AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 27, 2005May 5, 2006
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 20-F
   
(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, 20042005
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)
80 Strand
London, England WC2R 0RL
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
   
Title of Class Name of Each Exchange on Which Registered
   
*Ordinary Shares, 25p par value New York Stock Exchange
American Depositary Shares, each Representing One Ordinary Share, 25p per Ordinary Share New York Stock Exchange
 
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’s classes of capital or common stock at the close of the period covered by the annual report:
     
Ordinary Shares, 25p par value  803,250,000804,020,000 
     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 þ         No o
     Indicate by check mark which financial statement item the Registrant has elected to follow:
Item 17 þ                   Item 18 o
     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 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
 
 


TABLE OF CONTENTS
       
    Page
     
   Introduction  4 
   Forward-Looking Statements  4 
 PART I
 Identity of Directors, Senior Management and Advisers  6 
  Offer Statistics and Expected Timetable  6 
  Key Information  6 
   Selected Consolidated Financial Data  6 
   Dividend Information  8 
   Exchange Rate Information  98 
   Risk Factors  9 
  Information on the Company  12 
   Pearson  12 
   Overview of Operating Divisions  12 
   Our Strategy  1312 
   Operating Divisions  13 
     Pearson Education  13 
     The FT Group  1514 
     The Penguin Group  16 
   Competition  1716 
   Intellectual Property  17 
   Raw Materials  17 
   Government Regulation  1817 
   Licenses, Patents and Contracts  1817 
   Recent Developments  1817 
   Organizational Structure  1917 
   Property, Plant and Equipment18
Unresolved Staff Comments  19 
  Operating and Financial Review and Prospects  2019 
   General Overview  2019 
   Results of Operations  2624 
   Liquidity and Capital Resources  4037 
   Accounting Principles  4239 
  Directors, Senior Management and Employees  4642 
   Directors and Senior Management  4642 
   Compensation of Senior Management  4744 
   Share Options of Senior Management  5349 
   Share Ownership of Senior Management  5551 
   Employee Share Ownership Plans  5651 
   Board Practices  5651 
   Employees  5752 
  Major Shareholders and Related Party Transactions  5753 
  Financial Information  5853 
   Legal Proceedings  5853 
  The Offer and Listing  5853 
  Additional Information  5954 
  Quantitative and Qualitative Disclosures About Market Risk  6862 
   Introduction  6862 
   Interest Rates  6862 
   Currency Exchange Rates  6863 
   Forward Foreign Exchange Contracts  6963 
  Description of Securities Other Than Equity Securities  7064 

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    Page
     
 PART II
  Defaults, Dividend Arrearages and Delinquencies  7064 
  Material Modifications to the Rights of Security Holders and Use of Proceeds  7064 
  Controls and Procedures  7064 
  Audit Committee Financial Expert  7065 
  Code of Ethics  7065 
  Principal Accountant Fees and Services  7165 
  Exemptions from the Listing Standards for Audit Committees  7166 
  Purchases of Equity Securities by the Issuer and Affiliated Purchases  7166
 
 PART III
  Financial Statements  7166 
  Financial Statements  7266 
  Exhibits  7266 
EX-2.2
EX-4.1
Ex-4.2
EX-8.1
EX-10
EX-12.1
EX-12.2
EX-13.1
EX-13.2

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INTRODUCTION
      In this Annual Report on Form 20-F (the “Annual Report”) references to “Pearson” or the “Group” are references to Pearson plc, its predecessors and its consolidated subsidiaries, except as the context otherwise requires. “Ordinary Shares” refer to the ordinary share capital of Pearson of par value 25p each. “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”) and owners and holders of ADSs (the “Deposit Agreement”). ADSs are represented by American Depositary Receipts (“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 5. Operating and Financial Review and Prospects — Accounting Principles”, and in note 3435 to our consolidated financial statements included in “Item 17. Financial 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.
      In common with other listed companies governed by the law of an EU member state, for financial years beginning on or after January 1, 2005 the Group will be required to prepare its financial statements in accordance with international accounting standards adopted at the European level (endorsed IAS’s or IFRS’s). This requirement will therefore first be applicable to the Group’s financial statements for the year ended December 31, 2005. Details of the impact of IFRS on the Group’s 2004 financial statements are available on our website,www.pearson.com/ifrs. The information on this website is not incorporated by reference into 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 “£” 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 sterlingSterling figures into US dollars at the rate of £1.00 = $1.92,$1.72, 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, 2004.30, 2005, the last business day of 2005. 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 April 28, 2006 the noon buying rate for sterling was £1.00 = $1.82.
FORWARD-LOOKING STATEMENTS
      You should not rely unduly on forward-looking statements in this Annual Report. This Annual Report, including the sections entitled “Item 3. Key Information — Risk Factors”, “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and 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”, “will”, “should”, “expect”, “intend”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “potential”, “continue” or the negative of these terms or other comparable

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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,
 
 • debt levels, and
 
 • general market and economic conditions.

4


      These forward-looking statements are only predictions. They involve known and unknown risks, uncertainties and other factors that may cause our or our industry’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 3. Key Information — Risk Factors”, which may cause actual events or our industry’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.

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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
      The table below shows selected consolidated financial data for each of the years in the five-year period ended December 31, 2004.2005. The selected consolidated profit and loss account data for the years ended December 31, 2005, 2004 2003 and 20022003 and the selected consolidated balance sheet data as at December 31, 2005, 2004 and 2003 have been derived from our audited 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, 2001 and 2000, and the selected consolidated balance sheet data as at December 31, 2002, 2001 and 2000 have been derived from our audited consolidated financial statements for those periods and as of those dates, which are not included in this Annual Report.
      Our consolidated financial statements have been prepared in accordance with UK GAAP,IFRS.
      Our consolidated financial statements for the year ended December 31, 2005 have been prepared in accordance with IFRS, which differs from US GAAP in certain significant respects. See “Item 5. Operating and Financial Review and Prospects — Accounting Principles” and note 3435 to ourthe consolidated financial statements. The consolidated financial statements contain a reconciliation to US GAAP of profit/loss for the financial year, shareholders’ funds and certain other financial data.
      The selected consolidated financial information should be read in conjunction with “Item 5. Operating and Financial Review and 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.
      For convenience, we have translated the 20042005 amounts into US dollars at the rate of £1.00 = $1.92,$1.72, the noon buying rate in The City of New York on December 31, 2004.30, 2005.
Restatement
      TheIn accordance with EU regulations, the Company has restated its UK GAAP shareholders’ funds forprepared the financial years ended December 31, 2003 and 2002 for adoption of UITF Abstract 38 “Accounting for ESOP trusts’. This has reduced shareholders’ fundsstatements as at December 31, 20032005 in accordance with EU-adopted International Financial Reporting Standards (IFRS) and 2002 by £59 million and £62 million respectively (see note 24 in “Item 17.International Financial Statements”)Reporting Interpretations Committee interpretations (IFRIC).
      The Company has restated its US GAAP profit and loss account and shareholders’ funds for the Consolidated financial years endedstatements of Pearson until December 31, 20032004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and 2002consolidation methods applied in the UK GAAP financial statements to reflect the correct accounting treatmentcomply with IFRS. The comparative figures in respect of incentives2004 and fixed rental escalations under one of its leases. Previously the incentives2003 were recognized in the profit and loss account over the period during which the lease incentives were applicable until the lease returnedrestated to a market level. Additionally, fixed future market-based rent increases were chargedreflect these adjustments. See note 34 to the profit and loss account as they became applicable under the termsour consolidated financial statements for an explanation of the lease. As required by US GAAP, both the lease incentives and fixed market-based rent increases are now being chargedeffects of transition to the profit and loss account over the entire term of the lease. Consequently, the profit reported under US GAAP for the 2003 and 2002 financial years has been reduced by £14 million and £12 million, respectively, on a pre-tax basis and £10 million and £9 million, respectively, on a post-tax basis and the shareholders’ funds reported as at December 31, 2003 and 2002 has been reduced by £19 million and £9 million, respectively, from amounts previously reported.IFRS.

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 Year Ended December 31 Year Ended December 31
    
 2004 2004 2003 2002 2001 2000 2005 2005 2004 2003
                    
     Restated Restated Restated Restated   IFRS IFRS IFRS
 $ £ £ £ £ £ IFRS £ £ £
 (In millions, except for per share amounts) $
UK GAAP Information:
                   
 (In millions, except for per share amounts)
IFRS Information:
             
Consolidated Profit and Loss Account Data
                                
Statutory Measures
                                
Total sales  7,524  3,919  4,048  4,320  4,225  3,874   7,045  4,096  3,696  3,850 
Total operating profit/(loss)  444  231  226  143  (47)  209   922  536  404  406 
Profit/(loss) after taxation  209  109  77  (89)  (403)  173 
Profit/(loss) after taxation from continuing operations  588  342  262  252 
Profit/(loss) for the financial year  169  88  55  (111)  (423)  174   1,108  644  284  275 
Basic earnings/(loss) per equity share(4) $0.21  11.1p  6.9p  (13.9)p  (53.2)p  23.9p $1.35  78.2p  32.9p  31.7p
Diluted earnings/(loss) per equity share(5) $0.21  11.0p  6.9p  (13.9)p  (53.2)p  23.4p $1.34  78.1p  32.9p  31.7p
Dividends per ordinary share $0.49  25.4p  24.2p  23.4p  22.3p  21.4p $0.46  27.0p  25.4p  24.2p
Consolidated Balance Sheet Data
                                
Total assets (Fixed assets plus Current assets)  11,493  5,986  6,336  6,790  8,209  8,924   13,072  7,600  6,578  6,736 
Shareholders funds  4,998  2,603  2,893  3,276  3,712  4,100   6,130  3,564  2,800  2,969 
Long-term obligations(6)  (3,291)  (1,714)  (1,349)  (1,737)  (2,616)  (2,715)  (4,300)  (2,500)  (2,403)  (1,982)
Capital stock(1)  386  201  201  200  200  199   346  201  201  201 
Number of equity shares outstanding (millions of ordinary shares)  803  803  802  802  801  798   804  804  803  802 
                                          
 Year Ended December 31 Year Ended December 31
    
 2004 2004 2003 2002 2001 2000 2005 2005 2004 2003 2002 2001
                        
     Restated Restated       £ £ £ £ £
 $ £ £ £ £ £ $  
 (In millions, except for per share amounts) (In m illions, except for per share amounts)
US GAAP Information(7):
                                      
Consolidated Profit and Loss Account Data
                                      
Statutory Measures
                                      
Total sales  7,465  3,888  4,048  4,320  4,225  3,874   7,045  4,096  3,696  3,879  4,320  4,225 
Total operating profit/(loss)(2)  564  294  397  453  (389)  25   746  434  260  364  453  (389)
Profit/(loss) after taxation  390  203  198  219  (1,483)  1,370 
Profit/(loss) after taxation from continuing operations  330  192  203  198  219  (1,483)
Profit/(loss) for the financial year(8)  349  182  173  189  (1,500)  1,362   707  411  182  173  189  (1,500)
Profit/(loss) from continuing operations for the financial year(3)  319  166  160  216  (476)  (61)  299  174  166  160  221  (424)
(Loss)/profit from discontinued operations(3)  31  16  16  (5)  (39)  1,434   (3)  (2)  16  16  (10)  (91)
Loss on disposal of discontinued operations(3)      (3)  (1)  (985)   
Profit/(loss) on disposal of discontinued operations(3)  411  239    (3)  (1)  (985)
Basic earnings/(loss) per equity share(4) $0.44  22.9p  21.8p  23.7p  (188.6)p  187.2p $0.89  51.5p  22.9p  21.8p  23.7p  (188.6)p
Diluted earnings/(loss) per equity share(5) $0.44  22.8p  21.8p  23.7p  (188.6)p  185.0p $0.88  51.4p  22.8p  21.8p  23.7p  (188.6)p
Basic earnings/(loss) from continuing operations per equity share(1)(4) $0.40  20.9p  20.1p  27.1p  (59.8)p  (8.4)p $0.37  21.8p  20.9p  20.1p  27.8p  (53.3)p
Diluted earnings/(loss) from continuing operations per equity shares(3)(5) $0.40  20.8p  20.1p  27.1p  (59.8)p  (8.4)p $0.37  21.7p  20.8p  20.1p  27.8p  (53.3)p
Basic (loss)/earnings per share from discontinued operations(3)(4) $0.04  2.0p  1.7p  (3.4)p  (128.7)p  195.6p $0.51  29.7p  2.0p  1.7p  (4.1)p  (135.3)p
Diluted (loss)/earnings per share from discontinued operations(3)(5) $0.51  29.7p  2.0p  1.7p  (4.1)p  (135.3)p
Dividends per ordinary share $0.46  27.0p  25.4p  24.2p  22.7p  21.9p
Consolidated Balance Sheet Data
                   
Total assets  13,416  7,800  7,040  7,101  6,767  8,280 
Shareholders’ funds  6,601  3,838  3,218  3,333  4,155  4,155 
Long-term obligations(6)  (4,123)  (2,397)  (2,392)  (1,951)  (2,026)  (2,829)

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  Year Ended December 31
   
  2004 2004 2003 2002 2001 2000
             
      Restated Restated    
  $ £ £ £ £ £
  (In millions, except for per share amounts)
Diluted (loss)/earnings per share from discontinued operations(3)(5) $0.04   2.0p  1.7p  (3.4)p  (128.7)p  193.4p
Dividends per ordinary share $0.47   24.5p  23.7p  22.7p  21.9p  20.6p
Consolidated Balance Sheet Data
                        
Total assets  12,048   6,275   6,381   6,767   8,280   10,066 
Shareholders’ funds  6,179   3,218   3,333   3,699   4,155   6,018 
Long-term obligations(6)  (3,807)  (1,983)  (1,647)  (2,026)  (2,829)  (2,715)
 
(1) Capital stock and the number of equity shares outstanding are the same under both UKIFRS and US GAAP.
 
(2) Total operating profit under US GAAP includes a profit of £nil in 2005 (a profit of £14 million in 2004 (aand a loss of £7 million in 2003 and a loss of £15 million in 2002)2003) 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 3435 in “Item 17. Financial Statements”.
 
(3) Discontinued operations under both UK GAAPIFRS and US GAAP comprise the results of Recoletos Grupo de Comunicacion SA for all years presented and the results of RTL 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.2001. Discontinued operations under US GAAP also include the results of the Forum Corporation for 2003, 2002 2001 and 2000.2001.
 
(4) 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.
 
(5) 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 both 2002 and 2001, the Group made a retained loss for the financial year. Consequently the effect of share options is anti-dilutive for those years and there is no difference between the basic loss per share and the diluted loss per share.
 
(6) Long-term obligations are comprisedcomprise any liabilities with a maturity of more than one year, including medium and long-term borrowings, amounts falling due after more than one year related toderivative financial instruments, pension obligations under finance leases and amounts falling due after more than one year in respect of pension obligations.deferred income tax liabilities.
 
(7) See note 3435 to the consolidated financial statements included in this Annual Report entitled “Summary of principal differences between United KingdomInternational Financial Reporting Standards and United States of America generally accepted accounting principles”.
 
(8) The loss of £1,500 million in 2001 and profit of £1,362 million in 2000 areis after charging goodwill amortization of £527 million and £288 million respectively.million. 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 £21 million in respect of the cumulative effect of a change in accounting principle. See note 3435 in “Item 17. Financial Statements”.
Dividend Information
      We pay dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. Our board of directors normally declares an interim dividend in July or August of each year to be paid in September or October. Our 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’ approval at our annual general meeting. At our annual general meeting on April 29,

8


200521, 2006 our shareholders approved a final dividend of 15.7p17.0p per ordinary share for the year ended December 31, 2004.2005.
      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 city of New York on each of the respective payment dates for interim and final dividends. The final dividend for the 20042005 fiscal year waswill be paid inon 5 May 2005.2006.
                                          
Fiscal Year Interim Final Total Interim Final Total Interim Final Total Interim Final Total
                        
 (Pence per ordinary share) (Cents per ordinary share) (Pence per ordinary share) (Cents per ordinary share)
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   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   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   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   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 
      Future dividends will be dependent on our future earnings, financial condition and cash flow, as well as other factors affecting the 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 city of New York on each day during a monthly period and on the last day of each month

8


during an annual period. On December 31, 2004,30, 2005, the noon buying rate for sterling was £1.00 = $1.92.$1.72. On April 28, 2006 the noon buying rate for sterling was £1.00 = $1.82.
         
Month High Low
     
May 2005 $1.90  $1.82 
April 2005 $1.92  $1.87 
March 2005 $1.93  $1.87 
February 2005 $1.92  $1.87 
January 2005 $1.91  $1.86 
December 2004 $1.95  $1.91 
         
Month High Low
     
April 2006 $1.82  $1.74 
March 2006 $1.76  $1.73 
February 2006 $1.78  $1.73 
January 2006 $1.79  $1.74 
December 2005 $1.77  $1.72 
November 2005 $1.78  $1.71 
        
Year Ended December 31 Average Rate Average Rate
    
2005 $1.81 
2004 $1.84  $1.84 
2003 $1.63  $1.63 
2002 $1.51  $1.51 
2001 $1.45  $1.45 
2000 $1.52 
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 US educational textbook and testing businesses may be adversely affected by changes in state educational funding that resultresulting from the condition of the local state or US economy,either general economic conditions, changes in government educational funding, programmes and legislation both(both at the federal and state level,level), and/or changes in the state procurement process.
      The results of our US educational textbook and testing business Pearson Education, which accounted for 60% of our total 2004 revenue, dependdepends on the level of US and state educational funding. The economic slowdownfunding and this funding is a significant influence on our ability to grow.
      With the improvement in 2002 and 2003, coupled with decliningthe US economy state educational expenditure has increased as state tax revenues, resulted in some US states deferring

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purchases as they sought to reducereceipts have increased, reducing or eliminating state budget deficits. State budgets have begun to recover but theredeficits, thereby minimizing the risk that state educational expenditure is no guarantee that states will fund new programs,cut or that we will win this business.
      Legislativedeferred. Federal legislative changes can also affect the funding available for educational expenditure.expenditure, e.g. the No Child Left Behind Act. These might also include changes in the procurement process for textbooks, learning material and student tests, particularly in the adoptions market and thus our ability to grow.market. 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 businessbusinesses may be adversely affected by areductions in advertising revenues and/or circulation either due to weak global advertising environmentgeneral economic conditions or competing news information distribution channels, particularly online and other economic and market factors.digital formats.
      Our newspaper business resultsbusinesses are highly geared and remain dependent on advertising revenue; relatively small changes in revenue, positive or negative, have been adversely affected by the reductiona disproportionate affect on profitability. We are beginning to see an increase in advertising particularlyrevenues compared to prior years, however any downturn in corporate and financial advertising since 2001. Also some ofspend would negatively impact our newspapers’ circulation is declining or static due to general economic conditions and changesresults.
      Changes in consumer purchasing habits, as readers look to alternative sources and/or providers of information, such as the internet.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.

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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 be sure that our proprietary rights will not be challenged, invalidated or circumvented. Our intellectual property rights in countries such as the United States and the United Kingdom, which are the jurisdictions with the largest proportions of 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. The 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 the authors. This lawsuit seeks to demarcate the extent to which search engines and other internet operators may rely on the fair-use doctrine to copy content without authorization from the copyright proprietors, and may give publishers more control overon-line users of their intellectual property. If the lawsuit is unsuccessful, publishers and authors may not be able to control copying of their content for purposes of on-line searching, which could have an adverse impact on our business and financial performance.
The contracting risks associated with our Professional division within Pearson Education are complex and if unmanaged, could adversely affect our financial results and growth prospects.
      In recent years we have begun, through ourOur Professional division to offerprovides services ranging from call center operations to complete outsourcing of administrative functions. Customers are government agencies and professional organizations, mainly in the United StatesUSA and the United Kingdom,UK, and commercial businesses. These services are provided under contracts with values that vary significantly, from a few million to several hundred million pounds over the term of the contract, which can run from one to ten years in length. The results of our Professional division can be significantly dependent on a small number of large contracts.
      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, which could adversely affect our financial performance and/or reputation. In addition, US government contracts are subject to audit and investigation by the applicable contracting government entity and may otherwise be investigated by the government, and this can result in payment delays and, in certain circumstances, reductions in the amounts received, penalties or other sanctions.

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A control breakdown in our school testing businesses could result in financial loss and reputational damage.
      There are inherent risks particularly associated with our school testing businesses, both in the United StatesUSA and the United Kingdom.UK. A breakdown in our testing and assessment products and processes could lead to either a mis-grading of student test scorestests and/or late delivery of test scoresresults to students and their schools. In either event we may be subject to legal claims, penalty charges under our contracts, and non-renewal of contracts.contracts and in the case of our UK testing business, the suspension or withdrawal of our accreditation. It is also likelypossible that such events would result in adverse publicity, which may affect our school testing business’s ability to retain existing clientscontracts and/or obtain new clients.customers.
      We have recently experienced adverse publicity as a result of the rescoring of the October 2005 Scholastic Aptitude Test, or SAT, in the USA. We provide answer sheet scanning services for the College Board, which administers the SAT. We rescanned approximately 1.5 million tests taken in October 2005 through January 2006 and, as a result, the College Board reissued higher scores for about 4,400 out of

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approximately 495,000 tests taken in October. We have also been named along with the College Board as a defendant in a class action lawsuit filed as a result of the revised scores.
Changes in the Penguin business may restrict our ability to grow and return this business to historical profit levels.our profitability.
      Weak US market conditions (particularly in mass market books), higher than average historical return rates,New distribution channels, e.g. digital format, the weak US dollar and distribution problems ininternet, used books, combined with the United Kingdom associated with a new automated warehouse facility all adversely affectedconcentration of retailer power pose multiple threats to our traditional consumer publishing models. Penguin’s financial performance in 2004. Our ability to restore Penguin to historical profit levels will be constrained if the US mass market does not recover. Penguin’s financial performance willcan also be negatively affected if book return rates remain above their historical average or increase further.
      The majority of the UK warehousing problems were resolved by the 2004 year end. We are planning to move Pearson Education into this new facility in the second half of 2005. This represents a short term operational risk to both businesses. We will continue to incur dual running costs until this project is successfully completed.increase.
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 constantly change in response to competition, technological innovations and other factors. To remain competitive we continue to invest in our authors, products and services. There is no guarantee that these investments will generate the anticipated returns or protect us from being placed at a competitive disadvantage with respect to scale, resources and our ability to develop and exploit opportunities. Specific competitive threats we face at present include:
 • Students seeking cheaper sources of content, e.g. on-line, used books or imported textbooks. To counter this trend we introduced our own on-line format (called SafariX) and are providing students with a greater choice and customization of our products.
 
 • Competition from major publishers and other educational material and service providers in our US educational textbook and testing business.businesses.
 
 • AuthorPenguin — Authors’ advances in Penguin.consumer publishing. We compete with other publishing businesses for the rights to author manuscripts, and a competitive situation arises wheremanuscripts. In certain instances author advances can be bid up to a level at which we cannot generate a sufficient return on our investment.
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 technology. We either provide software and/or internet services or we 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 technology security (including virus and hacker attacks), e-commerce, enterprise resource planning system implementations and upgrades and business continuity in the event of a disaster at a key data center.

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Our reported earnings may be adversely affected by changes in our pension costs and funding requirements due to poor investment returns and/or changes in pension regulations.
      We operate 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 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 scheme is adequately funded to meet its ongoing and future liabilities. Our earnings may be adversely affected by lower investment returns due to a general deterioration in equity or bond markets, requiring increased company funding of these schemes to eliminate any deficits over time. Similarly, changes in pension regulations, including accounting rules, may affect our pension costs and funding status.
Sarbanes-Oxley (SOX) 404 Compliance cost
      Beginning with our 2006 fiscal year, we will be required to comply with section 404 of SOX relating to internal control over financial reporting. Our SOX 404 implementation project commenced in 2003 and we believe we are on track to be compliant. However, the cost of complying with SOX 404 may reduce our earnings.

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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.
      As with any international business our earnings can be materially affected by exchange rate movements. We are particularly exposed to movements in the US dollar to sterling exchange rate as approximately 65% of our revenue is generated in US dollars. We estimate that if 20032004 average rates had prevailed in 2004,2005, sales for 20042005 would have been £306£46 million or 8% higher.1% lower. 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. We estimate that a five cent change in the average exchange rate between the US dollar and sterling in any year could affect our reported earnings per share by approximately 1 penny.pence.
ITEM 4.INFORMATION ON THE COMPANY
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, 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
      Although our businesses increasingly share markets, brands, processes and facilities, they consist of three core operations:
     Pearson Education is a global leader in educational publishing and services. We are a leading international publisher of textbooks, supplementary materials and electronic education programs for elementary and secondary school, higher education and business and professional markets worldwide. We also play a major role in the testing and certification of school students and professionals, mainly in the US but increasingly in the UK. Pearson Education consists of the following three operating segments:
• School — publisher, provider of testing and software services for primary and secondary schools
• Higher Education — publishes textbooks and related course materials for colleges and universities
• Professional — publishes texts, reference and interactive products for industry professionals. Provides various testing and service arrangements for government departments and professional bodies.
     The FT Group consists of our international newspaper, print and online financial information, business magazine and professional publishing interests. Our flagship product is theFinancial Times,published internationally and known for its premium editorial content and international scope both in newspaper and internet formats. The FT Group comprises the following operating segments:

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• FT Publishing — publishes theFinancial Times, other business newspapers, magazines and specialist information
• Interactive Data (“IDC”) — provides financial and business information to financial institutions and retail investors.
     The Penguin Group is one of the premier English language publishers in the world, with brand imprints such as Penguin, Putnam, Berkley, Viking and Dorling Kindersley (“DK”). We publish the works of many authors in an extensive portfolio of fiction, non-fiction, reference and illustrated works.
Our Strategy
      Since 1997, we have reshaped Pearson by divesting a range of non-core interests and investing over $7 billion in education, consumer publishing and business information companies. Each one of our businesses

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aims to benefit from educating, informing and entertaining people in an increasingly knowledge-based economy. Our strategy is:
 • to focus on businesses which provide “education”“education,” in the broadest sense of the word.word, through intellectual property;
 
 • to provide a combination of publishing, both in print and online, and related services that make our publishing more valuable and take us into new, faster-growing markets.markets;
 
 • to continue to invest in the growth of our businesses, including:
 • extending our lead in education publishing, investing in new programs for students in School and Higher Education and in testing and software services that help educators to personalize 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;
 
 • building the international reach of theFinancial 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.content;
 • to foster a collaborative culture which facilitates greater productivity and innovation by sharing processes, costs, technology, talent and assets across our business.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 Education
      Pearson Education is one of the world’s largest publishers of textbooks and online teaching materials based on published sales figures and independent estimates of sales. Pearson Education serves the growing demands of teachers, students, parents and professionals throughout the world for stimulating and effective education programs. With federal and state governments under pressureincreasingly required to measure academic progress against clear objective standards, the market for educational testing services in the United States has grown significantly. Pearson Assessments & Testing enablessignificantly, as have markets around the world. Our integrated approach to education has helped us to combine testing and assessment withgrow faster because of 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 and reporting.breadth.
      We report Pearson Education’s performance along the lines ofby the three marketsmarket segments it serves: School, Higher Education and Professional. In 2004,2005, Pearson Education had sales of £2,356£2,663 million or 60%65% of Pearson’s total sales (61%(63% in 2003)2004).
School
      In the United States, our School business includes publishing, testing and software operations. Outside of the United States, we have a growing English Language Teaching business and we also publish school and

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college materials in local languages in a number of countries. In the United States, we publish for pre-kindergarten through 12th grade, with a comprehensive range of textbooks, supplementary materials and electronic education programs. Pearson Education’s elementary school imprint, Pearson Scott Foresman, and premier secondary school imprint, Pearson Prentice Hall School, 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 Digital Learning, whose offerings include SuccessMaker, NovaNet and the Waterford Early Reading Program. Through LessonLab,Pearson Achievement Solutions, 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.
      In the US, Pearson’s Assessmentsassessments & Testingtesting operations make us aare leading service providerproviders in the markets for test development, 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 each year.

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      Pearson School Systems provideprovides district-wide solutions that combine the power of assessment, student information, financial systems and actionable reporting to improve student performance. We are the market leader in student information with our solutions used by over 16,00020% of schools nationwide and we are the provider of the newest technologies for benchmark testing and student progress analysis.
      Over 90% of education spending for kindergarten through 12th grade in the United States is financed at the state or local level, with the remainder coming from Federalfederal funds. The School division’s major customers are state education boards and local school districts. In the United States, 21 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 marketsell directly to the school districts. In the states without adoptions, orcalled “open territories”, local school districts choose education programs from the extensiveentire range available. We actively marketsell to school districts in open territories as well.
      In 2004, Edexcel won a five year contract for the administration and marking of “Key Stage” testing for 11 and 14 year old students in the UK. Edexcel also began electronic scanning and marking of GCSE and A-level exams in 2004. 3.54 million scripts are expected to bewere marked electronically in 2005.
Higher Education
      Pearson Education is the United 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 forces call on college educators, who choose the textbooks and online resources to be purchased by their students. In 2004, over one2005, 1.8 million college students registered for our online offerings, which include homework and assessment products, online study guides and textbook companion websites. Many of our online offerings are integrated with course management systems that provide easy-to-use tools that enable professors to create online courses. In addition, our custom publishing business, Pearson Custom, works with professors to produce textbooks specifically adapted for their particular course.
Professional
      We publish text, reference, and interactive products 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. Publishing imprints in this area include Addison Wesley Professional, Prentice Hall PTR, and Cisco Press (our three high end(IT professional imprints), Peachpit Press and New Riders Press (our graphics(graphics and design imprints), Que/Sams (consumer and professional imprint), and Prentice Hall Financial Times (professional business imprint) and BradyGames (software game guides(business imprint). We also generate revenues through our own website — InformIt.InformIT, and through Safari Books Online (a joint venture with O’Reilly Media). We also provide services to

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professional markets. We manage significantmarkets, managing several commercial contracts to implement and execute qualification and assessment systems for individual professions, including IT professionals and nurses.
      Our Government Solutions group manages and processes student loan applications on behalf of the US Department of Education and hasEducation. It also provides a number of education, testing-relatednon-education and other testing and service-related contracts with various government departments.agencies both within and outside the US.
      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 2004, our Assessment & Testing business won a number of contracts, the most significant beingContracts include a seven year contract to develop and deliver the Graduate Management Admissions Test (GMAT) worldwide. We will begin receiving revenues from this contractworldwide, beginning in 2006. Another successful tender was for theJanuary 2006 and a nine year,non-exclusive contract to deliver the National Association of Security Dealers exams over nine years on a non-exclusive basis.exams.
The FT Group
      The FT Group, one of the world’s leading business information companies,sources, aims to provide a broad range of business information,data, analysis and services to an audience of internationally-minded business people. In 2004,2005, the FT Group had sales of £777£629 million, or 20%15% of Pearson’s total sales (19%(16% in 2003)2004). The FT Group’s business is global,

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producing a combination of news, data, comment, analysis and context. In addition to professional and business consumers, individuals worldwide are demanding such strategic business information. We believe that the FT Group is well positioned to supply information and benefit from these trends.
The Financial Times NewspaperFT Publishing
      TheFinancial Timesis a leading international daily business newspaper. Its average daily circulation of 427,800439,563 copies in December 2004,2005, as reported by the Audit Bureau of Circulation, gives theFinancial Timesthe second largest circulation of any English language business daily in the world. TheFinancial Timesderived approximately 67% of its revenue in 20042005 from advertising and approximately 33% from circulation.print and online content sales. The geographic distribution of theFinancial Timesaverage daily circulation in 20042005 was:
     
United Kingdom/ Republic of Ireland  31%32%
Continental Europe, Africa and Middle East  32%31%
Americas  30%29%
Asia  7%8%
      TheFinancial Timesis printed on contract in 2423 cities around the world and our sales mix is increasingly international. The newspaper draws upon an extensive local network of correspondents to produce unique, informative and timely business information. For production and distribution, theFinancial Timesuses computer-driven communications and printing technology for timely delivery of the various editions of the newspaper to the appropriate geographic markets. TheFinancial Timesis distributed through independent newsagents and direct delivery to homes and institutions.
      The FT seeks to make its content available both in print and online, through FT.com, its internet service, and sales of electronic content to third parties. FT.com charges subscribers for detailed industry news, comment and analysis, while providing general news and market data to a wider audience. The business earns revenues by selling content directly, selling advertising and selling subscriptions. At the end of JanuaryDecember 2005, FT.com had 76,00084,000 paying subscribers. According to figures independently audited by ABC, the site has 3.7subscribers and an average of 3.2 million unique monthly users and 58.3 million page views.users.
Financial Times Publishing
      Our other business publishing interests include France’s leading business newspaper,Les Echoswith an average daily 2005 circulation of 119,800119,000 and lesechos.fr, its internet service.
      FT Business produces specialist information on the retail, personal and institutional finance industries and publishes the UK’s premier personal finance magazine,Investors Chronicle, together withMoney Management, Financial AdvisorandThe Bankerfor professional advisers and financial sector professionals.

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Recoletos
      On December 14, 2004, the Group announced an agreement with Retos Catera S.A. to sell our 79% stake in Recoletos, a publicly quoted Spanish media group that we built with its Spanish founding shareholders over a number of years, for gross proceeds of743 million. The consortium of investors behind Retos Cartera includes members of the Recoletos management team, individual Spanish investors and the Banesto banking group. We decided to accept Retos Catera’s financial offer as Recoletos’ strategy in sport, lifestyle and general publications had taken it further away from the FT Group’s core focus on financial and business news and information. The sale became unconditional in February, 2005 and net cash proceeds of £372 million were received on April 8, 2005.
Interactive Data Corporation
      Through our 61%62% interest in Interactive Data Corporation (“Interactive Data”), we are one of the world’s leading global providers of financial market data, analytics and business informationrelated services to financial institutions, active traders and retailindividual investors. Interactive Data supplies time-sensitive pricing, dividend, corporate action, and descriptive information 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 support of their trading, analysis, portfolio management, and valuation activities.
Recoletos
      On December 14, 2004, the Group announced that we had accepted an offer from Retos Catera S.A. to sell our 79% stake in Recoletos, a publicly quoted Spanish media group that we built with its Spanish founding shareholders over a number of years, for gross proceeds of743 million. The consortium of investors behind Retos Cartera included members of the Recoletos management team, individual Spanish investors and the Banesto banking group. We decided to accept the offer as Recoletos’ strategy in sport, lifestyle and general publications had taken it further away from Pearson’s core focus on financial and business news and information. The sale became unconditional in February, 2005 and net cash proceeds of £371 million were received on April 8, 2005 resulting in a profit on disposal of £306 million.
Joint Ventures and Associates
      As at 20042005 year end, the FT Group also had a number of other associates and joint ventures, including:
      A 50% interest inFT Deutschland,launched in February 2000, in partnership with Gruner + Jahr,Jahr.FT Deutschland is oura German language newspaper with a fully integrated online business news, analysis and data service. Its circulation grew by 5.4%6% in 20042005 to 96,900102,000 copies.

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      A 50% interest in The Economist Group, which publishes the world’s leading weekly business and current affairs magazine. Its circulation increased by 10% to 1,038,519 for the January to June 2005 period.
      A 50% interest in FTSE International, a joint venture with the London Stock Exchange, which among other things, publishes a wide range of global indices, including the important FTSE index.
      A 33% interest inVedomosti, a leading Russian business newspaper and a partnership venture with Dow Jones and IMH Media Ltd.
      A 50% interest inBusiness Day andFinancial Mail, publishers of South Africa’s leading financial newspaper and magazine.
      A 14% interest inBusiness Standard, India’s secondthird largest daily financial newspaper.
      A 22% interest in MarketWatch, a financial and business information website (sold in January 2005).
The Penguin Group
      Penguin is one of the premier English language book publishers in the world. We publish an extensive backlist and frontlist of titles, including some of the very best new fiction and non-fiction, literary prize winners and commercial bestsellers. 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. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the United States, the United Kingdom, 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’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2004,2005, Penguin’s US imprints placed 132129 titles onThe New York Timesbestseller list. In the United Kingdom,

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49 54 Penguin titles featured on the Nielsen Bookscan top fifteenten 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 and online.
      In 2004,2005, Penguin had sales of £786£804 million, representing 20% of Pearson’s total sales (21% in 2003)2004). Revenues are balanced between frontlist and backlist titles. The Penguin Group earns over 95% 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.
      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.
      The Penguin Group’s gateway internet site, Penguin.com, provides access to its focused websites in the United States, Canada, United Kingdom and Australia. Websites have also been developed to target certain niche audiences. For example, Penguinclassics.com has an entire online service for the classics, with anthologies, original essays, interviews and discussions and links to other classics sites.
      In 2004, we decided to close Penguin TV, created from the former Pearson Broadband Television Group and specializing in two areas: factual, non-fiction documentary programming and children’s programming.
Competition
      All of Pearson’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 as McGraw-Hill, Reed Elsevier, Houghton Mifflin and Thomson. 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’s newspapers and magazines compete with newspapers and other information sources, such asThe Wall Street Journal,by offering timely and expert journalism. It competes for advertisers with

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other forms of media based on the ability to offer an effective means for advertisers to reach their target audience. The efficiency of its cost base is also a competitive factor.
      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.
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
      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

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our 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
      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 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
      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
      InOn January 2005, we9, 2006 Pearson announced the salepurchase of our 22.4% stake1,130,739 shares in MarketWatchInteractive Data from an individual shareholder for $21.67 per share in cash. This purchase brings Pearson’s total holding in Interactive Data to Dow Jones for $101 million.almost 62%.
      In February 2005, we acquired the remaining 25% of Edexcel Limited that we did not already own for £30 million.
      In April 2005, we completed the sale of our 79% stake in Recoletos to Retos Catera S.A, receiving net cash proceeds of £372 million.
      In June 2005, weOn January 23, 2006 Pearson announced the acquisition of AGS PublishingPromissor, a leading professional testing business from WRC MediaHoughton Mifflin Company for $270 million. AGS Publishing specialises$42m in cash.
      On April 25, 2006 Pearson announced the acquisition of National Evaluation Systems, Inc, a leading teacher certification testing and publishing for students with special educational needscompany in the United States school market.US.

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      On May 5, 2006 Pearson announced the acquisition of an 80% stake in Paravia Bruno Mondadori, one of Italy’s leading educational publishing companies.
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, 2004,2005, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.

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    Percentage
    Interest/Voting
Name Country of Incorporation/Residence Power
     
Pearson Education
      
Pearson Education Inc. Inc United States (Delaware)  100% 
Pearson Education Ltd. Ltd England and Wales  100% 
NCS Pearson Inc. Inc United States (Minnesota)  100% 
FT Group
      
The Financial Times Limited England and Wales  100% 
Financial Times Business Ltd. Ltd England and Wales  100% 
Interactive Data Corporation United States (Delaware)  61%
Recoletos Grupo de Comunicacion SASpain79% 
Les Echos SA France  100% 
The Penguin Group
      
Penguin Group (USA) Inc. Inc United States (Delaware)  100% 
The Penguin Publishing Co Ltd. Ltd England and Wales  100% 
Dorling Kindersley Holdings Ltd. Ltd England and Wales  100% 
Property, Plant and Equipment
      Our headquarters is located at leasehold premises in London, England. We own or lease over approximately 650 properties in more than 50 countries worldwide, the majority of which are located in the United Kingdom and the United States.
      All of the properties owned and leased by us are suitable for their respective purposes and are in good operating condition.
      We own the following principal properties:
       
General Use of Property Location Area in Square Feet
     
Warehouse Pittstown, Pennsylvania, USA  510,000 
Warehouse Kirkwood, New York, USA  409,000 
Offices Iowa City, Iowa, USA  310,000 
Offices Old Tappan, New Jersey, USA  210,100 
Warehouse/office Cedar Rapids, Iowa, USA  205,000 
Offices Reading, Massachusetts, USA(1)USA  158,527177,800 
Offices London, UK  152,986155,000 
Printing/ Processing Owatonna, Minnesota, USA  128,000 
Printing/ Processing Columbia, Pennsylvania, USA  121,400 
Offices Eagan, Minnesota, USA  109,500 
Offices Mesa, Arizona, USA  96,000 
(1) Held for sale.

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      We lease the following principal properties:
       
General Use of Property Location Area in Square Feet
     
Warehouses/ Offices Lebanon, Indiana, USA  1,091,400 
Warehouse/ Offices Cranbury, New Jersey, USA  886,700 
Warehouse Indianapolis, Indiana, USA  737,850 
Warehouse/ Offices Newmarket, Ontario, Canada  518,128 
Warehouse/ OfficesRugby, UK476,000
Offices Upper Saddle River, New Jersey, USA  474,801
Warehouse/ OfficesRugby, UK446,000
OfficesLondon, UK375,000 
Offices Hudson St., New York, USA  302,000 
OfficesLondon, UK273,000
Warehouse/ Offices Austin, Texas, USA  226,100 
WarehouseOffices Bitteswell, UKBoston, Massachusetts, USA  221,909225,299 
Warehouse Scoresby, Victoria, Australia  215,280215,820 
Offices Boston, Massachusetts, USA  191,360 
Offices Glenview, Illinois, USA  187,500 
Offices Bloomington, Minnesota, USA  151,056 
Offices Parsippany, New Jersey, USA  143,800 
Offices Harlow, UK  137,900 
OfficesChester, Virginia, USA123,200
Warehouse San Antonio Zomeyucan, Mexico  107,642113,638 
Offices Boston, Massachusetts, USALondon, UK  102,751112,000 
Offices New York, New York, USA  101,000
OfficesBedford, Massachusetts, USA80,348
OfficesCamberwell, Victoria, Australia52,656107,939 
ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS
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 3435 to our consolidated financial statements, included in “Item 17. Financial 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. These consolidated financial statements are the Group’s first financial statements to be prepared in accordance with IFRS, as adopted by the EU. Consolidated financial statements of Pearson up to and including December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. Note 34 included in “Item 17. Financial Statements”, describes how, in preparing the consolidated financial statements, the Group has applied accounting standards as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1.
General Overview
Introduction
      Sales declinedincreased from £4,048 million in 2003 to £3,919£3,696 million in 2004 to £4,096 million in 2005, an increase of 11%. The increase reflected growth across all the businesses with a decrease of 3%. This declineparticularly strong performance at Pearson Education. The year on year growth was attributable to the impact ofimpacted by exchange principally the weakness of therates but less so than in previous years. The average US dollar exchange rate strengthened slightly in 2005, which had the affecteffect of reducingincreasing reported sales in 20042005 by £306£46 million when compared to the equivalent figure at constant 20032004 rates. After taking out the effect of currency there were increases in sales at Pearson Education and IDC. Reported operating profit increased by 2%33% from £226 million in 2003 to £231£404 million in 2004 despiteto £536 million in 2005. Pearson Education benefited from strong sales growth and improved margins in the adverse impactSchool and Higher Education businesses. FT Group benefited from improved profits largely as a result of increases in advertising revenues at FT Publishing and IDC’s continued strong organic growth and synergies from the integration of recent acquisitions. Penguin profits benefited from

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the effect of exchange rates. Thererates but still improved from the prior year, with margins increasing despite only a small increase in sales. Included within operating profit in 2005 was good progressthe profit on the sale of MarketWatch of £40 million. Equivalent sales of businesses and investments in 2004 saw a profit of £9 million. Reported operating profit in 2005 was £12m higher than the equivalent figure reported at Pearson Education and a significant improvement at the Financial Times, but Penguin’s results were disappointing.constant 2004 exchange rates.
      A £171 million profitProfit before taxation in 20042005 of £466 million compares to a profit before taxation of £152£325 million in 2003.2004. The increase of £19£141 million or 13% mainly reflects the reduced charge for goodwill amortizationimproved operating performance and a reduction in net finance costs. Net finance costs which together offset the impact of exchange. The goodwill amortization charge fell by £40reduced from £79 million in 2004 due to the weaker US dollar and goodwill£70 million in respect of Family Education Network and Marketwatch having been fully amortized in 2003. Finance costs2005. Net interest payable benefited from the reduction in average

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net debt following receipt of the proceeds from the sale of Recoletos and MarketWatch and good cash generation from the businesses. Partially offsetting a generalthis effect was an increase in the group’s average net interest rate payable driven principally by the strong rise in US dollar interest rates. Netrates in the year. As at January 1, 2005 we adopted IAS 39‘Financial Instruments: Recognition and Measurement’ in our financial statements. This has had the effect of introducing increased volatility into the net finance cost and in 2005 the adoption of IAS 39 reduced net finance costs also benefitedby £14 million. There was no equivalent benefit in 2004 from a2005 to the one-off credit of £9 million relating tofor interest on a repayment of tax that occurred in France.2004.
      In December 2004,April 2005, Pearson announced its intention to dispose ofsold its 79% interest in Recoletos Grupo de Comunicacion S.A. to Retos Cartera, a consortium of investors, as part of a tender offer for all of Recoletos. The transaction was approved bybecame unconditional on approval from the Spanish regulatory authorities in February 2005, and the sale closed in April 2005, realizing net cash proceeds of £372 million.2005. The results of Recoletos have been consolidated for the period to February 28, 2005 and have been shown as discontinued operations in the consolidated profitincome statement for 2005, 2004 and loss account for 2004, 2003 and 2002.2003.
      Net cash inflowgenerated from operating activities increased to £530£709 million in 2005 from £562 million in 2004 from £359 million in 2003.with very strong cash generation across all the businesses. Cash flow in 2004 benefited from collection of the $151 million receivable in respect of the TSATransportation Security Administration (“TSA”) contract, together with continued underlying improvementsa contract to create a qualification, assessment, staffing and placement system for security screeners at airports in Pearson Education and IDC.the US. The weaknessrelative strength of the US Dollar reduceddollar also increased the value of our cash flows in Sterling. Capital expenditure was in excess of depreciation indown from 2004 due tofollowing the up-front expenditure on professional testing contracts in that year but oninvestment in pre-publication increased. On an average basis, the use of working capital continued to improve. Cash outflow on acquisitionsThe net cash inflow from disposals net of disposal proceedsacquisitions was £20£175 million in 2005 compared to a net cash outflow of £4 million in 2004. Dividends paid of £222 million in 2005 (including £17 million paid to minority interests) compares to £197 million in 2004 and, after dividends paid of £195 million and a favorablean adverse currency movement of £75£121 million, overall net borrowings (excluding finance leases) fell 11%18% from £1,361£1,221 million at the end of 20032004 to £1,206£996 million at the end of 2004.2005.
Outlook
      We expect 2006 to be another good year for Pearson as we anticipate increasing margins and growth ahead of our markets. We expect to growachieve strong earnings stronglygrowth, good cash generation and a further significant improvement in 2005 and beyond, with further progress on cash and return on invested capital. Our outlook is:
Pearson Education
      We expect our worldwide School businessPearson Education to deliver significant underlyingachieve sales and profit growth in 2005. Withthe 3-5% range, with similar rates of growth in each of its three worldwide businesses (School, Higher Education and Professional). We expect margins to improve in School and Professional and remain stable in the Higher Education business. School testing is strengthened by 2005 contract wins with a stronger adoption calendar, healthier state budgets, federal funds for readinglifetime value of $700 million (including Texas, Virginia, Michigan and testingMinnesota) and our investment in new programs, we expect ourthe US School publishing and testing operationsnew adoption market is expected to achieve double-digit sales growth. We also expect to achieve steady margin improvement in our US school publishing businessgrow strongly over the next three years, as we benefit from the adoption calendar in both 2006 andperiod 2007 in which weto 2009.
      We expect a significant increase in our new adoption participation rate compared with 2005.
      Our US Higher Education business continuesto continue to benefit from its scale, the strength of its publishing and its lead in technology. 2006 is expected to be a strong year for first editions, with major new titles in statistics, algebra, psychology, economics, health and writing. We expect that those qualities will enableplan to launch online homework and assessment programs in new curriculum areas including economics, psychology and development writing and to extend our businesshighly successful customized print publishing model to grow ahead of its industry once again in 2005, at a similar rate to 2004online curriculum and with similar margins. We see good growth prospects for our US and international higher education businesses.course management programs.
      We expect our Professional business to grow sales in the mid-single digits in 2005, helped by continued growth in our contract businesses and a stabilization in technology publishing. We expect this division to deliver sustained growth on the basis of our long-term contracts in Government Solutions and Professional Testing.Testing and to improve margins after the successful start-up of major new contracts in 2004 and 2005. We also expect to maintain our leading market share in professional

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publishing with a stronger schedule of releases in the professional and consumer technology market in 2006 and a strong list within the business publishing imprints.
FT Group
      We expect further profit progressimprovement at the FT Group. AdvertisingTheFinancial Times continues to show good momentum with circulation up 4% and advertising revenues at the Financial Times were up 3%continue to show double digit growth in the early part of 2005 and, assuming similar advertising revenue growth for the full year, we would expect the Financial Times to be around breakeven for the year as a whole.2006. IDC expects another good year, benefiting from similar business conditions to grow its reported revenues2005, strong organic growth and net income in the high single-digit to low double-digit range.
      The resultscontribution of Recoletos will be consolidated for January and February 2005 and, with the launch of its new freesheet during these months, its results during this period are likely to be around breakeven.recent acquisitions.
The Penguin Group
      Penguin is expected to grow at a similar rate in 2006 to 2005 will bewith continued investment in new markets and international talent and with a yearstrong list of transition for Penguin. We expect profitsnew titles from best selling authors. Margins are expected to improve in the UK, in spite of dual-running costs at our distribution centers. In the USsteadily as we are planning on the basis that the weak market conditions experienced in the second half of 2004 continue. We are taking action to adjust our publishing program and reduce costs, and we will expense approximately £5 million as a result of those actions in 2005.benefit from efficiency gains.

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Exchange rates
      We generate around two-thirds of total revenuessales in the US and a five cent change in the average exchange rate for the full year (which in 20042005 was £1: $1.83)$1.81) will have an impact of approximately 1p on adjusted earnings per share.
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
   
  2004 2003 2002
       
  £m £m £m
Pearson Education  2,356   2,451   2,756 
FT Group  587   588   578 
The Penguin Group  786   840   838 
          
Continuing operations  3,729   3,879   4,172 
Discontinued operations  190   169   148 
          
Total  3,919   4,048   4,320 
          
              
  Year Ended December 31
   
  2005 2004 2003
       
  £m £m £m
Education:     ��      
 School  1,295   1,087   1,149 
 Higher Education  779   729   770 
 Professional  589   507   503 
FT Group:            
 FT Publishing  332   318   315 
 IDC  297   269   273 
Penguin  804   786   840 
          
Total  4,096   3,696   3,850 
          
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
   
  2004 2003 2002
       
  £m £m £m
United Kingdom  545   474   411 
Continental Europe  300   294   271 
North America  2,505   2,742   3,139 
Asia Pacific  261   255   249 
Rest of World  118   114   102 
          
Continuing operations  3,729   3,879   4,172 
Discontinued operations  190   169   148 
          
Total  3,919   4,048   4,320 
          
             
  Year Ended December 31
   
  2005 2004 2003
       
  £m £m £m
European countries  963   835   768 
North America  2,717   2,504   2,742 
Asia Pacific  300   263   255 
Other countries  116   94   85 
          
Pearson Group  4,096   3,696   3,850 
          
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 $1.81 in 2005, $1.83 in 2004 and $1.63 in 2003 and $1.51 in 2002.2003. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. The Group generates approximately 65% of its sales in US dollars and a five cent change in the average exchange rate for the full year has an impact of approximately 1 pence on earnings per share. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information.

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Critical Accounting Policies
      Our consolidated financial statements, included in Item 17. “Financial Statements”, are prepared based on the accounting policies described in note 1 to the consolidated financial statements which are in conformityaccordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP.

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      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 34,35, 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
      Sales representRevenue comprises 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 anticipated returns, provided to external customers and associates.after eliminating sales within the Group. Revenue is recognized as follows:
      Revenue from the sale of books is recognized when title passes. AnticipatedA provision for anticipated returns areis made based primarily on historical return rates. If these estimates do not reflect actual return rates experiencedreturns in recent years.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 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 recognized for each element as if it were an individual contractual arrangement.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognized as performance occurs. 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 revenues recognized on a percentage of completion basis. Losses on 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. The assumptions, risks and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported.
      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
      Pre-publication costs represent direct costs incurred in the development of educational programs and titles prior to their publication. These costs are carried forward in stockcurrent intangible assets where the title to which they relate has a useful life in excess of one year.will generate probable future economic benefits and costs can be measured reliably. These costs are amortized 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, usually with a higher proportion of the amortization taken in the earlier years. The investment in pre-publication has been disclosed as part of the investing activities in the cash flow statement. The assessment of useful life and the calculation of amortization involve a significant amount of estimation and management judgment asbased on historical trends and management must estimate the sales cycle and lifeestimation of a particular title.their future potential sales. The overstatement of useful lives could result in excess amounts being carried forward in stock

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intangible assets that would otherwise have been written off to the profit and loss account in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication costs.

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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. Royalty advances which will be consumed within one year are held in current assets. This represents the operating cycle of consumer publishing titles. Royalty advances which will be consumed after one year are held in non-current assets. 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 judgmentjudgement in determining the profitability of individual author contracts. If the estimated net 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.written off.
Defined Benefit PensionsPension Obligations
      The liability in respect of defined benefit pension plans is the present value of the defined benefit obligation at the 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.
      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 statement of recognized income and expense.
      The service cost, representing benefits accruing over the year, is included as an operating cost and the unwinding of the discount rate on 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.
      The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes principally the UK-based scheme, is charged to the profit and loss account in order to apportion the cost of pensions over the service lives of the employees in the schemes, in accordance with Statement of Standard Accounting Practice 24. The determination of the pension costs, as well as the pension obligation, dependdepends on the selection of certain assumptions (see note 24 in “Item 17 — Financial Statements”) which include the expected long-termdiscount rate, ofinflation rate, salary growth, longevity and expected return on scheme assets, salary inflation rates and discount 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 the profit and loss accounts in future years. In particular, a reduction in the realized long-term rate of return on scheme assets and or a reduction to the discount rates would result in higher pension costs in futuresubsequent periods.
Deferred TaxIncome Taxes
      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 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 income tax is provided, using the liability method on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. 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 realized or the deferred income tax liability is settled.
      Deferred tax assets and liabilities require management judgment in determining the amounts to beare recognized and in particular, the extent to which deferred tax assets can be recognized. Under Financial Reporting Standard 19Deferred 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 assets to the extent that they are recoverable, based on the probabilityit is probable that therefuture taxable profit will be future taxable incomeavailable against which thesethe temporary differences can be utilized.
      Deferred income tax losses andis provided in respect of the undistributed earnings of subsidiaries, other timing differences maythan where it is intended that those undistributed earnings will not be utilized. We regularly review our deferredremitted in the foreseeable future.
      Deferred tax assetsis recognized in the income statement, except when the tax relates to ensure that they are recoverable and have exercised significant judgments when consideringitems charged or credited directly to equity, in which case the timing and level of future taxable income. Our business plans and any future tax planning strategies are considerationsis also recognized in our assessment of recoverability. If a deferred tax asset is not considered recoverable, a valuation allowance is recorded to the extent that recoverability is not deemed probable.equity.

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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 asGoodwill represents the nature and ageexcess of the business andcost of an acquisition over the stabilityfair value of the industry in whichGroup’s share of the acquired business operates as well as typical life spansnet identifiable assets of the acquired products to whichsubsidiary or associate at the goodwill attaches. The estimated useful lives ascribed to goodwill range from 3 to 20 years.date of acquisition. Goodwill relating toon 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. Gains and losses on the more established book publishing businesses is typically written off over 20 years whiledisposal of an entity include the carrying 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, 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

24


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, 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 are 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 are prepared at a reporting unit level as defined by Statement of Financial Accounting Standards (“SFAS”) No. 142 and incorporates 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.entity sold.
UK GAAPIFRS 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, 2004 under UK GAAP was £88 million compared with a profit of £182 million under US GAAP for the same year. The profit for the financial year ended December 31, 2003 under UK GAAP was £55 million, compared with a profit of £173 million under US GAAP for the same year. The loss for the financial year ended December 31, 2002 under UK GAAP was £111 million compared with a profit of £210 million under US GAAP for the same year.respective period:
      Equity shareholders’ funds at December 31, 2004 under UK GAAP were £2,603 million compared with £3,218 million under US GAAP. Equity shareholders’ funds at December 31, 2003 under UK GAAP were £2,893 million compared with £3,333 million under US GAAP.
      The Company has restated its UK GAAP shareholders’ funds for the financial years ended December 31, 2003 and 2002 for adoption of UITF Abstract 38 “Accounting for ESOP trusts”. This has reduced shareholders’ funds as at December 31, 2003 and 2002 by £59 million and £62 million respectively (see note 24 in “Item 17. Financial Statements”).

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      The Company has restated its US GAAP profit and loss account and shareholders’ funds for the financial years ended December 31, 2003 and 2002 to reflect the correct accounting treatment in respect of incentives and fixed rental escalations under one of its leases. Previously the incentives were recognized in the profit and loss account over the period during which the lease incentives were applicable until the lease returned to a market level. Additionally, fixed future market-based rent increases were charged to the profit and loss account as they became applicable under the terms of the lease. As required by US GAAP, both the lease incentives and fixed market-based rent increases are now being charged to the profit and loss account over the entire term of the lease. Consequently, the profit reported under US GAAP for the 2003 and 2002 financial years has been reduced by £14 million and £12 million, respectively, on a pre-tax basis and £10 million and £9 million, respectively, on a post-tax basis and the shareholders’ funds reported as at December 31, 2003 and 2002 has been reduced by £19 million and £9 million, respectively, from amounts previously reported.
              
  December 31, 2005 December 31, 2004 December 31, 2003
       
  £m £m £m
Profit for the financial year
            
 IFRS  624   262   252 
 US GAAP  411   182   173 
Equity shareholders’ funds
            
 IFRS  3,564   2,800     
 US GAAP  3,838   3,218     
      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 discussed in further detail under “— Accounting Principles” and in note 3435 to the consolidated financial statements.
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 £400 million, or 11%, to £4,096 million in 2005, from £3,696 million in 2004. Sales growth was due to strong performance in our markets, helped in part by a favourable exchange rate impact. We estimate that had the 2004 average rates prevailed in 2005, sales would have been approximately £4,050 million.
      Pearson Education had a strong year with an increase in sales of 15%. The School and Professional businesses were the biggest contributors to this growth with increases of 19% and 16% respectively. Higher Education growth was 5% in total and 6% in the US. Pearson’s US Higher Education business has grown faster than the industry for seven straight years. The School publishing business benefited from a large share of the new adoption market in the US and testing sales were up more than 20% as the business made significant market share gains and benefited from mandatory state testing in the US under No Child Left Behind. In the Professional business, Professional testing and Government Solutions sales were both up by more than a third on last year with 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 growth in consumer technology publishing.
      The FT Group sales were 7% ahead of last year. FT Publishing sales were up by 4% driven by higher advertising revenues at theFinancial Times and IDC sales were up by 10% with organic growth at all its businesses aided by a full year contribution from FutureSource, acquired in September 2004, and the strength of the US dollar. Penguin’s sales grew by 2% with successful format innovation helping to offset the weakness in the mass market category in the US, down a further 4% for the industry in 2005.
      Pearson Education, our largest business sector, accounted for 65% of our sales in 2005, compared to 63% in 2004. North America continued to be the most significant source of our sales although sales there decreased, as a proportion of total sales, to 66% in 2005, compared to 68% in 2004.

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Cost of Sales and Operating Expenses
      The following table summarizes our cost of sales and net operating expenses:
         
  Year Ended
  December 31
   
  2005 2004
     
  £m £m
Cost of goods sold  2,022   1,789 
       
Distribution costs  249   201 
Administrative and other expenses  1,384   1,365 
Other operating income  (41)  (46)
       
Total operating expenses  1,592   1,520 
       
Cost of Sales.Cost of sales consists of costs for raw materials, primarily paper, printing costs, amortization of pre-publication costs and royalty charges. Our cost of sales increased by £233 million, or 13%, to £2,022 million in 2005, from £1,789 million in 2004. The increase mainly reflected the increase in sales over the period although the overall gross margin declined slightly from 52% in 2004 to 51% in 2005.
Distribution Costs.Distribution costs consist primarily of shipping costs, postage and packing and are typically a fairly constant percentage of sales.
Administration and Other Expenses.Our administration and other expenses increased by £19 million, or 1%, to £1,384 million in 2005, from £1,365 million in 2004, although as a percentage of sales they decreased to 34% in 2005, from 37% in 2004. The increase in administration and other costs comes principally from additional employee benefit expense, but cost savings and more modest increases in other administration expenses has enabled overall operating margins to improve.
Other operating Income.Other operating income mainly consists of sub-rights and licensing income and distribution commissions. Other operating income decreased 11% to £41 million in 2005 from £46 million in 2004, with the decrease mainly representing the continued decline in commissions received for distribution of third party books.
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 £40 million profit on the sale of our associate interest in MarketWatch. In 2004, other gains and losses amounted to £9 million, with the principal 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 £8 million in 2004 to £14 million in 2005. The increase was due to profit improvement at The Economist Group and a reduction in losses at FT Deutschland.
Operating Profit
      The total operating profit increased by £132 million, or 32.7%, to £536 million in 2005 from £404��million in 2004. This £132 million or 33% increase was due to increases across all the businesses, the one-off gain from the sale of MarketWatch of £40 million and a beneficial impact of exchange. We estimate that had the 2004 average rates prevailed in 2005, operating profit would have been £12 million lower.
      Operating profit attributable to Pearson Education increased by £56 million, or 20%, to £343 million in 2005, from £287 million in 2004. The increase was due to strong sales and improved margins in both the School and Higher Education businesses. Operating profit attributable to the FT Group increased by £63 million, or 90%, to £133 million in 2005, from £70 million in 2004. £40 million of the increase was due to the profit from the sale of MarketWatch but there were also increases at IDC of £13 million and FT Publishing of £10 million. Operating profit attributable to the Penguin Group increased by £13 million, or 28%, to £60 million in 2005, from £47 million in 2004. The increase at Penguin was due in part to increased efficiencies and improved margins and also due to exchange gains and one-off items in 2004. Penguin’s

25


operating profit in 2004 was reduced by costs associated with disruption in UK distribution following the move to a new warehouse and closure costs associated with Penguin TV.
Net Finance Costs
      Net finance costs reduced from £79 million in 2004 to £70 million in 2005. Net interest payable in 2005 was £77 million, up from £74 million in 2004. The group’s net interest rate payable rose by 0.9% to 5.9%. Although we were partly protected by our fixed rate policy, the strong rise in US dollar floating interest rates had an adverse effect. Year on year, average three month LIBOR (weighted for the Group’s borrowings in US dollars, euro and sterling) rose by 1.9% to 3.4%. This 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 introducing increased volatility into the net finance cost and in 2005 the adoption of IAS 39 reduced net finance costs by £14 million. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowing” below and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
Taxation
      The total tax charge for the year was £124 million, representing a 27% rate on pre-tax profits of £466 million. This compares with a 2004 rate of 19% (or £63m on a pre-tax profit of £325m). 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 the profit of £40m on the sale of Marketwatch.com was free of tax.
Minority Interests
      Following the disposal of our 79% holding in Recoletos in April 2005 and the purchase of the 25% minority stake in Edexcel in February 2005, our minority interests now mainly comprise the 39% minority share in IDC.
Discontinued Operations
      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 £3 million compared to an operating profit in the full year to December 31, 2004 of £26 million. The profit on disposal of Recoletos reported in 2005 was £306 million.
Profit for the Financial Year
      The total profit for the financial year in 2005 was £644 million compared to a profit in 2004 of £284 million. The overall increase of £360 million was mainly due to the profit on disposal of Recoletos and MarketWatch 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 2005.
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 78.2 pence in 2005 compared to 32.9 pence in 2004 based on a weighted average number of shares in issue of 797.9 million in 2005 and 795.6 million in 2004. This increase in earnings per share was due to the additional profit for the financial year described above and was not significantly affected by the movement in the weighted average number of shares.
      The diluted earnings per ordinary share of 78.1 pence in 2005 and 32.9 pence in 2004 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.
Exchange Rate Fluctuations
      The strengthening of the US dollar against sterling on an average basis had a positive impact on reported sales and profits in 2005 compared to 2004. We estimate that if the 2004 average rates had prevailed in 2005, sales would have been lower by £46 million and operating profit would have been lower by £12 million. See

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“Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.
Sales and Operating Profit by Division
      The following table summarizes our operating profit and results from operations for each of Pearson’s divisions. Adjusted operating profit is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFAS 131. Since 1998 we have reshaped the Pearson portfolio by divesting of non-core interests and investing in educational publishing and testing, consumer publishing and business information companies. During this period of transformation management has used adjusted operating profit to track underlying core business performance.
      In our adjusted operating profit we have excluded amortization of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization of acquired intangibles is not considered to be 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 but which distort the performance for the year. Other net finance costs of associates are foreign exchange and other gains and losses that represent short-term fluctuations in market value and are subject to significant volatility. These gains and losses may not be realized in due course as it is normally the intention to hold these instruments to maturity. Increased volatility has been introduced as a result of adopting IAS 39 ’Financial Instruments: Recognition and Measurement’ as at January 1, 2005. Finance costs and income of joint ventures and associates are reported within the share of results of joint ventures and associates that is included within operating profit. Group finance costs and income are reported separately in the income statement below the operating profit line.

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      Adjusted operating profit enables management to more easily track the underlying operational performance of the group. A reconciliation of operating profit to adjusted operating profit is included in the table below:
                   
  Year Ended December 31
   
  2005 2004
     
  £m % £m %
         
Total operating profit
                
Pearson Education:                
 School  142   27   112   27 
 Higher Education  156   29   133   33 
 Professional  45   8   42   10 
FT Group:                
 FT Publishing  58   11   8   2 
 IDC  75   14   62   16 
Penguin  60   11   47   12 
             
Total  536   100   404   100 
             
  
Add back:
                
  
Amortization of acquired intangibles
                
  School  5            
  Higher Education              
  Professional              
  Penguin              
  FT Publishing  1            
  IDC  5       5     
             
  Total  11       5     
             
  
Other net gains and losses
                
  School         (4)    
  Higher Education         (4)    
  Professional         (2)    
  Penguin         5     
  FT Publishing  (40)      (4)    
  IDC              
             
  Total  (40)      (9)    
             
  
Other net finance costs of associates
                
  School              
  Higher Education              
  Professional              
  Penguin              
  FT Publishing  2            
  IDC              
             
  Total  2            
             
Adjusted operating profit
                
Pearson Education:                
 School  147   29   108   27 
 Higher Education  156   31   129   32 
 Professional  45   9   40   10 
FT Group:                
 FT Publishing  21   4   4   1 
 IDC  80   15   67   17 
Penguin  60   12   52   13 
             
Total  509   100   400   100 
             

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School
      School business sales increased by £208 million, or 19%, to £1,295 million in 2005, from £1,087 million in 2004 and adjusted operating profit increased by £39 million, or 36%, to £147 million in 2005 from £108 million 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 £34 million to sales and £2 million 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,Sky for secondary schools,Total English for 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 andA-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 £50 million, or 7%, to £779 million in 2005, from £729 million in 2004. Adjusted operating profit increased by £27 million, or 21%, to £156 million in 2005 from £129 million in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £14 million to sales and £3 million to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      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 the 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 students are studying through one of our online programs, an increase of 20% on 2004; and custom publishing, which builds customized textbooks and online services around the courses of individual 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 and online learning capabilities into new markets in Asia and the Middle East.
      Higher Education margins were up by 2.3% points to 20%. Good margin improvement in the US and in international publishing was helped by shared services and savings in central costs, technology, production and manufacturing.
Professional
      Professional sales increased by £82 million, or 16%, to £589 million in 2005 from £507 million in 2004. Adjusted operating profit increased by £5 million, or 13%, to £45 million in 2005, from £40 million in 2004. Sales benefited from the strengthening US dollar, which we estimate added £8 million to sales when compared to the equivalent figures at constant 2004 exchange rates.

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      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. Government Solutions grew sales by 38%, helped by new contracts with the US Department of Education and the Social Security Administration worth over $800 million, together with strong growth from add-ons to existing programs, including those with the US Department of Health and Human Services.
      Overall margins in the Professional business were a little lower in 2005 compared to 2004 mainly due to new contract start-up costs at Government Solutions. Margins in the Professional publishing businesses were maintained despite falling sales.
FT Publishing
      Sales at FT Publishing (excluding discontinued businesses) increased by £14 million or 4%, from £318 million in 2004 to £332 million in 2005. Adjusted operating profit increased by £17 million, from £4 million in 2004 to £21 million in 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 £14 million to register a profit of £2 million in 2005 compared to a loss of £12 million 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 3.2 million.
      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 Deutschland reduced its losses and increased its average circulation despite a weak advertising market in Germany andThe Economist increased profits helped by an increase in circulation (10% to an average weekly circulation of 1,038,519 for the January-June ABC period).
Interactive Data
      Interactive Data, grew its sales by 10% from £269 million in 2004 to £297 million in 2005. Adjusted operating profit grew by 19% from £67 million in 2004 to £80 million in 2005. Both sales and adjusted operating profit benefited from the strengthening US dollar, which we estimate added £2 million to sales and £1 million 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 £804 million in 2005 from £786 million in 2004 and adjusted operating profit up 15% to £60 million in 2005 from £52 million in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £9 million to sales and £6 million 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, successful format innovation helped to address weakness in the mass market category that saw a further decline of 4% for the industry in 2005. 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.

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      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 approximately 250 worldwide — its largest ever investment in new talent. Sue Monk Kidd’s first novel,The Secret Life of Bees, has been a New York Times bestseller for almost two years; her second,The Mermaid Chair, reached number one 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, there was also strong performance from new fiction authors including Jilliane Hoffman, PJ Tracy, Karen Joy Fowler and Marina Lewycka.
Results of Operations
Year ended December 31, 2004 compared to year ended December 31, 2003
Consolidated Results of Operations
Sales
      Our total sales decreased by £129£154 million to £3,919£3,696 million in 2004, from £4,048£3,850 million in 2003. This decrease of 3%4% was attributable to the effect of foreign currency exchange. The strength of sterling compared to the US dollar had a significant negative effect on sales, and we estimate that had the 2003 average rates prevailed in 2004, sales would have been higher by £306£301 million. In constant exchange rate terms Pearson Education had a strong year with an increase in sales of 4%5%. The Higher Education and Professional businesses were the main contributors to this growth with the Higher Education business growing faster than its market for the sixth straight year and Professional benefiting from new contracts and add-ons to existing contracts at Pearson Government Solutions. The School business was helped by a full year contribution from Edexcel, the UK testing business, but otherwise sales were flat as new adoption spending in the US fell by approximately $200 million. The FT Group sales were ahead of last year after another good year at Interactive Data and a return to sales growth for the Financial Times newspaper in a more stable business advertising environment. Penguin’s results were disappointing with sales down 6% as reported, but flat on a constant currency basis after disruption to UK distribution and a weakness in the US consumer publishing market.
      Pearson Education, our largest business sector, accounted for 60%63% of our sales in 2004 compared to 61%and in 2003. North America continued to be the most significant source of our sales although sales in the region decreased, as a proportion of total sales, to 64%68% in 2004, compared to 67%71% in 2003. This decrease in 2004, however, reflects the comparative strength of sterling and the euro compared to the US dollar.

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Cost of Sales and Net Operating Expenses
      The following table summarizes our cost of sales and net operating expenses:
         
  Year Ended
  December 31
   
  2004 2003
     
  £m £m
Cost of sales
  (1,866)  (1,910)
       
Distribution costs  (243)  (239)
Administration and other expenses  (1,635)  (1,724)
Other operating income  46   51 
       
Net operating expenses
  (1,832)  (1,912)
       
         
  Year Ended
  December 31
   
  2004 2003
     
  £m £m
Cost of goods sold  1,789   1,846 
       
Distribution costs  201   206 
Administrative and other expenses  1,365   1,439 
Other income  (46)  (51)
       
Total operating expenses  1,520   1,594 
       
     Cost of Sales.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 decreased by £44£57 million, or 2%3%, to £1,866

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£1,789 million in 2004, from £1,910£1,846 million in 2003. The decrease mainly reflected the decrease in sales over the period with overall gross margin remaining consistent.constant.
     Distribution Costs.Distribution costs consist primarily of shipping costs, postage and packing.
     Administration and Other Expenses.Our administration and other expenses decreased by £89£74 million, or 5%, to £1,635£1,365 million in 2004, from £1,724£1,439 million in 2003. Administration and other expenses as a percentage of sales decreased to 42% in 2004, from 43% in 2003. Included within administration and other expenses is the charge for goodwill amortization relating to subsidiaries. Total goodwill amortization, including that relating to associates (£nil in 2004; £7 million in 2003) decreased by £40 million to £224 million in 2004, from £264 million in 2003. This was mainly due to the weaker US dollar and goodwill in respect of Family Education Network and Marketwatch having been fully amortized in 2003.remained constant at 37%. The remainder of the decrease in administration and other costsexpenses comes from both the effect of exchange and increased efficiencies, in particular from the cost actions taken at the Financial Times in recent years.
      After excluding goodwill charges, administration and other expenses were £1,411 million in 2004 compared to £1,467 million in 2003. The 4% improvement of £56 million includes the beneficial effect of foreign currency exchange and cost savings described above.
     Other Operating Income.Other operating income mainly consists of sub-rights and licensing income and distribution commissions. Other operating income decreased 10% to £46 million in 2004 from £51 million in 2003 with the decrease mainly representing the continued decline in distribution commissions received for distribution of third party books.
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 2004, other gains and losses amounted to £9 million with the principal items being profits on the sale of stakes in Capella and Business.com. In 2003 there were small losses on a number of items totaling £6 million.
Share of results of joint ventures and associates
      The contribution from our joint ventures and associates increased from £2 million in 2003 to £8 million in 2004. The increase was largely due to a reduction in losses at FT Deutschland together with some improvement in profit at the Economist.
Operating Profit/Loss
      The total operating profit in 2004 of £231£404 million compares to a profit of £226£406 million in 2003. This 2% increasemarginal decrease was principally due to the £40 million reduction in the total goodwill charge partially offset by the impact of exchange.exchange rates. We estimate that had the 2003 average rates prevailed in 2004, operating profit before goodwill charges would have been £52£51 million greater.
Operating profit attributable to Pearson Education increased by £13 million, or 12%, to £119remained constant at £287 million in both 2004 from £106 million inand 2003. The increaseThere was due to a £33 million reduction in goodwill amortization, offset by an estimated reduction in profit of £29 million from exchange. After accounting for these two factors,exchange rates, operating profit was ahead in each of the School, Higher Education and Professional businesses.
Operating profit attributable to the FT Group increased by £38£33 million, or 136%89%, to £66£70 million in 2004, from £28£37 million in 2003. The increase was largely due to a £10 million reduction in goodwill amortization, another strong performance from Interactive Data and significant cost savings at the Financial Times newspaper.

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Operating profit attributable to the Penguin Group decreased by £37£35 million, or 53%43%, to £33£47 million in 2004, from £70£82 million in 2003. The biggest single factor in the profit decline was exchange rates, which are estimated to have accounted for £14 million of the difference. There were also a number of other factors, including disruption in UK distribution following the move to a new warehouse and the weakness of the US consumer publishing market.
      Operating profit attributable to our discontinued business, Recoletos, fell by £9m, or 41%, from £22 million in 2003 to £13 million in 2004 mainly due to one-off costs associated with the launch of a Spanish language newspaper in the US.
Non-operating Items
      Profit before taxation on the sale of fixed assets, investments, businesses and associates was £9 million in 2004 compared to a profit of £6 million in 2003. In 2004, the principal items were profits on the sale of stakes in Capella and Business.com which were partially offset by losses elsewhere. In 2003 the principal item was a profit of £12 million on the sale of an associate investment in Unedisa by Recoletos.
Net Finance Costs
      Net finance costs consist primarily of net interest expense relateddecreased by £14 million to our borrowings. Our total net£79 million in 2004 from £93 million in 2003. Net interest payable decreased by £11£10 million, or 14%12%, to £69£74 million in 2004, from £80£84 million in 2003. The reduction is due to lower average net debt levels in 2004, which more than offset the effect of a general increase in floating interest rates, and a one-off credit of £9 million for interest on a repayment of tax in France which reduced the net interest cost in 2004. Year end indebtedness (excluding finance leases) decreased to £1,206£1,221 million in 2004 compared to £1,361£1,376 million in 2003 due to funds generated from operations and foreign exchange movements. The weighted average three month London Interbank Offered (“LIBOR”) rate, reflecting our borrowings in US dollars, euros and sterling, rose by 40 basis points, or 0.4%. The company is partially protected from these increases by our treasury policy, which put £736 million of the year end debt on a fixed rate basis. As a result the net interest rate payable (excluding the £9 million credit referred to above) rose by only 25 basis points or 0.25% to 5% in 2004. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowing” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.

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Taxation
      The overall taxation charge for 2004 was £62£63 million, compared to a charge of £75£61 million in 2003. In 2004 the Group recorded a total pre-tax profit of £171£325 million giving a tax rate of 36%19% compared to a similar rate of 49%19% on total pre-tax profits of £152m£313 million in 2003. These highlow rates of tax were mainly a result of only partial tax relief being available for goodwill charged in the profit and loss account. The total tax charge in 2003 and 2004 also included credits of £56 million and £48 million respectively relating to prior year items; these reflect a combination of settlements with the Inland Revenue authorities and changes to deferred tax balances.
Minority Interests
      Minority interests principally consist of the public’s 39% interest in Interactive Data and 21% interest in Recoletos.Data.
Discontinued Operations
      Following the disposal of Recoletos in 2005, the results of Recoletos have been included in discontinued operations in 2004 and 2003. The results for 2004 include an operating profit of £26 million compared to an operating profit in 2003 of £43 million. The profit in 2003 includes a profit of £12 million on the sale of the Recoletos interest in El Mundo.
Profit for the Financial Year
      The total profit for the financial year after taxation and equity minority interests in 2004 was £88£284 million compared to a profit in 2003 of £55£275 million. The overall increase of £33£9 million or 60%, was mainly due to the reduced charges for goodwill amortization, interest and tax. Increasesdecrease in net finance costs in 2004 after adverse movements in exchange had eroded the underlying increase in operating profit before goodwill have been eroded by the adverse movement in exchange.profit.

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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 11.132.9 pence in 2004 compared to 6.931.7 pence in 2003 based on a weighted average number of shares in issue of 795.6 million in 2004 and 794.4 million in 2003. This increase in earnings per share was due to the additional profit for the financial year described above and was not significantly affected by the movement in the weighted average number of shares.
      The diluted earnings per ordinary share of 11.0p32.9 pence in 2004 and 6.9p31.7 pence in 2003 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.
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 2004 compared to 2003. We estimate that if the 2003 average rates had prevailed in 2004, sales would have been higher by £306£301 million and operating profit would have been higher by £52£51 million. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.
Sales and Operating Profit by Division
      The following table summarizes our operating profit and results from operations for each of Pearson’s divisions. Results from operations areAdjusted operating profit 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 SFAS 131. Since 1998 we have reshaped the Pearson portfolio by divesting of non-core interests and investing in educational publishing and testing, consumer publishing and business information companies. During this period of transformation management havehas used results from operationsadjusted operating profit to track underlying core business performance. Results from operations are determined by adding back to total
      In our adjusted operating profit we have excluded amortization of acquired intangibles, other gains and losses and other net finance costs or charges arising from significant acquisition activity, typically goodwillof associates. The amortization chargesof acquired intangibles is not considered to be fully reflective of the underlying performance of the group. Other gains and integration costs. This enableslosses represent profits and losses on the sale of subsidiaries, joint ventures, associates and investments that are included within continuing operations but which distort the performance for the year.

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      Adjusted operating profit enables management to more easily track the underlying operational performance of the group. A reconciliation of results from operationsoperating profit to adjusted operating profit is included in the table below:
                  
  Year Ended December 31
   
  2004 2003
     
  £m % £m %
         
Results from operations
                
Pearson Education  293   68   313   68 
FT Group  86   20   58   12 
The Penguin Group  54   12   91   20 
             
Pearson Group  433   100   462   100 
             
Less:
                
 
1) Goodwill Amortization
                
 Pearson Education  174       207     
 FT Group  20       30     
 The Penguin Group  21       21     
             
 Pearson Group  215       258     
             
 
2) Goodwill Impairment
                
 Pearson Education              
 FT Group              
 The Penguin Group              
             
 Pearson Group              
             
 
3) Integration Costs
                
 Pearson Education              
 FT Group              
 The Penguin Group              
             
 Pearson Group              
             
Operating profit from continuing operations
                
Pearson Education  119   55   106   52 
FT Group  66   30   28   14 
The Penguin Group  33   15   70   34 
             
Pearson Group  218   100   204   100 
             
Discontinued Operations (Recoletos)  13       22     
Total operating profit
  231       226     
             
Non operating items  9       6     
Net Finance Costs  (69)      (80)    
             
Profit/(Loss) before taxation
  171       152     
             
                   
  Year Ended December 31
   
  2004 2003
     
  £m % £m %
         
Total operating profit
                
Pearson Education:                
 School  112   27   114   28 
 Higher Education  133   33   140   35 
 Professional  42   10   33   8 
FT Group:                
 FT Publishing  8   2   (29)  (7)
 IDC  62   16   66   16 
Penguin  47   12   82   20 
             
Total  404   100   406   100 
             
  
Add back:
                
  
Amortization of acquired intangibles
                
  School              
  Higher Education              
  Professional              
  Penguin              
  FT Publishing              
  IDC  5       4     
             
  Total  5       4     
             
  
Other net gains and losses
                
  School  (4)      2     
  Higher Education  (4)      2     
  Professional  (2)      1     
  Penguin  5       1     
  FT Publishing  (4)           
  IDC              
             
  Total  (9)      6     
             
  
Other net finance costs of associates
                
  School              
  Higher Education              
  Professional              
  Penguin              
  FT Publishing              
  IDC              
             
Total              
             
Adjusted operating profit
                
Pearson Education:                
 School  108   27   116   28 
 Higher Education  129   32   142   34 
 Professional  40   10   34   8 
FT Group:                
 FT Publishing  4   1   (29)  (7)
 IDC  67   17   70   17 
Penguin  52   13   83   20 
             
Total  400   100   416   100 
             

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Pearson EducationSchool
      Pearson Education’s sales decreased by £95 million, or 4%, to £2,356 million in 2004 from £2,451 million in 2003, as good growth in our Higher Education and Professional businesses was reduced due to the effect of the weakening US dollar. Pearson Education’s 2004 sales comprised 60% of Pearson’s total sales. Results from operations decreased by £20 million, or 6%, from £313 million in 2003 to £293 million in 2004. The decrease is again attributable to exchange. After taking out the effect of exchange, profits were higher in all three businesses.
      The School business sales decreased by £58£62 million, or 5%, to £1,118£1,087 million in 2004, from £1,176£1,149 million in 2003 and results from operationsadjusted operating profit decreased by £10£8 million, or 8%7%, to £117£108 million in 2004 from £127£116 million in 2003. Both sales and resultsadjusted operating profit were adversely affected by the weakening US dollar and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £94£93 million higher than reported and results from operations £8 million higher. The School results include a full year contribution from Edexcel, 75% of which was acquired in 2003. The extra Edexcel contribution increased sales growth in 2004 but reduced profit growth as the business is loss making in the first half.
      In the US school market, adoption spending in 2004 fell by some $200 million to approximately $500 million. Our school businesses took the largest share (27%) of the new adoption opportunities. We benefited from strength across a wide range of subjects and grade levels, with a decline in elementary sales (after particularly strong market share growth in 2003) mitigated by a strong performance in the secondary market. We returned to growth in the open territories and in supplementary publishing, helped by restructuring actions taken in 2003 and by the sharp recovery in US state budgets. Our US school testing business benefited from growth in new and existing state contracts, including Texas, Ohio, Virginia and Washington. We continued to win new multi-year contracts including Tennessee, New Jersey and California ahead of implementation of the No Child Left Behind Act testing requirements, which become mandatory in the school year starting in September 2005. Our digital learning business showed a further profit improvement on slightly lower sales as we continued to integrate our content, testing and technology in a more focused way.
      Outside the US, the School business sales increased with continued growth in English Language Teaching (ELT) helped by a very significant investment in ELT and in school testing we won $200 million of multi-year contracts.
      The
Higher Education
      Higher Education business saw a decline in sales ofdecreased by £41 million, to £731£729 million in 2004, from £772£770 million in 2003. Results from operationsAdjusted operating profit decreased by £15£13 million, or 10%9%, to £133£129 million in 2004 from £148£142 million in 2003. Both sales and resultsadjusted operating profit were adversely affected by the weakening US dollar, and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £69 million higher than reported and results from operations £16 million higher than reported. In the US we grew faster than the market for the sixth consecutive year in US dollar terms, up 4% while the industry without Pearson was up 2% according to the Association of American Publishers.
      In the US, our Higher Education business benefited from strength in two-year career colleges, a fast growing segment, with vocational programs in allied health, technology and graphic arts, and elsewhere in math and modern languages. Margins reduced a little as we achieved good growth outside the US and continued to invest to make our technology central to the teaching and learning process. Our custom publishing business, which creates specific programs built around the curricula of individual faculties or professors, grew strongly. Pearson Custom has now increased its sales in dollar terms eight-fold over the past six years and we have introduced our first customized online resources for individual college courses.
Professional
      Sales and resultsprofit from operations in our Professional business improved in spite of the weakening dollar. Sales increased by £4 million, or 1%, to £507 million in 2004 from £503 million in 2003. Results from operationsAdjusted operating profit increased by £5£6 million, or 13%18%, to £43£40 million in 2004, from £38£34 million in 2003. We estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £60 million higher than reported and results from operations £5 million higher than reported.
      After taking out the effect of exchange rates, Pearson Government Solutions grew sales by 25%, with strong growth from add-ons to existing programs. We also won some important new contracts, including multi-year contracts worth $500 million from customers

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such as the US Department of Health and Human Services and the London Borough of Southwark. Our professional testing business grew sales (before exchange impacts) by 31% as we benefited from the start-up of major new contracts, although we continued to operate at a small loss as we invested in building up the infrastructure for our 150-strong UK test center

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network. Markets remained tough for our technology publishing titles, where although sales were lower, profits were broadly level as a result of further cost actions.
FT GroupPublishing
      Sales at the FT GroupPublishing (excluding discontinued businesses) decreasedincreased by £1£3 million, from £588£315 million in 2003 to £587£318 million in 2004 but results from operationsand adjusted operating profit increased by £28£33 million or 48%, from £58a loss of £29 million in 2003 to £86a profit of £4 million in 2004. We estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £22 million higher than reported and results from operations £8 million higher than reported. Sales increased in all divisions with another good year for Interactive Data andwere boosted by a return to sales growth at theFinancial Times newspaper (“FT”) for the first year since 2000. The FT returned to profit in the seasonally strong fourth quarter of 2004 with both advertising and circulation revenues ahead for the full year.
      Advertising performance across all categories and regions at the FT were mixed throughout the year. While the recruitment and luxury goods categories increased by more than 20%, the business-to-business and technology sectors showed few signs of recovery. In terms of geography, good growth in Europe and Asia offset a very weak US corporate advertising market. Average circulation for 2004 was 3% lower than in 2003, whilst FT.com now has 76,000 paying subscribers and 3.73.0 million average unique monthly users.
      Results from operations Adjusted operating profit at the FT improved by £23£24 million over 2003 as we continued to reduce the FT’s cost base, which is now £110 million lower than it was in 2000.
      Les Echos achieved euro sales growth of 4% and profits grew strongly despite a volatile advertising market. Average circulation grew 3% to 119,800, while competitors saw falling sales. FT Business posted significant sales growth of 8%, with progress in all its main markets. Profits improved 25% following a continued emphasis on cost management.
      Results from operations Adjusted operating profit at the FT’s associates and joint ventures showed a profit of £6 million compared to £3£2 million in 2003. Losses narrowed at FT Deutschland as circulation and advertising revenue grew strongly. FT Deutschland reached the 100,000 copy sales mark in December and circulation averaged 96,600, up 6% on the previous year. The Economist Group again increased its results from operationsadjusted operating profit with The Economist’s circulation passing the 1 million mark with an average weekly circulation of 1,009,759.1,009,759(January-June Audit Bureau of Circulations period).
Interactive Data
      Interactive Data, our 61%-owned financial information business grew itssaw a decrease in sales of £4 million, from £273 million in 2003 to £269 million in 2004 and adjusted operating profit decreased by 3%£3 million from £70 million in 2003 to £67 million in 2004. We estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £22 million higher than reported and results from operations by 9% after taking out the effect of exchange rates.£7 million higher than reported.
      FT Interactive Data and e-Signal (its online(Interactive Data’s real-time financial market information and pricingdecision support tool business) performed well particularly in the US in 2004 where there were some signs of improvement in market conditions. Worldwide renewal rates among institutional clients remained at or above 95%. Demand for Interactive Data’s value-added services remained strong, with the signing of our 100th customer for our Fair Value Information Service product in December 2004. IDC had a first full year contribution from acquisitions made in 2003, ComStock and Hyperfeed Technologies, and acquired FutureSource in September 2004 to expand and compliment e-Signal. The consolidation of seven US data centers is on track for completion by the end of 2005.
      In December 2004 we announced our intention to sell our shareholding in Recoletos, our 79%-owned Spanish media group to Retos Cartera as part of a tender offer for all of Recoletos. Retos Cartera’s tender offer was launched on February 16, 2005 and we accepted it on February 25, 2005. The sale closed in early April and net cash proceeds of £372 million were received on April 8, 2005. In January 2005 we sold our 22% stake in MarketWatch to Dow Jones & Co for $101 million. The results of Recoletos have been included as a discontinued business in the financial statements.
The Penguin Group
      The Penguin Group had a difficult year2004 with sales down 6% to £786 million in 2004 from £840 million in 2003 and results from operationsadjusted operating profit down 41%37% to £54£52 million in 2004 from £91£83 million in 2003. Both sales and

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results adjusted operating profit were adversely affected by the weakening US dollar, and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £57 million higher than reported and results from operations £14 million higher than reported. In addition to exchange, the decline in results from operations was caused by a number of factors including disruption at the new UK warehouse and a weakening in the US consumer publishing market.
      In the UK, our move to a new warehouse, to be shared with Pearson Education, disrupted supply of our books and had a particular impact on backlist titles. Although we traded well in the second half of 2004, and shipped more books to our UK customers than in the previous year, we incurred some £9 million of additional costs as we took special measures to deliver books, including the costs of running two warehouses, shipping

36


books direct and additional marketing support. By the end of the year we had eliminated the order backlog in the warehouse and the new management team has continued to make good progress in the early part of 2005.
      After a good start to the year, the US consumer publishing market deteriorated sharply in the second half and full year industry sales were 1% lower than in 2003, according to the Association of American Publishers. The adult mass market segment, which accounts for approximately one-third of Penguin’s US sales, was down 9% for the industry for the full year, and 13% in the second half.
      Despite the problems outlined above, Penguin had another great publishing year.year in 2004. We benefited from our new imprint strategy, with a further four imprints published for the first time. Non-fiction performed particularly well, with a 40% increase in our titles on the New York Times bestseller list, including Lynne Truss’sEats, Shoots & Leaves(now (now with over one million copies in print), Ron Chernow’sAlexander Hamiltonand Maureen Dowd’sBushworld.Best selling UK titles included Jamie Oliver’sJamie’s Dinners, Sue Townsend’sAdrian Mole and the Weapons of Mass Destructionand Gillian McKeith’sYou Are What You Eat.
Year ended December 31, 2003 compared to year ended December 31, 2002
Consolidated Results of Operations
Sales
      Our total sales decreased by £272 million to £4,048 million, or 6%, in 2003, from £4,320 million in 2002. The decrease was mainly attributable to Pearson Education’s Professional business where the shortfall was due to the absence of reported sales from the £250 million TSA contract and the effect of foreign currency exchange. The strength of sterling compared to the US dollar had a significant negative effect on sales, and we estimate that had the 2002 average rates prevailed in 2003, sales would have been higher by £181 million. In constant exchange rate terms the School and Higher Education businesses increased sales in 2003 by 8% and 6% respectively. The School business was helped by the acquisition of 75% of Edexcel, the UK testing business, in the first half of 2003 that contributed additional sales of £89 million. Penguin saw a small increase in sales even after the adverse effect of foreign currency movements as the schedule of new titles enabled Penguin to grow ahead of the industry despite tough conditions for backlist publishing in the US. The FT Group sales were slightly ahead of last year mainly due to Interactive Data where sales increased for the fourth consecutive year in a difficult marketplace (even after excluding additional sales generated from the acquisition of ComStock at the beginning of 2003). Our business newspapers continued to suffer from the corporate advertising recession which has seen advertising volumes at theFinancial Timesnewspaper fall almost two-thirds since their peak in 2000.
      Pearson Education, our largest business sector, accounted for 61% of our sales in 2003, compared to 64% in 2002. North America continued to be the most significant source of our sales although sales in the region decreased, as a proportion of total sales, to 67% in 2003, compared to 72% in 2002. Some of this decrease, however, reflects the comparative strength of sterling and the euro compared to the US dollar.

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Cost of Sales and Net Operating Expenses
      The following table summarizes our cost of sales and net operating expenses:
         
  Year Ended
  December 31
   
  2003 2002
     
  £m £m
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)
       
Cost of Sales.Cost of sales consists of costs for raw materials, primarily paper, production costs, amortization of pre-publication costs and royalty charges. Our cost of sales decreased by £154 million, or 7%, to £1,910 million in 2003, from £2,064 million in 2002. The decrease mainly reflected the decrease in sales over the period with overall gross margins remaining consistent. Cost of sales as a percentage of sales improved slightly to 47% in 2003 from 48% in 2002.
Distribution Costs.Distribution costs consist primarily of shipping costs, postage and packing.
Administration and Other Expenses.Our administration and other expenses decreased by £164 million, or 9%, to £1,724 million in 2003, from £1,888 million in 2002. Administration and other expenses as a percentage of sales decreased to 43% in 2003, from 44% 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 (£7 million in 2003; £48 million in 2002) decreased by £66 million to £264 million in 2003, from £330 million in 2002. The main reason for this decrease over last year is Family Education Network and our interest in Marketwatch, where the final amortization charges were incurred in the first half of 2003. In 2002, we also took a goodwill impairment charge of £10 million relating to a subsidiary of Recoletos in Argentina while in 2003 no impairment charges were deemed necessary. Also included in administration and other costs are the one-off 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 £10 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 £1,467 million in 2003 compared to £1,586 million in 2002. This 8% improvement of £129 million includes the beneficial effect of exchange rate movements, the results of cost saving measures taken in 2002 and 2003 and a reduced spend on internet enterprises.
Other Operating Income.Other operating income mainly consists of sub-rights and licensing income and distribution commissions. Other operating income decreased to £51 million in 2003 from £59 million in 2002 with the decrease coming at both Pearson Education and Penguin where distribution commissions we receive for distributing third parties’ books has continued to decline.
Operating Profit/ Loss
      The total operating profit in 2003 of £226 million compares to a profit of £143 million in 2002. This 58% increase was principally due to a £76 million reduction in 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 absence of the prior year TSA contract, but this was offset by growth in School and Higher Education, Interactive Data and Penguin. In addition there were reduced losses following disposals and rationalization of the FT Knowledge business. In 2003, operating profit was adversely

34


affected by the weakening of the US dollar against sterling. We estimate that had the 2002 average rates prevailed in 2003, operating profit before goodwill charges would have been £27 million greater.
      Operating profit attributable to Pearson Education increased by £31 million, or 41%, to £106 million in 2003, from £75 million in 2002. The increase was due to a £37 million reduction in goodwill amortization, a £7 million reduction in integration costs, increases in profit reported by the School and Higher Education businesses of £12 million and £6 million respectively and the cessation of losses from FT Knowledge (a £12 million loss in 2002). Offsetting these favorable variances was the sharp reduction in profits in the Professional business of £43 million caused by both the absence of the prior year contribution from the TSA contract and further current year TSA contract close-out costs.
      Operating profit attributable to the FT Group increased by £45 million to £50 million in 2003, from £5 million in 2002. The increase was largely due to a £39 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.
      Operating profit attributable to the Penguin Group increased by £4 million, or 6%, to £70 million in 2003, from £66 million in 2002. The profit increase reflected 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 sale of fixed assets, investments, businesses and associates was £6 million in 2003 compared to a loss of £37 million in 2002. In 2003 the principal item was a profit of £12 million on the sale of an associate investment in Unedisa by Recoletos. In 2002, the principal items were a profit of £18 million relating to the completion of the sale of the RTL Group and a provision of £40 million for the loss on sale of our Forum business, which completed in January 2003. Other items in 2002 included a loss on sale of PH Direct of £8m, a profit of £3 million on finalization of the sale of the Journal of Commerce by the Economist and various smaller losses on investments and property.
Net Finance Costs
      Net finance costs consist primarily of net interest expense related to our borrowings. Our total net interest payable decreased by £51 million, or 39%, to £80 million in 2003, from £131 million in 2002. Our average net debt decreased by £157 million from £1,891 million in 2002 to £1,734 million in 2003, while our year end indebtedness (excluding finance leases) decreased to £1,361 million in 2003 compared to £1,408 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 in interest rates during the year. The weighted average three month London Interbank Offered (“LIBOR”) rate, reflecting our borrowings in US dollars, euros and sterling, fell by 75 basis points, or 0.75%. The impact of these falls was dampened by our treasury policy in 2003 of having 40-65% of net debt at fixed interest rates. As a result, our net interest rate payable averaged approximately 4.6% in 2003, improving from 5.0% in 2002. During 2002 we took an additional one-off charge of £37 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. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowing” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.

35


Taxation
      The overall taxation charge for 2003 was £75 million, compared to a charge of £64 million in 2002. In 2003 the Group recorded a total pre-tax profit of £152 million and the high rate of tax came about mainly because there was only very limited tax relief available for goodwill charged in the profit and loss account. The total tax charge in 2003 also included credits of £56 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 £25 million, which was also the result of only very limited tax relief available for goodwill. In 2002 there was also a tax credit of £45 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 2003 was £55 million compared to a loss in 2002 of £111 million. The overall change of £166 million was mainly due to the reduced goodwill amortization and impairment charges and lower interest payments. There was also a profit on the sale of fixed assets, investments, businesses and associates in 2003 compared to the loss in 2002.
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 pence in 2003 compared to a loss of 13.9 pence in 2002 based on a weighted average number of shares in issue of 794.4 million in 2003 and 796.3 million in 2002. This increase was due to the return to profit for the financial year described above and was not significantly affected by the decrease in the weighted average number of shares.
      In 2003 the diluted earnings per ordinary share was also 6.9 pence as the effect of dilutive share options was 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.
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 2003 compared to 2002. We estimate that if the 2002 average rates had prevailed in 2003, sales would have been higher by £181 million and operating profit would have been higher by £27 million. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.
Sales and Operating Profit by Division
      The following table summarizes our operating profit and results from operations for each of Pearson’s divisions. Results from operations are included as they are a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFAS 131. Since 1998 we have reshaped the Pearson portfolio by divesting of non-core interests and investing in educational publishing and testing, consumer publishing and business information companies. During this period of transformation management have used results from operations to track underlying core business performance. Results from operations are determined by adding back to total operating profit costs or charges arising from significant acquisition activity, typically goodwill amortization charges and integration costs. This enables

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management to more easily track the underlying operational performance of the group. A reconciliation of results from operations to operating profit is included in the table below:
                  
  Year Ended December 
  31
   
    2002
     
  2003    
       
  £m % £m %
Results from operations
                
Pearson Education  313   68   326   70 
FT Group  58   12   51   11 
The Penguin Group  91   20   87   19 
             
Pearson Group  462   100   464   100 
             
Less:
                
 
1) Goodwill Amortization
                
 Pearson Education  207       244     
 FT Group  30       49     
 The Penguin Group  21       18     
             
 Pearson Group  258       311     
             
 
2) Goodwill Impairment
                
 Pearson Education              
 FT Group         10     
 The Penguin Group              
             
 Pearson Group         10     
             
 
3) Integration Costs
                
 Pearson Education         7     
 FT Group              
 The Penguin Group         3     
             
 Pearson Group         10     
             
Operating profit from continuing operations
                
Pearson Education  106   52   75   56 
FT Group  28   14   (8)  (6)
The Penguin Group  70   34   66   50 
             
Pearson Group  204   100   133   100 
             
Discontinued Operations (Recoletos and Television)  22       10     
Total operating profit
  226       143     
             
Non operating items  6       (37)    
Net Finance Costs  (80)      (131)    
Profit/(Loss) before taxation
  152       (25)    
             
Pearson Education
      Pearson Education’s sales decreased by £305 million, or 11%, to £2,451 million in 2003 from £2,756 million in 2002, as good growth in our School and Higher Education businesses was reduced due to the effect of the weakening US dollar and the Professional business did not fill the gap left by the absence of the TSA contract. Pearson Education’s 2003 sales comprised 61% of Pearson’s total sales. Results from operations decreased by £13 million or 4% from £326 million in 2002 to £313 million in 2003. The decrease can be

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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 reduced losses at FT Knowledge following disposals and reorganization of that business.
      The School business sales increased by £25 million, or 2%, to £1,176 million in 2003, from £1,151 million in 2002 and results from operations increased by £12 million, or 10%, to £127 million in 2003 from £115 million in 2002. Both sales and results were adversely affected by the weakening US dollar and we estimate that had 2002 average rates prevailed in 2003 then sales would have been approximately £72 million higher than reported and results from operations £8 million higher than reported. In the US our textbook publishing business grew as our Pearson Scott Foresman and Pearson Prentice Hall imprints increased revenues ahead of the overall basal market growth. Our new elementary social studies program took a market share of more than 50% in adoption states, helping Pearson to take the leading position in new adoptions with a share of approximately 29%. Sales at our supplementary publishing business were lower than in 2002 as we discontinued some unprofitable product lines and were affected by industry-wide weakness 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, Edexcel, contributed sales of £89 million following its acquisition in the first half of 2003.
      The Higher Education business saw a decline in sales of £3 million, to £772 million in 2003, from £775 million in 2002. Results from operations increased by £6 million, to £148 million in 2003, from £142 million in 2002. Both sales and results were adversely affected by the weakening US dollar, and we estimate that had 2002 average rates prevailed in 2003 then sales would have been approximately £49 million higher than reported and results from operations £10 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 a strong demand for post-secondary qualifications to more than offset the impact of state budget weakness and rising tuition fees.
      Our Higher Education business also benefited from a strong schedule of first editions including Faigley’s Penguin Handbook in English Composition, Wood & Wood’s Mastering World Psychology and Jones & Wood’s Created Equal in American History. The use 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 revenues 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 and Canada, solid local publishing and the introduction of our custom publishing model.
      Sales and results from operations were significantly lower in our Professional business, caused by both the absence of the prior 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 £281 million, to £503 million in 2003, from £784 million in 2002. Results from operations decreased by £43 million, to £38 million in 2003, from £81 million in 2002. Excluding the effect of the TSA contract, our Government Solutions business grew by 39%, benefiting from new contracts with the Department of Health and Human Services 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

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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 United States.
FT Group
      Sales at the FT Group (excluding discontinued businesses) increased £10 million or 2%, from £578 million in 2002 to £588 million in 2003 and results from operations increased by £7 million, or 14%, from £51 million in 2002 to £58 million in 2003. The main contributors to the sales increase was Interactive Data. Interactive Data posted a 10% sales increase despite the negative impact of exchange as it benefited from the acquisition of ComStock, in February 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 £100 million over the same period.
      Results from operations at the Financial Times (“FT”) decreased by £9 million over 2002 as advertising revenues fell by £23m and we invested some £10m 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 £3 million (£6 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.
      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 installed 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.
      In December 2004 we announced our intention to sell our shareholding in Recoletos, our 79%-owned Spanish media group. The sale was completed in early April 2005. The results of Recoletos have been included as a discontinued business in the financial statements.

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The Penguin Group
      The Penguin Group increased sales to £840 million in 2003 from £838 million in 2002 and increased its results from operations to £91 million in 2003 from £87 million in 2002. In the US, our largest market, accounting 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 novelThe Secret Life of Bees(2.3 million copies sold), John Steinbeck’sEast of Eden(1.5 million), Al Franken’sLies and the Lying Liars Who Tell Them(1.1 million), Scott Berg’sKate Remembered(0.5 million), Paul Burrell’sA Royal Duty(0.9 million), Madonna’sThe English RosesandMr Peabody’s Apples(1.2 million) and Michael Moore’sStupid 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 ane-Encyclopaediapublished 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.
Liquidity and Capital Resources
Cash Flows and Financing
      Net cash inflow from operating activities increased by £171£170 million, or 48%24%, to £530£875 million in 2005, from £705 million in 2004, from £359 million in 2003. Thiseven though the 2004 cash inflow was aided byincluded collection of the $151 million receivable in respect of the TSA contract. Cash flows within Pearson Educationthe education businesses and IDC in particular continued to be strong despite the weakness of the US dollar reducing the value of ourgrow strongly and cash flows at Penguin recovered significantly from their lower levels in sterling terms. Even excluding2004 and 2003. Underlying working capital efficiency improved considerably. On an average basis (excluding the impact of collecting the TSA receivable, working capital continued to improve. On an average basis,receivable), the working capital to sales ratio for our book publishing businesses improved from 32.8%29.4% to 32.3%27.4%. Compared to 2002,2003, the net cash inflow from operating activities in 2003 decreased2004 increased by £170£174 million, or 32%33%, to £359£705 million from £529£531 million. This reflected close-out payments to creditorsAlthough the 2004 performance was helped by the receipt of the $151 million receivable in respect of the TSA contract, growth within the education businesses and IDC underpinned the concentration of the Penguin publishing schedule in the fourth quarter which pushed cash collection from debtors into 2004.underlying improvement.
      Net interest paid was £72 million in 2005 compared to £85 million in 2004 compared toand £76 million in 20032003. The 7% decrease in 2005 over 2004 reflected the reduction in debt following receipt of the proceeds from the disposals of Recoletos and £140 millionMarketWatch (offset in 2002. The 12% increase in 2004 over 2003 reflectedpart by the impact of the year on year increaseincreases in interest rates,rates), while the 2003 decrease2004 increase compared to 2002 benefited from2003 was entirely due to the full year effect of the 2002 debt repayment using the proceeds of the RTL Group sale and the non recurrence of £37 million of swap close-out costs.on year increases in interest rates.
      InCapital expenditure on property, plant and equipment was £76 million in 2005 compared to £101 million in 2004 capital expenditure wasand £79 million in excess of depreciation due2003. The higher spending in 2004, compared to both 2005 and 2003, reflected up-front expenditure on our Professional testing contracts and continued upgrading of our facilities and equipment. Capital expenditure was £125 million in 2004 compared to £105 million in 2003 and £126 million in 2002.contracts.
      The acquisition of subsidiaries, joint ventures and associates accounted for a cash outflow of £35£253 million in 2005 against £51 million in 2004 against £94and £65 million in 20032003. The principal acquisitions in 2005 were of AGS for £161 million within the School business and £87IS. Teledata for £29 million in 2002.by Interactive Data. The principal acquisitions in 2004 were of KAT and Dominie Press for £10 million each by Pearson Educationwithin our education businesses and FutureSource by Interactive Data for £9 million. The principal acquisitionsacquisition in 2003 werewas of ComStock by Interactive Data for net cash of £68 million and 75% of Edexcel by Pearson Education for net cash of £16 million. The largest acquisition in 2002 was the purchase of Merrill Lynch’s Securities Pricing Services by Interactive Data for net cash of £30 million. The sale of subsidiaries and associates produced a cash inflow of £24£430 million in 2005 against £31 million in 2004 against £53 million in 2003 and £923£56 million in 2002. All theThe principal disposals in 2005 were of Recoletos for net cash proceeds of £371 million and MarketWatch for net cash proceeds of £54 million. The proceeds in 2004 relate primarily to the sale of Argentaria Cartera by Recoletos. The principal disposal in 2003 was the sale of Unedisa by Recoletos. Virtually all the proceeds in 2002 relate to the sale of the RTL Group.

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      The cash outflow from financing of £59m£321 million in 2005 reflects the improved group dividend and the repayment of bank borrowings following the sale of Recoletos. The cash outflow from financing of £261 million in 2004 reflects the payment of the group dividend and the repayment of one550 million bond offset by the proceeds from the issue of new $350 million and $400 million bonds. The cash inflowoutflow from financing of £64£142 million in 2003 largelyagain reflects the group dividend and the issue in the year of a $300 million bond as we took advantage of favorable market conditions, offset by the repayment of a250 million bond. The outflow of £663 million in 2002 was due to the repayment of loans and bonds using the proceeds from the sale of RTL Group. Bonds are issued as part of our overall financing program to support general corporate expenditure.

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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, 2004,2005, our net debt (excluding finance leases) was £1,206£996 million compared to net debt of £1,361£1,221 million at December 31, 2003.2004. 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 £1,819£1,959 million at December 31, 2004,2005, compared to £1,922£1,823 million at December 31, 2003.2004. At December 31, 2004,2005, cash and liquid resources were £613£902 million, compared to £561£461 million at December 31, 2003.2004.
Contractual Obligations
      The following table summarizes the maturity of our borrowings and our obligations under non-cancelable operating leases.
             
 At December 31, 2004           
    At December 31, 2005
   Two to After   
   Less Than One to Five Five    Less Than One to Two to After Five
 Total One Year Two Years Years Years  Total One Year Two Years Five Years Years
                     
 £m £m £m £m £m  £m £m £m £m £m
Gross borrowings:Gross borrowings:                Gross borrowings:                
Bank loans, overdrafts and commercial paper  169  107    62   Bank loans, overdrafts and commercial paper  102  102       
Variable rate loan notes           Variable rate loan notes           
Bonds  1,650    130  671  849 Bonds  1,854  152  436  310  956 
Lease obligationsLease obligations  1,051  115  101  250  585 Lease obligations  1,395  129  115  288  863 
                       
Total
Total
  2,870  222  231  983  1,434 
Total
  3,351  383  551  598  1,819 
                       
      The group had capital commitments for fixed assets, including finance leases already under contract, of £6£1 million. 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 quarterly fee of 0.125% 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 in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations”,that have or are reasonably likely to have a material current or future effect on the Group’s financial position or results of operations.
      The group is committed to a quarterly fee of 0.125% on the unused amount of the group’s bank facility.

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Borrowings
      We have in place a $1.85$1.35 billion term revolving credit facility, which matures in July 2009. At December 31, 2004,2005, approximately $1.23$1.35 billion was available under this facility. This included allocations to

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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:
      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” refers to earnings before interest, taxes, depreciation and amortization. We are currently in compliance with these covenants.
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 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 11. Quantitative and Qualitative Disclosures About Market Risk”.
Related Parties
      There were no significant or unusual related party transactions in 2005, 2004 2003 or 2002.2003. Refer to note 3032 in “Item 17. Financial Statements.”Statements”.
Accounting Principles
      The following summarizes the principal differences between UK GAAPIFRS and US GAAP in respect of our financial statements. For further details refer to note 3435 in “Item 17. Financial Statements”.
      Prior toBefore the adoption of IFRS 3 on 1 January 2003 and before the adoption of FAS 142 on 1998, under UK GAAP,January 2002, goodwill was written off to the profit and loss reserve in the year of acquisition. Under US GAAP, as well as UK GAAP from January 1, 1998, goodwill is recognized as an asset and amortization expense iswas recorded over useful lives ranging between 3 and 20 years. Under US GAAP,IFRS 3 and FAS 142 goodwill arising from acquisitions completed subsequent to July 1, 2001 is no longer amortized however it isbut tested annually for impairment atimpairment. Before the reporting unit level at least annually or more frequently when a triggering event occurs. In addition, amortization for all goodwill balances ceasedadoption of IFRS, the Group’s intangible assets were not recognized as of January 1, 2002 under US GAAP. Intangible assetsthey did not meet the requirements under UK GAAP are recognized only when they may be disposed of without also disposing of the business to which they relate,GAAP. Under IFRS and for that reason it is rare thatUS GAAP, 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,Therefore, 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. TheA difference between US GAAP and IFRS arises in goodwill and intangible assets due to the different adoption dates of IFRS 3 and FAS 142 as well as the impact of foreign exchange on the translation of those underlying assets that are denominated in a foreign currency. This difference 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

42


capitalized and amortized be removed from the profit and loss reserve upon disposal and factored into the gain or loss on disposal calculation.business.
      Under UK GAAP,IFRS, 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.annually. These reviews are based on estimated discountedcomparing the fair value of the Group’s cash-generating units determined by discounting future cash flows from operating activities compared with theto their carrying value of goodwill, and any impairment is recognized on the basis of such comparison.value. 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.FAS 142. The Group performed the transitional impairment test under SFASFAS 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 SFASFAS 142 at the end ofin 2005, 2004 2003 and 2002.2003. The Group has determined that its reporting units under FAS 142 are consistent with its cash-generating units under IAS.
      Under UK GAAP, FRS 19,IAS 12Deferred Taxation”,Income Taxes”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 timingtemporary differences, with deferred tax assets recognized to the extent that they are more likely than not recoverable against future taxable profits. DeferredUnder US GAAP, deferred tax assets not considered recoverable are adjusted for through a separate valuation allowance in the balance sheet. There are no separate valuation allowances under IFRS. Under US GAAP, deferred taxes are accounted for in accordance with SFASFAS 109,“Accounting for Income Taxes”Taxes,”with a full provision also made for deferred taxes on all timing temporary

39


differences and a valuation allowance is established for the amount of the deferred tax assetswhen it is more likely than not considered recoverable.that they will not be realised. This is similar to the treatment required under FRS 19. The primary differences relate toIAS 12.
      Using the deferred tax on intangible assets, which are not recorded undertransitional exceptions of IAS 39, derivatives were accounted for in accordance with UK GAAP for the years ended 31 December 2003 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.
2004. 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. From 1 January 2005, the Group has adopted IAS 39“Financial Instruments: Recognition and Measurement” and IAS 32“Financial Instruments: Disclosure and Presentation”.Under US GAAP, we have adopted SFASFAS 133,“Accounting for Derivative Instruments and Hedging Activities”and its related guidance. DuringIn 2003, and 2002, 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. In 2004 the Group met the prescribed designation requirements and hedge effectiveness tests under US GAAP for certain of its derivative 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 bond or asset.
      Finance lease rentals are capitalisedcapitalized at the net present value of the total amount of rentals payable under the leasing agreement (excluding finance charges) and depreciated over the period of the lease (if in respect of property) or the useful economic life of the asset (if in respect of plant and equipment). 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 charged to the profit and loss on a straight-line basis over the duration of each lease term.
      Under UK GAAP, the cost of providing pension benefits is expensed over the average expected remaining service lives of eligible employees, using long-term actuarial assumptions. UnderIFRS and US GAAP, the annual pension costs comprise the estimated cost of benefits accruingis determined in the period,accordance with IAS 19 “Employee Benefits” and actuarialFAS 87 “Employers Accounting for Pensions”. Actuarial assumptions are adjusted annually to reflect current market and economic conditions. Additionally, underUnder IFRS the difference between the fair value of the assets and the defined benefit obligation is recognized as a prepayment/ liability. Actuarial gains and losses are recognized in the statement of recognized income and expenses. Under US GAAP, if the fair value of a pension plan’s assets is below the plan’s accumulated benefit obligation, a minimum pension liability is required to be recognized in the balance sheet. Unrecognized gains or losses outside the 10% corridor 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 exercise price of the option at the date of grant is equal to or greater than the market value on that date.

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UnderIFRS and US GAAP, we have adopted theaccount for options and restricted shares granted to employees using their fair value method of accounting for options.value. Compensation expense is determined based upon the fair value at the grant date, and has been estimated using the Black Scholes, model.Binomial or Monte Carlo model as appropriate. Compensation cost is recognized over the service life of the awards, which is normally equal to the vesting period. Compensation expense is also recognized underDifferences between the US GAAP and IFRS charges are mainly due to the different treatment of options with respect to UK qualified non-compensatory plans, suchgraded vesting features. Under IFRS, the charge is recognized as the Save as You Earn option plan andoptions gradually vest. Under US GAAP, the Worldwide Save for Shares plan, as these plans offer employeescharge is recognized on a discountstraight line basis over the vesting period. Other noteable differences include the treatment of greater than 5% of market value at the date of grant.forfeitures.
      For a further explanation of the differences between UK GAAPIFRS and US GAAP see note 3435 to the consolidated financial statements.
Recent U.S. Accounting Pronouncements
      In December 2003, the FASB issued FIN 46R“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 46R 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. The effective date for public companies is 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 a material impact on the financial position, cash flows or results of the Group under US GAAP as at December 31, 2004.
      In May 2004, the FASB issued FSP No. 106-2 (“FSP 106-2”), “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the “Medicare Act”). The Medicare Act was enacted December 8, 2003. FSP 106-2 supersedes FSP 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” and provides authoritative guidance on accounting for the federal subsidy specified in the Medicare Act. The Medicare Act provides for a federal subsidy equal to 28% of certain prescription drug claims for sponsors of retiree health care plans with drug benefits that are at least actuarially equivalent to those to be offered under Medicare Part D, beginning in 2006. The adoption of FSP 106-2 did not have a material impact on the financial position, cash flows or results of the Group under US GAAP as at December 31, 2004.
      In November 2004, the FASB issued SFASFASB Statement No. 151 “Inventory“Inventory Costs  — An Amendment of ARB No. 43, Chapter 4”4 (“SFASFAS 151”). SFASFAS 151 amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFASFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFASFAS 151 is effective for fiscal years beginning after June 15, 2005.

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The Group is currently evaluating the effect that the adoption of SFASwill adopt FAS 151 will have on its consolidated results of operations and financial conditionin 2006 but does not expect SFAS 151the adoption of the new standard to have a material impact.
      In December 2004, the FASB issued SFASFASB Statement No. 153 “Exchanges“Exchanges of Non monetaryNonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Non monetaryNonmonetary Transactions” (“SFASFAS 153”). SFASFAS 153 eliminates the exception from fair value measurement for non monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Non monetaryNonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFASFAS 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFASFAS 153 is effective for the fiscal periods beginning after

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June 15, 2005. The Group is currently evaluating the effect that the adoption of SFASwill adopt FAS 153 will havein 2006 but does not expect itthe adoption of the new standard to have a material impact.
      In December 2004, the FASB issued SFASFASB Statement No. 123 (revised 2004), “Share-Based“Share-Based Payment” (“SFAS 123R”FAS 123(R)”), which replaces SFASFAS No. 123 “Accounting“Accounting for Stock-Based Compensation,”Compensation” (“SFASFAS 123”) and supersedes APB Opinion No. 25 “Accounting“Accounting for Stock Issued to Employees.” SFAS 123R FAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFASFAS 123 no longer will be an alternative to financial statement recognition. The Group will adopt FAS 123(R) in 2006 but does not expect the adoption of the new standard to have a material impact as it already recognizes share-based payment cost in its income statement in accordance with FAS 123.
      In March 2005, the FASB issued FASB Interpretation No. 47“Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or settlement are conditional on a future event. FIN 47 is effective for the fiscal periods ending after December 15, 2005. The adoption of FIN 47 did not have a material impact on the Group.
      In May 2005, the FASB issued Statement No. 154,“Accounting Changes and Error Corrections — A replacement of APB Opinion No. 20 and FASB Statement No. 3” (“FAS 154”). This statement requires retrospective application to prior periods’ financial statements of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement applies to all voluntary changes in accounting principles and changes required by an accounting pronouncement that does not include specific transition provisions. FAS 154 is required to be adopted in fiscal years beginning after December 15, 2005. FAS 154 would not have had a material effect on the financial position, results of operations or cash flows of the Group under US GAAP as at December 31, 2005.
      In October 2005, the FASB issued FASB Staff Position (FSP) 13-1“Accounting for Rental Costs Incurred during a Construction Period” (“FSP 13-1”). FSP 13-1 requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense and included in income from continuing operations. FSP 13-1 is effective for the fiscal periods beginning after December 15, 2005. The Group will adopt FSP 13-1 in 2006 but does not expect the adoption of the new standard to have a material impact.
      In January 2006 the FASB issued FASB Statement No. 155“Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140” (“FAS 155”). FAS 155 provides entities with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract. FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Group is currently evaluating the impact ofthe adoption of SFAS 123(R)FAS 155 will have, but because it already applies the requirements SFAS 123 it does not expect adoption of the new standardit to have a material impact.
Recent UK and International Accounting Pronouncements
     In December, 2003, UITF 38, “Accounting for ESOP trusts”IFRS 7 “Financial Instruments: Disclosures”., was issued by the Urgent Issues Task Force IFRS 7 introduces new disclosures of the UK Accounting Standards Board. The consensus is that parent company shares held in trust should be treated as treasury sharesqualitative and deductedquantitative information about exposure to risks arising from shareholders’ funds rather than being held as fixed asset investments. The Group adopted UITF 38 in 2004financial instruments, including specified minimum disclosures about credit risk, liquidity risk and has re-stated the 2003 and 2002 comparatives accordingly (seen notes 24 and 34 in “Item 17. Financial Statements”).
      FRS 20 (IFRS 2), “Share-based payment”, was issued by the ASB on Aprilmarket risk. IFRS 7 2004. It is effective for listed entitiesaccounting

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periods beginning on or after 1 January 2007. The Group is currently assessing the impact of IFRS 7 on the Group’s financial statements, but does not expect it to be significant.
      A complementary amendment of IAS 1“Presentation of Financial Statements — Capital Disclosures”. The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. The amendment to IAS 1 is effective for accounting periods beginning on or after January 2005. It2007. The Group is currently assessing the impact of the amendment to IAS 1, but does not expect it to be significant.
      IFRIC 4“Determining whether an Arrangement contains a Lease”. IFRIC 4 requires the determination if whether an arrangement is or contains a lease to be based on the substance of the arrangement. IFRIC 4 is effective for accounting periods beginning on or after 1 January 2006. The Group will implement IFRIC 4 from 1 January 2006 but does not expect it to have a significant impact on the Group’s operations.
      IAS 21 (Amendment)“Net investment in a foreign operation”. This amendment deals with the requirement for a monetary item that forms part of a reporting entity’s net investment in a foreign operation to be denominated in the functional currency of either the reporting entity or the foreign operation. The amendment also clarifies the accounting fortreatment of exchange differences arising on a loan made between two “sister companies” within a group. The exchange differences would be taken to equity in the parent’s consolidated financial statements, irrespective of the currency in which the loan is made, provided that the nature of the loan is similar to an equity investment, that is, settlement of the loan is neither planned nor expected to occur in the foreseeable future.
      IFRIC 8“Scope of IFRS 2”. IFRIC 8 clarifies that transactions where anwithin the scope of IFRS 2“Share-based payment”, include those in which the entity obtainscannot specifically identify some or all of the goods or services from other parties (including employees or suppliers) inreceived. If the identifiable consideration for the entity’s equity instruments (including shares or share options) or cash-settled amounts based on the value of the entity’s equity instruments. It represents a significant change from current practice in the UK under UITF Abstract 17, where the charge is based on the intrinsic value of the share option (fair value of the share at the date of grantgiven appears to be less exercise price). Use ofthan the fair value of share options is expected tothe equity instruments granted or liability incurred, this situation generally result in higher charges in the profit and loss account for share compensation. We are currently considering the impact of this standard.
      The following Financial Reporting Standards have recentlyindicates that other consideration has been issued by the ASB. These accounting standards all mirror International Accounting Standards andor will be adopted by the group as part of the transition to IFRS as noted below:received.
ITEM 6.     • FRS 21 (IAS 10), “Events after the balance sheet date”;
• FRS 22 (IAS 33), “Earnings per share”;
• FRS 23 (IAS 21), “The effects of changes in foreign exchange rates”;
• FRS 24 (IAS 29), “Financial reporting in hyperinflationary economies”;
• FRS 25 (IAS 32), “Financial instruments; presentation and disclosure”;
• FRS 26 (IAS 39), “Financial instruments; measurement”.DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
      In common with other listed companies governed by the law of an EU member state, for financial years beginning on or after January 1, 2005 the Group will be required to prepare its financial statements in accordance with international accounting standards adopted at the European level (endorsed IAS’s or IFRS’s). This requirement will therefore first be applicable to the Group’s financial statements for the year ended December 31, 2005.
      Full details of the impact of IFRS on the Group’s 2004 financial statements are available on our website,www.pearson.com/ifrs. The information on this website is not incorporated by reference into this report.

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ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and Senior 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”.
      The following table sets forth information concerning senior management, as of April 2005.2006.
       
Name Age Position
     
Dennis StevensonGlen Moreno  5962  Chairman
Marjorie Scardino  5859  Chief Executive
David Bell  5859  Director for People and Chairman of the FT Group
Terry Burns  6162  Non-executive Director
Patrick Cescau  5657  Non-executive Director
Rona Fairhead  4344  Chief Financial Officer
Susan Fuhrman  6162  Non-executive Director
John Makinson  5051  Chairman and Chief Executive Officer, Penguin Group
Reuben Mark  6667  Non-executive Director
Vernon Sankey  5556  Non-executive Director
Rana Talwar  5758Non-executive Director
David Arculus59Non-executive Director
Ken Hydon61  Non-executive Director
     Dennis StevensonGlen Morenowas appointed a non-executive director in 1986 and became chairman in 1997.on 1 October 2005. He is a member of our treasury committee and chairman of the nomination committee. He is also chairman of HBOS plc and asenior independent non-executive director of Manpower Inc. in the US. On February 27, 2005 Pearson announced that Dennis intends to retire later in the year.Man Group plc and also a director of Fidelity International Limited and a trustee of The Prince of Liechtenstein Foundation and of The Liechtenstein Global Trust.
     Marjorie Scardinojoined the board and became chief executive in January 1997. She is a member of ourPearson’s nomination committee. She was chief executive of The Economist Group from 1993 until joining Pearson. She is also a non-executive director of Nokia Corporation.

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     David Bellbecame a director in March 1996. He is chairman of the FT Group, having 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 is also a non-executive director of VITEC Group plc and chairman of the International Youth Foundation.
     Terry Burnsbecame a non-executive director in May 1999 and ourthe senior independent director in February 2004. He currently serves on the audit, nomination and personnel committees. He was the UK government’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 Banco Santander Central HispanaHispano. On 1 October 2005, he was appointed deputy chairman of Marks and The British Land Company PLC.Spencer Group plc.
     Patrick Cescaubecame a non-executive director in April 2002. He joined ourthe audit committee in January this year,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 Director of Unilever’s Foods Division. He is currently chairmangroup chief executive of Unilever.
     Rona Fairheadbecame a director and chief financial officer in June 2002. She had served as deputy finance director 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.

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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.
     Susan Fuhrmanbecame a non-executive director in July 2004. She is a member of ourthe audit and nomination committee. Susancommittees. She is dean of Pennthe 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 a member of the Council for Corporate and School Partnerships of the Coca-Cola Foundation.
     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 in December 2002. He served as Pearson Finance Director from March 1996 until June 2002. From 1994 to 1996 he was managing 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 Markbecame a non-executive director in 1988 and currently servesserved on the audit and nomination committees 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. He retired from the board at the 2006 AGM.
     Vernon Sankeybecame a non-executive director in 1993 and currently servesserved as chairman of the audit committee and as a member of the treasury and nomination committees. He was previously chief executive of Reckitt & Colman plc and is chairman of Photo-Me International plc. He is also a non-executive director of Taylor Woodrow plc and Zurich Financial Services AG. He retired from the board at the 2006 AGM.
     Rana Talwarbecame a non-executive director in March 2000 and currently serves on the personnel, nomination and treasury 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.
David Arculus became 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 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 of United Business Media plc, group managing director of EMAP plc andnon-executive director of Barclays Bank plc.
Ken Hydon became 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 and Reckitt Benckiser plc. He was previously finance director of Vodafone Group plc and of subsidiaries of Racal Electronics.

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Compensation of Senior Management
      It is the role of the personnel 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. 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
      Pearson seeks to generate a performance culture by developing programsoperating incentive programmes that support its business goals and rewardingreward their achievement. It is the company’s policy that total remuneration (base compensation plus short-termshort- 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’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 programsprogrammes should ensure that Pearson retains a competitive recruiting advantage.
      Share ownership is encouraged throughout the company. Equity-based reward programsprogrammes align the interests of directors, and employees in general, with those of shareholders by linking rewards withdirectly to Pearson’s financial success.performance.
      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.

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      Total remuneration is made up of fixed and performance-linked elements.elements, with each element supporting different objectives. Base salary and other fixed remuneration (such as benefits and pension) reflect competitive market level, role and individual contribution. Annual incentives motivate achievement of annual strategic and operational goals. Long-term incentives focus on long-term earnings and share price growth, improvement in returns and value creation and align with shareholders’ interests through ownership and retention of shares.
      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
      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 companies of comparable sizeUK and global reachUS companies in different sectors including the media sector insector. Some are of a similar size to Pearson, some smaller, others are larger, but the UK andmethod which the committee’s independent advisers use to make comparisons on remuneration takes this into account. In addition, all have very substantial overseas operations. We also use selected media companies in North America to make this comparison. We use these companiesas well as the UK 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 policy is to review salaries annually.annually, considering levels of pay and pay increases throughout the company.
Other Emoluments
      Other emoluments may include benefits such as company car, healthcare, and, where relevant, amounts paid in respect of housing or other costs.
      It is the company’s policy that its benefit programsprogrammes should be competitive in the context of the local laborlabour market, but as an international company we require executives to operate worldwide and recognize the requirements, circumstances and mobility of individual executives.that recruitment also operates worldwide.
Annual Bonus
      The committee establishes the annual bonusincentive plans for the executive directors and the chief executives of the company’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 targetsperform-

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ance measures relate to the company’s main drivers of business performance at both the corporate and operating company level. With the exception of the CEO, 10% of the total annual incentive opportunity for the executive directors and other members of the Pearson Management Committee is based on performance against personal objectives. For the CEO, all measures are financial.
      For 2005,2006, the financial performance measures for Pearson plc are sales, growth in underlying adjusted earnings per share cash flow andfor continuing operations at constant exchange rates, average working capital as a ratio to sales. For subsequent years, the measures will be set at the time.sales and operating cash flow.
      For 2005,There have been no changes to the committee reviewed the target annual bonus opportunity forexecutive directors’ individual incentive opportunities. For the CEO, based on an assessment of market practice by Towers Perrin, and increased it from 75% to 100% of base salary.
      The committee is satisfied with the CEO’s resulting target total direct compensation relative to the market and the increase in the proportion of her compensation that is performance-related. The target annual incentive opportunity foris 100% of base salary and the maximum is 150%. For the other executive directors and other members of the Pearson Management Committee, remainsthe target is up to a maximum of 75% of salary. Thesalary and the maximum bonus for performance in excess of target remains in all cases, including the CEO, 150% of salary.is twice target.
      The committee may award individual discretionary bonuses.payments or exercise discretion in the payment of bonuses under the plan.
      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, bonusesAnnual incentive payments do not form part of pensionable earnings. In the US, bonuses up to 50% of base salary are pensionable under the supplemental executive retirement plan, consistent with US market practice.
Bonus Share Matching
      The company encourages executive directors and other senior executives to acquire and hold Pearson shares in many ways.shares.

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      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 to be made in 2006 and thereafter, if these shares are held and the company’s adjusted earnings per share increase in real terms by at least 3% per annum compound, the company will match them on a gross basis of one share for every two held after three years, and another one for two originally held (i.e. a total of one-for-one) after five 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 to measure the company’s financial progress over the period to which the entitlement to matching shares relates.
The Long-Term Incentive Plan
      Shareholders at the AGM approved the renewal of the long-term incentive plan first introduced in 2001. The committee has reviewed the operation of this plan in the light of the company’s strategic goals and concluded that it is operating satisfactorily and achieving its objectives. We have therefore sought and received approval of its renewal on broadly its original terms.
Executive directors, senior executives and other executives and managers arewill be eligible to participate in Pearson’s long-term incentivethe plan, introduced in 2001.which can deliver restricted stock and/or stock options. The plan consists of two parts: stock options and/or restricted stock. The aim as before is to give the committee a range of tools with which to link corporate performance to management’s long-term reward in a flexible way.
      Restricted stock granted to executive directors will vest only when stretching corporate performance targets over a specified period have been met. Awards will vest on a sliding scale based on performance over the period. There will be no retesting. The principles underlying it are as follows:committee will determine the performance measures and targets governing an award of restricted stock prior to grant.
• the Personnel Committee establishes guidelines that set out the maximum expected value of awards each year using an economic valuation methodology for fixing the relative values of both option grants and restricted stock awards;
• the maximum expected value of awards for executive directors is based on assessment of market practice for comparable companies;
• no more than 10% of Pearson equity will be issued, or be capable of being issued, under all Pearson’s share plans in any ten-year period commencing in January 1997;
• awards of restricted stock are satisfied using existing shares.
      For      It is not the committee’s intention to grant stock options within this overall 10% limit, upin 2006. Should the committee decide to 1.5% of new issue equity may be placed under option under the plangrant them in any year, subjectfuture, options granted 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 annumexecutive directors would come with a minimum three-year vesting period and would vest on a sliding scale based on stretching performance over the three-year period prior to grant.with no retesting.
      The vestingcommittee’s independent advisers calculate the expected value of both restricted stock is normally dependent onand stock options i.e. their net present value after taking into account all the satisfactionconditions and, in particular, the probability that any performance conditions will be met. Taking into account the independent advisors’ values and assessments of a stretching corporate performance target over a three-year period.market practice for comparable companies, the committee establishes guidelines each year for the maximum expected value of individual awards.
      In any rolling 10-year period, no more than 10% of Pearson equity will be issued, or available for issue, under all Pearson’s share plans, and no more than 5% of Pearson equity will be issued, or available for issue, under executive or discretionary plans.

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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 appropriatenecessary to specify a particular relationship of shareholding to salary.
Service Agreements
      ExecutiveIn 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.
      The terms of theThese service agreements permitprovide that the company tomay terminate these agreements by giving 12 months’ notice, although there may be circumstances when a longer notice period may be justified. The agreements alsoand 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.
      For health reasons, Peter Jovanovich stood down as a director of the company for health reasons on 31 January 31, 2005, but remainsremained entitled to contractual short- and long-term disability and other benefits. These arrangements are set out in an agreement dated 28 January 28, 2005 between the company2005. Dennis Stevenson retired as chairman and Mr Jovanovich. The major terms of this agreement are set forth in “Item 10. Additional Information — material contracts”.director on 1 October 2005. Glen Moreno was appointed chairman and director on 1 October 2005.

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Retirement Benefits
      We describeFollowing are the retirement benefits for each of the executive directors.
      Executive directors participate in the approved pension arrangements set up for Pearson employees. Marjorie Scardino, John Makinson, Rona Fairhead and Peter Jovanovich 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 dependentsdependants is also available on death.
      In the US, the approved defined benefit arrangement is the Pearson Inc. Pension Plan. This plan provides a lump sum convertible to a pension on retirement.
The lump sum accrued at 6% of capped compensation until 31 December 31, 2001 when further benefit accruals ceased. Normal retirement is age 65 although early retirement is possible subject to a reduction for early payment. No increases are guaranteed for pensions in payment. There is a spouse’s pension on death in service and the option to provide a death in retirement pension by reducing the member’s pension.
      The approved defined contribution arrangement in the US is a 401(k) plan. At retirement, the account balances will be used to provide benefits. In the event of death before retirement, the account balances will be used to provide benefits for dependants.
      In the UK, the approved schemeplan is the Pearson Group Pension Plan and some executive directors participate in the Final Pay section. Normal retirement age is 62 but, subject to company consent, retirement is possible after age 50. The accrued pension is reduced on retirement prior to age 60. Pensions in payment are guaranteed to increase each year at 5% or the increase in the Index of Retail Prices, if lower. Pensions for a member’s spouse, dependent children and/or nominated financial dependentdependant are payable in the event of death.
      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 will be offered a cash supplement as an alternative to further accrual of pension benefits on a basis that is broadly cost neutral to the company. Further details will be set out in the report on directors’ remuneration for 2006.
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

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funded defined contribution plan approved by the UK InlandHM Revenue and Customs as a corresponding schemeplan to 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 earlyservice. 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 earnings cap introduced by the Finance Act 1989. The company also contributes 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.

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Peter Jovanovich
      Peter Jovanovich is a member of the Pearson Inc. Pension Plan and the approved 401(k) plan. He also participates in an unfunded, unapproved Supplemental Executive Retirement Plan (SERP) that provides an annual accrual of 2% of final average earnings, less benefits accrued in the Pearson Inc. Pension Plan and US Social Security. He ceased to build up further benefits in the SERP at 31 December 31, 2002. Additional defined contribution benefits are provided through a funded, unapproved 401(k) excess plan and an unfunded, unapproved arrangement. In the event of death while in receipt of disability benefits, the account balances in the defined contribution arrangements will be used to provide benefits for dependants. The SERP arrangement provides a spouse’s pension on death while in receipt of disability benefits and the option of a death in retirement pension by reducing the member’s pension.
John Makinson
      John Makinson is a member of the Pearson Group Pension Plan under which his pensionable salary is restricted to the earnings cap. The company ceased contributions on 31 December 2001 to his FURBS arrangement. During 2002 it set up an Unfunded Unapproved Retirement Benefits Scheme (UURBS) for him. The UURBS tops up the pensions 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 Index of Retail Prices. 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.
Chairman’s Remuneration
Chairman’s Remuneration
      Our policy is that the chairman’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 is eligible to participate in the company’s worldwide save for shares plan on the same terms as all other eligible employees.
      For 2004, theThe committee’s view wasis that, taking into account the remuneration of chairmen in comparable positions, the appropriate total pay level wasis £425,000 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 that the committee accepted. Instead, the committee recommended to the board that the chairman’s salary should be £325,000 for 2004, an increase of £50,000, and that he should receive a one-off restricted share award of 30,000 shares. This award is linked to the company’s share price and will not be released to him unless the Pearson share price reaches £9.00 within a maximum period of three years.Non-executive Directors
      For 2005, the committee recommended to the board that the chairman’s salary should be increased towards the appropriate total pay level of £425,000 previously noted and that this increase should be delivered in Pearson shares purchased in the market at the prevailing share price. No awards of performance-related restricted shares will be granted. Full details will be set out in the report on directors’ remuneration for 2005.
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’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’s equity-based incentive plans.

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      For 2004, the non-executive directors received an annual fee of £35,000 each. Two non-UK based directors were paid a supplement of £7,000 per annum. The non-executive directors who chaired the personnel and audit committees each received an additional fee of £5,000 per annum.
      In the case of Patrick Cescau, his fee was paid over to his employer. For those non-executive directors who retained their fees personally, £10,000 of the total fee, or all of the fee in the case of Rana Talwar, was payable in the form of Pearson shares which the non-executive directors have committed to retain for the period of their directorships.
      For 2005, the chairman and the executive directors of the board reviewed the level and structure of non-executive directors’ fees, which had not been changed since January 2000. After reviewing external benchmarks, they agreed an increase in the basic fee to £45,000, an increase in the fee for the audit and personnel committee chairmen to £10,000, the introduction of separate fees of £5,000 for audit and personnel committee membership and of £10,000 for the senior independent director and the replacement of the fee for non-UK based directors with a fee of £2,500 for overseas meetings.
      One-third of the basic fee, will beor the entire fee in the case of Rana Talwar, is paid in Pearson shares. Full details will be set out inshares that the report on directors’ remunerationnon-executive directors have committed to retain for 2005.the period of their directorships.
      In the case of Patrick Cescau, his fee was paid over to his employer.
      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.
Remuneration of Senior Management
Remuneration of Senior Management
      Excluding contributions to pension funds and related benefits, senior management remuneration for 20042005 was as follows:
                       
 Salaries/Fees Bonus(1) Other(2) Total Salaries/Fees Bonus(1) Other(2) Total
                
 £’000 £’000 £’000 £’000 £’000 £’000 £’000 £’000
Chairman
                          
Dennis Stevenson  325      325 
Dennis Stevenson (retired 1 October 2005)  281      281 
Glen Moreno (appointed 1 October 2005)  106      106 
Executive directors
                          
Marjorie Scardino  645  831  62  1,538   710  1,038  62  1,810 
David Bell  375  483  16  874   395  560  17  972 
Rona Fairhead  390  503  14  907   420  608  16  1,044 
Peter Jovanovich  473  571  8  1,052   41    373  414 
John Makinson  460  119  212  791   475  564  211  1,250 
                  
Senior management as a group
  2,668  2,507  312  5,487   2,428  2,770  679  5,877 
                  
 
(1) For Marjorie Scardino, David Bell and Rona Fairhead, bonusesannual incentives were related tobased on the financial performance of Pearson plc. In the case 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 and John Makinson, 10% of their annual incentives was based on performance against personal objectives.
      In the case of Peter Jovanovich and John Makinson, part of their bonuses related to the performance of Pearson Education and Penguin Group respectively and part to the performance of Pearson plc.
      For Pearson plc, the performance measures were earnings per share growth, operating cash flow, sales and average working capital as a ratio to sales. Actual underlying growth in adjusted earnings per share at constant exchange rates consistent with the reported adjusted earnings per share (pre-intangibles) of 34.1p, operating cash flow of £570m and average working capital as a ratio to sales were aboveeach better than the level of performance required for maximum and growth in underlyingpayout. Actual sales and operating cash conversion were above target but below maximum.
      For Pearson Education, average working capital as a ratio to sales and operating cash conversion were above maximum, and sales and operating marginat £4,096m were above target but below maximum.
      For Penguin Group, growth in underlying sales,the performance measures were operating margin,profit, operating cash flow and average working capital as a ratio to sales. For operating cash flow and working capital as a ratio to sales actual performance was better than that required for maximum payout and for operating cash conversion wereprofit was above target but below threshold.maximum.
      In the case of Pearson plc and Pearson Education, cash received in 2004 in relation to the outstanding receivable due from the TSA contract in 2002 was not included for bonus purposes.

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(2) Other emoluments include company car and healthcare benefits and, inbenefits. In the case of Marjorie Scardino, these include £37,955£39,245 in respect of housing costs.costs and a cash US payroll supplement of £8,372. 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. He received £184,517£186,279 in cash for 2004.2005. Marjorie Scardino, Rona Fairhead, David Bell and John Makinson have the use of a chauffeur. In accordance with the agreement dated 28 January 2005 referred to on page 26 of this report, Peter Jovanovich received short-and long-term disability payments in cash for the period 1 February 2005 to 31 December 2005.

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Share Options of Senior Management
      This table sets forth for each director the number of share options held as of December 31, 20042005 as well as the exercise price, rounded to the nearest whole penny/cent, and the range of expiration dates of these options.
                     
  Number of   Exercise Earliest  
Director Options (1) Price Exercise Date Expiry Date
           
Dennis Stevenson  3,556   b   494.8p   01/08/11   01/02/12 
                
Total
  3,556                
                
Marjorie Scardino  176,556   a*  974p973.3p   14/09/01   14/09/08 
   5,660   a*  1090p1090.0p   14/09/01   14/09/08 
   2,839b687p01/08/0501/02/06
2,224   b   425p424.8p   01/08/06   01/02/07 
   37,583   c*  1373p1372.4p08/06/0208/06/09
37,583c*1647.5p   08/06/02   08/06/09 
   37,583   c   1648p08/06/0208/06/09
37,583c1922p1921.6p   08/06/02   08/06/09 
   36,983   c   2764p03/05/0303/05/10
36,983c3225p3224.3p   03/05/03   03/05/10 
   41,550   d*  1421p1421.0p   09/05/02   09/05/11 
   41,550   d*  1421p1421.0p   09/05/03   09/05/11 
   41,550   d*  1421p1421.0p   09/05/04   09/05/11 
   41,550   d*  1421p1421.0p   09/05/05   09/05/11 
                
Total
  540,194500,372                
                
David Bell  20,496   a*  974p973.3p   14/09/01   14/09/08 
   184b*913p01/08/0401/02/05
202b*957p01/08/0401/02/05
272   b   696p696.0p   01/08/05   01/02/06 
   444   b   425p424.8p   01/08/06   01/02/07 
   1,142   b   494.8p   01/08/07   01/02/08 
   373b507.6p01/08/0801/02/09
18,705   c*  1373p1372.4p08/06/0208/06/09
18,705c*1647.5p   08/06/02   08/06/09 
   18,705   c   1648p08/06/0208/06/09
18,705c1922p1921.6p   08/06/02   08/06/09 
   18,686   c   2764p03/05/0303/05/10
18,686c3225p3224.3p   03/05/03   03/05/10 
   16,350   d*  1421p1421.0p   09/05/02   09/05/11 
   16,350   d*  1421p1421.0p   09/05/03   09/05/11 
   16,350   d*  1421p1421.0p   09/05/04   09/05/11 
   16,350   d*  1421p1421.0p   09/05/05   09/05/11 
                
Total
  181,627162,928
Rona Fairhead1,904b494.8p01/08/0701/02/08
20,000d*822.0p01/11/0201/11/11
20,000d*822.0p01/11/0301/11/11
20,000d*822.0p01/11/0401/11/11
Total
61,904                
                

5349


                                       
 Number of   Exercise Earliest   Number of   Exercise Earliest  
Director Options (1) Price Exercise Date Expiry Date Options (1) Price Exercise Date Expiry Date
                    
Rona Fairhead  1,904  b  494.8p  01/08/07  01/02/08 
  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
  61,904            
           
Peter Jovanovich  8,250  a*  758p  12/09/00  12/09/07   8,250  a*  757.5p  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   102,520  a*  676.4p  12/09/00  12/09/07 
  32,406  c  1648p  08/06/02  08/06/09   32,406  c*  1372.4p  08/06/02  08/06/09 
  32,406  c  1922p  08/06/02  08/06/09   32,406  c*  1647.5p  08/06/02  08/06/09 
  33,528  c  2764p  03/05/03  03/05/10   32,406  c  1921.6p  08/06/02  08/06/09 
  33,528  c  3225p  03/05/03  03/05/10   33,528  c  3224.3p  03/05/03  03/05/10 
  31,170  d* $21.00  09/05/02  09/05/11   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  09/05/03  09/05/11 
  31,170  d* $21.00  09/05/04  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   31,170  d* $21.00  09/05/05  09/05/11 
  19,998  d* $11.97  01/11/02  01/11/11   20,000  d* $11.97  01/11/02  01/11/11 
  19,998  d* $11.97  01/11/03  01/11/11   20,000  d* $11.97  01/11/03  01/11/11 
  20,004  d $11.97  01/11/04  01/11/11   20,000  d* $11.97  01/11/04  01/11/11 
                      
Total
  459,724              426,196            
                      
John Makinson  20,160  a*  487p  20/04/98  20/04/05   36,736  a*  584.0p  08/08/99  08/08/06 
  36,736  a*  584p  08/08/99  08/08/06   73,920  a*  676.4p  12/09/00  12/09/07 
  73,920  a*  677p  12/09/00  12/09/07   30,576  a*  973.3p  14/09/01  14/09/08 
  30,576  a*  974p  14/09/01  14/09/08   4,178  b  424.8p  01/08/10  01/02/11 
  4,178  b  425p  01/08/10  01/02/11   21,477  c*  1372.4p  08/06/02  08/06/09 
  21,477  c  1373p  08/06/02  08/06/09   21,477  c*  1647.5p  08/06/02  08/06/09 
  21,477  c  1648p  08/06/02  08/06/09   21,477  c  1921.6p  08/06/02  08/06/09 
  21,477  c  1922p  08/06/02  08/06/09   21,356  c  3224.3p  03/05/03  03/05/10 
  21,356  c  2764p  03/05/03  03/05/10   19,785  d*  1421.0p  09/05/02  09/05/11 
  21,356  c  3225p  03/05/03  03/05/10   19,785  d*  1421.0p  09/05/03  09/05/11 
  19,785  d*  1421p  09/05/02  09/05/11   19,785  d*  1421.0p  09/05/04  09/05/11 
  19,785  d*  1421p  09/05/03  09/05/11   19,785  d*  1421.0p  09/05/05  09/05/11 
  19,785  d*  1421p  09/05/04  09/05/11            
  19,785  d  1421p  09/05/05  09/05/11 
           
Total
  351,853              310,337            
                      
 
(1) Shares under option are designated as:aexecutive;bworldwide save for shares;cpremium priced; anddlong-term incentive; and*where options are exercisable.
aExecutive
 Subject to any performance condition being met, executive options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth.

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 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.
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
 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
dLong-term incentive

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 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 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 Management
      The table below sets forth the number of ordinary shares and restricted shares held by each of our directors as at March 31, 2005.2006. Additional information with respect to share options held by, and bonus awards for, these persons is set out above in “Remuneration of Senior Management” and “Share Options for Senior Management”. The total number of ordinary shares held by senior management as of March 31, 20052006 was 571,754626,152 representing less than 1% of the issued share capital on March 31, 2005.2006.
                
As at March 31, 2005 Ordinary Shares(1) Restricted Shares(2)
As at March 31, 2006 Ordinary Shares(1) Restricted Shares(2)
        
Dennis Stevenson  168,190  30,000 
Glen Moreno  100,000   
Marjorie Scardino  145,044  975,648   184,889  1,336,015 
David Bell  84,106  455,969   103,158  587,829 
Terry Burns  4,432     5,717   
Patrick Cescau          
Rona Fairhead  15,660  444,803   43,209  637,936 
Susan Fuhrman  992     2,681   
John Makinson  124,127  511,184   149,466  642,756 
Reuben Mark  15,245     16,908   
Vernon Sankey  4,287     5,563   
Rana Talwar  9,671     14,561   
 
(1) Amounts include shares acquired by individuals under the annual bonus share matching plan and amounts purchased in the market by individuals.

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(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
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’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’s listing on the New York Stock Exchange. Under it, participants save a portion of their monthly salary over six month periods, at the end of which they have 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.
Board Practices
      Our board currently comprises the chairman, who is a part-timenon-executive, four executive directors and six 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 to one-third, shall retire from office. The directors to

51


retire each year are the directors who have been longest in office since their last election or appointment. A retiring director is eligible for re-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 been re-elected, unless at or prior to such meeting it is expressly resolved not to fill the vacated office, or unless a resolution for the re-election of that director has been put to the meeting and lost. Our articles of association also provide that every director be subject to re-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, Patrick Cescau and Reuben Mark are members. TheThis 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. Until April 21, 2006, Vernon Sankey ischaired this committee and Terry Burns, Patrick Cescau and Reuben Mark were members. Vernon Sankey was also the designated audit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission. Vernon Sankey and Reuben Mark retired from the committee on April 21, 2006 and Terry Burns stepped down from the committee on April 27, 2006. Ken Hydon, David Arculus and Susan Fuhrman have now joined the committee, with Ken Hydon as both the chairman and designated audit committee financial expert. 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
      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’s remuneration to the board of directors for its decision and reviews management development and succession plans. Until April 21, 2006, Reuben Mark chaired this committee and Terry Burns and Rana Talwar were members. Reuben Mark retired from the committee on April 21, 2006. David Arculus has now joined the committee as chairman. All the three members are non-executive directors.

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Nomination Committee
      This committee is chaired by Dennis Stevenson and comprises Marjorie Scardino and all of the non-executive directors. The committee meets from time to time as necessary to consider the appointment of new directors. The committee is chaired by Glen Moreno and comprises Marjorie Scardino and all of the non-executive directors.
Treasury Committee
      This committee is chaired by Dennis Stevenson and also comprises Rona Fairhead, Vernon Sankey and Rana Talwar. The committee sets the policies for our treasury department and reviews its procedures on a regular basis. Dennis Stevenson was chairman of the committee until his retirement on October 1, 2005 and Rona Fairhead, Vernon Sankey and Rana Talwar were members. Vernon Sankey retired from the committee on April 21, 2006. The constitution of the committee will be reviewed later in the year.
Employees
      The average numbers of persons employed by us during each of the three fiscal years ended 20042005 were as follows:
 • 33,38932,203 in fiscal 20042005
 
 • 30,86833,086 in fiscal 2003,2004, and
 
 • 30,35930,584 in fiscal 2002.2003.
      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.

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      The table set forth below shows for 2005, 2004 and 2003 the average number of persons employed in each of our operating divisions in the United Kingdom, the United States, other locations and in total.divisions.
                 
Business Unit UK US Other Total
         
Pearson Education  2,071   16,133   4,080   22,284 
FT Group  1,709   1,352   2,594   5,655 
The Penguin Group  1,067   2,026   992   4,085 
Other  792   572   1   1,365 
             
Total Pearson
  5,639   20,083   7,667   33,389 
             
             
Average number employed 2005 2004 2003
       
School  10,133   10,403   9,348 
Higher Education  4,196   4,087   3,912 
Professional  8,342   7,491   6,434 
Penguin  4,051   4,085   4,318 
FT Publishing  1,952   1,989   2,283 
IDC  1,956   1,826   1,628 
Other  1,573   1,365   928 
Continuing operations  32,203   31,246   28,851 
          
Discontinued operations     1,840   1,733 
          
Total  32,203   33,086   30,584 
          
ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
      To our knowledge, as of March 31, 2005,February 26, 2006, the only beneficial owners of 3% or more of our issued and outstanding ordinary share capital were Franklin Resources Inc. which owned 104,485,808 ordinary shares representing 13.0% of our outstanding ordinary shares and The Capital Group Companies Inc. which owned 120,639,43255,653,209 ordinary shares representing 15.0% of our outstanding ordinary shares, Franklin Resources Inc. which owned 96,437,794 ordinary shares representing 12.0% of our outstanding ordinary shares and Legal and General which owned 24,046,759 ordinary shares representing 3.0%6.9% of our outstanding ordinary shares. On March 31, 2005,February 26, 2006, record holders with registered addresses in the United States held 20,196,87734,992,603 ADRs, which represented 2.5%4.4% 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, 20042005 are shown in notesnote 13 and 14 in “Item 17. Financial Statements.”. Amounts due from joint ventures and associates are set out in note 17 and dividends receivable from joint ventures and associates are set out in notesnote 13 and 14 in “Item 17. Financial Statements”. There were no other related party transactions in 2004.2005.

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ITEM 8.     FINANCIAL INFORMATION
ITEM 8.     FINANCIAL INFORMATION
      The financial statements filed as part of this Annual Report are included on pages F-1 through F-69 F-80 hereof.
      Other than those events described in note 3133 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, 2003.2005. 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 3. Key Information” above.
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 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.
ITEM 9.     THE OFFER AND LISTING
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.

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      The ADSs trade on the New York Stock Exchange under the symbol “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 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.

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 Ordinary Shares    Ordinary Shares  
   Average Daily    Average Daily
Reference PeriodReference Period High Low Trading VolumeReference Period High Low Trading Volume
             
   (Ordinary    (Ordinary
 (In pence) shares)  (In pence) shares)
Five Most Recent Fiscal Years
Five Most Recent Fiscal Years
          
Five Most Recent Fiscal Years
          
2004  682  579  6,219,200 2005  695  608  5,296,700 
2003  680  430  6,631,800 2004  682  579  6,219,200 
2002  922  505  6,164,500 2003  680  430  6,631,800 
2001  1,726  645  5,245,000 2002  922  505  6,164,500 
2000  2,302  1,470  2,686,700 2001  1,726  645  5,245,000 
Most Recent Quarter and Two Most Recent Fiscal Years
Most Recent Quarter and Two Most Recent Fiscal Years
          
Most Recent Quarter and Two Most Recent Fiscal Years
          
2005 First quarter  662  608  5,626,100 
2006 First quarter2006 First quarter  811  671  6,395,400 
2005 Fourth quarter2005 Fourth quarter  692  616  4,947,900 
Third quarterThird quarter  695  652  4,860,700 
Second quarterSecond quarter  668  628  5,823,300 
First quarterFirst quarter  662  608  5,626,100 
2004 Fourth quarter2004 Fourth quarter  640  590  5,020,800 2004 Fourth quarter  640  590  5,020,800 
 Third quarter  657  579  5,864,300 
 Second quarter  682  623  6,993,900 
 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 
Third quarterThird quarter  657  579  5,864,300 
Second quarterSecond quarter  682  623  6,993,900 
First quarterFirst quarter  657  584  7,039,600 
Most Recent Six Months
Most Recent Six Months
          
Most Recent Six Months
          
 May 2005  666  635  7,486,700 
 April 2005  655  628  6,085,700 
 March 2005  647  626  7,654,100 
 February 2005  662  623  4,800,100 
 January 2005  638  608  4,124,200 
 December 2004  630  603  3,122,200 
April 2006April 2006  798  756  7,614,100 
March 2006March 2006  811  720  7,055,300 
February 2006February 2006  737  706  4,336,400 
January 2006January 2006  734  671  7,577,400 
December 2005December 2005  692  674  3,912,900 
November 2005November 2005  673  636  6,524,000 
ITEM 10.     ADDITIONAL INFORMATION
ITEM 10.     ADDITIONAL INFORMATION
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 our annual 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.
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
      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

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his interest and acted in accordance with law, no such contract or arrangement shall be avoided and no

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director so contracting or being interested shall be liable to account to us for any profit realized 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’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
 
 • any proposal concerning insurance that we propose to maintain or purchase for the benefit of directors or for the benefit of persons, including directors.
      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
      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’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 any intra-group debts, shall not at any time exceed a sum equal to twice the aggregate of the adjusted capital and reserves, unless the shareholders in general meeting sanction an excession of this limitation.
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 of non-executive directors, up to an aggregate of £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. While the Companies Act 1985 states that no 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.

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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
 
 • 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 than one-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 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
      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, the Causeway, Worthing, West Sussex BN99 6DA, United Kingdom, telephone number +44-1903-502-541.+44-1903-502-541.
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’ 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’ 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

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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.

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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
 
 • 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
      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
      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.
      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
      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.

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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 of three-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

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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 least one-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 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%,
comes under an obligation to disclose prescribed particulars to us in respect of those ordinary shares. A disclosure obligation also arises where a person’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
      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.
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 $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 $350 million principal amount of 4.70% senior notes due 2009 and $400 million principal amount of 5.70% senior notes due 2014, in each case

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fully and unconditionally guaranteed by Pearson plc, under an indenture dated May 25, 2004 between Pearson Dollar Finance plc, Pearson plc and The Bank of New York, as trustee. The first semi-annual interest payment was made on December 1, 2004. Pearson Dollar Finance may redeem the notes at any time, in whole or in part, at its option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than an insolvency or bankruptcy of Pearson 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.

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Issuance of $300,000,000 4.625% Senior Notes due 2018
      We issued $300 million 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 first semi-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.
Agreement to Sell Shares of Recoletos Grupo de Comunicación, S.A. to Retos Cartera, S.A.
      We entered into an irrevocable undertaking on December 14, 2004 with Retos Cartera, S.A., with respect to the sale of our 79% stake in Recoletos Grupo de Comunicacion, S.A. Pursuant to the irrevocable undertaking, we agreed to sell our shares in Recoletos to Retos Cartera for the price set forth in its concurrent tender offer to all shareholders of Recoletos. On April 8, 2005, Retos Cartera successfully completed its tender for 100% of the shares of Recoletos, and paid us net cash proceeds of £372 million for our 79% stake.
      Retos Cartera also agreed to pay us additional deferred consideration in the event that it, or one of its affiliates, disposes of its shares in, or the assets of, Recoletos, for a period of 18 months after the closing of the tender offer. The obligation to pay deferred consideration is subject to certain limitations. The parties have made representations and warranties to each other that are customary for a transaction of this type. We have agreed to indemnify Retos Cartera for any breach of a representation or warranty, and both parties have agreed to be liable for losses associated with a breach of its obligations in the irrevocable undertaking.
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 6. Directors, Senior Management & Employees — Compensation of Senior Management”. Each agreement may be terminated by us on 12 months’ notice or by the executive director on six months’ notice. In the event we terminate any executive director without giving the full 12 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.

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Agreement with Peter Jovanovich
      On January 28, 2005, we entered into a letter agreement with Peter Jovanovich with respect to his employment with Pearson Education and its affiliates. Due to poor health, Mr. Jovanovich terminated his employment with us. The letter agreement sets forth the terms of his disability leave and confirms his existing disability benefits, including benefits under our short term disability plan, long-term disability plan, and supplemental long-term disability plan. Under the terms of the agreement, Mr. Jovanovich will receive standard benefits (except awards under Pearson plc stock plans), and thereafter, will receive coverage under our medical, dental and vision plans and our life insurance plan, plus a payment for unused vacation days. We have agreed to continue to credit Mr. Jovanovich’s individual defined contribution arrangement. We also agreed to pay him his 2004 annual bonus. The value of Mr. Jovanovich’s disability package, and his total remuneration for our 2004 financial year, is included in “Item 6. Directors and Senior Management”.
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” below.
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.
      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,

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 • 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

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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 discussions below regarding US residents are based on the articles of the New Income Tax Treaty.
      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 US and 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 the US federal, state and local, UK and other, including foreign, tax consequences of investing in the ordinary shares or ADSs. The statements of US and 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 Distributions
      The United Kingdom does not impose dividend withholding tax on dividends paid to US holders.
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 excess of our current and accumulated earnings and profits will constitute a non-taxable return of capital to a US holder and will be applied against and reduce the US holder’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.
      A distribution by the Company to noncorporate shareholders before 2009 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.

60


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.

66


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’s adjusted tax basis in the ordinary shares or ADSs. Any gain or loss recognized will be capital gain or loss and will be long-term capital gain or loss if the US holder has held the ordinary shares or ADSs for more than one year. Long-term capital gain of a noncorporate US holder is generally taxed at a maximum rate of 15%. This long-term capital gain rate is scheduled to expire in 2009.
      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
      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’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’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 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
      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 £5.00 per instrument of transfer.
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
      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

61


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.

67


ITEM 11.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction
      Our principal market risks are changes in interest rates and currency exchange rates. Following 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 a Treasury Committee of our board of directors. A Treasury Committee of the boardThis receives regular reports on our treasury activities, which outside advisers also review periodically.
      We have a policy of not undertaking any speculative transactions, and we hold the derivative and other financial instruments for purposes other than trading.
      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 2005 and 2004 (but not 2003) we qualified for hedge accounting under US GAAP on a limited number of our key derivative 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
Adoption of International Financial Reporting Standards
      From 1 January 2005 the Group adopted IAS 39 “Financial Instruments: Recognition and Measurement” and IAS 32 “Financial Instruments: Disclosure and Presentation”. The market values of the Group’s derivatives were recognized in the balance sheet at the date of adoption. Subsequent changes in their market value will change the carrying values on the balance sheet and create movements in the finance cost section of the income statement, unless they have been designated (and passed the prescribed tests) for hedge accounting treatment. In addition, IAS 39 requires to value the Group’s derivatives at 1 January 2005 as if the standard had been in place at the start date of each individual contract. This has given rise to transition adjustments, which in some cases are being amortised over the remaining life of the relevant transaction. Also, where the Group qualifies for hedge accounting on a derivative, the carrying value of the relevant bond is adjusted to reflect this (in addition to the requirement under IFRS that accrued interest should be included in the carrying value of the bond or derivative).
      As the Group elected to adopt IAS 39 from 1 January 2005 as permitted by the transitional provisions in IFRS 1, the effects described above are not reflected in the 2004 and 2003 comparatives. A detailed description on the effects of the adoption of IAS 39 is included in note 191 and note 34 in “Item 17. Financial Statements” for discussion of treasury policy in these areas..
Interest Rates
      OurThe Group’s financial exposuresexposure to interest rates arisearises primarily from ourits borrowings, particularly those in US dollars. We manage ourThe Group manages its exposure by borrowing at fixed and variable rates of interest, and by entering into derivative instruments. Objectives approved by ourthe Treasury Committee of the board concerning the proportion of debt outstanding at fixed rates govern ourthe use of these financial instruments.
      OurThe Group’s objectives are applied to core net debt, which is year-end borrowings net of year-end cash and liquid funds. Those objectives are that for between 40% and 65%Since September 2005 the objective has been to maintain a proportion of currentforecast core net debt the rate of interest should bein fixed or capped form for the next four years.years, subject to a maximum of 65% and a minimum that starts at 40% and falls by 10% each year. Within this target range the proportion that is hedged is triggered by a formula based on historical interest rate frequencies. Previously the minimum was 40%.
      The principal method to hedge interest rate risk is to enter into an agreement 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 these contracts are US dollar denominated,

62


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 and 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 rate on a single transaction unduly influencing our overall net interest expense, it 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. In several cases, the bond issue was denominated in a different currency than the debt being refinanced and we havethe Group has entered into a related interest rate and currency swap in order to maintain an unchanged borrowing risk profile.
      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 sharply the income statement impact of changes in the market value of a derivative). The Group then divides the total portfolio between hedge-accounted and pooled segments, so that the expected movement on the pooled segment is minimal.
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.dollar.

68


      OurThe 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 external borrowings and currency swaps to manage this exposure. This policy aims to dampen the impact of changes in foreign exchange rates on consolidated interest cover and earnings. While long-term core borrowingIn September 2005 this policy was modified to apply only to currencies that accounted for more than 15% of group operating profit, which is now limitedcurrently only the US dollar. Previously, the policy applied specifically to US dollars, euroEuro and sterling, weSterling. 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, 20042005 the split of aggregateGroup’s net borrowingsborrowings/ (cash) in corethe three currencies wasabove (taking into account currency rate swaps) were: US dollar 88%,£1114 million, euro 7%£78 million and sterling 5%. We£(93) million
      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 movements on it to be taken to reserves) for the purposes of reporting under IFRS and 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, although they do not give rise to any realized gain or loss, nor to any currency cash flows.
      The Group is also exposed to currency exchange rates in ourits cash transactions and ourits investments in overseas transactions.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 we paythe Group pays or receive.
      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.receives.
Forward Foreign Exchange Contracts
      We useThe 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

63


exchange rate. OurThe Group’s policy is to effect transactional conversions between currencies, for example to collect receivables or settle payables, at the relevant spot exchange rate.
      We seekThe 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 useusing short-dated swaps between currencies.
      Although we prepare ourthe Group prepares its consolidated accountsfinancial statements in sterling, weSterling, significant 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,Sterling, and also between the euroEuro and sterling,Sterling, are likely to affect shareholders’ funds and other accounting values.
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 gainsboth IFRS 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 2004, unlikeUsing the transitional exceptions of IAS 39, derivatives were accounted for in accordance with UK GAAP for the years ended December 31, 2003 and 2002,2004. 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. From January 1, 2005, the Group qualifiedhas adopted IAS 39“Financial Instruments: Recognition and Measurement” and IAS 32“Financial Instruments: Disclosure and Presentation”, which resulted in a transitional adjustment in reserves of £12 million.
      Under US GAAP, in 2003 our derivative contracts did not meet the prescribed criteria for hedge accounting, under US GAAPand have been recorded at market value at each period end, with changes in respect of a number of its key derivative contracts. The remainder of our derivatives did not meettheir fair value being recorded in the profit and loss account. In 2005 and 2004 the Group met the prescribed designation requirements and hedge effectiveness tests under US GAAP which are notfor certain of its derivative contracts. As a requirement to obtain hedge accounting under UK GAAP. Consequentlyresult, the Group has recorded the changesmovements in the fair valuesvalue of these derivative contracts throughthe effective portion of fair value hedges and net investment hedges have been offset in earnings under US GAAP.and other comprehensive income respectively by the corresponding movement in the fair value of the underlying bond or asset.
      In line with the Group’s treasury policy, none of these were trading instruments and each was transacted solely to match an underlying financial exposure.

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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
      Not applicable.
ITEM 15.     CONTROLS AND PROCEDURES
ITEM 15.CONTROLS AND PROCEDURES
      An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 20042005 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

64


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. We recently identified a US GAAP adjustment, to reflect the correct accounting treatment of incentives and fixed rental escalations under one of our leases, which we consider to be material. The US GAAP profit and loss account and shareholders’ funds for the financial years ended December 31, 2003 and 2002 have been restated accordingly. This restatement is discussed on page F-56 and has the effect of reducing our US GAAP profit for the 2003 and 2002 financial years by £14 million and £12 million pre tax (£10 million and £9 million post tax), respectively, and reducing the Company’s shareholders’ funds reported as of December 31, 2003 and 2002 by £26 million and £12 million pre tax (£19 million and £9 million post tax), respectively, from amounts previously reported. No adjustments are required in respect of the Company’s primary UK GAAP financial statements and no issues of governance arise as a consequence of making these adjustments. The Chief Executive Officer and Chief Financial Officer believe that the need for this restatement constitutes a significant control deficiency but not a material control weakness (as such terms are used in the US federal securities laws) forDuring the period under review. This conclusion is basedcovered by this Annual Report on the factForm 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 procedures have improved year on year leading to the identification and correction of the issues for the 2004 year end.
      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 or material weaknesses.over financial reporting.
ITEM 16A.     AUDIT COMMITTEE FINANCIAL EXPERT
      The members of the Board of Directors of Pearson plc have determined that Vernon Sankey iswas an audit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission.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

70


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 or Deputy 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 2004 2003 2005 2004 2003
          
 £m £m £m £m £m
Statutory audit and audit-related regulatory reporting services  4  3 
Statutory audit  4  3  3 
Audit-related regulatory reporting services  1  1   
Non-audit services  2  2   2  2  2 
Non-audit services were as follows:       
Non-audit services are analysed as follows:          
Tax compliance services  1  1   1  1  1 
Tax advisory services  1  1     1  1 
Other non-audit services  1     
 
Note Included in statutory audit fees are amounts relating to the parent company of £20,000 (2003:£30,000 (2004: £20,000; 2003: £20,000). Audit-related regulatory reporting fees are £225,000 (2003:(2004: £225,000; 2003: £200,000). Non-audit fees in the UK in 20042005 are £1,000,000 (2003:(2004: £1,000,000; 2003: £341,000) and are in respect of tax advisory and tax compliance services and other advisory services. The remainder of the non-audit fees relate to overseas subsidiaries.

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ITEM 16D.     EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
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 of of shares that
      units purchased may yet be
      as part of publicly purchased under
  Total number of Average price announced plans the plans or
Period shares purchased paid per share or programs programs
         
AprilSeptember 1, 20042005 - AprilSeptember 30, 20042005  170,850625,000   £6.65N/AN/A
May 1, 2004 - May 31, 200485,510£6.756.63   N/A   N/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-69F-79 hereof.

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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 23, 2003 between Pearson plc and The Bank of New York, as trustee.†
2.2 Indenture 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.Agent.#
4.1 Letter Agreement dated January 28, 2005 between Pearson plc and Peter Jovanovich.Jovanovich.#
4.2 Irrevocable undertakings in respect of an offer by Retos Cartera, for the shares of Recoletos Grupo de Communicación, dated December 14, 2004 between Pearson plc and Retos Cartera.Cartera.#
8.1 List of Significant Subsidiaries.
10Consent of PricewaterhouseCoopers LLP.
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.
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.

7266


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
   
  Page
Report of Independent Registered Public Accounting Firm F-2
Consolidated ProfitIncome Statement for the year ended December 31, 2005F-3
Statement of Recognized Income and Loss AccountExpense for the Year Ended December 31, 20042005 F-3F-4
Consolidated Balance Sheet as at December 31, 20042005 F-4F-5
Consolidated Cash Flow Statement for the Year Ended December 31, 20042005 F-5
Statement of Total Recognized Gains and Losses for the Year Ended December 31, 2004F-6
Reconciliation of Movements in Equity Shareholders’ Funds for the Year Ended December 31, 2004F-6F-7
Notes to the Accounts F-8

F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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,income statements, consolidated statements of total recognized gainsrecognised income and losses, reconciliations of movements in equity shareholders’ funds,expense, and consolidated cash flow statements present fairly, in all material respects, the financial position of Pearson plc and its subsidiaries at 31 December 2005, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended 31 December 2004,2005, in conformity with accounting principles generally accepted in the United Kingdom.EU-adopted International Financial Reporting Standards. 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 auditingthe 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 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 audits provide a reasonable basis for our opinion.
      As discussed in noteNote 1, the Company changed its method of accounting for employee share ownership trustsadopted International Accounting Standards (IAS) 32 “Financial Instruments: Disclosure and employee share schemesPresentation” and IAS 39 “Financial Instruments: Recognition and Measurement” in accordance with International Financial Reporting Standards as adopted by the accounting principles generally accepted in the United Kingdom.European Union. The change has been accounted for by restating comparative information at December 31, 2003 and 2002 and for the years then ended.prospectively from 1 January 2005.
     Accounting principles generally accepted in the United KingdomEU-adopted International Financial Reporting Standards 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, as restated,Note 35 to the consolidated financial statements.
PricewaterhouseCoopers LLP
London, United KingdomEngland
June 27, 2005May 5, 2006

F-2


CONSOLIDATED PROFIT AND LOSS ACCOUNTINCOME STATEMENT
YEAR ENDED 31 DECEMBER 20042005
(All figures in £ millions)
                 
  Note 2004 2003 2002
         
Sales (including share of joint ventures)
      3,940   4,066   4,331 
Less: share of joint ventures      (21)  (18)  (11)
             
Sales of which
  2a   3,919   4,048   4,320 
Continuing operations      3,729   3,879   4,172 
Discontinued operations  31   190   169   148 
Group operating profit of which
      221   226   194 
Continuing operations      210   206   180 
Discontinued operations  31   11   20   14 
Share of operating profit of joint ventures and associates of which
  2c/d   10      (51)
Continuing operations      8   (2)  (47)
Discontinued operations  31   2   2   (4)
             
Total operating profit
  2b   231   226   143 
             
Continuing operations                
Profit/(loss) on sale of fixed assets and investments  4a   12   (2)  (11)
Loss on sale of subsidiaries and associates  4b   (3)  (4)  (45)
Discontinued operations                
Loss on sale of fixed assets and investments  4a         (2)
Profit on sale of subsidiaries and associates  4b      12   18 
Profit on sale of a subsidiary by an associate  4c         3 
             
Non operating items
      9   6   (37)
             
Profit before interest and taxation
      240   232   106 
Net finance costs  5   (69)  (80)  (131)
             
Profit/(loss) before taxation
      171   152   (25)
Taxation  7   (62)  (75)  (64)
             
Profit/(loss) after taxation
      109   77   (89)
Equity minority interests      (21)  (22)  (22)
             
Profit/(loss) for the financial year
      88   55   (111)
Dividends on equity shares
  8   (201)  (192)  (187)
             
Loss retained
      (113)  (137)  (298)
             
Basic earnings per share
  9   11.1p  6.9p  (13.9)p
Diluted earnings per share
  9   11.0p  6.9p  (13.9)p
Dividends per share
  8   25.4p  24.2p  23.4p
                 
  Notes 2005 2004 2003
         
Continuing operations
                
Sales
  2   4,096   3,696   3,850 
Cost of goods sold      (2,022)  (1,789)  (1,846)
             
Gross profit      2,074   1,907   2,004 
Operating expenses  5   (1,592)  (1,520)  (1,594)
Other net gains and losses  4   40   9   (6)
Share of results of joint ventures and associates      14   8   2 
             
Operating profit
  2   536   404   406 
Finance costs  7   (132)  (96)  (100)
Finance income  7   62   17   7 
             
Profit before tax
      466   325   313 
Income tax  8   (124)  (63)  (61)
             
Profit for the year from continuing operations
      342   262   252 
Profit for the year from discontinued operations  3   302   22   23 
             
Profit for the year
      644   284   275 
             
Attributable to:
                
Equity holders of the Company      624   262   252 
Minority interest      20   22   23 
             
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   78.2p  32.9p  31.7p
— diluted  9   78.1p  32.9p  31.7p
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   40.4p  30.8p  29.4p
— diluted  9   40.3p  30.8p  29.4p
             
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 STATEMENT OF RECOGNISED INCOME AND EXPENSE
YEAR ENDED 3 DECEMBER 2005
(All figures in £ millions)
                 
  Notes 2005 2004 2003
         
Net exchange differences on translation of foreign operations  26   327   (203)  (288)
Actuarial gains/(losses)on defined benefit pension and post-retirement medical schemes  24   26   (61)  (28)
Taxation on items taken directly to equity  8   12   9    
             
Net income/(expense) recognised directly in equity
      365   (255)  (316)
Profit for the year      644   284   275 
             
Total recognised income and expense for the year
      1,009   29   (41)
             
Attributable to:
                
Equity holders of the Company      989   7   (64)
Minority interest      20   22   23 
             
Effect of transition adjustment on adoption of IAS 39
                
Attributable to:
                
Equity holders of the Company  34   (12)        
             

F-4


CONSOLIDATED BALANCE SHEET
AS AT 31 DECEMBER 20042005
(All figures in £ millions)
              
      2003
  Note 2004 restated
       
Fixed assets
            
Intangible assets  11   2,890   3,260 
Tangible assets  12   473   468 
Investments: joint ventures  13         
 Share of gross assets      9   7 
 Share of gross liabilities      (2)  (1)
          
       7   6 
Investments: associates  14   41   58 
Investments: other  15   17   21 
          
       3,428   3,813 
          
Current assets
            
Stocks  16   676   683 
Debtors  17   1,103   1,132 
Deferred taxation  21   165   145 
Investments      1   2 
Cash at bank and in hand  18   613   561 
          
       2,558   2,523 
          
Creditors — amounts falling due within one year
            
Short-term borrowing  19   (107)  (575)
Other creditors  20   (1,168)  (1,129)
          
       (1,275)  (1,704)
          
Net current assets
      1,283   819 
          
Total assets less current liabilities
      4,711   4,632 
Creditors — amounts falling due after more than one year
            
Medium and long-term borrowing  19   (1,712)  (1,347)
Other creditors  20   (60)  (45)
          
       (1,772)  (1,392)
          
Provisions for liabilities and charges
  22   (123)  (152)
          
Net assets
      2,816   3,088 
          
Capital and reserves
            
Called up share capital  23   201   201 
Share premium account  24   2,473   2,469 
Profit and loss account  24   (71)  223 
          
Equity shareholders’ funds      2,603   2,893 
Equity minority interests      213   195 
          
       2,816   3,088 
          
                 
  Notes 2005 2004 2003
         
Assets
                
Non-current assets
                
Property, plant and equipment  11   384   355   402 
Intangible assets  12   3,854   3,278   3,550 
Investments in joint ventures and associates  13   36   47   64 
Deferred income tax assets  14   385   359   342 
Financial assets — Derivative financial instruments  16   79       
Other financial assets  15   18   15   21 
Other receivables  19   108   102   100 
             
       4,864   4,156   4,479 
Current assets
                
Intangible assets — pre-publication  17   426   356   362 
Inventories  18   373   314   319 
Trade and other receivables  19   1,031   933   1,025 
Financial assets — Derivative financial instruments  16   4       
Cash and cash equivalents (excluding overdrafts)  20   902   461   551 
             
       2,736   2,064   2,257 
Non-current assets classified as held for sale         358    
             
       2,736   2,422   2,257 
             
Total assets
      7,600   6,578   6,736 
             

F-5


CONSOLIDATED BALANCE SHEET (CONTINUED)
AS AT 31 DECEMBER 2005
(All figures in £ millions)
                 
  Notes 2005 2004 2003
         
Liabilities
                
Non-current liabilities
                
Financial liabilities—Borrowings  21   (1,703)  (1,714)  (1,349)
Financial liabilities—Derivative financial instruments  16   (22)      
Deferred income tax liabilities  14   (204)  (139)  (140)
Retirement benefit obligations  24   (389)  (408)  (364)
Provisions for other liabilities and charges  22   (31)  (43)  (59)
Other liabilities  23   (151)  (99)  (70)
             
       (2,500)  (2,403)  (1,982)
Current liabilities
                
Trade and other liabilities  23   (974)  (868)  (943)
Financial liabilities — Borrowings  21   (256)  (109)  (578)
Current income tax liabilities      (104)  (89)  (54)
Provisions for other liabilities and charges  22   (33)  (14)  (18)
             
       (1,367)  (1,080)  (1,593)
Liabilities directly associated with non-current assets classified as held for sale         (81)   
             
Total liabilities
      (3,867)  (3,564)  (3,575)
             
Net assets
      3,733   3,014   3,161 
             
Equity
                
Share capital  25   201   201   201 
Share premium  25   2,477   2,473   2,469 
Other reserves  26   (328)  (623)  (410)
Retained earnings  26   1,214   749   709 
             
Total equity attributable to equity holders of the Company
      3,564   2,800   2,969 
Minority interest      169   214   192 
             
Total equity
      3,733   3,014   3,161 
             
The 2003 and 2002 comparativesThese financial statements have been restatedapproved for the adoption of UITF 38 (see note 24).
The company balance sheet is shown in note 32.
The financial statements were approvedissue by the board of directors on 2726 February 20052006 and signed on its behalf by
Dennis Stevenson, Chairman
Rona Fairhead, Chief financial officer
Rona Fairhead, Chief financial officer

F-4F-6


CONSOLIDATED CASH FLOW STATEMENT
YEAR ENDED 31 DECEMBER 20042005
(All figures in £ millions)
                 
      2003 2002
  Note 2004 restated restated
         
Net cash inflow from operating activities
  27   530   359   529 
             
Dividends from joint ventures and associates
      10   9   6 
             
Interest received      13   11   11 
Interest paid      (97)  (86)  (151)
Debt issue costs      (1)  (1)   
Dividends paid to equity minority interests      (2)  (19)  (1)
             
Returns on investments and servicing of finance
      (87)  (95)  (141)
             
Taxation
      (45)  (44)  (55)
             
Purchase of tangible fixed assets      (125)  (105)  (126)
Sale of tangible fixed assets      4   8   7 
Purchase of investments      (1)  (3)  (3)
Sale of investments      17      3 
             
Capital expenditure and financial investment
      (105)  (100)  (119)
             
Purchase of subsidiaries  25   (35)  (94)  (87)
Net cash acquired with subsidiaries         34   1 
Purchase of joint ventures and associates      (10)  (5)  (40)
Sale of subsidiaries  26      (4)  3 
Net overdrafts disposed with subsidiaries      1   1   (1)
Sale of associates      24   57   920 
             
Acquisitions and disposals
      (20)  (11)  796 
             
Equity dividends paid
      (195)  (188)  (181)
             
Net cash inflow/(outflow) before management of liquid resources and financing
      88   (70)  835 
Liquid resources acquired      1   (85)  (65)
Collateral deposit reimbursed            22 
             
Management of liquid resources
      1   (85)  (43)
             
Issue of equity share capital      4   5   6 
Purchase of own shares      (10)  (1)  (18)
Capital element of finance leases      (2)  (3)  (5)
Loan facility (repaid)/advanced      (42)  1   (507)
Bonds advanced      414   180    
Bonds repaid      (456)  (159)  (167)
Collateral deposit (placed)/reimbursed      (26)  54   17 
Net movement in other borrowings      59   (13)  (7)
             
Financing
      (59)  64   (681)
             
Increase/(decrease) in cash in the year
  27   30   (91)  111 
             
                 
  Notes 2005 2004 2003
         
Cash flows from operating activities
                
Cash generated from operations  29   875   705   531 
Interest paid      (101)  (98)  (87)
Tax paid      (65)  (45)  (44)
             
Net cash generated from operating activities
      709   562   400 
             
Cash flows from investing activities
                
Acquisition of subsidiaries, net of cash acquired  27   (246)  (41)  (60)
Acquisition of joint ventures and associates      (7)  (10)  (5)
Purchase of property, plant and equipment (PPE)      (76)  (101)  (79)
Proceeds from sale of PPE  29   3   4   8 
Purchase of intangible assets      (24)  (24)  (26)
Investment in pre-publication      (222)  (181)  (173)
Purchase of other financial assets      (2)  (1)  (3)
Disposal of subsidiaries, net of cash disposed  28   376   7   (3)
Disposal of joint ventures and associates      54   24   57 
Disposal of other financial assets         17    
Interest received      29   13   11 
Dividends received from joint ventures and associates      14   12   10 
             
Net cash used in investing activities
      (101)  (281)  (263)
             
Cash flows from financing activities
                
Proceeds from issue of ordinary shares  25   4   4   5 
Purchase of treasury shares      (21)  (10)  (1)
Proceeds from borrowings         414   235 
Short-term investments (acquired)/repaid         (5)  1 
Other borrowings         59   (13)
Repayments of borrowings      (79)  (524)  (159)
Finance lease principal payments      (3)  (2)  (3)
Dividends paid to Company’s shareholders  10   (205)  (195)  (188)
Dividends paid to minority interests      (17)  (2)  (19)
             
Net cash used in financing activities
      (321)  (261)  (142)
Effects of exchange rate changes on cash and cash equivalents      13   (4)  45 
             
Net increase in cash and cash equivalents
      300   16   40 
             
Cash and cash equivalents at beginning of year      544   528   488 
             
Cash and cash equivalents at end of year
  20   844   544   528 
             

F-5


STATEMENT OF TOTAL RECOGNIZED GAINS AND LOSSES
YEAR ENDED 31 DECEMBER 2004
(All figures in £ millions)
                 
  Note 2004 2003 2002
         
Profit/(loss) for the financial year      88   55   (111)
Other net gains and losses recognised in reserves                
Exchange differences      (181)  (254)  (315)
Taxation on exchange differences      5      5 
             
Total recognised gains and losses relating to the year
      (88)  (199)  (421)
             
Prior year adjustment  24   37      209 
             
Total recognised gains and losses
      (51)  (199)  (212)
             
Included within profit/(loss) for the financial year is a loss of £7m (2003: loss of £10m) relating to joint ventures and a profit of £15m (2003: profit of £13m) relating to associates.
RECONCILIATION OF MOVEMENTS IN EQUITY SHAREHOLDERS’ FUNDS
YEAR ENDED 31 DECEMBER 2004
(All figures in £ millions)
                 
      2003 2002
  Note 2004 restated restated
         
Profit for the financial year      88   55   (111)
Dividends on equity shares      (201)  (192)  (187)
             
       (113)  (137)  (298)
             
Exchange differences net of taxation      (176)  (254)  (310)
Goodwill written back on sale of subsidiaries and associates            144 
Shares issued      4   5   6 
Purchase of own shares      (10)  (1)  (18)
Replacement options granted on acquisition of subsidiary            1 
UITF 17 charge for the year      5   4   7 
             
Net movement for the year      (290)  (383)  (468)
Equity shareholders’ funds at beginning of the year      2,893   3,276   3,797 
Prior year adjustment — UITF 38  24         (53)
             
Equity shareholders’ funds at end of the year
      2,603   2,893   3,276 
             
Restatement
      The Company has restated its UK GAAP shareholders’ funds for the financial years ended December 31, 2003 and 2002 for adoption of UITF Abstract 38 “Accounting for ESOP trusts’. This has reduced shareholders’ funds as at December 31, 2003 and 2002 by £59 million and £62 million respectively (see note 24 in “Item 17. Financial Statements”).
      The Company has restated its US GAAP profit and loss account and shareholders’ funds for the financial years ended December 31, 2003 and 2002 to reflect a revised accounting treatment in respect of incentives and fixed rental escalations under one of its leases. Previously the incentive was recognized in the profit and loss account over the period during which the lease incentive was applicable until the lease returned to a market level. Additionally, future market-based rent increases were charged to the profit and loss account as they

F-6


became applicable under the terms of the lease. Both the lease incentives and market-based rent increases are now being charged to the profit and loss account over the entire term of the lease. Consequently, the profit reported under US GAAP for the 2003 and 2002 financial years has been reduced by £14 million and £12 million, respectively, on a pre-tax basis and £10 million and £9 million, respectively, on a post-tax basis and the shareholders’ funds reported as at December 31, 2003 and 2002 has been reduced by £19 million and £9 million, respectively, from amounts previously reported.

F-7


NOTES TO THE ACCOUNTSCONSOLIDATED 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 26 February 2006.
1ACCOUNTING POLICIESAccounting policies
      AccountingThe 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.
      IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ has been applied in preparing these financial statements. These consolidated financial statements are the Group’s first financial statements to be prepared in accordance with IFRS as adopted by the EU.
      The policies set out below have been consistently applied except that UITF 38 ’Accounting for ESOP trusts’to all the years presented, with the exception of IAS 32 ‘Financial Instruments: Disclosure and the revision of UITF 17 ‘Employee share schemes’Presentation’ and IAS 39 ‘Financial Instruments: Recognition and Measurement’ which have been adoptedapplied with effect from 1 January 2005.
      Consolidated financial statements of Pearson plc until 31 December 2004 had been prepared in these statements.accordance with UK GAAP. UK GAAP differs in certain respects from IFRS.
      When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The adoption of these standards represents a change in accounting policy and the comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments.
      Note 34 describes how, in preparing these consolidated financial statements, the Directors have applied accounting standards as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1.
      These consolidated financial statements have been restated accordingly. The effect of these changes in accounting policy is disclosed in note 24.
a. Basis of accounting — The accounts are prepared under the historical cost conventionconvention.
      The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are disclosed below in ‘Critical accounting assumptions and judgements’.

F-8


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Interpretations and amendments to published standards effective in 2005
      The following amendments and interpretations to standards are mandatory for the Group’s accounting periods beginning on or after 1 January 2005:
• IFRIC 2 ‘Members’ Shares in Co-operative Entities and Similar Instruments’;
• SIC 12 (Amendment) ‘Consolidation — Special Purpose Entities’; and
• IAS 39 (Amendment) ‘Transition and Recognition of Financial Assets and Financial Liabilities’.
      Management assessed the relevance of these amendments and interpretations with respect to the Group’s operations and concluded that they are not relevant to the Group.
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 mandatory for the Group’s accounting periods beginning on or after 1 January 2006 or later periods but which the Group has not early adopted. These 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 specified 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 of an entity’s capital and how it manages capital. Management is currently assessing the impact of IFRS 7 and the complementary amendment to IAS 1 on the Group’s financial statements; and
• IFRIC 4 ‘Determining whether an Arrangement contains a Lease’ (effective from 1 January 2006). IFRIC 4 requires the determination whether an arrangement is or contains a lease to be based on the substance of the arrangement. Management is currently assessing the impact of IFRIC 4 on the Group’s operations, but does not expect it to be significant.
      In addition, management assessed the relevance of the following amendments and interpretations with respect to the Group’s operations and concluded that they are not relevant to the Group:
• IAS 39 (Amendment) ‘Cash Flow Hedge Accounting of Forecast Intragroup Transactions’ (effective from 1 January 2006);
• IAS 39 (Amendment) ‘The Fair Value Option’ (effective from 1 January 2006);
• IAS 39 (Amendment) and IFRS 4 (Amendment) ‘Financial Guarantee Contracts’ (effective from 1 January 2006);
• IFRS 1 (Amendment) ‘First-time Adoption of International Financial Reporting Standards’ (effective from 1 January 2006);
• IFRS 6 ‘Exploration for and Evaluation of Mineral Resources’ (effective from 1 January 2006);
• IFRIC 5 ‘Rights of Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds’ (effective from 1 January 2006); and
• IFRIC 6 ‘Liabilities arising from Participating in a Specific Market — Waste Electrical and Electronic Equipment’ (effective from 1 December 2005).
b.Consolidation
(1) 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.

F-9


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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.
      The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. Acquisitions made prior to the date of transition to IFRS were accounted for in accordance with UK GAAP (see note 34). The cost of an acquisition is measured as the Companies Act and applicable accounting standards. A summaryfair value of the significant accounting policies is set out below.
b. Basisassets given, equity instruments issued and liabilities incurred or assumed at the date of consolidation —exchange, plus costs directly attributable to the acquisition. Identifiable assets and contingent assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. 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 resultsexcess of the Group includescost of acquisition over the fair value of the Group’s share of the resultsidentifiable net assets acquired, after the identification of jointpurchased intangible assets, is recorded as goodwill. See note 1e(1)for the accounting policy on goodwill.
(2) 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 ventures, under a contractual arrangement. Associates are entities over which the consolidated balance sheet includesGroup has significant influence but not the Group’s interestpower to control, 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 of accounting 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 book valuedates of attributable netthe transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and attributable goodwill.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 as from 1 January 2005.
     c.(3) Group companies — The results and financial position of all Group entities 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.

F-10


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      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 intercompany loan balances, which are not intended to be repaid for the foreseeable future, as part of its net investment. When a foreign 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 IFRS 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 $1.81 (2004: $1.83; 2003: $1.63) and the year end rate was $1.72 (2004: $1.92; 2003: $1.79).
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.
e.Intangible assets
(1) Goodwill — From 1 January 1998 goodwill, being eitherGoodwill represents the net excess of the cost of sharesan 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. 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) Software development costs — Costs directly associated with the production of identifiable and unique software products, where it is probable that they will generate economic benefits exceeding costs, are recognised as intangible assets and are amortised over their estimated useful lives not exceeding ten years from when the software is available for use.
(3) Acquired intangible assets — Acquired intangible assets comprise publishing rights, customer lists and relationships, technology, trade names and trademarks. These assets are capitalised on acquisition and included in intangible assets and amortised over their estimated useful lives between two and 30 years.
(4) Pre-publication costs — Pre-publication costs represent direct costs incurred in the development of educational programmes and titles prior to their publication. These costs are carried forward in current intangible assets where the title will generate probable future economic benefits and costs can be measured reliably. These costs are amortized upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the amortization taken in the earlier years. The investment in pre-publication has been disclosed as part of the investing activities in the cash flow statement.

F-11


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
f.Other financial assets
Up to 31 December 2004 — Other financial assets include investments in companies other than subsidiaries joint ventures and associates and other securities. Financial fixed assets are recorded at historical cost less provisions for diminution in value.
From 1 January 2005 — 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 and other direct costs and related production overheads. Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs necessary to make the sale. Provision is 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 bring the amount down to its net realisable value. 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. This represents the operating cycle of consumer publishing titles. 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 extra costs arising 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 statement of cash flows 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 shown within 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.

F-12


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. From 1 January 2005, accrued interest is also included as part of the borrowing. Where a debt instrument is in a fair value hedging relationship, an adjustment is made to the bond carrying value to reflect the hedged risk.
m.Derivative financial instruments
Upto 31 December 2004 — Amounts payable or receivable in respect of interest rate derivatives are accrued within 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 income statement. Foreign currency borrowings together with their related cross currency 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 income statement in line with the transactions which they are hedging.
From 1 January 2005 — Derivatives are initially recognised at fair value at the date of transition to IAS 39 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 cashflow 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 value 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 netfair value is recognised in finance income or finance costs in the income statement immediately.
n.Taxation
      Current tax is recognized 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 on acquisitionand liabilities and their carrying amounts in the consolidated financial statements. 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 costdeferred 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 goodwillthan where it is intended that those undistributed earnings will not be remitted in the foreseeable future.

F-13


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      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 recognized equity.
o.Employee benefits
(1) Retirement benefit obligations — The Group has elected to early adopt the amendment to IAS 19 “Employee Benefits’ with effect from the date of transition to IFRS. The liability in respect of defined benefit pension plans is the present value of the defined benefit obligations at the balance sheet date minus the fair value of plan assets. The defined benefit obligation is calculated annually by purchase, is capitalised and amortised throughindependent actuaries using the profit and loss account on a straight-line basis over its estimated useful life not exceeding 20 years. Estimated useful lifeprojected 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.
      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 as an operating cost and the unwinding of the discount rate on 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 recognised as an 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 compensation — The Group has a number of employee option and performance share schemes. The fair value of options granted is recognised as an employee expense after taking into account such factors as the nature and ageCompany’s best estimate of the businessnumber of awards expected to vest. Fair value is measured at the date of grant and is spread over the vesting period of the instrument. 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. 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 recognized 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 stability ofamount can be reliably estimated. Provisions are discounted to present value where the industryeffect 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 for integration and reorganisation costs in the period in which the acquired business operates, as well as typical life spansGroup becomes legally or constructively committed to making the payment.
      The Group recognises a provision for onerous lease contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. The 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.

F-14


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
q.Revenue recognition
      Revenue comprises the fair value of the acquired products to whichconsideration received or receivable for 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 amountsale of goods and services net of value addedvalue-added tax and other sales taxes, rebates and excluding trade discounts, and anticipated returns, provided to external customers and associates.after eliminating sales within the Group. Revenue is recognized as follows:
      Revenue from the sale of books is recognisedrecognized when title passes. Anticipated returns are estimated 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 multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. 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 direct and indirecttotal costs of the contract exceed the estimated total revenues that will be generated by the contract.

F-8


NOTES TO THE ACCOUNTS (Continued)
      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.
r.Leases
      Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at the commencement of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are included in other long-term payables. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The property, plant and equipment acquired under finance 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 rewards of ownership are retained by the lessor are classified as operating leases by the lessee. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
s.Dividends
      Dividends are recorded in the Group’s financial statements in the 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.

F-15


e. PensionNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
t.Non-current assets held for sale and discontinued operations
      Non-current assets are classified as assets held for sale and stated at the 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.
u.Trade receivables
      Trade receivables are recognised at fair value less provision for bad and doubtful debts and anticipated future sales returns (see also note 1q).
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 consolidated financial statements, are discussed below.
Critical accounting estimates and assumptions
(1) Revenue recognition — Revenue from the sale of books is recognized 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. The provision for sales returns is set out in note 19.
(2) Pre-publication costs — The regularassessment of the useful life of pre-publication costs and the calculation of amortisation involve a significant amount of judgement based on historical trends and management estimation of their future potential sales, in accordance with the accounting policy stated in note 1e(4). The overstatement of useful lives 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 costs. The carrying amount of pre-publication costs is set out in note 17.
(3) Royalty advances — The realisable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts, in accordance with the accounting policy stated in note 1h. 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 carrying amount of royalty advances is set out in note 19.
(4) Income taxes — 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 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.
(5) Goodwill — The Group tests annually whether goodwill has suffered any impairment, in accordance with the accounting policy stated in note 1e(1). 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).

F-16


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Critical judgements in applying the Group’s accounting policies
(1) Revenue recognition — Revenue from multi-year contractual arrangements is recognised as performance occurs. The assumptions, risks, and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported.
(2) Retirement benefit obligations — 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.
(3) Deferred income tax — Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, significant judgement is chargedused when assessing the extent to which deferred tax assets should be recognised with consideration given to the profittiming and loss account inlevel of future taxable income together with any future tax planning strategies.
Financial risk management
      The Group’s treasury policy governs the management of financial risks within the Group. The policy, which is approved by the treasury committee, covers interest rate risk, liquidity and refinancing risk, counterparty risk and foreign currency risk. In accordance with SSAP 24 ‘Accountingthe treasury policy, the Group actively monitors and manages its financial risk exposures. The policy permits the use of financial instruments such as derivatives, where appropriate. The policy only permits transactions related to underlying positions and speculative transactions are not permitted.
Interest rate risk — A change in market interest rates can cause fluctuations in the Group’s net income or financial position. The Group is predominantly funded through bonds issued at fixed rates and nearly all of these bonds have been swapped to a floating rate for pension costs’the term of the debt. The Group’s policy (as updated in September 2005) requires that interest rates on its net debt position are fixed for the next four years such that the fixed rate portion is within a range of 65% to 40% in the first year, with the lower end of the range declining by 10% each year such that the fixed rate portion falls within a range of 65% to 10% in year four. The Group also uses derivatives to change the currency profile of its debt and to alter the timing of floating interest rate resets in order to apportioncomply with its policy. The Group manages the cost of pensions overderivatives and debt to achieve policy objectives on a portfolio basis. The Group designates derivatives as hedges under IAS 39 where hedge accounting is possible, so long as a designation will not have an adverse effect on the service lives of employees in the schemes.
      Variations are apportioned over the expected service lives of current employees in the schemes. The pension costbalancing of the Group’s defined contribution schemes is the amount of contributions payable for the year.portfolio.
     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 assetsLiquidity and refinancing risk — The Group’s funding objective is to ensure that committed funding is available to the Group at a reasonable cost, with an extended maturity profile and that funding is available from diverse sources. To assist with the diversity of tangible fixed assets other than freehold land is depreciated over estimated economic lives in equal annual amounts. Generally, freeholds are depreciated at 1%funding objective, the Group has ratings with Moody’s and Standard & Poor’s, which provides greater access 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.international capital markets.
     h. LeasesCounterparty risk — Finance lease rentalsThe Group’s risk of loss on deposits or derivative contracts with individual banks is managed in part through the use of counterparty limits reflecting published credit ratings. Exposures to individual counterparties 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 charged to the profit and loss accountmonitored on a straight-line basis overregular basis. Where appropriate, ISDA Master Agreements permitting the durationnetting of each lease term.transactions in the event of counterparty failure are entered into with derivative counterparties.
     i. Fixed asset investmentsForeign currency risk — Fixed asset investments are statedThe Group has operations overseas and is therefore exposed to movements in foreign currencies, particularly the US dollar. For transactional foreign exchange exposure, the policy allows the use of derivatives where appropriate. The Group mainly converts foreign currencies at cost less provisions for diminutionspot rate and had no cash flow hedges in value.
j. Share schemes — Shares held by employee share ownership trusts are shownplace at cost and recorded as a deduction in arriving at shareholders’ funds. The costs of funding and administering the trusts are charged to the profit and loss account in the period to which they relate. The fair market value of the shares at the date of 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 adjustment to the charge is 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 educational programmes and 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 paydate. Translational foreign exchange exposure is of more tax in the future. Deferred tax assets are recognisedsignificance to the extent that itGroup. It seeks to offset this exposure through its policy of aligning approximately the currency composition of its core net borrowings with its forecast operating profit. This policy only applies where a currency accounts for more than 15% of Group operating profit and currently is regarded as more likelyonly applicable to the

F-9F-17


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 sheet date. Deferred tax assets and liabilities are not discounted.
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.
US dollar. The Group uses derivative financial instruments to manage its exposure to interest ratedollar denominated debt and the foreign exchange risks. These include interest rate swaps,portion of certain cross currency swaps and forward currency contracts.
      Amounts payable or receivable in respect of interest rate derivatives as net investment hedges of foreign operations. Unremitted profits are accruednot hedged 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 takenas the Company judges it inappropriate to hedge non-cash flow translational exposure with cash flow instruments.
2     Segment information
      Due to the profitdiffering risks and loss account in linerewards associated with each business segment and the transactions which they are hedging. Premiums paid on contracts designed to manage currency exposure on specific acquisitions or disposals are charged todifferent customer focus of each segment, business is 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 atGroup’s primary reporting segment. 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 forDecember 2005 the Group is organised into five primary business segments, School, Higher Education, Penguin, FT Publishing and Interactive Data Corporation (IDC).The remaining business group, Professional, brings together a number of education publishing, testing and services businesses and does not meet the US dollar. The average ratecriteria for the year against sterling was $1.83 (2003: $1.63) and the year end rate was $1.92 (2003: $1.79).
r. Liquid resources — Liquid resources comprise short-term deposits of less than one year and investments which are readily realisable and held onclassification as 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-10


NOTES TO THE ACCOUNTS (Continued)“segment” under IFRS.
2aANALYSIS OF SALESPrimary reporting format — business segments
             
  2004 2003 2002
       
  (All figures in £ millions)
Business sectors
            
Pearson Education  2,356   2,451   2,756 
FT Group  587   588   578 
The Penguin Group  786   840   838 
          
Continuing operations  3,729   3,879   4,172 
Discontinued operations  190   169   148 
          
   3,919   4,048   4,320 
          
Geographical markets supplied
            
United Kingdom  545   474   411 
Continental Europe  300   294   271 
North America  2,505   2,742   3,139 
Asia Pacific  261   255   249 
Rest of world  118   114   102 
          
Continuing operations  3,729   3,879   4,172 
Discontinued operations  190   169   148 
          
   3,919   4,048   4,320 
          
                                 
    Higher     FT     2005
  School Education Professional Penguin Publishing IDC Corporate Group
                 
  (All figures in £ millions)
Continuing operations
                                
Sales (external)  1,295   779   589   804   332   297      4,096 
Sales (inter-segment)           16            16 
                         
Operating profit before joint ventures and associates  138   156   44   60   49   75      522 
Share of results of joint ventures and associates  4      1      9         14 
                         
Operating profit
  142   156   45   60   58   75      536 
                         
Finance costs                              (132)
                         
Finance income           ��                  62 
Profit before tax
                              466 
                         
Income tax                              (124)
                         
Profit for the year from continuing operations
                              342 
                         
Reconciliation to adjusted operating profit
                                
Operating profit  142   156   45   60   58   75      536 
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   45   60   21   80      509 
                         
Segment assets  2,067   1,402   1,705   960   154   291   985   7,564 
Joint ventures  6         2   4         12 
Associates  6            18         24 
                         
Total assets
  2,079   1,402   1,705   962   176   291   985   7,600 
                         
Total liabilities
  (557)  (341)  (263)  (280)  (336)  (109)  (1,981)  (3,867)
                         
Other segment items
                                
Capital expenditure (notes 11, 12 and 17)  114   96   43   34   14   19      320 
Depreciation (note 11)  26   8   17   7   11   11      80 
Amortisation (notes 12 and 17)  91   78   20   24   3   5      221 
                         
                                     
  2004 2003 2002
       
  Total Inter- Total Total Inter- Total Total Inter- Total
  by source regional sales by source regional sales by source regional sales
                   
  (All figures in £ millions)
Geographical source of sales
                                    
United Kingdom  802   (57)  745   751   (60)  691   644   (25)  619 
Continental Europe  174   (1)  173   166      166   156   (4)  152 
North America  2,499   (2)  2,497   2,721   (2)  2,719   3,144   (36)  3,108��
Asia Pacific  225   (2)  223   230   (1)  229   226   (2)  224 
Rest of world  93   (2)  91   74      74   69      69 
                            
Continuing operations  3,793   (64)  3,729   3,942   (63)  3,879   4,239   (67)  4,172 
Discontinued operations  190      190   169      169   148      148 
                            
   3,983   (64)  3,919   4,111   (63)  4,048   4,387   (67)  4,320 
                            
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 2004 is an amount of £10m attributable to acquisitions made during the year.

F-11F-18


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
2b     ANALYSIS OF TOTAL OPERATING PROFIT
                     
  2004
   
  Results from Integration Goodwill Goodwill Operating
  operations costs amortisation impairment profit
           
  (All figures in £ millions)
Business sectors
                    
Pearson Education  293      (174)     119 
FT Group  86       (20)      66 
The Penguin Group  54      (21)     33 
                
Continuing operations  433      (215)     218 
Discontinued operations  22      (9)     13 
                
   455      (224)     231 
                
Geographical markets supplied
                    
United Kingdom  (26)     (30)     (56)
Continental Europe  21      (2)     19 
North America  393      (177)     216 
Asia Pacific  31      (5)     26 
Rest of world  14      (1)     13 
                
Continuing operations  433      (215)     218 
Discontinued operations  22      (9)     13 
                
   455      (224)     231 
                
                     
  2003
   
  Results from Integration Goodwill Goodwill Operating
  operations costs amortisation impairment profit
           
  (All figures in £ millions)
Business sectors
                    
Pearson Education  313      (207)     106 
FT Group  58      (30)     28 
The Penguin Group  91      (21)     70 
                
Continuing operations  462      (258)     204 
Discontinued operations  28      (6)     22 
                
   490      (264)     226 
                
Geographical markets supplied
                    
United Kingdom  (46)     (31)     (77)
Continental Europe  1      (4)     (3)
North America  466      (218)     248 
Asia Pacific  33      (5)     28 
Rest of world  8            8 
                
Continuing operations  462      (258)     204 
Discontinued operations  28      (6)     22 
                
   490      (264)     226 
                
                                 
    Higher     FT     2004
  School Education Professional Penguin Publishing IDC Corporate Group
                 
  (All figures in £ millions)
Continuing operations
                                
Sales (external)  1,087   729   507   786   318   269      3,696 
Sales (inter-segment)           15            15 
                         
Operating profit before joint ventures and associates  109   133   42   46   4   62      396 
Share of results of joint ventures and associates  3         1   4         8 
                         
Operating profit
  112   133   42   47   8   62      404 
                         
Finance costs                              (96)
Finance income                              17 
                         
Profit before tax
                              325 
                         
Income tax                              (63)
                         
Profit for the year from continuing operations
                              262 
                         
Reconciliation to adjusted operating profit
                                
Operating profit  112   133   42   47   8   62      404 
Amortisation of acquired intangibles                 5      5 
Other net gains and losses  (4)  (4)  (2)  5   (4)        (9)
                         
Adjusted operating profit — continuing operations  108   129   40   52   4   67      400 
                         
Segment assets  1,860   1,224   1,345   892   502   247   461   6,531 
Joint ventures  7         5   2         14 
Associates  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 (notes 11,12 and 17)  104   79   62   36   15   12      308 
Depreciation (note 11)  25   9   16   9   16   9      84 
Amortisation (notes 12 and 17)  74   65   18   29   2   5      193 
                         

F-12F-19


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     
  2002
   
  Results from Integration Goodwill Goodwill Operating
  operations costs amortisation impairment profit
           
  (All figures in £ millions)
Business sectors
                    
Pearson Education  326   (7)  (244)     75 
FT Group  51      (49)  (10)  (8)
The Penguin Group  87   (3)  (18)     66 
                
Continuing operations  464   (10)  (311)  (10)  133 
Discontinued operations  29      (19)     10 
                
   493   (10)  (330)  (10)  143 
                
Geographical markets supplied
                    
United Kingdom  (72)  (5)  (9)     (86)
Continental Europe  11      (8)     3 
North America  495   (5)  (288)     202 
Asia Pacific  31      (6)     25 
Rest of world  (1)        (10)  (11)
                
Continuing operations  464   (10)  (311)  (10)  133 
Discontinued operations  29      (19)     10 
                
   493   (10)  (330)  (10)  143 
                
                                 
    Higher     FT     2003
  School Education Professional Penguin Publishing IDC Corporate Group
                 
  (All figures in £ millions)
Continuing operations
                                
Sales (external)  1,149   770   503   840   315   273      3,850 
Sales (inter-segment)        1   15            16 
                         
Operating profit before joint ventures and associates  112   140   33   81   (28)  66      404 
Share of results of joint ventures and associates  2         1   (1)        2 
                         
Operating profit
  114   140   33   82   (29)  66      406 
                         
Finance costs                              (100)
Finance income                              7 
                         
Profit before tax
                              313 
                         
Income tax                              (61)
                         
Profit for the year from continuing operations
                              252 
                         
Reconciliation to adjusted operating profit
                                
Operating profit  114   140   33   82   (29)  66      406 
Amortisation of acquired intangibles                 4      4 
Other net gains and losses  2   2   1   1            6 
                         
Adjusted operating profit — continuing operations  116   142   34   83   (29)  70      416 
                         
Segment assets  2,072   1,157   1,387   907   358   240   551   6,672 
Joint ventures  6         4   2         12 
Associates  5            47         52 
                         
Total assets
  2,083   1,157   1,387   911   407   240   551   6,736 
                         
Total liabilities
  (458)  (318)  (158)  (398)  (203)  (113)  (1,927)  (3,575)
                         
Other segment items
                                
Capital expenditure (notes 11, 12 and 17)  101   65   21   47   26   17      277 
Depreciation (note 11)  26   9   13   6   19   12      85 
Amortisation (notes 12 and 17)  68   58   18   39   2   5      190 
                         
Note Discontinued operations relate      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 disposalGroup result. Inter-segment pricing is determined on an arm’s length basis. Segment assets consist primarily of the Group’s interest in Recoletos, 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, 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).
      Property plant and equipment and intangible assets acquired through business combinations were £111m (2004: £16m; 2003: £54m)(see note 31. Included within operating profit for 2004 is an amount of £1m attributable to acquisitions made during the year.notes 11, 12 and 17). Capital expenditure, depreciation and amortisation
2c     SHARE OF OPERATING LOSS OF JOINT VENTURES
             
  2004
   
  Results from Goodwill Operating
  operations amortisation profit/(loss)
       
  (All figures in £ millions)
Business sectors
            
Pearson Education         
FT Group  (8)     (8)
The Penguin Group  1      1 
          
Continuing operations  (7)     (7)
          
             
  2003
   
  Results from Goodwill Operating
  operations amortisation profit/(loss)
       
  (All figures in £ millions)
Business sectors
            
Pearson Education         
FT Group  (11)     (11)
The Penguin Group  1      1 
          
Continuing operations  (10)     (10)
          

F-13F-20


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
includes amounts relating to discontinued operations. In April 2005, Pearson sold its 79% interest in Recoletos Grupo de Communicación S.A. This operation is now disclosed as a ‘discontinued’ operation. The related assets and liabilities are disclosed within the FT Publishing segment in 2004 and 2003.
Secondary reporting format — geographical segments
      Although the Group’s business segments are managed on a worldwide basis, they all operate in the following main geographical areas:
             
  2002
   
  Results from Goodwill Operating
  operations amortisation profit/(loss)
       
  (All figures in £ millions)
Business sectors
            
Pearson Education  (1)     (1)
FT Group  (13)     (13)
The Penguin Group  1      1 
          
Continuing operations  (13)     (13)
          
                                     
  Sales Total assets Capital expenditure
       
  2005 2004 2003 2005 2004 2003 2005 2004 2003
                   
  (All figures in £ millions)
Continuing operations
                                    
European countries  963   835   768   1,711   1,112   1,003   60   79   63 
North America  2,717   2,504   2,742   5,476   4,716   5,015   242   208   188 
Asia Pacific  300   263   255   325   302   301   13   10   11 
Other countries  116   94   85   52   43   37   2   3   4 
                            
Total
  4,096   3,696   3,850   7,564   6,173   6,356   317   300   266 
                            
Discontinued operations (European countries)  27   190   169      358   316   3   8   11 
Joint ventures and associates           36   47   64          
                            
Total
  4,123   3,886   4,019   7,600   6,578   6,736   320   308   277 
                            
2d     SHARE OF OPERATING PROFIT/(LOSS) OF ASSOCIATES      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. Total assets and capital expenditure are allocated to where the assets are located.
             
  2004
   
  Results from Goodwill Operating
  operations amortisation profit
       
  (All figures in £ millions)
Business sectors
            
Pearson Education  1      1 
FT Group  14      14 
The Penguin Group         
          
Continuing operations  15      15 
Discontinued operations  2      2 
          
   17      17 
          
             
  2003
   
  Results from Goodwill Operating
  operations amortisation profit
       
  (All figures in £ millions)
Business sectors
            
Pearson Education  1      1 
FT Group  14   (7)  7 
The Penguin Group         
          
Continuing operations  15   (7)  8 
Discontinued operations  2      2 
          
   17   (7)  10 
          
             
  2002
   
  Results from Goodwill Operating
  operations amortisation profit
       
  (All figures in £ millions)
Business sectors
            
Pearson Education  3   (1)  2 
FT Group  7   (43)  (36)
The Penguin Group         
          
Continuing operations  10   (44)  (34)
Discontinued operations     (4)  (4)
          
   10   (48)  (38)
          

F-14F-21


NOTES TO THE ACCOUNTS (Continued)
2e     ANALYSIS OF CAPITAL EMPLOYED
         
    2003
  2004 restated
     
  (All figures in
  £ millions)
Business sectors
        
Pearson Education  3,059   3,457 
FT Group  198   256 
The Penguin Group  593   591 
       
Continuing operations  3,850   4,304 
Discontinued operations  130   152 
       
   3,980   4,456 
       
Geographical location
        
United Kingdom  410   425 
Continental Europe  58   62 
North America  3,245   3,676 
Asia Pacific  114   120 
Rest of world  23   21 
       
Continuing operations  3,850   4,304 
Discontinued operations  130   152 
    ��  
   3,980   4,456 
       
             
      2003
  Note 2004 restated
       
    (All figures in
    £ millions)
Reconciliation of capital employed to net assets
            
Capital employed      3,980   4,456 
Add: deferred taxation  21   165   145 
Less: provisions for liabilities and charges  22   (123)  (152)
Less: net debt excluding finance leases  27   (1,206)  (1,361)
          
Net assets      2,816   3,088 
          

F-15


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
3ANALYSIS OF CONSOLIDATED PROFIT AND LOSS ACCOUNTDiscontinued operations
      In April 2005, Pearson sold its 79% interest in Recoletos Grupo de Communicación S.A. to Retos Cartera, a consortium of investors. This operation is disclosed as a ‘discontinued’ operation (see note 28).
      An analysis of the result and cash flows of discontinued operations is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Sales  27   190   169 
          
Operating (loss)/profit  (3)  26   43 
Net finance income     3   3 
          
(Loss)/profit before tax
  (3)  29   46 
          
Attributable tax benefit/(expense)  1   (7)  (23)
          
(Loss)/profit after tax
  (2)  22   23 
Profit on disposal of discontinued operations (note 28)  306       
Attributable tax expense  (2)      
          
Profit for the year from discontinued operations
  302   22   23 
          
Operating cash flows  (6)  12   11 
Investing cash flows     17   47 
Financing cash flows        (92)
          
Total cash flows
  (6)  29   (34)
          
4Other net gains and losses
             
  2004 2003 2002
       
  (All figures in £ millions)
Cost of sales
  (1,866)  (1,910)  2,064 
          
Gross profit
  2,053   2,138   2,256 
          
Distribution costs  (243)  (239)  (233)
Administration and other expenses  (1,635)  (1,724)  (1,888)
Other operating income  46   51   59 
          
Net operating expenses
  (1,832)  (1,912)  (2,062)
          
Analysed as            
Net operating expenses — before other items  (1,608)  (1,655)  (1,760)
Net operating expenses — other items            
— Integration costs        (10)
— Goodwill amortisation  (224)  (257)  (282)
— Goodwill impairment        (10)
          
Net operating expenses
  (1,832)  (1,912)  (2,062)
          
             
  2005 2004 2003
       
  (All figures in £
  millions)
Profit on sale of interest in MarketWatch  40       
Other items     9   (6)
          
Total other net gains and losses
  40   9   (6)
          
Note      Other items are all included in administrationnet gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and other expenses. Included abovefinancial assets that are included within continuing operations.

F-22


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5Operating expenses
             
  2005 2004 2003
       
  (All figures in £ millions)
By function:
            
Cost of goods sold  2,022   1,789   1,846 
          
Operating expenses
            
Distribution costs  249   201   206 
Administrative and other expenses  1,384   1,365   1,439 
Other income  (41)  (46)  (51)
          
Total operating expenses
  1,592   1,520   1,594 
          
Total
  3,614   3,309   3,440 
          
By nature:
            
Utilisation of inventory  768   700   710 
Depreciation of property, plant and equipment (note 11)  80   78   79 
Amortisation of intangible assets — pre-publication (note 17)  192   168   158 
Amortisation of intangible assets — other (note 12)  29   25   32 
Employee benefit expense (note 6)  1,273   1,154   1,156 
Operating lease rentals  119   126   148 
Other property costs  88   73   61 
Royalties expensed  363   331   354 
Advertising, promotion and marketing  202   181   193 
Information technology costs  84   76   85 
Other costs  457   443   515 
Other income  (41)  (46)  (51)
          
Total
  3,614   3,309   3,440 
          
      During the year the Group obtained the following amountsservices from the Group’s auditor:
             
  2005 2004 2003
       
  (All figures in £ millions)
Statutory audit  4   3   3 
Audit-related regulatory reporting services  1   1    
Non-audit services:            
Tax compliance  1   1   1 
Tax advisory     1   1 
Other non-audit services  1       
          
      Audit-related regulatory reporting services were £700,000 (2004: £600,000; 2003: £nil). This relates to services in respect of discontinued operations: cost of sales £61m (2003: £53m), distribution costs £40m (2003: £33m)the transition to IFRS and administrationSarbanes-Oxley section 404 compliance services. Other non-audit services were £700,000 (2004: £100,000; 2003: £400,000) and other expenses £66m (2003: £55m).
             
  2004 2003 2002
       
  (All figures in £ millions)
Other operating income
            
Income from other investments            
Unlisted     4   2 
Other operating income (mainly royalties, rights and commission income)  46   47   57 
          
   46   51   59 
          
Profit/(loss) before taxation is stated after charging
            
Amortisation of pre-publication costs  168   158   170 
Depreciation  102   111   122 
Operating lease rentals            
— Plant and machinery  9   14   11 
— Properties  97   113   101 
— Other  13   9   13 
Auditors’ remuneration            
Statutory audit and audit-related regulatory reporting services  4   3   3 
Non-audit services  2   2   3 
Non-audit services were as follows
            
Tax compliance services  1   1   2 
Tax advisory services  1   1   1 
mainly relate to due diligence work performed at IDC.
Note Included in statutory audit fees are amounts relating to the parent company of £20,000 (2003: £20,000). Audit-related regulatory reporting fees relating to the parent company are £225,000 (2003: £200,000) and £600,000 (2003: £nil) relating to overseas subsidiaries.      Non-audit fees in the UK in 2004 are £1m (2003:

F-16


NOTES TO THE ACCOUNTS (Continued)
£341,000)were £1.0m (2004: £1.0m; 2003: £300,000) and arewere in respect of tax advisory, tax compliance services and other advisory services. The remainder of the non-audit fees relaterelated to overseas subsidiaries.
4a     PROFIT/(LOSS) ON SALE OF FIXED ASSETS AND INVESTMENTS
             
  2004 2003 2002
       
  (All figures in £ millions)
Net loss on sale of property  (4)  (1)  (3)
Net gain/(loss) on sale of investments  16   (1)  (8)
Continuing operations  12   (2)  (11)
Discontinued operations        (2)
          
   12   (2)  (13)
          
Taxation  (2)     6 
          
4b     PROFIT/(LOSS) ON SALE OF SUBSIDIARIES AND ASSOCIATES
             
  2004 2003 2002
       
  (All figures in £ millions)
Net loss on sale of subsidiaries and associates  (3)  (4)  (45)
Continuing operations  (3)  (4)  (45)
Discontinued operations     12   18 
          
   (3)  8   (27)
          
Taxation  1   (3)  (6)
          
4c     PROFIT ON SALE OF A SUBSIDIARY BY AN ASSOCIATE
             
  2004 2003 2002
       
  (All figures in £ millions)
Net profit on sale of a subsidiary by an associate — discontinued operations        3 
5NET FINANCE COSTS
                 
  Note 2004 2003 2002
         
    (All figures in £ millions)
Net interest payable                
— Group  6   (70)  (81)  (94)
— Associates      1   1    
Early repayment of debt and termination of swap contracts            (37)
             
Total net finance costs      (69)  (80)  (131)
             

F-17F-23


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
6NET INTEREST PAYABLE — GROUPEmployee information
             
  2004 2003 2002
       
  (All figures in £ millions)
Interest payable and similar charges
            
Bank loans, overdrafts, bonds and commercial paper
            
On borrowing repayable wholly within five years  (58)  (60)  (54)
On borrowing repayable wholly or partly after five years  (32)  (31)  (51)
Other borrowings
            
On borrowing repayable wholly within five years  (1)  (2)   
          
   (91)  (93)  (105)
          
Interest receivable and similar income
            
On deposits, liquid funds and other  21   12   11 
          
Net interest payable
  (70)  (81)  (94)
          
             
  2005 2004 2003
       
  (All figures in £ millions)
Employee benefit expense
            
Wages and salaries (including termination benefits and restructuring costs)  1,088   983   988 
Social security costs  101   89   87 
Share-based payment costs (note 24)  23   25   29 
Pension costs — defined contribution plans (note 24)  35   32   28 
Pension costs — defined benefit plans (note 24)  25   24   23 
Other post-retirement benefits (note 24)  1   1   1 
          
   1,273   1,154   1,156 
          
7TAXATION
             
  2004 2003 2002
       
  (All figures in £ millions)
Analysis of (charge)/benefit in the year
            
Current taxation
            
UK corporation tax for the year  10   (9)  11 
Adjustments in respect of prior years  (2)  10   58 
          
   8   1   69 
Overseas tax for the year  (82)  (59)  (63)
Adjustments in respect of prior years  27   3    
Associates  (3)  (5)  (4)
          
   (50)  (60)  2 
          
Deferred taxation
            
Origination and reversal of timing differences            
UK  (5)  (4)  (11)
Overseas  (30)  (54)  (56)
Adjustments in respect of prior years  23   43   1 
          
   (12)  (15)  (66)
          
Taxation
  (62)  (75)  (64)
          

F-18


NOTES TO THE ACCOUNTS (Continued)
      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:
             
  2004 2003 2002
       
  (All figures in £ millions)
Profit before tax  171   152   (25)
          
Expected charge at UK corporation tax rate of 30% (2003: 30%)  (51)  (46)  8 
Effect of overseas tax rates  7   8   11 
Effect of tax losses  (9)  (5)  (7)
Timing differences  35   64   55 
Non-deductible goodwill amortisation  (61)  (90)  (111)
Adjustments in respect of prior years and other items  29   9   46 
          
Current tax (charge)/benefit for the year
  (50)  (60)  2 
          
             
  2004 2003 2002
       
  (All figures in percentages)
Tax rate reconciliation
            
UK tax rate  30.0   30.0   30.0 
Effect of overseas tax rates  1.4   1.3   2.8 
Other items  (1.1)  (0.1)   
          
Tax rate reflected in adjusted earnings
  30.3   31.2   32.8 
          
Note The current tax charge on profit before tax will continue to be affected by the fact that there is only partial tax relief available on the goodwill amortisation charged in the accounts. The charge will also be affected by the utilisation of tax losses and by the impact of other timing differences, in both cases mainly in the United States.
In both 2004 and 2003 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.
8DIVIDENDS ON EQUITY SHARES
                         
  2004 2003 2002
       
  Pence   Pence   Pence  
  per share £m per share £m per share £m
             
Interim paid  9.7   76   9.4   73   9.1   72 
Final proposed  15.7   125   14.8   119   14.3   115 
                   
Dividends for the year
  25.4   201   24.2   192   23.4   187 
                   
Note Dividends in respect of the company’s shares held by employee share trusts (see note 24) have been waived.

F-19


NOTES TO THE ACCOUNTS (Continued)
9EARNINGS/(LOSS) PER SHARE
                             
    2004 2003 2002
         
      Earnings/   Earnings/   Earnings/
      (loss)   (loss)   (loss)
      per share   per share   per share
  Note £m (p) £m (p) £m (p)
               
Profit/(loss) for the financial year      88   11.1   55   6.9   (111)  (13.9)
Diluted earnings/(loss)      88   11.0   55   6.9   (111)  (13.9)
                      
Weighted average number of shares (millions)                            
 — for basic earnings and adjusted earnings      795.6       794.4       796.3     
Effect of dilutive share options      1.1       0.9            
Weighted average number of shares (millions)                            
                      
 — for diluted earnings      796.7       795.3       796.3     
                      
10a     EMPLOYEE INFORMATION
      The details of the emoluments of the directors of Pearson plc are shown on pages 4621 to 57.37.
             
  2004 2003 2002
       
  (All figures in £ millions)
Staff costs
            
Wages and salaries  1,023   1,027   1,106 
Social security costs  105   99   106 
Post-retirement costs  68   62   59 
          
   1,196   1,188   1,271 
          
                 
  UK US Other Total
         
Average number employed 2004
                
Pearson Education  2,071   16,133   4,080   22,284 
FT Group  1,709   1,352   2,594   5,655 
The Penguin Group  1,067   2,026   992   4,085 
Other  792   572   1   1,365 
             
   5,639   20,083   7,667   33,389 
             
                 
  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 
             
             
  2005 2004 2003
       
  (Average number employed)
School  10,133   10,403   9,348 
Higher Education  4,196   4,087   3,912 
Professional  8,342   7,491   6,434 
Penguin  4,051   4,085   4,318 
FT Publishing  1,952   1,989   2,283 
IDC  1,956   1,826   1,628 
Other  1,573   1,365   928 
          
Continuing operations
  32,203   31,246   28,851 
          
Discontinued operations
     1,840   1,733 
          
   32,203   33,086   30,584 
          

F-20F-24


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
7Net finance costs
                 
  UK US Other Total
         
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 
             
             
  2005 2004 2003
       
  (All figures in £ millions)
Interest payable  (98)  (91)  (91)
Finance costs re employee benefits  (7)  (5)  (9)
Net foreign exchange losses  (9)      
Other losses on financial instruments in a hedging relationship:            
— fair value hedges  (1)      
— net investment hedges         
Other losses on financial instruments not in a hedging relationship:            
— derivatives  (17)      
          
Finance costs
  (132)  (96)  (100)
          
Interest receivable  21   17   7 
Net foreign exchange gains  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  7       
— derivatives  9       
          
Finance income
  62   17   7 
          
Net finance costs
  (70)  (79)  (93)
          
Analysed as:
            
Net interest payable  (77)  (74)  (84)
Finance costs re employee benefits  (7)  (5)  (9)
          
Net finance costs reflected in adjusted earnings  (84)  (79)  (93)
Other net finance income  14       
          
Total net finance costs
  (70)  (79)  (93)
          
8Income tax
             
  2005 2004 2003
       
  (All figures in £ millions)
Current tax
            
Charge in respect of current year  (76)  (65)  (45)
Adjustments in respect of prior years  (1)  25   13 
          
Total current tax charge
  (77)  (40)  (32)
          
Deferred tax
            
In respect of timing differences  (66)  (46)  (72)
Adjustments in respect of prior years  19   23   43 
          
Total deferred tax charge (note 14)
  (47)  (23)  (29)
          
Total tax charge
  (124)  (63)  (61)
          

F-25


10b     PENSIONSNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the UK tax rate as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Profit before tax  466   325   313 
Tax calculated at UK rate  (140)  (97)  (94)
Effect of overseas tax rates  (22)  (8)  (6)
Joint venture and associate income reported net of tax  5   2    
Income not subject to tax  16   6   11 
Expenses not deductible for tax purposes  (9)  (5)  (7)
Utilisation of previously unrecognised tax losses  11   5   15 
Unutilised tax losses  (3)  (14)  (36)
Prior year adjustments  18   48   56 
          
Total tax charge
  (124)  (63)  (61)
          
UK  (26)  5   (13)
Overseas  (98)  (68)  (48)
          
Total tax charge
  (124)  (63)  (61)
          
Add back: tax benefit on other gains and losses  (4)  (36)  (35)
Add back: tax benefit on amortisation of acquired intangibles  (4)  (2)  (1)
Add back: tax charge on other finance income  3       — 
          
Adjusted income tax charge — continuing operations  (129)  (101)  (97)
Adjusted income tax charge — discontinued operations  1   (7)  (19)
          
Total adjusted income tax charge
  (128)  (108)  (116)
          
Tax rate reflected in adjusted earnings
  30.3%  30.9%  32.5%
          
      The tax benefit on items charged to equity is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Deferred tax on stock options  3   4    
Current tax on foreign exchange gains and losses  9   5    
          
   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 any tax consequences that might arise from conversion of those shares.

F-26


SSAP 24NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  2005 2004 2003
       
  (All figures in £ millions)
Earnings  624   262   252 
Adjustments to exclude profit for the year from discontinued operations:            
Profit for the year from discontinued operations  (302)  (22)  (23)
Minority interest share of above     5   5 
          
Earnings — continuing operations
  322   245   234 
          
Earnings  624   262   252 
          
Weighted average number of shares (millions)  797.9   795.6   794.4 
Effect of dilutive share options (millions)  1.1   1.1   0.9 
          
Weighted average number of shares (millions) for diluted earnings  799.0   796.7   795.3 
          
Earnings per share from continuing and discontinued operations
            
Basic  78.2p  32.9p  31.7p
Diluted  78.1p  32.9p  31.7p
          
Earnings per share from continuing operations
            
Basic  40.4p  30.8p  29.4p
Diluted  40.3p  30.8p  29.4p
          
Earnings per share from discontinued operations
            
Basic  37.8p  2.1p  2.3p
Diluted  37.8p  2.1p  2.3p
          
10Dividends
             
  2005 2004 2003
       
  (All figures in £ millions)
Final paid in respect of prior year 15.7p (2004: 14.8p; 2003: 14.3p)  125   119   115 
Interim paid in respect of current year 10p (2004: 9.7p; 2003: 9.4p)  80   76   73 
          
   205   195   188 
          
      The directors are proposing a final dividend in respect of the financial year ending 31 December 2005 of 17.0p per share which will absorb an estimated £136m of shareholders’ funds. It will be paid on 5 May 2006 to shareholders who are on the register of members on 7 April 2006. These financial statements do not reflect this dividend payable (see note 34k).

F-27


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11Property, plant and equipment
                 
      Assets in  
  Land and Plant and course of  
  buildings equipment construction Total
         
  (All figures in £ millions)
Cost
                
At 1 January 2003
  319   619   20   958 
Exchange differences  (19)  (28)  (3)  (50)
Additions  12   52   14   78 
Disposals  (15)  (55)     (70)
Acquisition through business combination  5   19      24 
Disposal through business disposal  (2)  (6)     (8)
Reclassifications  1   9   (10)   
             
At 31 December 2003
  301   610   21   932 
             
Exchange differences  (9)  (10)  (1)  (20)
Additions  14   81   8   103 
Disposals  (13)  (39)     (52)
Acquisition through business combination  1   4      5 
Disposal through business disposal  (4)        (4)
Reclassifications     13   (13)   
Transfer to non-current assets held for sale  (14)  (81)  (2)  (97)
             
At 31 December 2004
  276   578   13   867 
             
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
  324   657   7   988 
             

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 2003  (104)  (419)     (523)
Exchange differences  10   17      27 
Charge for the year  (16)  (69)     (85)
Disposals  7   53      60 
Acquisition through business combination     (14)     (14)
Disposal through business disposal  1   4      5 
             
At 31 December 2003
  (102)  (428)     (530)
             
Exchange differences  4   5      9 
Charge for the year  (16)  (68)     (84)
Disposals  6   38      44 
Acquisition through business combination     (4)     (4)
Disposal through business disposal  4         4 
Transfer to non-current assets held for sale  2   47      49 
             
At 31 December 2004
  (102)  (410)     (512)
             
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
  (126)  (478)     (604)
             
Carrying amounts
                
At 1 January 2003  215   200   20   435 
At 31 December 2003  199   182   21   402 
At 31 December 2004  174   168   13   355 
At 31 December 2005
  198   179   7   384 
             
      Depreciation expense of £19m (2004: £17m; 2003: £15m) has been included in the income statement in cost of goods sold, £7m (2004: £6m; 2003: £6m) in distribution expenses and £54m (2004: £55m; 2003: £58m) in administrative and other expenses. In 2004 £6m (2003: £6m) 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 £3m (2004: £3m; 2003: £5m).

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 2003  3,610   146            3,756 
Exchange differences  (275)  (10)           (285)
Additions  113   26            139 
Disposals  (4)  (2)           (6)
Acquisition through business combination           44   44   44 
                   
At 31 December 2003
  3,444   160      44   44   3,648 
                   
Exchange differences  (201)  (8)     (3)  (3)  (212)
Additions  22   24            46 
Disposals  (4)  (11)           (15)
Acquisition through business combination        10   5   15   15 
Transfer to non-current assets held for sale  (101)              (101)
                   
At 31 December 2004
  3,160   165   10   46   56   3,381 
                   
Exchange differences  345   15   2   4   6   366 
Transfers     (13)           (13)
Additions  155   24            179 
Disposals  (6)  (10)           (16)
Acquisition through business combination        56   33   89   89 
                   
At 31 December 2005
  3,654   181   68   83   151   3,986 
                   

F-30


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                         
      Acquired Other Total  
      publishing intangibles intangibles  
  Goodwill Software rights acquired acquired Total
             
  (All figures in £ millions)
Amortisation
                        
At 1 January 2003     (75)           (75)
Exchange differences     7            7 
Charge for the year     (28)     (4)  (4)  (32)
Disposals     2            2 
Acquisition through business combination                  
                   
At 31 December 2003
     (94)     (4)  (4)  (98)
                   
Exchange differences     8      1   1   9 
Charge for the year     (20)     (5)  (5)  (25)
Disposals     11            11 
Acquisition through business combination                  
                   
At 31 December 2004
     (95)     (8)  (8)  (103)
                   
Exchange differences     (10)           (10)
Charge for the year     (18)  (5)  (6)  (11)  (29)
Disposals     10            10 
Acquisition through business combination                  
                   
At 31 December 2005
     (113)  (5)  (14)  (19)  (132)
                   
Carrying amounts
                        
At 1 January 2003  3,610   71            3,681 
At 31 December 2003  3,444   66      40   40   3,550 
At 31 December 2004  3,160   70   10   38   48   3,278 
                   
At 31 December 2005
  3,654   68   63   69   132   3,854 
                   
      Other intangibles acquired include customer lists and relationships, technology, trade names and trademarks. Amortisation of £4m (2004: £3m; 2003: £5m) is included in the income statement in cost of sales and £25m (2004: £22m; 2003: £27m) in administrative and other expenses.
Impairment tests for cash-generating units containing goodwill
      Impairment tests have been 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.

F-31


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Goodwill has been allocated as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Higher Education  1,106   950   1,007 
School Book  861   739   783 
School Assessment and Testing  271   232   246 
School Technology  385   330   350 
Other Assessment and Testing  245   211   223 
Other Government Solutions  234   201   213 
Other Book  70   60   63 
          
Pearson Education total
  3,172   2,723   2,885 
          
Penguin US  149   122   138 
Penguin UK  146   146   146 
Pearson Australia  45   42   44 
          
Penguin total
  340   310   328 
          
IDC
  138   123   127 
          
FT Publishing
  4   4   4 
          
Recoletos
        100 
          
Total goodwill
  3,654   3,160   3,444 
          
      The Group has adopted IFRS 3 ‘Business Combinations’ with effect from the date of transition to IFRS. In accordance with IFRS 3, goodwill is no longer amortised but rather tested for impairment on an annual basis. Goodwill has been allocated for impairment purposes to twelve 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.
      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 of 8.5% to 11.5% for the Pearson Education businesses, 8% to 13% for the Penguin businesses and 8.5% to 11.5% for the FT Publishing businesses.
Perpetuity growth rates — The cash flows subsequent to the approval 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 3.0% to 4.0%. 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.

F-32


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13Investments in joint ventures and associates
Joint ventures
             
  2005 2004 2003
       
  (All figures in £ millions)
At beginning of year  14   12   12 
Exchange differences  (3)  1   4 
Share of loss after tax  (1)  (5)  (9)
Dividends  (4)  (3)  (2)
Additions or further investment  6   9   7 
          
At end of year
  12   14   12 
          
      Investments in joint ventures are accounted for by 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:
             
  2005 2004 2003
       
  (All figures in £ millions)
Assets
            
Non-current assets  3   3    
Current assets  26   19   18 
          
 
Liabilities
            
Current liabilities  (17)  (8)  (6)
          
Net assets
  12   14   12 
          
Income  46   37   33 
Expenses  (47)  (42)  (42)
          
Loss after income tax
  (1)  (5)  (9)
          
Associates
             
  2005 2004 2003
       
  (All figures in £ millions)
At beginning of year  33   52   94 
Share of profit after tax  15   15   13 
Dividends  (10)  (9)  (8)
Loan repayment        (2)
Additions     1    
Disposals  (14)  (24)  (45)
Transfer to non-current assets held for sale     (2)   
          
At end of year
  24   33   52 
          
      Investments in associates at 31 December 2005 include goodwill of £nil (2004: £6m; 2003: £7m). The share of profit after tax includes £nil (2004: £2m; 2003: £2m) in respect of discontinued operations.

F-33


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The Group’s interests in its principal associates, all of which are unlisted, were as follows:
                         
    %        
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 
                   
                         
    %        
2004 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
  (All figures in £ millions)
The Economist Newspaper Ltd  England   50   71   (62)  98   11 
Other          42   (18)  192   4 
                   
Total
          113   (80)  290   15 
                   
                         
    %        
2003 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
  (All figures in £ millions)
The Economist Newspaper Ltd  England   50   103   (101)  95   9 
Other          81   (31)  139   4 
                   
Total
          184   (132)  234   13 
                   
14Deferred income tax
             
  2005 2004 2003
       
  (All figures in £ millions)
Deferred tax assets
            
Deferred tax asset to be recovered after more than 12 months  343   318   313 
Deferred tax asset to be recovered within 12 months  42   41   29 
          
   385   359   342 
          
Deferred tax liabilities
            
Deferred tax liability to be settled after more than 12 months  (204)  (139)  (140)
Deferred tax liability to be settled within 12 months         — 
          
   (204)  (139)  (140)
          
Net deferred tax
  181   220   202 
          
      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 unprovided deferred tax assets at 31 December 2005 in respect of UK losses (£32m) and US losses (£37m) and has not recognised a deferred tax asset on the net pension deficit on the basis that it is not sufficiently certain that suitable future profits will arise against which to offset the liability. The related unprovided deferred tax asset is £96m.
      The recognition of the deferred tax assets is supported by management’s forecasts of the future profitability of the relevant business units.

F-34


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The gross movement on the deferred income tax account is as follows:
             
  2005 2004 2003
       
  (All figures in £
  millions)
At beginning of year  220   202   255 
Transition adjustment on adoption of IAS 39  5       — 
Exchange differences  21   (13)  (34)
Acquisition through business combination  (21)     (15)
Transfer between current and deferred taxation     41   25 
Income statement charge (note 8)  (47)  (23)  (29)
Tax benefit to equity (note 8)  3   4    
Transfer to non-current assets held for sale     9    
          
At end of year
  181   220   202 
          
      The movement in deferred income tax assets and liabilities during the year is as follows:
                 
    Goodwill    
  Tax and    
  losses intangibles Other Total
         
  (All figures in £ millions)
Deferred income tax assets
                
At 1 January 2003  131   57   186   374 
Exchange differences  (16)  (4)  (22)  (42)
Transfer between current and deferred taxation  25      (17)  8 
Income statement (charge)/release  (27)  (7)  36   2 
             
At 31 December 2003
  113   46   183   342 
             
Exchange differences  (10)  (3)  (11)  (24)
Transfer between current and deferred taxation  41      (11)  30 
Income statement release/(charge)  6   (6)  7   7 
Tax benefit to equity        4   4 
             
At 31 December 2004
  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 
             
      Other deferred tax assets include temporary differences on inventory, sales returns and other provisions.

F-35


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  Goodwill and    
  intangibles Other Total
       
  (All figures in £ millions)
Deferred income tax liabilities
            
At 1 January 2003  (25)  (94)  (119)
Exchange differences     8   8 
Acquisition through business combination  (15)     (15)
Transfer between current and deferred taxation     17   17 
Income statement charge  (19)  (12)  (31)
          
At 31 December 2003
  (59)  (81)  (140)
          
Exchange differences  8   3   11 
Transfer between current and deferred taxation     11   11 
Income statement charge  (8)  (22)  (30)
Transfer to non-current assets held for sale     9   9 
          
At 31 December 2004
  (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)
          
      Other deferred tax liabilities include temporary differences on capital allowances and royalty advances.
15Other financial assets
             
  2005 2004 2003
       
  (All figures in £
  millions)
At beginning of year  15   21   22 
Exchange differences  1   (1)  (3)
Additions  4   5   3 
Disposals  (2)  (8)  (1)
Transfer to non-current assets held for sale     (2)   
          
At end of year
  18   15   21 
          
      Other financial assets are non-current unlisted securities.

F-36


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16Derivative financial instruments
         
  2005 2005
  Assets Liabilities
     
  (All figures in £
  millions)
Interest rate derivatives — in a fair value hedging relationship  31   (16)
Interest rate derivatives — not in a hedging relationship  18   (6)
Cross currency rate derivatives — in a net investment hedging relationship  13    
Cross currency rate derivatives — not in a hedging relationship  21    
       
   83   (22)
       
Analysed as:
        
Non-current  79   (22)
Current (expiring in less than 1 year)  4    
       
   83   (22)
       
      The fair value of the above derivative financial instruments is the same as the carrying value.
      The Group’s portfolio of derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges, significantly reduces the risk of income statement volatility.
      Counterparty exposure from 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 had received an amount of £43m equivalent as collateral under amark-to-market agreement. This reflected the amount, at market rates prevailing at the end of October 2005, owed to the Group by the counterparty for a set of three related derivatives. Under these the Group is due to exchange $209m for204m in February 2007. 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 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
             
  2005 2004 2003
       
  (All figures in £ millions)
Cost
            
At beginning of year  1,109   1,104   1,189 
Exchange differences  112   (63)  (90)
Acquisition through business combination  27       — 
Additions  222   181   173 
Disposals  (113)  (113)  (168)
          
At end of year
  1,357   1,109   1,104 
          
Amortisation
            
At beginning of year  (753)  (742)  (809)
Exchange differences  (87)  44   57 
Acquisition through business combination  (12)      — 
Charge for the year  (192)  (168)  (158)
Disposals  113   113   168 
          
At end of year
  (931)  (753)  (742)
          
Carrying amounts
            
At end of year
  426   356   362 
          
      Amortisation is included in the income statement in cost of goods sold.
18Inventories
             
  2005 2004 2003
       
  (All figures in £ millions)
Raw materials  23   23   19 
Work in progress  43   35   30 
Finished goods  307   256   270 
          
   373   314   319 
          
      The cost of inventories recognised as an expense and included in the income statement in cost of goods sold amounted to £768m (2004: £700m; 2003: £710m). In 2005 £42m (2004: £41m; 2003: £37m) 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
             
  2005 2004 2003
       
  (All figures in £ millions)
Current
            
Trade receivables  825   725   814 
Royalty advances  124   114   110 
Prepayments and accrued income  38   41   38 
Other receivables  42   51   62 
Receivables from related parties  2   2   1 
          
   1,031   933   1,025 
          
Non-current
            
Royalty advances  67   70   83 
Prepayments and accrued income  4   1   1 
Other receivables  37   31   16 
          
   108   102   100 
          
      Trade receivables are stated net of provisions for bad and doubtful debts and sales returns of £313m (2004: £354m; 2003: £339m). 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)
             
  2005 2004 2003
       
  (All figures in £ millions)
Cash at bank and in hand  393   338   302 
Short-term bank deposits  509   123   249 
          
   902   461   551 
          
      Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates.
      The currency split of cash and cash equivalents in 2005 is 31% US dollars (2004: 38%), 38% Sterling (2004: 31%), 24% Euro (2004: 12%) and other 7% (2004: 19%).
      The fair value of cash and cash equivalents is the same as the carrying value.
      Cash and cash equivalents include the following for the purpose of the cash flow statement:
             
  2005 2004 2003
       
  (All figures in £ millions)
Cash and cash equivalents  902   461   551 
Cash and cash equivalents included in assets classified as held for sale     141    
Bank overdrafts  (58)  (58)  (23)
          
   844   544   528 
          

F-39


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21Financial liabilities — Borrowings
      The Group’s current and non-current borrowings are as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Non-current
            
Bank borrowings     62   85 
7.375% US Dollar notes 2006 (nominal amount $250m)     130   139 
6.125% Euro Bonds 2007 (nominal amount591m)
  436   390   343 
10.5% Sterling Bonds 2008 (nominal amount £100m)  107   100   100 
4.7% US Dollar Bonds 2009 (nominal amount $350m)  203   181    
7% Global Dollar Bonds 2011 (nominal amount $500m)  307   260   278 
7% Sterling Bonds 2014 (nominal amount £250m)  250   226   235 
5.7% US Dollar Bonds 2014 (nominal amount $400m)  238   207    
4.625% US Dollar notes 2018 (nominal amount $300m)  161   156   167 
Finance lease liabilities  1   2   2 
          
   1,703   1,714   1,349 
          
Included in the above is £35m of accrued interest in 2005.
             
Current
            
Due within one year or on demand:
            
Bank loans and overdrafts  102   107   119 
7.375% US Dollar notes 2006  152       — 
9.5% Sterling Bonds 2004        108 
4.625% Euro Bonds 2004        348 
Finance lease liabilities  2   2   3 
          
   256   109   578 
          
Total borrowings
  1,959   1,823   1,927 
          
Included in the above is £3m of accrued interest in 2005.
      The Group has elected to apply the provisions of IAS 32 and IAS 39 with effect from 1 January 2005. The comparative financial information is prepared in accordance with UKGAAP. The nature of the main adjustments that would make the information comply with IAS 32 and IAS 39 are set out in note 34.
      The 2004 and 2003 figures for the 2007 Euro Bonds and 2014 Sterling Bonds (together with the 2004 Sterling and Euro Bonds which have now been redeemed) include the effect of accounting for the foreign exchange element of the related derivatives.
      All of the Group’s borrowings are unsecured. In respect of finance lease obligations (£3m in 2005; £4m in 2004 and £5m in 2003) the rights to the leased asset revert to the lessor in the event of default.

F-40


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The maturity of the Group’s non-current borrowing is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Between one and two years  437   131   86 
Between two and five years  310   734   583 
Over five years  956   849   680 
          
   1,703   1,714   1,349 
          
      As at 31 December 2005 the exposure of the borrowings of the Group to interest 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  1,959   256   747   956 
Effect of interest rate swaps     1,161   (473)  (688)
             
   1,959   1,417   274   268 
             
      The carrying amounts and fair values of non-current borrowings are as follows:
                             
    Carrying   Carrying   Carrying  
  Effective amount Fair value amount Fair value amount Fair value
  interest Rate 2005 2005 2004 2004 2003 2003
               
  (All figures in £ millions)
Bank borrowings  n/a         62   62   85   85 
7.375% US Dollar notes 2006  7.75%        130   138   139   157 
6.125% Euro Bonds 2007  6.18%  436   419   390   409   343   448 
10.5% Sterling Bonds 2008  10.53%  107   113   100   116   100   120 
4.7% US Dollar Bonds 2009  4.86%  203   200   181   185       
7% Global Dollar Bonds 2011  7.16%  307   310   260   293   278   317 
7% Sterling Bonds 2014  7.20%  250   282   226   255   235   275 
5.7% US Dollar Bonds 2014  5.88%  238   234   207   217       
4.625% US Dollar notes 2018  4.69%  161   155   156   142   167   151 
Finance lease liabilities  n/a   1   1   2   2   2   2 
                      
       1,703   1,714   1,714   1,819   1,349   1,555 
                      
      The fair 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 current borrowings approximate their fair value.
      The carrying amounts of the Group’s borrowings are denominated in the following currencies:
             
  2005 2004 2003
       
  (All figures in £ millions)
US dollar  1,165   1,335   1,432 
Sterling  357   202   201 
Euro  437   284   292 
Other currencies     2   2 
          
   1,959   1,823   1,927 
          

F-41


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The maturity of the Group’s finance lease obligations is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Finance lease liabilities — minimum lease payments
            
Not later than one year  2   2   3 
Later than one year and not later than five years  1   2   3 
Later than five years         — 
Future finance charges on finance leases        (1)
Present value of finance lease liabilities  3   4   5 
      The present value of finance lease liabilities is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Not later than one year  2   2   3 
Later than one year and not later than five years  1   2   2 
Later than five years         
          
   3   4   5 
          
      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:
             
  2005 2004 2003
       
  (All figures in £ millions)
Floating rate
            
— expiring within one year         
— expiring beyond one year  786   641   950 
          
   786   641   950 
          
      In addition to the above facilities, there are a number of short-term facilities that are utilised in the normal course of business.
22Provisions
                         
  Deferred   Re-      
  consideration Integration organisations Leases Other Total
             
  (All figures in £ millions)
At 1 January 2005  20   5   11   14   7   57 
Exchange differences  2      1   1      4 
Charged to consolidated income statement
                        
— Additional provisions           1   13   14 
— Unused amounts reversed        (1)  (3)  (1)  (5)
On acquisition/disposal  5               5 
Utilised during year  (1)  (2)  (6)  (1)  (1)  (11)
                   
At 31 December 2005
  26   3   5   12   18   64 
                   

F-42


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  2005 2004 2003
       
  (All figures in £ millions)
Analysis of provisions
            
Non-current  31   43   59 
Current  33   14   18 
          
   64   57   77 
          
Deferred consideration — During the year, additional deferred consideration of £5m was incurred mainly relating to the acquisition of Index books.
Integration — During the year, £2m 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.
Reorganisations — There were no additional provisions in 2005 and £5m has been utilised, mainly in respect of redundancies.
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
             
  2005 2004 2003
       
  (All figures in £ millions)
Trade payables  348   316   405 
Social security and other taxes  21   14   4 
Accruals and deferred income  600   509   465 
Other liabilities  156   128   139 
          
   1,125   967   1,013 
          
Less: non-current portion
            
Accruals and deferred income  66   21   9 
Other liabilities  85   78   61 
          
   151   99   70 
          
Current portion
  974   868   943 
          
      The carrying value of the Group’s trade and other liabilities approximates their fair value.
24Employee benefits
Retirement benefit obligations
The Group operates a number of pension schemesretirement benefit plans 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. PensionRetirement benefit costs are assessed in accordance with the advice of independent qualified actuaries. The UK Group scheme is a hybrid scheme with both defined benefit and defined contribution 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:
             
  2004 2003 2002
       
  (All figures in £ millions)
UK Group scheme
            
Regular pension cost            
— Defined benefit sections  10   10   11 
— Defined contribution sections  8   7   7 
Variation cost  9   6    
          
   27   23   18 
          
Other schemes
            
Defined benefit schemes  6   7   6 
Defined contribution schemes  29   27   30 
          
   35   34   36 
          
   62   57   54 
          
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 the balance sheet, there is a pension provision of £19m (2003: £29m) as measured in accordance with SSAP 24 (see note 22).

F-21


NOTES TO THE ACCOUNTS (Continued)
      A fullmost recent actuarial valuation of the UK Group scheme was performed as atcompleted on 1 January 2004 using the projected unit method of valuation.2004.

F-43


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The market value of the assets of the scheme at 1 January 2004 was £1,091m. The majorprincipal assumptions used to determine the SSAP 24 charge are as follows:
UK Group
scheme
(All figures in
percentages)
Inflation2.75
Rate of increase in salaries4.75
Rate of increase for pensions in payment and deferred pensions2.0 to 4.5
Return on investments7.1
Level of funding95
      The funding policy differs from the accounting policy to the extent that more conservative assumptions are used for funding purposes. In particular, the deficit measured on the funding assumptions was £137m (compared to £56m on the SSAP 24 assumptions). Please refer to page F-23 for further details of the funding of the scheme.
      The next full actuarial valuation of the UK Group scheme for funding purposes is due to be carried out as at 1 January 2006. The date of the most recent valuation of the US plan was 1 January 2004.
FRS 17 disclosuresThe 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 2004. The assumptions used are shown below. Weighted average assumptions have been shown for the other schemes.
                                         
 2004 2003 2002 2005 2005 2004 2004 2003 2003
       UK Group Other UK Group Other UK Group Other
 UK Group Other UK Group Other UK Group Other
 scheme schemes scheme schemes scheme schemes
            
% scheme schemes scheme schemes scheme schemes
 (All figures in percentages)            
Inflation  2.80  3.00  2.75  3.00  2.25  3.00   2.80  2.95  2.80  2.98  2.75  2.98 
Rate of increase in salaries  4.80  4.50  4.75  4.50  4.25  4.50 
Rate of increase for pensions in payment and deferred pensions  2.80–4.00    2.75–4.00    2.25–4.00   
Expected rate of increase in salaries  4.50  4.43  4.80  4.44  4.75  4.45 
Expected rate of increase for pensions in payment and deferred pensions 2.50 to 4.00   2.80 to 4.00   2.75 to 4.00   
Rate used to discount scheme liabilities  5.40  5.85  5.50  6.10  5.70  6.75   4.85  5.54  5.40  5.84  5.50  6.11 
Expected return on assets  6.40  7.31  6.60  7.23  6.81  7.75 
             
      The amounts recognised in the income statement are as follows:
                     
    Defined      
  UK Group benefit   Defined 2005
  scheme other Sub Total contribution Total
           
  (All figures in £ millions)
Current service cost  (25)  (2)  (27)  (35)  (62)
Past service cost               
Curtailments     2   2      2 
                
Total operating charge
  (25)     (25)  (35)  (60)
                
Expected return on plan assets  75   6   81      81 
Interest on pension scheme liabilities  (79)  (6)  (85)     (85)
                
Net finance charge
  (4)     (4)     (4)
                
Net income statement charge
  (29)     (29)  (35)  (64)
                
Actual return on plan assets
  214   7   221      221 
                
                     
    Defined      
  UK Group benefit   Defined 2004
  scheme other Sub Total contribution Total
           
  (All figures in £ millions)
Current service cost  (22)  (2)  (24)  (32)  (56)
Past service cost               
                
Total operating charge
  (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 charge
  (1)     (1)     (1)
                
Net income statement charge
  (23)  (2)  (25)  (32)  (57)
                
Actual return on plan assets
  135   9   144      144 
                

F-22F-44


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     
    Defined      
  UK Group benefit Sub Defined 2003
  scheme other Total contribution Total
           
  (All figures in £ millions)
Current service cost  (21)  (2)  (23)  (28)  (51)
Past service cost               
                
Total operating charge
  (21)  (2)  (23)  (28)  (51)
                
Expected return on plan assets  65   4   69      69 
Interest on pension scheme liabilities  (67)  (7)  (74)     (74)
                
Net finance charge
  (2)  (3)  (5)     (5)
                
Net income statement charge
  (23)  (5)  (28)  (28)  (56)
                
Actual return on plan assets
  145   12   157      157 
                
      The total operating charge is included in administrative and other expenses.
      The assets ofamounts recognised in 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,balance sheet 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 2004 31 Dec 2004 31 Dec 2003 31 Dec 2003 31 Dec 2002 31 Dec 2002
             
  % £m % £m % £m
UK Group scheme
                        
Equities  7.50   638   7.75   589   8.00   472 
Bonds  4.75   276   5.00   262   4.75   284 
Properties  6.25   113   6.50   107   6.50   112 
Other  6.25   174   6.50   133   6.50   108 
                   
Total market value of assets      1,201       1,091       976 
Present value of scheme liabilities      (1,495)      (1,316)      (1,189)
Deficit in the scheme      (294)      (225)      (213)
Related deferred tax asset      88       68       64 
                   
Net pension liability
      (206)      (157)      (149)
                   
Other schemes
                        
Equities  8.50   45   9.00   41   9.75   33 
Bonds  5.50   26   6.00   25   6.00   23 
Other  3.75   2   2.80   1   2.75   1 
                   
Total market value of assets      73       67       57 
Present value of scheme liabilities      (102)      (104)      (96)
Deficit in the schemes      (29)      (37)      (39)
Related deferred tax asset      10       13       14 
                   
Net pension liability
      (19)      (24)      (25)
                   
                                                 
  2005 2005 2005   2004 2004 2004   2003 2003 2003  
  UK Other Other   UK Other Other   UK Other Other  
  Group funded unfunded 2005 Group funded unfunded 2004 Group funded unfunded 2003
  scheme plans plans Total scheme plans plans Total scheme plans plans Total
                         
  (All figures in £ millions)
Fair value of plan assets  1,390   110      1,500   1,198   82      1,280   1,089   75      1,164 
Present value of plan liabilities  (1,661)  (131)  (11)  (1,803)  (1,502)  (104)  (9)  (1,615)  (1,340)  (105)  (9)  (1,454)
                                     
Net pension liability
  (271)  (21)  (11)  (303)  (304)  (22)  (9)  (335)  (251)  (30)  (9)  (290)
                                     
Other post-retirement medical benefit obligation              (60)              (58)              (61)
Other pension accruals              (26)              (15)              (13)
                                     
Total retirement benefit obligations
              (389)              (408)              (364)
                                     
Note      The measurement of the deficitfollowing amounts have been recognised in the scheme for FRS 17 follows a different approach to SSAP 24.statement of recognised income and expense:
             
  2005 2004 2003
       
  (All figures in
  £ millions)
Amounts recognised for defined benefit schemes  21   (60)  (25)
Amounts recognised on post-retirement medical benefit schemes  5   (1)  (3)
          
Total recognised in year
  26   (61)  (28)
          
Cumulative amounts recognised
  (63)  (89)  (28)
          
      The FRS 17 measurement date is 31 December 2004. Although the rise in stock markets in 2004 increased the marketfair value of plan assets comprises the UK Group scheme assets, this is more than offset by the increase in the present value of the UK Group scheme liabilities. This increase has largely been caused by use of the 1 January 2004 formal funding valuation and the change in both economic and mortality assumptions used for FRS 17 purposes since 31 December 2003. This has resulted in an increased deficit in the UK Group scheme under FRS 17.following:
                                     
  2005 2005   2004 2004   2003 2003  
  UK Other   UK Other   UK Other  
  group funded 2005 Group funded 2004 Group funded 2003
% scheme plans Total scheme plans Total scheme plans Total
                   
Equities  47.4   4.3   51.7   49.7   4.2   53.9   50.5   4.2   54.7 
Bonds  24.7   2.0   26.7   21.5   2.1   23.6   22.5   2.1   24.6 
Properties  8.9      8.9   8.9      8.9   9.2      9.2 
Other  11.7   1.0   12.7   13.5   0.1   13.6   11.4   0.1   11.5 

F-23F-45


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
                     
    Defined      
  UK Group benefit   Defined 2004
  scheme other Sub-total contribution Total
           
  (All figures in £ millions)
Operating charge
                    
Current service cost  (24)  (1)  (25)  (29)  (54)
Past service cost               
                
Total operating charge
  (24)  (1)  (25)  (29)  (54)
                
Other finance income/(charge)
                    
Expected return on pension scheme assets  73   5   78      78 
Interest on pension scheme liabilities  (70)  (6)  (76)     (76)
                
Net finance credit/(charge)  3   (1)  2      2 
                
Net profit and loss impact
  (21)  (2)  (23)  (29)  (52)
                
Statement of total recognised gains and losses
                    
Actual return less expected return on pension scheme assets  60   2   62         
Experience (losses)/gains arising on the scheme liabilities  (62)  1   (61)        
Changes in assumptions underlying the present value of the scheme liabilities  (76)  (4)  (80)        
Exchange differences     2   2         
                
Actuarial (loss)/gain
  (78)  1   (77)        
                
Movement in deficit during the year
                    
Deficit in scheme at beginning of the year  (225)  (37)  (262)        
Current service cost  (24)  (1)  (25)        
Past service cost                 
Contributions  30   9   39         
Other finance charge  3   (1)  2         
Actuarial (loss)/gain  (78)  1   (77)        
                
Deficit in scheme at end of the year
  (294)  (29)  (323)        
                
Related deferred tax asset  88   10   98         
                
Net pension deficit
  (206)  (19)  (225)        
                
      Following the 1 January 2004 actuarial valuation for funding purposes, the Group has agreed to pay contributions of 14.8% of pensionable salaries, plus contributions in respectThe plan assets do not include any of the Money Purchase 2003 section introduced with effect from 1 January 2003, in respect of future service benefits. Further, the Group has agreed to pay contributions of £10m in respect of 2004, £15m in respect of 2005 and £21m in respect of each year from 2006 to 2013 to fund the past service deficit revealedGroup’s own financial instruments, nor any property occupied by the funding valuation.Group.
      Changes in the values of plan assets and liabilities are as follows:
                                     
  2005     2004     2003    
  UK Group 2005 2005 UK Group 2004 2004 UK Group 2003 2003
  scheme Other Total scheme Other Total scheme Other Total
                   
  (All figures in £ millions)
Fair value of assets
                                    
Opening fair value of plan assets  1,198   82   1,280   1,089   75   1,164   974   57   1,031 
Exchange differences     9   9      (5)  (5)     (5)  (5)
Expected return on plan assets  75   6   81   71   6   77   65   4   69 
Actuarial gains and losses  139   1   140   64   3   67   80   8   88 
Contributions by employer  35   10   45   30   9   39   24   9   33 
Contributions by employee  6      6   6      6   6      6 
Benefits paid  (63)  (6)  (69)  (62)  (6)  (68)  (60)  (6)  (66)
Acquisition through business combination     8   8               8   8 
                            
Closing fair value of plan assets
  1,390   110   1,500   1,198   82   1,280   1,089   75   1,164 
                            
Present value of defined benefit obligation
                                    
Opening defined benefit obligation  (1,502)  (113)  (1,615)  (1,340)  (114)  (1,454)  (1,207)  (96)  (1,303)
Exchange differences     (12)  (12)     6   6      9   9 
Current service cost  (25)  (2)  (27)  (22)  (2)  (24)  (21)  (2)  (23)
Curtailment     2   2                   — 
Interest cost  (79)  (6)  (85)  (72)  (6)  (78)  (67)  (7)  (74)
Contributions by employee  (6)     (6)  (6)     (6)  (6)     (6)
Acquisition through business combination     (10)  (10)              (10)  (10)
Benefits paid  63   6   69   62   6   68   60   6   66 
Actuarial gains and losses  (112)  (7)  (119)  (124)  (3)  (127)  (99)  (14)  (113)
                            
Closing defined benefit obligation
  (1,661)  (142)  (1,803)  (1,502)  (113)  (1,615)  (1,340)  (114)  (1,454)
                            
      The history of the defined benefit plans is as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Present value of defined benefit obligation  (1,803)  (1,615)  (1,454)
Fair value of plan assets  1,500   1,280   1,164 
          
Net pension liability
  (303)  (335)  (290)
          
Experience adjustments on plan liabilities  (119)  (127)  (113)
Experience adjustments on plan assets  140   67   88 
          

F-24F-46


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      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 £41m to its defined benefit plans in 2006.
Other post-retirement obligations
      The Group operates a number of post-retirement medical benefit schemes, principally in the USA. These plans are unfunded. The method of accounting and the frequency of valuations are similar to those used for defined benefit pension schemes.
      The principal assumptions used are shown below:
                     
    Defined      
  UK Group benefit   Defined 2003
  scheme other Sub-total contribution Total
           
  (All figures in £ 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 finance 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)        
                
             
% 2005 2004 2003
       
Inflation  3.0   3.0   3.0 
Initial rate of increase in healthcare rates  10.0   12.0   12.0 
Ultimate rate of increase in healthcare rates  5.0   5.0   5.0 
Rate used to discount scheme liabilities  5.6   6.1   6.1 
      The contribution rate for 2003 foramounts recognised in the UK Group scheme was 17.1%income statement are as follows:
             
  2005 2004 2003
       
  (All figures in £ millions)
Current service cost  (1)  (1)  (1)
Interest cost  (3)  (4)  (4)
          
Net income statement charge
  (4)  (5)  (5)
          
      The current service cost has been included in administrative and other expenses.
             
  2005 2004 2003
       
  (All figures in £ millions)
Opening obligation  (58)  (61)  (63)
Exchange differences  (7)  6   6 
Current service cost  (1)  (1)  (1)
Interest cost  (3)  (4)  (4)
Benefits paid  4   3   4 
Actuarial gains and losses  5   (1)  (3)
          
Closing obligation
  (60)  (58)  (61)
          
      The effect of pensionable salaries, plus £1ma one percentage point increase (and decrease) in respect of the new Money Purchase section introduced with effect from 1 January 2003. In addition, a one-off contribution of £5m was paid into this scheme to improve the funding position.assumed medical cost trend rates is as follows:
                         
  2005 2005 2004 2004 2003 2003
  1% increase 1% decrease 1% increase 1% decrease 1% increase 1% decrease
             
  (All figures in £ millions)
Effect on:
                        
Aggregate of service cost and interest cost  0.2   (0.2)  0.2   (0.2)  0.3   (0.3)
Defined benefit obligation  4.7   4.1   4.1   (3.7)  4.8   (4.2)

F-25F-47


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
Share-based compensation
      The Group recognised the following charges in the income statement in respect of its share-based payment plans:
                     
    Defined      
  UK Group benefit   Defined 2002
  scheme other Sub-total contribution Total
           
  (All figures in £ 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 finance 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 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 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)        
                
             
  2005 2004 2003
       
  (All figures in £ millions)
Pearson plans  13   15   20 
IDC plans  10   10   9 
          
Total share-based payment costs
  23   25   29 
          
      The contribution rate for 2002 forGroup operates the UK Group scheme was 17.1% of pensionable salaries.
      The experience gainsfollowing equity-settled employee option and losses of both the UK Group scheme and other schemes are shown below:
             
  2004 2003 2002
       
History of experience gains and losses
            
Difference between the actual and expected return on scheme assets  £62m   £88m   £(176)m 
As a percentage of year end assets  5%   8%   (17)% 
Experience gains and (losses) on scheme liabilities  £(61)m   £(9)m   £16m 
As a percentage of year end liabilities  (4)%   (1)%   1% 
Total amount recognised in statement of total recognised gains and losses  £(77)m   £(19)m   £(159)m 
As a percentage of year end liabilities  (5)%   (1)%   (12)% 

F-26


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 2004 would be as follows:
         
  2004 2003
     
  (All figures in
  £ millions)
Net assets excluding pension liability (see note below)  2,835   3,117 
FRS 17 pension liability  (225)  (181)
       
Net assets including FRS 17 pension liability
  2,610   2,936 
       
Profit and loss reserve excluding pension reserve (see note below)  (52)  252 
FRS 17 pension reserve  (225)  (181)
       
Profit and loss reserve including FRS 17 pension reserves
  (277)  71 
       
Note The net assets and profit and loss reserve exclude the pension liability of £19m (2003: £29m) included within provisions (see note 22).performance plans:
10cOTHER POST-RETIREMENT BENEFITS
UITF 6 accountingThe Group provides certain healthcare and life assurance benefits principally for retired US employees and their dependents. 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 valuation with a measurement date of 31 December 2003, are as follows:
             
  2004 2003 2002
       
  (All figures in £ millions)
Other post-retirement benefits  6   5   5 
      Profit Sharing Plan — The Group operates a profit sharing plan for all employees, the payment of which is at the discretion of the Pearson board and may be made in cash or Pearson shares.
 
      Save for Shares Plans — 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.
(All figures in
      Employee Stock Purchase Plan — In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the United States 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.
percentages)
      Executive Share Option Plan — Under this plan, options were granted to senior management at an exercise price equal to the market price of the shares on the date of grant. Options granted prior to 1996 are not subject to performance conditions. The exercise of options granted since 1996 is subject to growth in the Group’s adjusted earnings per share over a three year period prior to exercise. Options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.
 
InflationReward Plan — Awards of premium priced options were made under this plan in 1999 and 2000 with an exercise price above the market value of the shares at the grant date. The exercise of options is subject to Pearson’s share price remaining above certain thresholds for specified periods of time and to growth in the Group’s adjusted earnings per share over the three year period prior to exercise. Options became exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.
 3.0
Initial rateSpecial Share Option Plan — In 2000, the Group made a special one-off award of increaseshare options with an exercise price equal to the market price of the shares on the grant date. They vested in healthcare rates12.0
Ultimate ratetranches of increase in healthcare rates (2008)5.0
Rate used to discount scheme liabilities6.150% on the first anniversary of the date of grant and 25% on the second and third anniversaries of the grant date. Options lapse if they remain unexercised at the tenth anniversary of the grant date. No new awards will be made under this plan.
      Included in the balance sheet, there is a post-retirement medical benefits provision of £51m (2003: £51m). In accordance with UITF 6, the cost of post-retirement benefits, and related provisions, are based on the equivalent US GAAP standard, FAS 106 (see note 22).
FRS 17 disclosuresThe 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 2004 using the assumptions listed below.
             
  2004 2003 2002
       
  (All figures in percentages)
Inflation  3.00   3.00   3.00 
Initial rate of increase in healthcare rates  12.00   12.00   12.00 
Ultimate rate of increase in healthcare rates (2009; 2008; 2007)  5.00   5.00   5.00 
Rate used to discount scheme liabilities  5.85   6.10   6.75 

F-27F-48


NOTES TO THE ACCOUNTS (Continued)
             
  2004 2003 2002
       
  (All figures in £ millions)
The value of the unfunded liability is as follows:            
Present value of unfunded liabilities  (58)  (61)  (63)
Related deferred tax asset  20   21   22 
          
Net post-retirement healthcare liability
  (38)  (40)  (41)
          
Operating charge
            
Current service cost  (1)  (1)  (1)
Past service cost         
          
Total operating charge
  (1)  (1)  (1)
          
Other finance charge
            
Interest on pension scheme liabilities  (3)  (4)  (4)
Net finance charge  (3)  (4)  (4)
          
Net profit and loss impact
  (4)  (5)  (5)
          
Statement of total recognised gains and losses
            
Experience gains arising on the scheme liabilities  5   3   3 
Changes in assumptions underlying the present value of the scheme liabilities  (5)  (6)  (7)
Exchange differences  4   6   5 
          
Actuarial gain
  4   3   1 
          
Movement in deficit during the year
            
Deficit in scheme at beginning of the year  (61)  (63)  (63)
Current service cost  (1)  (1)  (1)
Contributions  3   4   4 
Other finance charge  (3)  (4)  (4)
Actuarial gain  4   3   1 
          
Deficit in scheme at end of the year
  (58)  (61)  (63)
          
Related deferred tax asset  20   21   22 
          
Net post-retirement deficit
  (38)  (40)  (41)
          
The experience gains and losses for the schemes are shown below:
             
  2004 2003 2002
       
History of experience gains and losses
            
Experience gains on scheme liabilities  £5m  £3m  £3m
As a percentage of year end liabilities  9%  5%  4%
Total amount recognised in statement of total recognised gains and losses  £4m  £3m  £1m
As a percentage of year end liabilities  7%  5%  2%

F-28


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 2004 would be as follows:
         
  2004 2003
     
  (All figures in
  £ millions)
Net assets excluding post-retirement healthcare liability (see note below)  2,867   3,139 
FRS 17 post-retirement healthcare liability  (38)  (40)
       
Net assets including FRS 17 post-retirement healthcare liability
  2,829   3,099 
       
Profit and loss reserve excluding post-retirement healthcare reserve (see note below)  (20)  274 
FRS 17 post-retirement healthcare reserve  (38)  (40)
       
Profit and loss reserve including FRS 17 post-retirement healthcare reserve
  (58)  234 
       
Note The net assets and profit and loss reserve exclude the post-retirement healthcare liability of £51m (2003: £51m) included within provisions (see note 22).
11INTANGIBLE FIXED ASSETS
Goodwill
(All figures in
£ millions)
Cost
At 31 December 2002
4,487
Exchange differences(321)
Additions157
Disposals(99)
At 31 December 2003
4,224
Exchange differences(245)
Additions33
Disposals
At 31 December 2004
4,012
Amortisation
At 31 December 2002
(877)
Exchange differences75
Provided in the year(257)
Disposals95
At 31 December 2003
(964)
Exchange differences66
Provided in the year(224)
Disposals
At 31 December 2004
(1,122)
Net carrying amount
At 31 December 20033,260
At 31 December 2004
2,890

F-29


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
12TANGIBLE FIXED ASSETSLong-Term Incentive Plan — This plan was introduced in 2001 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 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 granted in 2001 vested based on Pearson’s three-year cumulative free cash flow per share performance. Awards made in December 2002 and September 2003 vest in tranches. One sixth of the award vests after three years with no performance conditions. The vesting of the balance depends on Pearson’s share price performance over the seven year period following the grants. Restricted shares awarded in December 2004 and September 2005 vest dependent on the following market and non-market performance criteria: relative shareholder return, return on invested capital and a combination of earnings per share and sales growth. The award is split equally across all three measures.
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 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 everyone held after three years and another one for two originally held after five years.
      The number and weighted average exercise prices of share options granted under the Group’s schemes are as follows:
                 
      Assets in  
  Freehold and Plant and course of  
  leasehold property equipment construction Total
         
  (All figures in £ millions)
Cost
                
At 31 December 2002
  319   750   20   1,089 
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
  301   753   22   1,076 
Exchange differences  (9)  (27)     (36)
Reclassifications     14   (14)   
Owned by subsidiaries acquired  1   4      5 
Owned by subsidiaries disposed  (4)        (4)
Additions  14   103   10   127 
Disposals  (13)  (44)     (57)
             
At 31 December 2004
  290   803   18   1,111 
             
Depreciation
                
At 31 December 2002
  (104)  (482)     (586)
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
  (102)  (506)     (608)
Exchange differences  4   19      23 
Provided in the year  (16)  (86)     (102)
Owned by subsidiaries acquired     (4)     (4)
Owned by subsidiaries disposed  4         4 
Disposals  6   43      49 
             
At 31 December 2004
  (104)  (534)     (638)
             
Net book value
                
At 31 December 2003  199   247   22   468 
At 31 December 2004
  186   269   18   473 
                         
  2005 2005 2004 2004 2003 2003
  Number of Weighted Number of Weighted Number of Weighted
  share average share average share average
  options exercise options exercise options exercise
  000s price £ 000s price £ 000s price £
             
Outstanding at beginning of year  26,179   5.93   32,284   6.93   35,608   8.84 
Granted during the year  606   5.06   886   4.56   2,309   5.16 
Exercised during the year  (324)  6.78   (254)  10.10   (89)  10.60 
Forfeited during the year  (4,352)  10.42   (6,301)  7.49   (5,053)  16.25 
Expired during the year  (432)     (436)     (491)   
                   
Outstanding at end of year
  21,677   5.05   26,179   5.93   32,284   6.93 
                   
Options exercisable at the end of year
  7,634   7.80   9,071   9.23   9,882   9.44 
                   
      FreeholdOptions were exercised regularly throughout the year. The weighted average share price during the year was £6.52 (2004: £6.25; 2003: £5.72). Early exercises are treated as an acceleration of vesting and leasehold property — Net book value includes freeholdthe remaining charge is recognised at the date of £109m (2003: £120m) and short leases of £77m (2003: £79m).
Capital commitments — The Group had capital commitments for fixed assets, including finance leases, already under contract amounting to £6m at 31 December 2004 (2003: £1m).exercise.

F-30F-49


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Other notesThe options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:
                         
  2005 2005 2004 2004 2003 2003
  Number of Weighted Number of Weighted Number of Weighted
  share average share average share average
Range of exercise prices options contractual options contractual options contractual
£ 000s life years 000s life years 000s life years
             
0 — 5  2,773   2.08   3,251   2.97   2,740   3.66 
5 — 10  5,555   4.48   6,538   5.44   7,797   6.02 
10 — 15  8,237   4.63   9,604   5.57   11,758   6.63 
15 — 20  1,168   3.80   1,469   4.81   2,210   5.78 
20 — 25  930   3.80   1,346   4.92   2,210   6.02 
>25  3,014   4.22   3,971   4.65   5,569   5.79 
                   
   21,677   4.13   26,179   5.00   32,284   5.99 
                   
      In 2005, 2004 and 2003 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.
      The weighted average estimated fair values and the inputs in to the Black-Scholes model are as follows:
             
  2005 2004 2003
  Weighted Weighted Weighted
  average average average
       
Fair value  £2.34   £2.70   £1.82 
          
Weighted average share price  £6.54   £6.58   £5.15 
Weighted average exercise price  £5.08   £4.96   £4.25 
Expected volatility  33.69%  41.95%  48.74%
Expected life  3.6 years   3.8 years   4.0 years 
Risk free rate  4.48%  4.77%  3.84%
Expected dividend yield  2.40%  2.72%  4.55%
Forfeiture rate  20.0%  21.1%  18.7%
          
      The expected volatility is based on the historic volatility of the Company’s share price over the previous 3 — 7 years depending on the vesting term of the options.
      During the year the following shares were granted under restricted share arrangements:
                         
  2005 2005   2004   2003
  Number Weighted 2004 Weighted 2003 Weighted
  of shares average Number average Number average
  000s fair value of shares fair value of shares fair value
    £ 000s £ 000s £
             
Annual Bonus Share Matching Plan  71   5.57   53   5.42   108   4.36 
Long-term Incentive Plan  3,987   5.05   2,413   4.54   1,711   5.21 

F-50


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The net bookfair value of shares awarded under the Annual Bonus Share Matching Plan was determined using a Black-Scholes model. Shares awarded under the Long-Term Incentive Plan were also valued using a Black-Scholes model provided the shares vest unconditionally. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
         
  2005 2004
  Weighted Weighted
  Average Average
     
Fair value  £6.19   £4.54 
       
Weighted average share price  £6.69   £6.13 
Weighted average exercise price      
Expected volatility  32.79%  38.39%
Expected life  3.3 years   3.0 years 
Risk free rate  4.19%  4.59%
Expected dividend yield  2.35%  4.00%
Forfeiture rate  9.9%  4.5%
       
      In 2003, no restricted shares granted were valued using a Black-Scholes model. The fair value of restricted shares that vest conditionally upon the fulfilment of a market condition were valued by an independent actuary using a Monte Carlo model. Shares with a non-market vesting condition were fair valued based on the share price at the date of grant taking into account any future dividend payments. The 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 61% subsidiary of the Group, tangible fixed assets includes £3m (2003: £5m) in respect of assets held under finance leases. Depreciation on these assets charged in 2004 was £2m (2003: £2m).operates the following share-based payment plans:
13JOINT VENTURES2001 Employee Stock Purchase PlanIn 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 PlanUnder 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-base 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 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.
                 
  2004 2003
     
  Valuation Book value Valuation Book value
         
  (All figures in £ millions)
Unlisted joint ventures  7   7   6   6 
             
     
NoteIn addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of IDC. The valuationsawarded shares are available for distribution, at no cost, at the end of unlisted joint venturesa three-year vesting period. No performance criteria are directors’ valuations as at 31 December 2004. If realised at these values there would be an estimated liability for taxation of £nil (2003: £nil). The Group had no capital commitmentsattached to subscribe for further capital or loan stock.shares granted under this plan.
             
  Share   Total
  of equity Reserves net assets
       
  (All figures in £ millions)
Summary of movements
            
At 31 December 2003
  75   (69)  6 
Exchange differences  1      1 
Additions  10   (2)  8 
Dividends (including tax credits) from joint ventures     (1)  (1)
Retained loss for the year     (7)  (7)
          
At 31 December 2004
  86   (79)  7 
          
                         
  2004 2003 2002
       
  Operating Total Operating Total Operating Total
  loss net assets loss net assets loss net assets
             
  (All figures in £ millions)
Business sectors                        
Pearson Education              (1)   
FT Group  (8)  2   (11)  2   (13)  3 
The Penguin Group  1   5   1   4   1   4 
                   
   (7)  7   (10)  6   (13)  7 
                   
Geographical markets supplied and location of net assets
                        
United Kingdom  1   4   1   4   1   4 
Continental Europe  (8)  3   (11)  2   (13)  3 
North America              (1)   
                   
   (7)  7   (10)  6   (13)  7 
                   
             
  2004 2003 2002
       
  (All figures in £ millions)
Reconciliation to retained loss
            
Operating loss of joint ventures  (7)  (10)  (13)
Taxation         
          
Retained loss for the year
  (7)  (10)  (13)
          

F-31F-51


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan is as follows:
14ASSOCIATES
                 
  2004 2003
     
  Valuation Book value Valuation Book value
         
  (All figures in £ millions)
Listed associates  53   9   27   9 
Unlisted associates  175   32   192   49 
             
   228   41   219   58 
             
                                     
    2005     2004     2003  
  2005 Weighted 2005 2004 Weighted 2004 2003 Weighted 2003
  Number average Weighted Number average Weighted Number average Weighted
  of share exercise average of share exercise average of share exercise average
  options price exercise options price exercise options price exercise
  000s $ price £ 000s $ price £ 000s $ price £
                   
Outstanding at beginning of year  9,832   13.46   7.36   9,358   12.15   7.44   8,619   10.43   6.38 
Granted during the year  1,940   21.38   11.80   1,937   17.48   9.56   2,107   16.40   10.04 
Exercised during the year  (1,412)  11.57   6.39   (1,157)  9.59   5.24   (1,195)  7.20   4.41 
Forfeited during the year  (292)  16.86   9.31   (306)  13.32   7.28   (173)  12.36   7.57 
                            
Outstanding at end of year
  10,068   15.16   8.37   9,832   13.46   7.36   9,358   12.15   7.44 
                            
Options exercisable at end of year
  6,052   12.58   6.94   5,321   11.41   6.24   4,259   9.93   6.08 
                            
      The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:
                         
  2005 2005 2004 2004 2003 2003
  Number Weighted Number Weighted Number Weighted
  of share average of share average of share average
Range of exercise prices options contractual options contractual options contractual
$ 000s life years 000s life years 000s life years
             
0 — 4.4  33   4.2   64   4.3   143   6.1 
4.4 — 7.5  206   3.6   287   4.5   499   5.0 
7.5 — 12  2,685   5.3   3,398   6.3   4,117   7.3 
12 — 20  5,243   7.4   6,083   8.4   4,599   8.8 
>20  1,901   9.5             — 
                   
   10,068   5.4   9,832   7.5   9,358   7.9 
                   
      During the year IDC granted the following shares under restricted share arrangements:
                                     
    2005              
  2005 Weighted 2005   2004 2004   2003 2003
  Number average Weighted 2004 Weighted Weighted 2003 Weighted Weighted
  of shares fair value average Number average average Number average average
  000s $ fair value of shares fair value fair value of shares fair value fair value
      £ 000s $ £ 000s $ £
                   
2000 Long-Term Incentive Plan  148   20.57   11.35   69   17.57   9.61   76   16.97   10.39 
2001 Employee Stock Purchase Plan  178   3.68   2.03   124   3.24   1.77   118   2.64   1.62 
Note Principal associates are listed in note 34.      Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant. The valuationsfair value of unlisted associates are directors’ valuations as at 31 December 2004. If realised at these values there would be anthe options granted under the Long-Term Incentive Plan and of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated liability for taxation of £nil (2003: £nil). The Group had no capital commitments to subscribe for further capital or loan stock.using a Black-Scholes model.
                         
  Share         Total
  of equity Loans Reserves Total Goodwill net assets
             
  (All figures in £ millions)
Summary of movements
                        
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 
Exchange differences  (1)     1          
Additions  1         1      1 
Disposals  (24)        (24)     (24)
Retained profit for the year        6   6      6 
                   
At 31 December 2004
  25      16   41      41 
                   

F-32F-52


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
                         
  2004 2003 2002
       
  Operating Total Operating Total Operating Total
  profit net assets profit net assets loss net assets
             
  (All figures in £ millions)
Business sectors
                        
Pearson Education  1   5   1   4   2   8 
FT Group  14   33   7   30   (37)  98 
                   
Continuing operations  15   38   8   34   (35)  106 
Discontinued operations  2   3   2   24   (3)   
                   
   17   41   10   58   (38)  106 
                   
Geographical markets supplied and location of net assets/(liabilities)
                        
United Kingdom  9   19   10   20   11   9 
Continental Europe  1   13   2   39   (1)  92 
North America  4   (1)  (3)  (7)  (45)  (5)
Rest of world  1   7   1   6      10 
                   
Continuing operations  15   38   10   58   (35)  106 
Discontinued operations  2   3         (3)   
                   
   17   41   10   58   (38)  106 
                   
             
  2004 2003 2002
       
  (All figures in £ millions)
Reconciliation to retained profit
            
Operating profit of associates (before goodwill amortisation)  17   17   10 
Interest  1   1    
Profit on sale of subsidiaries        3 
Taxation  (3)  (5)  (4)
Dividends (including tax credits) from unlisted associates  (9)  (8)  (7)
          
Retained profit for the year
  6   5   2 
          
                         
  Long-Term Incentive Plan Employee Stock Purchase Plan
     
  2005 2004 2003 2005 2004 2003
  Weighted Weighted Weighted Weighted Weighted Weighted
  average average average average average average
             
Fair value  $ 5.56   $ 7.50   $ 8.09   $ 3.68   $ 3.24   $ 2.64 
                   
Weighted average share price  $21.38   $17.48   $16.40   $15.46   $14.48   $11.24 
Weighted average exercise price  $21.38   $17.48   $16.40   $15.46   $14.48   $11.24 
Expected volatility  24.50%  32.20%  61.10%  20.00%  20.00%  25.00%
Expected life  4.0  years   4.0  years   4.0  years   0.5  years   0.5  years   0.5  years 
Risk free rate  3.86%  3.45%  2.00%  2.33%  1.03%  1.20%
Expected dividend yield  0.0%  0.0%  0.0%  0.0%  0.0%  0.0%
Forfeiture rate  0.0%  0.0%  0.0%  0.0%  0.0%  0.0%
                   
      The aggregate of the Group’s share in its associates is shown below:
             
  2004 2003 2002
       
  (All figures in £ millions)
Sales
  290   234   141 
Fixed assets  22   24   28 
Current assets  102   116   130 
Liabilities due within one year  (75)  (70)  (76)
Liabilities due after one year or more  (8)  (12)  (8)
          
Net assets
  41   58   74 
          

F-33


NOTES TO THE ACCOUNTS (Continued)
15OTHER FIXED ASSET INVESTMENTS
                 
    2003
  2004 restated
     
  Valuation Book value Valuation Book value
         
  (All figures in £ millions)
Unlisted other fixed asset investments  17   17   21   21 
Note The valuations of unlisted investments are directors’ valuations as at 31 December 2004. If realised at valuation there would be an estimated liability for taxation of £nil (2003: £nil). Other fixed asset investments have been restated for the adoption of UITF 38 (see note 24).
Total
(All figures in
£ millions)
Cost
At 31 December 2002 restated60
Exchange differences(3)
Additions3
Disposals(1)
At 31 December 2003 restated59
Exchange differences(2)
Additions1
Disposals(25)
At 31 December 2004
33
Provision
At 31 December 2002 restated(38)
Provided during the year
At 31 December 2003 restated(38)
Exchange differences1
Provision written back in the year4
Disposals17
At 31 December 2004
(16)
Net book value
At 31 December 2003 restated21
At 31 December 2004
17
16STOCKS
         
  2004 2003
     
  (All figures in £
  millions)
Raw materials  27   24 
Work in progress  36   30 
Finished goods  261   270 
Pre-publication costs  352   359 
       
   676   683 
       

F-34


NOTES TO THE ACCOUNTS (Continued)
Note The replacement cost of stocks is not materially different from book value.
17DEBTORS
         
  2004 2003
     
  (All figures in
  £ millions)
Amounts falling due within one year
        
Trade debtors  785   822 
Associates  1   1 
Joint ventures  1    
Royalty advances  116   110 
Other debtors  53   61 
Prepayments and accrued income  45   38 
       
   1,001   1,032 
       
Amounts falling due after more than one year
        
Royalty advances  70   83 
Other debtors  31   16 
Prepayments and accrued income  1   1 
       
   102   100 
       
   1,103   1,132 
       
18CASH AT BANK AND IN HAND
                 
  2004 2003
     
  Group Company Group Company
         
  (All figures in £ millions)
Cash, bank current accounts and overnight deposits  371      309    
Certificates of deposit and commercial paper  5 ��    8    
Term bank deposits  237   87   244   75 
             
   613   87   561   75 
             
19FINANCIAL INSTRUMENTS
Treasury policyThe 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,

F-35


NOTES TO THE ACCOUNTS (Continued)
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 riskThe 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 2004 that ratio was 61%. A 1% change in the Group’s variable rate US dollar, euro and sterling interest rates would have a £5m effect on profit before tax.
Liquidity and refinancing riskThe 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 2004 the average maturity of gross borrowings was six years and non-banks provided £1,650m (91%) of them (up from 4.9 years and 89% 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. 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 strives to maintain a rating of at least BBB+/ Baa1 over the long term. The Group will also continue to use internally a range of ratios to monitor and manage its finances. These include interest cover, net debt to operating profit, net debt to enterprise value and cash flow to debt measures. The Group also maintains undrawn committed borrowing facilities. At the end of 2004 these amounted to £641m and their weighted average maturity was 4.5 years.
Counterparty riskThe Group’s risk of loss on deposits 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. In addition, for certain longer-dated, higher-value derivative contracts, specifically, a currency swap that transforms a major part of the 6.125% eurobonds due 2007 into a US dollar liability, the Group has entered into mark-to-market agreements whose effect is to reduce significantly the counterparty risk of the relevant transactions.
Currency riskAlthough 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 affected 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 transnational exposure with cash flow instruments. However, the Group does seek to create a “natural hedge” through 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 88%, euro 7% and sterling 5%.
      Short-term debtors and creditors have been excluded from all the following disclosures, other than currency risk disclosures as set out in table e.

F-36


NOTES TO THE ACCOUNTS (Continued)
a.     Maturity of borrowings and other financial liabilities
      The maturity profile of the Group’s borrowings and other financial liabilities is shown below:
                 
  2004 2003
     
  Group Company Group Company
         
  (All figures in £ millions)
Maturity of borrowings
                
Short-term
                
Bank loans and overdrafts  107   139   119   262 
9.5% Sterling Bonds 2004        108    
4.625% Euro Bonds 2004        348   348 
             
Total due within one year, or on demand
  107   139   575   610 
             
Medium and long-term
                
Loans or instalments thereof repayable:                
From one to two years  130      85    
From two to five years  733   541   582   443 
After five years not by instalments  849   640   680   680 
             
Total due after more than one year
  1,712   1,181   1,347   1,123 
             
Total borrowings
  1,819   1,320   1,922   1,733 
             
Note At 31 December 2004 £61m (2003: £85m) of debt, including commercial paper, currently classified from two to five 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.
                         
  2004 2003
     
  Group Group other   Group Group other  
  finance financial Group finance financial Group
  leases liabilities total leases liabilities total
             
  (All figures in £ millions)
Maturity of other financial liabilities
                        
Amounts falling due:                        
In one year or less or on demand  2   4   6   3   5   8 
In more than one year but not more than two years  1   19   20   1   14   15 
In more than two years but not more than five years  1   9   10   1   7   8 
In more than five years     25   25      21   21 
                   
   4   57   61   5   47   52 
                   

F-37


NOTES TO THE ACCOUNTS (Continued)
b.Borrowings by instrument
                 
  2004 2003
     
  Group Company Group Company
         
  (All figures in £ millions)
Unsecured
                
9.5% Sterling Bonds 2004        108    
4.625% Euro Bonds 2004        348   348 
7.375% US Dollar notes 2006  130      139    
6.125% Euro Bonds 2007  390   390   343   343 
10.5% Sterling Bonds 2008  100   100   100   100 
4.7% US Dollar Bonds 2009  181          
7% Global Dollar Bonds 2011  260   260   278   278 
7% Sterling Bonds 2014  226   226   235   235 
5.7% US Dollar Bonds 2014  207          
4.625% US Dollar notes 2018  156   156   167   167 
Bank loans and overdrafts and commercial paper  169   188   204   262 
             
Total borrowings
  1,819   1,320   1,922   1,733 
             
c.Undrawn committed borrowing facilities
         
  2004 2003
     
  (All figures in
  £ millions)
Expiring within one year      
Expiring between one and two years     950 
Expiring in more than two years  641    
       
   641   950 
       
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.
d.Currency and interest rate risk profile
                     
  2004
   
    Fixed rate borrowings
     
      Weighted
    Weighted average
    Total Total average period for
    variable fixed interest which rate is
  Borrowings rate rate rate fixed —
  £m £m £m % years
           
Currency and interest rate risk profile of borrowings
                    
US dollar  1,332   830   502   5.8   2.4 
Sterling  201   91   110   8.9   6.4 
Euro  284   160   124   5.6   1.5 
Other currencies  2   2          
                
   1,819   1,083   736         
                

F-38


NOTES TO THE ACCOUNTS (Continued)
                     
  2003
   
    Fixed rate borrowings
     
      Weighted
    Weighted average
    Total Total average period for
    variable fixed interest which rate is
  Borrowings rate rate rate fixed —
  £m £m £m % years
           
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         
                
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.
             
  2004
   
  Other Total Total
  financial fixed no interest
  liabilities rate paid
       
  (All figures in £ millions)
Currency and interest rate risk profile of other financial liabilities
            
US dollar  40   10   30 
Sterling  8   3   5 
Euro  11      11 
Other currencies  2   1   1 
          
   61   14   47 
          
Note The US dollar fixed rate liability is fixed for 7 years at a rate of 6.3%. The sterling fixed rate liability is fixed for 2 years at a rate of 6.9%. The other currencies fixed rate liability is fixed for 3 years at a rate of 5.0%.
             
  2003
   
  Other Total Total
  financial fixed no interest
  liabilities rate paid
       
  (All figures in £ 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-39


NOTES TO THE ACCOUNTS (Continued)
                     
  2004
   
    Other  
  US dollar Sterling Euro currencies Total
           
  (All figures in £ millions)
Currency and interest rate risk profile of financial assets
                    
Cash at bank and in hand  170   52   72   77   371 
Short-term deposits  7   89   125   21   242 
Other financial assets  33   12   3   1   49 
                
   210   153   200   99   662 
                
Fixed rate  5   3      1   9 
Floating rate  189   140   195   95   619 
No interest received  16   10   5   3   34 
                
   210   153   200   99   662 
                
Note The US dollar fixed rate asset is fixed for 11 years at a rate of 8.2%. The sterling fixed rate asset is fixed for 5 years at a rate of 7.0%. The other currencies fixed rate asset is fixed for 7 years at a rate of 2.0%.
                     
  2003
   
    Other  
  US dollar Sterling Euro currencies Total
           
  (All figures in £ 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 
                
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.
                     
  2004
  Net foreign monetary assets/(liabilities)
   
    Other  
  US dollar Sterling Euro currencies Total
           
  (All figures in £ millions)
Functional currency of entity
                    
US dollar     1      5   6 
Sterling  (6)     9   3   6 
Euro               
Other currencies  20   (1)        19 
                
   14      9   8   31 
                

F-40


NOTES TO THE ACCOUNTS (Continued)
                     
  2003
  Net foreign monetary assets/(liabilities)
   
    Other  
  US dollar Sterling Euro currencies Total
           
  (All figures in £ 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 
                
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:
                 
  2004 2003
     
  Book Fair Book Fair
  value value value value
         
  (All figures in £ millions)
Primary financial instruments held or issued to finance the Group’s operations
                
Other financial assets  49   49   59   59 
Other financial liabilities  (61)  (61)  (52)  (52)
Cash at bank and in hand  371   371   309   309 
Short-term deposits  242   242   252   252 
Short-term borrowings  (107)  (107)  (575)  (619)
Medium and long-term borrowings  (1,712)  (1,817)  (1,347)  (1,553)
             
Derivative financial instruments held to manage the interest rate and currency profile
                
Interest rate swaps     23      (4)
Currency swaps     11      26 
             
Note Other financial assets, other financial liabilities, cash at bank and in hand, short-term deposits and short-term borrowings: 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 valueexpected volatility is based on market values or, where these are not available, on the quoted market priceshistoric volatility of comparable debt issued by other companies. Interest rate swaps:IDC’s share price over the fair value of interest rate swaps is based on market values. At 31 December 2004 the notional principal value of these swaps was £2,824m (2003: £2,394m). Currency swaps: the fair value of these contracts is based on market values. At 31 December 2004 the Group had £368m (2003: £1,096m) of such contracts outstanding.

F-41


NOTES TO THE ACCOUNTS (Continued)
g.Hedges
      The Group’s policy on hedges is explained on page F-35. 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 endvesting term 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
  Unrecognised Unrecognised total net
  gains losses gains/(losses)
       
  (All figures in £ millions)
Gains and losses on hedges at 31 December 2003  82   (60)  22 
Gains and losses arising in previous years that were recognised in 2004  (19)     (19)
          
Gains and losses arising before 31 December 2003 that were not recognised in 2004
  63   (60)  3 
Gains and losses arising in 2004 that were not recognised in 2004  10   21   31 
          
Unrecognised gains and losses on hedges at 31 December 2004
  73   (39)  34 
Of which:            
Gains and losses expected to be recognised in 2005  1   (2)  (1)
          
Gains and losses expected to be recognised in 2006 or later  72   (37)  35 
          
20OTHER CREDITORS
         
  2004 2003
     
  (All figures in
  £ millions)
Amounts falling due within one year
        
Trade creditors  349   407 
Taxation  91   55 
Social security and other taxes  14   4 
Other creditors  75   85 
Accruals and deferred income  512   456 
Obligations under finance leases  2   3 
Dividends  125   119 
       
   1,168   1,129 
       
Amounts falling due after more than one year
        
Other creditors  37   34 
Accruals and deferred income  21   9 
Obligations under finance leases  2   2 
       
   60   45 
       

F-42


NOTES TO THE ACCOUNTS (Continued)
21DEFERRED TAXATION
(All figures in
£ millions)
Summary of movements
At 31 December 2003145
Exchange differences(9)
Transfers41
Net release in the year(12)
At 31 December 2004
165
         
  2004 2003
     
  (All figures in
  £ millions)
Deferred taxation derives from
        
Capital allowances  (31)  (21)
Tax losses carried forward  150   168 
Taxation on unremitted overseas earnings  (2)  (4)
Other timing differences  48   2 
       
   165   145 
       
Deferred taxation not provided
        
Relating to gains subject to roll-over relief     1 
       
Note The Group has calculated deferred tax not provided on rolled over gains in 2004, 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-43


NOTES TO THE ACCOUNTS (Continued)
22PROVISIONS FOR LIABILITIES AND CHARGES
                             
  Post- Deferred   Reorganis-      
  retirement consideration Integration ations Leases Other Total
               
  (All figures in £ millions)
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 
Exchange differences  (7)  (2)  (1)  (1)  (1)     (12)
Arising on acquisitions  1   (3)              (2)
Released     (2)     (1)     (1)  (4)
Provided  68         5      6   79 
Utilised  (72)  (1)  (3)  (8)  (3)  (3)  (90)
                      
At 31 December 2004
  70   21   5   7   10   10   123 
                      
Note
a  Post-retirement provisions are in respect of pensions, £19m (2003: £29m) and post-retirement medical benefits, £51m (2003: £51m).
b  Integration. During the year, £3m 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.
c  Reorganisations. £5m has been provided during the year and £8m utilised mainly in respect of redundancies.
d  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-44


NOTES TO THE ACCOUNTS (Continued)
23SHARE CAPITAL
         
  Number  
  of shares  
  (000’s) £m
     
Ordinary shares of 25p each        
Authorised
        
At 31 December 2003
  1,178,000   295 
       
At 31 December 2004
  1,182,000   296 
       
Called up, allotted and fully paid
        
At 31 December 2002
  801,662   200 
Issued under share option and employee share schemes  726   1 
       
At 31 December 2003
  802,388   201 
Issued under share option and employee share schemes  862    
       
At 31 December 2004
  803,250   201 
       
Note The consideration received in respect of shares issued during the year was £4m (2003: £5m).
                 
    Number   Original
  When of shares   subscription
  granted (000’s) Price (p) exercise period
         
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         
             

F-45


NOTES TO THE ACCOUNTS (Continued)
                 
    Number   Original
  When of shares   subscription
  granted (000’s) Price (p) exercise period
         
Options outstanding at 31 December 2004
                
Worldwide Save for Shares plans  1997   5   530   2004 — 05 
   1998   46   687   2005 — 06 
   1999   118   913 — 926   2004 — 07 
   2000   52   1,277 — 1,481   2005 — 08 
   2001   303   957 — 1,096   2004 — 09 
   2002   474   696   2005 — 10 
   2003   1,978   425 — 426   2006 — 11 
   2004   878   495 — 518   2007 — 12 
             
       3,854         
             
Discretionary share option plans  1995   116   487 — 545   1998 — 05 
   1996   195   584 — 654   1999 — 06 
   1997   943   677 — 758   2000 — 07 
   1998   1,483   847 — 1,090   2001 — 08 
   1999   2,950   1,081 — 1,922   2002 — 09 
   2000   5,432   64 — 3,224   2000 — 10 
   2001   11,206   822 — 1,421   2002 — 11 
             
       22,325         
             
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-46


NOTES TO THE ACCOUNTS (Continued)
24RESERVES
         
  Share Profit
  premium and loss
  account account
     
  (All figures in
  £ millions)
Summary of movements
        
At 31 December 2002 restated  2,465   611 
Exchange differences net of taxation     (254)
Premium on issue of equity shares  4    
Loss retained for the year     (137)
Purchase of own shares     (1)
UITF 17 charge for the year     4 
       
At 31 December 2003 restated
  2,469   223 
       
Analysed as
        
Joint ventures and associates      (60)
Group excluding joint ventures and associates      283 
       
Summary of movements
        
At 31 December 2003 restated  2,469   223 
Exchange differences net of taxation     (176)
Premium on issue of equity shares  4    
Loss retained for the year     (113)
Purchase of own shares     (10)
UITF 17 charge for the year     5 
       
At 31 December 2004
  2,473   (71)
       
Analysed as
        
Joint ventures and associates      (63)
Group excluding joint ventures and associates      (8)
       
Note Cumulative goodwill relating to acquisitions made prior to 1998, which was deducted from reserves, amounts to £915m (2003: £961m). Included in exchange differences are exchange gains of £nil (2003: £74m) arising on borrowings denominated in, or swapped into, foreign currencies designated as hedges of net investments overseas.
Prior year adjustment
      UITF Abstract 38 ‘Accounting for ESOP trusts’ and the revision of UITF Abstract 17 ‘Employee share schemes’ were issued on 15 December 2003 and these revisions have been applied for the first time in 2004. Under UITF 38 own shares held in treasury or through an ESOP trust are recorded at cost and shown as a deduction in arriving at shareholders’ funds. Previously these shares were recorded at cost less provision for impairment and shown as a fixed asset investment with impairment charges being taken to the profit and loss account. Under the revised UITF 17, employee share scheme charges to the profit and loss account are now always calculated as the intrinsic value of the award and spread over the performance period. The intrinsic value is the difference between the fair value of shares at the date of grant and the amount paid by the employee to exercise the rights to those shares irrespective of the cost of shares purchased to fund the award.

F-47


NOTES TO THE ACCOUNTS (Continued)
      The reclassification of own shares from fixed asset investments to equity has reduced net assets by £59m at 31 December 2003 (1 January 2003: £62m). The reversal of prior year impairments taken on the cost of shares held in trust (£37m) has been shown as a prior year adjustment in the statement of total recognised gains and losses. The amendment to UITF 17 in respect of the calculation of share scheme charges has had no material effect on the profit and loss account.
      Included within own shares are shares held by the Pearson Employee Share Trust and Pearson plc Employee Share Ownership Trusts. Together they hold 6.9 million (2003: 7.5 million) Pearson plc ordinary shares which had a market value of £43m at 31 December 2004 (2003: £46m). 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 £2m (2003: £2m).
      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 Group has made use of the exemption under UITF 17 not to recognise any compensation charge in respect of these options.

F-48


NOTES TO THE ACCOUNTS (Continued)
25ACQUISITIONS
      All acquisitions have been consolidated applying acquisition accounting principles.
a.Acquisition of subsidiariesShare capital and share premium
         
  2004 2003
     
  (All figures in
  £ millions)
Tangible fixed assets  1   10 
Stocks  2    
Debtors  3   32 
Creditors  (2)  (95)
Provisions  1   (4)
Deferred taxation     (15)
Net cash and short-term deposits acquired     34 
       
   5   (38)
Equity minority interests  (7)  (8)
       
Net liabilities acquired at fair value  (2)  (46)
       
Fair value of consideration
        
Cash  (33)  (87)
Deferred cash consideration     (24)
Costs provided for  (1)   
Net prior year adjustments  3    
       
Total consideration  (31)  (111)
       
Goodwill arising
  33   157 
       
Acquisition fair values
        
Book value of net liabilities acquired  (3)  (32)
Fair value adjustments  1   (14)
       
Fair value to the Group
  (2)  (46)
       
             
  Number of Ordinary Share
  shares shares premium
  (thousands) £m £m
       
At 1 January 2003  801,662   200   2,465 
Issue of shares — share option schemes  726   1   4 
          
At 31 December 2003
  802,388   201   2,469 
Issue of shares — share option schemes  862      4 
          
At 31 December 2004
  803,250   201   2,473 
Issue of shares — share option schemes  770      4 
          
At 31 December 2005
  804,020   201   2,477 
          
Note      The fairtotal authorised number of ordinary shares is 1,186 million shares (2004: 1,182 million shares; 2003: 1,178 million shares) with a par value adjustments above relate to acquisitions made in both 2003 and 2004. They include adjustments to provisions and accruals and an adjustment to a pension scheme liability. The fair value adjustments relating to 2004 acquisitionsof 25 pence per share (2004: 25p per share;2003:25p per share). All issued shares are provisional and will be finalised in the 2005 financial statements.fully paid.
b.Cash flow from acquisitions
             
  2004 2003 2002
       
  (All figures in £ millions)
Cash — current year acquisitions  33   87   74 
Deferred payments for prior year acquisitions and other items  2   7   13 
          
Net cash outflow
  35   94   87 
          

F-49F-53


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
26DISPOSALS
a.Disposal of subsidiariesOther reserves
             
  2004 2003 2002
       
  (All figures in £ millions)
Intangible fixed assets     (4)  (41)
Tangible fixed assets     (3)   
Stocks     (2)  (3)
Debtors  (4)  (9)  (2)
Creditors     10   (3)
Provisions        1 
Net overdraft/(cash)  1   1   (1)
Equity minority interest        3 
          
Net assets disposed of  (3)  (7)  (46)
Proceeds received  2   1   11 
Deferred consideration     2    
Costs  (2)  (1)  (7)
Net prior year adjustments     1   (3)
          
Loss on sale
  (3)  (4)  (45)
          
                     
        Total  
  Treasury Translation Fair value other Retained
  shares reserve reserve reserves earnings
           
  (All figures in £ millions)
At 1 January 2003  (121)        (121)  644 
Net exchange differences on translation of foreign operations     (288)     (288)   
Purchase of treasury shares  (1)        (1)   
Profit for the year attributable to equity holders of the parent              252 
Dividends paid              (188)
Equity settled transactions              29 
Actuarial gains and losses on defined benefit schemes              (28)
Taxation on items taken directly to equity               
                
At 31 December 2003
  (122)  (288)     (410)  709 
                
Net exchange differences on translation of foreign operations     (203)     (203)   
Purchase of treasury shares  (10)        (10)   
Profit for the year attributable to equity holders of the parent              262 
Dividends paid              (195)
Equity settled transactions              25 
Actuarial gains and losses on defined benefit schemes              (61)
Taxation on items taken directly to equity              9 
                
At 31 December 2004
  (132)  (491)     (623)  749 
                
Net exchange differences on translation of foreign operations     327      327    
Cumulative translation adjustment disposed     (14)     (14)   
Purchase of treasury shares  (21)        (21)   
Profit for the year attributable to equity holders of the parent              624 
Dividends paid              (205)
Equity settled transactions              23 
Actuarial gains and losses on defined benefit schemes              26 
Taxation on items taken directly to equity              12 
Transition adjustment on adoption of IAS 39 (note 34)     3      3   (15)
                
At 31 December 2005
  (153)  (175)     (328)  1,214 
                
      The translation reserve includes 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.
b.Cash flow from disposals
             
  2004 2003 2002
       
  (All figures in £ millions)
Cash — current year disposals  2   1   11 
Costs paid  (2)  (2)  (3)
Deferred receipts and payments from prior year disposals and other amounts     (3)  (5)
          
Net cash (outflow)/inflow
     (4)  3 
          

F-50F-54


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
27NOTES TO CONSOLIDATED CASH FLOW STATEMENTBusiness combinations
                                     
  2004 2003 restated 2002 restated
       
  Continuing Discontinued Total Continuing Discontinued Total Continuing Discontinued Total
                   
  (All figures in £ millions)
a. Reconciliation of operating profit to net cash inflow from operating activities
                                    
Total operating profit  218   13   231   204   22   226   130   13   143 
Share of operating profit of joint ventures and associates  (8)  (2)  (10)  2   (2)     50   1   51 
Depreciation  95   7   102   104   7   111   114   8   122 
Goodwill amortisation and impairment  215   9   224   251   6   257   278   14   292 
(Increase)/decrease in stocks  (26)  (1)  (27)  (8)     (8)  41   2   43 
Increase in debtors  (10)  (5)  (15)  (93)  (3)  (96)  (111)     (111)
Increase/(decrease) in creditors  47   3   50   (71)  3   (68)  57   7   64 
Decrease in operating provisions  (15)     (15)  (20)     (20)  (50)     (50)
Other and non-cash items  (10)     (10)  (44)  1   (43)  (29)  4   (25)
                            
Net cash inflow from operating activities
  506   24   530   325   34   359   480   49   529 
                            
                                 
          Debt due Debt due    
        Short-term within after Finance  
  Cash Overdrafts Sub-total deposits one year one year leases Total
                 
  (All figures in £ millions)
b. Analysis of net debt
                                
At 31 December 2003
  309   (23)  286   252   (552)  (1,347)  (5)  (1,366)
Exchange differences  (5)  2   (3)  (9)  37   50      75 
Other non-cash items                    (1)  (1)
Net cash flow  67   (37)  30   (1)  466   (415)  2   82 
                         
At 31 December 2004
  371   (58)  313   242   (49)  (1,712)  (4)  (1,210)
                         
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)
                         
     
Note Finance leases are included withinOn 22 July 2005 the Group acquired 100% of the voting rights of AGS Publishing, an educational assessments and curriculum materials publisher. In addition, several other creditorsbusinesses were acquired in the balance sheet (see note 20).current and prior years, none of which were individually material to the Group.
      The assets and liabilities arising from acquisitions in each of the years are as follows:
                             
  2005    
    2004 2003
  AGS AGS AGS Other Total Total Total
  carrying fair value fair fair fair fair fair
  amount adjs value value value value value
               
  (All figures in £ millions)
Tangible fixed assets  1      1   6   7   1   10 
Intangible assets     58   58   31   89   15   44 
Intangible assets — pre-publication  15      15      15       — 
Inventory  3      3   7   10   2    
Receivables  7      7   25   32   3   32 
Payables  (5)  (1)  (6)  (36)  (42)  (4)  (95)
Provisions  (2)     (2)  (1)  (3)  1   (4)
Deferred taxation     (20)  (20)  (1)  (21)     (15)
Cash and cash equivalents  (1)     (1)  4   3      34 
Equity minority interests           8   8   (3)  (8)
                      
Net assets/(liabilities) acquired at fair value
  18   37   55   43   98   15   (2)
                      
Goodwill
  105      105   50   155   22   113 
                      
Total
          160   93   253   37   111 
                      
Satisfied by:
                            
Cash          (160)  (89)  (249)  (39)  (87)
Deferred cash consideration             (5)  (5)     (24)
Costs provided for             1   1   (1)   
Net prior year adjustments                   3    
                      
Total consideration
          (160)  (93)  (253)  (37)  (111)
                      
Book value of net assets/(liabilities acquired)          18   40   58   4   (32)
Fair value adjustments          37   3   40   1   30 
                      
Fair value to the Group
          55   43   98   5   (2)
                      
      The fair value adjustments relating to the acquisition of AGS are provisional and will be finalised during 2006. They include the valuation of intangible assets, the related deferred tax effect and recognition of provisions. Adjustments to 2004 provisional fair values largely relate to the acquisition of Dominie Press.
      Net cash outflow on acquisition:
             
  2005 2004 2003
       
  (All figures in £ millions)
Cash — current year acquisitions  (249)  (39)  (87)
Deferred payments for prior year acquisitions and other items     (2)  (7)
Cash and cash equivalents acquired  3      34 
          
Cash outflow on acquisition
  (246)  (41)  (60)
          

F-51F-55


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  2004 2003 2002
       
  (All figures in £ millions)
c. Reconciliation of net cash flow to movement in net debt
            
Increase/(decrease) in cash in the year  30   (91)  111 
(Increase)/decrease in net debt from management of liquid resources  (1)  85   43 
Decrease/(increase) in net debt from other borrowings  51   (63)  664 
Decrease in finance leases  2   3   5 
Acquired with subsidiary        24 
Other non-cash items  (1)  (2)  (1)
Exchange differences  75   117   132 
          
Movement in net debt in the year  156   49   978 
Net debt at beginning of the year  (1,366)  (1,415)  (2,393)
          
Net debt at end of the year
  (1,210)  (1,366)  (1,415)
          
      The goodwill arising on the acquisition of AGS is attributable to the profitability of the acquired business and the significant synergies expected to arise.
      AGS contributed £21m of sales and £6m to the Group’s profit before tax between the date of acquisition and the balance sheet date. Other businesses acquired contributed £1m to the Group’s profit before tax between the date of acquisition and the balance sheet date.
      If the acquisitions had been completed on 1 January 2005, total Group sales for the period would have been £4,168m, and profit before tax would have been £474m.
28CONTINGENT LIABILITIESDisposals
      In April 2005 the Group disposed of its 79% interest in Recoletos Grupo de Communicación S.A.
                     
  2005    
    2004 2003
  Recoletos Other Total Total Total
           
  (All figures in £ millions)
Disposal of subsidiaries
                    
Property, plant and equipment  (48)     (48)     (3)
Other financial assets  (2)     (2)      — 
Associates  (3)     (3)      — 
Inventory  (4)     (4)     (2)
Receivables  (59)     (59)  (4)  (9)
Payables  68   3   71   2   10 
Provisions  2   1   3       — 
Deferred taxation  8      8       — 
Net (cash and cash equivalents)/borrowings  (132)  (2)  (134)  1   1 
Equity minority interests  60   (6)  54   (4)   
Attributable goodwill  (98)  (6)  (104)  (4)  (4)
Currency translation adjustment  14      14       — 
                
Net assets disposed of
  (194)  (10)  (204)  (9)  (7)
                
Proceeds received  503   10   513   8   1 
Costs  (3)     (3)  (2)  (1)
Deferred consideration              2 
Net prior year adjustments              1 
                
Profit/(loss) on sale
  306      306   (3)  (4)
                
             
  2005 2004 2003
       
Cash flow from disposals
            
Cash — current year disposals  513   8   1 
Costs paid  (3)  (2)  (2)
Deferred receipts and payments from prior year disposals and other amounts        (3)
Cash and cash equivalents/net debt disposed of  (134)  1   1 
          
Net cash outflow
  376   7   (3)
          

F-56


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
29Cash generated from operations
             
  2005 2004 2003
       
  (All figures in £ millions)
Net profit  644   284   275 
Adjustments for:
            
Tax  125   70   84 
Depreciation  80   84   85 
Amortisation of purchased intangible assets  11   5   4 
Amortisation of other intangible assets  18   20   28 
Amortisation of pre-publication investment  192   168   158 
Loss on sale of property, plant and equipment     4   2 
(Profit)/loss on sale of other financial assets     (16)  1 
Net finance costs  70   76   90 
Share of results of joint ventures and associates  (14)  (10)  (4)
(Profit)/loss on sale of subsidiaries and associates  (346)  3   (8)
Net foreign exchange losses/(gains) from transactions  39   (15)  (51)
Share-based payments  23   25   29 
Inventories  (17)  (12)  10 
Trade and other receivables  (4)  (18)  (92)
Trade and other payables  71   61   (50)
Provisions  (17)  (24)  (30)
          
Cash generated from operations
  875   705   531 
          
      In the cash flow statement, proceeds from sale of property, plant and equipment comprise:
             
  2005 2004 2003
       
  (All figures in
  £ millions)
Net book amount  3   8   10 
Loss on sale of property, plant and equipment     (4)  (2)
          
Proceeds from sale of property, plant and equipment
  3   4   8 
          
Non-cash transactions
            
The principal non-cash transactions are movements in finance lease obligations     (1)  (1)
          
30Contingencies
      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 areis expected to result in a material gain or loss to the Group.

F-57


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
29COMMITMENTS UNDER LEASES
31     Commitments
Capital commitments
      At 31 December 2004Capital expenditure contracted for at the balance sheet date but not yet incurred is as follows:
             
  2005 2004 2003
       
  (All figures in
  £ millions)
Property, plant and equipment  1   6   1 
          
      The Group had commitmentsleases various offices and warehouses under non-cancellable operating lease agreements. The leases other than financehave 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 makethe income statement during the year is disclosed in note 5.
      The future aggregate minimum lease payments in 2005respect of operating leases are as follows:
         
  Land and  
  buildings Other
     
  (All figures in
  £ millions)
For leases expiring
        
In 2005  7   4 
Between 2006 and 2009  22   15 
Thereafter  67    
       
   96   19 
       
             
  2005 2004 2003
       
  (All figures in £ millions)
Not later than one year  129   117   123 
Later than one year and not later than five years  397   353   375 
Later than five years  869   584   529 
          
   1,395   1,054   1,027 
          
32     Related party transactions
30RELATED PARTIES
     Joint ventures and associates — Loans and equityAmounts advanced to joint ventures and associates during the year and at the balance sheet date are shownset out in notes 13 and 14.note 13. Amounts falling due from joint ventures and associates are set out in note 17. Dividends receivable from joint ventures19.
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 associates are set outcontrolling the activities of the Group. Key management personnel compensation is disclosed in notes 13 and 14.the directors’ remuneration report.
      There were no other material related party transactionstransactions.
      No guarantees have been provided to related parties.
33     Events after the balance sheet date
      On 9 January 2006 Pearson announced the purchase of 1,130,739 shares in 2004.Interactive Data Corporation (IDC) for $21.67 per share in cash. This purchase brings Pearson’s total holding in IDC to almost 62%. On 23 January 2006 Pearson announced the acquisition of Promissor, a leading professional testing business from Houghton Mifflin Company for $42m in cash. On April 25, 2006 Pearson announced the acquisition of National Evaluation Systems, Inc, a leading teacher certification testing company in the US. On May 5, 2006 Pearson announced the acquisition of an 80% stake in Paravia Bruno Mondadori, one of Italy’s leading educational publishing companies.
34     Explanation of transition to IFRS
      These are the Group’s first consolidated financial statements prepared in accordance with IFRS as adopted by the EU.
      The accounting policies set out in note 1 have been applied in preparing the financial statements for the year ended 31 December 2005, the comparative information presented in these financial statements for the

F-58


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
years ended 31 December 2004 and 31 December 2003 and the preparation of an opening IFRS balance sheet at 1 January 2003 (the Group’s date of transition). IAS 39 ‘Financial Instruments: Recognition and Measurement’ and IAS 32 ‘Financial Instruments: Disclosure and Presentation’ have not been applied to the comparative periods because the Group has taken a transitional exemption and adopted those standards prospectively from 1 January 2005. The effect of the transitional adjustment on the balance sheet as at 1 January 2005 is set out in the tables below.
      In preparing its opening IFRS balance sheet, the Group has made adjustments to amounts previously reported in its financial statements under UK GAAP. An explanation of how the transition from previous UK GAAP to IFRS has affected the Group’s financial position and cash flows is set out in the tables and notes below. These adjustments include some reclassifications of items within the income statement and within the balance sheet in accordance with IFRS disclosure requirements.

F-59


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Balance sheet as at 1 January 2003 (date of transition)
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Assets
Non-current assets
            
Property, plant and equipment  503   (68)  435 
Intangible assets  3,610   71   3,681 
Investments in joint ventures and associates  113   (7)  106 
Deferred income tax assets     374   374 
Other financial assets  22      22 
Other receivables     74   74 
          
   4,248   444   4,692 
          
Current assets
            
Intangible assets — pre-publication     380   380 
Inventories  734   (380)  354 
Trade and other receivables  1,059   (79)  980 
Deferred income tax assets  174   (174)   
Cash and cash equivalents  575   (10)  565 
          
   2,542   (263)  2,279 
          
Total assets
  6,790   181   6,971 
          
 
Liabilities
Non-current liabilities
            
Financial liabilities — Borrowings  (1,734)  (2)  (1,736)
Deferred income tax liabilities     (119)  (119)
Retirement benefit obligations     (351)  (351)
Provisions for other liabilities and charges  (165)  120   (45)
Other liabilities  (60)  (10)  (70)
          
   (1,959)  (362)  (2,321)
          
Current liabilities
            
Trade and other liabilities  (1,114)  178   (936)
Financial liabilities — Borrowings  (249)  (3)  (252)
Current income tax liabilities     (52)  (52)
Provisions for other liabilities and charges     (34)  (34)
          
   (1,363)  89   (1,274)
Total liabilities
  (3,322)  (273)  (3,595)
          
Net assets
  3,468   (92)  3,376 
          
Equity
            
Share capital  200      200 
Share premium  2,465      2,465 
Other reserves  (121)     (121)
Retained earnings  732   (88)  644 
          
Total equity attributable to equity holders of the Company
  3,276   (88)  3,188 
Minority interest  192   (4)  188 
          
Total equity
  3,468   (92)  3,376 
          

F-60


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Balance sheet as at 31 December 2003
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Assets
Non-current assets
            
Property, plant and equipment  468   (66)  402 
Intangible assets  3,260   290   3,550 
Investments in joint ventures and associates  64      64 
Deferred income tax assets     342   342 
Other financial assets  21      21 
Other receivables     100   100 
          
   3,813   666   4,479 
          
Current assets
            
Intangible assets — pre-publication     362   362 
Inventories  683   (364)  319 
Trade and other receivables  1,134   (109)  1,025 
Deferred income tax assets  145   (145)   
Cash and cash equivalents  561   (10)  551 
          
   2,523   (266)  2,257 
          
Total assets
  6,336   400   6,736 
          
 
Liabilities
Non-current liabilities
            
Financial liabilities — Borrowings  (1,347)  (2)  (1,349)
Deferred income tax liabilities     (140)  (140)
Retirement benefit obligations     (364)  (364)
Provisions for other liabilities and charges  (152)  93   (59)
Other liabilities  (45)  (25)  (70)
          
   (1,544)  (438)  (1,982)
          
Current liabilities
            
Trade and other liabilities  (1,129)  186   (943)
Financial liabilities — Borrowings  (575)  (3)  (578)
Current income tax liabilities     (54)  (54)
Provisions for other liabilities and charges     (18)  (18)
          
   (1,704)  111   (1,593)
Total liabilities
  (3,248)  (327)  (3,575)
          
Net assets
  3,088   73   3,161 
          
Equity
            
Share capital  201      201 
Share premium  2,469      2,469 
Other reserves  (122)  (288)  (410)
Retained earnings  345   364   709 
          
Total equity attributable to equity holders of the Company
  2,893   76   2,969 
Minority interest  195   (3)  192 
          
Total equity
  3,088   73   3,161 
          

F-61


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Balance sheet as at 31 December 2004
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Assets
Non-current assets
            
Property, plant and equipment  473   (118)  355 
Intangible assets  2,890   388   3,278 
Investments in joint ventures and associates  48   (1)  47 
Deferred income tax assets     359   359 
Other financial assets  17   (2)  15 
Other receivables     102   102 
          
   3,428   728   4,156 
          
Current assets
            
Intangible assets — pre-publication     356   356 
Inventories  676   (362)  314 
Trade and other receivables  1,104   (171)  933 
Deferred income tax assets  165   (165)   
Cash and cash equivalents  613   (152)  461 
          
   2,558   (494)  2,064 
Non-current assets classified as held for sale     358   358 
          
   2,558   (136)  2,422 
          
Total assets
  5,986   592   6,578 
          
 
Liabilities
Non-current liabilities
            
Financial liabilities — Borrowings  (1,712)  (2)  (1,714)
Deferred income tax liabilities     (139)  (139)
Retirement benefit obligations     (408)  (408)
Provisions for other liabilities and charges  (123)  80   (43)
Other liabilities  (60)  (39)  (99)
          
   (1,895)  (508)  (2,403)
          
Current liabilities
            
Trade and other liabilities  (1,168)  300   (868)
Financial liabilities — Borrowings  (107)  (2)  (109)
Current income tax liabilities     (89)  (89)
Provisions for other liabilities and charges     (14)  (14)
          
   (1,275)  195   (1,080)
Liabilities directly associated with non-current assets classified as held for sale     (81)  (81)
          
Total liabilities
  (3,170)  (394)  (3,564)
          
Net assets
  2,816   198   3,014 
          
Equity
            
Share capital  201      201 
Share premium  2,473      2,473 
Other reserves  (132)  (491)  (623)
Retained earnings  61   688   749 
          
Total equity attributable to equity holders of the Company
  2,603   197   2,800 
Minority interest  213   1   214 
          
Total equity
  2,816   198   3,014 
          

F-62


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Adjustments to equity
                 
  Notes 1 Jan 2003 31 Dec 2003 31 Dec 2004
         
    (All figures in £ millions)
Total equity UK GAAP
      3,468   3,088   2,816 
Goodwill amortisation  a   66   228   394 
Intangible assets acquired  b      40   48 
Intangible assets — capitalised software costs  c   3       
Intangible assets — pre-publication expenditure  d          
Share-based payments  e   13   15   22 
Employee benefits  f   (259)  (284)  (338)
Leases  g   (12)  (22)  (33)
Joint ventures  h   (3)  (5)  (6)
Associates  i   (10)  (10)  (8)
Income taxes  j   (3)  (5)  (7)
Dividends  k   115   119   125 
Other      (2)  (3)  1 
Discontinued operations  l          
             
Total adjustments to equity
      (92)  73   198 
             
Total equity IFRS
      3,376   3,161   3,014 
             
Income statement for the year to 31 December 2003
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Continuing operations
            
Sales  4,048   (198)  3,850 
Cost of goods sold  (1,910)  64   (1,846)
          
Gross profit
  2,138   (134)  2,004 
Operating expenses  (1,912)  318   (1,594)
Other net gains and losses  6   (12)  (6)
Share of results of joint ventures and associates     2   2 
          
Operating profit
  232   174   406 
Net finance costs  (80)  (13)  (93)
          
Profit before tax
  152   161   313 
Income tax  (75)  14   (61)
          
Profit for the year from continuing operations
  77   175   252 
Profit for the year from discontinued operations     23   23 
          
Profit for the year
  77   198   275 
          

F-63


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Income statement for the year to 31 December 2004
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Continuing operations
            
Sales  3,919   (223)  3,696 
Cost of goods sold  (1,866)  77   (1,789)
          
Gross profit
  2,053   (146)  1,907 
Operating expenses  (1,832)  312   (1,520)
Other net gains and losses  9      9 
Share of results of joint ventures and associates  10   (2)  8 
          
Operating profit
  240   164   404 
Net finance costs  (69)  (10)  (79)
          
Profit before tax
  171   154   325 
Income tax  (62)  (1)  (63)
          
Profit for the year from continuing operations
  109   153   262 
Profit for the year from discontinued operations     22   22 
          
Profit for the year
  109   175   284 
          
Adjustments to profit
             
  Notes 2003 2004
       
    (All figures in £
    millions)
Profit for the year UK GAAP
      77   109 
          
Goodwill amortisation  a   242   204 
Intangible assets acquired  b   (4)  (5)
Intangible assets — capitalised software costs  c   (1)  (1)
Intangible assets — pre-publication expenditure  d       
Share-based payments  e   (23)  (16)
Employee benefits  f   1   6 
Leases  g   (10)  (12)
Joint ventures  h   (2)  (2)
Associates  i   (2)  (2)
Income taxes  j   (2)  (2)
Other      (1)  5 
Discontinued operations  l       
          
Total adjustments to profit for the year
      198   175 
          
Profit for the year IFRS
      275   284 
          

F-64


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Cash flow for the year to 31 December 2003
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Cash flows from operating activities  228   172   400 
Cash flows from investing activities  (91)  (172)  (263)
Cash flows from financing activities  (228)  86   (142)
Effects of exchange rate changes on cash and cash equivalents  37   8   45 
          
Net (decrease)/increase in cash and cash equivalents
  (54)  94   40 
          
Cash and cash equivalents at beginning of year  340   148   488 
Cash and cash equivalents at end of year
  286   242   528 
          
Cash flow for the year to 31 December 2004
             
  UK GAAP Adjs IFRS
       
  (All figures in £ millions)
Cash flows from operating activities  387   175   562 
Cash flows from investing activities  (102)  (179)  (281)
Cash flows from financing activities  (255)  (6)  (261)
Effects of exchange rate changes on cash and cash equivalents  (3)  (1)  (4)
          
Net increase/(decrease) in cash and cash equivalents
  27   (11)  16 
          
Cash and cash equivalents at beginning of year  286   242   528 
Cash and cash equivalents at end of year
  313   231   544 
          
Effect of IAS 32 and IAS 39 transitional adjustment (note 1m)
             
  31 Dec 2004 Adj 1 Jan 2005
       
  (All figures in £ millions)
Non-current assets
            
Deferred income tax assets  359   5   364 
Financial assets — Derivative financial instruments     145   145 
          
Current assets
            
Financial assets — Derivative financial instruments     1   1 
          
Non-current liabilities
            
Financial liabilities — Borrowings  (1,714)  (134)  (1,848)
Financial liabilities — Derivative financial instruments     (40)  (40)
          
Current liabilities
            
Trade and other liabilities  (868)  14   (854)
Financial liabilities — Borrowings  (109)     (109)
Financial liabilities — Derivative financial instruments     (3)  (3)
          
Reserves
  (126)  12   (114)
          
First-time adoption exemptions applied
      IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ sets out the transition rules which must be applied when IFRS is adopted for the first time in reporting IFRS financial information. In

F-65


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
general the Group is required to select accounting policies in accordance with IFRS valid at its first IFRS reporting date and apply those polices retrospectively. The standard sets out certain mandatory exceptions to retrospective application and certain optional exemptions. The most significant optional exemptions adopted by the Group are set out below:
311POST BALANCE SHEET EVENTSBusiness combinations
      In December 2004, Pearson announced its intentionThe Group has elected not to disposeapply IFRS 3 ‘Business Combinations’ retrospectively to business combinations that occurred before the date of its 79% interest in Recoletos Grupo de Comunicaciòn, S.A.transition. Subject to Retos Cartera, a consortiumthe transition adjustments to IFRS required by IFRS 1, the accounting for business combinations before the date of investors, as parttransition is grandfathered at the date of a tender offer for all of Recoletos. The transaction was approved bytransition from the Spanish regulatory authorities in February 2005 and will close in the early part of 2005. In January 2005 Pearson sold its 22% stake in MarketWatch to Dow Jones & Co for $101m.

F-52


NOTES TO THE ACCOUNTS (Continued)UK GAAP financial statements.
322COMPANY BALANCE SHEET AS AT 31 DECEMBER 2004Employee benefits
             
      2003
  Note 2004 restated
       
    (All figures in
    £ millions)
Fixed assets
            
Investments: subsidiaries  33   7,134   6,343 
          
       7,134   6,343 
          
Current assets
            
Debtors:            
Amounts due from subsidiaries — due within one year      674   1,394 
Amounts due from subsidiaries — due after more than one year      288   944 
Taxation      66   3 
Other debtors          
Cash at bank and in hand  18   87   75 
          
       1,115   2,416 
          
Creditors — amounts falling due within one year
            
Short-term borrowing  19   (139)  (610)
Amounts due to subsidiaries      (1,815)  (2,860)
Other creditors      (2)  (1)
Accruals and deferred income      (11)  (16)
Dividends  8   (125)  (119)
          
       (2,092)  (3,606)
          
Net current liabilities
      (977)  (1,190)
          
Total assets less current liabilities
      6,157   5,153 
          
Creditors — amounts falling due after more than one year
            
Medium and long-term borrowing  19   (1,181)  (1,123)
Amounts due to subsidiaries      (440)  (234)
Provisions for liabilities and charges      (4)  (2)
          
       (1,625)  (1,359)
          
Net assets
      4,532   3,794 
          
Capital and reserves
            
Called up share capital  23   201   201 
Share premium account  33   2,473   2,469 
Special reserve  33   397   397 
Other reserves  33   26   17 
Profit and loss account  33   1,435   710 
          
Equity shareholders’ funds
      4,532   3,794 
          
The 2003 comparatives      All cumulative actuarial gains and losses have been restatedrecognised in full in the period in which they occur in the statement of recognised income and expense in accordance with IAS 19 ‘Employee Benefits’ (as amended on 16 December 2004).
3Share-based payments
      The Group has elected to apply IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the date of transition. Consequently the share-based payment charge from 2003 represents the charge for all options granted and not fully vested at 31 December 2002.
4Financial instruments
      The Group has elected to apply IAS 39 ‘Financial Instruments: Recognition and Measurement’ and IAS 32 ‘Financial Instruments: Disclosure and Presentation’ from 1 January 2005. After this date, where hedge accounting cannot be applied under IAS 39, changes in the adoptionmarket value of UITF38 (see note 24).
Thefinancial instruments will be taken to the income statement. No adjustment to the 2003 or 2004 UK GAAP financial statements was required due to the chosen adoption date of IAS 32 and IAS 39.
5Cumulative translation differences
      The Group has deemed the cumulative translation differences for foreign operations to be zero at the date of transition. Any gains and losses on disposals of foreign operations will exclude translation differences arising prior to the transition date.
Significant adjustments
a. Goodwill amortisation — IFRS 3 ‘Business Combinations’ requires that goodwill is not amortised but instead is subject to an impairment review annually or when there are indications that the carrying value may not be recoverable. The Group has elected not to apply IFRS 3 retrospectively to business combinations before the date of transition.
b. Intangible assets acquired — Business combinations since the date of transition have been accounted for in accordance with IFRS 3 ‘Business Combinations’, with intangible assets recognised and amortised over their useful economic lives where they are separable or arise from a contractual or legal right. As part of the acquisition of Comstock Inc in February 2003, certain intangible assets were approved byacquired, mainly relating to customer lists and acquired technology, which are being amortised over periods between two and 30 years. In addition, other less significant intangible assets, mainly relating to publishing rights, have been recognised for some of the boardsmaller acquisitions made during 2004 and amortised over periods of directors on 27 February 2005 and signed on its behalf byup to 15 years.
Dennis Stevenson, Chairman                                         Rona Fairhead, Chief Financial Officerc. Capitalised software costs — Under IAS 38 ‘Intangible Assets’ computer software which is not integral to a related item of hardware should be classified as an intangible asset. As such, certain computer

F-53F-66


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
33     NOTES TO THE COMPANY BALANCE SHEETsoftware costs have been re-classified from property, plant and equipment to intangible assets. In addition, certain costs relating to software development, previously expensed under UK GAAP, have been capitalised under IAS 38 and are being amortised over their estimated useful lives.
(All figures in
£ millions)
Investment in subsidiaries
At 31 December 2002
6,422
External acquisition15
Disposal to subsidiary(22)
Provision for diminution in value(33)
Revaluations(39)
At 31 December 2003
6,343
Subscription for share capital in subsidiary915
Provision for diminution in value(100)
Revaluations(24)
At 31 December 2004
7,134
     
d. Pre-publication expenditure — Under IAS 38 ‘Intangible Assets’, intangible assets are required to be recognized if they meet the criteria of identifiability, control over a resource and existence or probability of inflow of future economic benefits. As such pre-publication costs (the direct costs incurred in the development of educational programmes and titles prior to their publication) have been re-classified from inventory to intangible assets. They continue to be amortised upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years.
Notee. Share-based payments Shares are stated— IFRS 2 ‘Share-based Payment’ requires that the expense incurred for equity instruments granted is recognised in the financial statements at cost less provisions for diminution intheir fair value or directors’ valuations.
                     
  Share     Profit  
  premium Special Other and loss  
  account reserve reserves account Total
           
  (All figures in £ millions)
Reserves
                    
Summary of movements
                    
At 31 December 2002
  2,465   397   11   935   3,808 
Exchange differences           (23)  (23)
Premium on issue of equity shares  4            4 
Net amount received in respect of ESOP shares        6      6 
Loss for the financial year           (10)  (10)
Dividends on equity shares           (192)  (192)
                
At 31 December 2003
  2,469   397   17   710   3,593 
Exchange differences           (20)  (20)
Premium on issue of equity shares  4            4 
Net amount received in respect of ESOP shares        9      9 
Profit for the financial year           946   946 
Dividends on equity shares           (201)  (201)
                
At 31 December 2004
  2,473   397   26   1,435   4,331 
                
Notemeasured at the date of grant and that the expense is recognised over the vesting period of the instrument. The special reserveGroup has a number of employee option and performance share schemes. The Group has elected to apply IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the transition date. Consequently the share-based payment charge from 2003 represents the cumulative effectcharge for all options granted and not fully vested at 31 December 2002.
f. Employee benefits — IAS 19 ‘Employee Benefits’ was amended on 16 December 2004. The Group has elected to adopt the December 2004 amendments to the standard early and differences between the actual and expected return on assets, changes in the retirement benefit obligation due to experience and changes in actuarial assumptions are included in full in equity in the statement of cancellationrecognised income and expense. Therefore the amount recognised on the balance sheet in respect of liabilities for defined benefit pension and other post-retirement benefit plans represents the present value of the company’s share premium account. As permittedobligations for past service offset by section 230(4)the fair value of scheme assets.
      The service cost of benefits accruing is accounted for as an operating cost and the unwinding of the Companies Act 1985, onlydiscount rate on the scheme liabilities and the expected return on scheme assets as a financing charge or financing income. The Group has adopted the same assumptions under IAS 19 as were used for FRS 17 purposes under UK GAAP in 2003 and 2004.
      The restated opening IFRS balance sheet reflects the fair value of the plan assets and the present value of the defined benefit obligation of the Group’s defined benefit schemes.
g. Leases — IAS 17 ‘Leases’ sets out additional criteria to be considered in ascertaining whether a lease is a finance or operating lease. Following a review of all lease agreements no properties have been re-classified.
      In addition, IAS 17 requires that the expense is recognised on a straight line basis over the lease term, including any rent-free periods given at the inception of a lease. Contracted future lease increments must also be amortised evenly over the full period of the lease rather than the period to which the lease is estimated to revert to market rates. The profit and loss account has been presented.adjusted to take into account the amortisation of lease incentives over longer periods than under UK GAAP and to accelerate the charge in respect of fixed contractual increments in lease payments.
h. Joint ventures — Following a review, the Group has concluded that its 50% holding in Maskew Miller Longman should be accounted for as a joint venture under IFRS rather than its classification as a subsidiary under UK GAAP.
i. Joint ventures and associates — The results of all joint ventures and associates have been adjusted to take into account IFRS adjustments within their own financial statements.
j. Income taxes — IAS 12 ‘Income Taxes’, requires that deferred taxation also be provided on all temporary differences, not just timing differences as required under UK GAAP. Deferred tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and

F-67


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
their carrying amounts in the financial statements unless the initial recognition exemption applies. Deferred tax is not recognised for temporary differences arising on initial recognition of an asset or liability in a transaction other than a business combination if at the time of transaction neither accounting nor taxable profit is affected. Deferred taxation has been provided on the post-acquisition difference between the book and tax bases of intangible assets and goodwill if its amortisation is tax deductible. A deferred tax liability has also been recognised 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.
      Deferred taxation has been recognised on the IFRS adjustments at the tax rates that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the asset is realised or the 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.
k. Dividends — IAS 10 ‘Events after the Balance Sheet Date’ requires that dividends declared after the balance sheet date should not be recognised as a liability at the balance sheet date as they do not represent a present obligation at that date as defined by IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’.
      The final dividends relating to the years to 31 December 2002, 2003 and 2004 have been reversed and recognised as a liability in the years 2003, 2004 and 2005 respectively.
l. Discontinued operations — Consistent with the UK GAAP treatment, Recoletos has been treated as discontinued as at 31 December 2004 and met the criteria as ‘held for sale’ at that date. Accordingly the results are disclosed in one line in the income statement, ‘Profit for the year from discontinued operations’ for both 2003 and 2004 and, at 31 December 2004, it is disclosed in the balance sheet in two lines — ‘Non-current assets classified as held for sale’ and ‘Liabilities associated with non-current assets classified as held for sale’.
      When an asset’s carrying value will be recovered principally through a sale transaction rather than through continuing use and certain criteria regarding probability and proximity of the sale are satisfied, it is classified as held for sale and stated at the lower of carrying value and fair value less costs to sell. No depreciation is charged in respect of non-current assets classified as held for sale.
34.35.SUMMARY OF PRINCIPAL DIFFERENCES BETWEEN UNITED KINGDOMINTERNATIONAL ACCOUNTING STANDARDS 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 KingdomEU-adopted International Financial Accounting Standards (“UK GAAP”IFRS”), which differ in certain significant

F-54


NOTES TO THE ACCOUNTS (Continued)
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 UKIFRS and US GAAP.

F-68


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Reconciliation of consolidated profit/(loss)profit for the financial year
                  
    Year ended December 31
     
      Restated
       
  Note 2004 2003 2002
         
    £m £m £m
Profit/(loss) for the financial year under UK GAAP
      88   55   (111)
US GAAP adjustments:                
 Goodwill amortization and impairment  (i)  215   251   270 
 Intangible amortization  (i)  (81)  (103)  (119)
 Discontinued operations  (ii)  9   1   17 
 Disposal adjustments  (iii)  3   (6)  (3)
 Pensions and other post-retirement benefits  (iv)  (18)  (3)  7 
 Deferred taxation  (v)  (2)  (27)  1 
 Leases  (vi)  (16)  (16)  (9)
 Options  (vii)  (32)  (30)  (46)
 Derivatives  (viii)  (23)  35   187 
 Capitalized costs  (ix)        1 
 Acquisition adjustments  (x)        (2)
 Partnerships and associates  (xi)  1   5   42 
 Interest in own shares  (xiii)         
 Minority interests  (xiv)  (3)  (4)  (7)
 Other      (5)      
 Taxation effect of US GAAP adjustments  (v)  46   15   (18)
             
Total US GAAP adjustments      94   118   321 
             
Profit for the financial year under US GAAP
      182   173   210 
             
 Cumulative effect of change in accounting principle (less (benefit from) applicable taxes £(9)m)  (iv)        (21)
Profit for the financial year under US GAAP after cumulative effect of change in accounting principle
      182   173   189 
             
Profit from continuing operations (less charge for applicable taxes 2004: £11m, 2003: £71m, 2002: £67m)      166   160   216 
Profit/(loss) from discontinued operations (less charge for applicable taxes 2004: £6m, 2003: £22, 2002: £12m)      16   16   (5)
Loss on disposal of discontinued operations (less charge for/(benefit from) applicable taxes 2004: £nil, 2003: £2m, 2002 £(4)m)         (3)  (1)
             
Profit for the financial year under US GAAP
      182   173   210 
             
 Cumulative effect of change in accounting principle (less (benefit from) applicable taxes £(9)m)  (iv)        (21)
             
Profit for the financial year under US GAAP after cumulative effect of change in accounting principle
      182   173   189 
             
                  
    Year ended December 31
     
  Note 2005 2004 2003
         
    £m £m £m
Profit for the financial year under IFRS
      624   262   252 
US GAAP adjustments:                
 Intangible amortization  (i)  (60)  (75)  (97)
 Discontinued operations  (ii)     (1)  (3)
 Disposal adjustments  (iii)  (119)  3   (6)
 Pensions and other post-retirement benefits  (iv)  (26)  (23)  (4)
 Deferred taxation  (v)  1      (27)
 Share based payments  (vi)  (4)  (13)  (4)
 Derivative financial instruments  (vii)  (12)  (23)  35 
 Acquisition adjustments  (x)  1       
 Partnerships and associates  (viii)  (2)     (3)
 Minority interests  (ix)  2      (1)
 Other      (9)  (1)  4 
 Taxation effect of US GAAP adjustments  (v)  15   53   27 
             
Total US GAAP adjustments      (213)  (80)  (79)
             
Profit for the financial year under US GAAP
      411   182   173 
             
Profit from continuing operations (less charge for applicable taxes 2005: £107m, 2004: £11m, 2003: £71m)      174   166   160 
(Loss)/profit from discontinued operations (less charge for/(benefit from) applicable taxes 2005: £(1)m; 2004: £6m, 2003: £22m)      (2)  16   16 
Profit/(loss) on disposal of discontinued operations (less charge for applicable taxes 2005: £1m; 2004: £nil, 2003: £2m)      239      (3)
             
Profit for the financial year under US GAAP
      411   182   173 
             

F-55F-69


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
   Year ended December 31
                    
     Restated   Year ended December 31
          
 Note 2004 2003 2002 Note 2005 2004 2003
                
Presentation of earnings per equity share under US GAAP
  (xv)            (xi)          
Earnings per equity share     (p)  (p)  (p)     (p)  (p)  (p)
Basic:                          
Continuing operations     20.9  20.1  27.1      21.8  20.9  20.1 
Discontinued operations     2.0  1.7  (0.8)     29.7  2.0  1.7 
Cumulative effect of change in accounting principle         (2.6)
                  
Total     22.9  21.8  23.7      51.5  22.9  21.8 
                  
Diluted:                          
Continuing operations     20.8  20.1  27.1      21.7  20.8  20.1 
Discontinued operations     2.0  1.7  (0.8)     29.7  2.0  1.7 
Cumulative effect of change in accounting principle         (2.6)
                  
Total     22.8  21.8  23.7      51.4  22.8  21.8 
                  
Average shares outstanding (millions)     795.6  794.4  796.3      797.9  795.6  794.4 
Dilutive effect of stock options (millions)     1.1  0.9  0.4      1.1  1.1  0.9 
                  
Average number of shares outstanding assuming dilution (millions)     796.7  795.3  796.7      799.0  796.7  795.3 
                  

F-56


NOTES TO THE ACCOUNTS (Continued)
Reconciliation of consolidated shareholders’ funds
                        
   Year ended    Year ended
   December 31    December 31
         
     Restated  Note 2005 2004
             
 Note 2004 2003    £m £m
      
   £m £m
Shareholders’ funds under UK GAAP
     2,603  2,893 
Shareholders’ funds under IFRS
Shareholders’ funds under IFRS
     3,564  2,800 
US GAAP adjustments:US GAAP adjustments:          US GAAP adjustments:          
Goodwill  (i)  492  300 
Intangibles  (i)  315  401 
Discontinued operations  (ii)  67  58 
Disposal adjustments  (iii)    (4)
Pensions and other post-retirement benefits  (iv)  (276)  (304)
Deferred taxation  (v)  (6)  29 
Leases  (vi)  (47)  (31)
Options  (vii)    2 Goodwill  (i)  88  136 
Derivatives  (viii)  11  21 Intangibles  (i)  231  267 
Capitalized costs  (ix)     Discontinued operations  (ii)    49 
Acquisition adjustments  (x)  19  24 Pensions and other post-retirement benefits  (iv)  61  62 
Partnerships and associates  (xi)  11  (5)Derivative financial instruments  (vii)  15  11 
Ordinary dividends  (xii)  125  119 Acquisition adjustments  (x)  26  20 
Interest in own shares  (xiii)     Partnerships and associates  (viii)  15  9 
Minority interests  (xiv)  (20)  (18)Minority interests  (ix)  (30)  (15)
Other     (5)   Other     (6)  3 
Taxation effect of US GAAP adjustments  (v)  (71)  (152)Taxation effect of US GAAP adjustments  (v)  (126)  (124)
               
Total US GAAP adjustmentsTotal US GAAP adjustments     615  440 Total US GAAP adjustments     274  418 
               
Shareholders’ funds under US GAAP
Shareholders’ funds under US GAAP
     3,218  3,333 
Shareholders’ funds under US GAAP
     3,838  3,218 
               
Restatements
      The Company has restated itsconsolidated financial statements on pages F-3 toF-68 are the Group’s first financial statements to be prepared in accordance withEU-adopted IFRS. Consolidated financial statements of Pearson until December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP shareholders’ funds fordiffers in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial years ended December 31, 2003statements, management has amended certain accounting, valuation and 2002 forconsolidation methods applied in the adoption of UITF Abstract 38 “Accounting for ESOP trusts”. This has reduced shareholders’ funds under UK GAAP as at December 31, 2003 and 2002 by £59 million and £62 million respectively (see note 24 in “Item 17. Financial Statements”).
      The Company has restated its US GAAP profit and loss account and shareholders’ funds for the financial years ended December 31, 2003 and 2002statements to reflect the correct accounting treatment in respect of incentives and fixed rental escalations under one of its leases. Previously the incentives were recognized in the profit and loss account over the period during which the lease incentives were applicable until the lease returned to a market level. Additionally, fixed future market-based rent increases were charged to the profit and loss account as they became applicable under the terms of the lease. As required by US GAAP, both the lease incentives and fixed market-based rent increases are now being charged to the profit and loss account over the entire term of the lease. Consequently, the profit reported under US GAAP for the 2003 and 2002 financial years has been reduced by £14 million and £12 million, respectively, on a pre-tax basis and £10 million and £9 million, respectively, on a post-tax basis and the shareholders’ funds reported as at December 31, 2003 and 2002 has been reduced by £19 million and £9 million, respectively, from amounts previously reported.

F-57F-70


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. Note 34 included in “Item 17. Financial Statements”, describes how, in preparing the consolidated financial statements, the Group has applied IFRS as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1. The reconciliations between IFRS and US GAAP for the years ended December 31, 2004 and 2003 have been restated accordingly.
      A summary of the principal differences and additional disclosures applicable to the Group are set out below:
     (i) Goodwill and intangibles
     (i) Goodwill and intangibles
      Both UK GAAPIFRS 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, priorbefore the transition to the implementation of FRS 10“Goodwill and Intangible Assets”, for periods endingIFRS on January 1, 2003, goodwill arising on acquisitions prior to January 1, 1998 the Group haswas written off goodwill directly to the profit and loss reservereserves in the year of acquisition. If a subsidiary or aacquisition and goodwill arising from January 1, 1998 to December 31, 2002 was capitalized and amortized over its estimated useful life. Following the adoption of IFRS on January 1, 2003, goodwill is no longer required to be amortized but is tested for impairment on an annual basis in accordance with IFRS 3‘Business Combinations’. Goodwill arising on business is subsequently sold or closed, previously written off goodwill which wascombinations before January 1, 2003 has been grandfathered under the resultfirst time adoption provisions of the initial acquisition is taken into account in determining the profit or loss on sale or closure.IFRS 1.
      For the purposes of US GAAP, all goodwill written off against reserves under UK GAAPbefore 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 Statement of Financial Accounting Standard (“SFAS”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 SFASFAS 142. The 2004, 2003Impairment reviews were performed and, 2002 US GAAP adjustments reverse the amortization expense recorded under UK GAAP.consistent with IFRS, no cash-generating 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 periodically reviews the recoverability of goodwill,did 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 recognizesrecognize 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,prior to January 1, 2003. In accordance with IFRS 3, acquired intangible assets such(such as publishing rights, know-how, patentscustomer relationships, technology and advertising relationshipstrademarks) in respect of acquisitions after January 1, 2003 have been recognized as intangible assets as required under SFAS 141 “Business Combinations”capitalized and are being amortized over a range of estimated useful lives of between 2 and 2530 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.
     (ii) Discontinued operations Under both IFRS and US GAAP pre-publication costs and software development costs (both of which are internally generated) are also recognized as intangible assets. Under US GAAP, all intangible assets would be classified asnon-current.
      FollowingGAAP 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 strategic reviewdeduction to reserves under IFRS but has been capitalized under US GAAP. In respect of the business, the Group approvedacquisitions between January 1, 1998 and announced, in December 2004, its intention to dispose of its 79% interest in Recoletos Grupo de Comunicacion, S.A. to Retos Cartera, a consortium of investors, as part of a tender offer for all the share capital of Recoletos. The transaction was approved by the Spanish regulatory authorities in February 2005 and completed in April 2005 with the Group receiving net cash proceeds of £372 million. In accordance with the provisions of SFAS 144“Accounting for the Impairment or Disposal of Long-Lived Assets”the results of Recoletos31, 2002, no acquired intangible assets have been reclassifiedrecognized 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 discontinued operation.
      Followingcost of acquisition under IFRS, if it is probable that 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 Forumcontingent consideration will be paid 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, the results of the Forum Corporation have been reclassified as a discontinued operation.can be measured reliably. Under US GAAP, contingent consideration is only recognised when paid (see acquisition adjustments (x) below).

F-58F-71


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      In connection with
     (ii) Discontinued operations
      Discontinued operations comprise the decision to dispose of Forum in 2002, a loss on disposal was booked underdifferences between IFRS and US GAAP reflecting the excessin respect 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 dateRecoletos for 2005, 2004 and provisions for future operating losses being removed from the disposal calculation under US GAAP.2003.
      The operating profits, assets and liabilities in respect of discontinued operations under US GAAP are set out in the table below:as follows:
                      
 2004 2003 2002 2005 2004 2003
            
 £m £m £m £m £m £m
Total operating profit in respect of discontinued operations  21  27  22 
Total operating profit/(loss) in respect of discontinued operations  (3)  21  27 
Assets in respect of discontinued operations  413  402        413    
Liabilities in respect of discontinued operations  (148)  (147)        (148)    
     (iii) Disposal adjustments
     (iii) Disposal adjustments
      In 2005, 2004 2003 and 20022003 gains and losses were recognized under UK GAAPIFRS on the disposal of a number of the Group’s businesses and assets. Adjustments made to reconcile US GAAP and UK GAAPIFRS have an effect on the net assets of these businesses and, accordingly, a corresponding impact on the gain or loss on disposal.
      Under US GAAP, profits and losses from the sale of fixed assets or investments are included within operating profit. Under UK GAAP, the corresponding profits and losses are disclosed as non-operating (see note 4a of “Item 17. Financial Statements”). Under US GAAP, the profit on sale of fixed assets and investments was £14 million in 2004 (a loss of £7 million in 2003 and a loss of £15 million in 2002).
      Under UK GAAP, the full amount of anyIFRS, goodwill previously written off to reserves, which has been grandfathered under the first time adoption provisions of IFRS 1, is accounted fornot treated as part of the calculation of profit or loss on disposal of an entity.when the business to which it relates is sold. This usually results in lowerhigher profits (or higher losses) on disposals of entitiesdisposal than under US GAAP, where thesethe goodwill balances have been partially amortized. Additionally, underwas 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, whereas under UKbusiness. However, a GAAP this is not required.difference arises on disposals of entities acquired before the adoption of IFRS as the translation reserve was reset to zero at the date of 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.
      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 GAAPIFRS and US GAAP.
     (iv) Pensions      The reconciling items between IFRS and other post-retirement benefitsUS GAAP in respect of disposals are summarised as follows:
             
  2005 2004 2003
       
  £m £m £m
Difference in carrying value on disposal  (86)      
Cumulative translation adjustment  (33)      
Timing on property disposals     3   (6)
          
Total US GAAP differences in respect of disposals
  (119)  3   (6)
          
     (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 GAAPIFRS, the costexpense of providingdefined benefit pension schemes and other post-retirement benefits is expensedcharged to the income statement as an operating expense over the average expected service lives of eligible employees in accordance withperiods benefiting from the provisions of Statement of Standard Accounting Practice (“SSAP”) 24“Accounting for Pension Costs”. SSAP 24 aims to produce an estimate of costemployee’s services. The charge is based on long-term actuarial assumptions. Variations fromassumptions reflecting market conditions at the regular pension cost arising from, for example, experience deficiencies or surpluses, are charged or credited tobeginning of the profit and loss account over the expected average remaining service lives of current employees in the schemes.financial year.
      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 methodology required is broadly similar to IFRS, however, different assumptions on the significant actuarial assumptions annually to reflect current market and economic conditions. Therefore, different assumptionsexpected asset return are used in the

F-72


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SFAS 87 calculation of pensions.pension calculation. Additionally, under US GAAP, where an accumulated benefit obligation exists in excess of the fair value plan assets and is not covered by a prepaid pension asset has beenliability recognized on the balance sheet, an additional minimum pension liability has been booked with the offset as a reduction to

F-59


NOTES TO THE ACCOUNTS (Continued)
equity. equity through other comprehensive income. Under UK GAAP,IFRS, there is no requirement to recognize a minimum pension liability in respect of the unfunded accumulated benefit obligation.
      Under IAS 19, the Group has recognized a pension obligation representing the excess of the defined benefit obligation over the fair value of assets as at 31 December 2005. 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 SFAS 87, the Group has recognised an assetrecognized prepaid pension cost amounting to £57 million and a minimum pension liability of £298 million in respect of pensions and other post retirement benefits,pensions. In respect of post-retirement benefit plans the majority of which is attributableaccrued pension cost amounts to prior acquisitions.£49 million as at December 31, 2005. The difference between this assetthe net balance sheet position and the plans’ funded status (the difference between the fair value of the plan assets and liabilities) is held as unrecognisedan unrecognized off-balance sheet item and spread over the employees’ remaining service lifetimes. However, the unrecognisedunrecognized 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.
      In 2002, the Group elected
     (v) Deferred taxation
      IAS 12“Income Taxes” requires a full provision to change the measurement date of its defined benefit plans under US GAAP from 30 Septemberbe made for deferred taxes. Deferred taxes are to 31 December. As a result the 2002 profit and loss charge under US GAAPbe accounted for pension plans includes a pre-tax charge of £30 million reflecting the cumulative effect of this change in accounting principle.
     (v) Deferred taxation
      Under FRS 19 the recognition criteria foron all temporary differences with deferred tax assets changed resulting inrecognized to the recognition of a deferred tax asset under UK GAAP in respect of US tax losses and other timing differencesextent that they are regarded as more likely than not to be recoverable against future taxable 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 more likely than not to crystallize in future periods. 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 providedtax assets not considered recoverable are adjusted for onthrough a separate valuation allowance in the balance sheet. There are no separate valuation allowances under IFRS. Under US GAAP, deferred taxes are accounted for in accordance with SFAS 109,“Accounting for Income Taxes” with a full liability basis. Underprovision also made for deferred taxes on all temporary differences and a valuation allowance established for the full liability method,amount of the deferred tax assets or liabilities are recognized for differences betweennot considered recoverable. This is similar to 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.treatment required under IAS 12.
      The reconciling items in 2004, 20032005 and 20022004 reflect the impact of recording the full provision and deferred tax assets, net of valuation allowance, and are summarized below:
                
   Stockholders   Stockholders
 Net income equity Net income equity
     Restated                    
       Income Equity Income Equity Income
 2004 2004 2003 2003 2005 2005 2004 2004 2003
                  
 £m £m £m £m £m £m £m £m £m
Tax effect of GAAP adjustments on:
                             
Goodwill and intangible amortization  (23)  (108)  29  (128)  18  (121)  17  (129)  20 
Derivatives  38  (3)  (21)  (41)
Derivative financial instruments  3  (5)  38  (3)  (21)
Options, pensions, disposals and other adjustments  31  40  7  17   (6)    (2)  8  28 
                    
Total taxation effect of US GAAP adjustments
  46  (71)  15  (152)  15  (126)  53  (124)  27 
                    
      Income tax adjustments on the GAAP differences on goodwill and intangible amortization are calculated by reference to each specific acquisition. These adjustments arise on tax deductible goodwill and intangibles dueprimarily on acquisitions prior to the different amortization periods adopted under the different GAAPs and due to the recognition of temporary differences between the tax base cost ofJanuary 1, 2003 where intangibles and their book value at acquisitionhave been recognized under US GAAP that arewhich have not been recognized under UK GAAP.IFRS. The net effect of the adjustments is to recognize a greatersmaller deferred tax liability under US GAAP.

F-60


NOTES TO THE ACCOUNTS (Continued)
      Adjustments to the deferred tax on derivatives are provided on the gross adjustment to the value of the derivatives at the balance sheet date with the movement on the tax adjustment shown as a reconciling item in the profit and loss account. Where related exchange gains and losses recognized in reserves for UK GAAP are taken to the profit and loss account under US GAAP then the related tax adjustment is also taken to the profit and loss account.

F-73


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      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 continuallyregularly 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.
      The deferred tax 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,IFRS, but which was required to be adjusted against goodwill under US GAAP.
     (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. As a result, the Group has certain leases for which the classification is operating under UK GAAP and finance (capital) under US GAAP.
      Differences can also arise in respect of the timing of recognition of lease incentives and future fixed market-based rent escalations. Under UK GAAP lease incentives are recognized in the profit and loss account over the period until the lease rentals revert to a market level, and future market-based rental increases are recognized as they become applicable under the terms of the lease. Under US GAAP, both lease incentives and fixed market-based rent increases are recognized on a straight-line basis over the entire fixed term of the lease.
     (vii) Options
     (vi) Share based payments
      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.
      Underboth IFRS and 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 expenseshare-based payment charge is determined based uponon the fair value of the award at the grant date for awards, and has been estimated using the Black Scholes model. Such compensation cost is recognizedspread over the service life of the awards.vesting period.
      Under both IFRS and US GAAP, the total compensation charge for stock-based compensation schemes was £37m in 2004, £33m in 2003 and £53m in 2002. The fair value of Company optionsawards is determined at the date of grant using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the weighted averageaward. These models require assumptions used into be made regarding share price volatility, dividend yield, risk free rate of return and expected option lives. Differences between the

F-61


NOTES TO THE ACCOUNTS (Continued)
Black Scholes model for determining US GAAP and IFRS charge are mainly due to the fair valuesdifferent treatment of options issuedwith graded vesting features. Under IFRS the charge is recognized as the options gradually vest, whereas under US GAAP the Company option schemes for eachcharge is recognized on a straight line basis over the vesting period ending December 31, 2004, 2003 and 2002 are as follows:
                         
    Weighted   Weighted   Weighted
  Number average Number average Number average
  granted fair value granted fair value granted fair value
  2004 2004 2003 2003 2002 2002
             
            £
  (’000) £ (’000) £ (’000)  
Fair value of company options  1,116   2.53   2,885   1.86   1,557   3.60 
Fair value of shares granted under restricted share schemes:                        
Annual Bonus Share Matching Plan  53   5.42   108   5.41   50   9.03 
Long Term Incentive Plan  2,413   4.54   1,711   5.21   3,194   5.67 
             
  2004 2003 2002
       
Assumption for company options:
            
Risk free interest rate  4.78%  3.90%  5.19%
Expected life (years)  3.34   3.55   4.05 
Expected dividend yield  3.72%  4.45%  2.61%
Expected volatility  37.32%  47.96%  49.18%
      Under UK GAAP, compensationresulting in an additional cost is chargedof £5.4 million. The remainder of the adjustment relates to the income statement with the offsetting amount recorded as either a reductiontreatment 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 chargedforfeitures.
     (vii) Derivative financial instruments
      Prior to the income statement with the offsetting amount recorded directly to shareholders’ funds.
adoption of IAS 39     (viii) Derivatives‘Financial Instruments: Recognition and Measurement’
      Under UK GAAP, on January 1, 2005, the Group’s derivatives arewere recorded as hedging instruments. Amounts payable or receivable in respect of interest rate swaps arewere accrued with net interest payable over the period of the contract. Unrealized gains and losses on currency swaps and forward currency contracts arewere deferred and recognized when paid.
      UnderFollowing 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. The transitional effect of recording all the Group’s derivative financial instruments at fair value on January 1, 2005 is shown in note 34 to these financial statements.
      For both IFRS and US GAAP, the Group is requireddesignates certain of the derivative financial instruments in its portfolio to record all derivative instruments onbe hedges of the balance sheet at fair value. Derivatives not classified as hedges are adjusted to fair value through earnings. Movementsof 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 hedge risk. The effective portion of derivative instruments which qualify as either fair value hedges or net investment hedges have been offset in earnings and other comprehensive income respectively by the corresponding movementchanges 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 underlying bondincome statement when the corresponding foreign operation is disposed of. Gains or asset. Any movements onlosses relating to the ineffective portion are recognized immediately in the income statement. Changes in the fair value of derivatives thatnot in hedging relationships are classified as hedges are immediately recognized in earnings.the income statement.
      In 2003, and 2002,under US GAAP, the Group did not meet the prescribed designation requirements and hedge effectiveness tests under US GAAP for its derivative contracts, which are not a requirement to obtain hedge accounting under UK GAAP.accounting. Consequently, for those years,that year, the Group has recorded the changes in the fair values of theseits derivative contracts through earnings under US GAAP. In line with the Group’s treasury policy, these are not tradingCertain derivative financial instruments and are transacted solely to match underlying financial exposures. In 2004 the Group met the prescribed designation and testing requirements for hedge accounting for 2004 and hedge effectiveness tests under US GAAP for certain of its derivative contracts. The movements in the fair value of the effective portion of qualifying 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 bond or asset.
      The principal method the Group uses to manage its interest rate risk is to enter into swaps to pay a fixed rate and receive a floating rate. The majority of these contracts are US dollar denominated, and some 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, and the dates on which these rates are set2005.

F-62F-74


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
do not necessarily exactly match those      On adoption of IAS 39 on January 1, 2005, certain of the borrowings that are being hedged.Group’s derivative financial instruments were deemed to be in fair value hedging relationships for the purposes of calculating the transition adjustment. The Group believes that its portfoliohas elected not to designate all of such swapsthese derivatives as hedges on an ongoing basis. In this circumstance, the transitional adjustment to the carrying value of those bonds deemed to be in fair value hedging relationships is an efficient economic hedgebeing amortized over the life of its portfolio of variable rate borrowings.
     (ix) Capitalized Costs
      In earlier periods, the group has capitalized certain amounts under UK GAAP for purchased software, software licencescorresponding derivative financial instrument. This gives rise to a difference between IFRS and consulting services. Under US GAAP certain of these costs cannot be capitalized and must be expensed as incurred. The resulting adjustment takes into consideration the treatment of these costs, as well as any depreciation taken in subsequent periods.
     (x) Acquisition adjustments
      Acquisition adjustments principally relate to restructuring provisions recognized under US GAAP in purchase accounting as an increase in goodwill under EITF 95-3“Recognition of Liabilities in Connection with a Business Purchase Combination”. Under UK GAAP, these costs were treated as period costs and were recorded as exceptional items in the profit and loss account.
      Under US GAAP, consideration related to the acquisition of businesses contingent on achieving specific earnings levels in future periodsthis amortization is recorded only when the specified conditions are met and the consideration distributable, in accordance withSFAS 141 “Business Combinations.”Under UK GAAP, contingent consideration is treated as part of the purchase price on the date of acquisition.
      Under US GAAP, the Group cannot hedge the foreign-currency risk related to a purchase business combination because only direct costs of an acquisition are allowed to be included in the purchase price. Derivative gains and losses do not qualify as direct costs. As a result, gains relating to foreign-currency forward contracts are recorded in earningsincome statement under IFRS with no corresponding entry under US GAAP. These are reflected as adjustments to the purchase price under UK GAAP.
     (xi) Partnerships and associates
     (viii) 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’s investments in partnerships and associates include: historic goodwill, amortization, pensions derivatives, and goodwill impairment charges.derivatives.
      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.
     (xii) Ordinary dividends
     (ix) Minority interests
      Under UK GAAP, ordinary dividends proposed are provided for inIFRS, when less than 100% of a subsidiary has been acquired, minority interest is stated at the year in respect of which they are recommended by the board of directors although approvalminority’s proportion of the final dividend will not take place until the Annual General Meeting subsequent to the year-end.net fair value of acquired assets, liabilities and contingent liabilities assumed. Under US GAAP, such dividends are provided forthe minority interest is valued at historical book value. In the years ended December 31, 2005, 2004 and 2003, there was no difference between IFRS and US GAAP in the year in which they are declared and approved by the boardrecognition of directors.
     (xiii) Interest in own shares
      Under UK GAAP, following the adoption of UITF Abstract 38 ‘Accounting for ESOP trusts’, and also under US GAAP, own shares held in treasury or through an ESOP trust are recorded at cost and shown as a deduction from shareholders’ funds. As a result, there is no longer any GAAP difference in respect of interests in own shares.

F-63


NOTES TO THE ACCOUNTS (Continued)
     (xiv) Minority interests
      Minorityminority interest. In all years, minority interests represent the minority share of US GAAP adjustments.
     (xv) Presentation      Under IFRS, minority interest is classified as a component of shareholders’ equity. Under US GAAP, minority interest is classified outside of equity.
     (x) Acquisition adjustments
      Under US GAAP, consideration related to the acquisition of businesses contingent on a future event such as achieving specific earnings per equity sharelevels in future periods, is recorded only when the specified conditions are met and the consideration determinable, in accordance withSFAS 141 “Business Combinations.” 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. Additionally, certain post-acquisition restructuring costs are capitalized under US GAAP in accordance with Emerging Issues Task Force No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination”, but are charged to the income statement under IFRS.
     (xi) 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. Accordingly, the Group has presented EPS for income from continuing operations, discontinued operations cumulative effect of an accounting change and net income.
     (xvi) Other disclosures required by US GAAP
     (xii) Other disclosures required by US GAAP
     Cash flow information
      Under UK GAAP, the Consolidated Cash Flow Statements are presented in accordance with FRS 1, as revised,Cash Flow Statements. The statements prepared under FRS 1 present substantially the same information as that required under US GAAP as interpreted by SFAS 95 “Statement 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 activities under US GAAP. Capital expenditure and financial investment, dividends received from joint ventures and associates, and cash flows from acquisitions and disposals would be 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 the liquid resources may be considered a cash equivalent under US GAAP, depending on the nature of the liquid resources.
      A summary of the Group’s operating, investing and financing activities, classified in accordance with US GAAP, are as follows:
             
  2004 2003 2002
       
  £m £m £m
Net cash provided by operating activities  402   239   334 
Net cash (used in)/provided by investing activities  (115)  (102)  689 
Net cash used in financing activities  (226)  (164)  (819)
Foreign exchange differences  (6)  14   (14)
          
Net (decrease)/increase in cash and cash equivalents  55   (13)  190 
Cash and cash equivalents under US GAAP at the beginning of the year  558   571   381 
          
Cash and cash equivalents under US GAAP at the end of the year
  613   558   571 
          

F-64


NOTES TO THE ACCOUNTS (Continued)
     Discontinued operations
      The Group analyses turnover and operating profit between continuing and discontinued operations. Under US GAAP, for transactions occurring in 2004, 2003 and 2002, the operating results from discontinued operations have been accounted for under SFAS 144 and are shown on a separate line in the profit and loss statement below income from continuing operations, net of the related tax impact.
     Revenue Recognition
      Revenue from the sale of books is recognized 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 multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognized as performance occurs. 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 revenues recognized on a percentage of completion basis. Losses on 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.
      Circulation and advertising revenue is recognized when the newspaper or other publication is published. Subscription revenue is recognized on a straight-line basis over the life of the subscription.
      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 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 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.

F-65


NOTES TO THE ACCOUNTS (Continued)
     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, 2004. All leases have been classified as capital or operating in accordance with FAS 13“Accounting For Leases”:
                 
  Capital Capital Operating Operating
  leases — land leases — plant leases — land leases — plant
  & buildings & machinery/other & buildings & machinery/other
         
  £m £m £m £m
Fiscal year ending December 31,                
2005     (2)  (96)  (19)
2006     (1)  (89)  (12)
2007     (1)  (84)  (5)
2008        (81)  (2)
2009        (78)  (1)
Thereafter        (584)   
             
Total minimum lease payments
     (4)  (1,012)  (39)
             
     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

F-75


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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’s share of the net earnings of these companies is included in the consolidated 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.
      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
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.
     Companies Act 1985
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, 20022005, 2004 and 20012003 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.

F-66


NOTES TO THE ACCOUNTS (Continued)
     Recently issued accounting standards
      In December 2003, the FASB issued FIN 46R “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 46R 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. The effective date for public companies is 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 a material impact on the financial position, cash flows or results of the Group under US GAAP as at December 31, 2004.
      In May 2004, the FASB issued FSP No. 106-2 (“FSP 106-2”), “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the “Medicare Act”). The Medicare Act was enacted December 8, 2003. FSP 106-2 supersedes FSP 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” and provides authoritative guidance on accounting for the federal subsidy specified in the Medicare Act. The Medicare Act provides for a federal subsidy equal to 28% of certain prescription drug claims for sponsors of retiree health care plans with drug benefits that are at least actuarially equivalent to those to be offered under Medicare Part D, beginning in 2006. The adoption of FSP 106-2 did not have a material impact on the financial position, cash flows or results of the Group under US GAAP as at December 31, 2004.
Recent U.S. Accounting Pronouncements
      In November 2004, the FASB issued SFASFASB Statement No. 151 “Inventory Costs-An“Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFASFAS 151”). SFASFAS 151 amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFASFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFASFAS 151 is effective for fiscal years beginning after June 15,2005.15, 2005. The Group is currently evaluating the effect that the adoption of SFASwill adopt FAS 151 will have on its consolidated results of operations and financial conditionin 2006 but does not expect SFAS 151the adoption of the new standard to have a material impact.
      In December 2004, the FASB issued SFASFASB Statement No. 153 “Exchanges“Exchanges of Non monetary Assets-AnNonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Non monetaryNonmonetary Transactions” (“SFASFAS 153”). SFASFAS 153 eliminates the exception from fair value measurement for non monetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Non monetaryNonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFASFAS 153 specifies that a non- monetarynon-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFASFAS 153 is effective for the fiscal periods beginning after June 15, 2005. The Group is currently evaluating the effect that the adoption of SFASwill adopt FAS 153 will havein 2006 but does not expect itthe adoption of the new standard to have a material impact.

F-76


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      In December 2004, the FASB issued SFASFASB Statement No. 123 (revised 2004), “Share-Based“Share-Based Payment” (“SFAS 123R”FAS 123(R)”), which replaces SFASFAS No. 123 “Accounting“Accounting for Stock-Based Compensation,”Compensation” (“SFASFAS 123”) and supersedes APB Opinion No. 25 “Accounting“Accounting for Stock Issued to Employees.” SFAS 123R FAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15,2005,15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted

F-67


NOTES TO THE ACCOUNTS (Continued)
under SFASFAS 123 no longer will be an alternative to financial statement recognition. The Group is currently evaluatingwill adopt FAS 123(R) in 2006 but does not expect the impact of adoption of SFAS 123R willthe new standard to have but becausea material impact as it already recognizes share-based payment cost in its income statement in accordance with FAS 123.
      In March 2005, the FASB issued FASB Interpretation No. 47“Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143” (“FIN 47”). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or settlement are conditional on a future event. FIN 47 is effective for the fiscal periods ending after December 15, 2005. The adoption of FIN 47 did not have a material impact on the Group.
      In May 2005, the FASB issued Statement No. 154,“Accounting Changes and Error Corrections — A replacement of APB Opinion No. 20 and FASB Statement No. 3” (“FAS 154”). This statement requires retrospective application to prior periods’ financial statements of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement applies the requirements SFAS 123 itto all voluntary changes in accounting principles and changes required by an accounting pronouncement that does not include specific transition provisions. FAS 154 is required to be adopted in fiscal years beginning after December 15, 2005. FAS 154 would not have had a material effect on the financial position, results of operations or cash flows of the Group under US GAAP as at December 31, 2005.
      In October 2005, the FASB issued FASB Staff Position (FSP) 13-1“Accounting for Rental Costs Incurred during a Construction Period” (“FSP 13-1”). FSP 13-1 requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense and included in income from continuing operations. FSP 13-1 is effective for the fiscal periods beginning after December 15, 2005. The Group will adopt FSP 13-1 in 2006 but does not expect the adoption of the new standard to have a material impact.
      In January 2006 the FASB issued FASB Statement No. 155“Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140” (“FAS 155”). FAS 155 provides entities with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract. FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Group is currently evaluating the impact the adoption of FAS 155 will have, but does not expect it to have a material impact.
Recent International Accounting Pronouncements
      IFRS 7“Financial Instruments: Disclosures”. IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk. IFRS 7 is effective for accounting periods beginning on or after 1 January 2007. The Group is currently assessing the impact of IFRS 7 on the Group’s financial statements, but does not expect it to be significant.
      A complementary amendment of IAS 1“Presentation of Financial Statements — Capital Disclosures”. The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. The amendment to IAS 1 is effective for accounting periods beginning on or after 1 January 2007. The Group is currently assessing the impact of the amendment to IAS 1, but does not expect it to be significant.

F-68F-77


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      IFRIC 4“Determining whether an Arrangement contains a Lease”. IFRIC 4 requires the determination of whether an arrangement is or contains a lease to be based on the substance of the arrangement. IFRIC 4 is effective for accounting periods beginning on or after 1 January 2006. The Group will implement IFRIC 4 from 1 January 2006 but does not expect it to have a significant impact on the Group’s operations.
      IAS 21 (Amendment)“Net investment in a foreign operation”. This amendment deals with the requirement for a monetary item that forms part of a reporting entity’s net investment in a foreign operation to be denominated in the functional currency of either the reporting entity or the foreign operation. The amendment also clarifies the accounting treatment of exchange differences arising on a loan made between two “sister companies” within a group. The exchange differences would be taken to equity in the parent’s consolidated financial statements, irrespective of the currency in which the loan is made, provided that the nature of the loan is similar to an equity investment, that is, settlement of the loan is neither planned nor expected to occur in the foreseeable future.
      IFRIC 8“Scope of IFRS 2”. IFRIC 8 clarifies that transactions within the scope of IFRS 2 “Share-based payment”, include those in which the entity cannot specifically identify some or all of the goods or services received. If the identifiable consideration given appears to be less than the fair value of the equity instruments granted or liability incurred, this situation generally indicates that other consideration has been or will be received.

F-78


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
Date: June 27, 2005May 5, 2006

F-69F-79