAS 115 were designated by management as available for
sale.

(XV)  INTEREST IN SHARES OF PEARSON PLC

     Under UK GAAP, shares in Pearson plc held by the employee share ownership
trusts are recorded in the balance sheet within fixed asset investments. These
shares are recorded at cost including expenses. Under US GAAP, shares in Pearson
plc held by the employee share ownership trusts are recorded at cost as a direct
reduction to shareholders funds.

     Under UK GAAP, the carrying value of shares in Pearson plc was written down
by L37m in 2001 to reflect the market value of the shares on December 31, 2001
due to the decline in the market value of these shares since the date of
purchase. Under US GAAP, this impairment charge was reversed.

(XVI)  MINORITY INTERESTS

     Minorityyears, minority interests represent the minority share of US GAAP adjustments.

(XVII)  PRESENTATION OF EARNINGS PER EQUITY SHARE
      Under IFRS, minority interest is classified as a component of shareholders’ equity. Under US GAAP, minority interest is classified outside of equity.
(xii) Acquisition adjustments
      Under US GAAP, consideration related to the acquisition of businesses contingent on a future event such as achieving specific earnings levels in future periods, that is treated as additional purchase price is recorded only when the specified conditions are met and the consideration determinable, in accordance withSFAS 141 “Business Combinations.”Consideration related to the acquisition of a business contingent on a future event that is treated as compensation expense is recorded over the period in which the compensation is earned. Under IFRS, contingent consideration is treated as part of the purchase price on the date of acquisition, if it is probable that the contingent consideration will be paid and can be measured reliably.
(xiii) Presentation of earnings per equity share
      Under US GAAP an entity that reports a discontinued operation or cumulative
effect of an accounting change must present basic and diluted EPS for those line
items.discontinued operations or the cumulative effect of an accounting change. Accordingly, the Group has presented EPS for income from continuing operations, discontinued operations cumulative effect of an accounting change
and net income.

     In 2001
(xiv) Deferred taxation
      Under IFRS, IAS 12“Income Taxes”, deferred tax is recognized if it is probable that sufficient taxable profit is available against which the Group recorded a loss for the financial year under US GAAP.
Consequently the effect of share options is anti-dilutive and has been excluded
from the calculation of diluted loss per share.

(XVIII)  OTHER DISCLOSURES REQUIRED BYtemporary difference can be utilized. Under US GAAP, CASH FLOW INFORMATION

     Under UKdeferred tax is recognized in full but then reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized.
F-67
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The reconciling items in 2006, 2005 and 2004 reflect the impact of recording the full provision and deferred tax assets, net of valuation allowance, and are summarized below:
                     
  Income Equity Income Equity Income
  2006 2006 2005 2005 2004
           
  £m £m £m £m £m
Tax effect of GAAP adjustments on:
                    
Goodwill and intangible amortization  20   (94)  18   (121)  17 
Derivative financial instruments  3   (1)  3   (5)  38 
Options, pensions, disposals and other adjustments  33   34   (6)  —   (2)
                
Total taxation effect of US GAAP adjustments
  56   (61)  15   (126)  53 
                
      Income tax adjustments on the GAAP the Consolidated Cash Flow Statementsdifferences on goodwill and intangible amortization are presented in
accordance with FRScalculated by reference to each specific acquisition. These adjustments arise on tax deductible goodwill and intangibles primarily on acquisitions prior to January 1, as revised, Cash Flow Statements. The statements prepared
under FRS 1 present substantially the same information as that required2003 where intangibles have been recognized under US GAAP as interpreted by SFAS 95 "Statementwhich have not been recognized under IFRS. The net effect of Cash Flows."

     The definition of "cash flow" differs between UK and US GAAP. Cash flow
under UK GAAP represents increases or decreases in "cash", which comprises cash
in hand and repayable on demand and overdrafts. Under US GAAP, cash flow
represents increases or decreases in "cash and cash equivalents", which include
short term, highly liquid investments with original maturities of less than 90
days, and exclude overdrafts.

     Under UK GAAP, cash flows are presented for operating activities; dividends
received from partnerships and other associates; returns on investments and
servicing of finance; taxation; capital expenditure and financial investment;
acquisitions and disposals; equity dividends paid; management of liquid
resources and financing. US GAAP requires the classification of cash flows as
resulting from operating, investing and financing activities.

     Cash flows under UK GAAP in respect of interest received, interest paid,
investment income and taxation would be included within operating activitiesadjustments is to recognize a smaller deferred tax liability under US GAAP. Capital expenditure and financial investment, dividends received
from joint ventures and associates, and cash flows from acquisitions and
disposals would be

                                       F-60

                       NOTES TO THE ACCOUNTS (CONTINUED)

included within investing activities under US GAAP. Equity dividends paid would
be included within financing activities under US GAAP. Management of liquid
resources may be included within financing activities or
      Adjustments to the liquid resources
may be considered a cash equivalent under US GAAP, dependingdeferred tax on derivatives are provided on the naturegross adjustment to the value of the liquid resources.

     A summary ofderivatives at the Group's operating, investing and financing activities,
classified in accordancebalance sheet date with US GAAP, arethe movement on the tax adjustment shown as follows:



                                                              2003    2002    2001
                                                              ----    ----    ----
                                                               LM      LM      LM

Net cash provided by operating activities...................   239     334     263
Net cash (used in)/provided by investing activities.........  (102)    689    (145)
Net cash used in financing activities.......................  (164)   (819)   (182)
Foreign exchange differences................................    14     (14)    (10)
                                                              ----    ----    ----
Net (decrease)/increase in cash and cash equivalents........   (13)    190     (74)
Cash and cash equivalents under US GAAP at the beginning of
  the year..................................................   571     381     455
                                                              ----    ----    ----
Cash and cash equivalents under US GAAP at the end of the
  year......................................................   558     571     381
                                                              ====    ====    ====



DISCONTINUED OPERATIONS

     The Group analyses turnover and operating profit between continuing and
discontinued operations. Under US GAAP, for transactions occurring in 2003 and
2002, the operating results from discontinued operations have been accounted for
under SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
and are shown on a separate linereconciling item in the profit and loss statement below income
from continuing operations, netaccount.
      Valuation allowances have previously been recognized in respect of the related tax impact. Priorlosses carried forward. Following a review of the tax position in the US and the likely utilization of operating losses, the Group has released its valuation allowance in respect of the deferred tax asset relating to 2002, these
transactions haveits US share-based payment plans amounting to £38m in 2006. These plans are not in the money and, consequently, a deferred tax asset has not been accounted for in accordance with APB 30 "Reporting the
Results of Operations, Reporting the effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions."

REVENUE RECOGNITION

     Revenue from the sale of books is recognized when the goods are shipped
(which is also when title passes), persuasive evidence of an arrangement exists,
the fee is determinable and collectability is probable. A provision for sales
returns is estimated on the basis of historical returns and recorded so as to
allocate these returns to the same period as the original sales are recorded.

     Revenue from long term contracts, such as contracts to process qualifying
tests for individual professions and government departments, is recognized as
services are delivered. Losses on long-term services contracts are recognized in line with IAS 12. FAS 123(R) only permits a valuation allowance where there are insufficient future taxable profits to utilize the period in which the loss first becomes foreseeable. Contract losses are
determined to be the amount by which estimated direct and indirect costsreversal of the contract exceed the estimated total revenues that will be generated by the
contract.

     Advertising revenue is recognized when the advertisement appears in the
publication. Online advertising revenue is recognized ratably during the period
in which the advertising is displayed and obligations are satisfied.

     Subscription income is recorded as revenue as earned. Deferred subscription
revenue, which primarily represents amounts received from customers in advance
of newspaper and magazine delivery and the supply of business information, is
included in revenue over the subscription term.

     The Group recognizes software revenue in accordance with the provisions of
the Statement of Position 97-2, "Software Revenue Recognition," as amended. The
Group recognizes license revenue upon shipment of a product to the customer if a
signed contractual agreement exists, the fee is fixed and determinable and
collection of the resulting receivables is probable. For contracts with multiple
elements, the Group allocates revenue to each

                                       F-61

                       NOTES TO THE ACCOUNTS (CONTINUED)

component of the contract based on vendor-specific objective evidence of its
fair value. Vendor-specific objective evidence of fair value is determined using
the price charged when that element is sold separately.

     Any significant up-front set-up fees are deferred and recognized ratably
over the estimated service period. Revenues for hosting services are recognized
monthly as the services are provided.

     The Group recognizes revenue related to hardware maintenance and software
support fees for ongoing customer support and product updates, ratably over the
period of the maintenance contract. Payments for these fees are generally made
in advance and are non-refundable. Revenues from professional services such as
training, implementation, and consulting are recognized as the services are
performed.

     On certain contracts, where the Group acts as agent, only commissions and
fees receivable for services rendered are recognized as revenue. Any third party
costs incurred on behalf of the principal that are rechargeable under the
contractual arrangement are not included in revenue.

LEASE COMMITMENTS

     The following is a summary of future minimum rental payments for all leases
with terms greater than one year remaining as at December 31, 2003. All leases
have been classified as capital or operating in accordance with UK GAAP:

temporary difference.

                                          CAPITAL             CAPITAL           OPERATING           OPERATING
                                      LEASES -- LAND &   LEASES -- PLANT &   LEASES -- LAND &   LEASES -- PLANT &
                                         BUILDINGS        MACHINERY/OTHER       BUILDINGS        MACHINERY/OTHER
                                      ----------------   -----------------   ----------------   -----------------
                                             LM                 LM                  LM                 LM

Fiscal year ending December 31,
2004................................        --                   3                   99                17
2005................................        --                   2                   94                13
2006................................        --                  --                   85                 8
2007................................        --                  --                   79                 4
2008................................        --                  --                   74                 1
Thereafter..........................        --                  --                  594                --
                                             --                  --               -----                --
TOTAL MINIMUM LEASE PAYMENTS........        --                   5                1,025                43
                                             ==                  ==               =====                ==

Other disclosures required by US GAAP


CONSOLIDATION
     Consolidation
      The consolidated financial statements include the accounts of the Group and majority-owned and controlled subsidiaries. Under UK GAAP,IFRS, the investments in companies in which the Group is unable to exercise control but has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method, which is consistent with the equity method under US GAAP. Accordingly, the Group'sGroup’s share of the net earnings of these companies is included in the consolidated net income.profit and loss. The investments in other companies are carried at cost or fair value, as appropriate.cost. Inter-company accounts and transactions are eliminated upon consolidation.

USE OF ESTIMATES
      The Group consolidates variable interest entities where we are deemed to be the primary beneficiary of the entity. Operating results for variable interest entities in which we are deemed the primary beneficiary are included in the profit and loss account from the date such determination is made.
     Use of estimates
      Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Accounting estimates have been used in these financial statements to determine reported amounts, including realizability, useful lives of tangible and intangible assets, income taxes and other items. Actual results could differ from those estimates.

                                       F-62

F-68
NOTES TO THE ACCOUNTS (CONTINUED)

COMPANIES ACT 1985

     The consolidated financial statements do not constitute "statutory
accounts" within the meaning of the Companies Act 1985 of Great Britain for any
of the periods presented. Statutory accounts for the years ended December 31,
2003, 2002 and 2001 have been filed with the United Kingdom's Registrar of
Companies. The auditors have reported on these accounts. Their reports were
unqualified and did not contain statements under Section 237 (2) or (3) of that
Act.

     These consolidated financial statements include all material disclosures
required by generally accepted accounting principles in the United Kingdom
including those Companies Act 1985 disclosures relating to the profit and loss
account and balance sheet items.

RECENTLY ISSUED ACCOUNTING STANDARDSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
     U.S. Accounting Pronouncements
      In May 2003,July 2006, the FASB issued SFAS 150, "AccountingInterpretation No. 48, “Accounting for Certain Financial
InstrumentsUncertainty in Income Taxes” (“FIN 48”), an Interpretation of FASB Statement No. 109. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with Characteristicsthe cumulative effect of Both Liabilitiesa change in accounting principle recorded as an adjustment to opening retained earnings. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. FIN 48 requires that the Group recognizes in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognizing, classification, interest and Equity"penalties, accounting in interim periods, disclosure, and transition attributable to the tax position. Management is currently assessing the impact of FIN 48 on the Group.
International Accounting Pronouncements
      IFRS 7 ‘Financial Instruments: Disclosures’ (effective from January 1, 2007). SFAS 150
improves the accounting for certainIFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, that, under previous
guidance, companies could only account for as equityincluding specific minimum disclosures about credit risk, liquidity risk and requires that these
instruments be classified as liabilities inmarket risk. Management is currently assessing the impact of IFRS 7 on the Group’s financial statements.
      A complementary amendment to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’ (effective from 1 January 2007). The amendment to IAS 1 introduces disclosures about the level and the management of the capital of an entity. Management is currently assessing the impact of the complementary amendment to IAS 1 on the Group’s financial statements of financial position.
The statement is effective prospectively for financial instruments entered into
or modified after May 31, 2003 and otherwise is effective for pre-existing
instruments as of
      IFRS 8 ‘Operating Segments’ (effective January 1, 2004. These requirements currently have no material
effect2009). IFRS 8 requires an entity to adopt the ‘management approach’ to reporting on the financial position and resultsperformance of its operating segments, revise explanations of the Group under US GAAP.

     In January 2003,basis on which the FASB issued FIN 46 "Consolidationsegment information is prepared and provide reconciliations to the amounts recognized in the income statement and balance sheet. Management is currently assessing the impact of Variable Interest
Entities -- an interpretationIFRS 8 on the Group’s financial statements.
      IFRIC 8 ‘Scope of ARB No. 51", which clarifiesIFRS 2’ (effective for annual periods beginning on or after May 1, 2006). IFRIC 8 requires consideration of transactions involving the applicationissuance of equity instruments — where the identifiable consideration received is less than the fair value of the consolidation rulesequity instruments issued — to certain variable interest entities. In general, a
variable interest entityestablish whether or not they fall within the scope of IFRS 2. The Group will apply IFRIC 8 from January 1, 2007, but it is a corporation, partnership, trust, or any other
legal structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entityexpected to support its activities. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns, or both. A revision (FIN 46R) was issued in December 2003 which
deferred the effective date for public companies to the end of the first
reporting period ending after March 15, 2004, except that all public companies
must, at a minimum, apply the provisions to entities that were previously
considered "special-purpose entities' by the end of the first reporting period
ending after December 15, 2003. The adoption of FIN 46R did not have any impact on the financial position, cash flows or results of the Group under US GAAP as
at December 31, 2003 under the transitional arrangements. Currently the Group is
evaluating FIN 46RGroup’s accounts.
      IFRIC 10 ‘Interim Financial Reporting and Impairment’ (effective for transactions entered into prior to February 1, 2003 and
does not believe there will be any material impact upon full adoption in 2004.

     In November 2003, the EITF reached a final consensus on Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This EITF
provides guidance on when and how to separate elements of an arrangement that
may involve the delivery or performance of multiple products, services and
rights to use assets into separate units of accounting. The guidance in the
consensus is effective for revenue arrangements entered into in fiscalannual periods beginning on or after June 15, 2003November 1, 2006). IFRIC 10 prohibits impairment losses recognized in an interim period on goodwill, investments in equity instruments and investments in financial assets carried at cost to be reversed at a subsequent balance sheet date. The Group will apply to the Group for any arrangements
entered into afterIFRIC 10 from January 1, 2004. Currently, this2007 but it is not expected to have a material effectsignificant impact on the financial position and resultsGroup’s accounts.
      IFRIC 7 ‘Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies’ (effective for annual reporting periods beginning on or after March 1, 2006). IFRIC 7 provides guidance on how to apply the requirements of IAS 29 in a reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency, when the economy was not hyperinflationary in the prior period. As none of the Group entities have a currency of a hyperinflationary economy as their functional currency, IFRIC 7 is not relevant to the Group’s operations.
      IFRIC 9 ‘Reassessment of Embedded Derivatives’ (effective for annual periods beginning on or after June 1, 2006). IFRIC 9 requires an entity to assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative when the entity first becomes a party to the contract. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under US
GAAP.

                                       F-63
the contract, in which case reassessment is required. The Group does not expect IFRIC 9 to have a material impact.
F-69
SIGNATURES
      The registrant hereby certifies that it meets all the of the requirements for filing on Form 20-F and that it has caused and authorized the undersigned to sign this annual report on its behalf.

                                          PEARSON PLC

                                          /s/ RONA FAIRHEAD
                                          Rona Fairhead
                                          Chief Financial Officer

Pearson plc
/s/ Robin Freestone
Robin Freestone
Chief Financial Officer
Date: May 7, 2004
April 30, 2007
F-70